Fitch Ratings has upgraded Indonesia-based property developer PT Pakuwon Jati Tbk's (PWON) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BB'.

The Outlook is Stable. The agency also upgraded PWON's senior unsecured rating and the rating on its USD400 million notes due 2028 to 'BB+' from 'BB'.

The upgrade reflects PWON's strong non-development cash flow growth as its asset portfolio stabilises post-Covid, and its ongoing conservative financial profile. We expect non-development cash flow - the company's main income source - to continue to improve under its growth plans. We also view the increased development risk from new greenfield projects to be manageable as the company has sufficient rating headroom to absorb its planned capex.

Key Rating Drivers

Strong Non-Development Cash Flow: Fitch forecasts non-development EBITDA to reach IDR2.7 trillion in 2024, underpinned by higher rental and service-fee income, as well as a continued growth in the hotel segment. We expect non-development EBITDA to continue to grow to more than 80%-85% of total EBITDA in the next few years, driven by higher occupancy, positive rent reversion, as well as additional income from Bekasi Mall which will open in November 2024.

Strong Recovery Post-Covid: We expect the company to maintain positive rent reversion and shopping mall occupancy above 90% in 2024. Most of its malls are in integrated developments next to residential properties, offices and hotels, supporting higher footfall than at standalone malls. Shopping malls recently acquired, such as those at Yogyakarta and Solo, have achieved strong occupancy rates after the completion of asset-enhancement initiatives.

Robust Portfolio, Concentrated Assets: PWON's rating is driven by its well-located investment properties in Indonesia's most affluent cities - Jakarta and Surabaya - which generate solid non-development EBITDA. We believe the top-four assets' quality mitigates concentration risk, of which more than 80% of non-development revenue are from four mixed-use projects.

Increased but Manageable Development Exposure: We expect PWON to maintain comfortable rating headroom despite anticipated higher capex and potential acquisitions, with non-development EBITDA/net interest expense well above the 4.0x negative sensitivity. PWON will spend about IDR7.5 trillion through to 2029 to develop new superblocks in Batam and Semarang, expand its malls' net lettable area by 36% to 1,067,000 sq m, and increase hotel rooms by 75% to 3,997.

To support long term portfolio growth, we forecast spending of up to IDR1.1 trillion in 2024 and about IDR800 billion a year subsequently on opportunistic acquisitions of land and operational assets. We expect expansion to be comfortably funded by its cash balance and strong internal cash flow.

Prudent Project Execution: We expect PWON to continue to be prudent in developing mixed-used projects despite multiple new greenfield projects in Ibu Kota Nusantara, Batam and Semarang in the medium term. Each superblock development is multi-phased, extending over seven to eight years, with staged construction of residential and commercial components. We expect PWON to be able to secure enough presales to fund construction of the for-sale properties.

Steady Contracted Sales: We expect presales to remain steady at IDR1.4 trillion in 2024, as the value-added tax (VAT) rebate announced in November 2023 will support demand. It provides a 11% discount on the first IDR2 billion of the value of houses sold and handed over by end-June 2024, with half of the discount applying thereafter until end-2024. PWON's medium-term presales should be driven by newly launched high-rise apartments in existing and new superblocks.

Presales, however, might be affected by rising mortgage rates following recent interest-rate increases and a planned VAT rise in January 2025. Nevertheless, Indonesia's long-term housing demand will be supported by a young population and rapid urbanisation, driving economic growth. We forecast GDP growth to remain healthy at 4.9% in 2024 and 5.3% in 2025. Domestic banks will remain supportive of consumer home loans despite an expected increase in mortgage rates.

Derivation Summary

PWON is rated two notches higher than PT Bumi Serpong Damai Tbk (BSD, BB-/Stable) due to its much larger non-development EBITDA, which has proven more resilient to economic downturns than the homebuilding sector. PWON's non-development EBITDA stems from premium well-located shopping malls with strong tenants in mixed-use superblocks, while BSD's mainstay is its property development business which is more cyclical. BSD also has a smaller portfolio of standalone offices, less-prime hotels and smaller strata-title shopping malls than PWON which faces greater challenges from e-commerce.

This, together with PWON's stronger balance sheet, supports a two-notch higher rating and offsets risks from PWON's property-development business, which is smaller in scale and focuses on narrower products and price points than BSD.

PWON is rated multiple notches higher than Lippo Malls Indonesia Retail Trust (LMIRT, CC) due to its stronger investment-property portfolio, which has larger and better-quality retail malls with higher occupancy located in mixed developments, and solid liquidity. PWON has no debt maturity until 2028 while LMIRT's rating reflects the high likelihood of a debt restructuring or a distressed debt exchange (DDE) on its term loans and notes due June 2024. These factors more than offset PWON's for-sale property-development risks, which LMIRT does not have. PWON's strong financial profile stems from its conservative approach to property development and expansion.

InRetail Real Estate Corp. (BBB-/Stable) is a leading shopping mall operator in Peru. The underlying business profile is stronger than that of PWON, driven by higher portfolio liquidity and leveragability and more granular assets that more than offset their weaker financial profiles. PWON derives about 60% of its non-development revenue from three key assets, while the peers generate roughly the same proportion from 10-15 assets. InRetail's investment-grade rating reflects its parent's consolidated profile, which has diversified businesses in food, pharmacy retail and shopping malls.

Key Assumptions

Fitch's Key Assumptions within our Rating Case for the Issuer

Mall occupancy at 93% in 2024 and 92% in 2025 (2025 occupancy includes Bekasi Mall which is slated to open in November 2024)

Overall occupancy, including office and hotels, estimated to rise to 86% over the same period

Positive rent reversions on retail leases

Non-development EBITDA of IDR2.7 trillion in 2024 and IDR2.9 trillion in 2025 (2023: IDR2.6 trillion)

Pre-sales of IDR1.4 trillion in 2024 and IDR1.5 trillion in 2025 (2023: IDR1.3 trillion)

Capex and discretionary acquisition of land and operational assets totalling IDR1.9 trillion in 2024 and IDR1.7 trillion in 2025 (2023: IDR1.4 trillion)

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

We do not expect an upgrade in the medium term due to PWON's asset concentration and exposure to the more cyclical homebuilding segment.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

A sustained decline in non-development EBITDA, including falling occupancy rates and negative rental reversions for a sustained period

Non-development EBITDA/net interest expense falling to below 4.0x for a sustained period

Liquidity and Debt Structure

Strong Liquidity, Concentrated Funding: PWON's liquidity was supported by IDR7.6 trillion in cash at end-2023, against estimated negative FCF of IDR177 billion. There are no debt maturities until 2028, when all debt - comprising USD400 million unsecured notes (around IDR6.5 trillion at today's exchange rate) - is due.

We expect PWON to use its cash balance for expansion over the next few years and to maintain a prudent balance sheet in line with its record. PWON is currently entirely reliant on capital-market debt, but has a strong record of liquidity management and has benefited incrementally from lower funding costs.

Issuer Profile

PWON is one of the leading integrated property companies in Indonesia. Most of its cash flow stems from its portfolio of rented shopping malls, offices and hotels, with property-development cash flow accounting for a minority. PWON owns and operates 11 malls, five offices, seven hotels and two serviced apartments.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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