Investment Highlights

• Positive on the sector. We affirm BUY on Tenaga Nasional (TNB) with an unchanged DCF-based fair value of RM12.00/share (terminal growth rate: 2.0%, WACC: 7.0%). Due to our BUY call on TNB, our recommendation on the power sector is OVERWEIGHT. We are positive on the power sector as electricity demand is expected to recover by 3.0% in 2021E and 2.0% in 2022F. In addition, dividend yields of the power companies are decent. Based on a share price of RM0.835, Malakoff’s FY21E dividend yield is 6.6%. Based on a share price of RM9.63, TNB’s FY21E dividend yield is 8.3%.

• TNB and YTL Power (YTLP) to record healthy net profit growth in FY21E. We forecast TNB’s normalised net profit (adjusted for forex, electricity discounts/donations and impairments) would improve by 11.6% in FY21E on the back of strong hydro earnings in 1QFY21 and lower repairs and maintenance expenses. YTLP is expected to record a robust net profit growth of 479.6% in FY21E underpinned by an earnings turnaround in YTLP Seraya in Singapore. YTLP Seraya is envisaged to enjoy improved operating profit margins in FY21E due to low energy costs that were locked in 2Q2020 and 3Q2020.

• Muted FY21E net profit growth for Malakoff. On the other hand, we estimate Malakoff’s core net profit to inch up by only 1.8% (ex-FY20’s RM25mil impairments) in FY21E. We have forecast Alam Flora’s net profit to remain flat at RM57mil in FY21E. Alam Flora accounted for 18.3% of Malakoff’s core net profit in FY20.

Outlook and Developments in 2H2021 and Beyond

• Electricity volume to improve by 3.0% in Peninsular Malaysia in FY21E (FY20: -5.0%). We believe that this would be supported by the industrial sector, which consists mainly of electronic and electric industries, petrochemical, steel and cement. GDP growth of the electronic and electric industries is estimated to be stronger at 8.7% in 2021E vs. 2.6% in 2020 underpinned by robust global demand for chips and other processors. We reckon that electricity demand from the domestic (residential households) would also remain stable as the working population continues to work from home.

• Demand from the commercial sector may be weak in 2H2021. The increase in demand from the industries and domestic segments would help compensate for weak demand from the commercial sector (mainly educational facilities, hotels and shopping malls) in 2021F. A prolonged lockdown may result in a delay in the reopening of shopping malls, schools and universities and the closing down of mid-tier hotels. Electricity demand from the commercial sector fell by 12.1% in FY20.

• More than a third of electricity sales volume are from industries. Industries made up 39% of TNB’s electricity sales volume in FY20 while the commercial sector accounted for 32%. The domestic (residential households) segment made up another 27% of TNB’s electricity sales volume in FY20 while others (mining, agriculture and public lighting) made up the balance 2%.

• Energy reserve margin is rising. We believe that Malaysia’s reserve margin would rise to 47% in 2H2021. The rise in the reserve margin is not only due to the commissioning of new gas power plants but also because of the commissioning of the solar power plants awarded under LSS1 (large-scale solar). TNB commissioned its 1,440MW Southern Power Plant (combined cycle gas power plant) in Pasir Gudang in December 2020 and February 2021.

• Edra Energy’s power plant to come onstream in 2H2021. The three generating blocks of Edra Energy’s 2,242MW gas power plant in Alor Gajah, Melaka are expected to start operations by the end of 2021E. This would be the largest combined cycle gas power plant in Malaysia.

• Paka’s PPA expired in June 2021. We believe that only one PPA (power purchase agreement) would be expiring in 2021E, which YTLP’s 585MW Paka power plant in Terengganu. Based on precedents, we believe that the PPA for Paka would not be renewed. Hence, YTLP may be selling the machinery and equipment of the power plant to an overseas buyer. According to YTLP’s 2020 Annual Report, the net asset value of Paka is RM218.2mil. Paka accounted for 13.6% of YTLP’s pre-tax profit in FY20.

