Investment Highlights

• Protected returns, proxy to country’s economic recovery. We believe that Tenaga Nasional’s (TNB) returns are protected as the rate of return is regulated and stipulated under the Incentive Based Framework (IBR). Also, we reckon that TNB is a proxy to Malaysia’s economic recovery. Currently, Bloomberg consensus is forecasting Malaysia’s real GDP growth to be 6.8% in 2021F compared with –5.5% in 2020E. Under the RP2 (Regulatory Period), TNB’s rate of return is 7.3%.
• OVERWEIGHT. Hence, we remain positive on the power sector in spite of Tenaga Nasional’s (TNB) share price underperformance in 2020E. At a share price of RM10.64, TNB’s FY21F PE of 11.9x is undemanding. Also, FY21F dividend yield is decent at 5.2% based on a gross DPS of 55.0 sen. Our DCF-based fair value for TNB is RM13.95/share (terminal growth rate: 2%, WACC: 7.0%). We also like Malakoff for its attractive FY21F dividend yield of 7.8% (based on a gross DPS of 7.0 sen and share price of RM0.895).
• Earnings recovery in FY21F. We believe that TNB’s normalised net profit (adjusted for forex, electricity discounts/donations and impairments) would rebound by 29.8% to RM5.1bil in FY21F after plunging by 18.8% in FY20E. TNB’s earnings recovery in FY21F is expected to be underpinned by a decline in provision for doubtful debts, lower effective tax rate and resumption of Manjung 5 Power Plant’s operations.
• We anticipate a smaller earnings growth of 0.5% for Malakoff in FY21F as FY20E had already reflected the full-year impact of Alam Flora’s earnings and the incremental profits from Malakoff’s acquisition of an additional 12% effective stake in the Shuaibah assets.

