We has turned mildly positive on TENAGA post last Friday’s conference call with management given that the earnings stability is more certain following the implementation of ICPT as the fuel cost risk is to be passed on to the end-users. Management had clarified that the RM727m over-recovery in 2014 will be passed through to customer in the form of “rebate” in Mar-Jun 2015 instead of “tariff cut”. The 38.53 sen/kWh and the three fuel cost reference prices are to remain as base-rate and base-reference price till 2017 with a half-yearly review. We laud this mechanism as it is in the spirit of a full fuelcost pass-through structure. As such, the continuity of such practice of rate rebate in Jun-Review is crucial to the government on its commitment to the ICPT mechanism. Post-clarification, we adjusted back the 2.25 sen/kWh to topline and added it to operating cost. This resulted in a 0.2%/7.8%/7.6% upgrade in FY15E-FY17E earnings. Even then, TENAGA’s valuation still does not appear to be attractive at CY15 14x PER. With unchanged targeted CY15 PER of 14.3x (5-year average), our price target is raised to RM13.94/share from RM13.59/share. We upgrade our call to MARKET PERFORM from UNDERPERFORM following the contraction in its share price last week.

It is a rebate not a tariff cut. Following last Wednesday’s government announcement on tariff adjustment, which saw TENAGA share price tanking 6% in two days. The management then conducted a tele-conference call with analysts last Friday to clarify the 2.25 sen/kWh tariff adjustment arising from the ICPT saving of RM726.9m, is in a form of rebate to customer instead of tariff cut. This means that customers are still paying the base rate of 38.53 sen/kWh in Mar-Jun 2015 and will receive a 2.25 sen/kWh rebate on the bill. As such, there is no change in TENAGA topline and the rebate 2.25 sen/kWh or RM726.9m will be added into operating cost.

RM848m ICPT compensation no longer there. Management further explained that the RM726.9m ICPT saving resulted from the over-recovery of fuel costs in 2014 is based on a “10-month actual and 2-month estimated” calculation while the previously RM848.0m ICPT compensation announced by the Minister in Nov 2014 was based on a “2-month actual and 2-month estimated” calculation. With this latest announcement, the RM848.0m ICPT compensation is no longer there. However, the RM1.68b saving from the Gen1 PPA renegotiations is still available which will be utilised to offset under-recovery of fuel cost should fuel prices are above the reference price.

The average tariff rate of 38.53 sen/kWh is a 4-year base rate till 2017. Management clarified that the average tariff rate of 38.53 sen/kWh is a 4-year base rate for 2014-2017, is based on the assumptions of (i) gas price of RM15.20/mmbtu, (ii) LNG price of RM41.68/mmbtu, and (iii) coal price of USD87.5 /mt. This means that there will be no tariff cut or hike till 2017 as the adjustment will come in the form of (i) rebate to customer when there is an over-recovery of fuel cost as fuel prices above the reference price (as per the assumptions stated above), or (ii) offsetting the RM1.68b PPA saving fund when there is an underrecovery of fuel cost when fuel prices are below the reference prices.

A full fuel-cost pass-through but… We welcome this full ICPT mechanism as the fuel cost risk will be passed on to the end-user, ensuring earnings stability at TENAGA’s end. However, the mechanism is only fruitful if the government shows its commitment to adjust once in every 6 months as per timeline stated earlier. Otherwise, the 2.25 sen/kWh rebate is only a one-off event. On the other hand, the success of implementing this ICPT also means that the subsidy rationalisation plan on gas price is impossible to happen before 2018. If it does happen in 2018, tariff adjustment for reflecting gas at market price is too high as the LNG price is nearly 3x higher than current subsidiary gas price.

Upgrade to MARKET PERFORM. We upgrade FY15-FY17 earnings by 1-8% after adding back the 2.25 sen/kwh to topline and to reflect it as operating cost. With unchanged targeted CY15 PER of 14.3x (5-year average), our new price target is now at RM13.94/share, from RM13.59/share previously, which is now at the current price level following last week’s share correction. Thus, we upgrade the stock to MARKET PERFORM from UNDERPERFORM previously. We still believe TENAGA should be valued at market valuation but only on its ability to secure a tariff adjustment once in 6 months as per schedule. 

Source: Kenanga