We are Underweight on the power sector as valuations are no longer appealing. Tenaga Nasional (TNB) is trading close to 19x FY25F earnings and its FY25F dividend yield is below 4%. We believe that RP4 (Regulatory Period 4) would be neutral for TNB, as we expect allowable demand growth to range from 2% to 4% and the rate of return is unlikely to fall below 7%. As such, the group may not benefit from any exceptional demand coming from data centres. We have BUYs on YTL Power (New target price: RM5.45/share) and Mega First (Target price: RM5.40/share). We are positive on Mega First as the unfavourable impact from the depreciation of the USD has already been reflected in the share price. In fact, the USD has risen by 9% against the MYR since touching a low of RM4.12 on 30 September. YTL Power's FY25F PE is appealing at 8x as the share price has fallen by 41% from the peak of RM5.30/share on 12 May.

• Downgrade to Underweight. We downgrade TNB to UNDERWEIGHT from HOLD as its share price has exceeded our new target price of RM12.00/share. Our target price for TNB is based on a FY26F PE of 16x, which is the five-year average. We have switched to PE from DCF to value the power companies in our coverage as we believe that earnings are a better reflection of the companies' outlook. Also, we reckon that the two-fold jump in TNB's share price from the low of RM7.06/share in July 2022 has already accounted for any positive outcome from RP4 and favourable impact of the proliferation of data centres (DC) in Malaysia.
• TNB may not benefit from DC-driven electricity demand. This is due to the Price and Revenue Caps stipulated under the IBR Framework. We think that the allowable demand growth under RP4 (Regulatory Period 4) would range between 2% and 4%. Bloomberg consensus estimates Malaysia's GDP to be 4.6% in 2025F (2024E: 5%). Hence if actual electricity demand exceeds the cap, TNB has to return the excess returns to the Energy Industry Fund. Under RP3, the allowable demand growth was 1.7%. TNB returned RM1.1bil to the Fund in 1HFY24. Out of this, RM745.8mil or 68% was in respect of the Revenue Cap (excess volume) while the balance RM350.7mil or 32% pertained to the Price Cap (higher-than-expected selling price).
• Some positive sector developments - new power plants coming up? There is a possibility that the country's energy reserve margin may drop below 30% in 2031F due to the expiry of a few power plants. These include TNB's Janamanjung 1-3 in 2030F and Malakoff's TBP in 2031F. As such, we think that the government may approve new power plants to replace the expired ones. We reckon that companies like Malakoff and YTL Power would be interested in setting up and owning new power plants.
• LSS6 in 2025F? We think that the terms for LSS6 would be similar to LSS5. The size of LSS6 is likely to be 2,000MW without reference tariffs. We believe that the IRR for the LSS projects would range from 8% to 12%. Returns are expected to be decent as the cost of solar panels is still low i.e. below US$0.10/kWh. Interested parties include Malakoff, Solarvest, Mega First and SD Guthrie. Stock Universe

Source: AmInvest Research - 20 Nov 2024