Investment Highlights

• OVERWEIGHT. We have BUYs on Tenaga Nasional (TNB) with a DCF-based fair value of RM12.00/share (terminal growth rate: 2.0%, WACC: 7.0%) and YTL Power (YTLP) with an RNAV-based fair value of RM0.77/share. We are positive on TNB for its undemanding FYE12/22F PE of 11.6x and decent dividend yield of 8.6%. We like YTLP for its attractive FYE6/22F dividend yield of 6.6% and earnings turnaround in Singapore. We have a HOLD on Malakoff Corporation with a DCF-based fair value of RM0.90/share (WACC: 7.5%).

• Net profit to grow in 2023F after falling in 2022F due to the prosperity tax in Malaysia. TNB’s normalised net profit (adjusted for forex and impairments) is forecast to fall by 1.7% to RM4.6bil in FYE12/22F mainly due to a higher effective tax rate of 22.0% vs. 15.0% in FYE12/21E. In FY12/23F, we project a net profit growth of 14.1% as the effective tax rate falls. Recall that the prosperity tax in Malaysia only takes place in 2022F. YTLP is expected to swing into the black in FYE6/22F after being hit by a deferred tax charge in FYE6/21. Malakoff’s net profit is estimated to inch down by 1.6% to RM312.3mil in FYE12/22F mainly due to a higher effective tax rate. Operationally, Malakoff’s earnings are expected to be supported by Alam Flora and the associates in the Middle East.

• ESG risk arising from the emissions of greenhouse gases. This is mainly due to the power companies’ exposure to coal. Currently, coal power plants account for less than 25% of TNB’s revenue. However in Peninsular Malaysia, coal accounted for 60.9% of generation mix in 3Q2021 while gas made up another 33.0%. Renewables such as hydro and solar accounted for only 6.0% of generation mix in 3Q2021. About 58% of Malakoff’s effective power generating capacity (excluding associates) is from coal power plants. YTLP’s sole coal exposure is via its 20%-owned associate PT Jawa in Indonesia.

• Moving away from coal. TNB will not be developing new coal power plants going forward. Also, TNB plans to increase its renewable exposure to 8,300MW in FYE12/25F from 3,421MW as at end-September 2021 through acquisitions. Malakoff also plans to expand its renewable energy capacity to 1,000MW in FYE12/25F from 44MW currently. Malakoff is focussing on waste management and rooftop solar panel projects. Malakoff is also bidding for large-scale solar projects and wasteto-energy power plants in Malaysia.

Outlook and Developments in 2022F

• Electricity volume to improve by 3.0% in Peninsular Malaysia in 2022F (2021E: 3.0%). We believe that this would be driven by the commercial sector, which resumed operations in September 2021. Recall that hotels, shopping malls and educational facilities were closed for a few months in FY21E due to MCO 3.0. We expect demand for electricity from the industrial sector to be stable in 2022F. We reckon that there would be fewer plant or factory disruptions in 2022F as the number of Covid-19 cases has declined. We think that there may be a small decline in electricity demand from the domestic or residential sector as the working population returns to offices.

• Industries to account for a significant portion of electricity demand in 2022F. We think that the industrial sector would continue to be the major driver of electricity demand. The industrial sector accounted for 39% of electricity demand in 9M2021 while the domestic household accounted for another 29%. The commercial sector accounted for an additional 30% of electricity demand in 9M2021 while others (public lighting, agriculture and mining) made up the balance 2%. The industrial sector comprises mainly companies in the electronic and electric, petrochemical, steel and cement industries.

• Energy reserve margin to be close to 50% in 2022F. We estimate the country’s energy reserve margin to range from 45% to 50% in FY22F due to the commissioning of Edra Energy’s 2,242MW combined cycle gas power plant in 2H2021 and 713MW of solar power plants coming onstream under the LSS1 and LSS2. On the other hand, only one power purchase agreement is expected to expire in 2022F. This is Malakoff’s GB3 gas power plant, which commands a capacity of 640MW.

