Fitch Assigns 'BBB' Rating to Hutama Karya's Notes Under MTN Programme

(Fitch Ratings - Jakarta/Singapore - 26 Apr 2020)--Fitch Ratings has assigned Indonesia-based state-linked construction company PT Hutama Karya (Persero)'s (HK, BBB-/Stable) proposed US dollar government-guaranteed notes issued under its USD1.5 billion medium-term note (MTN) programme a rating of 'BBB'.

The guaranteed note rating is the same as that of bonds issued by Indonesia due to the unconditional and irrevocable guarantee by the sovereign. The government bonds are, in turn, rated in line with Indonesia's Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB'. The proposed government guaranteed global note will rank equal to other guarantees issued by the guarantor and other unsubordinated external debt, or debt denominated in a currency other than the rupiah, of the guarantor. HK plans to use the proceeds to refinance its existing debt and/or fund capex.

HK's IDR reflects our view of the company's strategic importance to the Indonesian government's infrastructure-development programme. HK's IDR is one notch below the Indonesia's rating, in line with Fitch's Government-Related Entities (GRE) Rating Criteria. This is based on our assessment of strong linkages between HK and the government as well as the government's incentive to provide support.

HK is pivotal to the government as it is an investor in Indonesia's longest toll road in Sumatra. The government wants to improve connectivity in Sumatra to accelerate economic growth as well as significantly reduce travelling time on the island. Fitch assesses HK's Standalone Credit Profile (SCP) at 'b-', which factors in its strong order book and the key constraint of a weak financial profile. HK's strategic importance to the government's infrastructure-development programme incentivises the government to provide support. Leverage will remain high in the medium term but we do not expect rating pressure as the bulk of HK's loans are guaranteed by the government. This differentiates HK from its construction peers, as it is the only wholly state-owned construction company with government-guaranteed debt.

 

GREs are the main participants in the government's infrastructure programme, as there are substantial regulatory and bureaucratic hurdles to overcome, and projects require substantial investment outlay on behalf of the government. In addition, many projects are on a turnkey basis, with payments received only upon completion, which results in stretched balance sheets and long payback periods for the companies. This has increased the government's reliance on, and importance of, large GREs. HK's stable EBITDA margin and sustainable order book as an important state-owned construction company are counterbalanced by significant working-capital pressures that result in volatile cash flows from operations and rising leverage.

KEY RATING DRIVERS

Strong Ownership, Support Record: Fitch assesses HK's status, ownership and control as 'Very Strong'. The government owns 100% of HK mainly via the Ministry of State Owned Enterprises, and controls the company's investment decisions, strategy and operations. HK is the only construction company that is 100% state owned. The government has close oversight of HK's board of directors and commissioners, and provided tangible support - via equity injections, asset securitisation and construction support - to support HK's order-book growth and toll-road investments in the last five years.

HK won IDR92 trillion of new orders in 2015-2019. Nearly 70% of its order book in 2019 comprised national strategic projects, mostly toll roads. HK's key project is the important trans-Sumatra toll road, from which the company obtained a total of IDR65 trillion new contracts in 2016-2019, or 62% of total contracts won. The government also guarantees all of HK's debt for the toll road.

'Moderate' Socio-Political Implications of Default: Infrastructure development is a cornerstone of the government's economic growth and urbanisation agenda. HK was appointed to build the trans-Sumatra toll road by presidential decree. However, the road is not an essential service, such as provision of food or utilities. In addition, we believe that a default by HK will only temporarily disrupt its infrastructure projects because other GREs are available to step in as contractors if required over the medium-to-longer term.

'Strong' Financial Implications of Default: Fitch believes that a default by HK will affect the ability of the sovereign and other GREs to raise funding as its debt is guaranteed by the government, and there is reputational risk. HK has limited exposure to capital markets, mainly via the issuance of IDR6.8 trillion (over USD450 million) of domestic, local-currency notes, which are due within the next seven years.

Healthy Order Book Growth: We expect HK's order book to increase to IDR68 trillion by end-2020 and IDR86 trillion by end-2021, from IDR59 trillion at end-2019. We expect the ratio of order book to revenue to remain healthy at more than 2x over the next few years. HK is also one of the largest investors in toll-road concessions in Indonesia with over IDR63 trillion of toll-road concession rights, according to unaudited end-December 2019 figures.

