OREANDA-NEWS. Fitch Ratings has assigned Indonesia-based port operator PT Pelabuhan Indonesia II (Persero) (Pelindo II) a Long-Term Foreign Currency Issuer Default Rating (IDR) and a senior unsecured rating of 'BBB-'. The Outlook is Stable. Fitch has also assigned Pelindo II's proposed senior unsecured US dollar bonds a 'BBB-(EXP)' expected rating.

The 'BBB-' ratings reflect Pelindo II's standalone credit profile, which benefits from its entrenched market position with limited competition in the regions it operates in, robust growth prospects and its stable operating cash flows. The standalone ratings are constrained by Pelindo II's large expansionary capex programme, leading to sizeable negative free cash flows over the medium term. The ratings would benefit from two notches of uplift in the event its standalone credit profile falls below that of its 100% shareholder, the Republic of Indonesia (BBB-/Stable), owing to its strategic importance to the state.

The proposed US dollar bonds are rated at the same level as Pelindo II's IDR because they will constitute direct, unconditional and senior unsecured obligations of the company. The final rating on the proposed bonds is contingent upon the receipt of final documents conforming to the information already received.

KEY RATING DRIVERS

Entrenched Position: Pelindo II accounts for over 90% of the container traffic in its regions of operation, including the capital Jakarta and West Java, and 46% of Indonesia's total container traffic in 2014. Limited alternative ports in these regions, the importance of sea freight in cargo transport across the Indonesian archipelago, underdeveloped road infrastructure and on-going capacity expansions should ensure that Pelindo II captures the expected growth in regional business volumes. Almost all new port infrastructure in Pelindo II's regions are either directly owned by it or held through joint ventures.

Strong Volume Profile: The company's business volumes mostly comprises origination and destination (O&D) cargo - that is either produced or consumed in the regions it operates in. Fitch views the low reliance on the more substitutable transhipment cargo relative to some other Asian ports positively.

Pelindo II's container traffic volumes expanded at a CAGR of about 9% over the past five years - higher than Indonesia's economic growth rate. Fitch expects strong growth to continue due to increasing containerisation and healthy economic growth. Pelindo II's new joint-venture container terminal (CT1) in its main port, Tanjung Priok, will add another 1.5m twenty-foot equivalent units (TEU) of capacity in late 2015 to Tanjung Priok's existing capacity of 7.1m TEU, which will allow Pelindo II to tap expected container shipment growth. Average utilisation was about 81% for Tanjung Priok - including PT Jakarta International Container Terminal (JICT) and Kerjasama Operasi Terminal Petikemas Koja (KOJA) - in 2014.

Stable Cash Generation: Fitch expects Pelindo II's adjusted EBITDA to rise to around IDR4trn in 2016 from IDR2.4trn in 2014 mainly due to higher fixed rentals inflows from existing JVs and associates, start of rental inflows from CT1 and an increase in container tariffs in November 2014. Fitch includes the rentals and royalty receipts and dividends from JICT and KOJA, which are equity accounted for in its financial statements, when computing Pelindo II's adjusted EBITDA, funds flow from operations (FFO) and related financial ratios.

Higher Fixed Royalties from JVs and Associates: Fitch expects 50% to 60% of Pelindo II's adjusted EBITDA from 2015 to comprise fixed rental receipts for the provision of port facilities from its 49% owned JV, JICT, and its 55% owned, KOJA. JICT and KOJA are the largest international container terminals at the Tanjung Priok port. The operating agreements between Pelindo II and these companies were renewed in 2014 and revised so that Pelindo II will receive a fixed annual rental payment that is higher than the revenue-linked royalty previously. Fitch expects dividends and royalties from JICT and KOJA to increase to about IDR1.8trn a year from about IDR0.9trn in 2014. The CT1 terminal will add USD56m a year to Pelindo II's EBITDA when it starts operating in late-2015.

Fitch also expects earnings at Pelindo II's own port facilities to improve from 2015 because of the increase in tariffs for container handling in November 2014. Fitch estimates that container handling accounts for over 75% of Pelindo II's adjusted EBITDA.

High Capex, Negative Cash Flows: High capacity utilisation at Pelindo II's existing ports will require it to continue investing in new capacity to accommodate the expected volume growth. This includes the extension of its Tanjung Priok port platform on which the new terminals will be set up. Fitch estimates that the ongoing capacity enhancements can accommodate additional volumes till about 2017 or 2018, after which further new terminal capacity will be required. Its capex also includes the construction of new ports and expansion of its other existing ones.

The company has opted for a sub-concession model, where a large portion of capex will be borne by JV partners. Nevertheless, Pelindo II's aggregate capex over the next five years will amount to about IDR31trn, exceeding our expectation of aggregate operating cash generation of IDR19bn over the same period.

Higher Leverage: Fitch expects Pelindo II's FFO adjusted net leverage to increase to between 3.5x and 4.5x in the next two to three years, up from from 2.6x in 2014 due to its large capex programme. Fitch also expects its FFO fixed charge coverage to remain above 3.5x in the short to medium term while it undertakes debt-funded capital expenditure. Pelindo II expects to issue senior unsecured notes to fund its capex over the next few years.

Sovereign Linkage: Pelindo II's ratings would benefit from two notches of uplift in the event its standalone ratings fall below that of Indonesia, due to the strategic importance of its ports, in line with Fitch's parent and subsidiary linkage methodology. Pelindo II's ports are key gateways for goods transport in the regions it operates in. Its Tajung Priok port is the largest in Indonesia by container volumes. Pelindo II's management is appointed by the state and its expansion reflects the government's strategy of improving Indonesia's infrastructure.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Annual container volume growth at Pelindo II and its JVs accelerates to 7% in 2016 and 2017 from 4% in 2015, supported by on-going and expected capacity additions over the medium term
- Rentals and dividend inflows from JICT and KOJA to increase to IDR1.8trn a year from 2015 compared with IDR0.9trn in 2014
- High capex to cater to volume growth, with the expansion of its Tanjung Priok terminal to account for a most of its capex. Total capex of IDR31trn for 2015-2019, leading to negative free cash generation during this period
- No additional equity assumed; additional debt raised to fund capex in the medium term

RATING SENSITIVITIES

Negative: Future developments that may collectively or individually lead to negative rating actions include:
- Negative rating action on the sovereign
- A sustained weakening of Pelindo II's FFO adjusted net leverage above 4.5x and FFO fixed charge coverage below 2.5x, will lead to a downgrade of Pelindo II' standalone rating. However, provided the rating linkages between the company and the state remain intact, two notches of support will be provided, which is currently not applicable as the company's standalone profile is level with the ratings of Indonesia.

Positive: Future developments that may collectively or individually lead to positive rating actions include
- Positive rating action on the sovereign could lead to an upgrade provided Pelindo II's linkages with the state remain intact
- Fitch does not anticipate positive rating action on the standalone ratings of Pelindo II in the medium term given the company's high capex and resultant large negative free cash generation.

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 13 November 2014:

The main factors that could, individually or collectively, lead to positive rating action, are:
- A strengthening of the external balances, making Indonesia less vulnerable to sudden changes in foreign investor sentiment, for instance through lower commodity export dependence or higher FDI inflows.
- Implementation of structural reforms or improvements in infrastructure that would allow for higher sustainable GDP growth.

The main factors that could, individually or collectively, lead to negative rating action, are:
- A sharp and sustained external shock to foreign and/or domestic investors' confidence with the potential to cause external financing difficulties, for example, as a result of an undue change in the authorities' current cautious monetary policy strategy.
- A rise in the public debt burden caused by discontinuation of adherence to the fiscal policy rule.