Meghalaya Energy Corporation Limited (MeECL) Bond Review

Meghalaya Energy Corporation Limited (MeECL)  has recently issued bonds to the tune of INR 241 crores in the month of April 2023.

The government of Meghalaya guarantees these bonds, and the additional support is provided by the trustee-administered escrow and payment mechanism.

These bonds are called State guaranteed bonds or SGBs. However, they are riskier than State development loans (SDLs) and Government bonds.

But first, let’s understand Meghalaya Energy Corporation Limited. It is a Meghalaya State Government-owned company  and it is responsible for the coordinated development of generation, distribution, and transmission of electricity in the State of Meghalaya which is engaged in the business of transmission and distribution of power within the state.

The company started operations from April 2010 onwards, post the transfer of assets and liabilities of the erstwhile MSEB (Meghalaya State Electricity Board)

It is a strategically important entity of the power sector infrastructure for the state of Meghalaya. It is also the nodal agency of the government for undertaking power generation, transmission and distribution activity in the state. Being the power generation, transmission and distribution licensee by MSERC, MeECL is mandated to ensure the generation of power from its installed capacity and for undertaking Rural Electrification (RE) task in the state with the objective of providing access of electricity to all rural households in line with the National Rural Electrification Policy.

It is also to be noted that Meghalaya State has a special category status . For Meghalaya, as in other states with a special category status, the centre pays 90% of the funds required through a centrally sponsored scheme, as against 60% in the case of normal states, to be utilised for augmenting growth.

There are three subsidiaries of the MeECL: – 

One can wonder what the difference is between Transmission and Distribution. The transmission lines operate at high voltages, and they are used to transmit the power from the generating station to the substations, whereas distribution lines operate at low voltages and transport electric power from substations to the consumer’s loads.

That means the electricity we are consuming in our households are being supplied by the distribution companies (Discom)

Understanding the Business of the MeECL

We now know about the MeECL; let’s understand the business model of this company. The  company earn its revenue by charging tariffs to household, commercial or industrial customers.

These tariffs are generally decided by the state governments.

Generally, all the electricity distribution companies of states in India are making huge losses. However, the state governments provide subsidies and guarantees on the loans of these companies.

Since these companies work for the public good, and the performance of these companies is measured by AT&C Losses and ACS-ARR gap.

Let us also understand two important terms that are being used to measure the performance of these companies: –

1. Aggregate Technical and Commercial (AT&C) losses:- The concept of Aggregate Technical & Commercial losses provides a realistic picture of the loss situation in the context it is measured. It is a combination of energy loss (Technical loss + Theft + inefficiency in billing)& commercial loss (Default in payment + inefficiency in the collection)

It is calculated as below:- 

AT&C Losses = {1 – (Billing Efficiency X Collection Efficiency)} X 100

• The gap in average cost of supply and average revenue requirement (ACS-ARR): – This is calculated on a per Kilowatt hour basis by deducting the Total expenditure from the revenue received from the sale of power, including the subsidy received. 

 For MeECL, as per the information provided by the rating agencies, the liquidity position of the company will improve backed by the gradually improving business risk profile with continuously enhancing generation capacity and declining AT&C losses. The latest numbers for AT&C losses and ACS-ARR gap is not available for the company.

Financials :- 

 *The company has not provided the financials for FY 22 in the Information Memorandum. It has provided financials for the half year ended March 2022 and half year ended September 2022.

As you see in the above table, it is difficult to make decision purely on the basis of the financials of the company as it is loss-making.

*Entity made a profit in H1 FY 2023 only because of substantial increase in the other income. So, on operational level, the company is making losses on consolidated and standalone level.

The unsupported rating by the Acuite (without the guarantee of Meghalaya govt and escrow mechanism) of the company is C which is lower than the investment grade or can be termed a junk rating. As per the information available in the rating rationale, the company has instances of delay in payment to the non guaranteed debt funded by Financial Institutions such as PFC and REC, which are not guaranteed by the GoMe.

