Tenaga bonds offer trading opportunity

There are currently a couple of major policy moves by the government about the power sector. However, details are only coming in gradually and more complete details are anticipated from the government by September:

• Energy Exchange Malaysia (Enegem) program. This is a market for cross-border trading of green electricity. We understand the Single Buyer is an independent entity under Tenaga Nasional Berhad (Tenaga) for domestic usage. It was reported in the news that a pilot auction of 100mw has been announced to “interested purchasers”.

• Third-party access (TPA) framework. The plan allows consumers to buy electricity directly from power producers, not just Tenaga.

• Electricity surcharges. Recently, the government announced electricity surcharges for the period 2H2024. Under the Imbalance Cost Pass Through (ICPT) framework, Tenaga’s coal and energy costs are reflected in the electricity surcharge or rebate every six (6) months, which protects Tenaga against input cost volatility.

The TPA framework may ultimately have a limited negative impact on Tenaga. We cite reasons being 1) Tenaga would still be the choice for consumers due to its track record, technology in place, experience and retail expertise, and 2) for instances that IPPs may instead win some market share, those IPPs are still obligated to transfer electricity via Tenaga’s grid, of which Tenaga will be compensated “wheeling” charges.

We believe long-term demand growth and a good financial outlook are promising for Tenaga. Demand growth and sustained firm Malaysia GDP performance in the coming 2-3 years should support electricity consumption growth. AmInvestment foresees Tenaga revenue growth rising from MYR62.3 billion in 2024 to MYR63.3 billion in 2025 to MYR64.3 billion in 2026 (or averaging 1.5% per annum). Also, as RP4 will be kicked off next year (for the period 2025-2027), the ICPT for Tenaga to compensate for energy input price variations should mean less volatility for Tenaga’s numbers.

Though yields could rise on profit-taking pressure, the opportunity now exists for short- to medium-term trading gains in the PDS space as spreads have widened to early 2024 levels. Despite the risk of profit-taking in the short-term in the MGS space, we think MGS yields are primed to show a modest c. 10 bps decline in 4Q2024-2Q2025. We foresee that select power bonds will offer trading opportunities. Along the AAA curve, we think there’s an opportunity on AAA Tenaga with 5Y-10Y maturities. On a Risk-Reward Ratio (RRR) basis, Tenaga with 6Y-7Y and 9Y-10Y duration provides better returns per unit of risk vis-à-vis Sarawak Energy (Exhibits 2-3).

Latest industry policy moves and how they relate to Tenaga

A short recap of NETR policy. It’s been about three-quarters of a year since Malaysia’s authorities introduced the National Energy Transition Roadmap (NETR). To recap, the NETR is targeted as an industry-wide long-term plan for the power sector in Malaysia, where the primary aim is for Malaysia to achieve a more sustainable energy landscape with a net-zero emissions target by 2050. The initiative includes the government allocating a MYR2.0 billion facilitation fund and financial institutions providing financing facilities with a total value of MYR200.0 billion to push industries to transition into a low-carbon economy. Also, there will be tax exemptions for fund management companies managing sustainable and responsible investment (SRI) funds, and tax cuts on the issuance of SRI sukuk will be extended until 2027. The Malaysian government has estimated a requirement of MYR180 billion until 2050 to develop a robust and flexible grid to facilitate the country’s energy transition.

A couple of major new policy moves. In any case, there are currently a couple of major policy moves by the government about the power sector. However, details are only coming in gradually and more complete details are anticipated from the government by September:

• Energy Exchange Malaysia (Enegem) program. This is a market for cross-border trading of green electricity. As we understand, for the renewable energy (RE) generated under this program, there will be a Single Buyer to facilitate the purchase and then to sell on to the user/consumer, akin to an operator of an exchange. We understand the Single Buyer is an independent entity under Tenaga Nasional Berhad (Tenaga) for domestic usage.
  • It was reported in the news that a pilot auction of 100mw has been announced to “interested purchasers” with an electricity generation and/or retailer licence for the Singapore electricity market. The government reportedly has plans to scale it up to 300mw, depending on the response to the first 100mw.
     
• Third-party access (TPA) framework. The intended new framework regards the working of the national power grid, where the plan is to allow consumers to buy electricity directly from a power producer, which will include Independent Power Producers (IPPs) and not just Tenaga-related companies. Tenaga owns the grid, but purchase agreements will be independent of Tenaga in the reported plan. However, Tenaga, the grid owner, will charge “wheeling” costs as a fee to use its grid.

• Electricity surcharges. Recently, the government announced electricity surcharges for 1 July-31 December 2024 (i.e., 2H2024). Under the Imbalance Cost Pass Through (ICPT) framework, Tenaga’s coal and energy costs (and thus changes to these costs) are reflected in the electricity surcharge or rebate every six (6) months, which protects Tenaga against input cost volatility. The latest iteration sees no revisions for domestic consumers. However, the surcharge is lower for commercial and industrial users at 16 sen/kWh in 2H2024 vs. 17 sen/kWh in 1H2024.
   
  • Of the ICPT, surcharges are partly subsidised by the government. Electricity subsidies to be borne by the government are estimated at MYR2.2 billion in 2H2024 vs. MYR1.9 billion in 1H2024.
     
  • Under RP3 (Regulatory Period 3), the reference price for coal is USD79/tonne and MYR30/mmbtu (Petronas prices) for Tier 1 gas.
     
