The Philippines Biggest Power Distributor: Manila Electric Company
GuruFocus.com
- By Mark Yu
The P302 billion ($6 billion) Pasig-city based electric producer reported its first quarter 2017 results in May. Manila Electric Company or Meralco generated 10.6% revenue growth to P66.6 billion compared to the same period a yer earlier while profits rose 5.9% to P4.8 billion.
As observed, overall costs and expenses increased by 12% in the quarter compared to a year earlier while other income rose 347% secondary to rise in foreign exchange gains, net earnings in equity stakes among others.
"Strong macroeconomic fundamentals underpin the past growth trajectory of the Philippines and we see these as being sustained in the short- to medium-term. Hence, despite global growth and geopolitical uncertainties, we remain confident that the domestic economy will continue to expand at the current pace, or potentially faster, as new drivers weigh in, such as more government/public private partnership projects with more bilateral funding from regional powerhouses."
Meralco chairman Manuel V. Pangilinan
Valuations
Manial Electric is slightly undervalued compared to its peers. According to GuruFocus data, the company had trailing P/E ratio 15.6 times vs. industry median 17.6 times, P/B ratio 4.4 times vs. 1.6 times, and P/S ratio 1.2 times vs. 1.7 times.
The company had a 3.24% dividend yield with 0% payout ratio (Reuters). Meralco's ADR shares, meanwhile, had trailing dividend yield 1.76% with 26% payout ratio (GuruFocus).
Average 2017 revenue and earnings-per-share estimates indicated forward multiples of 1.1 times and 16 times.
Total returns
Meralco underperformed so far this year compared to the local broader index, iShares MSCI Philippines ETF (EPHE), with 5.32% gains vs. 12.98%; while having outperformed the index in the past three year with 8.32% (annualized) vs. 0.12% (Morningstar).
Meralco ADR shares, meanwhile, performed poorly so far this year with (-)20.34% total losses vs. the S&P 500 index 11.05% gains.
Manila Electric Company
Manila Electric Company, or Meralco, traces its roots in the name of the company La Electricista, a company organized in 1891 and that began operations in late 1894. Acquisitions decades later with the lead of an American businessman and lawyer Charles Swift brought to life the Manila Electric Railroad and Light Company, which was mainly a public transportation company. Power generation later generated more revenue for the company.
According to filings, Meralco holds a congressional franchise under the Philippine Republic Act No. 9209 effective June 2003. The Republic Act grants MERALCO a 25-year franchise valid through June 28, 2028, to construct, operate and maintain the electric distribution system in the cities and municipalities of Bulacan, Cavite, Metro Manila and Rizal and certain cities, municipalities and barangays in the provinces of Batangas, Laguna, Pampanga and Quezon (1).
These cities and municipalities mainly comprises the Philippines' National Capital Region--the second most populous region in the Philippines. In 2016, the region continued to account for the largest share of the national economy as it had the largest share of the country's GDP at 36.6%.
The power segment, primarily power distribution, consists of operations of Meralco and its subsidiary, Clark Electric Distribution Corporation (CEDC). Granted by Clark Development Corp., CEDC is a registered private distribution utility, franchised to own, operate and maintain a power distribution system and to distribute power exclusively within its franchise area, which includes the Clark Freeport Zone and the sub-zone as determined pursuant to Presidential Decree No. 66 and the Joint Venture Agreement executed between CDC and Meralco Industrial Engineering Services Corporation dated February 1997.
Further, Meralco has an equity interest in a power generating company, Global Business Power Corp. (GBPC). GBPC is developing power generation plants through its wholly owned subsidiary, MGen.
Through several subsidiaries in the services segment, Meralco provides engineering, design, construction and consulting services, bill collection services, distribution and energy management services, and communications, information systems and technology services.
In addition, Meralco manages electric distribution facilities of Pampanga Electric Cooperative II through Comstech under an Investment Management Agreement. Meralco also manages electric distribution facilities in the Cavite Economic Zone under a 25-year concession agreement with Philippine Economic Zone Authority.
As of recent annual filing, Meralco is owned directly by two major stockholder groups, Beacon Electric Asset Holdings and JG Summit Holdings. Beacon Electric is a joint venture between Metro Pacific Investments Corporation and PLDT Communications and Energy Ventures. Metro Pacific, First Philippine Holdings Corp. and First Philippine Utilities Corp., also have direct equity ownership in Meralco.
Meralco has two segments: power and others.
Power
Meralco's power segment consists of three parts: electricity distribution, power generation and local retail electricity supplier.
