Nov 8, 2010

Gajah Tunggal rating upgraded to B

Standard & Poor's Ratings Services said today that it had raised the corporate credit rating on Indonesia-based tire manufacturer PT Gajah Tunggal Tbk (GJTL) to B from B-. The outlook is stable. 
"We also raised the issue rating on the senior secured notes issued by GT2005 Bonds B.V. to B from B-. We upgraded Gajah Tunggal to reflect the company's rapidly improving profitability, a trend that is in line with broad industry cycles. Although Gajah Tunggal's operating performance and credit protection metrics may weaken over the next six months to 12 months, in our view, they are likely to remain adequate for a 'B' rating," said Standard & Poor's credit analyst Wee Khim Loy in a press statement.
Gajah Tunggal is unlikely to maintain a gross margin of more than 20%, a level it achieved in the first half of 2010. This is because raw rubber prices continue to rise. 
"We expect an EBITDA margin of 14%-17% and the ratio of debt to EBITDA to hover at 2.8x-3.5x in the next six months."
Gajah Tunggal's improved margins are primarily attributable to significantly better EBITDA margins, given lower raw material costs--particularly since the second quarter of fiscal 2009--and stronger demand from its domestic and export markets. 
The EBITDA margin for the rolling 12-month period ended Sept. 30, 2010, was almost 20%, compared with 10.4% for the previous corresponding period ended June 30, 2009. The volatility in margins reflects the high risks inherent in the tire industry.
"We estimate that to meet improved tire demand, Gajah Tunggal's capital expenditure (capex) is likely to increase to about Indonesian rupiah Rp550 billion (or US$62 million) for 2010, or 6% of revenue, and Rp600 billion (US$67 million) for 2011." 
Given the company's intensive capex plans, we expect Gajah Tunggal's ratio of funds from operations (FFO) to debt to moderate to 10%-15%, which we believe is more sustainable. In our view, its free operating cash flow will remain negative in the next six to 12 months until cash flow contributions from ramped-up production come onstream.
After the completion of an exchange offer in July 2009, Gajah Tunggal lengthened its debt maturity profile to 2014 from 2010 and lowered its interest expenses by half. 
The company strengthened its ratio of debt to EBITDA to 2.3x and EBITDA interest cover to 4.3x for the rolling 12-month period ended Sept. 30, 2010. That compares with a ratio of debt to EBITDA of 5.8x and EBITDA interest cover of 1.4x in the previous corresponding period ended June 30, 2009. 
The company's ratio of FFO to debt held up well, at almost 40%, due to substantially tighter controls over working capital and reduced capex. The company cut capex for 2009 to IDR335.6 billion, or 4% of revenue.
"In our view, Gajah Tunggal's liquidity is adequate. Its cash balance and short-term investments of Rp1.04 trillion at Sept. 30, 2010, was sufficient compared with short-term debt of Rp80.9 billion, which is mostly interest payable."
But, Gajah Tunggal's financial flexibility is limited, as its back-up liquidity arrangements remain weak. However, given the improved cash flow generation from higher revenue.
"We expect Gajah Tunggal to internally fund working capital needs in the next six to 12 months. In addition, by lengthening its debt maturity profile to 2014 from 2011, the company has alleviated potential short-term liquidity pressures."

Disclosure: No position at the stock mentioned above. 

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