We see two key catalysts in 2015; (i) the usual half-yearly tariff review, and (ii) the long awaited listing of 1MDB and Malakoff. The falling fuel costs like coal price and lesser consumption of expensive LNG as the coal plants are back in action augur well for TENAGA, which also meant a less-pressing tariff hike in coming June 2015 review. In fact, with the on-going recognition of PPA savings, TENAGA can afford a zero adjustment in the June 2015 review. Nonetheless, the June 2015 review is still a tough call given the planned GST implementation in April 2015. The two new IPOs are likely to be in 1H15 with 1MDB expecting to raise one of the biggest proceeds sum in market history. Nevertheless, with the current lacklustre market condition and the less-than-promising 2015 outlook, these listings may prove challenging in terms of pricing. 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.

Jun-Review in 2015 is a tough call. Under the Imbalance Cost Pass Through (ICPT) mechanism which was implemented in January 2014, it allows the government to review the tariff every six months based on changes in fuel costs. In November 2014, the authority announced that there was no tariff adjustment till June 2015 as the incremental ICPT cost amounting to RM1.68b for the period from January 2014 to June 2015 would be offset by the savings from the renegotiation of GEN1 PPA. With the balance of PPA saving of RM170m, a decision for a tariff adjustment in June 2015 is possible. However, this is a tough call for the government given the planned GST implementation in April 2015, which could lead to inflationary pressure.

Tariff adjustment quantum could be small. We learnt that the PPA savings is c.RM1.6b which is from April 2013 to June 2017, which implies c.RM400m savings a year. This also means that TENAGA (OP; TP: RM14.65) could recognise another RM200m savings comes June 2015 based on a half-yearly basis. Based on the 1,000mmscfd guaranteed gas supply at subsidised price of RM15.20/mmbtu, TENAGA’s gas fuel cost could increase by RM274m on a six-month basis should subsidised gas price rise by RM1.50/mmbtu as per scheduled earlier. With declining fuel cost like coal, the actual increment for tariff adjustment in June review could be fairly lower. In fact, if the government wants to be aggressive, there could be no tariff adjustment for 2H of 2015. In our opinion, gas price should raise accordingly as per schedule, at RM1.50/mmbtu per six months or the previous planned RM3.00/mmbtu per six months. With the help of PPA savings, the impact could be lessened and hasten to bring it to market price in meeting the subsidy rationalisation target.

Listing of 1MDB and Malakoff finally here? After delaying several times, MMCCORP (MP; TP: RM3.21) announced in end-November that the listing of its power assets, Malakoff, is to be in 2Q15. Based on our DCF valuation, MMCCORP would be able to raise RM2.1b, valuing the IPO at 12.3x on CY15 earnings. In our opinion, pricing is fair in line with YTLPOWR (OP; TP: RM1.70)’s valuation of 10x. It may even fetch better valuation given its quality power assets. On the other hand, 1MDB may see its power assets listed as soon as March 2014 as reported in the press. It was reported that the listing would raise USD3b, making it one of the biggest IPOs, and believed to be priced at 20x earnings multiplier. If this is true, we believe the valuation is on the high side. In all, we believe that pricing for both 1MDB and Malakoff IPOs is crucial and is heavily dependent on general market underlying performance. Given the current lacklustre market performance and less optimistic market outlook, getting good pricing may prove challenging.

Still OVERWEIGHTing the sector with TENAGA remaining as TOP PICK. We were surprised and disappointed with the zero tariff adjustment this round in Dec 2014 when the government used the PPA savings to offset higher fuel costs resulting in no adjustment in the tariff structure. In our opinion, the government should raise fuel cost to better match the market price. Judging from the fuel cost trends and availability of PPA savings fund, there could be another zero adjustment in tariff in the coming June review in 2015. The upcoming 1MDB and Malakoff IPOs could offer another two defensive stocks to the market. TENAGA continues to be our TOP PICK for the rerating catalyst coupled with still compelling valuations. The small cap PESTECH (OP; TP: RM4.36) also remains as our alternative sector play for its explosive earnings growth story, with near-term strong contract flow expected.

Source: Kenanga