October 4, 2017 / 10:23 AM / a year ago

Fitch Downgrades Alam Sutera to 'B'; Places on Watch Negative

(The following statement was released by the rating agency) SINGAPORE, October 04 (Fitch) Fitch Ratings has downgraded Indonesia-based property developer PT Alam Sutera Realty Tbk's (ASRI) Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating to 'B' from 'B+' and separately placed the ratings on Rating Watch Negative (RWN). A full list of rating actions is at the end of this commentary. The downgrade reflects ASRI's lower annual contracted sales over the last two years, which Fitch believes is due to the company's weaker sales execution capabilities compared with peers. We do not expect ASRI's scale of operations, as measured by annual contracted sales, to improve materially in the next two years because as much as IDR2 trillion of its sales pipeline still consists of its new-build prime office tower, The Tower, in central Jakarta amid an office-space glut. We believe the still-limited development progress at ASRI's second township in Pasar Kemis is likely to constrain its ability to increase annual contracted sales over the next two years. Nevertheless, ASRI's 'B' ratings benefit from its large low-cost land bank of more than 19 million square metres (sq m), healthy profit margins, moderate leverage and comfortable liquidity. The RWN separately reflects a possible covenant breach of the restricted payment test on ASRI's US dollar bonds, which were issued by its wholly owned subsidiary, Alam Synergy Pte Ltd, and guaranteed by ASRI and its subsidiaries. The test links payment of dividends to successfully passing a debt incurrence test ratio for EBITDA-based interest cover of 2.5x. Fitch believes ASRI missed this covenanted level on certificates during 2016 and potentially on a latest 12 months basis through 1H17. The debt incurrence test has substantial carve-outs for refinancing and additional new debt, limiting liquidity implications, but the restricted payment test, which affects dividends, does not. A small dividend of around IDR29 billion (USD2 million) was declared in July 2017, which Fitch believes may conflict with the restricted payment test, as the test does not have a materiality threshold for failure. It does, however, have a USD10 million threshold test for notifications to the trustee and bondholders. Technically, a breach of this covenant would have no further effect in the absence of a notice from the trustee or bondholders, but creates the potential for a technical event of default under the bonds. ASRI has indicated that they are working to resolve the issue, and we are likely to affirm ASRI's ratings once the company can demonstrate compliance with the covenant or if any breach is regularised via waiver or other action. KEY RATING DRIVERS Pre-Sales Continue to Lag: It remains possible that 4Q17 transactions could meet ASRI's presale target by year-end, but 1H17 presale underperformance underlines the non-negligible execution risk associated with current operations. One major issue is the lack of progress on sales from The Tower, which represented 40% of the original 2017 contracted sales target. Positively, we expect most of ASRI's deliveries to its Chinese development partner, China Fortune Land Development (CFLD), to be delivered during 2017, despite a delay on titles for a small number of parcels. Debt Covenant Potentially Breached: ASRI was below the debt incurrence covenant level as at end-2016. There are significant carve-outs permitting additional debt-raising; refinancing is permitted and the covenant does not apply to new debt of less than IDR270 billion (USD20 million) and also excludes construction and development loans up to 7.5% of total assets up to around IDR1.5 trillion. A restricted payment test, with what appears to be a USD1.00 threshold test, nonetheless potentially prevents dividend payments if the ratio element of the debt incurrence covenant is not met. The modest dividend of IDR29 billion paid in July 2017 potentially breached the covenant Land Sales Hike Concentration: ASRI's liquidity has benefited from its partnership with CFLD in Pasar Kemis, under which CFLD buys raw, zoned land from ASRI's deep local land bank in the area. This offtake does, however, significantly increase concentration around one buyer for a large portion of ASRI's cash flow. CFLD's involvement will accelerate the achievement of critical mass for a development located on the outer-edge of greater Jakarta, but also ties ASRI's own land bank in the area more closely to the development success or failure of a third party. Development Strategy in Mild Shift: ASRI's original Alam Sutera township, located close to Jakarta CBD and served by retail, commercial and increasingly light-business properties, is already approaching a mature phase. Future residential developments will seek to make more use of high-rise units, where ASRI has a shorter record, rather than houses. Commercial projects are also likely to feature condominiums as part of mixed-use developments, notably in potential redevelopment of ASRI's other Jakarta CBD property, the older Wisma Argo Manunggal centre. The property's scheduling will be timed in line with progress on sales from the already-completed The Tower project. Solid Land Bank: The company has a large low-cost land bank and an established domestic franchise. The land bank extended to over 18.9 million sq m available for development with a carrying value of IDR9.4 trillion as at June 2017. In particular, ASRI still benefits from 150 hectares of prime development land bank within the original Alam Sutera township plus adjacent land purchased or under negotiation for purchase from fellow developer, PT Modernland Realty Tbk (B/Stable) and other land owners. Finances Still Stretched: Land sales, including to CFLD, have helped plug lower-than-anticipated presales in a market already facing headwinds from continued supply growth. This