JAKS (4723) - Jaks Resources - Perfect Conditions

Jaks Resources - Perfect Conditions
"@ deMusangking 

Mark my words, even at half of 800 cent is already hard to achieve. 

My opinion on DK66 computation for his TP between rm6 to rm10 is based on perfect conditions such as : 
1.40% ownership which currently not materialise yet a 
2. Assuming zero delays 
3. Zero cost escalation(in capex & opex) in next 25 years 
4. No changes in government(incl policies)in the next 25 years 
5. Forex remains unchanged for next 25 years(@RM 4.15:1USD) 
6. No financial difficulty in loan servicing on the USD1.4 bil for both Jaks and CPECC. 
7. Assuming interest rate at 6% for the next 25 years. 
8. Assuming no financial crisis in Vietnam that impacts on demand of electricity despite the "guarantee of payment". 
9. No financial criminal in the collaboration eg: fraud or scandals in the 25 years journey. 
10. Assuming no changes in State Bank of Vietnam(Central Bank) policies on funds repatriation, capital control and money outflows. Able to repatriate the earnings back to Msia in the next 25 years without hiccups. 
Remember China's recent restriction."
On 21/3/2019, Newbie8080 wrote the above comment, and I promised to respond. 
As I have said, many will find my target price between RM7 - RM10 hard to swallow. Believe it or not, I only used Price Earnings Ratio (PE) between 10 - 15.
Newbie8080 listed 10 "perfect conditions" for my target price to materialise. Do these conditions make my target price seems like 1000 miles away ? Nope, much closer than you think if these are the only conditions. 
 
Let me go through them one by one;
1. 40% ownership which currently not materialise yet
The option to purchase 10% from CPECC at cost plus carrying cost expires on the 3rd anniversary after the commercial operation date (COD). My estimate is it will cost around RM270m for the additional 10%. Based on the past distributions of Mong Dong 2, Jaks will receive about RM120m a year based on 30% sharing. Therefore, even without fresh funds, Jaks is able to exercise the 10% option with distributions from the power plant.
 
2. Assuming zero delays 
The deadline for unit one shall be 48 months and 54 months for unit 2 after the construction start date which was agreed to be 1st Oct 2016.
The JV agreement provided that Jaks resources (JRB) shall execute subcontract agreement with CEEC in relation to its scope of work under the EPC Contract 2. Therefore, Jaks is not directly involved in the construction of the power plant.
Is there any reason to doubt the chinese partner's capability in completing the power plant on time?
"CEEC is an ultra-large backbone enterprise engaged in a complete business chain ranging from power planning & engineering consultation, engineering, project contracting, equipment manufacturing to investment and operation. With a registered capital of RMB26 billion, currently the company has total assets of RMB187.5 billion and more than 160,000 employees. In 2013, it registered RMB158 billion operating revenues and RMB4.2 billion profits. It is an engineering group featuring the greatest comprehensive strength, largest scale and broadest market in the energy engineering field of China. Domestically, the company undertakes most of the fossil fuel power and grid projects engineering and takes up 2/3 of fossil fuel power construction market and 1/3 of hydropower construction market. It has undertaken the engineering work for more than 200 major projects in over 20 countries and regions, and contracted projects in over 80 countries and regions around the world. Energy China was ranked the 465th in the Fortune Global 500 in 2014, its subsidiary CGGC was ranked the 37th in the Top 250 Global Contractors, and another of its subsidiaries CPECC was ranked the 42nd in the Top 150 Global Design Firms, all of them forming a main force in the energy engineering field both at home and abroad."
Why should anyone doubt CECC's ability to complete the power plant on time especially after it has just completed, 6 months ahead of schedule, an equivalent 1,200MW Vinh Tan 1 thermal power plant in central vietnam recently ?
 
3. Zero cost escalation(in capex & opex) in next 25 years 
The power purchase agreement (PPA) allows the capex and opex to be adjusted based on the US CPI for US dollar denominated costs, and Vietnam CPI for Don denominated costs. Hence, cost escalations due to inflation will not impact the profitability of the power plant.
The PPA provides for EVN to purchase and the BOT Company to sell electricity generating capacity and electricity generated by the Facility for 25 years after the commercial operation date of the Facility unless extended or earlier terminated as stipulated under the PPA. The tariff charged by JAKS Hai Duong to EVN comprises the capacity charge, energy charge and supplemental charge. Fuel (coal and secondary fuel) and limestone costs will be passed-through costs under the PPA.
Therefore, fluctuation in fuel costs has no impact on the power plant operations.
 
