KAPAR ENERGY VENTURES SDN BHD - 2016

MARC has affirmed its AA+_IS rating on Kapar Energy Ventures Sdn Bhd’s (KEV) RM2.0 billion Sukuk Ijarah (sukuk) but revised the outlook to negative from stable.

The affirmed rating incorporates a two-notch uplift from KEV’s standalone rating of AA- based on MARC’s continued assessment of a high probability of parental support from KEV’s majority shareholder, Tenaga Nasional Berhad (TNB), which carries a senior unsecured rating of AAA/Stable. The assessment considers TNB’s strategic interest in KEV and the strong financial and operational linkages between them. KEV is the owner and operator of Kapar Power Station (KPS), the largest domestic multi-fuel thermal power station with a nominal capacity of 2,420MW. The sukuk is backed by operational revenue derived from a 25-year power purchase agreement with TNB expiring in 2029.

The negative outlook reflects the weakened operational performance of KEV’s multi-fuel thermal power station, leading to low liquidity buffer to meet its near term debt obligations. MARC notes that the recurring multiple operational issues at KEV’s four generating facilities (GF) contributed to lower capacity payments (CP) of 14.0% and 15.2% below the projected capacity revenue for the financial years ended August 31, 2015 (FY2015) and 1HFY2016 respectively. In particular, KEV’s GF2 and GF3 achieved average rolling unplanned outage rates (UOR) that sharply exceeded the stipulated unplanned outage limit of 6%. KEV has undertaken rectification measures, among which were upgrades mainly targeting boiler tubes and cooling water pumps, to mitigate significant UOL breaches from occurring going forward. The measures enabled KEV to reduce the combined rolling UOR of all four GFs to 8.7% as at end-1HFY2016.

For FY2015, KEV recorded a significant increase of 40.0% y-o-y in CP amounting to RM558.0 million, due largely to the recovery of GF3 from an extended unscheduled outage in FY2014, reducing its UOR to 18.1% from 45.4%. KEV recorded lower energy revenue of RM1.4 billion (FY2014: RM1.9 billion) on lower energy prices but fuel cost was fully passed through to TNB. The improvement in capacity revenue led to higher operating profit of RM86.6 million (FY2014: RM43.7 million). However, KEV registered pre-tax losses of RM198.3 million (FY2014: negative RM147.3 million) due to high finance costs. MARC opines that KEV’s profitability will remain under pressure given that the operational issues of the GFs have not been fully resolved.

KEV registered weaker operating cash flow of RM89.3 million (FY2014: RM180.5 million) despite higher CP in FY2015 due to increased working capital requirements. Coupled with high financing obligations of RM271.1 million due in FY2015, the company’s cash and cash equivalents declined to RM28.9 million (FY2014: RM229.4 million). Nonetheless, the outstanding amount in the finance service reserve account of RM241.5 million as at February 28, 2016 was sufficient to meet the principal repayment of RM180.0 million and profit payment of about RM37.6 million due on July 5, 2016. KEV’s finance-to-equity (FE) ratio of 69:31 as at January 6, 2016, which is well within the covenanted FE ratio of no more than 80:20, benefits from equity treatment accorded to its redeemable unsecured loan stocks (RULS). The current principal outstanding balance of the RULS is RM853.6 million following principal repayments of RM38.0 million and RM12.0 million in FY2015 and 1HFY2016 respectively.

KEV’s liquidity position remains sensitive to extended plant underperformance and higher-than-projected repair and maintenance costs. For FY2017, KEV is expected to generate free cash flow of RM409.0 million to cover the next sukuk repayment and profit payment of RM200.0 million and RM66.5 million respectively, translating to a pre-distribution finance service coverage ratio (FSCR) of 1.86 times (x). MARC’s sensitivity analysis reveals that the pre-distribution FSCR will fall below the minimum covenanted FSCR of 1.30x in FY2025 if the UOR increase by 5% or if repair and maintenance costs increase by 2.5% throughout the sukuk’s tenure. As at January 6, 2016, KEV’s FSCR stood at 2.10x.

The negative outlook reflects MARC’s view that KEV’s weak liquidity position is likely to persist over the near term. Any further significant plant underperformance in KEV’s cash flow and/or changes in TNB’s rating and/or its supportive stance towards KEV will exert pressure on the sukuk rating. Conversely, the rating agency may reverse the rating outlook to stable if KEV’s operational performance improves.

Major Rating Factors

Strengths

• Very strong support from majority shareholder Tenaga Nasional Berhad; and
• Protective debt covenants.

Challenges/Risks

• Operational and technical issues of the generating facilities; and
• Weaker cash flow coverage after step-down of capacity rate financial in 2020.