1) Electricity distribution - This is principally electricity distribution and supply of power on a pass-through basis covering all captive customers in the Meralco and the CEDC franchise areas in the Luzon Grid. Electricity distribution within the MERALCO franchise area accounts for approximately 55% of the power requirements of the country. CEDC's franchise area covers the Clark Freeport Zone and the sub-zone.
2) Power generation - Meralco's re-entry in the power generation business is through investments in operating companies or participation in the development of power generation projects.
MGen, the power generation arm of the Meralco Group, has a 14% equity interest in GBPC effective June 2016. GBPC currently operates a total of 859 MegaWatt (MW) - gross of coal and diesel-fired power plants, which include a 150 MW - gross coal-fired power plant in the Panay Island which was commissioned in November 2016.
MGen also owns an effective 28% equity in PacificLight Power Pte in Jurong Island, Singapore. PacificLight Power, which owns and operates a 2 x 400 MW liquefied natural gas power plant, began commercial operations in February 2014 (2).
Meralco also subscribed to a 50% equity interest in Pure Meridian Hydropower Corporation which shall undertake the development of various mini-hydroelectric power projects. A project in Quezon province has initiated in May.
3) Local retail electricity supplier (RES) - This covers the sourcing and supply of electricity to qualified contestable customers. Meralco serves as a local retail electricity supplier within its franchise area under a separate business unit, MPower.
Under Retail Competition and Open Access, qualified contestable customers who opt to switch to contestability and become contestable customers may source their electricity supply from competing RESs, including MPower (3).
In the first quarter, revenue from Meralco's power generation business grew 11.9% year over year to P64.7 billion (96.7% of total unadjusted company revenue) and had a profit margin of 7.1% vs. 7.3% in the same period last year.
Power generation metrics: generation charge, system loss, and customers.
Power generation charge
According to filings, 62% of Meralco's power/electricity revenue came from its generation charges. The average generation charge to captive customers in the recent quarter was 22% higher year over year at P4.95 per kilowatt hour (kWh) vs. P4.05 per kWh in the year prior period.
System loss
System loss (technical and nontechnical) may be passed on to Meralco's customers.
According to filings, the maximum rate of system loss that a utility can pass on to its customers is currently being deliberated in the Philippine Senate as of February whereby a legislator, late last year, proposed a bill to lower the current cap of system loss rate from 8.5% to 5% for private distribution utilities, and from 13% to 10% for electric cooperatives, and to exclude non-technical system losses and electricity used by the private distribution utilities and electrical cooperatives.
Nonetheless, Meralco reported an impressive 114-year low of 6.19% in the first quarter compared to 6.49% in the same period last year. This is lower than the cap rate of 8.5%.
Customers
As of March 2017, Meralco's customer base grew by 5% to 6.1 million customer accounts from March 2016. Residential customers continue to represent 92% of the total 6.1 million customer accounts. Further, residential and commercial customer counts rose by 5% and 3%, respectively.
Others
The other services segment is involved principally in electricity-related services, such as; electro-mechanical engineering, construction, consulting and related manpower services, e-transaction and bills collection, telecoms services, rail-related operations and maintenance services, insurance and re-insurance, e-business development, power distribution management, and energy systems management and harnessing renewable energy (4).
In the recent quarter, revenue in the other services segment fell 18% year over year to P2.2 billion and registered a margin of 12% vs. 13% in the same period last year.
According to filings, the revenue reduction was mainly due to the following Meralco subsidiaries (i) MIESCOR, whose major transmission line and substation projects were completed in 2016; (ii) MServ, whose major projects related to strategic loadside outsourcing and energy efficiency solutions were completed in 2016; and (ii) Republic Surety and Insurance Company, whose gross revenues decreased due to higher cost of reinsurance.
Sales and profits
In the past three years, Meralco registered a revenue decline average of 4.9%, profit growth average of 3.67%, and profit margin average of 7.2% (Morningstar).
Cash, debt and book value
As of March, Meralco had P49.4 billion in cash and cash equivalents and P40 billion in debt with debt-equity ratio 0.58 times vs. 0.4 time the year prior. Overall debt rose P10.2 billion while equity declined by P4.6 billion year over year.
Meralco did not exhibit any blue sky elements such as goodwill and intangible elements while book value drop by 6.1% year over year to P69.7 billion.
Cash flow
In the recent quarter, Meralco's cash flow from operations dropped by 21% year over year to P6.2 billion secondary to cash flow reduction in its interest and financial income, earnings in associates and joint ventures, receivables, inventories, and customer refunds.
Capital expenditures were P2.7 billion leaving the company with P3.6 billion in free cash flow vs. P6 billion in the year earlier period. 0.14% of its free cash flow were provided as dividends in the quarter. Meralco also allocated P320 million in interests and debt repayments net any issuances.
