Kapar Energy Ventures Sdn Bhd - 2010

MARC has affirmed its rating on Kapar Energy Ventures Sdn Bhd’s (KEV) RM3,402.0 million Bai’ Bithaman Ajil Islamic Debt Securities (BaIDS) at AA+ID with a stable outlook. The rating has been affirmed despite KEV's weak liquidity and second consecutive year of losses on MARC's expectation of ongoing support from Tenaga Nasional Berhad (TNB), KEV's ultimate holding company. MARC notes that TNB has recently provided confirmation of their intention to provide financial support to KEV to enable it to punctually meet its obligations to facilitate the preparation of KEV's financial statements on a 'going concern' basis. MARC's decision not to equalise the senior unsecured debt ratings of TNB and KEV following the TNB's recent rating upgrade to AAA/Stable takes into account KEV's very much weaker fundamentals relative to TNB and MARC's view that KEV is not a core operating subsidiary of TNB. The stable outlook on the senior debt rating reflects MARC's view that, in the short term, there is very limited up or downside potential for the rating.

KEV was established to acquire and operate the Stesen Janaelektrik Sultan Salahuddin Abdul Aziz, or KPS, the largest multi-fuel thermal power station in Malaysia with a 2,420-megawatt (MW) nominal capacity. KPS currently operates four generating facilities (GF) running on coal, natural gas or oil. Distillate, a standby fuel, is also used for gas turbines as back-up. Fuel supply risk is mitigated by long-term supply agreements entered into with TNB and TNB Fuel Services Sdn Bhd. All fuel costs incurred in generating electricity are passed through to TNB. Under a 25-year Power Purchase Agreement (PPA), KEV receives payments from TNB, the plant’s offtaker, comprising monthly capacity payments (CP) and energy payments (EP). CPs are designed to cover fixed operating costs, debt service payments and provide returns to shareholders while EPs cover fuel costs and variable operating costs. However, actual monthly CPs have been negatively affected by a higher level of unplanned outages than allowed under the PPA.

Although the overall plant’s average availability of 80.5% (FY2009: 62.9%) for the 12 months ended August 31, 2010 (FY2010) improved compared to a year ago, unplanned outages at two of four GFs exceeded the PPA required level, resulting in lower CP income for KEV. On a positive note, MARC notes that operational issues at both GFs have been resolved before the start of FY2011. Apart from the operational challenges experienced by the GFs, lower electricity demand in 2009 had also affected electricity generation at the plant. Between September 2009 and January 2010, electricity generation only averaged 287.9 gigawatt hours (GWh) before recovering in February 2010 to 777.1 GWh; electricity generation averaged 558.9 GWh for the whole of FY2010.

KEV recorded a smaller pre-tax loss of RM197.7 million in FY2010 (FY2009: RM302.6 million). CP revenue increased to RM508.7 million (FY2009: FY439.7 million) due to overall improvement in plant availability. EP contributed 66.4% of the total revenue, up by 27.7% from the previous year on the back of higher despatches. KEV’s profitability continues to be constrained by its high debt load and associated finance costs.

KEV’s aggregate debt service profile is outpacing its cash flow generation. MARC observes that KEV has only been servicing its obligations on the BaIDS from its internally generated cash flow. During FY2010, total BaIDS debt servicing requirements totalled RM436.7 million (FY2009: RM423.9 million), of which RM264 million was principal repayment and the balance, profit payment. This is reflected in a growing amount of unpaid interest due to shareholders on their holdings of KEV’s redeemable unsecured loan stocks (RULS) despite RULS holders’ consent to lower the compounding interest rate from 15% to 5% per annum on unpaid interest after the due date. As of August 31, 2010, KEV owed TNB and 40% shareholder Malakoff Berhad RM375.4 million and RM250.3 million, respectively, in interest expense on the RULS, up from RM279.8 million and RM186.5 million respectively a year ago. Interest on the RULS is cumulative, the RULS have a long maturity and are subordinated to all KEV’s debts, and any redemption is subject to the satisfaction of a distribution test. The full equity credit given to KEV’s outstanding RULS of RM892.6 million in the gearing calculation for covenant compliance has enabled KEV to remain in compliance with its gearing covenant of 80:20 (actual: 77:23 as at January 8, 2011) in spite of its growing accumulated losses and negative shareholder’s funds.

Cash flow from operations (CFO) improved to RM533.2 million (FY2009: RM465.9 million), attributed mainly to working capital releases. MARC notes, however, that trade receivables due from TNB had increased to RM458.9 million as of end-August 2010 from RM288.4 million. MARC further notes a significant increase in amounts due to related companies, of which payables in respect of coal supplied to KEV appears to be a large component. Unpaid coal billings which rose to RM702.2 million as at August 31, 2010 from RM225.7 million a year ago attract interest on late payment of 7.5% per annum. The interest component of coal billing payables had risen to RM42.6 million as of end-August 2010 from RM10.8 million a year ago, which MARC considers as an indication of tight liquidity at KEV, along with its negative net working capital position. The improved outlook for operating performance over the next 12 months is, however, expected to translate into higher cash flow generation. Cash balances in KEV’s designated accounts totalling RM331.6 million after its January 7, 2011 BaIDS redemption offer BaIDS holders near-term protection against liquidity risk in respect of its July 8, 2011 forthcoming commitments of RM212.4 million comprising RM136 million of principal repayment and RM76.4 million of profit payment.

The stable outlook reflects MARC’s expectation of improvement in KEV’s financial performance and liquidity position. MARC believes that KEV is reliant on continued upward momentum in its operating environment and satisfactory operational performance of KPS to improve its credit metrics. Factors that could place negative pressure on the rating include significantly worse-than-expected operating and financial performance and resulting erosion of financial covenant headroom.

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