Elevator Pitch
I maintain a "Neutral" rating on Philippines-listed electric utility Manila Electric Company (OTCPK:MAEOY) [MER:PM]. There is still significant uncertainty over the timeline for the fifth rate regulatory period and the potential changes to Manila Electric's tariff rates for its power distribution business. This remains the key downside risk for Manila Electric. Furthermore, potential delays in the construction of new power plants increase the downside risks for the earnings generated from Manila Electric's power generation business.
Although Manila Electric's forward P/E valuation is undemanding relative to historical averages, I don't find the stock sufficiently attractive due to regulatory risks. As such, a "Neutral" rating for the stock is warranted.
This is an update of my initiation article on Manila Electric published on November 5, 2019. Manila Electric's share price has declined by -24% from PHP338.40 as of November 1, 2019 to PHP258.00 as of March 9, 2020 since my initiation. Manila Electric currently trades at 12.5 times consensus forward FY2020 P/E, which represents a discount to its historical three-year and five-year average forward P/E multiples of 18.6 times and 19.5 times respectively. But Manila Electric has traded as low as 6 times forward P/E during the 2008-2009 Global Financial Crisis. The stock also offers a consensus forward FY2020 dividend yield of 6.0%.
Readers are advised to trade in Manila Electric shares listed on the Philippines Stock Exchange with the ticker MER:PM where average daily trading value for the past three months exceeds $1 million and market capitalization is above $5.5 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers, Fidelity, Charles Schwab, or local brokers operating in their respective domestic markets.
Regulatory Uncertainties Persist For Power Distribution Business
According to the Performance-Based Regulation in the Philippines, the tariffs for Manila Electric's power distribution business are reset every four years by the Energy Regulatory Commission. There is significant uncertainty over the timeline for the fifth rate regulatory period and the potential changes to Manila Electric's tariff rates for its power distribution business.
At the company's 4Q2019 earnings call on February 24, 2020, Manila Electric disclosed that "we're still just waiting word from the ERC (Energy Regulatory Commission) on when the formal process (for the resetting of tariff rates) will start."
Nevertheless, there are signs suggesting that Manila Electric's tariff rates for its power distribution business could be significantly reduced going forward.
Firstly, Philippines' president Rodrigo Duterte has been "pushing a populist agenda that's endearing him to his supporters", according to a Bloomberg article published on January 28, 2020. A number of regulated monopolies operating in the Philippines have been targeted in recent times.
Manila Water Company (OTCPK:MWTCY) (OTCPK:MWTCF) [MWC:PM] has a regulated monopoly to supply water in the East Zone of Metro Manila. Manila Water originally had its water supply concession extended till 2037, but president Duterte had asked for the company's water supply concession extension to be renegotiated in December 2019. On February 10, 2020, the New York Times reported that broadcast network ABS-CBN [ABS:PM] might not have its franchise (which expires in March 2020) renewed, highlighting that ABS-CBN was "at the forefront of critical reporting about the anti-drug campaign" initiated by president Duterte. Earlier in February 2019, Philippine telecommunications company PLDT (PHI) (OTCPK:PHTCF) [TEL:PM] was threatened of being "shut down" if the company "won't set up more trunk lines" to facilitate a new hotline set up for the purpose of reporting corruption, as reported by The Philippine Star.
Assuming consumers' rights and interests are the priority of the Philippine government, there is likely to be significant downward pressure on the new tariff rates for Manila Electric's power distribution business.
Secondly, it was reported in local media in October 2019 that the Supreme Court had asked the Energy Regulatory Commission to review Manila Electric's "asset base to provide the electricity that is of the 'least cost' to consumers." Furthermore, the Supreme Court highlighted that the Energy Regulatory Commission "should determine whether expenses that are not directly related to Meralco's (Manila Electric) operation were passed on to consumers."
In other words, Manila Electric's tariff rates for its power distribution business could potentially be significantly lowered during the new fifth rate regulatory period. This could happen if Energy Regulatory Commission determines that certain costs are now excluded from the new tariff calculations, and Manila Electric's regulatory asset base is valued using a different methodology that implies lower regulated returns for the company.
