Fitch Affirms Indonesia's Inalum at 'BBB-'; Outlook Stable

(Fitch Ratings - Singapore/Jakarta - 23 October 2019)--Fitch Ratings has affirmed PT Indonesia Asahan Aluminium (Persero)'s (Inalum) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB-' with a Stable Outlook. Fitch has also affirmed Inalum's senior unsecured rating and the rating on its USD4 billion of senior unsecured notes at 'BBB-'.

Inalum's rating is one notch below the rating of Indonesia (BBB/Stable), in line with Fitch's Government-Related Entities (GRE) Rating Criteria. This is based on our assessment of strong linkages between Inalum and the state as well as the state's incentive to provide support.

However, we have lowered our assessment of Inalum's Standalone Credit Profile (SCP), which includes evaluation of Inalum, its subsidiaries and associates, but assumes no exceptional support from the government in a situation of financial difficulty, to 'b-', from 'b+'. We expect standalone EBITDA/interest coverage, after adding net dividend inflows to EBITDA, to be below 1x in 2019-2020 and forecast adjusted debt/EBITDAR leverage, based on proportionate consolidation of subsidiaries, to increase to around 10x-11x over 2019-2020 (2018: 7.5x). This factors in higher operating costs for aluminium smelting and coal mining and the risk of lower sales volume for nickel ore. We also expect sustained capex on capacity enhancement and downstream projects, negative free cash flow and further debt drawdown. Despite this, Inalum's SCP is supported by adequate liquidity due to robust banking relationships, especially with state-owned domestic banks. We also expect standalone coverage to improve to above 1x and leverage to moderate to around 7.5x by 2021 once meaningful dividends from the Grasberg mine begin.

Key Rating Drivers

Strong State Linkage: Fitch sees Inalum's status, ownership and control by the Indonesian sovereign as strong. The company is fully owned by the government and is the state mining holding company, owning 65% stakes in three subsidiaries - PT Bukit Asam Tbk (PTBA), PT Aneka Tambang Tbk (ANTAM) and PT Timah Tbk - that were transferred by the government. The government also mandated Inalum to acquire additional shares in the strategically important Grasberg mine. The sovereign's support record is strong, with a 2015 capital injection of IDR3.5 trillion in ANTAM via a rights issue and consolidation of mining assets under Inalum to improve its business profile. We expect the strong support to continue.

State's Incentive to Provide Support: Fitch sees the socio-political implications of a default by Inalum as moderate. A default could damage the government's reputation and hamper Inalum's project funding, but we do not believe it would result in severe social-political fallout at the existing mining operations of Inalum's subsidiaries. We assess the financial implications of a default as very strong. Inalum is one of Indonesia's key state-owned enterprises and we believe a financial default could damage investor confidence in the sovereign and other state-owned enterprises.

Weaker Outlook for Key Subsidiaries: We expect performance of PTBA and ANTAM, which together contributed around 75% of Inalum's consolidated 2018 EBITDA, to be affected by higher costs and lower volume, respectively. PTBA, a thermal-coal producer, has faced falling prices in 2019 as well as a higher strip ratio and operating costs. The company is producing higher calorific-value coal to counter the weak prices, which is also associated with higher strip ratios. We forecast unit costs to remain high, which is likely to restrict an earning recovery in 2020-2021.

ANTAM has been affected by the government's ban on nickel-ore exports from 2020. We expect the company to export around 5 million tonnes (mt) of nickel ore in 2019 and believe finding substitute domestic buyers for such volume would be difficult in the short term. Therefore, we assume lower sales volume in 2020-2021, which should weaken EBITDA. The lower volume could be offset by higher international nickel prices, but it is unclear if domestic prices will remain in line or diverge due to excess supply.

Lower Standalone EBITDA: Inalum's standalone operation, which comprises of the country's only aluminium smelter, has been affected by weak product prices and spreads and higher costs for carbon inputs of calcined petroleum coke and coal-tar pitch. As such, we estimate EBITDA will fall by more than 60% yoy in 2019. Earnings should recover from 2020 based on our assumption of moderating carbon input costs, although sustained lower supply from China for carbon inputs due to environment-related curbs could keep costs elevated.

