Fitch Affirms Pelindo III at ‘BBB-‘; Outlook Stable

Fitch Ratings has affirmed Indonesia-based port operator PT Pelabuhan Indonesia III (Persero)’s (Pelindo III) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘. The Outlook is Stable. A full list of rating actions is at the end of this commentary.

RATING RATIONALE
The coronavirus pandemic and government containment measures worldwide have created an uncertain global environment for sea ports in the near term. Fitch’s ratings are forward-looking, and we will monitor pandemic-related developments in the sector for severity and duration, and incorporate revised base- and rating-case qualitative and quantitative inputs based on our expectations for performance and assessment of key risks.

The virus outbreak could result in weaker domestic consumption and export demand for Indonesia. The shutdown of factories in China, Indonesia’s major trading partner, inevitably hurt container throughput at Indonesia’s ports in 1Q20. Pelindo III’s international container throughput fell 1% yoy in the first two months of 2020, led by a 6% decline in container throughput to and from China. The spread of the coronavirus globally will intensify the impact on throughput in 2Q20. However, cargo mobility remains largely uninterrupted by government lockdowns, which only restrict people’s mobility, to ensure efficient logistics for critical goods like food and medical supplies. Pelindo III’s management also confirmed that its ports’ daily operations are continuing with no issues in cargo evacuation. The company expects domestic container throughput to remain little changed in 2020 and international container throughput to decline 5%-10%.

The company had a cash balance of IDR3.6 trillion by end-2019 and it has no near-term refinancing needs. In addition, the terminal operations rely on contractual labor and, therefore, operating expenses could drop in light of the reduced throughput. Management expects to keep operating expense at about IDR6.4 trillion in 2020, including about IDR1.4 trillion in depreciation and amortisation. Most of Pelindo III’s capex budget is expansionary and we believe the company has timing flexibility in executing its plans. Management has significantly cut the capex budget to IDR3 trillion in 2020 and about IDR4 trillion per annum thereafter.

Pelindo III’s IDR and senior unsecured ratings are one notch below the rating of its parent, the Indonesian sovereign (BBB/Stable), in line with Fitch’s Government-Related Entities (GRE) Rating Criteria, which takes into consideration the strength of the linkages between Pelindo III and the government, as well as the government’s incentive to provide support to Pelindo III.

Pelindo III’s ‘bb+’ underlying rating reflects the company’s strong market position, its limited exposure to competition and transhipments as well as its resilience through economic cycles. The profile also factors in moderate flexibility in setting tariffs and management’s capex plan. The revised Fitch rating case assumes a decline in throughput in 2020, followed by a recovery in 2021. We forecast five-year throughput CAGR of 2.4% between 2019 and 2024. Our lower throughput and EBITDA forecast is offset by lower capex. Pelindo III’s adjusted net debt/EBITDAR will average 3.7x over the next five years under the Fitch rating case. Pelindo III’s leverage average is below our positive trigger, but we do not upgrade its ratings due to the uncertainty over the impact of COVID-19 on throughput and revenue.

GRE Assessment

Strength of Linkages: Fitch assesses Pelindo III’s status, ownership and control by the sovereign as ‘Strong’. The state owns 100% of the company, appoints Pelindo III’s commissioners and board members, and controls its investment plans and capex decisions. We also consider the support record and expectations for state support to Pelindo III as ‘Strong’. The government has not provided tangible support to the company because of its generally sound financial profile. However, we expect Pelindo III to receive support from the government, if needed, as we believe the company plays an important role in the country’s economic development.

State’s Incentive to Support: Fitch assesses the socio-political implications of a potential default by Pelindo III as ‘Moderate’. A default by Pelindo III would damage the government’s reputation, but, in our view, it would not result in any severe disruption to Indonesia’s trade activities as the country’s port infrastructure would remain intact and other operators may step in to run Pelindo III’s ports. Our assessment of the financial implications of a potential default by Pelindo III is ‘Strong’. This is because Pelindo III is regarded as one of the key state-owned enterprises (SOEs) in Indonesia and any default by the company would reduce investors’ confidence in the sovereign as well as other SOEs.

KEY RATING DRIVERS
Limited Competition, Resilient Volume – Revenue Risk (Volume): Midrange

Pelindo III operates the primary ports of call within its served region, which includes Surabaya, the second-largest city in Indonesia by population. Pelindo III has a dominant container market share in its operating area with limited competition. Its traffic is mainly origin and destination (O&D) with very limited transhipment cargo. Pelindo III’s container throughput has proven resilient through economic and business cycles, including increasing by 2% during the global financial crisis in 2009 and rising by 1% in 2015 when Indonesia’s commodity sector experienced a downturn. The concessions for most of its ports have 30-year terms ending in 2045. Land access to Pelindo III’s ports is largely limited to road transport. Pelindo III’s largest port, Tanjung Perak, has a draft of 12 metres and can handle containerships of up to 4,000 TEUs. However, the increase in sizes of ships deployed by shipping lines may present challenges to the port’s infrastructure over the longer term.

