The new year 2014 will start with a new electricity tariff rate in the Peninsular marking the beginning of a fuel cost-pass-through mechanism, albeit a partial one. A full pass-through mechanism will take place eventually as consumers are expected to bear the changes in fuel costs. Although the next six-month review will be in June/July 2014, we expect the existing tariff rate to stay at least for the next 12 months given the public outcry against the recent slew of rising subsidy cut, which had resulted in rising living cost and inflationary pressure. The restructuring of the Selangor water assets is back in a deadlock again after the concessionaires disagreed with the 4th offer price. As a result, we are NEUTRAL on the Water Utility again and may revisit the sector once the issue is settled. In all, our preference remains the Power Utility as the sector restructuring is heading in the right direction. TENAGA remains as our TOP PICK for the sector given its re-rating story coupled with compelling valuation with significant FBMKLCI weighting.

POWER: New tariff from January onwards. After much anticipation, Tenaga Nasional Bhd (TENAGA, OP; TP: RM12.07) finally got its tariff hike for the first time in more than two years. The 15% tariff hike, effective 1 Jan, is still a partially fuel cost-pass-through with the next review in six months later. The message from the regulators, i.e., Energy Commission and MyPower, in the recent conference call is loud and clear; that 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 is definitely positive for TENAGA, which will reduce its earnings exposure risk to fuel costs making operational efficiency as the key deciding factor to its bottom-line. Under the plan, fuel prices such as piped gas, imported LNG and coal will be reviewed half yearly while the base tariff will stay till 2017 for the next review. As such, 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.

But a six-month review is a tough call in 2014. While a review on tariff structure is expected in every six months, we expect the existing tariff to stay at least throughout 2014 given the recent wave of subsidies cut, which had resulted in rising living cost and inflationary pressure. In any case, the future new tariff structure will be earnings neutral to TENAGA. Going forward, the electricity demand in the Peninsular will be there to support the integrated utility’s top-line while improvement in operational efficiency will determine its bottom-line performance. All said, we expect the electricity sales in the Peninsular to grow at 4.4% in 2014, mainly driven by the commercial and industrial segments. From the supply side, the bidding outcome of Track 3B Project is likely to be announced in 1Q14. It was reported that YTL Power International Bhd (YTLPOWR, MP; TP: RM1.97) had put in the lowest bid for this 2,000MW coal-fired plant against TENAGA, 1MDB (NOT LISTED) and Malakoff (NOT LISTED).

WATER: Deadlock to continue… After the failed takeover attempt by Kumpulan Darul Ehsan Bhd (KDEB) on 4 Dec-13 due to several issues i.e. (i) key component as stated in the previous offer dated 21 Feb-13 namely payment of surplus book value of assets over liabilities was removed, (ii) the valuation methodology of using ROE 12% p.a. was not fair, and (iii) long overdue receivables from Syabas to WTP operators incurred from tariff hike compensation should be included in the offer; we believe there will be another round of “deadlock” as was the case from the 1st – 4th offer, hence further delaying the state’s water consolidation exercise. The delay will not only affect the water operators, but also the whole Selangor water industry as Langat 2 and NRW reduction programme will not take off pending completion of this exercise. Going forward, it is rather challenging to gauge when these water players will reach a point of agreement with KDEB to resolve the pricing issues.

PREFER Power with TENAGA remaining as the TOP PICK. The Power Utility remains as our preference over Water Utility given the expected sector-wide structural change in the Power segment as it progresses towards a full fuel cost-pass-through mechanism while the Selangor water structuring exercise is still in a deadlock. As such, we are NEUTRAL on Puncak Niaga Holdings Bhd (PUNCAK, MP; TP: RM3.50) until it resolves the pricing issue with the State Government of Selangor. We continue to favour TENAGA as our TOP PICK for the sector for its rerating story couple with still compelling valuation. Meanwhile, we have OUTPERFORM and MARKET PERFORM on MMC Corp Bhd (MMCCORP, OP; TP: RM3.60) and YTLPOWR respectively.

Source: Kenanga