Fitch Affirms Wijaya Karya at 'BB' and 'AA-(idn)'; Outlook Revised to Stable

(Fitch Ratings-Singapore/Jakarta-06 December 2019)-- Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of Indonesian state-owned construction company PT Wijaya Karya (Persero) Tbk (WIKA) at 'BB'. At the same time, PT Fitch Ratings Indonesia has affirmed WIKA's National Long-Term Rating at 'AA-(idn)'. The Outlook on the ratings has been revised to Stable from Negative. A full list of rating actions is at the end of this rating commentary.

The affirmation of WIKA's ratings and the revision of its Outlook to Stable from Negative reflects our view that WIKA warrants up to three notches of rating uplift from its Standalone Credit Profile (SCP) of 'b+' for implied state support, because it is of strategic importance to the government's infrastructure development programme. WIKA's support score under our Government-Related Entities Rating Criteria is 15, which with the five-notch distance between WIKA's SCP and the sovereign rating (BBB/Stable), could lead to either a two- or three-notch uplift being included in WIKA's IDR. However, the IDR is capped at 'BB' as per the Government-Related Entities Rating Criteria.

We have chosen a three- rather than two-notch uplift because of WIKA's status as one of the largest state-owned construction companies, with a strong track record in executing large strategic infrastructure projects. State-owned companies dominate the government's infrastructure programme, which not only requires participants to overcome regulatory and bureaucratic hurdles, but also requires firms to invest in projects that have long payback periods on behalf of the government. In addition, participants have to execute turnkey contracts where payments are received only upon completion, which puts pressure on companies' financial performance. Therefore, private-sector and foreign companies tend to shy away from government projects, increasing the government's reliance on, and importance of, large state-owned companies, such as WIKA.

'AA' National Ratings denote expectations of a very low level of default risk relative to other issuers or obligations in the same country or monetary union. The default risk inherent differs only slightly from that of the country's highest rated issuers or obligations.

KEY RATING DRIVERS

Strong Ownership, Support Track Record: Fitch assesses WIKA's status, ownership and control as 'Strong'. The government of Indonesia owns 65% of WIKA primarily via the Ministry of State Owned Enterprises, and has strong influence over the company's investment decisions, strategy and operations. The government holds a golden share that allows it to veto important decisions regarding the appointment and dismissal of board members, distribution of profit and M&A, among others, irrespective of the presence of minority shareholders.

The state has provided tangible support in the form of an equity injection of IDR4 trillion in 2016 to support WIKA's order-book growth and the execution of large strategic projects. WIKA was the lead contractor of Jakarta international airport's new passenger terminal, which was completed in 2016, and is the lead domestic contractor of the Jakarta-Bandung high-speed railway, executing around 30% of the total IDR54 trillion (USD3.9 billion) contract value. WIKA also has a lead role in several key toll roads, such as the Bangkinang-Pangkalan section of the Trans Sumatra toll road valued at IDR8.7 trillion, and the Balikpapan-Samarinda toll road valued at IDR8.0 trillion.

'Moderate' Socio-Political Importance: We assess the socio-political impact of WIKA's default as 'Moderate' because infrastructure development is a cornerstone of the current government's economic growth and urbanisation agenda and is of moderate political importance, but it is not an essential service such as food or utilities. In addition, we believe that a default by WIKA will only temporarily disrupt the infrastructure projects it constructs because other government-related entities (GREs) are available to step in as contractors if required.

'Weak' Financial Implications of Default: Fitch believes that a default by WIKA will have only a minimal impact on the ability of the sovereign and other GRE's to raise financing. WIKA has only limited exposure to capital markets, mainly via the international issuance of local-currency 'Komodo' senior unsecured notes of IDR5.4 trillion (around USD385 million) due in 2021.

Order-Book Growth to Resume: We expect WIKA's order book to increase to IDR142 trillion by end-2019 and IDR159 trillion by end-2020, from IDR123 trillion at end-2018. This is lower than previously expected because new orders slowed in 9M19 due to the presidential elections in April. We expect the company to book around IDR40 trillion-45 trillion of new orders in 2019. The ratio of orders to revenue should remain high at 4.0x-4.5x over the next few years.

A key driver of WIKA's order growth is likely to be the government's 2020-2024 Medium Term Development Plan, which requires around IDR37,000 trillion of investments, with 9% from state-owned enterprises. There will be another IDR466 trillion of projects from the plan to move Indonesia's capital from Jakarta to East Kalimantan by 2024.

Leverage to Remain High: We expect leverage, measured as debt net of seasonally-adjusted cash/EBITDAR, to remain at more than 2.0x over the next few years, driven by a high level of investments and capex as WIKA executes its order book. WIKA's 'b+' SCP reflects its high leverage, at 5.3x based on trailing 12-month EBITDA to end-September 2019. We expect the company to receive around IDR5 trillion in 4Q19 from the completed Balikpapan-Samarinda toll road, which should help moderate leverage.

