Highlights/ Comment

• Malaysia power demand growth is expected to normalize back to 2.5% yoy in 2017 (after El Nino steering 2016 growth to an expected high of 4-4.5%). Malaysia’s GDP growth is increasingly driven by services sector (relatively lower energy intensity) and less reliant on manufacturing.

• On a positive note, government has been consistent and committed to IBR (Incentive Based Regulation) and FCPT (Fuel Cost Pass Through). The mechanisms are meant to protect the power industry from energy price fluctuation, i.e. improve earnings and cashflow certainties of the industry (particularly TNB). Over the past 2 years, there were 5 tariff adjustments for FCPT along with gas price increases.

• We note the fuel cost has been on increasing trend – coal price surged to US$70/mt since mid-2016 (from low of US$40-45/mt) while piped gas price continued to be hiked by RM1.50/MMBtu for every 6 months. Hence, we expect effective tariff rates to increase in the next review (Jun 2017). Despite the surge in coal price, coal power generation is expected to remain as the main component of power generation mix, as it is still the cheapest source of fuel and its function as base load power generation.

• 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 end users. On currency effect, TNB is affected negatively through its loan exposure of RM2.9bn denominated in US$ and RM3.0bn denominated in JP¥. However net impact should be immaterial given its large earnings base. On the other hand, YTLP is affected through lower RM translation contribution from subsidiary Wessex, which is denominated in UK£.

Risks

• Surge in global energy prices (gas and coal).

• Supply shortage of energy fuel (gas and coal).

• Unscheduled power plant outage.

• Depreciation of RM.

• Discontinuation/suspension of IBR/FCPT mechanisms.

Forecasts

• TNB: Cut earnings for FY18-19 by 1.7% and 1.6% respectively after conservatively adjusting for lower regulated return of 6.5% for assets under Transmission and Distribution segment by next IBR review (Jan 2018).

• YTLP: Unchanged.

Rating

Overweight ↔

• Despite being pressured by increasing energy costs and RM depreciation, we believe power industry is protected under PPA, IBR and FCPT mechanisms, which provide for fix regulated earning margins for the industry and implementation of cost past-through to end users.

Valuation

• Maintain Buy on Tenaga with lower TP of RM17.00 (from RM17.50) based on DCFE. We remain positive on TNB’s long term growth and strong cash flow. The recent change in dividend payout policy will improve dividend yields.

• Maintain Hold on YTLP with unchanged TP of RM1.45 based on SOP. The share price is expected to be supported by high dividend yield.

Source: Hong Leong Investment Bank Research - 10 Jan 2017