We believe a tariff revision will take place during the December Review window ahead of the GST implementation in April next year. A hike would definitely be a share price catalyst to TENAGA as past trends shown that the integrated utility benefited from both share price appreciation and better earnings during each and every tariff hike. Elsewhere, at least two new plants will face delay in commissioning, prompting the possibility of PPA extension for GEN1 IPPs, where YTLPOWR’s Paka and Pasir Gudang plants are the likely candidates. While the controversial Track 4A is going ahead without YTLPOWR, the focus now will be on how the EC will award the upcoming Track 4B since a direct award is not healthy for sector reforms. In all, we remain OVERWEIGHT on the sector while TENAGA is still our TOP PICK for the tariff hike catalyst. For alternative play, we still like the small cap PESTECH for its explosive earnings growth story.

2QCY14 results were mixed, with two within expectations, one each for above and below. YTLPOWR (OP; TP: RM1.70)’s 4Q14 was disappointing, no thanks to weaker-than-expected earnings from the local IPPs and PowerSeraya while losses at YES widened. However, there was a dividend surprise with a 10 sen payout; such big payout had not been seen in four years. On the other hand, TENAGA (OP; TP: RM13.77)’s 3Q14 results beat our forecast due to lower-than-expected effective tax rate. Both MMCCORP (MP; TP: RM2.77)’s 2Q14 results and PESTECH (OP; TP: RM4.36)’s 2Q15 results were fairly within expectations. Worth mentioning was MMCCORP which managed to meet expectations after two quarters of disappointing results as the Tanjung Bin Power Plant was back in normalised operations.

Track 4A is done; Next is Track 4B. After much controversy, SIPP (NOT LISTED) and TENAGA went ahead with the Track 4A project without YTLPOWR as they signed the heads of agreement in July. To recap, the Track 4A was awarded by the Energy Commission in early May to a consortium which included YTLPOWR, SIPP and TENAGA via a direct negotiation to fast-track the 1,000MW-1,400MW combined cycle power-generating plant and commission by Jun-18 which is two years ahead of schedule. This fast track project which went for direct negotiation after the sudden blackout in five states in early May which caused concerns of declining reserve margins. We maintain that a direct award of IPP contract without open tender is not healthy for the sector reforms. Now, the focus will be on the upcoming Track 4B which is likely a coal-fired plant as well, as on how it will be awarded in the near future.

After the two problematic coal-fired power plants, other hiccups on the way? As we mentioned in our last strategy piece, the Tanjung Bin and Jimah Power Plants are on track to settle their problems by mid-2015 and end-2014, respectively. However, according to official from TENAGA, there are other problems coming up, like the new 1,000MW coal-fired plant in Tanjung Bin which is facing a delay of six months to a year which was initially due to operate in Mar 2016. Besides, IMDB’s Track 3B 2,000MW coal-fired plant in Jimah East may also have problems meeting its scheduled operations of Phase 1 in Oct 2018 and Phase 2 in Apr 2019. This had spiked speculations that the government may plan to extend the existing PPAs for GEN1 IPPS; this is especially so for YTLPOWR’ GEN1 Paka and Pasir Gudang plants to benefit the most. Given that the problem at GEN3 Tanjung Bin plant is set to be resolved by mid-2015, MMCCORP indicated that the re-listing of MALAKOFF (NOT LISTED) is likely to take place in 2Q of 2015.

Still OVERWEIGHTing the sector with TENAGA remaining as TOP PICK. There is no changes in our view in the past three quarters since the 1Q14 Strategy as there was no tariff adjustment in the June Review due to the inflationary pressure but a tariff revision in the December Review is likely possible. We still believe a tariff revision in the December Review is highly likely ahead of the GST implementation in Apr 2015. As such, TENAGA will be the key beneficiary in this case and it remains as our TOP PICK for this rerating catalyst coupled with still compelling valuations. The small cap PESTECH also remains as our alternative sector play for its explosive earnings growth story, with near term strong contract flow expected.

Source: Kenanga