Fitch Downgrades Geo Energy to 'B-'; Outlook Negative

(Fitch Ratings - Singapore - 28 November 2019)--Fitch Ratings has downgraded Geo Energy Resources Limited's Long-Term Issuer Default Rating (IDR) to 'B-' from 'B'. The Outlook is Negative. The agency has also downgraded the rating on Geo Coal International Pte. Ltd.'s USD300 million senior unsecured guaranteed notes to 'B-' from 'B' with a Recover Rating of 'RR4'.

The downgrade reflects Fitch's expectation of weakened operating cash flow and thereby increased refinancing risk for Geo's US dollar notes following the downward revision of Fitch's coal-price assumptions. The Negative Outlook reflects our expectation that Geo's production growth will be constrained by low reserves and that its profitability and cash flow will be limited by its weak cost structure at the same time that the company faces heightened refinancing risk.

We may take further negative rating action if Geo fails to remove the risk of a put option in April 2021. Geo is likely to circumvent the put option being triggered by meeting reserve requirements via the acquisition of a 51% stake in PT Bara Anugrah Sejahtera (BAS) and PT Banjarsari Pribumi (BP) - Indonesian coal mines owned by PT Titan Infra Energy - by end-2019.

We believe the proposed acquisition may help Geo postpone redemption pressure on its US dollar notes, but will not be sufficient to materially improve Geo's credit profile due to limited incremental cash flow from the acquired mines. Geo is likely to continue to face heightened refinancing risk on its US-dollar bond maturity in October 2022 if it does not significantly strengthen its business profile.

Key Rating Drivers

Falling Cash Balance; Rising Refinancing Risk: We expect Geo's cash flow to remain weak due to low coal prices and modest capex requirements, leading the company to burn through its cash balance and limiting its financial flexibility. Internally generated cash flow is likely to be insufficient to redeem the US dollar notes on maturity or put option date. The refinancing risk also reflects Geo's deteriorating operating profile when the notes are due. However, Geo's existing cash balance could be used to turn around its deteriorating operating profile through acquisitions.

Planned Acquisition of Little Benefit: Fitch does not believe that Geo's proposed 51% stake in the two South Sumatra-based coal mines - BAS and BP - will boost the company's credit profile, as we do not expect significant cash accretion from the mines. This would leave Geo still facing considerable refinancing risk when its US dollar notes mature in October 2022, even if the acquisition averts the April 2021 put option. Geo is required to repay the notes early in May 2021 if its operating reserves are below 80 million tonnes (mt) in April 2021; its operating reserves were 68mt in June 2019.

Weak Cost Position: Geo has one of the weakest energy-adjusted cost positions among Fitch-rated Indonesian coal miners. This, coupled with its average-quality coal, will keep unit profitability stressed at around USD3/tonne, dropping from around USD10/tonne in 2018. Geo's has, however, renegotiated contracts with it service providers to curb costs, which has somewhat offset the weak coal prices.

Declining Reserves; Small Scale: Fitch believes Geo's small and declining reserve base is likely to challenge the continuity of its operation in the absence of acquisitions. Geo's operating reserve comprised of 24mt at PT Sungal Danau Jaya (SDJ) and 44mt at PT Tanah Bumbu Resources (TBR) as of June 2019. The company will exhaust its operating reserve in seven years, based on Fitch's expected annual production of 9.0mt (9M19: 5.5mt, 2018: 7.0mt). Geo expects 12mt annual production.

Geo has two other mines, but one is still in the exploratory phase and the other has a weak cost position, making mining operations unviable. In addition, the mining licenses of the SDJ and TBR mines expire in 2022; Fitch will treat any adverse developments pertaining to the renewal of the licences, including non-renewal, as an event risk.

Low Off-Taker and Contractor Risk: Geo has life-of-mine contracts for its two key operating mines on all coal produced, minimising off-take risk. It has also entered into a new offtake agreement for its SDJ mine with Trafigura Pte. Ltd, effective 1 January 2020. We do not expect the new contract to significantly change Geo's profile, but it should slightly benefit SDJ's average selling price. Geo has prepayment facilities with off-takers for both mines, supporting working-capital management. Its coal production and over-burden removal contracts for the mines is with one of Indonesia's largest mining contractors, PT Bukit Makmur Mandiri Utama (BB-/Stable), limiting contractor risk.

Derivation Summary

Geo's ratings are lower than those of PT Indika Energy Tbk (BB-/Stable) and PT Golden Energy Mines Tbk (GEMS; B+/Stable), reflecting its heightened refinancing risk, weaker cost position and considerably smaller scale.

GEMS has a much larger reserve base and higher production level of 22mt in 2018 than Geo. GEMS also has a stronger financial profile, which explains the rating difference between the two entities. Indika has stronger operations, with an integrated business model, as well as larger production of 34mt and larger reserves of 422mt in 2018. Indika's stronger cost position and better financial profile reflect its three-notch higher rating than Geo. (ends)