Moderate Pricing Flexibility – Revenue Risk (Price): Midrange

Pelindo III’s tariffs are commercially negotiated with shipping associations but require consultation with the Ministry of Transport. This limits the company’s pricing flexibility, evident from the largely flat tariffs for international shipments at its major ports in the past. However, tariffs on domestic containers have been increasing. Once fixed, the tariff structure will remain valid for at least two years. Pelindo III’s predominantly O&D cargo profile underpins its pricing power and operating margin. However, a lack of minimum guaranteed revenue or long-term take-or-pay contractual arrangements could limit the ports’ revenue stability in an economic downturn.

Significant Capital Expenditure Plan – Infrastructure Development and Renewal: Midrange

Pelindo III’s container capacity utilisation rate remains elevated at about 70% (based on yard capacity) despite capacity additions over the past few years. Fitch expects Pelindo III to incur total capex of IDR19 trillion over 2020-2024, above the IDR15 trillion cash flow from operations over the same period under Fitch’s rating case. As such, we expect Pelindo III to rely on external debt to fund the planned capex and dividend distributions. The timing of the execution of the capex plan is flexible as it is mainly for expansion and any delay will not materially affect existing operations.

Reliance on US Dollar Fixed-Rate Bullet Notes – Debt Structure: Midrange

All of Pelindo III’s consolidated debt is raised by the parent company and carries fixed rates. The debt mainly comprises US dollar bullet bonds, which present significant refinancing risk, although this is partly mitigated by the company’s demonstrated access to capital markets and long concession tenor. With its US dollar bonds due in 2023 and 2024, Pelindo III has no near-term refinancing needs. The US dollar notes do not contain restrictive financial covenants and Fitch expects leverage to increase in the near term. Pelindo III previously relied on natural hedging to manage its foreign-exchange risk. However, the company suffered a foreign-exchange loss in 2018 due to the sharp depreciation of the Indonesian rupiah against the US dollar. Management has now put in place an active hedging strategy to manage the company’s foreign-exchange exposure, which seeks to moderate these losses.

PEER GROUP
PT Pelabuhan Indonesia II (Persero) (Pelindo II, BBB/Stable; underlying rating: bbb) is the largest container port operator in Indonesia, followed by Pelindo III. Pelindo II benefits from stable rental income from joint ventures and is thus better placed than Pelindo III. Both companies are undertaking heavy expansion plans to support the development of Indonesia’s maritime industry, but Pelindo II has lower average leverage than Pelindo III over the five-year forecast period under Fitch’s rating case, and a ‘Stronger’ volume risk assessment compared with a ‘Midrange’ assessment for Pelindo III.

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

– Sustained deterioration of Fitch-adjusted net debt/EBITDAR above 5.0x under Fitch’s rating case could lead to a lowering of its underlying rating

– Weakening of linkages with the government of Indonesia

– Downgrade of Indonesian sovereign rating

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

– Sustained improvement of Fitch-adjusted net debt/EBITDAR below 4.0x under Fitch’s rating case could lead to raising its underlying rating

– Strengthening of linkages with the government of Indonesia

– Upgrade of Indonesian sovereign rating

BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

CREDIT UPDATE
Pelindo III’s container throughput growth slowed to just 1.7% in 2019, from 8.5% in 2018 on weak international trade. Throughput growth for domestic containers decelerated to 3.6% in 2019 from 7.8% in 2018 and international containers contracted 0.9% in 2019 after growth of 9.4% a year earlier. The COVID-19 pandemic will likely weigh on throughput growth in the near term.

FINANCIAL ANALYSIS
The Fitch base case forecasts container throughput to decline by 5% in 2020 and increase subsequently in line with GDP. We assume container tariffs will track Indonesian inflation. We assume cash operating expenses will increase by 6% CAGR over the same period. The Fitch base case assumptions also include total capex of IDR19 trillion in 2020-2024 and a dividend payout of 30% of net income. As a result, the Fitch adjusted net debt/EBITDAR will average 3.4x in 2020-2024.

The Fitch rating case assumes 8% container throughput decline in 2020, and a recovery to the pre-outbreak level in 2021. We assume the throughput will rise by 0.8x GDP thereafter. We assume container tariffs will increase by 2% each year. We forecast cash operating expense to increase at 5% CAGR. Our capex and dividend assumptions are in line with the Fitch base case. As a result, the Fitch adjusted net debt/EBITDAR will average 3.7x in 2020-2024 with a peak of 3.8x in 2024.

We also ran a COVID-19 stress case where we assumed the throughput would drop by 13% in 2020 and recover to the pre-outbreak level only in 2022. Our COVID-19 stress case generated a leverage average of 4.1x, with a maximum of 4.3x in 2024.

Long-Term Foreign-Currency IDR affirmed at ‘BBB-‘; Outlook Stable

Senior unsecured rating affirmed at ‘BBB-‘; Outlook Stable

USD500 million senior unsecured notes due 2023 affirmed at ‘BBB-‘; Outlook Stable

USD500 million senior unsecured notes due 2024 affirmed at ‘BBB-‘; Outlook Stable

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
Pelindo III’s IDR and senior unsecured ratings are one notch below the rating of its 100% shareholder, Indonesia.
Source: Fitch Ratings