Tenaga is not expected to be materially affected by the on-going Malaysia power sector review, while YTLP continues to be dragged by Singapore Seraya and 1Bestarinet. We downgrade the sector call to NEUTRAL (from Overweight) with HOLD recommendation on Tenaga (unchanged TP: RM13.65, based on DCFE) and YTLP (lower TP: RM0.80, based on 25% discount to SOP).

Tenaga (HOLD; TP: RM13.65)

IBR/ICPT intact. The recent announcement of unchanged base tariffs, surcharges and effective tariffs (see figure #1) under IBR/ICPT mechanism has re-affirmed our view that the IBR/ICPT mechanism remains intact. Tenaga was allowed to recoup back RM1.6bn cost under recovery of fuel costs (mainly due to higher actual coal cost at USD99.24/mt vs benchmark cost at USD75/mt) in 1H19 as well as the hike in gas price by RM1.50/mmtbu to RM28.70/mmtbu effective Jul 2019. Tenaga will remain neutral from the fluctuation of fuel prices (gas, LNG and coal) under the cost past through to end users under ICPT (in terms of rebates or surcharges), while electricity demand will remain healthy on the immaterial net change in electricity tariffs.

Risks of sector liberalization. MESTEC is currently studying a proposal whether to allow new energy suppliers to come into the market to allow consumers to choose electricity suppliers other than Tenaga, effectively promoting for more competitive tariffs. We believe the liberalization of the power retail market will not post material earning risks to Tenaga as the allowable return for the segment under RP2 is RM18.8-22.6m per annum (based on WACC 7.3% x Average RAB RM258-310m for consumer service segment), translating into equity return of RM12.6-15.2m per annum for 2018-2020 (see figure #2), only 0.2% of Tenaga’s annual earnings of RM5.6-5.8bn.

Maintain HOLD, TP: RM13.65. We maintain HOLD recommendation on Tenaga with unchanged DCFE-derived TP: RM13.65. Tenaga’s earnings and cash flow are expected to be stable under the IBR/ICPT mechanism. Dividend is expected to remain stable at 50-60sen/share.

YTLP (HOLD; TP: RM0.80)

Singapore Seraya… has plunged into red territory since early 1QFY19, owning to further cut in vesting contract to 14% (from 20%) by Singapore government. The whole Singapore power sector is in losses, mainly due to overcapacity and fixed take or-pay contract of LNG import up to 2023. We are concerned the situation will persist until 2023 before any signs of potential recovery.

1Bestarinet. 60% owned YTLC is in an on-going tussle with the Malaysia government over the cancellation of 1Bestarinet contract. We do not anticipate any satisfactory outcome from the tussle. We believe there is possibility of impairments and higher losses in FY20 due to the loss of the contract. YTLC recorded LBT of RM28.3m in 9MFY19 and RM98.8m in FY18.

New Jordan and Indonesia plants. 45% owned Attarat Jordan plant construction progress at c. 60%, remains on track to commence operation by end 2020. However, 80% owned Tg Jati plant has not reach financial close yet, pending issuance of a business viability guarantee letter by Indonesia government.

HOLD, TP: RM0.80. We maintain HOLD recommendation on YTLP with lower TP: RM0.80 (from RM0.88) based on 25% discount to SOP: RM1.07, as we imputed higher discount rate at 25% (from 20%) due to increasing earnings uncertainty posted by the now loss-making Singapore Seraya and YES.

Source: Hong Leong Investment Bank Research - 12 Jul 2019