Investment Highlights

• Neutral on the sector. We are cautious on the power sector until the Malaysian government announces details on energy reforms in 2H2019. Also in the immediate term, Tenaga Nasional’s topline growth is envisaged to be partly restrained by the revenue and price caps stipulated by the RP2 (Regulatory Period 2) Framework. RP2 is effective for the period of 2018 to 2020. Hence, even though the country’s electricity demand growth is strong, Tenaga may only record an effective sales volume growth of 2%. We have a HOLD recommendation on Tenaga with a fair value of RM13.50/share.

Malakoff’s (fair value: RM0.90) earnings may not be exciting in FY20F as the RM944.6mil proposed acquisition of Alam Flora Bhd has not been completed. The completion date of the proposed acquisition has been delayed to end-FY19F. If the acquisition is approved, Alam Flora would increase Malakoff’s net profit by about 10%. YTL Power’s (fair value: RM0.94) short-term profitability is expected to be affected by weak operating profit margins in Singapore, a fall in water tariffs in the UK and the potential expiry of the RM4bil 1BestariNet contract.

• Silver lining is the dividend yields of power companies. Dividend yields of the power companies are expected to be decent in FY19F backed by recurring and stable cash flows. We forecast Tenaga’s FY19F dividend yield to be 4.0% and Malakoff’s FY19F dividend yield to be 5.9%. We estimate YTL Power’s dividend yield to be 6.1% in FYE6/19F.

Outlook and developments in 2H2019

• Energy reforms to be announced in 2H2019. We reckon that any proposal for the power industry has to honour the sanctity of the power purchase agreements (PPAs) between the power producers and Tenaga. The capacity payments are an integral part of the PPA. Without the capacity payments, there would be a default in bond covenants.

Hence, there may be a hybrid system whereby the capacity payments will still be honoured while allowing power pooling. In Singapore, consumers are allowed to buy electricity from the retailers or power producers directly. This resulted in a fall in operating profit margins as power producers in Singapore competed to sell the cheapest electricity to the users. The distribution and transmission network in Singapore is owned by a government agency. YTL Power’s Singapore unit recorded a pre-tax loss of RM149.1mil (ex-impairment) in 9MFYE6/19.

Tenaga also believes that the energy reforms would involve either: (1) opening up the retail segment i.e. allowing other parties to buy electricity from Tenaga and then selling it to the consumers, or (2) taking out the single buyer entity, which is currently ring-fenced within Tenaga. The impact of these on Tenaga is not envisaged to be material.

• Lower energy costs in 1H2019 to translate into tariff rebate for electricity users in 2H2019? Whether or not savings from the decline in energy costs would be passed on to the consumers would be decided by the authorities. Industrial customers are currently lobbying for a tariff rebate due to the fall in energy costs. Recall that a tariff surcharge of 2.55 sen/kwH was imposed on industrial customers from 1 March to 30 June 2019 due to the rise in energy costs in 2H2018. Residential customers were not affected in 1H2019 as they were subsidised by the Electricity Industry Fund.

As at 7 June 2019, coal price was US$74.05/tonne (RP2 reference price: US$75/tonne) while LNG price was US$4.475/mmbtu (RP2 reference price: RM35/mmbtu). According to Bloomberg, average coal price was US$90.99/tonne in 5M2019, 9.2% lower than the average price of US$100.19/tonne recorded in 5M2018. Also, average LNG price has declined by 30.4% to US$6.14/mmbtu in 5M2019 from US$8.816/mmbtu in 5M2018. Coal accounted for 57.5% of Tenaga’s generation mix in 4QFY18 while LNG made up another 38.5%. Hydro, solar and distillates accounted for the balance 4% of Tenaga’s fuel mix in 4QFY18.

• While energy costs are falling, Tenaga’s revenue growth may be flat. The RP 2 Framework caps the revenue of Tenaga’s distribution and transmission units. As such, Tenaga’s effective tariff in Malaysia is expected to be capped at RP2’s base tariff of 39.45 sen/kWh for the period of 2018 to 2020. Any excess revenue will be reversed and returned to the Electricity Industry Fund. There have been periods where Tenaga’s effective tariff was higher than the base tariff as its customer mix was more favourable than the one stipulated under the RP2 Framework.

