Fitch Ratings has downgraded Indonesia-based garment manufacturer PT Pan Brothers Tbk's (PB) Long-Term Issuer Default Rating (IDR) to 'RD' from 'C'.

Fitch has also affirmed PB's USD171 million of senior unsecured notes due January 2022, issued by PB International B.V., at 'C' with the Recovery Rating remaining at 'RR4'. At the same time, Fitch Ratings Indonesia has downgraded PB's National Long-Term Rating to 'RD(idn)' from 'C(idn)'.

The downgrade to 'RD' follows events of default due to non-payment under various banking facilities and the expiry of the standstill agreement period on 12 February 2021. No further extension on the standstill has been unanimously agreed by all the syndicated and bilateral lenders at this stage, despite ongoing discussions.

'RD' National Ratings indicate an issuer that, in Fitch's opinion, has experienced an uncured payment default on a bond, loan or other material financial obligation but that has not entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, and has not otherwise ceased business.

KEY RATING DRIVERS

Missed Payment: The downgrade reflects the non-payment under banking facilities following the expiry of the standstill agreement. Accordingly, the banks may elect to accelerate and enforce the bilateral loans and USD138.5 million syndication loan. The non-payment has caused a default on its USD171.1 million bonds maturing in January 2022. However, the bonds will only be accelerated if at least 25% of the holders choose to do so, which has not happened yet.

The company continues to negotiate with the banks in respect of an extension the standstill period from 12 February 2021 until end-March 2021, but formal approval from all the lenders has not been forthcoming.

Lengthy Negotiations: PB is also continuing discussions with lenders and targets to finalise the terms of the loan extension by end-March 2021. However, there is currently uncertainty on the timeline of the loan extension, with discussion protracted due to multiple lenders involved, which may delay PB's planned USD350 million bond issuance. PB is seeking a 'one-plus-one' extension of the loan by two years to end-January 2023, whereby the second year from end-January 2022 to end-January 2023 will be subject to the refinancing or restructuring of its USD171 million bond due January 2022 into a longer tenor.

Negative Cash Flow: PB's cash flow from operations is consistently negative because its business requires heavy working capital. New customer acquisitions have stretched the working-capital cycle. PB plans to shorten the working-capital cycle with technology and automation, and is reviewing its raw-material supply with a preference for local suppliers. However, the working-capital revamp will take time and, therefore, PB's growth remains reliant on external funding, which may prove to be challenging given the negotiations with its existing lenders on its defaulted loans.

ESG - Governance: PB has an ESG Relevance Score of '5' for Management Strategy because of management's inability to complete the extension of the syndicated loan before maturity. There are also higher refinancing risks as PB continues to negotiate with banks without receiving formal approval to extend the standstill agreement period.

DERIVATION SUMMARY

PB's downgrade to 'RD' reflects the payment default on its bilateral loans and USD138.5 million syndication loan has remained uncured after the standstill agreement period expired on 12 February 2021 with uncertainty on further standstill extension.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Net sales growth of 5% in 2020, 2% in 2021 and around 8% in 2022-2023 (2019: 9%);

EBITDA margin of between 9% and 10% in 2020-2023 (2019: 9%);

Capex of around 2% of revenue in 2020-2023 (2019: 2%).

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that PB would be reorganised as a going-concern in bankruptcy rather than liquidated. We assume a 10% administrative claim

Going-Concern Approach

The going concern EBITDA estimate reflects Fitch's view of a sustainable, post-reorganisation EBITDA level upon which we base the enterprise valuation.

We estimate EBITDA at USD62 million; this is 5% lower than the last 12 months 3Q20 EBITDA to reflect the industry's mid-cycle conditions and competitive dynamics.

An enterprise value multiple of 5x EBITDA is applied to the going-concern EBITDA to calculate a post-reorganisation enterprise value. The multiple reflects a discount from the median global multiple of 9x for completed M&A transactions in the textile industry over the past decade, based on Bloomberg data. The 5x multiple also reflects PB's smaller size compared with global manufacturers.

We also assume fully drawn syndicated and short-term loan facilities - which have priority over senior unsecured debt - to the extent allowed by the bond indenture.

The going-concern enterprise value covers 71%-90% of PB's unsecured debt, corresponding to a 'RR2' Recovery Rating for the senior unsecured notes after adjusting for administrative claims. Nevertheless, Fitch has rated the senior unsecured bonds 'C'/'RR4', because, under our Country-Specific Treatment of Recovery Ratings Criteria, Indonesia is classified under the Group D of countries in terms of creditor friendliness, and the instrument ratings of issuers with assets located in this group are subject to a soft cap at the issuer's IDR

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch will reassess PB's capital structure and liquidity when the extension of the USD138.5 million syndicated loan is secured.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Fitch will further downgrade to 'D' if PB enters into bankruptcy proceedings, administration, receivership, liquidation or other formal winding-up procedures or if it ceases operations.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Standstill Expired: We view PB's refinancing risk as high, given the company is still in lengthy negotiations with banks to finalise the extension terms of its USD138.5 million syndicated loan, which matured on 27 January 2021. Furthermore, the standstill agreement ended on 12 February 2021 with the standstill extension proposal until end-March 2021 yet to be approved by all the lenders.

The company's liquidity to fund its operations remains tight with the potential delay of the launch of the USD350 million bond, a cash position of USD52 million at end-September 2020 and consistent negative cash flow from operations due to prolonged working-capital cycle.

SUMMARY OF FINANCIAL ADJUSTMENTS

Fitch includes advance payments, which are mostly for raw materials, as part of the working-capital calculation.

Fitch assumes USD25 million of year-end cash will be restricted, reflecting cash set aside for seasonal working-capital purposes

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

PB has an ESG Relevance Score of '5' for Management Strategy due to management's inability to complete the extension of the syndicated loan before its maturity while its standstill agreement period has expired. This has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING	RECOVERY	PRIOR
PT Pan Brothers Tbk	LT IDR	RD 	Downgrade		C
	Natl LT	RD(idn) 	Downgrade		C(idn)

PB International B.V.

senior unsecured

LT	C 	Affirmed	RR4	C

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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