  • After a low of USD116/tonne at the end of January 2024, coal (Australian prices) has risen to USD140/tonne after hitting a YTD high of USD147.75. Meanwhile, gas (Henry Hub) is now at USD2.05/mmbtu, which is lower than the YTD high of USD3.13 but off the YTD low of USD1.58/mmbtu.

TPA is a risk, but the impact on Tenaga may be muted. Our power sector colleague at AmInvestment Bank equity research team recently downgraded Tenaga’s stock price from Buy to a Hold. The analyst cited that the price had risen to her fair value of MYR14.55 per share, implying a PE of 20.6x for the financial year 2025. The key here is that the stock price may not show stronger EPS growth after the strong performance in 2024 (at +32.8%), and our take is that net profit (though expected to remain positive in 2024-2026) may face risk from the TPA framework. Yet, our equities colleague also mentioned that the TPA framework may ultimately have a limited negative impact on Tenaga. We cite the following reasons being:

• Tenaga would still be the choice for consumers due to its track record, technology in place, experience and retail expertise.

• For instances in which IPPs may win some market share instead, those IPPs are still obligated to transfer electricity via Tenaga’s grid, for which Tenaga will be compensated “wheeling” charges.

In our opinion, long-term demand growth and financial outlook are promising for Tenaga. We feel that there will be a short-term, though muted, impact on Tenaga; the longer term should see Tenaga providing better financial performance. Demand growth and sustained firm Malaysia GDP performance in the coming 2-3 years should support electricity consumption growth. AmInvestment foresees Tenaga revenue growth rising from MYR62.3 billion in 2024 to MYR63.3 billion in 2025 to MYR64.3 billion in 2026 (or averaging 1.5% per annum). Net profit, estimated at MYR63.7 billion in 2023 though dropping to MYR62.3 billion in 2024, should rise modestly to MYR63.3 billion in 2025 and MYR64.3 billion by 2026. Also, as RP4 will be kicked off next year (for the period 2025-2027), the ICPT for Tenaga to compensate for energy input price variations should mean less volatility for Tenaga’s numbers. We note that Malaysia's latest rise in the trend in new powerintensive data centres will spur electricity demand. At its earnings conference call last month, Tenaga said it had signed 10 electricity supply agreements (ESA) for a total energy demand of 2,000mw.

RE main player. As for RE and the Energy Exchange (Enegem), we anticipate Tenaga to be the major player. On top of being the operator of the Enegem, Tenaga is likely to lead the way in RE power generation in Malaysia amid reportedly MYR90 billion capex plan by the company for 2025-2030. Tenaga’s Energy Transition Plan sees the company planning to transition to net zero emissions at the interim target of a 35% reduction in emission intensity by 2035 before achieving Net Zero Emissions by 2050.

Tenaga bonds offer trading opportunity

Short- to medium-term trading opportunity in corporate bonds space. As for the fixed income space, we expect that in 2H2024, credit spreads will see a modest widening but remain tight from a historical perspective. We note that spreads have already widened since late April 2024. We further note the spread compression in 2023 and 2024, including where quasi-government and AAA spreads tightened to sub-10 bps and 20 bps, respectively, before the recent correction (to >10 bps and >20 bps) in 2Q2024, were in large part due to a lack of new supply of bonds, especially net issuance amount, since the pandemic. The steadier rise in issuances since 2Q-3Q2023 then contributed to the broader credit spreads this year. Nevertheless, we note that MGS yields have come down by 5-10bps in the past week, corresponding with the drop in global bond yields (such as >20 bps declines in the UST curve). Though yields could rise again on profit-taking pressure, the opportunity now exists for short- to medium-term trading gains in the PDS space as spreads have widened to early 2024 levels (Exhibit 1). Despite the risk of profittaking in the short-term in the MGS space, we think MGS yields are primed to show a modest c. 10 bps decline in 4Q2024-2Q2025 amid a continued anticipated drop in global rates in the coming year and supportive onshore demand for bonds.

Select AAA Tenaga offers trading opportunities. Along the AAA curve, after net buying interest into Sarawak Energy last week, we think there’s an opportunity on AAA Tenaga with 5Y-10Y maturities. On a Risk-Reward Ratio (RRR) basis, Tenaga with 6Y-7Y and 9Y-10Y duration provides better returns per unit of risk vis-à-vis Sarawak Energy (Exhibits 2-3).

The AA3 curve offers various Tenaga and non-Tenaga papers. Along the AA3/AA- curve, Tenaga-related power sector issuers include Jimah East Power Sdn Bhd (JEP) (70% indirect stake by Tenaga) and Southern Power Generation Sdn Bhd (SPG), which has a MYR4.7 billion 1,440mw combined cycle power plant (Tenaga JV with SIPP Energy Sdn Bhd). SPG looks already tight on a yield basis versus the AA3 indicative curve (Exhibit 4), but JEP offers yield levels above 4.00% for investors looking for yield pickup. JEP has a Stable rating outlook at AA- by MARC Ratings. However, JEP remains at risk from any volatility in coal prices as it operates a 2x1,000-MW ultra-supercritical coal plant under a 25-year power purchase agreement (PPA) with Tenaga. As an alternative, AA3/AA- rated Edra Energy (China General Nuclear Power Corp subsidiary) offers a yield above 3.70% for 1Y-5Y tenors (part of the curve where SPG is tighter). Edra offers >3.90% for tenors >7Y, but we note that SPG offers yield pickup on these tenors vis-à-vis Edra. For exposure into RE, there’s Quantum Solar Park Semenanjung Sdn Bhd with >3.90% levels for <10Y tenors.

Source: AmInvest Research - 1 Aug 2024