Fitch Downgrades Waskita Karya to 'B(idn)'; on Rating Watch Negative

(Fitch Ratings - Jakarta - 19 Aug 2020)-- Fitch Ratings Indonesia has downgraded Indonesia-based contractor PT Waskita Karya (Persero) Tbk's (WSKT) National Long-Term Rating to 'B(idn)' from 'BBB+(idn)'/Negative and placed the rating on Rating Watch Negative. At the same time, the agency has downgraded WSKT's senior unsecured note programme and the notes issued under the programme to 'B-(idn)' from 'BBB(idn)'.

The downgrade reflects WSKT's tight liquidity position, which is exacerbated by the coronavirus pandemic. Fitch believes this elevates WSKT's refinancing risks in repaying its near-term maturities that include its supply-chain financing (SCF) facilities and IDR2.5 trillion in bonds maturing October 2020. The Rating Watch Negative reflects the uncertainty over the company's ability to boost liquidity in a timely manner to repay the near-term debt maturities and Fitch's potential re-assessment of government support.

WSKT's rating of 'B(idn)' incorporates a four-notch uplift from its standalone credit profile (SCP) of 'ccc-(idn)' due to the company's strong linkages with its majority shareholder, the Indonesian sovereign (BBB/Stable).

The programme and the bonds issued under the programme will continue to be rated one notch below the company's National Long-Term Rating in light of significant prior-ranking debt. We expect WSKT's prior-ranking debt/EBITDA to be considerably above 2.5x, the threshold at which we believe the interests of senior unsecured creditors are significantly subordinated to the interests of secured or prior-ranking creditors.

'B' National Ratings denote a significantly elevated level of default risk relative to other issuers or obligations in the same country or monetary union.

KEY RATING DRIVERS

Weakening Liquidity; Higher Refinancing Risk: The social-distancing measures during the pandemic have slowed construction progress, weakened cash collection and cut new contracts, materially weakening WSKT's liquidity. Fitch believes this raises WSKT's refinancing risk in repaying its near-term maturities until end-2020, including the SCF facilities of IDR7.7 trillion in 1Q20 and the total IDR2.5 trillion in bonds maturing in October 2020. The company will also be dependent on further external funding and the availability of an undrawn loan facility (1Q20: IDR10 trillion) to support its substantial capex and debt-servicing obligations.

Negative FCF; Elevated Leverage: Fitch believes the challenges in collecting payments due to the slower completion of its projects, including turnkey contracts, will result in negative cash flow from operations as the working-capital cycle is lengthened. The company received turnkey payments of IDR7.1 trillion in the year to June 2020, which it will mainly use to reduce debt, although this will be temporary. Fitch projects free cash flow (FCF) will continue to be negative while leverage (net debt/EBITDA) will remain high, above 15x, and coverage (EBITDA/interest paid) will be below 1.0x in the medium term due to high investments to complete toll-road projects.

Weakening New Contracts Amid Pandemic: We expect growth in WSKT's order book to slow as tenders from government and private parties will be limited during the pandemic. We estimate new contract wins will drop by 25% to IDR19 trillion (1H20: IDR8.1 trillion) in 2020 as both domestic and offshore projects will be affected by the lockdown.

Our rating case assumes that social-distancing measures will ease in 2021, at which time major tenders will resume. This could boost WSKT's new contracts to IDR25 trillion-35 trillion in 2021-2023. However, a prolonged pandemic may prompt the government to re-allocate resources away from infrastructure projects to combat COVID-19, which would reduce the number of contracts up for tender.

Strong State Linkage: The state owns 66% of WSKT, primarily via the Ministry of State Owned Enterprises, and has strong influence over investment decisions, strategy and operations. The state holds a 'golden share' that allows it to veto important decisions, including the appointment and dismissal of board members, distribution of profit and M&A, irrespective of the presence of minority shareholders. The government also injected IDR3.5 trillion of equity into WSKT in 2015 and supported WSKT's subsidiary, PT Waskita Toll Road, through strategic partnerships via government-affiliated institutions with total proceeds of IDR3.5 trillion in 2017. Around 70% of WSKT's outstanding order book at end-2019 included nationally strategic government projects.

This results in our assessment of the company's strong operational and strategic linkages with the Indonesian government, which is a stronger parent, based on Fitch's Parent and Subsidiary Rating Linkage criteria, which is reflected by the four-notch uplift to WSKT's SCP. However, Fitch may re-assess the linkages should there be evidence of weaker support when WSKT's liquidity is under pressure.

DERIVATION SUMMARY

WSKT's SCP reflects the company's pressured liquidity and elevated refinancing risks due to its weaker cash flow generation, which may result in challenges to repay its near-term maturities. We believe the execution risk of the company's strategy to boost its liquidity in a timely manner during the pandemic, such as obtaining further external debt facilities and collecting major cash inflows from its projects, heightens its refinancing risks.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- New contract wins of IDR19 trillion in 2020 and IDR26 trillion in 2021 (2019: IDR26 trillion)

- Slower contribution from turnkey projects in 2H20

- EBITDA margin of 14.5%-15.5% in 2020-2021

- Capex of IDR9 trillion in 2020 and IDR10 trillion-11 trillion in 2021-2022

- Dividend payout ratio of 20% in 2021-2023

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Fitch may resolve the Rating Watch Negative if WSKT can meaningfully improve its liquidity such that it is able to address its near-term debt maturities.

- Stronger linkage between WSKT and the Indonesian government

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Further weakening in liquidity that undermines WSKT's ability to service its debt

- Weakening linkage between WSKT and the Indonesian government

LIQUIDITY AND DEBT STRUCTURE

High Refinancing Risk: We believe the company's cash generation has been materially affected by the pandemic, with challenges in collecting cash due to the slower progress in construction pressuring liquidity. The sustained negative free cash flow as a result will cause WSKT to depend on the availability of its undrawn bank facilities (1Q20: IDR10 trillion) as well as the ability to source further external funding. The pressure on liquidity also highlights the difficulty in repaying the maturing SCF facilities and bonds due October 2020.