OREANDA-NEWS. Fitch Ratings says PT Garuda Indonesia (Persero) Tbk's (BBB+(idn)/Negative) short-term liquidity pressures have eased with its USD500m five-year unrated sukuk deal in May 2015. Fitch believes Garuda's funding sources are now more diversified with its established track record in global sukuk, an important factor in addressing its tight liquidity profile. Garuda had USD465m in unrestricted cash at end-1Q15 against USD802m in short-term debt maturities.

Garuda turned a USD166m net loss in 1Q14 into a USD12.4m net profit in 1Q15. This was driven by the combination of a 38% drop in fuel costs, improved load factor, and efficiency from non-fuel expenses. However, Fitch views operating fundamentals as still weak, driven by a currency mismatch and with an unsustainably low oil price. We believe the currency mismatch is Garuda's key financial weakness: more than 50% of revenue is derived from domestic flights that are quoted in Indonesian rupiah and subject to the government's tariff cap, while 60%-70% of operating costs are denominated in or linked to US dollars.

Our updated projection estimates that leverage (measured by FFO-adjusted leverage) will continue to be in breach of negative rating guidelines at 8x. The ratio should improve to 7.2x by end-2015 from 10.8x in 2014, but we do not feel that the improvement is fundamentally sustainable - given the limited ability to make structural changes in its operations. We expect Garuda's financial metrics will again breach negative triggers from 2016 - as reflected in the Negative Outlook - based on the assumption that the oil price will rise gradually and the rupiah continues to depreciate.

Garuda's weak financial profile is due to margin swings resulting from exposure to the currency mismatch, and with a high proportion of leased aircraft which are of a fixed cost. This situation is exacerbated by intensifying competition in the last few years, both in the domestic or regional market, which will continue to add pressure to airlines' profitability - at least in the next 24 months. The rating, however, recognises Garuda's strong market position in the domestic full-service segment, and growth opportunities in light of Indonesia's poor transportation infrastructure.

New management, which was appointed in late 2014, carried out various efficiency efforts to prioritise profitability over growth. These moves had translated into a USD40m savings in non-fuel expenses by end-April 2015, and management is targeting total savings of USD198m by end-2015. However, we believe Garuda has only a limited ability for further savings - given the high fixed costs, a structurally inefficient domestic airlines operation, and yield pressures from competition.