OREANDA-NEWS. Fitch Ratings has affirmed PT Telekomunikasi Indonesia Tbk's (Telkom) Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs), as well as its foreign-currency senior unsecured rating at 'BBB-'. The Outlooks on the IDRs are Stable.

KEY RATING DRIVERS

Sovereign Constraint: Telkom's IDRs continue to be capped by the Indonesian sovereign (BBB-/Stable) due to the state's majority shareholding (52.6% at end-March 2016) and its significant influence over key operating and financial decisions through its control of the company's board of directors. Telkom is also strategically important as Indonesia's largest fixed and wireless operator.

Reduced Ratings Headroom: Fitch expects Telkom's funds flow from operations (FFO)-adjusted net leverage to increase to just over 1.0x in 2016 and 2017 (2015: 0.9x) due to high capex needs and dividend commitments. Nevertheless, the rating headroom remains large for Telkom's IDRs. The company's solid market position, low leverage and high operating EBITDAR margin of over 50% should continue to support its robust credit profile.

M&A Prospects: The prospect of M&A remains in light of Telkom's ambitions to pursue growth outside Indonesia. However, Fitch does not expect Telkom to undertake debt-funded acquisitions significant enough to have a negative effect on its credit profile - given its conservative nature and the lengthy approval process for state-owned firms. Telkom has considered many M&A deals, including the acquisition of Guam's telecom and pay TV operator, GTA, which fell through in June 2016.

FCF Deficit, High Capex: Telkom's cash flow from operations of IDR36trn-38trn in 2016 and 2017 may not be sufficient to fully cover capex and dividends. Fitch expects capex/revenue to be around 25%-26%, driven by investment in long-term evolution networks and fibre expansion. Further capex may stem from a possible spectrum auction in 2H16, although we believe this should not materially impact Telkom's credit profile.

Margin Dilution: Fitch expects operating EBITDAR margin to decline 100bp-150bp each year due to the rising share of lower-margin data services in the company's revenue mix. Direct impact from the regulator's proposed cut in interconnection rate - if implemented - will be limited as interconnection revenues only accounted for 4% of Telkom's revenue in 1Q16. Our forecast assumes high single-digit revenue growth and continued price discipline amidst a more benign competitive environment.

LIQUIDITY

Strong Liquidity: Telkom's unrestricted cash of IDR35.7trn at end-March 2016 is sufficient to meet debt maturities of IDR7.7trn over the next 24 months. We expect liquidity to remain strong, given its robust financial position and strong access to capital markets and local banks. Telkom has a low exposure to foreign-currency debt, with 89% of its IDR30.4bn borrowings in rupiah and the remaining 11.2% in US dollar and yen.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Telkom include:

- Revenue to increase at 7%-8% a year in 2016-2017 driven by data services;

- Competition to remain fairly rational, with greater emphasis on profitability than market share;

- Operating EBITDAR margin of around 52%-53% in 2016-2017 due to data-led substitution of more profitable voice and text services;

- Annual cash capex/revenue of around 25%-26% in 2016-2017;

- No material debt-funded M&A plans; and

- Dividend payout ratio of 60% in 2016-2017, consistent with 2015's level.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to positive rating action include:

- Upgrade in the sovereign's IDRs

- Weaker links between the government and Telkom

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Downgrade of the sovereign's IDRs.

- A significant increase in shareholder return and/or a major debt-funded acquisition.