TNB Northern Energy Bhd - 2013

MARC has assigned rating of AAAIS to TNB Northern Energy Berhad's (TNB Northern Energy) issuance of Islamic securities (sukuk) of RM1.625 billion with a stable outlook. TNB Northern Energy is a wholly-owned funding vehicle of TNB Prai Sdn Bhd (TNB Prai) which in turn is wholly owned by national utility company Tenaga Nasional Berhad (TNB). TNB Northern Energy is using the sukuk proceeds to part-finance the construction of a RM2.49 billion combined-cycle gas power plant (the project) in Seberang Perai Tengah, Pulau Pinang. The project will be 65:35 financed by the sukuk proceeds and equity contributions in the form of redeemable preference shares and shareholder's equity during construction.

Periodic distribution payments to sukukholders will be funded by Ijarah rentals paid by TNB Prai to TNB Northern Energy under a lease agreement subsequent to project completion. Project company TNB Prai will fund the Ijarah rentals with the cash flow derived from the sale of capacity and energy from the 1,071.43-megawatt (MW) combined-cycle facility to TNB.

The sale of capacity and energy from the project is governed by a power purchase agreement (PPA) with duration of 21 years from the time the project enters commercial operation which is expected by January 1, 2016 (COD). The PPA allows for a full pass-through of fuel costs contingent upon the power plant operating within specified heat rates. Fuel risks are also mitigated through a long-term gas supply agreement with Petroliam Nasional Berhad (PETRONAS). Related entity and experienced plant operator TNB Repair and Maintenance Sdn Bhd (REMACO) will operate and maintain the plant. MARC also expects an adequate insurance programme to be available both during the construction and operation of the project.

The rating on the sukuk mirrors and is wholly dependent on the rating of TNB which has sole ownership of TNB Prai and TNB Northern Energy. The rating on the sukuk reflects credit substitution from TNB by virtue of the project completion support and rolling guarantee of TNB Northern Energy's semi-annual distributions on the sukuk. (MARC had affirmed TNB’s issuer rating at AAA with a stable outlook on January 31, 2013.) The support provided by TNB for the sukuk addresses residual project completion and operating risks related to performance shortfalls not assumed by the engineering, procurement and construction (EPC) contractor Samsung Engineering & Construction (M) Sdn Bhd (Samsung E&C) and other project parties. Accordingly, MARC believes that the aforementioned credit support adequately mitigates project-level risks at the 'AAA' rating level. TNB Prai's operational proximity to project sponsor and offtaker TNB lends further support to MARC's belief that the credit profiles of TNB Prai and TNB Northern Energy cannot be meaningfully segregated from that of TNB.

TNB's creditworthiness continues to be underpinned by its critical role in the domestic electricity sector, support from its government majority owner and sound debt maturity profile. That said, future tariff uncertainty, combined with the national utility's projected capital expenditure programme, point to a continued uptrend in gearing and reduced debt protection measures in the quarters ahead. The growth of TNB's contingent liabilities could also place pressure on its overall financial profile on a consolidated basis.
 
The EPC contract for the project has been awarded to Samsung E&C on a fixed-price turnkey basis with adequate provisions for liquidated damages relating to completion delay. The track record and creditworthiness of the contractor, and the reasonable construction schedule of 37 months (from limited notice to proceed) offer moderate protection from project completion risk. The remaining construction risks which are not allocated to the EPC contractor are addressed by TNB's completion support guarantee. This comprises funding commitments of up to 10% of project cost to finance cost overruns outside the EPC contract's scope of work as well as funding support for scheduled distributions on the sukuk for the 12-month period commencing from the scheduled COD of January 1, 2016.
 
Until operations begin and the project demonstrates an adequate performance record, some operational uncertainty is posed by the short operational history of a variant of a commercially proven gas turbine model, the Siemens AG SGT5-8000H gas turbine that will be used by the project. MARC acknowledges the project's independent engineer's assessment that the plant should be in a position to achieve the operational requirements under the PPA. TNB Prai's average availability target is set as 94% and it has been granted unplanned outage rate (UOR) allowance of 4%. Partly mitigating technological and operating risks, including potential challenges posed by the fairly demanding performance standards required under the PPA, are the project's experienced operations and maintenance (O&M) operator and performance guarantee and warranties provided under the EPC contract on the achievement of TNB Prai's contractual performance under the PPA. Turbine reliability risks are also partly addressed by a long-term maintenance programme contract with the gas turbine supplier.

The sukuk is structured with a fairly level amortisation profile. Under a base case scenario of not less than 94% availability, the six-month finance service cover ratio (FSCR) without cash balances for TNB Prai and TNB Northern Energy on a consolidated basis averages 1.31 times (x) for the term of the sukuk with a minimum coverage level of 1.26x. The projected financial results and sensitivity analyses lead MARC to conclude that the ability of the project to service the sukuk is adequate under mild stress scenarios. The rather limited cushion for performance shortfalls and projected consolidated cash position that is only expected to be sufficient for working capital needs are derived from the project's very competitive tariff structure for its capacity revenues under the PPA. In the event of a prolonged unscheduled plant outage, the rolling guarantee would have to be relied upon to service the sukuk.
 
TNB's rolling guarantee covers scheduled semi-annual distributions on the sukuk on a non-accelerable basis. MARC is satisfied that per the sukuk documentation, there is adequate time for a draw to be made on the rolling guarantee and have funds deposited into the issuer's revenue account to make timely payment to sukukholders, as well as to prevent an actual missed payment and an acceleration of the sukuk. The rating agency has concluded that as long as TNB Northern Energy is able to rely on TNB's rolling guarantee as a liquidity bridge for extended periods, it will have sufficient funds to make timely principal and profit payments on the sukuk.

The stable outlook mirrors the outlook on TNB's senior unsecured rating. Any changes in TNB Northern Energy's rating and/or outlook would be primarily driven by revision of TNB's rating and/or outlook.

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