TNB Western Energy Bhd - 2013

MARC has assigned a rating of AAAIS to TNB Western Energy Berhad’s (TNB Western Energy) issuance of Islamic Sukuk (sukuk) of up to RM4.0 billion with a stable outlook. TNB Western Energy is a wholly-owned funding vehicle of TNB Manjung Five Sdn Bhd (TNB Manjung Five) which in turn is wholly owned by national utility company Tenaga Nasional Berhad (TNB). TNB Manjung Five is the project company for the construction of a 1,000-megawatt (MW) ultra-supercritical (USC) coal-fired power plant (the project) on existing land owned by TNB Janamanjung Sdn Bhd (TNBJ) in Manjung, Perak.

The project will be financed through a 74:26 financing mix comprising the sukuk proceeds and sponsor’s equity. The sponsor’s equity will be in the form of direct equity and/or TNB guaranteed equity bridge financing which is subordinated to the sukuk. The periodic distribution payments to sukukholders will be met by Ijarah rentals from TNB Manjung Five to TNB Western Energy subsequent to project completion. The Ijarah rentals will be funded by the cash flow derived from the sale of capacity and energy from the project under a 25-year power purchase agreement (PPA) to TNB commencing from the commercial operation date (COD) of the project, which is expected by October 1, 2017.
 
The assigned rating on the sukuk is underpinned by credit substitution from TNB by virtue of the project completion support and rolling guarantee for semi-annual distributions (principal and profit payments) on the sukuk. The rating of the sukuk draws strength from the creditworthiness of TNB as measured by its rating of AAA/stable maintained by MARC. The credit support provided by TNB addresses residual project completion and operating risks related to performance shortfalls not assumed by the engineering, procurement and construction (EPC) contractors. This comprises funding commitments of up to 10% of project cost to finance cost overruns as well as funding support for scheduled distributions on the sukuk for up to 12-month period commencing from the scheduled COD. TNB Manjung Five's operational proximity to the project sponsor and offtaker TNB lends further support to MARC's belief that the subsidiary and parent credit profiles are highly correlated. TNB Manjung Five’s long-term PPA with TNB is also a key credit strength for the sukuk.

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, the utility’s reliance on tariff revision, 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 recently announced hike in electricity tariffs by 14.9% effective January 1, 2014 and the expected implementation of incentive-based regulation (IBR) signal progress by the authorities in redressing the long-standing issue of reconciling regulated tariff pricing and total cost recovery. The hike in tariffs will address the increase in the cost of imported liquefied natural gas and allow TNB to partially recover capital investments on the group’s newer power plant projects. Certainly for the near term, MARC views the improved visibility on pricing and cost recovery prospects favourably. However, the rating agency believes that some challenges remain on the path towards a more predictable and favourable tariff regime.

The EPC contract for the project has been awarded on a fixed-price turnkey basis to an EPC consortium comprising Sumitomo Corporation, Daelim Industrial Co Ltd, Sumi-Power Malaysia Sdn Bhd and Daelim Malaysia Sdn Bhd. The track record and creditworthiness of the contractors and the reasonable construction schedule of 45 months offer moderate protection from project completion risk. In addition, the EPC contract incorporates adequate provisions for liquidated damages (LDs) relating to completion delays while the remaining construction risks which are not allocated to the EPC contractor are addressed by TNB's completion support guarantee. The location of the project, adjacent to four existing power plants owned by TNBJ (Manjung 1, 2 and 3 are currently in operations while Manjung 4 is still under construction), allows the plant to share common facilities, thus reducing the need to duplicate various operational facilities.

The project will employ the relatively new USC technology which supports improved efficiency levels and lowers emissions from coal-fired power generation. MARC assesses technology risk to be low given the plant’s use of proven technology; the technology has been deployed in 50 similar USC power plants in Japan, China, South Korea, Europe and the United States. TNB Manjung Five has appointed TNB Repair and Maintenance Sdn Bhd (REMACO), a related entity and experienced plant operator, albeit with limited experience in operating USC-plants, to operate and maintain the plant. MARC also expects an adequate insurance programme to be available for coverage from unexpected events during both the construction and operational phases and the LDs payable by the EPC contractor and plant operator to mitigate operating risks in the initial operating phase and after the plant attains a steady operating profile. The PPA allows for a full pass-through of fuel cost subject to the power plant’s achievement of required heat rates. The coal supply is sourced from TNB Fuel Services Sdn Bhd (TFS) under a coal supply and transportation agreement which is coterminous with the PPA. MARC believes that the coal supply arrangement with TFS and TFS’s procurement strategy mitigates coal supply and suitability risks.

Under the consolidated cash flow projections of TNB Manjung Five and TNB Western Energy, the project is forecast to have base case minimum and average finance service cover ratios (FCSR) with cash balance of 1.38 times and 1.46 times respectively. The forecast FSCRs, which are lower than other MARC-rated independent power producers (IPP), indicate lower resilience to operational issues that could result in reduced cash flow. Protecting sukukholders from financial performance that is materially below expectations is TNB’s rolling guarantee which covers any shortfall encountered by the issuer in meeting its scheduled semi-annual distributions on the sukuk. While the rolling guarantee does not include accelerated payments, MARC notes that there is adequate time for a draw to be made on the rolling guarantee and have funds deposited into the issuer’s finance service account to make timely payments to the sukukholders. The issue structure’s balloon repayment of RM1.3 billion in 2033 introduces a significant element of refinancing risk to TNB Western Energy, which MARC believes is effectively transferred to TNB under the rolling guarantee.

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

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