Think tank Bloomberg Intelligence came out with a report warning of a deteriorating credit profile of San Miguel Corp.'s energy unit SMC Global Power.

The report said SMC Global Power's attempt to renegotiate tariffs for one gigawatt of power supply to its largest offtaker, Meralco could stir legal and regulatory risks.

"The regulator (Energy Regulatory Commission) rejected the proposal but SMC Global Power could pursue legal remedies."

Below is the full research paper:

SMC Global Could Face Legal Risk With Power Cutoff:
Credit React

RECENT EVENT REACTION: SMC Global Power's potential termination of 1 GW in power-supply agreements (PSAs) with Meralco could curb losses but heighten legal risks. The PSAs don't allow SMC to pass through fuel costs and are unprofitable amid rising coal and gas prices. Meralco could take legal action if the power utility stops supplying electricity under the PSAs, after an unsuccessful attempt to temporarily hike tariffs. (10/05/22)

1. SMC Global Power's Cost, Capex Pressure Mounts:
Credit Outlook

THESIS: SMC Global Power's senior perpetual bonds could widen further as they look tight relative to B to BB- rated bonds in Asia. FF0-to-net debt could weaken to 1-2% this year with high capex and cost pressure from rising commodity prices. Its balance sheet could gradually recover from next year, though the perps face high non-call risk as funding costs increase, exacerbated by its exposure to coal. (10/11/22)

CREDIT CONSIDERATIONS

• Credit Checklist NEW © Liquidity: More Funds Needed Soon NEW
• Credit Driver: Deteriorating Balance Sheet NEW • Valuation: Rising Non-Call Risk NEW

SMC Global Power's balance sheet could stay under pressure from high energy costs, which it can't completely pass on to customers. FF0-to-net debt could decline to 1-2% in 2022 before recovering next year, by our calculations. SMC Global's swelling capex to boost capacity — to more than 9,000 megawatts (MW) by 2025 – could keep leverage lofty, and it may need to borrow up to $1 billion by next June. The unrated utility has high coal exposure, but could have access to domestic funding given its status as the flagship power company of San Miguel Corp., one of the Philippines' leading conglomerates.

Its attempt to renegotiate tariffs for one gigawatt (GW) of power supply to its largest offtaker, Meralco could stir legal and regulatory risks. The regulator rejected the proposal, but MC Global could pursue legal remedies. (10/10/22)

SMC Global Power's balance sheet faces further pressure from a spike in energy prices and high capex. FFO-to-net debt might fall to 1% this year, assuming 30% of fuel-cost increases can't be passed on. This ratio could be closer to 2% if it successfully hikes tariffs on 1GW of power supply agreements with Meralco. Credit metrics could gradually improve from next year as it commissions new battery energy storage capacity and commodity prices moderate.

The power company has been able to partly pass on higher costs to most retail customers, on top of 40-50% of power-purchase agreements, which allow for fuel-cost pass through. Only about 10% of coal needs are at fixed price and it might struggle to source gas in 2H as production drops from the Malampaya gas field and a LNG terminal project is delayed. (10/11/22)

SMC Global's capex could remain high as it aims to almost double capacity to over 9,000 MW by 2025. Annual capex could be about 50-60 billion pesos in 2022 and 2023, a small increase from 2021 but almost double 2020's spending. The majority of capacity would still be in thermal power, exposing it to fuel-cost volatility and environmental concerns. But battery energy storage projects can generate stable capacity-based payments, providing some offset.

SMC Global is considering other legal remedies after the regulator rejected its proposal to temporarily hike tariffs for 1GW in power supply agreements (PSAs) with Meralco, which didn't allow for fuel-cost pass through. This could pose some legal and regulatory risk and could also affect its bids for future PSAs. (10/11/22)

SMC Global's credit profile might weaken to a B1 profile based on Moody's rating methodology for unregulated power companies. It might not benefit from uplift for support from its parent San Miguel Corp. which also has high leverage. SMC Global scores poorly for its financial policy and credit metrics, with its FFO-to-debt ratio dropping to Caa levels due to high input costs and capex.

It is exposed to currency risk, though this is partly offset by a natural hedge with about 35% of contracted capacity allowing for forex tariff adjustments and less than 10% of its $2 billion net liabilities in dollars hedged as of June.
Interest cover might weaken somewhat due to rising rates, with about 30% of debt in floating rate. (10/11/22)

Liquidity: More Funds Needed Soon
SMC Global Power Faces Funding Shortfall, High
Extension Risk
SMC Global Power risks a funding shortfall as high as $1 billion by next June, which could be partly offset by domestic bonds and bank loans. Most of its $3.4 billion in dollar-denominated perpetual notes — callable between 2024 and 2026
— face high extension risk given its rising funding costs and poor liquidity. (10/10/22)

SMC Global Power could face a funding shortfall of up to $1 billion by next June due to flagging cash flows and high capital investment. Even with about $300 million in undrawn credit and a 40 billion-peso bond issue in July, it might fall short of covering short term dues and cash outflows. Its status as the flagship power company within San Miguel Corp., one of the Philippines' leading conglomerates, could promote access to domestic markets, as evidenced by its recent 3-10 year bond issue at coupon rates of 8% and below. This contrasts with its dollar perpetual notes, which trade at double-digit yields. It could raise another 20 billion pesos, as its shelf-registration is for 60 billion pesos.

SMC Global was in compliance with its financial covenants as of June, with net debt-to-equity at 1x vs. a 3.25x covenant limit. (10/10/22)

SMC Global's annual debt maturity in the coming years amounts to the equivalent of about $500 million, yet its dollar perpetual notes could face high non-call risk given its rising funding costs. On top of rising rates, its coal exposure might make refinancing on the dollar bond market tougher and more costly, as investors increasingly shun coal-fired power plants. The company aims to redeem the $3.4 billion perpetual notes on the first call dates, which fall between 2024 and 2026. They have high coupon resets of at least 6.5% above five-year Treasuries, but this is still below current yields of about 11%-12%, other than its 7% notes callable from 2025, which reset at 9.2%.

Upcoming maturities are from bank loans and domestic bonds could be refinanced domestically, (10/10/22)

Valuation: Rising Non-Call Risk
SMC Global Perps' 11% Yield Might Not Be Enough for High Risks
Most SMC Global Power's senior perpetual dollar bonds are quoted at about 11% yield-to-worst, which look tight compared with other Asian high-yield bonds. Other than its 7% notes callable from 2025, the bonds face high non-call risk due to its weak balance sheet, liquidity needs and rising funding costs, exacerbated by its large exposure to coal. (10/07/22)

SMC Global Power vs. B, B, B+ Rated Bonds
SMC Global Power's dollar bonds are trading on the tight end compared with single-B rated Asian bonds. They trade in-line with B+ rated oil and gas firm Medco Energi and Macau gaming company MGM China, B rated bonds in Asian emerging markets, ex-China are trading much wider with Wynn Macau and SJM at over 13% yields and Indonesia's Lippo Malls at over 20%.

SMC Global aims to redeem perpetuals on the first call date, with a track record of doing so. But the company's weak liquidity and rising funding costs could heighten non-call risk, other than for its 7% notes callable from 2025 which have a much-higher coupon reset at 5-year Treasury plus 9.2%. This is reflected in the 7% bonds' trading level, with a yield-to-worst of 12%, reflecting a likelihood of getting called on the first call date. (10/07/22)

To contact the analyst for this research:
Sharon Chen at schen1281@bloomberg.net