Sep 4, 2011

Moody's confirms B3 for Gajah Tunggal

Moody's Investors Service has confirmed PT Gajah Tunggal Tbk's (GJTL) B3 corporate family and senior secured ratings. 
The outlook for both ratings is stable. This closes the review action initiated on July 08, 2011 following publicity surrounding an alleged claim of covenant breach by an anonymous bondholder. 
The situation arose after the payment of a dividend to shareholders which could potentially be construed as being in contravention of the terms of Gajah Tunggal's restructured bonds. 
In Moody's view, the risk of an event of default being called on the basis of the dividend payments between now and the bond's maturity in July 2014 is remote. 
However, the decision to pay dividends before the bond's coupon returned to 10.25% is, in Moody's view, a clear instance of management passing some of the interest, surrendered by bondholders in 2009, to shareholders. 
"It seems that there was no appetite among bondholders to challenge the payments and so the trustee had no obligation to take the matter further" said Alan Greene, a Moody's Vice President and Senior Credit Officer. 
"Our focus now is on the company's performance over the next 3 years and whether GJTL can successfully address the principal repayment risk" said Greene. 
The bond is structured to encourage GJTL to reduce the amount outstanding. As well as a coupon step-up, from 6% now, to 8% in July 2012 and 10.25% in July 2013, there is a requirement to repurchase 10% of the initial par amount by July 2013. 
Furthermore, Gajah Tunggal can now, at any time, buy in all or part of the bond, on the market or at 100%. 
"In the past, Gajah Tunggal has simply refinanced maturing debts with ever larger bonds, as the business cycle of the tire industry, in terms of margins and capital expenditure, has seemingly driven events. Given the flexibility of the bond terms, there is an opportunity for active management of its future debt maturity profile," said Greene, who is also Moody's Lead Analyst for Gajah Tunggal. 
The rating outlook is stable. Moody's is mindful of how the free cash flow might be impacted over the next one to two years by an accelerating capex programme, the impact of higher raw material costs on prices and margins and the effect on working capital needs of both inflation and the rising exposure to the original equipment market. 
At the same time, Gajah Tunggal's debt service burden is rising and the rating remains sensitive to corporate governance concerns. 
The B3 ratings are unlikely to be upgraded in the near future. However, moves to address the challenges of the discrete bond repayment well before July 2014, coupled with the maintenance of margins, will assuage many concerns and point to a sustainable balance of business and financial risk. 
The achievement of free cash flow to adjusted debt of over 5% on a sustainable basis could point to upward pressure on the rating. 

Disclosure: No position at the stock mentioned above.

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