Tenaga Nasional Bhd. #BBB+# Rating Affirmed With Stable Outlook

Stocks and Financial Services Press Releases Wednesday February 25, 2015 17:30
SINGAPORE--25 Feb--Standard & Poor's

SINGAPORE (Standard & Poor's) Feb. 25, 2015--Standard & Poor's RatingsServices said today that it had affirmed its 'BBB+' long-term corporate creditrating on Tenaga Nasional Bhd., a Malaysian integrated utility. The outlook isstable. We also affirmed our 'axA+' long-term and 'axA-1' short-term ASEANregional scale ratings on the company. At the same time, we affirmed our'BBB+' issue ratings on Tenaga's senior unsecured notes.

"We affirmed the rating because we expect Tenaga to maintain its strong marketposition and financial strength over the next 12-18 months despite heavycapital expenditure plans," said Standard & Poor's credit analyst AbhishekDangra.

We expect the tariff mechanism in Malaysia to lower the company's exposure tovolatile fuel costs. However, the fuel-cost adjustment mechanism has yet toestablish a track record, particularly in case of under-recoveries (tariffsnot allowing full recovery of fuel costs) and needs cabinet approval. In the

meanwhile, any delays in adjustment may expose Tenaga to fluctuations in fuelcosts.

Tenaga's dominant position as an integrated power provider in Malaysiaunderpins its "satisfactory" business risk profile. The company contributesabout 50% of Malaysia's installed capacity, and is the sole owner and operatorof peninsular Malaysia's electricity transmission and distribution network.Tenaga's revenues, while concentrated in Malaysia, are well distributedbetween domestic customers.

Tenaga benefits from regulated tariffs, which are calculated based on theexpected fuel costs and fuel mix for the company. However, actual costs canvary depending on the market and operatingconditions. In the past, thisvariance led to significant volatility in EBITDA margins. Further, Tenaga isobliged to make fixed capacity payments to independent power producers (IPPs)under long-term power purchase agreements (PPAs). Tenaga's margins in 2014were flat despite an increase in electricity tariffs of more than 14% becauseof its greater reliance on liquefied natural gas than coal, a lower cost fuel.Partial or delayed pass through of fuel costs and Tenaga's exposure to risksassociated with the debt servicing and execution of new generation projectsare the key reasons why we view the company's competitive position as "fair."

"We believe the full implementation of a semi-annual fuel-cost adjustmentmechanism effective January 2015 can bring greater stability to Tenaga's cashflows," said Mr. Dangra. Under this mechanism, tariffs could be adjusted forany under- or over-recovery by Tenaga due to differences in fuel costs or fuelmix. In February 2015, the government lowered the tariffs for March to June2015 because of falling fuel costs and over-recoveries in 2014. We believesimilar timely tariff revisions will be essential even in case of

under-recoveries, considering that the prices of many fuels such as coal andoil are at multi-year lows. Such timely revisions can ensure that Tenaga isnot exposed to the risk of an increase in fuel costs (after adjusting savingsfrom the lower cost of PPAs).

Tenaga's "significant" financial risk profile assessment incorporates our viewthat the company will maintain its margins and financial strength in 2015 and2016. Our view is based on our expectation of revisions in tariffs for anyunder- or over-recovery of fuel costs. We expect Tenaga's free operating cashflows to be negative in 2015 as its capital expenditure remains high. Thiscapital spending is largely toward new generation capacity. We believe thatTenaga's capital expenditure will significantly reduce after 2017 because thecompany will likely shift its spending focus on adding transmission

infrastructure rather than more capital-intensive generation projects. Weexpect the company's cash flows to remain stable with a ratio of funds fromoperations (FFO) to debt of about 17%-19%.

In our view, Tenaga is likely to benefit from its status as agovernment-related entity (GRE). The rating is therefore two notches higherthan the company's stand-alone credit profile. Based on our criteria for GREs,our view of a "high" likelihood of extraordinary government support is basedon Tenaga's "very important" role to, and "strong" link with, the government.

We assess Tenaga's liquidity as "adequate" because we expect the company'sliquidity sources to exceed liquidity uses by at least 1.2x over the next12-24 months.

The stable outlook reflects our expectation that Tenaga's operating andfinancial performances will be stable over the next 12-18 months. We assumethat the company will be able to pass on any under- or over-recovery throughtariff adjustments or savings from PPA contracts. We also expect Tenaga'scapital expenditure to reduce from 2017 once the company completes some of itslarge generation projects in 2016.

We could raise the rating if the timely implementation of tariff reformsresults in a more transparent and defined tariff regime that: (1) meaningfullyeases the pressure of increasing fuel costs and margin volatility on Tenaga;and (2) sustainably improves the stability of the company's profitability. We

may also upgrade Tenaga if its financial performance improves sustainably,such that the FFO-to-debt ratio is above 25%. A more favorable view of thelikelihood of extraordinary government support would also be positive for therating.

We may downgrade Tenaga if the company continues to make aggressivedebt-funded investments in generation projects or faces higher-than-expectedfuel costs without tariff relief or lower-than-expected demand for power. Adowngrade trigger could be a ratio of FFO to debt of 13%-15% over a prolongedperiod.

We may also lower the rating if Tenaga's relationship with the governmentchanges materially or we believe the likelihood of extraordinary support hasdiminished. However, we see a low possibility of both scenarios happening overthe next 12-24 months.

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