Investment Highlights

• We remain OVERWEIGHT on the power sector. We expect unit demand to normalise going forward after eking out a 1.0% growth in 2017 following an exceptional 2016, which was lifted by the El Nino weather phenomenon. For CY18, we believe demand will pick up to 3.2% on the electricity demand/GDP growth multiplier in Peninsular Malaysia, which has been close to 0.5x-0.6x (Exhibit 2). Our stance on the sector is invariably tied to Tenaga, which is trading at attractive valuations.

• Our OVERWEIGHT stance on the power sector may be further strengthened by: i) the outcome of new regulatory requirements, which is expected to be unveiled in Dec 2017. It could dissipate uncertainty that we think is a current overhang to Tenaga; ii) strengthening of the MYR; and iii) an amicable solution to Tenaga’s tax dispute with the Inland Revenue Board (IRB) amounting to RM2.1bil or RM0.37 per share. On the other hand, possible turning points for the sector include: i) perceived heightened regulatory risk if Tenaga is unable to recoup its fuel cost without a corresponding electricity tariff rebate reduction; and ii) the unfavourable outcome to our aforementioned key drivers for the sector.

• Fuel costs above reference prices. As of December 2017, TNB’s ICPT and PPA saving fund is projected to have a surplus of RM0.3bil. However, with fuel prices, especially coal, above reference prices in MYR (coal as of 4QFY17: RM317/MT vs. reference price: RM273/MT or 16% higher), we expect TNB to report cost under-recovery going forward. Under the IBR framework, additional fuel cost above the reference prices should be passed on to consumers that would ensure Tenaga’s earnings are free from fuel price volatility. In phases of cost under-recovery, the earnings impact to Tenaga is neutral while its cash flow sees a temporary outflow, which will be reversed during phases of cost over-recovery or through an electricity tariff hike.

• YTLP most exposed to ringgit appreciation. This is because: 1) its 20%-owned associate PT Jawa Power receives capacity payment in USD; and 2) Wessex Water's earnings in MYR will increase by approximately 1% for every 10 sen depreciation of the MYR vs. GBP. As dividends are essentially supported by cash flow generated from Wessex Water, a sharp appreciation of the MYR may affect YTLP’s capability to meet its dividend payout. In regards to Tenaga and Malakoff, we see only a small negative impact. As of the latest quarter, the bulk of debt for Tenaga (77%) and Malakoff (85%) is denominated in ringgit.

• Tenaga Nasional (BUY, FV RM17.72) is our top pick in the sector. We continue to like the company due to: 1) its stable operating environment with the implementation of Incentive Based Regulation (IBR); 2) bottom-line enhancement from new generation capacity (1,000MW Manjung unit 5 in 2017 and 2,000MW Jimah East in 2019); 3) higher dividend payout (the group had recently announced a more aggressive policy of paying 30-60% from 30-50% of net profit, giving a yield of 5%) to potentially drive share price re-rating ahead; and 4) valuations are attractive, trading at 11.6x CY18F PER.

• YTLP (HOLD, FV RM1.38) – key drivers of growth only emerge in FY20. Earnings outlook remains unexciting due to structural headwinds in Singapore, a struggling mobile broadband segment and the lack of new power generation assets in the near term. The next major earnings kick will only materialise from FY20 onwards when the Tg Jati and the Enefit plants commence operations. In the interim, earnings growth looks flat with a 3-year FY17-FY20F CAGR of 2%. It suggests valuations trading at 13.1x CY18F PER may be unappealing. This is especially so when coupled with a downward adjusted dividend payout of 5 sen/share from 10 sen/share which implies a dividend yield of 4.3%.

• Malakoff (HOLD, FV RM1.09) – Execution continues to fall short. Near-term earnings outlook is weighed by the stepdown in Segari Energy Ventures (SEV) power plant's renewed power purchase agreement (PPA). SEV capacity income plunged close to 80%. Prior to the step-down in capacity income due to the revised PPA, SEV’s contribution comprises close to 30% of total capacity income. We share the concern over Malakoff’s ability as it has struggled in both operational and strategic execution in the form of unscheduled plant outages and absence of new assets respectively since its IPO in May 2015. It leaves foreign M&A increasingly a key focus as domestic generation capacity awarded thus far is sufficient for demand up till 2023. Therefore, Malakoff needs to deliver a meaningful M&A and successfully turn around its operations to reduce negative sentiment overhanging the IPP.

Source: AmInvest Research - 27 Dec 2017