Investment Highlights

• Neutral. The earnings growth of power companies is expected to be unexciting in FY19F as electricity demand growth is flat. TNB’s electricity demand growth is estimated to be 2.5% for FY19F, similar to FY18E. In addition, the implementation of the MFRS16 lease accounting standard may result in higher interest expense and lower net profit for power companies in FY19F. We have not accounted for this in our earnings forecasts for power companies yet. We have HOLD recommendations on TNB with a fair value of RM14.65/share and Malakoff with a fair value of RM0.85/share.
• We would only be upgrading the sector to an OVERWEIGHT when there is an earnings kicker from new power plant projects or if electricity demand growth turns out to be stronger than expected. Dividend yields are forecast to be more than 5% each for TNB and Malakoff in FY19F.

Developments in 2019F:

• Four PPAs are expiring in 2019F. The expiry of the power purchase agreements (PPAs) is expected to result in several outcomes. First, the PPAs may be extended but at reduced capacity payments. Second, the power plants may be tendered in a public bidding process and rebuilt at a higher capacity. Third, the power plants may be sold off. Fourth, the expired IPPs may sell their electricity to the grid through an open bidding process via the NEDA (new enhanced despatch agreement).
  
  The expiry of the TNB Connaught Bridge power plant (895MW) in December 2018 is not expected to affect TNB significantly in FY19F as this would be offset by earnings contribution from the 70%-owned Jimah East power plant (2,000MW). Unit 1 of Jimah East (1,000MW) will start operations in June 2019 while Unit 2 (1,000MW) will commence in December 2019.
  
  Also, we do not expect any impact from the expiry of the one of the generating units’ PPA at the Kapar Energy power plant. Kapar Energy is expected to make losses this year due to boiler issues.
  
  Based on a 60% shareholding and last year’s financials, we estimate that the three units at the Kapar power plant accounted for 1.7% or RM140.9mil of TNB’s pre-tax profit in FYE8/17. The Kapar power plant is 60% owned by TNB and 40% owned by Malakoff.
  
  The PPA for one of the generating facilities (220MW) of the Kapar power plant (2,420MW in total) will expire in July 2019. The PPAs for Malakoff’s PD power plant (436MW) and Edra Energy’s Powertek plant (434MW) will end in February and December 2019 respectively. The PPA for TNB’s Paka power plant in Terengganu (1,000MW) will expire in December 2019 while TNB’s Connaught Bridge power plant (895MW) ends in December 2018.

• Jimah East and Pengerang power plants will be coming onstream in 2019F. As at end-August 2018, Jimah East, which is a coal-fired power plant in Port Dickson, was 92% completed. Another 200MW of energy from the Pengerang power plant in Johor is expected to come onstream in 2019F. TNB has already signed a PPA with the Pengerang power plant, which is owned by Petronas, in 2017. Apart from these two, the Kenyir Gunkul solar power plant (29.99MW) in Dungun, Terengganu is also expected to start commercial operations on 31 December 2019.

• Cancellation of another four IPPs? We believe that the government would be cancelling another four independent power producers (IPPs) in 1H2019. Most of the IPPs were awarded on a direct negotiation basis. Additionally, we believe that the four IPPs would be those which have not secured financing with banks or signed PPAs with TNB.
  
  Companies which were awarded power plant projects by the previous government include Tadmax Resources. In July 2017, Tadmax received a conditional letter of award from the Energy Commission to build a 1,000MW combined cycle gas power plant in Pulau Indah, Selangor. In December 2017, Cypark Resources received a letter of acceptance from the Energy Commission to develop a large scale solar plant of 30MW in Negeri Sembilan via a competitive bidding process.
  
  Recall that the government cancelled four IPPs in October 2018. One of these was a power plant, which will replace an existing generating facility at the Kapar Power Plant while the other was in respect of Ranhill Holding’s 300MW combined cycle gas power plant in Sandakan, Sabah. The third cancelled IPP was TNB’s 1,400MW power plant in Paka, which was to replace the one expiring in December 2019 and the fourth was Edra Energy’s 400MW solar power plant.
• Government is tendering out RM2bil worth or 500MW of solar projects in 2019F. We believe that all of the power companies would be bidding for the solar projects. The size of the solar power plants is expected to range from 3MW to 50MW each. We reckon that some of the criteria that the government would be looking at, are the cost of the project and the ability of the bidders to secure financing. It is unknown if power companies can bid for more than one power plant.

• Long-term focus is renewable energy. We believe that the long-term focus is on renewable energy power plants. This is pursuant to the government’s target that 20% of Malaysia’s electricity would be generated from renewable sources by year 2030F compared with 2% currently. According to TNB’s annual report, renewable resources accounted for only 1.7% or 237MW of its total generating capacity in FY17.
  
  We believe that the issues with solar power plants are cost and scalability. Currently, the cost of building and operating a solar power plant is still more expensive than that of coal or gas. However, the International Renewable Energy Agency said that renewable energy technologies would be competitive on price with fossil fuels by year 2020F.
  
  Also according to Bloomberg New Energy Finance, the levelised cost of electricity for renewable energy in some countries is lower than gas and coal. In India, the levelised cost of electricity is only US$41/MWh for solar PV (photovoltaic) compared with US$68/MWh for coal and US$93/MWh for gas. The cost of renewable energy power plants has been declining due to the drop in the price of solar panels, improved efficiencies and usage of batteries to store power.

• In Malaysia, there is a feed-in tariff (FIT) so that renewable power plants can be viable. There is an additional bonus rate if certain criteria are met e.g. use of locally manufactured solar PV. Currently, the basic FIT rate for a solar power plant with a capacity of more than 24KW is RM0.4435/kwH. In comparison, TNB’s effective tariff rate was RM0.3973/kwH in FYE8/17. FITs are pre-determined rates between the power plants and TNB or Sabah Electricity Sdn Bhd. The tenure of the contracts are usually 21 years for the solar PV power plants.
  
  Currently, renewable energy power plants are subsidised by the Renewable Energy Fund. It is funded by surcharges on electricity bills paid by domestic customers. Households consuming more than 300kWh each month are required to pay the surcharge.

• No details on MESI 2.0 programme yet. Going forward, we are unsure if the government would propose changes such as power pooling or opening up certain segments of the power industry such as distribution. What is clear so far is the focus on renewables.
  
  The Power Electricity Reform Agency (MyPower) has three years to drive and implement initiatives. The government has said that under the Malaysia Energy Supply Industry (MESI) 2.0, MyPower will focus on three objectives i.e. improving industry efficiency, future-proof the industry structure, regulations and key processes and empowering consumers. After the reforms, the energy industry is supposed to be green, efficient, market-driven, competitive and sustainable.

Source: AmInvest Research - 26 Dec 2018