Thirdly, two of the existing five commissioners for the Energy Regulatory Commission are slated for retirement in mid-2020, and this adds further uncertainty to the decision making process in setting the new tariff rates for the fifth rate regulatory period.
Potential Delays In Construction Of New Power Plants For Power Generation Business
A key power generation project for Manila Electric is Atimonan One Energy, a 2x600 MW coal-fired power plant in Atimonan, Quezon, which is planned to commence commercial operations in 2024. The construction for Atimonan One Energy had been delayed, because of a court ruling in mid-2019 that required new power supply contracts in the country to be decided by a competitive bidding process. Atimonan One Energy was the only company that participated in the auction for a new 20-year 1,200MW power supply contract in December last year, and the Energy Regulatory Commission subsequently asked for a new auction to be held.
Manila Electric addressed this issue at the company's recent 4Q2019 results briefing on February 24, 2020 by stating that "maybe in the next few weeks, we can publish already and call for bids (for the new 1,200MW power supply contract)." While it is positive that the new auction could be potentially held soon, there are risks that Atimonan One Energy could fail to win the new power supply contract against other competitors in a competitive bidding process, leading to further delays for the construction of the new coal-fired power plant.
Renewable energy projects are also a key focus for Manila Electric's power generation business, apart from the coal-fired plant, Atimonan One Energy. Manila Electric started a new renewable energy business referred to as MGEN Renewable Energy, Inc., which is targeting 1,000 MW of renewable energy projects such as solar energy, hydro-power and wind energy for the next five to seven years.
Unfortunately, two new renewable energy projects that Manila Electric's power generation business has initiated since late-2019 are now facing delays. This is because the supply of photo-voltaic or PV panels from China has been disrupted due to the current coronavirus outbreak. On the flip side, the coronavirus outbreak could potentially have a positive impact on Manila Electric's power distribution business as detailed in the next section of this article.
Potential Impact Of Coronavirus Outbreak And Crackdown On POGOs
At the time of writing, there are 20 confirmed cases of coronavirus infections and a single death in the Philippines. The residential segment accounted for 31.1% of the total sales volumes for Manila Electric's power distribution business in FY2019. If more people in the Philippines choose to remain indoors and cut back on their outdoor activities due to the current coronavirus outbreak, Manila Electric's power distribution business could potentially benefit from higher power usage by residential customers.
On the other hand, the commercial segment contributed 39.4% of the power distribution business' sales volumes last year. Philippine Offshore Gaming Operators, or POGOs, which are a major driver of new office space demand in the country, have been under scrutiny. The Chinese Embassy in Philippines asked for tougher enforcement actions against POGOs hiring illegal Chinese nationals in August 2019, and new POGO applications were suspended by the Philippine gaming regulator in the same month.
A crackdown on POGOs in the Philippines or even a complete ban could potentially lead to lower power demand from commercial customers for Manila Electric's power distribution business. Nevertheless, Manila Electric emphasized at its 4Q2019 earnings call on February 24, 2020 that "we haven't seen any dent or any slowdown" with respect to POGO-driven demand for the commercial segment.
Valuation
Manila Electric trades at 12.5 times consensus forward FY2020 P/E and 12.7 times consensus forward FY2021 P/E based on its share price of PHP258.00 as of March 9, 2020. In comparison, the stock's historical three-year and five-year average forward P/E multiples were 18.6 times and 19.5 times respectively. During the 2008-2009 Global Financial Crisis, Manila Electric traded as low as 6 times forward P/E.
Manila Electric offers consensus forward FY2020 and FY2021 dividend yields of 6.0% and 6.2% respectively.
Risk Factors
The key risk factors for Manila Electric include lower-than-expected tariffs for the company's power distribution business, a delay in the construction of new power plants for the company's power generation business, and lower-than-expected dividends going forward.
Asia Value & Moat Stocks is a research service for value investors seeking value stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!
