The likely strained cash flow of Tenaga Nasional Bhd (Tenaga) is causing growing concern as the electricity tariff is not rising fast enough to keep up with escalating fuel costs.
The utility group will need to borrow more to maintain operations, as it has to shell out a larger sum up front given the sharp rise in fuel prices. To make matters worse, compensation for increased fuel costs only comes after six months or more.
During the quarter ended March 31 (1QFY2022), Tenaga recorded revenue of RM3.51 billion, which was an under-recovery of ICPT (imbalance cost pass-through).
The group can only recoup its underrecovered fuel costs every six months. In the past, the lag between the cost of fuel spent and the payment of increased costs through the ICPT mechanism had not been an issue due to the stability of fuel prices.
Already, Tenaga has increased its borrowing, drawing a total of RM5.13 billion from bank borrowings as of 1QFY2022, almost four times the amount in the year ended 31 December 2021 (FY2021).
Tenaga also issues medium-term debt securities. Last Thursday (June 30), it issued RM4 billion worth of sukuk wakalah, under its medium-term Islamic note program launched in June 2020.
Two weeks ago, Prime Minister Datuk Seri Ismail Sabri Yaakob announced that the electricity tariff in Peninsular Malaysia would be kept at current levels for the rest of the year via a subsidy bill of RM5.8 billion. additional.
This announcement surprised analysts and investors, considering that electricity prices are already skyrocketing in many countries. They had believed that Tenaga would be insulated from high fuel prices due to the fuel cost pass-through mechanism.
The news sent Tenaga’s share price crashing to a seven-year low of RM7.89 on June 28. The meter now trades at a 12-month (TTM) price-to-earnings ratio (PER) of 12.74x and a TTM dividend yield of 5%.
In January, the government raised the electricity tariff for non-domestic users by imposing a surcharge of 3.7 sen per kilowatt-hour (kWh) on top of the base tariff of 39.45 sen/kWh for the February period. to June, while domestic households continue to enjoy a two-sen discount on the base rate.
As of 1QFY2022, high fuel costs pushed Tenaga’s operating expenses up 47% to RM13.43 billion from RM9.15 billion a year ago. In the first half of the year, international coal prices had risen from US$157.50 per tonne to US$440 per tonne. Coal represents approximately 56% of Tenaga’s energy mix.
The average coal price agreed by the government and Tenaga for Regulatory Period 3 (RP3) is not known. Under the incentive regulation mechanism (IBR), the basic electricity tariff is set every three years, with the current RP3 running from February 2022 to December 2024.
Industry players say the average thermal coal agreed for the RP3 is US$79 per tonne.
“This means that TNB Fuel [Services Sdn Bhd]which is the sole buyer of coal for all the power plants on the peninsula, paid four to five times more for coal than the average price agreed with the government when setting the RP3 tariff in the first half of the year,” said one observer.
Now that the government has decided not to impose a higher surcharge in the second half to make up for the shortfall in the first half, Tenaga should see its cash flow affected. This resulted in higher current receivables for the group until 1QFY2022.
Tenaga’s current receivables jumped to RM14.07 billion from RM10.55 billion in the previous quarter, up 33.4% in three months. Its claims were only RM6.9 billion as of December 31, 2020.
The increase in current receivables could lead to a significant increase in working capital requirements and therefore affect Tenaga’s cash flow in the short term, said Hafriz Hezry, an analyst at MIDF Research who covers the power sector.
Analysts reduced their target prices for Tenaga after the government’s decision not to raise tariffs.
MIDF Research revised its target price on the stock to RM8.45 from RM9.55, but maintained a “neutral” call on it. Maybank Investment Bank has a target price of RM8.70, down from RM9.30 previously, with a “pending” call.
RHB Research downgraded the power sector from “overweight” to “neutral”. Its power sector analyst Sean Lim said Tenaga’s claims from the ICPT could continue to grow if fuel prices remain high in the second half.
“Our concern is the impact on operating cash flow, if the government is unable to pay on time. In the worst case, where the ICPT no longer holds, TNB’s defensive earnings could be at risk if it is vulnerable to fuel price volatility without being able to fully pass the costs on to end consumers,” he said in a June 30 report.
HLIB Research, however, remains positive on Tenaga’s outlook. Its analyst Daniel Wong maintains its ‘buy’ call and price target of RM13.40 as continued ICPT mechanism allays investors’ concerns over regulatory risks, it says in a report dated 27 June.
The question is whether the ICPT mechanism can be interpreted as intact, because the government does not want the end user to bear the brunt of high energy prices.
It will not be surprising if the government is slow in disbursing the electricity tariff subsidy to Tenaga.
In the 2020 annual report of Kumpulan Wang Industri Elektrik (KWIE), it said Tenaga requested to recover a total of RM1.89 billion for tariff reductions that the government imposed under Pakej Rangsangan Ekonomi 2020, Pakej Rangsangan Ekonomi Prihatin Rakyat and Bantuan Prihatin Elektrik.
Of this amount, RM1.05 billion had been repaid to the utility group from KWIE’s 2020 fund, while the balance was due to be repaid in 2021. This means that the balance of approximately 45% of the amount claimed n was not reimbursed the same year. .
It is unclear whether the government reimbursed Tenaga through KWIE or directly from its coffers. As of press time, Tenaga hadn’t responded to questions from The Edge about it.
Nonetheless, Tenaga’s credit rating appears to have remained intact. In a statement dated June 16, S&P Global Ratings raised its long-term issue rating on the company’s notes to reflect its expectations of a lower secured debt ratio and subordination risk.
However, the upgrade came before the announcement of the zero rate hike for 2H2022. The global rating agency then said Tenaga’s cash flows should remain largely predictable, with limited exposure to demand risk.
“The company should be able to continue to pass on real uncontrollable costs through an ICPT mechanism. The regulated ICPT mechanism allows Tenaga to pass on real uncontrollable fuel and production costs, but with a six-month lag.
“Fuel costs have increased significantly since the end of 2021. We estimate that TNB’s financial leverage, measured by an adjusted ratio of funds from operations (FFO) to debt, will remain at 16% to 18% in 2022 to 2023, compared to 18.6% in 2021”, indicates the rating agency.
He adds that the stable outlook on Tenaga reflects his expectation that the group will maintain its adjusted FFO-to-debt ratio above 15% over the next 12 to 18 months.
The credit agency estimates that Tenaga will be able to pass on any under- or over-recovery of fuel costs through rate adjustments.
Nevertheless, S&P Global Ratings indicates in its press release that it could revise its assessment downwards if Tenaga’s adjusted FFO/debt ratio falls below 15% with no prospect of improvement.
It says this could happen if, among other things, the group’s earnings before interest, tax, depreciation and amortization margin falls below 30%, due to rising fuel costs without tariff relief, or due adverse regulatory rulings when its business experiences regulatory resets.
Will the decision not to raise rates lead to a downgrade in TNB’s credit rating? The evolution of the price of coal will be a gauge.