TENAGA is clearly an election play with the election nearing since a tariff review is imminence post-GE13. Meanwhile, the government is likely to continue with the compensation structure, i.e. the fuel cost sharing mechanism until the tariff hike takes place and this will ensure earnings stability for TENAGA. In addition, when the new gas supply from the Melaka RGT comes into place in 2Q13, a new set of fuel cost pass-through mechanisms will address its rising gas cost. TENAGA remains as OUTPERFORM with an unchanged TP of RM8.05/share, based on 13x FY13 PER. It is now one of our TOP PICKs for our 2QCY13 Strategy.

An election play. With the pressure to raise tariff getting higher as the government/Petronas/TENAGA will not be able to absorb the higher fuel cost continuously, a tariff hike is highly likely post-GE13. The share price of Tenaga Nasional Bhd (TENAGA) is likely to react positively in the event of a tariff review based on past records. Since 2006, the tariff rates of Peninsular Malaysia have been revised four times (three being upward revisions and with one downward revision). The share price of TENAGA responded positively in each of these occasions except for the July-08 tariff revision when its share price was fairly flattish. The records show that the share price soared 3%-9% immediately the day after the announcement to as high as 8%-10% within a month. As such, we expect the share price to likely rally higher in the same this round.

Fuel cost sharing to cap earnings volatility. The earnings risk profile for TENAGA has changed to be less sensitive towards fuel price changes since the first fuel cost compensation scheme was introduced in Dec 2011. Under the fuel cost sharing mechanism, the government, Petronas and TENAGA will share equally the differential fuel cost incurred mainly due to the gas supply shortages. To recap, TENAGA received its first RM2.05b compensation (for the period of Jan 2010-Oct 2011) in Dec 2011 and in FY12, the group received RM1.44b in compensations. This is to ensure a more sustainable operation and cash flow for TENAGA to continue its operations with no major electricity brown/blackouts.

IBR supports the structural re-rating theory. The Energy Commission has a timeline to implement the Incentive-Based Regulation (IBR) as a ‘carrot and stick’ structure. One of the major assumptions of this structure is a fuel-cost pass-through mechanism, which supports our positive view on TENAGA. We also look forward to further updates on the stabilisation fund, which will help mute the full impact of any tariff hikes on the customers. Our positive view is also reflected in the rise in the foreign shareholdings of the shares to 15.0%, which is considered high since the foreign shareholdings remained below 12.6% for the last two years. According to TENAGA, foreign investors do want to see a firm tariff structure in place as it will provide less volatility for a concession-based utilities company like TENAGA.

TOP PICK for power utilities. With the fuel cost sharing mechanism now and later the IBR, TENAGA’s profitability is expected to be firmer as opposed to the past. In addition, coal prices are now hovering at USD85/mt for Newcastle 6700CV coal prices, which should improve TENAGA’s profit margins further. Management has guided for an average coal price of USD100/mt in FY13 (vs. ours of USD97/mt), demand growth of 4%-5% (vs. ours of 4.2%) and 3) a gas supply volume of 1,000MMscfd. These parameters should make our FY13 earnings estimates quite achievable. Our price target is maintained at RM8.05/share, based on 13.0x Fwd PER. We reaffirm our OUTPERFORM rating on TENAGA.

Source: Kenanga