• Exploring options for GB3 power plant after its PPA expires. Malakoff can either sell the parts and equipment to overseas countries or allow the GB3 power plant to continue operating by selling the electricity through the NEDA (New Enhanced Dispatch Agreement) system. Under NEDA, the single buyer (an independent entity under Tenaga Nasional) would buy electricity from expired power plants under a power pooling system. Malakoff sold the parts and equipment of its Port Dickson power plant to a buyer in Nigeria when its PPA expired in February 2019. GB3 accounted for 10.7% of Malakoff’s capacity payments and 0.6% of energy payments in 9MFY21. Due to precedents and the country’s high energy reserve margin, we believe that the PPA of GB3 would not be renewed.

• RP3 (Regulatory Period 3) uncertainties? There is risk that TNB’s rate of return under RP3 (for years 2022F to 2024F) would be lower than the 7.3% under RP2 Interim. Still, we believe that any decline in the rate of return would be compensated by an increase in the size of assets resulting from the capex carried out. Also, we reckon that the rate of return granted to TNB cannot be too low as there would not be any incentive for TNB to invest in capex.

• Tariff surcharge in 1H2022? We believe that there would be a tariff surcharge for commercial and industrial users in 1H2022. This is because fuel costs have exceeded the reference rates stipulated under RP2 Interim. For residential users, we believe that there may not be any tariff surcharge due to subsidies from the Energy Industry Fund. Due to the pass-through of costs to commercial and industrial users, we reckon that TNB will be not be affected by the surge in energy costs. Hence, TNB’s rate of return of 7.3% under RP2 Interim would be protected. Under RP2 Interim, the reference rates are US$67.45/tonne for coal and RM27.20/mmbtu. According to Bloomberg as at 15 December 2021, coal price (Australian prices) was US$169.25/tonne while gas price (Japan prices) was US$35.87/mmbtu.

• LSS5 tender in 2022F? There was no tender process for the LSS5 (large scale solar) in 2021E. In spite of the high energy reserve margin, we think that Malaysia may open up the bidding process for the LSS5 in 2022F. The country’s target is to have renewables account for 31% of generation mix in 2025F. We believe that the internal rate of return for solar plants under the LSS5 may be low as the bidding process is expected to be very competitive. The tariff reference rates for LSS tenders have been falling in the past couple of years. The tariff reference rate was 24.0 sen/kWh for the LSS4 compared with 41.0 sen/kWh for the LSS1 and 32.4 sen/kWh each for the LSS2 and LSS3.

• More bids for waste-to-energy (WTE) plants in 2022F? We believe that more states such as Pahang, Terengganu and Kedah would open up the bidding process for WTE plants in 2022F. Altogether, Malaysia is supposed to have six WTE plants in the coming three years. The bidding process for the WTE plants in Melaka and Johor closed in 2021E. We reckon that the winners of the WTE plants in Melaka and Johor would be announced anytime soon. Bidders included Malakoff. Based on Cypark Resources’ RM300mil WTE incinerator project in Negeri Sembilan, we estimate the cost of building a WTE plant to be RM13.6mil per MW.

• More overseas expansion in 2022F? To achieve their renewable capacity targets, we believe that TNB and Malakoff would be venturing overseas. Although there are LSS projects in Malaysia, the capacity is small at 50MW to 100MW each. In addition, the bidding process is very competitive and the rates of return are low. We believe that the pace of M&A activities would pick up in 2022F as international borders reopen. We reckon that TNB would be interested in renewable projects in the UK and Europe. In October 2021, TNB acquired a 49% stake in a UK wind company for an undisclosed sum. In September 2020, TNB increased its stake in Vortex Solar Investments to 55% from 50% for £11.0mil. Vortex Solar is one of the largest solar companies in the UK. In March 2020, TNB acquired the remaining 20% stake in its wind assets in the UK for £18.6mil.

Source: AmInvest Research - 24 Dec 2021