Leverage to Remain High: We expect leverage, measured as debt net of seasonally adjusted cash/EBITDA and including supplier chain financing and long-term trade payables, to remain high at more than 15x over the next two years, if HK executes its order book growth and toll-road investment plans. HK has substantial supplier chain financing and long-term payables to third parties, which we have classified as debt. Including these amounts, we estimate that a substantial 65% of HK's debt was guaranteed by the government at end-2019.

Inability to reduce leverage could lead to a lowering of HK's SCP. Leverage could decline if order-book execution slows or if the company continues to receive equity injections to help make up for a shortfall in its cash flows every year.

COVID-19 Impact Manageable: We expect HK to be moderately affected by the coronavirus crisis over the next few quarters. The planned IDR3.5 trillion equity injection into HK by the government for 2020 remains intact after the government revised its initial budget to support the economy, underscoring the importance of the trans-Sumatra toll road. Nevertheless, we have reduced our assumptions of HK's order book growth, as we expect construction activity to slow as the crisis deepens before gradually improving.

DERIVATION SUMMARY

In our assessment of government support, we compare HK with Indonesian peers such as PT Indonesia Asahan Aluminium (Persero) (Inalum, BBB-/Stable) and PT Pupuk Indonesia (Persero) (PTPI, AAA(idn)/Stable), and Chinese construction companies, such as China Railway Group Limited (A-/Stable).

Inalum is similar to HK as it is rated using a top-down approach at one notch below the sovereign rating. Inalum also has an aggregate GRE support score of 35 and its SCP is more than four notches below the sovereign rating. The key difference between our assessment of Inalum and HK 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 using a top-down approach at 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 believe that HK ranks slightly ahead in importance to the government due to its 100% ownership, guaranteed debt as well as its cornerstone role in Indonesia's infrastructure programme.

However, we assess the socio-political and financial implications of China Railway Group's default as 'Strong', compared with 'Moderate' and 'Strong', respectively, for HK. In our view, 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 leading contractors in China's railway development space and it will be difficult to find substitutes for them 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 Chinese sovereign and other GREs.

HK's National Long-Term Rating of 'AA+(idn)' can be compared with PTPI's 'AAA(idn)' rating. PTPI's rating is equalised with that of its parent, the Indonesian government, due to their strong operational and strategic linkages. PTPI is the government's sole agent in producing and distributing subsidised fertilisers to eligible farmers through a public-service obligation scheme. HK has strong strategic and operational ties with the government, but toll roads are less politically and socially important, hence we believe that the government will provide PTPI with a greater degree of support than HK.

HK's SCP of 'bb+(idn)' is lower than PT Waskita Karya (Persero) Tbk's (Waskita) 'bbb-(idn)' as HK has a weaker financial profile. HK has a smaller order book than Waskita, but we believe that HK's order book will expand to a comparable size when the pace of the trans-Sumatra toll-road development increases in the next few years. However, this will come with heavy capital spending and much higher debt. Fitch assesses that HK has closer ties to and is of greater importance to the government than Waskita. HK is the only construction company in Indonesia that is wholly owned by the government and is appointed by presidential decree to build the toll road in Sumatra. Its debt is also guaranteed by the government. In comparison, the government owns only 66% of Waskita. As a result, Fitch rates HK using a top-down approach while we rate Waskita using a bottom-up approach, with its National Long-Term Rating benefitting from three notches of uplift from its SCP to 'A(idn)' with a Stable Outlook.

Likewise, the ratings on PT Wijaya Karya (Persero) Tbk (WIKA, BB/AA-(idn)/Stable) are assessed using a bottom-up approach. HK and WIKA are similar in terms of scale, although HK has higher profit margins, measured using EBITDA and funds from operations. However HK has higher leverage than WIKA mainly due to its continued investments into toll-road concessions as part of the government's infrastructure drive. In addition, unlike HK, whose projects are assigned directly by the government, WIKA is publicly listed with the government holding a 66% stake, and may have less flexibility due to returns sought by investors and shareholder concerns. WIKA also has to bid for projects. (ends)