Fitch Revises Outlook on GEAR to Stable; Affirms 'B+' Rating

(Fitch Ratings - Singapore - 28 November 2019)--Fitch Ratings has revised its Outlook on Golden Energy and Resources Limited (GEAR) to Stable from Positive and affirmed the Long-Term Issuer Default Rating (IDR) of GEAR at 'B+'. The agency has also affirmed GEAR's senior unsecured US dollar bond at 'B+' with a 'RR4' Recovery Rating.

The Outlook revision reflects Fitch's expectation that GEAR's scale of EBITDA will be lower than previously expected under Fitch's recently lowered long-term coal price assumptions (see Fitch Ratings Updates Mid-Cycle Metals and Mining Price Assumptions, dated 6 November 2019). This is despite the company's on-track production volume ramp-up.

We calculate GEAR's EBITDA and credit metrics with proportionate consolidation of its 67%-owned key subsidiary, PT Golden Energy Mines Tbk (B+/Stable), as we assess GEAR's linkage with GEMS as moderate. We do not expect GEAR's adjusted EBITDA to rise above USD150 million before 2022.

GEAR's 'B+' ratings reflect the group's adequate financial profile, healthy reserve life and low cost position of its key mine, PT Borneo Indobara (BIB). The Recovery Rating of 'RR4' reflects average recovery prospect for its US dollar bondholders.

Key Rating Drivers

Moderate Linkages: The linkages between GEAR and GEMS are moderate, as assessed under Fitch's Parent and Subsidiary Rating Linkage criteria. GEMS accounts for almost all of the group's consolidated EBITDA; GEAR's standalone operations are not significant and most of its earnings are derived from GEMS's dividends. GEAR retains majority representation over GEMS's board, and is actively involved in managing GEMS's operation.

An agreement between GEMS's shareholders ensures that the company will maximise profit distribution by paying at least 80% of its free cash flow as dividends. However, GMR Coal Resources Pte. Ltd, which owns 30% of GEMS, has also appointed key management personnel and has veto power in major corporate transactions.

We expect GEAR to continue to seek acquisitions or investments to diversify its portfolio. We may reassess the linkages between GEAR and GEMS, including the Standalone Credit Profile of GEAR and its dependence on cash flow from GEMS, after further acquisitions.

Decline in Profitability: We expect GEMS's EBITDA per tonne to remain between USD4/tonne and USD5/tonne (2018: USD6.8/tonne) during 2019-2022, mainly on account of lower average selling prices. The decline in the profitability is in line with the industry; however, for GEMS the impact on cash flow is offset partly by our expectation of volume growth. We also expect the group to maintain a net debt position until 2022, as compared with a net cash position in 2017.

Increasing Production Scale: We expect GEMS's production to increase to 36 million tonnes (mt) in 2020 (2019E: 30mt, 2018: 22.6mt), driven mainly by the production from BIB. The company targets BIB's annual production to surpass 50mt by 2022. After the capacity expansion, GEMS's own port will be able to support shipping of about 44mt a year. GEMS also has contracts with third party ports, which would be used once their annual production surpasses 44mt. GEMS's expected increase in production volumes is dependent on the quotas it receives from the state. Fitch does not think this is a major risk to GEMS in light of its regulatory compliance in supplying to the domestic market.

We expect GEMS to require minimal capex towards infrastructure to support the increasing volumes, spending about USD25 million-30 million annually over the next three years to upgrade the capacity of the hauling roads and crushers. GEMS's lower capex requirement, compared with some of its peers, is due to the close proximity of its main mine to the port.

Limited Mine Diversity: BIB accounts for more than 90% of GEMS's total production and above 65% of the proven and probable (2P) reserves. We expect with BIB's production ramp-up and the contribution from GEMS's other mines, including the recently acquired PT Barasentosa Lestari (BLS), to remain small. Still, we believe the concentration of operational risk is mitigated by its contracts with two established mining contractors, PT Saptaindra Sejati (a subsidiary of PT Adaro Energy Tbk) and PT Putra Perkasa Abadi, which are among the top-five mining contractors in Indonesia. GEMS benefits from the low-cost structure of BIB, which is among the lowest-cost mines in the world due to the low strip ratio of 4x, coupled with short haulage requirements. However, the calorific value (CV) of GEMS's coal is lower than the Indonesian average, which results in a lower selling price.

Long Reserve Life: GEMS has one of the largest reserves compared with its coal mining peers in Indonesia. GEMS's reserves are the fourth-largest in Indonesia, with proven reserves of around 800mt at end-September 2019 (end-December 2018: 818mt), or a reserve life of 27 years based on its 2019 total expected production. GEMS's acquisition of BSL in the second half of 2018 had further improved its reserve base by adding 150mt of proved reserves. GEMS's BIB mine holds 586mt of the proven reserves, with a second-generation licence valid till 2036, alleviating any licence renewal uncertainty which is being faced by some peers.

Adequate Financial Profile: We expect GEAR's adjusted financial profile, based on the proportionate consolidation of GEMS, to remain adequate for its rating despite the decline in the coal prices. We expect the adjusted net debt/EBITDA to continue decline to below 2x, starting 2020 (2019E: 2.1x), supported by the rise in production volumes without major capex requirements. On a standalone basis, we expect GEAR's (the holding company) interest cover to improve again to 3x in 2020, as its dividend income improves, after declining to about 2.3x in 2019.

Diversification Credit Positive: GEAR intends to continue to increase its investment portfolio which could diversify its earnings. Fitch regards any acquisitions by GEAR as an event risk. We expect that GEAR's business profile may benefit from further asset and geographical diversification, if the company is able to acquire a majority of Stanmore. Stanmore's net cash position, expanding earnings and moderate capex requirements in the medium-term may support GEAR's financial profile.

Derivation Summary

The ratings of GEAR are based on the proportionately consolidated financial metrics of GEMS, to incorporate the presence and influence of significant minority shareholding. The ratings factor in the group's adequate credit ratios, large reserve base, limited mine diversity and low-cost position. GEAR's leverage and coverage are stronger than those of PT Indika Energy Tbk (BB-/Stable); and GEMS has a longer reserve life. However, Indika's operations are larger, more integrated and more diversified, which we believe justifies the one-notch difference in their IDRs. The production capacity of Indika's key coal asset, Kideco, is well-established, and is at its peak compared with GEMS, which is boosting production. We also think that both companies demonstrate similar sensitivity to declines in coal prices. (ends)