Period   1Q15

Actual vs. Expectations   1Q15 core profit of RM2.31b came in way above expectations, which made up 44% of our FY15 fullyear estimates and 38% that of market consensus.

  The stronger-than-expected results were attributed to: (i) lower fuel cost as total fuel cost in 1Q15 of RM4.33b only amounted to 22% of our FY15 fullyear assumption of RM19.85b, and (ii) lower taxation with an effective tax rate of 10.5% vs. our FY15 assumption of 24%, due to reinvestment allowance incentive. In fact, management mentioned that effective tax rate is likely to stay at low-teens till 2017.

  This result did not include the RM848.0m compensation, arising from Imbalance Cost Pass Through (ICPT), which was announced by the Minister last November. Management said the auditor has yet to finalise on the recognition matter.

Dividends   No dividend declared as expected.

Key Results Highlights   Despite topline dropping 6% to RM11.03b, 1Q15 core earnings surged 140% QoQ to RM2.31b thanks largely to lower fuel cost by RM843.2m (RM4.33b vs. RM5.17b) coupled with lower repair & maintenance and staff costs by RM399.9m (RM1.21b vs. RM1.61b) where charges for 4Q is seasonally higher than 1Q. As such, operating expenses in 1Q15 were reduced by RM1.33b to RM8.42b from RM9.75b in the preceding quarter.

  As 1Q is seasonally a weak quarter, the electricity demand in the Peninsular dipped 2.3% QoQ which dragged the total electricity sales in West Malaysia lower by 3% to RM10.21b. However, TENAGA continued to enjoy lower fuel cost such as average coal price, which fell to USD70.2/mt in 1Q15 from USD72.9/mt with coal generation mix increasing slightly to 46.3% from 45.6%. Meanwhile, average LNG price dropped to RM46.0/mmbtu in 4QCY14 from RM48.8/mmbtu in 3QCY14 as the average daily gas requirement inched up slightly to 1,218mmscfd in 1Q15 from 1,217mmscfd previously.

  YoY, 1Q15 core earnings soared 76% from RM1.31b in 1Q14, mainly driven by a 15% or RM1.45b jump in revenue after a 15% tariff hike which took effect in Jan 2014. Besides the tariff hike, the higher YoY revenue was also driven by a 3.3% increase in electricity demand in the Peninsular. In addition, the total fuel cost only rose by 1% or RM58.5m from RM4.27b to RM4.33b. Coal generation mix grew to 46.3% in 1Q15 from 39.8% in 1Q14 with average coal price falling to USD70.2/mt from USD77.2/mt. Average gas requirement in 1Q15 was 1,218mmscfd from 1,321mmscfd.

  On debt exposure, total debt dropped slightly to RM25.3b (net debt: RM20.4b) as at Nov 2014 from RM25.5b (net debt: RM17.3b) three months ago. Thus, gearing was also reduced to 35.6% (net: 28.7% from 36.9% (net: 25.2%) previously.

Outlook   The absence of tariff adjustment during the revised Budget 2015 early this week should have neutral impact to TENAGA’s earnings as the tariff adjustment is based on fuel-cost pass-through mechanism.   Falling fuel costs like coal price and lesser consumption of expensive LNG as the coal plants are back in action augur well for TENAGA. In fact, the gas requirement fell below 1,000mmscfd in Dec 2014 due to the flood in the East Coast states which could lead to a lower gas generation mix and hence lower fuel cost. Meanwhile, the coal-fired Janamanjung Unit 4 1,000MW Power Plant is on track for its commencing date in Mar 2015. All these should be able to bring down fuel cost further.

  Moving forward, as new set of fuel cost pass-through mechanism is now in place, TENAGA’s earnings are expected to stabilise. Its financial performance would depend mainly on its operational efficiency.

Change to Forecasts   After the strong 1Q15 results, we upgrade our FY15 estimates by 11.6% to account for changes in two assumptions: (i) coal price to USD75/mt from USD80/mt, and (ii) effective tax rate to 22% from 24%. Estimates for FY16-17 are raised slightly by 0.4% and 0.1% solely due to cashflow effect with other key assumptions unchanged.

Rating Maintain OUTPERFORM

Valuation   Given the strong share price performance in the past months as we believe investors are willing to pay higher valuation for this high-weighted index stock for earnings certainty, we upgrade again our targeted CY15 PER to 16x, from 15x previously, which is about the same valuation of the FBMKLCI.

  We believe the valuation multiple is not excessive given its index weighting, quality earnings profile and there is also not many companies with defensive earnings to shelter against the expected slowdown in the economy.

  As such, our new price target is now at RM16.82/share from RM14.65/share previously. Reiterating OUTPERFORM call and TOP PICK for the power sector.

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

Source: Kenanga