S&P places PT Gajah Tunggal 'B' rating On Watch Negative

Standard & Poor's Ratings Services said today that it had placed its 'B' long-term corporate credit rating on Indonesia-based tire manufacturer PT Gajah Tunggal Tbk. on CreditWatch with negative implications. We also placed our 'B' issue rating on the company's senior secured notes on CreditWatch with negative implications. 

We placed the ratings on Gajah Tunggal on CreditWatch to reflect the risk that the company's liquidity could significantly weaken if its recent dividend payment constitutes a covenant breach under the terms of its 2009 restructured bonds. 

On June 30, 2011, Gajah Tunggal paid Indonesian rupiah (IDR) 41.8 billion in dividends out of its 2010 profits. The company made the payment before July 21, 2011, the date on which the interest rate on the restructured bonds will increase to 6% from 5%. 

"We need more clarity on whether such action constitutes a covenant breach," said Standard & Poor's credit analyst Xavier Jean. 

"The covenants of Gajah Tunggal's restructured bonds restrict the company from making dividend payments under a number of circumstances, including before the interest step-up date. But the covenants also indicate that Gajah Tunggal may pay dividends before the interest step-up date if the Indonesian law requires the company to do so before that date." 

Gajah Tunggal does not consider the dividend payment as a covenant breach and has indicated that it will issue a formal response to its bondholders. 

We believe litigation risks from holders of the restructured bonds could arise if the dividend payment constitutes a covenant breach. An accelerated repayment of the principal of the restructured bond would severely impair Gajah Tunggal's liquidity and heighten the risk of default, in our opinion. 

The face value of the bond at about US$435 million (including US$10 million in contractual amortization to be repaid on or before July 21, 2011) is significantly larger than the company's cash and cash equivalents of about US$130 million as of March 31, 2011. 

However, we believe Gajah Tunggal's liquidity is adequate to service the partial principal amortization of about IDR85 billion and the coupon of the 2009 restructured bond in July 2011, given the company's cash balance of IDR466 billion as of March 31, 2011. 

The rating on Gajah Tunggal reflects the company's highly leveraged financial risk profile, its exposure to a cyclical and volatile industry, and its limited financial flexibility. Gajah Tunggal's competitive cost position and leading share in the Indonesian tire market temper these weaknesses. 

We aim to resolve the CreditWatch in the next three months, or sooner, when we have greater clarity on whether the dividend payment before the step-up date constitutes a covenant breach, and on the likelihood of bondholder litigation. 

We may lower the rating on Gajah Tunggal by multiple notches if the dividend distribution constitutes a covenant breach. Conversely, we may affirm the rating and remove it from CreditWatch if the dividend payment does not constitute a covenant breach.