It was a busy quarter in 2QCY15 which was riddled with mainly negative news, especially regarding the on-going 1MDB saga. This has exerted a negative impact not only to the sector but the overall market as well and is not expected to end anytime soon so long as the 1MDB issue is left unresolved. On the other hand, we welcome the government's decision to revise the piped gas price upwards by RM1.50/mmbtu for the first time since Jan 2014 which shows its commitment towards the subsidy rationalisation plan. Meanwhile, the extension of 2.25 sen/kWh rebate to Jul-Dec 2015 means the strong 1H15 TENAGA’s earnings are unlikely to be repeated in upcoming 2H15. Nonetheless, the ICPT mechanism is expected to be earnings neutral to TENAGA on a normalised basis. Given the lack of fresh leads, we maintain our NEUTRAL call on the sector. On the other hand, 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.

An “eventful” 2QCY15. In the past three months, it was a busy quarter for the sector as we saw the relisting of Malakoff Corporation Bhd (MALAKOF, OP; TP: RM2.22) in mid-May, and media reported that YTL Power international Bhd (YTLPOWR, MP; TP: RM1.65)’s 808MW Paka Power Plant and 1MDB’s 434MW Peaking Plant in Teluk Gong could be awarded Power Purchase Agreement (PPA) extensions but so far there has been no official statement from the EC yet. On the other hand, share prices of Tenaga Nasional Bhd (TENAGA, MP; TP: RM12.78) came down on heavy selling pressure during the later part of 2QCY15 following the government’s approval of the former taking over the Track 3B from 1MDB. Meanwhile, there was a weekly press report that SIPP Energy Sdn Bhd, one of the two partners for the Track 4A is seeking for a new partner to undertake the greenfield project and may even consider an outright sale of the concession. In addition, the 1MDB saga continued to hog the limelight with news saying the troubled group is looking to sell its IPPs assets to pare down debts.

1MDB still in the spotlight. The hottest news that dominated the headlines in the past few months was none other than the 1MDB saga. The relatively lacklustre power sector is very much affected by this saga, which we believe will persist so long as the disposal of 1MDB’s IPP unit, Edra Global is not settled. When news of its first IPP asset, the Track 3B was being taken over by TENAGA broke out, TENAGA immediately faced heavy selling pressure and tanked > 6% intraday. In our opinion, this could just be the beginning as there are still other IPP assets, which 1MDB bought in 2012-2013 for RM12.0b from three different parties. Although there are few parties interested as reported, TENAGA is still the only one with the financial muscle given the size of the assets. For the Track 3B, as TENAGA is the ultimate off-taker of the electricity generated, tariff rate may not be important. In addition, we see no hidden cost involved so long as there is no upfront fee to take over the project. The new levelised tariff for Track 3B is raised to 26.67 sen/kWh from 25.33 sen/kWh. With financial closing in mid-Oct, TENAGA has to make a decision on the takeover fairly soon.

2.25 sen/kWh rebate to continue in 2H15. In end-Jun, TENAGA announced that the government had approved the Imbalance Cost Past Through (ICPT) rebate of 2.25 sen/kWh in Mar-Jun to maintain into 2H15 despite a RM1.50/mmbtu revising in piped gas price to RM16.70/mmbtu from RM15.20/mmbtu previously. We were not surprised with the rebate given the still softening coal prices which is c.USD60/mt vs. the reference price of USD87.50/mt for calculating the base tariff of 38.53/kWh. On the other hand, we welcome the adjustment of piped gas which is part of the government's subsidy rationalisation plan albeit a slight behind schedule. This is the first piped gas adjustment since Jan 2014 when the ICPT implemented. To recap, the piped gas is supposed to be adjusted RM1.50/mmbtu upward every six months till 2017. Meanwhile, the 2.25 sen/kWh rebate in 2H15 means TENAGA is unlikely to see the strong 1H15 results to be repeated in the near future.

Still NEUTRAL for the sector. Given the on-going 1MDB saga, this sector is unlikely to excel in the near-term. This is especially so for TENAGA. In addition, while the ICPT mechanism is earnings neutral to TENAGA on a normalised basis, the strong 1H15 results are unlikely to be repeated in 2H15 which may not augur well for sentiment. Again, we welcome the review in piped gas prices for 2H15 which shows 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: RM6.11) as our alternative sector plays for its explosive earnings growth story, with near-term strong contract flows expected. 

Source: Kenanga Research - 3 Jul 2015