OREANDA-NEWS. Fitch Ratings has affirmed Indonesia-based PT Perusahaan Gas Negara Tbk's (PGN) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB-' and its National Long-Term Rating at 'AAA(idn)'. The Outlook is Stable. Fitch has also affirmed PGN's senior unsecured rating, including the rating of its USD1.35bn bonds due 2024, at 'BBB-'.

'AAA' National Ratings denote the highest rating assigned by the agency in its National Rating scale for that country. This rating is assigned to issuers or obligations with the lowest expectation of default risk relative to all other issuers or obligations in the same country.

KEY RATING DRIVERS

Strong Financial Profile: Fitch expects PGN's credit metrics to weaken over the medium term due to a decline in margins, slow volume growth and elevated capex. However, we expect the company to maintain a credit profile appropriate for its standalone 'BBB' rating level, with funds flow from operations (FFO) to adjusted debt remaining below 4.0x. PGN's IDR is constrained by the rating on the Republic of Indonesia (BBB-/Stable) because the government owns 57% of the gas distribution company.

Likely Decline in Margins: PGN's gas distribution margin, which is a key determinant of its operating cash generation, has been robust at USD3.5-4 per million British thermal units (mmbtu). However, we believe margin is likely to be lower in 2015 and beyond due to a lack of further cheap pre-paid gas volumes, a weaker Indonesian rupiah against the US dollar, likely lower margins on R-LNG (regasified liquefied natural gas) sales compared with piped gas, and lower earnings from surcharges levied on customers for using gas above their contracted volumes.

Slow Sales of R-LNG: R-LNG is the primary source of incremental gas supply for PGN, but the company has faced difficulty selling this form of gas due to its higher cost compared with piped gas from fields in Sumatra and Java. Piped gas supply could shrink due to maturing fields and delays in development activity. We believe R-LNG sales pick-up is likely to be slow. Consequently, PGN's distribution volume growth over the next few years would be limited to the low single-digits.

Sustained High Capex: PGN's investments picked up in 2013-14 to USD1.4bn in 2014 from USD160m in 2012, driven mainly by upstream acquisitions. Capex was also undertaken to enhance gas infrastructure in Indonesia, such as the development of the Lampung R-LNG network in South Sumatra. We expect the pace of investments to be sustained, with spending needed to continue gas infrastructure projects to support Indonesia's policy of increasing gas usage and development of its upstream assets.

Regulatory Risks: PGN is susceptible to regulatory intervention aimed at its influence in Indonesia's gas market. Among these is the long-standing issue of granting open-access to its distribution pipelines, which could impact PGN's business. While PGN's standalone credit profile of 'BBB' incorporates general regulatory risks in Indonesia, a regulatory development that materially impacts PGN financial profile will be treated as an event risk.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Piped gas volume of 860mmcf/d in 2015 and a 5% decline thereafter. We assume R-LNG sales volume of 35mmcf/d in 2015, and a gradual increase to 200mmcf/d by 2018.
- Distribution margin of USD3.25/mmbtu in 2015, rising gradually to USD3.40/mmbtu by 2018. We factor in a gradual strengthening of the rupiah, as well as improved margin on R-LNG sales.
- 2015 capex at USD1.4bn, and around USD1bn annually thereafter, based on company guidance. We expect spending to be almost equally split between its transmission/distribution business and its upstream operations.
- Dividend payout of 45% of net income in 2015 and thereafter, compared with an average of 51% over 2011-14. Our lower payout assumption factors in sustained high levels of capex by PGN to support the government's policy of improving gas usage in Indonesia, and a relatively weak rupiah.

RATING SENSITIVITIES

Negative: Future developments that may collectively or individually lead to negative rating actions include
-Negative rating action on the sovereign, as PGN's ratings are constrained by the sovereign's

Positive: Future developments that may collectively or individually lead to positive rating actions include
-Positive rating action on the sovereign

PGN's 'BBB' standalone profile could be negatively affected due to
- Major negative regulatory developments
- Financial leverage as measured by total adjusted debt to FFO increasing to over 4.0x on a sustained basis (2014: 1.8x).

In the event PGN's standalone ratings fall below that of Indonesia, a rating uplift of one-notch would be provided on account of its strategic linkages with the state, as per Fitch's Parent and Subsidiary Linkage methodology.

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.