Stake in Vale Indonesia: PT Vale Indonesia Tbk, a domestic nickel producer with around 70 kilotonnes (kt) of annual output, and its key shareholders have signed a heads of agreement with Inalum for the sale of a 20% stake in the company. The companies aim to sign definitive agreements by end-2019 and to complete the transaction by 1H20. Inalum's stake will be in line with its objective to obtain a 15%-20% share in domestic reserves of mineral resources, such as nickel, coal and bauxite. We assume debt-funded spending by Inalum of USD500 million based on Vale Indonesia's market capitalisation. Vale Indonesia has not been paying dividends and we do not assume any in our forecasts, although Inalum may look to influence pay out if it acquires a stake.

Increase in Grasberg Stake: Inalum increased its stake in PT Freeport Indonesia (PT FI), the operator of the Grasberg mine, to 51.2% in December 2018 for USD3.9 billion, from 9.4%, and is in the process of transferring a 10% stake in PT FI to the Papua government and Mimika Regency. However, pursuant to a shareholder agreement, the dividend share of Inalum and local-government partners will be just 18.7% from 2019 through 2022. Inalum and partners are also obligated to fund 40% of expansionary capex and receive 40% of cash flow benefit beyond a production threshold until 2022. Mining at Grasberg is transitioning to underground, which is likely to reduce copper volume by around 50% and 30% from 2018 volume in 2019 and 2020, respectively. As a result, we do not expect any dividends in 2019-2020. However, copper output should rise from 2021 to above the 2018 level and result in substantial dividend inflow.

Capex for Higher Integration: Inalum plans to set up a smelter-grade alumina refinery, which will allow it to process ANTAM's bauxite output and use the produced alumina in its aluminium smelter. ANTAM is also increasing the capacity of its ferronickel processing plant by 50% to 40.5kt. Other projects include addition of tin smelting capacity by Timah and power generation capacity by PTBA. Higher vertical integration should lower earning volatility for Inalum. However, benefits are likely to accrue gradually over the next four to five years as projects are completed and reach operating stability. Inalum aims to significantly increase its share of earnings from downstream projects, meaning further investments are probable.

Derivation Summary

Our assessment of sovereign support for Inalum can be compared with that for other GREs, such as PT Pertamina (Persero) (BBB/Stable), PT Telekomunikasi Indonesia Tbk (Telkom, BBB/Stable) and China Minmetals Corporation (Minmetals, BBB+/Stable).

The rating of Indonesia's national oil company, Pertamina, is equalised with the sovereign, reflecting a 'Very Strong' score on all GRE support parameters related to ownership and control, support record and expectations, socio-political as well as financial implications of default. Inalum scores lower than Pertamina on factors related to control, support and socio-political implications of default. Pertamina receives regular subsidies for meeting the government's public-service obligations and state involvement in its investment decisions and budgetary support is exceptionally high. In addition, any default by Pertamina would hamper its ability to procure sufficient products, with a significant impact on the economy and general public.

The rating of Indonesian telecommunications major, Telkom, which is majority-owned by the state, is constrained by the sovereign's rating. Similarly to Inalum, Telkom is rated 'Strong' on the GRE parameters of ownership and control and support record and expectations. It is also rated 'Moderate' on the parameter of socio-political implications of a default, as Fitch believes there will be limited political and economic impact from any service disruption for network connectivity. However, on the parameter of financial implications of a default, Telkom is assessed at 'Strong' compared with 'Very Strong' for Inalum, as it has lower outstanding debt and is not viewed as a proxy borrower of the state.

China's base-metal major, Minmetals, which is fully state-owned and receives support in the form of share capital and subsidies, is rated 'Strong' on the GRE parameters of ownership and control and support record and expectations. Similarly to Inalum, Minmetals' socio-political implications of a default are assessed as 'Moderate', as the impact on the general public of a default and potential disruption in domestic supply of base metals is limited. However, on the parameter of financial implications of a default, Minmetals is assessed at 'Strong', because even though a default would make funding difficult for other central GREs, the impact would not be as significant as the default of closer proxies to the central government, like the key oil and power GREs. (ends)