The Energy Commission’s (EC) decision on the tariff hike reinforces our view that any changes to the fuel cost will remain earnings neutral to Tenaga and supports our positive view on the shares. The EC’s tariff revision also removes the uncertainty over whether the government would continue with the current IBR framework. Reiterate BUY with an unchanged 12-month TP of RM18.70.

Strong Signal That IBR and ICPT Is Here to Stay

The government’s decision to maintain the current IBR (incentive-based regulation) and ICPT (imbalance cost pass-through) framework for RP2 to determine the tariff every 6 months until 2020 is, in our view, positive for Tenaga as it reinforces the idea that any changes to the fuel price will continue to be earnings neutral to Tenaga. The hike in the current effective tariff is the steepest since the introduction of the ICPT in 2014, and this is also the first time that a surcharge is being collected. The current rebate enjoyed by all users will also be abolished. We believe that this is a strong signal that there is only limited political influence in determining the tariff.

Uncertainty Removed - a Positive Catalyst

Before the announcement of the tariff, Tenaga’s share price had corrected by more than 13% over the past 2 months, mainly due to the uncertainty over the policy. The ICPT mechanism is important to Tenaga, as it helps to maintain a steady cash flow for Tenaga, which allows Tenaga to continue with its current dividend payout policy – at least 30-60% of its net profit to be returned to shareholders as dividends. With the uncertainty removed, the risk associated to Tenaga is also now lower, which we believe will act as a catalyst for the stock.

Maintain BUY With An Unchanged TP at RM18.70

We are maintaining our BUY call on the stock, with an unchanged DCFbased TP of RM18.70, as we believe that under the ICPT mechanism, the increase in fuel cost will continue to be earnings neutral to Tenaga, supporting its current payout. Tenaga is also our preferred pick for the sector, and one of Malaysia’s Top Buy ideas. Downside risks include the revision of policy and higher-than-expected losses from its associates.

Source: Affin Hwang Research - 2 Jul 2018