We are turning NEUTRAL on the sector following our recent downgrade in TENAGA after the government declared a 2.25 sen/kWh rebate for Mar-Jun 2015. With continuous low fuel prices trend, TENAGA is likely to see earnings weakness in 2H15 should the tariff rebate continues. While we like the ICPT mechanism, we prefer a direct tariff cut/hike instead of a tariff rebate to the base tariff of 38.53 sen/kWh. Based on the current scenario of the base tariff and fuel price assumptions staying till 2017, this does not align with the government’s subsidy rationalisation plan which now will take longer than anticipated. On the other hand, government’s commitment towards the ICPT will be judged in the upcoming Jun- Review. In all, we downgrade our sector call to NEUTRAL from OVERWEIGHT. Although there is no sector pick for this quarter, we still like small cap PESTECH as an alternative play for its explosive earnings growth story.

ICPT is good for the sector but… The latest turn of event where the government declared a 2.25 sen/kWh rebate for Mar-Jun 2015, which overturned previous its stand of no tariff adjustment for the rest of 2015, is short-term negative for TENAGA (MP; TP: RM13.94)’s as the fuel prices remains low since 4Q14. We agree that the Imbalance Cost Pass Through (ICPT) mechanism, which was implemented in Jan 2014 is good for TENAGA as fuel cost risk will be transferred to end-user while the mechanism will have a neutralised impact to its earnings on a normalised basis. While the upcoming 2Q15 results reporting is likely to be strong, however, the RM2.31b core net profit reported in 1Q15 is unlikely to be repeated in 2H15 given that coal prices remain at USD70/mt and below which is much lower than the USD78.5/mt reference price to derive the basic tariff of 38.53 sen/kWh.

How about the subsidies rationalisation? We like the ICPT mechanism, a base tariff of 38.53 sen/kWh with 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 will remain unchanged until 2017. This does not align with government’s subsidy rationalisation plan where the heavily subsidised gas price is unlikely to adjust to market price in the near-term. To recap, when the subsidised gas price was raised to RM13.70/mmbtu in Jun 2011 from RM10.70/mmbtu, the subsidised gas price was supposed to increase RM3.00/mmbtu every six months and the review will last until end-2015 and subsequently the gas price will be adjusted to market price by 2016. However, this RM3.00/mmbtu hike in every six months did not happen until Jan 2014 when the gas price was raised by only RM1.50/mmbtu to RM15.20/mmbtu which will remain until 2017. As such, the ICPT mechanism is only truly reflective of LNG and coal market price movements while the subsidised gas price will sustain until 2017.

Listing of Malakoff finally here but 1MDB’s still uncertain. The relisting of Malakoff is on track in 2Q15 after being delayed several times earlier. This would help MMCCORP (OP; TP: RM3.03) to unlock value through the listing of its power assets, Malakoff, slated to be in 2Q15. Based on the illustrative IPO price of RM1.80 (stated in the circular to shareholders), Malakoff is valued at RM9.0b. This implies 16.0x on CY15 earnings. Note that we only value Malakoff in MMC’s SoP valuation at RM6.9b. If it Malakoff IPO’s valuation is set at RM9.0b, our MMC’s TP will likely be revised higher to RM3.31 from currently RM3.03. In addition, Malakoff would be able to raise RM2.7b gross proceeds from the listing in which it intends to utilize most of them to pare down debts. However, news reports suggested that the listing of 1MDB could be delayed due to debt issues. On the other hand, in mid-Mar, the Energy Commission Chairman said the authority is looking at extending the PPAs of some existing IPPs with contracts of which are due in the next few years, in the wake of delays in the construction of the 2,000MW coal-fired Track 3B and the 1,000MW-1,400MW gas-fired Track 4A. This is positive news for YTLPOWR (MP; TP: RM1.68) but timing is crucial as its GEN1 IPP power plants at Paka and Pasir Gudang are expiring soon later this year and early next year. Besides, there are two other GEN1 IPPs that did not get their PPA extended in the last round, namely, Malakoff’s PD Power and 1MDB’s Telok Gong.

Cut sector rating to NEUTRAL as TENAGA’s downgraded earlier. We turned neutral on TENAGA following the recent 2.25 sen/kWh rebate’s announcement as it may see lower earnings in 2H15 given the current low fuel cost dynamic. As such, we downgrade our sector call to NEUTRAL from OVERWEIGHT given the high weighting from TENAGA. We like the ICPT mechanism which is earnings neutral to TENAGA on a normalised basis, but the strong 1Q15 results are unlikely to be repeated in 2H15 given the abovementioned reason. The upcoming Jun-Review window is very important as to show the government’s commitment to the ICPT mechanism. We have no sector pick for this quarter, but we continue to like small cap PESTECH (OP; TP: RM5.04) as our alternative sector play for its explosive earnings growth story, with near-term strong contract flows expected.

Source: Kenanga Research - 6 Apr 2015