4. No changes in government(incl policies)in the next 25 years 
JHDP company may terminate the BOT contract due to Vietnam side default or government events such as war, invasion, terrorist, revolution, strikes, none performance of GGU, change of laws.
The BOT contracts signed with MOIT provides that if there is any change in government policies that would jeopadise the interests of the operators, the MOIT will compensate the operators for the losses as a result of the changes.
Change in Government ?
There is no democratic election in Vietnam. It is a socialist republic with a one-party system led by the Communist Party of Vietnam. 
 
5. Forex remains unchanged for next 25 years(@RM 4.15:1USD) 
Forex will not remain unchanged forever. Fluctuation in US$ and Don will not affect the operation of the power plant. This is because all debts, interest, revenue and cost components are based in US$ or Don. All these cash flow components are matched to eliminate or minimise currency risks.
However, as far as Jaks is concerned, future distributions from JHDP are exposed to US$/RM exchange risks. Higher US$/RM rate will incease Jaks' earnings from Vietnam and vice versa.
 
6. No financial difficulty in loan servicing on the USD1.4 bil for both Jaks and CPECC. 
JHDP will be responsible for the loan repayments. I have extracted the following from my article "Understanding Jaks Hai Duong thermal power plant in Vietnam".
"Based on financing agreement of Mong Duong 2, the BOT company to maintain debt service coverage ratio (DSCR) of 1.4x – 1.5x 
http://www.academia.edu/26270684/Mong_Duong_Power_Project_the_Largest_... 

The ratio of (Operating income before interest and depreciation) / (Total loan principal and interest payments) must be above 1.5x otherwise the loan defaults. 

As the loan is non-recourse in nature and the collateral is a non-movable object with no market resale value, the banks would require very high certainty in earnings. In this case the capacity payment alone in the PPA which guarantee fixed annual payment for the tenure of the project must at least meet the DSCR requirements. 

Based on Jaks' Vietnam IPP loan of US$1.402b, interest of 6% (Est), Loan tenure of 18 years 
Annual principal repayment = 1.402b / 18 = 77.8m 
1st year interest repayment = 1.402b x 6% = 84.1m 

Based on 1.5x DSCR, Minimum operating income EBITA = (77.8+84.1) x 1.5 = US$242.85m 
Annual depreciation = 1.8685b / 25 = 74.7m 
Hence, Net Operating income = US$242.85 – 75.7 – 74.7 = US$92.45m 
Jaks 40% = US$92.45 x 40% x 4.15(us/rm) = RM153m / 546m = RM0.28 EPS 

In practice, the earnings must be much higher to be of comfort to protect the company from loan default risk due to earning fluctuations. "
Therefore, there is very high certainty that JHDP will not default on its loans.
 
7. Assuming interest rate at 6% for the next 25 years. 
The loan is USD denominated and its tenure is 18 years. The Fed Fund Rate is currently 2.25 - 2.5%. Recently, in fear of large scaled economic slowdown, the US Fed has signaled no rate hike in 2019. 
High interest rate is detrimental to economic growth globally. As seen during the economic crisis in 2008, US Fed lowered its Fed Fund rate aggressively to restore growth. 
A moderate monetary policy is necessary to maintain a vibrant economy while keeping a check on inflation. Therefore, US Fed is not expected to adopt aggressive tightening policy on interest rate going forward. 
Interest rate will always fluctuate within a norm. It will not stay too high or too low over a long period of time. Hence, not a concern over a long term period.
In any case, there are financial instruments to hedge against interest rate risks available to the company which can be employed during periods of adverse movement in interest rate.
 
