Malaysia power demand growth is expected to rebound +6.0% in 2021 (vs -5.0% in 2020). The IBR/ICPT mechanisms remain intact, protecting TNB transmission and distribution segment from fluctuation of power demand and fuel costs. A new gap year IBR 2021 to be introduced, with potentially lower return (vs. 7.3% in RP2) due to lower cost of debts, but should not have material impact to TNB. Government’s RE aspiration and MESI 2.0 will be negative to major IPP players mainly due to net reduction in capacity with expiring PPAs while risking ability to secure adequate capacity replacement from REs. We maintain NEUTRAL on Power sector, with BUY recommendation for TNB (TP: RM12.50) and HOLD for YTLP (TP: RM0.75), on the companies’ stable earnings and sustainable dividend payouts.

Sustainable power demand. For 9M20, Malaysia power demand (Peninsular) registered a drop of -6.2% (dragged by Industrial and Commercial segments), in line with the GDP of -6.4%, affected by Covid-19 pandemic and implementation of MCO since starting of the year. We believe 2020 year is an exceptional year (similar to GFC 2009) with a drop of -5.0% and expect the power demand to rebound +6.0% in 2021 before normalising back to c. +2.0% per annum in subsequent years.

IBR/ICPT intact. Implementation of IBR/ICPT remains intact under RP2 2018-2020, protecting TNB’s transmission and distribution from the fluctuation of power demand and fuel prices. Nevertheless, Tenaga has contributed RM250m (tax deductible) as part of its ESG obligation to support electricity tariff measures by government in 2020. EC has allowed for an introduction of gap year 2021 prior to RP3 2022-2024. We do not discount the allowable return to be lower than 7.3% under RP2, due to lower cost of debt assumption, but TNB’s bottomline should not be materially affected.

More REs. Government is committed to Renewable Energy (RE), targeting 20% of the country power capacity from RE by 2025, mainly driven by solar power projects in coming years. Major IPP players will be negatively affected by the government’s aspiration towards RE, as they face the risk of lower capacity replacement (each LSS capacity is only up to 50MW) for their expiring PPAs as well as increasing competition. During the previous round of LSS3 of 500MW tender, none of the major IPPs were successful in the tender.

Expiring PPAs. Within the next 8 years (until 2028), all listed power groups are expected to suffer from expiring PPAs with no meaningful replacement capacity. The least affected is TNB (-487MW), followed by YTLP (-585MW) and worst hit is Malakoff (-2,052MW). We do not expect the ongoing RE programs to be large enough to offset the retiring capacity due to limitations in place by EC and increasing entrance and competitors for the RE segment.

MESI 2.0 liberalization. There will be no more risk-free PPAs going forward as IPPs will not receive guaranteed capacity and energy payments, and instead required to participate in capacity and energy auction market. MESI 2.0 effectively increases earnings risks to power generators with uncertainty of fuel supply and sales of capacity/energy generation. Nevertheless, retired IPPs (i.e. YTLP and Malakoff) may also participate in the auctioning mechanism to continue generating income. Another risk to large IPP players is the emergence of the “Gentailer” segment, which may resell their excess power generation to the system. SEDA estimated that some 4.1m buildings in Malaysia might still accommodate solar panels, and potentially generate a total of 37.4GW peak of electricity vs. our current peak demand of 19GW.

Maintain NEUTRAL. We maintain Neutral on the Power sector, given the earnings and dividend sustainability of the sector in time of on-going market uncertainty in 2021. Maintain BUY on TNB (TP: RM12.50) and YTLP (TP: RM0.75).

Source: Hong Leong Investment Bank Research - 29 Dec 2020