OREANDA-NEWS. Fitch Ratings Indonesia has affirmed chemicals company PT Pupuk Indonesia (Persero)'s (PTPI) National Long-Term Rating at 'AAA(idn)'. The Outlook is Stable. At the same time, the agency has also affirmed PTPI's National senior unsecured rating and IDR1,699bn senior unsecured bond at 'AAA(idn)'.

'AAA' National Ratings denote the highest rating assigned by Fitch on 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
Rating Equalised with Sovereign: Fitch Ratings equalises PTPI's rating with the sovereign, as government has maintained its programme to subsidise the fertilizer industry through PTPI. We believe that the operational and strategic linkage between PTPI and the sovereign remains strong, based on the agency's Parent and Subsidiary Linkage methodology. The company plays a vital role in supporting national food security through the Public Service Obligation (PSO) scheme and PTPI's long-term revitalisation plan.

Strong Ongoing Government Support: Government support for the fertilizer industry remains strong as it has approved a subsidy allocation of IDR30trn, around 37% of its 2016 non-energy-related subsidy budget. This budget is expected to subsidise up to 9.55 million tonnes of fertilizer to eligible farmers with a farm area of less than 2 hectares, and support more than 20 million households engaged in rice farming.

Beneficiary of PSO Scheme: The PSO scheme will reimburse the excess of production and distribution costs plus a pre-determined margin over government's regulated fertilizer selling price. Government's reimbursement amounted to 40% of PTPI's revenue as of end-September 2015. PTPI, as the sole PSO agent in the industry, allocates 70%-75% of its current total fertilizer sales volume for the subsidised fertilizer programme. This PSO scheme provides protection to margins from the volatility of gas prices and other raw materials

Potential Lower Fixed-Gas Prices: President Joko Widodo issued government's Third Economic Policy Package on 7 October 2015, with one of the main points being that the fertilizer industry will be one of the beneficiaries of a lower fixed-gas price. The gas price is planned to be fixed at below the current price paid by the fertilizer industry of USD6-7 million British Thermal Units (MMBTU). However, the plan which should have been effective as per 1 January 2016, has been delayed until now as government is still finalising the regulation.

In addition, the Ministry of Natural Resources gives the fertilizer industry the second-highest priority in terms of securing gas supply (behind oil lifting, ahead of the electricity-generator industry). This positive government support will be vital to PTPI's operations, as gas accounts around 60%-70% of PTPI's fertilizer production cost.

Increasing Capacity and Efficiencies: PTPI commenced operation of its newest plant, Pupuk Kaltim (PKT)-V, in Bontang, East Kalimantan in November 2015. The new PKT-V plant adds urea and ammonia capacity by 450,000 tons/annum (tpa) and 250,000 tpa, respectively. Meanwhile, newer technologies enable PKT-V to lower urea production costs by around 8MMBTU/ton, hence lowering urea production cost by around USD50/ton. Another plant - PUSRI-llB in Palembang, South Sumatra - is likely to be completed in May-June 2016, and add urea net capacity by another 360,000 tpa. Most of PTPI's plant utilisation rate has got up to around 94%, which should mean that these additional capacities should boost PTPI's fertilizer sales volume.

Improved Efficiencies Benefit Government: Government has not raised regulated fertilizer prices since 2012, in order to provide farmers with affordable prices. This has led to a higher subsidy costs to cover the volatility of fertiliser prices and the costs of the fertilizer production. PTPI will follow PKT-V's efficient model by bringing new technologies to its existing and upcoming plants. PTPI plans to strengthen its logistics - such as purchasing new ships to transport its production more efficiently - to reduce distribution costs. These efficiencies will help reduce government's subsidy burden, and enhances PTPI's non-subsidised fertilizer margins.

Rising Leverage for Expansion: PTPI will undergo heavy debt-funded expansion in the medium term to finance its long-term revitalisation programme, as we expect annual capex to reach IDR15trn per annum in 2017-2018. We view PTPI's operational cash flow as insufficient to finance its revitalisation plan, hence the need to obtain external funding.

Profile Affected by Debt-Funded Expansion: The debt-funded expansion plan will lead to a weakening of PTPI's credit metrics, with EBITDA interest cover falling to under 4.0x over the next few years (2014:5.25x) and leverage increasing to above 4x (2014: 3.46x). However, the company has headroom in its covenants and we view PTPI's access to external funding as good - given its status as SOE, sole PSO agent in the fertilizer industry, and track record of execution.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:

- Continuing subsidy support from government
- Capex of around IDR11.6-15.1trn in 2016-2018
- EBITDA margin around 15%-16% level in 2016-2018
- Government subsidy receivable increases by 5% per annum throughout the forecast horizon.

RATING SENSITIVITIES
No positive rating action is possible, as the company's rating is already at the highest level on the national scale.

Negative: Developments that could, individually or collectively, lead to negative rating action would include:

- Evidence of weakening links with the Indonesian sovereign.