Following an update session with management, we remain neutral on Tenaga’s earnings outlook. Tenaga will remain regulated under IBR framework and management do not expect any reform to have material impact to its business model and earnings. The recent drop in energy prices will be reflected in upcoming 2H19 ICPT review, resulting in lower effective average tariff (vs 1H19 of 39.45s/kWh for domestic and 42.00s/kWh for non-domestic), while Tenaga will remain neutral from ICPT mechanism. Tenaga will continue to focus on expanding RE business as part of new government’s aspiration for RE target of 20% of total installed capacity by 2025. We maintain our HOLD recommendation with unchanged TP: RM13.10.

IBR still intact. Management re-affirmed that Incentive Based Regulation (IBR) is still intact and government will not terminate IBR or make changes to IBR framework, which may adversely affect Tenaga’s earnings. Nevertheless, the government seeks power industry reform to the benefit of end users while maintaining a justifiable return to power producers and service providers (i.e. Tenaga and IPPs). Among measures of industry reform being proposed include: 1) an independent Single Buyer entity to ensure fairness to all IPPs; and 2) opening up of Customer Service market to third party to allow competition and improve customer experience. Under RP2 2018-2020, the indicative allowable returns for Single Buyer Operation is RM1.1-RM1.8m while Consumer Service is RM19-23m, which are immaterial to TNB expected annual earnings of RM5.5bn. Furthermore, management expects any industry reform initiative will only be implemented earliest by 2021, in tandem with RP3 2021-2023.

Source: Hong Leong Investment Bank Research - 23 Apr 2019