Manila Electric Company (PSE: MER)

Business Profile

Manila Electric Company (MER, the Company) is the largest electricity distributor in the country providing power for over 5 million customers in 31 cities and 80 municipalities. The Company was awarded with the 25-year franchise covering an area of 9,337 km2 in 2003. To illustrate MER’s business:

The Company buys electricity from the Whole Sale Electricity Spot Market and power plants. MER then sells it to customers with no profit but just enough to cover the costs. The cost of electricity in the said process is called pass-through charges. Pass-through charges are revenue neutral or in other words, it does not add to profit nor does it cause losses to the Company. MER generates revenues through the collection of distribution charges. It is the costs paid by customers for using MER’s transmission lines and its services.

MER’s Strategy for Growth

The Company intends to source future growth through participation in the Open Access and Retail Competition (OARC) as a Retail Electricity Supplier (RES), entry to power generation, and franchise expansion.

Open Access and Retail Competition (OARC) is one of the reforms in the Philippine electricity industry which gives electricity end-users the right to choose their electricity service provider. The reform will be initiated in three phases. First, only end-users that have an average consumption of one megawatt (MW) and above in one year will have the right to choose their electricity service provider. The second phase will occur two years after the first phase, end-users that have an average consumption of 750 kilowatt (Kw) will also be able to choose. Subsequently, the Energy Regulatory Commission (ERC) will evaluate the market and gradually reduce the threshold until it reaches household consumption level. The intention of such reform is to lower electricity costs through competition. [1]

MER expects the implementation of OARC in the 2nd half of 2013. MER through its wholly owned subsidiary MERALCO Retail Electricity Supply (MERALCO RES) responded to the challenge by negotiating supply contracts with independent power producers and independent power producer administrator (IPPA), IPPA are private firms granted by the government to operate and maintain government owned power plants.[2]

MER ventures in to power generation through its wholly owned subsidiary Meralco PowerGen Corporation (MGEN). On June 27, 2011, the Company disclosed on a press release that they are to invest for a majority stake in Redondo Peninsula Energy, Inc. (RP Energy). RP Energy has the development rights and assets to a 2 x 300 Mw coal-fired power plant in the Subic Bay Freeport Zone. [3] On July 25, 2011, the Company disclosed that MGEN together with Meralco Pension Fund bought 50% + 3 shares in RP Energy. [4] MER expects the power plant to be operational in 2015. MGEN is also working in a broad range of pre-development studies in other power generating assets with an intention to reach an aggregate of 2,000 megawatts generation capacity. [5] The Company expressed their interest to invest in power generation in Vietnam through participation as a minority interest. [6]

 

Comments:

MER’s franchise generates a stable cash flow for the Company. As of December 31, 2011, MER’s free cash flow (FCF) stands at 25 billion. Assuming a 4.5% growth in the FCF for the remaining life of MER’s franchise and using the current weighted average cost of capital (WACC) of MER of 3%, we can value MER’s franchise at P380.31/sh (see Appendix).

The upcoming OACR which was designed to increase competition for MER actually presents an opportunity for MER. There is a high demand of electricity in the Luzon area but with tight electricity supply. In the next 2 years, I expect MER’s wholly owned subsidiary MERALCO RES to add in the Company’s revenues through electricity trading gains.

MER’s entry in power generation is a rational business move as this will provide additional cash flow for MER and add value to MER’s customers through lower electricity prices and stable electricity supply. Lower electricity costs will serve as MER’s competitive advantage in the future of the electricity industry where consumers will have the power to choose their electricity provider.

Other data:

Appendix

Weaknesses of assumptions:

  1. Even though the principle of conservatism is observed, long-term FCF growth rate might unfavorably deviate from conservative assumptions.
  2. Unexpected regulatory developments might affect calculations.

Sources:

  1. R.A. 9136, Electric Power Industry Reform Act of 2001, Section 31, http://www.lawphil.net/statutes/repacts/ra2001/ra_9136_2001.html
  2. Grant of Authority to enter into Contract for Supply of Electricity; Press Release re: Financial and Operating Results for 1st Quarter 2012, http://www.pse.com.ph/resource/disclosures/2012/pdf/dc2012-3159_MER.pdf
  3. Board approcale of investment in RP Energy; cash dividend declaration on preferred shares; Press Release: “Meralco invests in 600 MW Coal-Fired Plant,” http://www.pse.com.ph/resource/disclosures/2011/pdf/dc2011-4783_MER.pdf
  4. Clarification of news article: “Meralco acquires 52% shares of subic coal plant,” http://www.pse.com.ph/resource/disclosures/2011/pdf/dc2011-5497_MER.pdf
  5. Clarification of news article: “Meralco plans to build additional power plants,” http://www.pse.com.ph/resource/disclosures/2011/pdf/dc2011-7832_MER.pdf
  6. Clarification of news articles, http://www.pse.com.ph/resource/disclosures/2012/pdf/dc2012-7899_MER.pdf
  7. Power Development Plan 2009-2030, http://www.doe.gov.ph/EP/EP%20Update%2007272010/PDP%202009-2030.pdf

Disclaimer: I do not claim to be an expert and nothing I say should be taken as a recommendation to buy or sell.

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6 thoughts on “Manila Electric Company (PSE: MER)

  1. Thanks for this post. Can you give us a breakdown / formula for your 3% and 4% cost for equity and debt, respectively?

    Reply
    • For Capital:
      (in millions)
      Dividend paid: 9,866
      Capital Market value at the time of writing (279/sh) 314,468

      For debt:
      Interest expense net of tax: 814
      Debt: 19,816

      Weight:
      Capital: 94%
      Debt: 6%

      Reply
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