Period  2Q14/1H14

Actual vs. Expectations The 1H14 results came in within expectations with the RM2.14b core net earnings making up 46% of our FY14 full-year estimates and 44% of market consensus. We expect a stronger 2H14 on the back of the 15% tariff hike (effective Jan 2014) which only had two months impact in 2Q14.

 The non-recurring items in 1H14 include: (i) RM277.2m reinvestment allowance – RM201.7m in 1Q14 and RM75.5m in 2Q14, (ii) RM662m reversal of reinvestment allowance for FY13 – all in 2Q14, and (iii) RM188.7m for change in corporate tax rate – all in 1Q14.

Dividends  10 sen NDPS was declared in 2Q14, the same as 2Q13.

Key Results Highlights Despite revenue rising 4% QoQ, 2Q14 core net earnings declined 4% to RM1.05b as the two IPP coal-fired plants, namely Tanjung Bin and Jimah Power plants were still under maintenance, which resulted in a higher gas/LNG fuel requirement as substitution. The 4% growth in topline was mainly supported by the 15% tariff hike, although electricity units sold slid by 1.7% QoQ.

 Total fuel costs (including the IPP energy payment) in 2Q14 rose 9% QoQ, which mainly contributed to the higher generation costs from using more expensive LNG which cost doubled to RM937.4m from RM473.1m (average RM46 /mmbtu in 2Q14 vs. RM45/mmbtu in 1Q14). The big jump in LNG cost was partly due to the change in the threshold of subsidised gas supply to 1,000mmscfd from 1,250mmscfd (effective Jan). Thus, TENAGA has to pay the market price for the extra 250mmscfd.

 The gas supply rose to 1,350mmscfd on average in 2Q14 from 1,321mmscfd in 1Q14. As such, TENAGA still enjoyed a month fuel cost compensation of RM26.4m in Dec 2013 from RM116.5m in 1Q14 on the 50:50 cost sharing with Petronas. For the coal fuel cost, the average coal price in 2Q14 was USD77.8/mt from USD77.2/mt from the preceding quarter.

 On a YoY comparison, the 1H14 core earnings grew 13% to RM2.14b from RM1.90b previously, mainly attributed by higher revenue of 9% or RM1.61b. Total gas/LNG fuel cost surged 74.0% to RM5.45b while coal fuel cost declined 16.9% to RM2.28b. The average coal price was USD77.5/mt in 1H14 from USD84.6/mt in 1H13.

 On debt exposure, total debt increased to RM26.5b (net debt: RM13.0b) as at Feb-14 from RM23.0b (RM12.6b) three months ago. Thus, gearing also rose to 41.0% (net: 20.2%) from 39.6% (23.3%) previously.

Outlook  The new tariff rates, which took effect from 1st Jan 14, are expected to boost bottom-line by RM1.17b per annum. While a review on tariff structure is expected every six months, we expect the tariff to stay unchanged at least till Dec 2014 given the recent wave of subsidies cut, which had resulted in rising living cost and inflationary pressure. Moving forward, when a new set of fuel cost pass-through mechanism is in place, TENAGA’s earnings are expected to stabilise. Its financial performance would then depend mainly on its operational efficiency.

Change to Forecasts We keep our FY14-FY15 estimates unchanged for now. On the other hand, we introduce our FY16 forecast with net profit expecting to grow by 8% from FY15.

 Key assumptions for our FY16 earnings are: (i) electricity sales growth: 4.5% vs. 4.4% in FY14 and 4.5% in FY15, (ii) generation mix for gas and coal: 46.0% and 48.2%, vs. FY14-FY15’s 48.0% and 46.2%, (iii) coal price: USD95/mt as same FY14-FY15, (iv) gas and LNG price: RM15.20/mmbtu and RM41.68/mmbtu as same FY14-FY15, (v) oil price: USD103/bbl vs. USD102/bbl-USD106/bbl for FY14-FY15, and (vi) USDMYR: 3.15 vs. 3.25-3.19 for FY14-FY15.

Rating Maintain OUTPERFORM and TOP PICK for the power sector

Valuation  We have decided to roll over our valuation base-year to CY15 from CY14. Together with unchanged targeted PER of 14.3x (5-year average), our new price target for TENAGA is RM13.58/share from RM12.33/share previously.

Risks to Our Call A slow down in economy growth which will affect electricity demand.

Source: Kenanga