In the past three years, Meralco allocated 76% of its free cash flow in dividend payouts on average. The company accumulated P79.5 billion in free cash flow, P9.12 billion in debt, and paid out P58.9 billion in dividends in the period of three years.
Conclusion
As the country's largest power distributor accompanied by 25-year franchise agreements with the government, Meralco has built itself a hefty moat around its castle of operations and still developing other projects. Meanwhile, the company recorded steady low teen revenue growth figures in the first quarter after having revenue decline in recent years. As discussed earlier, higher kWh and growing customer base definitely helped improved Meralco's first quarter operations.
According to filings, the company recorded less revenue in its other services brought by completion and efficiency costs.
In addition, FPM Power-- where Meralco has P1.99 billion stake or 40%-owned--has its operations performed very poorly in recent years. FPM Power, which has a 70% interest in a liquid natural gas-fired power plant in Singapore registered a two-year revenue decline of 5.9% to P28.6 billion and accumulated total losses of P8.2 billion in the past three fiscal years. In 2016, FPM Power recorded a P1.2 billion goodwill impairment.
Meralco maintained a cash rich balance sheet that could pay its debt in entirety and a little more just by its current cash on hand. The company also maintained an impressive cash flow payout ratio in recent years absent any share dilution and prudent debt intake.
12 analysts have a median price target of P315 a share vs. P269.8 at the time of writing, suggesting a 16.8% upside. Applying three-year P/S multiple and revenue growth averages followed by a 20% margin application indicated a value of P208 a share.
In summary, Meralco is a buy with a price target of at least P300 a share. Meanwhile, Meralco's ADR is also a buy with 11.6% upside at $12.16 a share target.
Notes
(1) Company filings
On October 20, 2008, the Energy Regulatory Commission ("ERC") granted MERALCO a consolidated Certificate of Public Convenience and Necessity for the operation of electric service within its franchise coverage, effective until the expiration of MERALCO's congressional franchise. MERALCO's participation in retail electricity supply ("RES") is through its local RES unit, MPower. The ERC granted the following subsidiaries distinct RES licenses to operate as retail electricity suppliers in Luzon and Visayas: Vantage Energy Solutions and Management, Inc. ("VESM"), wholly owned subsidiary of MERALCO; Solvre, Inc., a wholly owned subsidiary of MERALCO PowerGen Corporation ("MGen"); and MeridianX Inc., a wholly owned subsidiary of Comstech Integration Alliance, Inc. ("Comstech"), on January 10, 2017, February 9, 2017 and February 9, 2017, respectively.
(2) Me: In addition to the aforementioned stakes, MGen has other projects.
Company filings
A1E is currently developing a 2 x 600 MW ultra supercritical coal-fired power plant in Atimonan, Quezon. A1E is in the process of selecting the Engineering, Procurement and Construction contractor for the project. Site preparation works are targeted to start in 2017, with expected completion of the first unit in 2021 and the second 600 MW by early 2022. A PSA have been executed between A1E and Meralco for the full capacity of the plant. The PSA was submitted to the ERC for approval.
Aside from A1E, MGen is currently (i) constructing a 455 MW net capacity supercritical coal-fired power plant in Mauban, Quezon through SBPL, (ii) developing a 2 x 300 MW Circulating Fluidized Bed, coal-fired power plant in the Subic Freeport Zone through Redondo Peninsula Energy, Inc., (iii) developing a 2 x 350 MW sub-critical pulverized coal-fired power plant in Calaca, Batangas through St. Raphael Power Generation Corporation, and (iv) developing a 4 x 132 MW (net) coalfired power plant in Mariveles Bataan through Mariveles Power Generation Corporation.
(3) Company filings
The Philippine ERC granted the following subsidiaries distinct RES licenses to operate as retail electricity suppliers in Luzon and Visayas: Vantage, a wholly-owned subsidiary of MERALCO; Solvre, a wholly-owned subsidiary of MGen; MeridianX, a wholly-owned subsidiary of Comstech, on January 10, 2017, February 9, 2017 and February 9, 2017, respectively. Clarion, a wholly-owned subsidiary of CEDC, is in process of preparing its requirements for its RES licensing for submission to the ERC.
(4) Company filings
These services are provided by MIESCOR, MBI and MLI (collectively known as "MIESCOR Group"), CIS, Bayad Center, CFSI and Fieldtech (collectively referred to as "CIS Group"), MRail, RSIC, LOIL, Finserve, Paragon and Radius (collectively referred to as "e-MVI"), Comstech, MEI and Spectrum
Disclosure: I have shares in Manila Electric Company.
