Highlights/ Comment

• Malaysia power demand is expected to experience slower growth at 3.0% yoy, which is 0.6x of GDP growth vs historical levels of 1.0x (prior to 2014). Malaysia’s GDP growth is increasingly driven more by services sector (less energy consumption) and less reliant on manufacturing as the economy develops.

• On a positive note, the implementation of IBR (Incentive Based Regulation) and FCPT (Fuel Cost Pass Through) are positive developments to protect the power sector from energy price fluctuation, which will improve the earnings and cashflow certainties of the sector (particularly TNB), ensuring dividend payout. Over the years, there were 3 tariff adjustments for FCPT with gas price increases.

• We believe that gas price hikes will be imminent (part of government rationalization plan), which will push up power generation costs, hence higher electricity tariff. Nevertheless, coal cost (adjusted for weaker RM) has slumped further, which may partially offset the higher cost from gas price hikes. Furthermore, the expected improvement in power generation mix from coal power plant may also partially offset the impact from gas price hikes.

• RM weakness does not pose a material threat to the operation cost of Malaysian power companies, as any fluctuation in fuel costs is pass-through to consumer. On currency effect, TNB is affected negatively by through its loan exposure of RM1.76bn denominated in US$ and RM3.57m denominated in JP¥. On the other hand, YTLP enjoys RM translation gain from its foreign subsidiaries.

• Despite the delay in new power plant projects, Malaysia’s power reserve margin is still relatively healthy due to slower demand growth as well as short term extension to 3 PPAs – YTLP (Paka), Edra (Powertek) and Malakoff (PDP).

Risks

• Downside risks
• Surge in global energy prices (gas and coal).
• Supply shortage of energy fuel (gas and coal).
• Unscheduled power plant outage.
• Depreciation of RM.

Forecasts

• Unchanged.

Rating

• Overweight

Positives

• 1) Continued economy growth albeit slower pace; 2) Implementation of fuel cost pass-through mechanism; and 3) Drop in energy (LNG and coal) prices.

Negatives

• 1) Continued natural gas supply disruption; and 2) RM depreciation.

Valuation

• Maintained Buy on Tenaga with unchanged TP of RM15.80 based on DCFE. The sale of Edra to CGN has removed the uncertainty of potential M&A/bailout risk.
• Maintained Hold on YTLP with unchanged TP of RM1.45 based on SOP.

Source: Hong Leong Investment Bank Research - 7 Jan 2016