prudent move has been at the cost of lowering operating cash flow quality and overall realisation from the company's land bank. Operating cash flow and working capital have been volatile over recent periods, with gross debt climbing as presales and booked revenue fall. DERIVATION SUMMARY ASRI's Long-Term IDR is well positioned relative to peers, such as Modernland and PT Kawasan Industri Jababeka Tbk (B+/Stable). Around half of ASRI's and Modernland's property sales consist of commercial and industrial property. Demand for these types of properties is more cyclical during economic downturns than for residential properties. However, ASRI has a better record of selling residential properties and a larger land bank to support sales compared with Modernland. Still, Modernland has demonstrated stronger sales execution during the recent downturn. These reasons, combined with our view that both companies will maintain comparable leverage levels, supports similar ratings. Jababeka is one of Indonesia's largest industrial property developers, but its Long-Term IDR is primarily driven by the strong recurring cash flows it derives from its thermal power plant, which has a 20-year power purchase agreement with the state-owned PT Perusahaan Listrik Negara (Persero) (BBB-/Positive), as well as from its dry port. These cash flows provide adequate cover for Jababeka's interest expenses across economic cycles. The stability of its recurring cash flow supports a higher rating than for ASRI, whose property sales have been volatile in the last two years. The cyclicality of Jababeka's industrial property sales are counterbalanced by limited infrastructure and capex requirements. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Annual contracted sales of around IDR3 trillion in 2017 and 2018 - The pace of cash collection to increase in the next two years because sales to CFLD and from commercial properties will make up a larger portion of ASRI's contracted sales than in the past - 40% of the refundable IDR1.4 trillion deposit received from CFLD, which is in an escrow account to be deployed against land acquisitions, has been treated as restricted cash - EBITDA margins to remain between 65%-70% in the next two years (2016: 60%), supported by the higher mix of land sales and commercial properties in the pipeline - ASRI to spend around IDR600 billion and IDR1 trillion on land banking in 2017 and 2018, respectively RATING SENSITIVITIES Future Developments that May, Individually or Collectively, Lead to Positive Rating Action -Resolution of RWN to Stable Outlook: Confirmation of compliance with or regularisation of the relevant covenant under the restricted payment test on ASRI's US dollar bonds - Upgrade to 'B+': Annual contracted sales, including sales to CFLD, sustained at more than IDR3.5 trillion -Upgrade to 'B+': Net debt/adjusted inventory sustained below 50% Future Developments that May, Individually or Collectively, Lead to Negative Rating Action -Resolution of RWN to downgrade: Non-compliance or failure to resolve non-compliance with the relevant covenant under the restricted payment test on ASRI's US dollar bonds -Downgrade to 'B-': Net debt/adjusted inventory above 60% for a sustained period -Downgrade to 'B-': Significant weakening in liquidity LIQUIDITY Satisfactory Liquidity: Structurally, the liquidity schedule looks manageable. Only modest maturities of less than IDR400 billion a year from amortising construction and development loans are due each year until 2020, when we expect the local bank market to be accommodating if cash flow do not permit deleveraging. ASRI employs corridor hedging for its US dollar bonds, which represent 85% of its debt, helping defray the foreign-currency exposure arising from a dollar-funded, rupiah-income profile. FULL LIST OF RATING ACTIONS PT Alam Sutera Realty Tbk --Long-Term Foreign-Currency IDR downgraded to 'B' from 'B+'; placed on Rating Watch Negative - Senior unsecured rating downgraded to 'B' with a Recovery Rating of RR4' from 'B+' with Recovery Rating of RR4'; placed on Rating Watch Negative Alam Synergy Pte Ltd - Long-term rating on USD245 million 6.625% senior unsecured bond due 2022 downgraded to 'B/RR4' from 'B+/RR4', placed on Rating Watch Negative - Long-term rating on USD235 million 6.95% senior unsecured bond due 2020 downgraded to 'B/RR4' from 'B+/RR4', placed on Rating Watch Negative Contact: Primary Analyst Hasira de Silva, CFA Director +65 6796 7240 Fitch Ratings Singapore Pte Ltd. One Raffles Quay South Tower #22-11 Singapore 048583 Secondary Analyst Bernard Kie Associate Director +62 21 2988 6815 Tertiary Analyst Richard Hunter Managing Director +44 20 3530 1102 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Summary of Financial Statement Adjustments - ASRI reports land purchase costs under investment cash flows (capex). We have removed these costs from cash flow from investments and included them under cash flow from operations as working capital (payments made to suppliers under the direct cash flow method). The company reports land bank as a long-term asset on its balance sheet. We have classified land bank as part of current inventory given the nature of ASRI's business of land development and sales. This adjustment was also reflected in the cash flow statement. We have added back capitalised interest to EBITDA to facilitate comparison with peers. All taxation was incorporated in a single line after operating income. We have included IDR560 billion of cash in an escrow account subject to CFLD's co-signature as restricted cash as at end-2016 alongside IDR246 billion of cash held as collateral for mortgages extended to ASRI customers. The blocked cash for land purchases has also been removed from the net debt/adjusted inventory ratio's denominator to reflect that it is earmarked against future inventory. Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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