However, the rating with the support of a guarantee is given at Acuite A- (Stable).

Existing issuance of the MeECL:- 

Following are the recent bond issuance of the issuer are available in the secondary market. These bonds were issued on private placement with a ticket size of INR 1 lacs to 10 lacs. However, these bonds are not frequently traded in the secondary market. So, Liquidity is not assured because of the higher ticket size.

Key Features of the Recent  Bond issuance of INR 240.70 crores

• The non-convertible debentures will have Quarterly interest.
• Tenure will be 10 years.
• Upfront creation of liquidity facility in the form of a DSRA for the next two quarters of principal and interest payments and Debenture redemption reserve account.
• The Company has to Follow T-7 Structuer for the repayment of the principal/interest before the due date as below:- 

1. The Bond Servicing Account is fully funded to the extent of the due amount before 15 days of the due date.
2. The Account Bank has to monitor the adequacy of the due amoun in the Bond servicing account. If the amount is insufficient, then the bank has to sent the notice to the company to make good for the shortfall before 10 days of the due date .
3. If the company has failed to meet the shortfall, then Govt of Meghalaya through invocation of the guarantee has to meet the shortfall before 7 days of the due date.

Should you invest in these Bonds?

These bonds comes with various type of risks. Some of the main risks has been mentioned below:

1. Credit Risk: –Credit risk is the risk of financial loss to the Company if a customer or counter party to a financial instrument fails to meet its contractual obligation resulting in a financial loss to the Company. Credit risk is mitigated by by the guarantee provided by the Government of Meghalaya and escrow mechanism for repayments.
2. Interest Rate Risk :- Bond Prices and Interest rates are inversely proportional. So if the interest rate in the economy rises, it may impact the yield of the bonds.
3. Liquidity Risk: – These bonds have higher ticket sizes and usually have low liquidity due to infrequent trades in the secondary market. 

It is to be noted that though the unsupported rating of the company is Acuite C, the bonds issued are guaranteed by the Meghalaya Government and have adequate liquidity measures in the structure.  However, one should read all the financial documents and should understand the risk involved and then make an informed decision on whether to invest in these instruments. 

Historically, we have seen default even by state-owned companies. 

The Power production or transmission companies, due to their huge losses, generally default in the repayment to Power Finance Corporation.

There are instance of delay in interest payment of the State Guaranteed bonds (SGBs) as well. State guaranteed bonds issued by Andhra Pradesh Power Finance Corporation Limited are in default as there is instances of delay in interest and principal repayment on the rated bonds. Timeliness of meeting obligations remains uncertain until there is a final resolution on distribution of assets and liabilities between the states of Andhra Pradesh (AP) and Telangana.

The rating rationale link and news article link has been attached below for reader’s reference: –

CRISIL Rating Rationale

ICRA Rating Rationale

News Article

In the case of Andhra Pradesh Power Corporation, what was observed is that the Debenture Trustee failed to invoke the guarantee of the State Government. This So the recovery is uncertain in these bonds. 

Madhya Pradesh, Uttar Pradesh, Bihar, Punjab and Orissa state PSU bonds also defaulted during 2000-2002. 

These bonds, however,  have been restructured and subsequently honoured, but the likelihood of defaults occurring again should not be ignored, even if the possibility of default is low.

Conclusion

Public welfare-oriented companies, which are primarily government-owned, may incur losses and deficits. To maintain their operations, they receive financial assistance from the government or borrow through term loans or debentures in the capital markets. It is crucial to evaluate the financial stability of the State and the State owned companies to make an informed decision.To be noted that just because there is a state guarantee it does not mean that these are risk free bonds. As we have seen in the article above, there have been instances where even state guaranteed bonds have defaulted.  Additionally, understanding the repayment structure’s escrow mechanism is important to ensure timely repayment of obligations.