Tenaga Nasional Bhd - 2014

MARC has affirmed Tenaga Nasional Berhad’s (TNB) issuer rating of AAA and Islamic debt rating of AAAID on its outstanding RM2.0 billion Al-Bai’ Bithaman Ajil Bonds. The outlook on the ratings is stable. The ratings continue to incorporate a two-notch uplift from TNB’s standalone corporate credit rating of AA/Stable to reflect the high likelihood of government support stemming from the company’s critical role as the country’s principal energy provider. MARC’s support assessment also considers the government’s indirect majority ownership in TNB and its golden share in the utility which allows the government to veto any actions by the company which require shareholders’ approval. On a standalone basis, TNB’s credit strength is underpinned by its monopoly in electricity transmission and distribution in Peninsular Malaysia and Sabah, steady operational track record and satisfactory debt service coverages. Moderating these strengths are its high capital expenditure requirements, increased borrowings and exposure to incomplete fuel cost pass-through mechanism.

The electricity tariff hike of 14.9% as a result of the implementation of incentive-based regulation (IBR) in January 2014 has helped address the long-standing issue of reconciling regulated tariff pricing and fuel cost recovery. Under the IBR framework, electricity tariff reviews are conducted on a half-yearly basis to capture fuel price fluctuations via an imbalance cost pass-through mechanism. While the new tariff regime allows TNB to achieve a stable operating margin, the recent announcement by the government that the electricity tariff will be maintained until December 31, 2015 confirms MARC’s earlier assessment on the challenges TNB faces in achieving a more predictable and favourable tariff regime. Additionally, public sensitivities over periodic tariff revisions may be an obstacle to the successful implementation of the IBR.

In the financial year ended August 31, 2014 (FY2014), TNB distributed 107,091 gigawatt-hour (GWh) of electricity to customers in Peninsular Malaysia and Sabah, a 2.4% growth from the previous financial year. This coupled with the aforementioned tariff revision resulted in TNB recording an increase of 12.3% in electricity sale in FY2014 (FY2014: RM39.6 billion; FY2013: RM35.2 billion). However, energy costs increased to RM26.5 billion (FY2013: RM22.5 billion) with the introduction of a two-tier natural gas pricing structure in May 2013. This followed the commissioning of the LNG Regasification Terminal in Melaka. The new gas pricing structure exposes TNB to higher rates for any gas consumption above 1,000 million standard cubic feet per day (mmscfd). The increase in energy cost was further compounded by outages at several coal-fired power plants in 1HFY2014. The outages resulted in lower capacity payments (FY2014: RM3.8 billion; FY2013: RM4.4 billion) to independent power producers; however, the savings from  the lower payments were  insufficient to offset the increase in  natural gas price. Assuming there are no unexpected prolonged outages in FY2015, MARC expects TNB to increase its dependence on cheaper coal fuel which currently accounts for 39.8% of the generation mix in Peninsular Malaysia. This amount will increase further with the commencement of commercial operations of the 1,000MW coal-fired Janamanjung Unit 4 starting March 31, 2015.

TNB registered a consolidated operating profit margin of 16.8% in FY2014 (FY2013: 15.9%). Net cash flow from operations (CFO) increased to RM10.4 billion from RM9.7 billion in line with the overall improvement of earnings performance. Higher capital expenditure and dividend payment of RM10.0 billion and RM1.4 billion (FY2013: RM8.6 billion; RM1.4 billion) respectively led to negative free cash flow of RM1.6 billion in FY2014 (FY2013: -RM734.5 million). Notwithstanding this, TNB’s financial metrics continue to be supported by its strong CFO interest coverage which improved to 13.68 times in FY2014 (FY2013: 12.41 times) and ample liquidity buffer of RM8.1 billion. Despite the increase in total borrowings to RM32.2 billion (FY2013: RM28.5 billion) mainly from TNB Western Energy Berhad’s sukuk issuance of RM3.7 billion for the construction of Manjung Unit 5, the growing equity base has helped TNB to maintain its debt-to-equity ratio at 0.74 times in FY2014 (FY2013: 0.75 times). TNB’s borrowings are expected to increase further to fund the construction of gas-fired power plant Track 4A in Pasir Gudang under a joint venture between TNB and SIPP Energy Sdn Bhd. The group has also provided liquidity support to some of its project debts in the form of completion support and rolling guarantees.

MARC notes that the weakening of the ringgit against the US dollar could lead to forex translation losses for TNB, although such losses may be moderated by the strengthening of the ringgit against the yen and the paring down of US dollar borrowings. As at August 31, 2014, its US dollar-denominated borrowings constitute 10.3% of total borrowings and are expected to decline after a US$350 million repayment in FY2015. The impact of the weakening ringgit on its US dollar-denominated coal costs has also been cushioned by the lower coal prices which averaged at US$70.2/MT in 1QFY2015 compared to US$77.2/MT in 1QFY2014.

The stable outlook reflects MARC’s expectations that the government support assumption will be sustained in the next 12 to 18 months in view of TNB’s strategic importance to the nation’s energy security. Any weakening in TNB’s debt protection measures and/or liquidity buffer would exert pressure on its standalone rating.

Major Rating Factors

Strengths

• High likelihood of government support;
• Largest power transmission and distribution company in Malaysia; and
• Strong operational profile and track record.

Challenges/Risks

• Exposure to incomplete fuel cost pass-through of fuel prices;
• Sensitivity of electricity demand to economic activity; and
• Increasing borrowings.