Tenaga (TNB) has announced an internal reorganisation which will split its current operations into 3 different entities (Generation, TNB and Retail) in anticipation of the upcoming regulatory changes under MESI 2.0. The reorganisation is to provide operational flexibility for its business segments to meet the required changes. If we use the changes as an indicator, MESI 2.0 is unlikely to cause major changes to Tenaga's profitability, at least in the near term. Reiterate HOLD call with an unchanged TP at RM14.10.

Bracing for More Competition Ahead

Although the government has yet to announce details of the reforms under MESI 2.0, Tenaga believes that its retail business is likely to be liberalised and opened up to competition. We believe the impact to TNB is limited, as the business division contributed around RM0.2bn (3%) out of the RM6.7bn EBIT the group generates. Management has also guided that under the Incentive Based Regulation (IBR), the retail portion is only 1sen/kwh (2.53%) out of the base tariff of 39.45sen/kwh. However, the transmission and distribution business is likely to maintain its current form, which contributed around 70% of EBIT in 2018.

Not the Worst-case Scenario for Generation Business

Based on our understanding, the government will likely introduce a hybrid model for the generation segment, in which certain capacity (demand) will get its supply from the merchant market, while existing power plants will continue to run down their existing PPA. Management believes that the changes could provide some opportunities for its expiring power plant; however, the current high reserve ratio is likely to limit the allocation for the merchant market, in our view. We believe that without a meaningful allocation, power producers are more likely to utilise their old power plants to supply to the grid instead of building new power plants.

Reiterate HOLD With An Unchanged TP of RM14.10

Although the proposed reorganisation is likely to alleviate some regulatory concern, the final decision on MESI 2.0 still lies in the hands of the government. However, we view the proactive measure taken by TNB positively, as the new organisation structure provides more flexibility and focus in dealing with the pending regulatory change. Reiterate HOLD call with an unchanged TP at RM14.10.

Source: Affin Hwang Research - 31 Jul 2019