Our ratings on Okinawa Electric reflect its excellent business profile, underpinned by its monopoly in Okinawa's electricity market, a favorable regulatory framework, and a transparent pricing mechanism. Okinawa Electric is the Okinawa region's exclusive provider of power generation and electricity transmission and distribution. Strong technological and solid operational capabilities underpin its market position, as do competitive prices and excellent facilities and maintenance services. In terms of electricity sales, Okinawa Electric is less susceptible to capital investment trends in the corporate sector than other electric power companies (EPCOs), because around 80% of its sales are from households and commercial users in the Okinawa region. Other factors supporting the ratings on the company include little prospect of substantial change in its competitive environment for the next two to three years and a stable financing structure. Also, we see prospects for electricity demand in Okinawa to grow steadily over the next two to three years. The central government and the government-backed Okinawa Development Finance Corporation give Okinawa Electric preferential treatment on taxes and low-interest-rate financing. On the other hand, we expect operating losses from small remote islands to continue, and we regard the company's heavy debt and weak financial ratios as burdens on the ratings.
In our opinion, Japan's stalled energy strategy following the Fukushima No. 1 nuclear power plant disaster has gradually weakened the credit quality of the nation's electric utilities sector. Continuing uncertainty over the regulation of nuclear plants and increasing costs for their operation could hurt the domestic electric utility company's stable operating profits and cash flow over the next two years.
However, Okinawa Electric doesn't operate a nuclear power plant and has no plans to construct one. Accordingly, increasing operational risk and weakening profitability of nuclear power plants put little pressure on Okinawa Electric's credit quality, in our view.
Standard & Poor's estimates that Okinawa Electric's financial performance will remain stable for the next one to two years. In fiscal 2012 (ending March 31, 2013), we estimate that Okinawa Electric's EBITDA margin will remain above 20%, compared with 22.6% in fiscal 2010, and its FFO to total debt will remain around 15%, compared with 14.5% in fiscal 2010.
The ratings on Okinawa Electric reflect our opinion that there is a "moderate" likelihood of the government providing the company with timely and sufficient extraordinary support in the event it suffered financial distress. As seen in the actions of the government following the Great East Japan Earthquake, tsunami, and nuclear crisis in March 2011, we are of the opinion that the likelihood of extraordinary government support has slightly increased. A "moderate" likelihood is equal to those we assign to other rated EPCOs in Japan except for TEPCO. Based on our criteria for government-related entities (GREs), a moderate likelihood of support does not justify any elevation of a GRE's ratings to a level higher than its stand-alone credit profile (SACP).
Our negative outlook reflects uncertainties surrounding the government policy framework for domestic power utilities. We also take the view that the sovereign ratings on Japan (AA-/Negative/A-1+) continue to constrain the ratings on Okinawa Electric, mainly because of its status as a public utility and the heavy dependence of its business on the domestic sector. We have incorporated into our assessment our expectation of a steady improvement in key financial ratios for Okinawa Electric after operation of the new No. 2 unit at its Yoshinoura liquefied natural gas (LNG) power plant begins after May 2013. Accordingly, diminishing prospects for improvement in key financial measures may pressure the ratings.
Standard & Poor's may consider lowering the ratings on Okinawa Electric if it lowers the long-term sovereign ratings on Japan. We may also consider lowering the ratings if the company's EBITDA margin weakens materially to around 15%, from above 20%, or its FFO to total debt falls to around 15% on a sustained basis. On the other hand, so long as the ratings on Japan and the outlook on those ratings remain unchanged, there is little likelihood we will raise the ratings on the company or make an upward revision to the outlook, even if the company greatly enhances its financial risk profile from the current level.
Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
Corporate Ratings Criteria 2008, April 15, 2008