Highlights/ Comment

The government has started the trial run implementation of IBR (Incentive Based Regulation) and FCPT (Fuel Cost Past Through) since 1 Jan 2014 (prior to effective implementation on 1 Jan 2015), which has increased the average tariff by 14.89% to 38.53 sen/kWh.

The new tariff structure is derived after taking into consideration power generation cost (including capacity payment and fuel cost), required 7.5% rate of return for power transmission and distribution, operational cost, depreciation and tax expenses.

The 7.5% rate of return is based on the weighted average cost of capital (WACC) for TNB’s transmission and distribution segments.

While the base tariff of 38.53 sen/kWh will be reviewed every 3 years by Energy Commission under IBR, there is also adjustment to the tariff due to changes in fuel cost under FCPT every 6 months. Domestic natural gas price is expected to be adjusted every 6 months under NEP.

Under the IBR, the recommended capex for power transmission and distribution is RM5-6.5bn per annum, which we expect TNB to spend less than the proposed amount, providing TNB opportunity to gain from higher earnings during the regulated period (incentives). Historically, TNB capex was only RM3-4bn per annum.

TNB is the major beneficiary of the implementations, as IBR ensures 7.5% rate of return (transmission and distribution) and FCPT protects TNB from fuel cost uncertainties. TNB will be more willing to invest in capex to improve system efficiency and service delivery.

On the other hand, power generation segment will go through competitive biddings, which allow the participation of TNB, domestic IPPs and international IPPs, in order to ensure continued low power generation cost (lower capacity payments and increase plant efficiency) or lower rate of return for the power generation industry. IPPs such as YTLP, 1MDB and Malakoff will have to accept lower IRR for new power generation projects.

Risks

• Downside risks –
• Surge in global energy prices (natural gas and coal).
• Supply disruption of energy resources.
• Depreciation of RM.

Forecasts

Unchanged.

Rating

Overweight

Positives –

• Expect continued economy growth albeit slower pace.
• Commencement of Melaka RGT (Stable gas supply).
• Implementation of FCPT and IBR.

Negatives –

• Depreciation of RM against US$.

Valuation

• Maintained Buy on Tenaga with higher TP of RM13.15.
• Maintained Hold on YTLP with unchanged TP of RM1.85.

Source: Hong Leong Investment Bank Research - 22 Jan 2014