• Electricity volume growth to be stable in 2H2019. We are keeping an electricity volume growth of 2.0% for Tenaga in FY19F compared with the 5.2% recorded in 1QFY19 and 2.6% registered in FY18. In spite of the decent increase of 5.2% in electricity demand in 1QFY19, we think that electricity demand would soften going forward as the weather has become cooler. The 5.2% rise in electricity demand in 1QFY19 was partly driven by an 11.1% increase in demand from the residential segment. We believe that residents turned on air-conditioners in full force due to the hot weather in 1QFY19. According to Bloomberg, Malaysia’s GDP growth is forecast to be 4.5% each in 2019F and 2020F vs. 4.7% in 2018.

• Winners of LSS (large scale solar) power plants to be announced by year-end. The bidding process for theRM2bil worth of 500MW large scale solar (LSS) power plants in Malaysia will close in August 2019. The winners are expected to be announced at the end of the year. We believe that Tenaga and Malakoff would be among the bidders. The internal rate of returns for the solar power plants are expected to be in low double digits compared with the high single digit for coal power plants.

• We do not think that the earnings contribution from the LSS power plants would be significant for Tenaga and Malakoff if they were to win a solar power plant. This is because the largest capacity that a bidder can bid for is 100MW. In comparison, Tenaga’s domestic generating capacity is expected to be 11,917.53MW in Peninsular Malaysia upon the commissioning of Unit 1 (1,000MW) of Jimah East Power Plant in June 2019. Currently, Malakoff has an effective generating capacity of 7,036MW in total (in Malaysia and overseas).

• Cost of solar power plants is falling. We believe that solar power plants would reach grid parity with the conventional power plants in a few years’ time. The levelised cost of tariff for a solar power plant in Malaysia is expected to be below 38 sen/kWh in Malaysia going forward compared with 25 sen/kWh for a coal power plant currently. The cost of building and operating a solar power plant has declined in the past couple of years due to cheaper batteries and solar panels.

• Expired PPAs will not be extended. Two PPAs will be expiring in 2H2019. Based on precedents, the PPAs would not be renewed. The PPAs of Tenaga’s Connaught Bridge (895MW), which expired in December 2018, and Malakoff Corporation’s Port Dickson power plant (436MW), which expired in February 2019, were not extended.

Malakoff has said that it would be selling its Port Dickson power plant to a foreign buyer. The land however, can still be used and may be used for future power projects.

The PPAs that are expiring in 2H2019 are a 220MW generating unit of Kapar Energy Ventures (expiring in July 2019) and Edra Energy’s 434MW Powertek power plant (expiring in December 2019). Upon expiry, these power plants would either continue to sell their electricity through a power pooling system called NEDA or be sold off.

• Overseas expansions to continue. We believe that power companies would continue to scour overseas for investment opportunities. This is in spite of Tenaga’s impairments for its Turkey and India assets, which exceeded RM1bil in FY18 and Malakoff’s issues in Algeria.

As Tenaga’s revenue is capped by the RP2 Framework, the only way for the group to grow is to either expand the portfolio of its renewable power plants in Malaysia or venture overseas. Earnings contribution (excluding impairments) from overseas assets to Tenaga’s bottom line is estimated to be less than 5% currently.

• We believe that Tenga has the financial strength to carry out acquisitions. Tenaga’s gross cash stood at RM8.7bil as at end-FY18 while net gearing was 51.4%. Currently, Tenaga’s overseas assets consist of a 20% stake in Malaysian Shoaiba Consortium in the Middle East, 30% shareholding in Gama Enerji in Turkey, 30% stake in GMR Energy in India, 50% equity interest in Vortex Solar Investment in the UK and 100% stake in Tenaga Wind Ventures in the UK.

Source: AmInvest Research - 21 Jun 2019