S&P upgrades Meralco’s credit rating outlook

MANILA, Philippines - S&P Global Ratings has upgraded its credit rating outlook on power distribution giant Manila Electric Co. (Meralco) despite perceived risks from the development of power generation with partners and regulatory hurdles.

S&P revised its outlook on Meralco from stable to positive over the next 12 to 18 months. It also affirmed its long-term corporate credit rating at “BB+” and its ASEAN regional scale rating at “axBBB+.”

The New York-based debt watcher said the revised outlook is based on its expectation Meralco will further consolidate its cash buffer and maintain a cautious balance sheet, at a time of high investments, sustained returns to shareholders and regulatory uncertainty.

“The positive outlook over the next 12-18 months reflects our expectation that Meralco’s operations and capital structure will remain consistent with past performance. This is because we foresee the regulatory reset will not materially change the company’s economic circumstances; and we anticipate that the generation assets under construction which Meralco has invested in will progress as scheduled with minimal cost overruns and performance issues,” the report read.

It noted Meralco has been consistently generating robust free operating cash flows (FOCF) because of its resilient profitability and predictable capital expenditure requirements, which have averaged about 35 percent of reported EBITDA over the past three years.

As a result, the company’s capital structure has steadily improved despite increasing dividend payout. As of Dec. 31, 2015, Meralco reported a net cash position of P20.5 billion.

S&P said it sees some uncertainty in the timing and magnitude of the tariff reset for power distribution for the coming regulatory period, which is already delayed.

This reset will materially influence Meralco’s FOCF over the following four years and, hence, the company’s financial metrics, the debt watcher said.

“Although we believe the regulatory environment remains broadly supportive of Meralco’s operations, the lengthy and uncertain decision-making process with the Energy Regulatory Commission weighs on Meralco’s credit quality, in our opinion,” S&P Global Ratings analyst Bertrand Jabouley said.

S&P also sees Meralco’s development of a portfolio of generation assets with partners as positive but those ventures bear significant execution risks given their size and financing structure across equity and debt.

Based on assumption of a cost of about $2 million per megawatt of capacity, the debt watcher estimates the three main projects Meralco is involved in will cost about $4.5 billion in total (close to half of it being its share, given the company’s objective to keep a minority stake in all ventures).

Currently, Meralco is working on the 455-megawatt (MW) San Buenaventura Power Ltd. (SBPL) project in Quezon; the Redondo Peninsula Energy (RP Energy) project in Subic, Zambales; and the 2x600 MW Atimonan One Energy project in Quezon, which it is being solely undertaken by subsidiary Meralco Powergen Corp. (MGen).

SBPL is a joint venture of MGen with New Growth B.V., a wholly-owned subsidiary of Thailand’s Energy Generating Co.

RP Energy is a consortium composed of MGen, Aboitiz Power Corp. and Taiwan Cogeneration International Corp.

Meralco also recently partnered with Semirara Mining and Power Corp. to construct a 2x350 MW coal-fired power generating facility in Calaca, Batangas through joint venture vehicle St. Raphael Power Generation Corp. (SRPGC).

“We do not consolidate the debt in Meralco’s balance sheet because we understand the company has collaborated with seasoned industrial partners and appointed prime contractors for the construction of the plants,” Jabouley said.

“However, we believe that off-balance-sheet risks call for heightened caution when it comes to Meralco’s capital structure management in case the project risk gets transferred to the company,” he said.

S&P said it could revise the outlook to stable if the FFO-to-debt ratio approaches 25 percent.

On the other hand, it said an upgrade will be in the offing if Meralco will demonstrate its willingness to maintain a conservative capital structure, with ratio of FFO to debt approaching 35 percent.

“We would consider an upgrade if we believe distributions to shareholders will not exceed Meralco’s recurring earnings, and witness timely progress in the construction of the company’s generation ventures,” it said.