Outlook and developments in 1H2021

• Electricity volume to grow 9.5% in Peninsular Malaysia in FY21F (FY20E: -6.0%). This is expected to be driven by increased economic activities in the industrial and commercial sectors. Industries such as electric, electronic industries and cement are envisaged to record positive growth in 2021F.
• Industries accounted for 38.0% of TNB’s electricity sales volume in 9MFY20 while commercial (mainly hotels and shopping malls) accounted for another 32.3%. Domestic (residential households) segment made up another 27.6% of TNB’s electricity sales volume in 9MFY20 while others (mining, agriculture and public lighting) accounted for the balance 2.1%.
• Edra Energy’s power plant to come on-stream in 2021F. Edra Energy’s 2,242MW gas power plant in Alor Gajah, Melaka is expected to start operations in 1QFY21. This would be the largest combined cycle gas power plant in Malaysia. On the back of this, we estimate Malaysia’s reserve margin to increase to 47% in FY21F from about 39% currently (inclusive of TNB’s 1,440MW Southern Power Plant, which came onstream in December 2020). Edra Energy is owned by China General Nuclear Power Corporation (CGN).
• One PPA is expiring in 2021F. In 2021E, we believe that only one PPA (power purchase agreement) would be expiring. The PPA for YTL Power’s (YTLP) 585MW Paka Power Plant in Terengganu is expected to expire in June 2021. Paka accounted for 13.6% of YTLP’s pre-tax profit in FY20. Based on past precedents, we do not think that the PPA would be renewed.
• Uncertainties over parameters for RP2 Interim for 2021F? We believe that the Energy Commission would be announcing the parameters for the RP2 Interim soon. There are concerns that TNB’s rate of return would fall below 7.0%, which may result in a lower base tariff. Currently, the base tariff under the RP2 is 39.45 sen/kWh. As mentioned in previous reports, we reckon that the rate of return cannot be too low as there would not be any incentive for TNB to invest in capex. TNB’s capex is about RM10bil to RM11bil per year. Out of these, about RM6.2bil to RM6.4bil are capex for regulated businesses (transmission and distribution assets).
• Fuel costs are increasing. However as the fuel costs are still below RP2’s reference rates, we believe that electricity users may not face a tariff surcharge in 2021E yet. There is no impact on TNB as any increase or decrease in fuel costs is recognised as under or over recovery of costs in the group’s revenue every quarter. Based on Australian prices, the price of coal has surged by 44.1% to US$70.30/tonne on 30 November from a low of US$48.80/tonne on 25 August. Based on Japan prices, the price of LNG has climbed by 267.2% to US$7.325/mmbtu on 30 November from a low of US$1.995/mmbtu on 27 April. The reference rates for fuel under the RP2 guidelines are US$75/tonne for coal and RM35/mmbtu for LNG.
• Moving away from coal. Going forward, we believe that there would not be any new coal power plant in Malaysia. Due to growing environmental concerns, we reckon that any capacity auction in Malaysia would involve gas or renewable energy. Recently, TNB pledged not to invest in green-field coal plants. In the past year, TNB has increased its stake in its solar and wind subsidiaries in the UK while Malakoff is positioned to bid for waste-to-energy plant projects in Malaysia in the future. In any case due to the high energy reserve margin, we believe that there would not be any tender for new power plants in Malaysia anytime soon. Based on previous proposals under the MESI 2.0, new capacity auction in Malaysia was supposed to take place only at the end of 2023F.
• Rising focus on renewable assets. We believe that TNB and Malakoff would continue seeking investment opportunities in the renewable energy space. TNB has a renewable energy target of 8,300MW by year 2025F (as at Nov 2020: 3,390MW). Although Malakoff sold MacArthur Wind Farm in Australia for RM988mil in late 2019, the group acquired Alam Flora (involved in waste management) for RM869.0mil. Malakoff also has plans to bid for waste-toenergy power plant projects in Malaysia. In July 2020, the Minister of Housing and Local Development said that there would be six waste-to-energy power plant projects in various states in Malaysia by year 2025F.
• Incidentally, utility companies were active in M&A in 2020E. YTLP proposed to acquire Tuaspring Power Plant for S$331.5mil in March 2020. As for TNB, the group increased its stake in its wind assets in the UK to 100% from 80% for £18.6mil and raised its stake in Vortex Solar Investments, UK to 55% from 50% for £11mil. TNB also raised its equity interest in Jimah Energy Ventures to 25% from 20% for RM80mil and increased its shareholding in Southern Power Plant, Johor to 70% from 51% for RM283mil.
• Growing importance of ESG criteria amongst funds. A growing number of global investment funds has set out ESG (environment, social and governance) criteria in their investment policies. In early 2020, Black Rock said that it would exit companies where more than 25% of the revenue come from thermal coal. Although utility companies in Malaysia such as Malakoff and TNB are not involved in coal mining, there are risks that they may be affected as they use coal to generate electricity. Incidentally, foreign shareholding in TNB has been falling since 2015. TNB’s foreign shareholding was 14.3% as at end-September 2020 compared with 22.8% as at end-August 2015. In the past 10 years, TNB’s lowest level of foreign shareholding was 10.5% in year 2010.
• Coal is still significant in Malaysia currently. Coal power plants are estimated to account for 20.7% of TNB’s revenue in FY20E. Coal is estimated to account for 57.5% of Malakoff’s effective generation capacity (excluding associates) currently. In terms of generation mix, coal accounted for 66.0% of the country’s energy generation in 1HFY20 while gas accounted for another 30.5%. Solar and hydro made up only 3.5% of Malaysia’s energy generation mix in 1HFY20.
• Winners of LSS4 will be announced soon. We believe that Malaysia would be announcing the winners of the RM4.0bil LSS4 (large-scale solar) project soon. Total capacity offered under the LSS4 is 1,000MW. There are two segments i.e. 10MW–30MW (total: 500MW) and 30MW–50MW (total: 500MW). The biggest capacity that a consortium can bid for is 50MW. The reference tariff rate is 24 sen/kWH for the LSS4 compared with 32.4 sen/kWh for the LSS3. We believe that Malakoff and TNB had already submitted their bids. Both companies did not win in the LSS3 (winners were announced in December 2019). The only listed company, which won a bid in the LSS3, was Cypark Resources.

Source: AmInvest Research - 15 Dec 2020