The Utility sector is expected to sustain into 2H22, as IBR/ICPT frameworks remain intact and demand for utility products continue to increase in tandem with the expected economy recovery. Increasing commodity fuel costs remains a concern for the sector, affecting Tenaga’s cash flow and PGB earnings (for utility segment), while YTLP should remain relatively stable. Nevertheless, we expect dividend yield for the sector to sustain in 2H22. We maintain our sector view OVERWEIGHT, with BUY for Tenaga (TP: RM11.65) and YTLP (TP: RM1.05), and HOLD for PGB (TP: RM17.85).

IBR/ICPT intact. The IBR/ICPT framework remains intact with RP3 being renewed for 2022-2024 and ICPT has continued into 2H22 with expected fuel cost recovery of RM7bn (RM5.8bn covered by government subsidies and remaining through surcharge 3.7 sen/kWh to non-domestic segment). The framework protects Tenaga (power transmission and distribution) from the fluctuation in demand as well as input costs (any shortage will be compensated in subsequent review period and vice versa for surplus). Similarly IBR framework for PGB (gas transportation and regasification) remains effective until today, with slightly lower adjusted tariff for gas transportation to RM1.128/Gj in 2022 (previously RM1.129/Gj). PGB is currently in discussion with the Energy Commission (EC) for the benchmark tariff in upcoming RP2 (2023-2025).

Demand for utility products on recovery in 2H22. As Malaysia economy continues its recovery towards 2H22, so will the demand for electricity and gas. However, the sector earnings are not expected to materially improve: 1. Tenaga: Majority of earnings are protected under IBR framework (power transmission & distribution). However, Tenaga’s power generation (PPA and SLA) will enjoy the benefit of higher energy demand, translating into higher earnings to the group. 2. YTLP: Majority of earnings are driven by overseas operations i.e. Wessex Water (UK) and Seraya Power (Singapore), with both entities seeing demand recovery as the economies continue to recover from economic reopening. 3. PGB: Under IBR framework (gas transportation and regasification), the assumed volume of gas are fixed, any surplus/shortfall of volume will be addressed through tariff rebate/surcharge to pass back to end users. Nevertheless, PGB’s utility segment and ancillary services will also enjoy higher demand volume.

Increasing commodity fuel costs. Global commodity fuel costs have been on increasing trend since mid-2021 and accelerated starting of 2022 when the Russia Ukraine war began and global sanctions were implemented against Russia (one of the major commodity fuel producing countries in the world). Coal prices has now recorded high at USD400/mt (RM1,760/mt) while gas prices has remained high at RM52.89/mmbtu (Japan LNG).

1. Tenaga: While fuel cost is pass-through under ICPT framework (power transmission & distribution), PPA (power generation) and SLA (power generation), Tenaga will still have to pay the higher fuel costs upfront in current period before being able to pass through in subsequent review period (every 6 months). We believe the recent approved RM7bn ICPT for 2H22 has not taken into account of the surge of coal prices since Mar 2022 (similar to the review for 1H22, where only RM1.67bn ICPT was approved based on the lower ACP Jun-Jul 2022 vs. RM4.1bn ICPT + other regulatory adjustments recognised by Tenaga in 2H21, as the delivered coal prices were already comparatively higher). Hence, Tenaga’s receivables may continue to climb in 2H22 if coal prices remain stubbornly high at current level despite receiving RM7bn ICPT payment during the period. Nevertheless, Tenaga has a large balance sheet to further leverage up for short term working capital purpose.

2. YTLP: Majority of the group’s earnings are not affected by higher commodity fuel costs. During recent tariff review, Wessex Water (UK) managed to secure 4.5% tariff hike effective Apr 2022, to address the higher inflationary cost pressures. Seraya Power (Singapore) has power generation and retails, which are exposed to imported gas and LNG prices. However, management assured that majority of their contracts are secured and hedged, while others have pass through clauses (variable contracts).

3. PGB: As gas prices continued on rising trend while electricity prices are fixed by government (benchmark to TNB’s approved tariff), PGB’s utility segment margin will be affected. However, the incurred internal gas consumption costs (transmission and regasification) are generally passed through to clients in subsequent IBR review period.

Source: Hong Leong Investment Bank Research - 12 Jul 2022