Bond Rating Same as IDR: We rate WIKA's senior unsecured bonds at the same level as its Long-Term Foreign-Currency IDR because they constitute direct, unsecured, and unsubordinated obligations of the company, and because WIKA's prior ranking and secured debt/EBITDA was at 2.5x at 31 December 2018. We would consider senior unsecured creditors' interests as materially subordinated if prior-ranking and secured debt was sustained above 2.5x of EBITDA, which could lead to the unsecured bonds being downgraded.

Seasonal Cash Receipts: WIKA's operating cash flows have become more seasonal in the last two years as it receives a bulk of payments for its completed turnkey projects mainly from state-owned entities in the fourth quarter, as opposed to receiving cash advances on private-sector projects. Consequently WIKA's leverage during the first nine months of the year is higher than at the year's end.

The cash balance at the end of the year is about IDR4 trillion more than in the earlier part of the year. Therefore we exclude IDR4 trillion from WIKA's cash when computing year-end leverage. We expect WIKA's working-capital cycle to gradually lengthen due to a higher mix of turnkey projects in its new orders, keeping with the industry trend.

DERIVATION SUMMARY

Our assessment of state support for WIKA can be compared with that for Indonesian peers such as PT Indonesia Asahan Aluminium (Persero) (Inalum, BBB-/Stable), and Chinese construction companies, such as China Railway Group Limited (A-/Stable) and Shanghai Construction Group Co., Ltd. (BBB+/Stable).

Inalum is rated at 'BBB-' using a top-down approach and is one notch below the sovereign rating given its aggregate GRE support score of 35, and its SCP is more than four notches away from the sovereign rating. The key difference between our assessment of Inalum and WIKA is that we believe Inalum's default would have 'Very Strong' implications on the cost and availability of financing to the Indonesian government and other GREs, because we believe investors view Inalum as a proxy financing vehicle for the state.

China Railway Group is rated at 'A-' using a top-down approach and is two notches below China's sovereign rating (A+/Stable). Its aggregate GRE support score is 30 points and its SCP of 'bb+' is more than four notches away from the sovereign rating. We assess the socio-political and financial implications of China Railway Group's default as 'Strong' which is the key difference with the assessments for WIKA. We believe a default by China Railway Group would result in significant disruption to China's railway services and development plan, which is pivotal in the country's urbanisation. It could also have a significant impact on China's geopolitical goals, as railway construction plays an important role in China's foreign policy. China Railway Group is one of two dominant contractors in China's railway development space and it will be difficult to substitute in the short to medium term. The company is also an active domestic and international bond issuer and we believe that a default could harm access to capital markets for the sovereign and other GREs.

Shanghai Construction Group is rated 'BBB+', using a bottom-up approach with two notches of uplift from its SCP of 'bbb-', given its aggregate GRE score of 15, and an SCP that is more than four notches away from China's sovereign rating. Shanghai Construction Group's aggregate GRE score is the same as WIKA's 15. However, we provide up to three notches of rating uplift to WIKA above its SCP because we believe WIKA is strategically more important to the Indonesian government. A default by Shanghai Construction Group would disrupt construction projects in Shanghai, but social consequences would be limited due to the city's high urbanisation rate. WIKA's default would have a higher impact on Indonesia's national infrastructure development plan, including the disruption of large strategic projects, at least in the medium term.

WIKA's National Long-Term Rating of 'AA-(idn)' can be compared with PT Pupuk Indonesia (Persero)'s (PTPI) AAA(idn) rating. PTPI's rating is equalised that of its parent, the Indonesian state, due to a strong operational and strategic linkage with the government. This is driven by PTPI's strategic role as the government's sole agent in producing and distributing subsidised fertilisers to eligible farmers through a public-service obligation scheme. WIKA has strong strategic and operational ties with the government but it is not as politically and socially important as PTPI and therefore we believe that the government will provide PTPI with a greater degree of support than WIKA, if required.

WIKA's SCP of 'b+' is comparable with the 'B+' Long-Term IDR on US-based construction company Tutor Perini Corporation. Compared to Tutor Perini, WIKA has a slightly smaller operating scale but has higher profit margins, stronger revenue growth and similar leverage over the medium term. Tutor Perini is exposed to the more mature engineering and construction market in the US, and is able to better manage its cash flows and working capital with moderately positive FCF expected over the next three years, particularly given its more limited growth prospects and capital requirements than WIKA. However we expect leverage to remain around the same for both companies in the medium term given WIKA's stronger EBITDA growth.

WIKA's national-scale SCP of 'a(idn)' is stronger than those of nationally rated peers such as PT Waskita Karya (Persero) Tbk (WSKT, A(idn)/Negative, SCP: bbb+(idn)). Waskita is a larger state-owned contractor than WIKA and is a specialist in toll-road development. As part of its remit, Waskita takes on a higher mix of turnkey engineering contracts on behalf of the state and also one of the biggest investors in toll roads with long payback periods, leading to significantly higher leverage than WIKA. Consequently we view WIKA as having a stronger SCP than Waskita. (ends)