Utility Sector Is Expected to Sustain Into 2H21, as IBR/ICPT Frameworks Remain Intact and Demand for Utility Products Will Rebound as the Country Progress Through the NRP’s Reopening Phases. Utility Groups Continued to Invest Into Their Infrastructure and Acquisition for Earnings Growth. We Expect Dividend Yield for the Sector to Sustain With Potential Special Dividend Payout. We Upgrade Our Sector View to OVERWEIGHT (from Neutral), With BUY for TNB (TP: RM12.50), BUY for YTLP (TP: RM0.85) and BUY for PGB (TP: RM19.00).

IBR/ICPT intact. IBR/ICPT framework remains intact despite the ongoing implementation of FMCO (Phase 1) nationwide. The framework protects TNB (power transmission and distribution) and PGB (gas transportation and regasification) from the fluctuation in demand as well as input costs over the longer term (any shortage will be compensated in subsequent review period and vice versa for surplus). Hence, large portion of both TNB and PGB’s earnings are expected to remain stable in 2H21.

Demand for utility products to rebound in 2H21. Demand for electricity and gas in Malaysia would be affected during FMCO implementation in Jun-Jul, but we expect a recovery in 2H21 as we progress through the National Recovery Plan’s (NRP) reopening phases. However, the sector earnings are not expected to be materially affected:

1. Tenaga: Majority of earnings are protected under IBR framework (power transmission & distribution), PPA (power generation) and SLA (power generation).
2. YTLP: Majority of earnings are driven by overseas operations i.e. Wessex Water (UK) and Seraya Power (Singapore), both entities are seeing demand recovery as the economies recover from the strict lock-down measures.
3. PGB: Majority of earnings are protected under IBR framework (gas transportation and regasification) and long term supply contracts (Petronas).

Earnings sustainability. Utility groups are positioning themselves for long term earnings sustainability by continued capex investment and exploring new/ancillary business opportunities.

1. Tenaga: Guided capex RM9bn capex for FY21 and we expect RM8-10bn for FY22-23, largely for transmission and distribution segment (increase regulated asset base), ensuring continued earnings growth for the segment. Also revealed RM6.5bn capex for RE investments in both domestic and foreign markets, providing additional EBIT RM2bn by 2025.
2. YTLP: Major earnings will be supported by: 1) allowable earnings based on the expected increase in Regulatory Capital Value (RCV) to GBP3.4bn (Mar 2025) from GBP3.1bn (Mar 2020) for Wessex Water in UK; and 2) newly acquired Tuaspring Power, complementing Seraya Power in leveraging onto the recovery of power tariff and demand in Singapore.
3. PGB: Investments into gas transmission network (RM100m debottlenecking exercise and RM541m new line to Pulau Indah), ensuring earnings sustainability under IBR framework.

Sustainable dividends. With the certainty of earnings, all the utility groups are expected to sustain their cash flows and maintain dividend payouts. We projected dividend yields for Tenaga at 5.1%, YTLP at 4.3% and PGB at 5.5% with potential special dividend for the year.

Upgrade to OVERWEIGHT. We upgrade our sector call on Utility to OVERWEIGHT (from Neutral), given the earnings and dividend sustainability of the sector in a time of market uncertainty plagued by the pandemic. Maintain BUY on TNB (TP: RM12.50), YTLP (TP: RM0.85) and PGB (TP: RM19.22).

Source: Hong Leong Investment Bank Research - 6 Jul 2021