8. Assuming no financial crisis in Vietnam that impacts on demand of electricity despite the "guarantee of payment". 
Vietnam is anticipating a potential power shortage in the next decade largely due to its projected rapid growth.
Viet Nam will likely face a power shortage in the period 2020-30 if electricity generation is not increased and there is not enough fuel (coal and gas) for generation.
The warning was made at the Viet Nam Energy Forum held by the Ministry of Industry and Trade (MoIT) in Hanoi on Thursday. Aug 9 2018
According to Viet Nam Electricity (EVN), to meet electricity demand for socio-economic development up to this year, EVN has completed 40 power plants with total capacity of 20,586MW.
By the end of 2018, total installed capacity of the sector is expected to reach 47,768MW (5.41 times higher than in 2003), ranking second in ASEAN (after Indonesia) and 25th in the world.
It is forecast that up to 2030, demand for electricity will continue to grow at a high level. The electricity sector will need to ensure 265-278 billion kWh by 2020 and around 572-632 billion kWh by 2030.
Thus, the growth rate in the period 2016-20 is 10.3-11.3 per cent per year and the period 2021-30 about 8-8.5 per cent.
Ngo Son Hai, Deputy General Director of EVN, said that the electricity supply in the years 2019-20 could be ensured. However, oil-fired thermal power plants would have to generate approximately 4.4 billion kWh by 2019 and 5.2 billion kWh by 2020.
“During the years 2021-30, the electricity system may not meet demand and power shortages could occur in the south,” said Hai.
Hai said power shortages may increase up to 2025 under scenarios including high load or the volume of water in reservoirs being lower than previous years. Furthermore, the gas projects of Bloc B and Ca Voi Xanh (Blue whale) and several others are being conducted slowly compared with the plan.
"Each of the 1,200MW coal-fired power plants in the south facing slow progress will worsen the shortage by 7.2-7.5 billion kWh per year," said Hai.
"Today, Viet Nam is one of the stars of the emerging markets universe. Its economic growth of 6-7% rivals China"
https://www.weforum.org/agenda/2018/09/how-vietnam-became-an-economic-miracle/
"When the 20-year Viet Nam War ended in 1975, Viet Nam’s economy was one of the poorest ion the world, and growth under the government’s subsequent five-year central plans was anaemic. By the mid-1980s, per capita GDP was stuck between $200 and $300. But then something changed. In 1986, the government introduced “Đổi Mới”, a series of economic and political reforms, and steered the country to becoming a “socialist-oriented market economy”.

Today, Viet Nam is one of the stars of the emerging markets universe. Its economic growth of 6-7% rivals China, and it exports are worth as much as the total value of its GDP. Anything from Nike sportswear to Samsung smartphones are manufactured in this ASEAN nation. Such is the success of the country, Sheng Lu, an assistant professor at the University of Delaware told the Financial Times that there are few spare workers or production facilities left."
Vietnam's economic growth is still high on trajectory, possibility of financial crisis seems remote currently. Given the severe shortage of electricity, even a financial upset may not dent its demand for electricity much.
 

9. No financial criminal in the collaboration eg: fraud or scandals in the 25 years journey. 
Speechless ............. You really got me with this one. 
JHDP is just an Independent Power Producer (IPP) which earns stable income through tariff payments from EVN, a govenment controlled company. Nevertheless, I can't bet my life saying that frauds will not happen to the company in future. Anyway, who can be certain that their investments are fraud free, now and forever ?? 
JHDP is jointly owned by two companies from two nations, China and Malaysia. CPECC is an internationally recognised company. What is the chances of it collaborating in criminal acts on JHDP which is a vietnamese company ? Will it disgrace china ?
JHDP is a vietnam registered company and is required to prepare financial reports and pay taxes under the jurisdiction of Vietnam. International companies are always closely monitored by the authorities for irregularities and attempts to escape duties and taxes.
 
10. Assuming no changes in State Bank of Vietnam(Central Bank) policies on funds repatriation, capital control and money outflows. Able to repatriate the earnings back to Msia in the next 25 years without hiccups. 

Again, I have extracted the following from my article "Understanding Jaks Hai Duong thermal power plant in Vietnam".

"Vietnam Government guarantee (GGU) guarantees USD currency conversion and right to remit

1. repayment of principal, interest, etc under financing document
2. quarterly and annually profit distribution to JPP
3. repayment of charter capital
4. any expenses due to contracts goods imported
5. any expenses due to foreign service contracts
6. any payment that are due in foreign currency "

 
Conclusion :  Jaks is well positioned to withstand financial risks.
 
P/S: Nothing is risk free, it is only a matter of risks vs rewards.
Charlie Munger's Big Lesson: Prepare for Opportunity 
What is the most important personal quality an investor can have? 
Patience... followed by pretty aggressive conduct. It is given to human beings who work hard at it—who look and sift the world for a mispriced bet — that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

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