We came away feeling optimistic from last Friday’s TENAGA conference call with management and officials from the regulators. The message from the regulators, namely Energy Commission and MyPower, is loud and clear: a full fuel cost-pass-through mechanism will be implemented eventually, which means consumers will ultimately have to bear with changes in fuel cost. This will reduce the integrated utility’s earnings exposure risk to fuel costs while operational efficiency will be the key deciding factor to bottom-line. Although the fuel cost component is expected to be reviewed every six month, we believe tariff rate is here to stay in the near-term given the public outcry after the slew of rising subsidies cut of late. In any case, the future new tariff structure will be earnings neutral to TENAGA. It remains an OUTPERFORM with TP of RM12.07/share.

A full fuel cost-pass-through mechanism eventually. Last Friday, TENAGA conducted an analyst’s briefing session together with officials from the regulators, i.e., Energy Commission and Malaysia Programme Office for Power Electricity Reforms (MyPower) in respect of the recent announcement of 14.89% tariff hike, which will take effect from 1 Jan-14. It revealed the rationale of the new tariff structure which is based on four components of: (i) domestic gas price adjusted to RM15.20/mmbtu from RM13.70/mmbtu, (ii) the imported LNG fixed at RM41.68/mmbtu, (iii) the coal base price of USD87.50/mt from USD85/mt, and (iv) the base tariff which is being raised by 2.69% or 0.90/kWh from the current average tariff. The message from the regulators is loud and clear: a full fuel cost-passthrough mechanism will be implemented eventually.

Still a six-month review. The regulators said the fuel cost components will still be reviewed once in every six months, especially for the piped gas which will be gradually adjusted to market price. In fact, increases for gas price have already been planned in Jun-11 at RM3/mmbtu for every six months but not implemented until this round with only a RM1.50/mmbtu hike. The fixed price of RM41.68/mmbtu of imported LNG price is based on the price for LNG price ex-Bintulu with transportation cost while the forex assumption for coal base price is based on MYR/USD of 3.14. We understand that the changes in fuel prices for the six-month period will be passed through or negative passed through (which means a decline in price) and to be reflected in the next six-month period. As such, the next review will be in end-Jun/early-Jul next year.

No change in base tariff till 2017. While the first three components are fuel cost related, which will be reviewed half yearly and is earnings neutral to TENAGA, the fourth component; the base tariff is set for the next three year till 2017 and it is to cover capex and operating expenses under the current rising cost environment. We have estimated earlier that the base tariff’s upward revision will benefit TENAGA potentially by RM900m annually. In all, this tariff hike would boost FY14 electricity sales by RM3.05b while the upward adjustment in gas prices would add an extra fuel cost of RM2.27b to TENAGA (Refer to our report dated 3 Dec-13).

OUTPERFORM maintained at RM12.07/share. While a review on tariff structure is expected in every six months, we expect the tariff to stay at least in the next 12 months given the recent wave of subsidies cut, which had resulted in rising living cost and inflationary pressure. Valuation-wise, although its share price has risen 56% YTD, the stock still trades at undemanding CY14 12.6x PER. Even at our price target of RM12.07/share, the stock is valued at only CY14 14x PER vs. market PER of 16x-17x despite its vital FBMKLCI weighting. TENAGA remains an OUTPERFORM and is our TOP PICK for power utilities.

Source: Kenanga