Tanjung Bin O&M Bhd - 2013

MARC assigns a rating of AA-IS to Tanjung Bin O&M Berhad’s (formerly known as Sterling Asia Berhad) (Tanjung Bin O&M or the Issuer) RM470.0 million Islamic Securities (Sukuk Wakalah or Sukuk) with a stable outlook.

The proceeds of the Sukuk issuance would be primarily utilised toward part-financing the acquisition costs of HICOM Power Sdn Bhd’s (HICOM Power) operations and maintenance (O&M) business. Pursuant to the acquisition, HICOM Power has novated its rights and obligations under (i) an operations and maintenance agreement (OMA) with related entity of Tanjung Bin O&M, Tanjung Bin Power Sdn Bhd (TBP) and (ii) a subcontract operations and maintenance agreement (sub-OMA) with the parent company of Tanjung Bin O&M, Malakoff Power Berhad (MPower) to Tanjung Bin O&M. The OMA and the sub-OMA are co-terminous with TBP’s power purchase agreement (PPA) with Tenaga Nasional Berhad (TNB) for its generation project, a 2,100MW coal-fired power plant in Tanjung Bin, Johor.

The assigned rating reflects the reliance on the future cash flows from the OMA originally signed between HICOM Power and TBP (MARC’s senior implied rating of AA/Stable) as a fairly predictable debt repayment source and the linkages between the credit profile of Tanjung Bin O&M and parent MPower (MARC senior debt rating of AA-/Stable). The ability of MPower to fulfill its cash deficiency support undertaking (as defined herein) and its obligations under the sub-OMA is integral to the assigned rating and acts as the rating floor for the transaction. MPower undertakes to fund deficiencies in Tanjung Bin O&M’s six-month finance service reserve via equity injection into Tanjung Bin O&M throughout the tenure of the Sukuk (cash deficiency support undertaking) and assumes all Sukuk payment obligations on a full and timely basis in the event the OMA is terminated due to reasons other than default or breach by Tanjung Bin O&M. The undertakings are designed to absorb the risks of operating cash flow shortfalls and the remotely low probability, high impact event of contract termination. MARC considers this contract monetisation transaction as highly leveraged with the purchase of assets and liabilities funded by the sukuk and equity on a 72:28 basis.

The rating acknowledges recent events leading to the unscheduled outages between December 2012 and April 2013 at the Tanjung Bin power plant which culminated in a reduced dispatch level of 63.0% for the first four months of 2013. The cause of the unscheduled outages have been identified as prolonged high load demand on the coal-fired power plant arising from the curtailment of gas supply to the power sector and possible coal type suitability issues. MPower’s support for Tanjung Bin O&M is evidenced by the unconditional and irrevocable undertaking that will be provided to the security agent of the Sukuk prior to the issuance whereby MPower undertakes to pay the liquidated damages and maintenance costs for the forced outages in the event that Tanjung Bin O&M is obligated to pay TBP the liquidated damages and maintenance costs for the forced outages. MPower will also waive its right to pursue a claim against Tanjung Bin O&M in relation to the said payments. MARC views the cash deficiency support undertaking provided by MPower throughout the tenure of Sukuk as particularly important to address the risks of operational challenges which may lead to difficulty in generating sufficient operating cash flow to cover finance service obligations.

Performance risks of Tanjung Bin O&M’s obligations under the OMA have been substantially allocated to MPower under the sub-OMA; Tanjung Bin O&M’s liability for liquidated damages is capped at RM18.0 million per contract year. MPower’s operating track record and knowledge of the power plant remain important rating considerations, particularly in light of TBP’s recent events affecting its operations. The power plant is currently undergoing maintenance and its performance is expected to be back on track by the second half of 2013. Residual performance risks of Tanjung Bin O&M mainly relate to cost overruns of major maintenance overhauls and liquidated damages. These risks are mainly managed through the availability of a maintenance reserve account of RM36.0 million, maintained using a standby letter of credit/bank guarantee (SBLC/BG) or cash or combination of SBLC/BG and cash.

TBP’s standalone credit profile, which MARC views as consistent with an implied ‘AA’ rating, serves as the ceiling for the transaction’s rating. The offtaker’s standalone credit profile is supported by the competitiveness of the coal-fired plant which should help to ensure continuation of a dispatch profile and sustained financial metrics commensurate with a ‘AA’ rating level. At the same time, the rating is constrained by its leveraged capital structure, including loan stocks, and dividend pressures by shareholders. Meanwhile, MPower’s senior unsecured debt rating of ‘AA-‘ by MARC reflects the low business risk profile of MPower’s O&M portfolio, good operational performance of its portfolio of power plants and predictable cash flow generation. The rating is constrained by MPower’s moderate reliance on TBP to generate most of its cash flows, the residual nature of its cash flows arising mainly from profit payments and principal redemption of loan stocks it holds in Malakoff Group’s power plants and its high gearing.

MARC’s rating on the transaction incorporates moderate demand risk exposure that exists in the OMA, which is partly mitigated by the plant’s competitive operating profile. The TBP plant has been operated primarily as base load since 2008. The country’s narrowing power reserve margins and the curtailment of gas supply to the power sector during 2011-2012 have been drivers behind the sustained high dispatch profile for coal-fired power plants. Under Tanjung Bin O&M’s base case scenario which assumes an average plant dispatch rate of 78.0% (save for 2013 with an expected annual dispatch rate of 65.3%), projected cash flows generate minimum and average post-distribution finance service cover ratios (FSCR) with cash balance of 2.00 times (x) and 4.20x respectively. Based on MARC’s analysis, the rating agency believes that Tanjung Bin O&M will face challenges servicing the Sukuk on a standalone basis should average plant dispatch rates fall below 62.5%, particularly as two-thirds of Tanjung Bin O&M’s projected revenue is expected to be derived from variable operating fees which are a function of total electricity dispatched by TBP’s power plant.

The stable outlook for the rating is based on the projected maintenance of finance service coverage on the expectation that plant operating performance will normalise and on the assumption that TBP will prudently manage its load requirements going forward. Further factored into the outlook is the cash deficiency support undertaking from MPower which provides a degree of mitigation against the risk of prolonged operating challenges at the power plant. The rating is sensitive to material changes in the credit quality of TBP and MPower given the extensive credit and operational linkages between Tanjung Bin O&M, TBP and MPower.

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