Lippo's Assets in Greater Jakarta - Photo by Lippo Karawaci

JAKARTA (TheInsiderStories) – Fitch Ratings Indonesia has downgraded foreign currency and local longterm ratings of PT Lippo Karawaci Tbk (IDX: LPKR) and a US dollar bond rating issued by Theta Capital Pte Ltd, guaranteed by Lippo and several of its subsidiaries, from B to CCC+.

At the same time, the agency has lowered the company’s national longterm rating and set a negative outlook. All ratings have been released from the Negative Watch Rating, which was previously set on May 3, 2018.

It said, the downgrade follows a significant weakening of the cash flow of Lippo property development amid to weak ongoing demand for the company’s products due to the company’s focus on middle and upper segment customers and weak execution of several projects which resulted in delayed completion of projects and reduced strength of the Lippo brand.

In Fitch’s view, could get worse with allegations of bribery and investigations of corruption cases relating to the Meikarta Project, Lippo association owned by 27 percent, PT Makhota Sentosa Utama. It said, the profile of Lippo credit could weaken further if there were large financial liabilities.

Lippo has postponed the launch of several of its projects in an effort to maintain margins in challenging property market conditions, mainly due to the most affected Lippo demographic target. The company plans to sell several non-cores assets to finance operational cash flows and interest payments in the next few years, which makes liquidity risk higher at the parent level standalone, because the sale of assets is exposed to market risk and potential delays are beyond management’s control.

However, Lippo has sufficient liquidity in the next 12 months, supported by the sale of a portion of First Real Estate Investment Trust (First REIT) in October 2018 amounting to SG$202 million and a controlled debt maturity schedule, where the next significant maturity – and not yet collected – is an unsecured bond amounting to $75 million due in June 2020. Liquidity is expected to be sufficient until the end of 2020 when calculating the potential sale of Lippo Puri Mall in the next six months.

However, Fitch added, the Group must be able to demonstrate the ability to significantly increase the sales of its property business so that operational cash flows, before taking into account the sale of non-core assets, are positive. If it fails to do this, the company may find it difficult to refinance unsecured bonds of US$410 million due in 2022.

Negative Outlook on Long-Term National Ranking reflects the possibility of a further downgrade if Lippo is unable to sell assets according to plan for the next six months.

The National Rating of ‘BB’ shows an increased risk of default relative to other issuers or debt securities in Indonesia. In the Indonesian context, uncertain payments to a certain extent and capacity for timely repayment remain more vulnerable to adverse economic changes over time.

KEY RATING DRIVERS

Uncertainty over Asset Sales: Lippo plans to sell Lippo Mall Puri in 1Q19 to Lippo Malls Indonesia Retail Trust (LMIRT) and also has allocated several other assets for sale if needed. However, such sales have significant market uncertainties and risks which are beyond management’s control.

For example, LMIRT shareholders have not given approval in terms of Puri Mall purchases and if approved, LMIRT is likely to have to raise equity to finance the purchase because the trust does not have enough headroom to meet the 45 percent gearing limit regulation to fully finance the purchase. Lippo must also contribute to the portion of its equity in accordance with 31 percent of its share ownership in LMIRT or sell the portion of its shares.

Lippo is expected to complete its sales in 4Q18 but the transaction encountered several delays. Fitch also sees that LPKR has a limited ability to continue to sell its assets because of its large and mature inventory assets with good quality continues to decrease.

Divestment from First REIT Supporting Liquidity: Lippo has sold 17.6 percent shares of First REIT on Oct. 26, 2018 to an affiliated company, OUE Lippo Healthcare Limited. Fitch estimates that the funds can support Lippo liquidity in the next 12 months and allow companies to pay debt obligations that are due in the near future.

However, sales also reduce recurring cash flows from asset-management revenue and dividends. Although recurring cash flows are relatively small against the Lippo property development business, this shows a significant shortfall in operating cash flows where Lippo must sell some of its attractive investments.

Weakened Property Development Model: Lippo has a land reserve of around 1,326 hectares, which, together with its property inventory, has a book value of Rp21.7 trillion at the end of June 2018. However, the company’s ability to monetize land reserves and inventories has weakened due to many projects delayed and weak execution.

Lippo sells around Rp393 billion of its property in 2017 from its inventory through projects of various levels in the completion phase. The company’s main focus for pre-sales is these projects in the next two years. The company has significant land reserves, including land in strategic locations, but there are no plans to launch new projects until property demand improves.

