MARC has affirmed its rating on Kapar Energy Ventures Sdn Bhd's (KEV) RM3,402.0 million Bai' Bithaman Ajil Islamic Debt Securities (BaIDS) at AA+ID with a stable outlook

The affirmed rating takes into account the recent improvement in KEV's operating and financial performance, as well as the rating agency's expectation of a very high probability of parental support from Tenaga Nasional Berhad (TNB). Since MARC's last rating action, KEV's financial performance has significantly turned around as a result of higher electricity sales and reduced power generation outages. KEV posted a pre-tax profit of RM134.3 million for the 12 months ended August 31, 2011 (FY2011) after two consecutive years of losses. MARC continues to view KEV as a strategic subsidiary of TNB and maintain its view that there is a very high likelihood that TNB would provide timely capital and funding support to KEV if needed, on account of KEV's strong operational and ownership ties with TNB (rated AAA/Stable).

The stable outlook reflects MARC's expectation that the KEV's multi-fuel thermal power station will demonstrate a satisfactory performance record in the coming quarters and the rating agency's current stable outlook on TNB's issuer and long-term senior debt ratings of AAA. The rating on the BaIDS will be sensitive to negative developments in KEV's stand-alone credit profile, a change in TNB's rating and/or its supportive stance towards KEV. The rating outlook acknowledges the ongoing pressure on TNB's financial profile stemming from unresolved gas supply shortages, however, MARC sees no immediate need to revisit its opinion on support, based on its view that KEV's improving operating and financial performance signals a reduced likelihood that near-term support would be required of TNB to meet forthcoming BaIDS maturities in the next 12 to 18 months.

KEV was established to acquire and operate the Stesen Janaelektrik Sultan Salahuddin Abdul Aziz, or KPS, the largest multi-fuel thermal power station in Malaysia with a 2,420-megawatt (MW) nominal capacity. KPS currently operates four generating facilities (GF) capable of running on coal, natural gas or oil. Distillate, a standby fuel, is also used as a back-up fuel for gas turbines. Fuel supply risks are mitigated by long-term supply agreements with TNB and TNB Fuel Services Sdn Bhd. All fuel costs incurred in generating electricity are passed through to TNB. Under a 25-year Power Purchase Agreement (PPA), KEV receives payments from sole offtaker TNB, comprising monthly capacity payments (CP) and energy payments (EP). CPs are designed to cover fixed operating costs, debt service payments and provide returns to shareholders while EPs cover fuel costs and variable operating costs. However, actual monthly CPs have been negatively affected by a higher level of unplanned outages than allowed under the PPA.

The plant's overall unplanned outage rate improved to 9.83% in FY2011 compared to 15.37%, although outages of GF2 and GF3 still exceeded their PPA specified levels. Capacity revenue increased 24.0% to RM630.6 million. EPs contributed 81.2% of the total revenue due to higher dispatch level of 11,789.9 GWh, up from 6,706.5 GWh in FY2010 to compensate for the shortfall in electricity generation by other gas power plants in Peninsular Malaysia. As a result, KEV recorded a higher operating profit before interest and tax (OPBIT) of RM426.4 million, notwithstanding a 9.2% increase in operating costs due to higher staff costs, administration and operational expenses. Finance costs were lower due to impact of the adoption of FRS139 on interest costs of the redeemable unsecured loan stocks (RULS) as well as the continued debt pay-down. Consequently, KEV recorded its first pre-tax profit of RM134.3 million since FY2008. However, KEV's profitability continues to be constrained by its significant finance costs.

KEV has been meeting its obligations on the BaIDS from its internally generated cash flow while deferring debt servicing on its redeemable unsecured loan stocks (RULS). Unpaid interest due to shareholders on their holdings of KEV's RULS continues to grow despite RULS holders' consent to lower the compounding interest rate from 15% to 5% per annum on unpaid interest after the due date. As of August 31, 2011, KEV owes its shareholders, TNB and Malakoff Berhad, RM476.0 million and RM317.3 million in interest expense on the RULS respectively, up from RM375.4 million and RM250.3 million respectively a year ago. The RULS are subordinated to all KEV's debts, and any redemption is subject to the satisfaction of a distribution test. The full equity credit given to KEV's outstanding RULS of RM892.6 million in the gearing calculation for covenant compliance has enabled KEV to remain in compliance with its gearing covenant of 80:20 (actual: 75:25 as at July 9, 2011).

Despite its improved profitability in FY2011, KEV generated lower cash flow from operations (CFO) of RM456.3 million compared to FY2010's RM533.2 million as a result of an increase in working capital requirements. The aforementioned increase in working capital was contributed by an increase in inventory and higher fuel purchases during the financial year. KEV's average collection period for receivables, meanwhile, improved to 71 days (FY2010: 90 days) notwithstanding the higher trade receivables due from TNB of RM852.1 million (FY2010: RM458.9 million) at year end. Reflecting the lower level of CFO generation, KEV's CFO interest coverage and finance service coverage ratio (FSCR) declined to 2.77 times (x) and 1.25 times respectively (FY2010: 2.97x and 1.37x respectively). MARC notes with some concern KEV's continuing negative net working capital position and the increase in the interest component of coal billing payables to RM81.6 million as of end-August 2011 from RM42.7 million a year ago. Cash balances in KEV's designated accounts which totalled RM317.1 million after its January 6, 2011 BaIDS redemption are sufficient to meet its next BaIDS obligation of RM203.9 million on July 6, 2012, comprising RM136 million of principal repayment and RM67.9 million of profit payment.

Contacts: David Lee, +603-2082 2255/david@marc.com.my; Sandeep Bhattacharya, +603-2082 2247/sandeep@marc.com.my.