• Malakoff’s GB3 640MW power plant’s PPA will expire in FY22F. Looking ahead to 2022F, there are no new large scale power plants coming onstream. Tadmax’s 40%-owned 1,200MW combined cycle gas power plant will come onstream in 2023F. We believe that only GB3’s PPA would expire in 2022F. Like the Port Dickson power plant, Malakoff is likely to sell the machineries and equipment of the power plant to an overseas buyer. GB3 accounted for 11.0% of Malakoff’s capacity payments and 1.0% of energy payments in FY20. Malakoff’s FY23F earnings are expected to be affected by the expiry of GB3’s PPA. We have already factored this into Malakoff’s FY23F net profit.

• RP3 uncertainties? The parameters for RP3 (Regulatory Period) are envisaged to be announced before year-end so that it can be effective from 2022F to 2024F. The concern is that the rate of return may fall below 7.0%. We believe that this is unlikely as there would be no incentive for TNB to invest in capex if the rate of return is too low. The bulk of the capex for the regulated assets is in respect of the distribution and transmission networks. Capex for these two amount to about RM6bil per year. Currently under RP2 Interim, TNB’s rate of return is 7.3%.

• Tariff surcharge for non-residential consumers in 1H2022? In 2H2021, there is a tariff rebate of 2.00 sen/khW as fuel costs were still below the reference rates in 1H2021. However, there is a risk of a tariff surcharge in 1H2022 as energy costs have increased. There is no earnings impact on TNB as any change in the costs of fuel is recognised as an over-recovery or under-recovery of costs in revenue every quarter. However, there is a lagged cash flow effect as the higher or lower tariff is only passed on to the consumers every six months. There is a possibility that non-residential consumers may face a tariff surcharge in 1H2022 as energy costs have surged. According to Bloomberg, the price of coal has climbed to US$152.75/tonne as at 30 July 2021 from US$80.50/tonne in the beginning of the year. Under RP2 Interim, the reference rate for coal is US$67.45/tonne. Based on Japan prices, the price of LNG has increased to US$14.755/mmbtu on 30 July from US$14.30/mmbtu on 31 December 2020. Under RP2 Interim, the reference price for gas is RM27.20/mmbtu. The forex assumption under RP2 Interim is US$1.00:RM4.212.

• Acquiring more renewable assets overseas? We believe that TNB and Malakoff would be looking to acquire renewable assets overseas in 2021E and 2022F. By acquiring assets, it is easier for TNB and Malakoff to achieve their renewable energy targets. However so far, there has not been any major announcement. We reckon that the acquisition process has been slow due to Covid-19 lockdown measures in Malaysia. TNB’s aim is to achieve renewable power assets of 8,300MW by 2025F. The generating capacity of the group’s renewable assets was 3,398MW as at end-December 2020. Out of the target of 8,300MW, about 5,200MW would be international assets while the balance 3,100MW would be domestic assets. Currently, the generating capacity of TNB’s international renewable assets is 666MW.

• More tenders for waste-to-energy power plants in Malaysia? Malaysia is expected to announce four more tenders for waste-to-energy (WTE) power plants in various states in the coming four years. In April 2021, Malakoff submitted a bid for an 880 tonnes/day WTE plant in Johor. We believe that the winners would be announced in 2H2021 or early 2022F. Based on Cypark Resources’ RM300mil WTE incinerator project in Negeri Sembilan, we estimate that the cost of a WTE plant to be RM13.6mil per MW. The generating capacity of Cypark’s Ladang Tanah Merah WTE plant is between 20MW and 25MW.

• ESG risk is a drag on the sector. A risk to the power sector’s share price performance is ESG. We believe that the main ESG risk is GHG emissions from the usage of coal. Incidentally, TNB’s foreign shareholding has been falling. TNB’s foreign shareholding stood at 12.4% as at end-March 2021 vs. 16.9% as at end-March 2020. In FY20, about 24% of TNB’s revenue came from coal power plants. TNB has said that it would ensure that the revenue from coal power plants would not exceed 25% of group revenue. TNB has also pledged not to invest in greenfield coal power plants. TNB’s last coal power plant was the 2,000MW Jimah East, which was commissioned in 2019.

Source: AmInvest Research - 3 Aug 2021