DERIVATION SUMMARY

The Lippo Long-Term Rupiah rating is driven by the weakening of its property business sales which have increased liquidity risk, the company’s dependence on asset sales to finance its debt obligations and also the risk of further downgrading if Lippo cannot execute its short-term plan.

Lippo National Long-Term Rating is one notch lower than PT Greenwood Sejahtera Tbk (BB (idn)/Stable). Greenwood’s credit profile is supported by recurring cash flows from office building rentals plus dividend income from its investments in several shopping mall malls.

This provides healthy interest coverage. Greenwood’s ratings are constrained by Fitch’s expectations that the company will accelerate construction from the Capital Square project until 2020, although its pre-sales remain weak – where there are no property sales in 2018 – and the strategy can increase debt and weaken liquidity.

However, Fitch sees Greenwood has greater flexibility in delaying its construction burden to be adjusted to its liquidity when compared to Lippo

ASSUMPTIONS KEY

The main assumptions of Fitch used for the Company’s rating case include:

– Pre-sales of Rp600 billion per year from projects that already exist in 2018 to 2020
– Annual income from non-property development business of Rp1.5 trillion in 2018 to 2020 (2017: Rp1.5 trillion)
– Annual operational cash outflows of Rp1.6 trillion in 2019 and Rp1.7 trillion in 2020, before calculating funds obtained from potential asset sales (2017: Rp1.3 trillion)

Assume Recovery Ratings:

– We assume that Lippo will be liquidated in a bankruptcy situation because the company is engaged in the asset sales business segment
– To estimate the value of liquidation, we assume an advance rate of 75 percent of receivables and an advance rate of 50 percent of adjusted inventories and fixed assets
– In our calculation of adjusted inventory, we estimate the market value of investment property and Lippo hotels at Rp8.3 trillion using the rate of market capitalization and also the latest market valuation from Lippo Mall Puri. We do not calculate per value

Its reported stocks of Rp13.3 trillion due to our view that the company’s property development business will be difficult to recover in the next two years, so the value of land reserve realization is difficult to estimate – Bank loans of Rp1.93 trillion have a higher rating compared to USD Lippo bonds which is not guaranteed – Reduces 10 percent from the calculation of liquidation value as an administrative claim – The above calculation results in a recovery of 44% of Lippo debt that is not guaranteed, which is ‘RR4’ Recovery Rating for US dollar bonds that are not guaranteed.

SENSITIVITIES RATING

Positive: Developments that can, individually or collectively, trigger positive rating actions include. Fitch does not expect a rating increase until Lippo shows its ability to significantly improve its property sales and sustainability, where cash flows from operations at the standalone parent level are no longer negative. Furthermore, outlook on National Long-Term Ranking can be revised to Stable if Lippo can sell Puri Mall in the short term, as planned

Negative: Developments that can, individually or collectively, trigger negative rating actions include the inability of companies to execute plans for assets to be sold, and cause companies to not be able to finance their debt obligations in the next six to 12 months

LIQUIDITY AND DEBT STRUCTURE

Sufficient Short-Term Liquidity: Lippo has a cash of around Rp801 billion at the standalone holding company level – that is, it does not take into account 51 percent owned PT Siloam International Hospitals Tbk (IDX: SILO) and 54 percent owned by PT Lippo Cikarang Tbk (IDX: LPCK)- at the end of September 2018.

Companies are required to have cash positions at least Rp800 billion in standalone holding companies as part of a covenant of working capital loans of $50 million from a consortium of foreign banks, where the maturity date has been extended to April 2019.

LPKR is expected to pay $50 million in working capital loans in April 2019, and also domestic bank debt of Rp107 billion in the next 12 months, using cash received from the sale of First REIT.

Fitch also expects Lippo to extend a guaranteed short-term working capital loan of IDR660 billion with a local bank, because local banks are likely to provide greater flexibility, especially because of the assets secured by the asset.

Based on Fitch’s policy, the issuer appealed and provided additional information to Fitch which resulted in a rating action that was different from the conclusion of the previous ranking committee.

Fitch has consolidated Siloam and Lippo Cikarang from Lippo financially on a consolidated basis in its rating to reflect the limited ability of Lippo to access cash flows from its subsidiaries.

Written by Staff Editor, Email: theinsiderstories@gmail.com

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