• Despite a healthy 2.7% electricity demand growth, 1H18 core earnings were under pressure (-6%) amidst lower returns on regulated asset base (RAB) and higher applicable fuel costs in RP2.

• We cut FY18-20F earnings estimates by 10-12% on weak 1H18 performance and revisit some of our opex assumptions.

• Still, FCF generation is strong at c.RM4-5bn pa while balance sheet remains healthy, providing room for higher dividend payout; at 60%, dividend yield could rise to 4.7% (from 3.9% @ 50% payout).

• Maintain HOLD with a lower DCF-derived TP of RM15.50 (from RM17). Accumulate on dips.

A defensive favourite

On adjusted earnings, Tenaga’s 1-year forward PE valuation has rerated by some 32% since end 2016 after adopting a new dividend policy (Chart 1). With a stable economic growth expected for Malaysia in 2019 and limited growth catalysts in other key sectors, we believe Tenaga would remain one of the favourite defensive stocks especially amongst Shariah-related portfolio investors.

Room for payout increase amidst uncertainties

Since the introduction of its new dividend policy, Tenaga have declared some RM6.4bn of dividends, implying payout ratios 44-50% pa. We believe its healthy FCF generation, estimated at c.RM4-5bn pa is sufficient for payouts to be raised to 60% while balance sheet remains solid with low net gearing levels. Our forecasts imply dividend yield of 4.7% (from 3.9%) should dividend payout is raised to 60% (from 50%) at current prices (Table 1).

A robust demand trend

For first half of 2018, the Peninsular Malaysia electricity demand grew healthily at 2.7%. As demand data are announced on quarterly basis (ie. Upon Tenaga’s results release), we turned to the Daily Logsheet Reports (DLR), released by the Energy Commission (EC); the amount of electricity generated for 2018 up to Sep, saw a 4.1% growth which we estimate could translate to c.3% demand growth.

Lower returns under RP2 setting in

Notwithstanding, its performance was anaemic; 1H18 core earnings fell 5.8% to RM3.7bn against similar period in FYE Aug 17 (ie. Dec ’16 - May ‘17). We cut FY18-20F forecasts by 10-12% (Table 2) adjusting for higher applicable fuel cost under RP2 and some of our opex assumptions.

Maintain HOLD with lower TP of RM15.50

We downgrade our DCF-derived TP to RM15.50 (from: RM17) which implies 2018/19F PE of 13.3x. Despite lower returns in RP2, we are still proponents of the stock owing to its defensive properties. Buy on dips.

Source: BIMB Securities Research - 27 Nov 2018