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Company Update Summary: Manila Electric Co (MER)

Core Content

Manila Electric Co (MER) is a regulated utility company primarily engaged in the distribution and sale of electric energy through its franchise areas. The company is also expanding its power generation portfolio through recent acquisitions. The report provides an update on the company's stock performance, financial forecasts, and regulatory environment, leading to a revised rating and price target.

Main Points

Rating and Price Target

• Rating: Downgraded from Hold to SELL.
• Price Target: Reduced from PHP336.70 to PHP280.00.
• Reason for Downgrade: Revised profit forecasts and lower rate assumptions starting July 2015.

Stock Information

• Ticker: MER PM / MER.PS
• Shares Issued (m): 1,127.1
• Market Cap (PHP m): 352,781.9
• Market Cap (USD m): 8,168.1
• 3-mth Avg Daily Turnover (USDm): 435.3
• PSEI: 6,483.57
• Free Float (%): 10.16

Major Shareholders

• Beacon Electric Asset Holdings Inc: 50.0%
• JG Summit Holdings Inc.: 19.5%
• First Philippine Holdings: 3.9%

Key Financial Indicators

• ROE (annualised %): 25.1
• Net Debt (PHP m): 4,066
• NTA/shr (PHP): 65.5
• Interest Cover (x): 14.7

Performance Overview

• 52-week High/Low: PHP397.00 / PHP248.00
• Absolute Earnings Growth (1-mth to YTD): 16.8% / 2.3% / -9.3% / 9.8% / 20.1%
• Relative Earnings Growth (1-mth to YTD): 13.9% / 3.8% / -4.8% / -10.2% / 8.6%

Earnings Forecasts

• 2013 Full-Year Estimate: PHP17.69b (up 0.05% from previous estimate)
• 2014 Forecast: PHP20.246b (up 7.5% from 2013 estimate)
• 2015 Forecast: PHP17.63b (down 13% from 2014)
• 2016 Forecast: PHP14.57b (down 17% from 2015)

Key Developments

New Acquisitions

• FPM Power Holdings Ltd (Singapore): Acquired 28% stake in a 2x400 MW LNG power plant, expected to contribute PHP1b in earnings in 2014.
• Global Business Power (GBP): Acquired a 20% stake in GBP, which has 480 MW of total capacity. This is expected to add PHP420m in earnings for 2014.

Capacity and Earnings Impact

• Attributable Capacity: Increased to 320 MW through the acquisitions.
• Equitized Earnings: Estimated to be PHP1.42b from power generation assets in 2014.

Regulatory and Rate Assumptions

• Rate Cuts Expected: Distribution rates are projected to decline from PHP1.64/kWh to PHP1.40/kWh in 2015 and to PHP1.13/kWh in 2016.
• WACC Adjustment: Lowered from 14.97% to 9.65% due to reduced risk-free rate and other factors.
• Risk-Free Rate: Estimated at 5.04% using a direct method, down from the previous 7.95%.

Beta and WACC Calculation

• Beta: Revised to 0.75x (from 0.83x), based on re-levered asset peer beta.
• Cost of Equity: Estimated at 9.51% (vs. current 14.79%).
• Cost of Debt: Reduced to 7.54% (vs. current 12.30%).
• WACC (pre-tax): Estimated at 9.65% (75th percentile), lower than the current 14.97%.

Key Information

Earnings Table (FYE 31 Dec)

Regulatory Implications

• Rate Adjustments: The regulatory body (ERC) is expected to impose lower rates due to a reduced risk-free rate and other factors.
• WACC Methodology: The report uses a direct method for calculating WACC, which results in a lower rate compared to the ERC's indirect method.
• Regulatory Period: The fourth regulatory period (July 2015 - June 2019) is expected to bring about a more challenging environment for MER due to lower rates and WACC.

Conclusion

The downgrade to SELL is primarily due to expected rate cuts in 2015 and 2016, which will negatively impact earnings despite continued volume growth. The company's recent acquisitions are expected to boost earnings in 2014, but long-term growth is at risk due to regulatory pressures and a shifting economic environment. The report highlights the importance of monitoring the regulatory framework and its impact on MER's financial performance.