Tenaga Nasional Bhd
(July 19, RM8.56)
Maintain buy at RM8.61 with target price cut to RM9.90 from RM10.15: Tenaga's annualised 9MFY2010 core net profit of RM2.1 billion was 8% below consensus and 20% below our forecast. The discrepancy with our forecast was mainly because we were overly optimistic on the tariff rates Tenaga was expected to enjoy. At the same time, non-electricity revenue was below expectation while "other costs" came in higher than expected. While Tenaga still posted a 21.9% year-to-date (YTD) jump in core net profit, quarter-on-quarter (q-o-q) core net profit plunged 37% as the 4.1% jump in units sold was not enough to offset the 11.3% rise in coal prices. Nonetheless, its balance sheet improved further as net gearing fell below 50% for the first time in over six years, raising the possibility of Tenaga considering higher dividends going forward.

YTD, given the constraints in gas supply, which is being channelled to non-power customers, the generation mix comprises 54% gas and 40% coal. As we do not expect much change to gas availability going forward, we tweak our forecast generation mix to 56% gas and 37% coal and leave our gas and coal price estimates unchanged for now.

Given that goods and services and deferred income revenue disappointed, we revise downwards our forecasts for these categories. We also trim our effective tariff rates and revise upwards "other costs". Based on these changes, our FY2010 core net profit forecast is reduced by 17.2% while our FY2011 forecast is cut by 14.6%.

The reduction in our profit forecast leads to our discounted cash flow-based fair value being lowered to RM9.90 from RM10.15 previously. Nonetheless, we maintain our buy call on Tenaga, noting that foreign shareholding in the counter had risen to 10.65% in June from a low of 8.51% in January. Tenaga remains a blue chip laggard that could draw greater interest. Our RM9.90 fair value is equivalent to 13.5 times FY2011 PER.

In 4Q, the ringgit somewhat stabilised against the US dollar and actually weakened against the Japanese yen. We believe this should prevail up to end-August. Having previously forecast an exception item in terms of forex gains of RM700 million for FY2010 versus the YTD gains of RM680.7 million, we leave our forecast forex gains unchanged for now.

YTD, Tenaga's peninsula demand numbers rose 10% while groupwide numbers are up 9.4% for 9MFY2010. Tenaga has expressed reservations on demand going forward as July demand has thus far showed a slight non-seasonal dip. Nonetheless, it expects peninsula FY2010 demand to grow by 9.5%, while for FY2011 the group is still hopeful of 3% to 4% growth. Given the contraction in sales in exports and Liberty Power, we cut our forecast group-wide sales growth from 8% to 7.3% but maintain our FY2011 growth at 3.8%.

As the major cost items ? IPP charges, fuel charges, repair & maintenance and staff costs ? were all within our estimates, we maintain our earlier assumptions on these costs, including effective coal prices of US$92 per tonne for FY2010 and US$98 for FY2011.

While the major cost items were within our expectations, the effective tariffs were lower than expected, as were non-electricity sales. "Other costs" were also higher than expected. Incorporating these into our forecasts, our effective tariff is cut from 31.7 sen per kWh to 31.5 sen per kWh. We also cut our sales numbers for EGAT and LPL while raising our "other cost" forecasts and tweaking our generation mix to reflect less hydro and more coal use. All in, our FY2010 core net profit forecast is lowered by 17.2%, our FY2011 cut by 14.6% and FY2012 down by 11.5%.

As Tenaga's profits will likely remain unspectacular due to higher coal costs, we believe the main catalyst shoring up its share price may be the anticipation of a tariff hike, particularly since the petrol subsidy has been reduced. While we are not including a tariff hike into our forecasts, we note that Tenaga's profit is most sensitive to a change in tariff. For now, we continue to value the counter on a DCF basis but tweak our WACC slightly lower from 10.7% to 10.4% to reflect greater optimism on tariff hikes. Nonetheless, the cut in our profit forecast reduces our fair value from RM10.15 to RM9.90. Maintain a buy call on Tenaga given its laggard blue-chip nature. ? OSK Investment Research, July 19

This article appeared in The Edge Financial Daily, July 20, 2010.