Issues surrounding 1MDB have been suppressing the overall sector for the past six months with TENAGA coming under heavy selling pressure. As media reports suggested that 1MDB has already shortlisted bidders for its proposed assets disposal, the overhanging issue affecting TENAGA could well be resolved soon. If this materialises, we believe it may then lead to a sector re-rating where TENAGA is a major beneficiary. On the other hand, the weakening of Ringgit will reduce the discount of cheap fuel cost that TENAGA has been enjoying since last year. Should the current weak Ringgit continue to persist in the next 2-3 months, the 2.25 sen/kWh tariff rebate in 2015 is likely to be reduced in the coming Dec Review. For now, we remain NEUTRAL but look forward to review with upside bias should the 1MDB issue is resolved. 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.

1MDB still in the limelight, hopefully the issue will finally come to an end as it has shortlisted four bidders for its proposed disposal of assets under Edra Global. According to news reports, Tenaga Nasional Bhd (TENAGA, MP; TP: RM12.78) and YTL Power International Bhd (YTLPOWR, OP; TP: RM1.73) are the two local bidders along with two other foreign utility groups, which were shortlisted for the bidding exercise. It was also reported that the dealmaker involved in the deal is looking at a price tag of RM10b while some parties bandied a price of RM8b, which came as a surprise to us as the previous market talks had it that 1MDB was looking to offload all its utility assets for as high as RM20b. Although we still believe the offer at RM10b is still pricey and RM8b is a fair deal, it is still better than the previous market talks of RM20b whereas 1MDB’s purchase cost was only RM12.5b 2-3 years ago. In any case, once the disposal is completed, it is positive for TENAGA as this will remove an overhanging issue which could warrant a re-rating to the pre-selldown level of 14x-15x PER.

Track 4A in limbo again. It was reported that Track 4A is in the limelight again as TENAGA decided to part with SIPP Energy Sdn Bhd (SIPP) for the project and now SIPP has to find another partner before meeting the submission dateline by end- September. This is opposed to the previous reports which stated that SIPP may consider an outright sale of the concession. To recap, the Track 4A was first a direct award to a consortium which consisted SIPP, YTLPOWR and TENAGA but later YTLPOWR decided to opt out of the project. With Track 3B already delayed, the EC will definitely put pressure on Track 4A to be on track to ensure power supply sustainability. In fact, YTLPOWR already disclosed in its latest 4Q15 results that its Gen 1 IPP, Paka Power Plant which PPA is expiring in September, has been awarded a PPA extension from March 2016 to December 2018 from EC with discussion on terms and conditions still on-going. However, so far there is no update on 1MDB’s Teluk Gong Power Plant and Malakoff Bhd (MALAKOF, OP; TP: RM2.21)’s PD Power where their PPAs are expiring early next year. As such, with the delay in Track 3B and SIPP likely unable to meet the dateline for Track 4A, the EC may extend short-term PPA similar to that given to Paka Power Plant for Teluk Gong Power Plant and PD Power.

Still lower fuel cost in 3QCY15? Looking at the current fuel prices, we expect the over-recovery trend to continue in the nearterm, but at a lower magnitude given the strong Greenback which could push up coal cost in MYR terms, although coal price remains sluggish. To recap, the reference coal price of USD87.5/mt was set based on MYR3.14/USD while the current weak MYR of c.4.40/USD multiply with current coal price of below c.USD60/mt is narrowing the discount which TENAGA enjoyed previously. Hence, the ICPT over-recovery is likely to reduce in the coming TENAGA’s 4Q15 results and should MYR remain weak, the next tariff review in Dec is likely to see tariff rebate of lesser than 2.25 sen/kWh for Dec 2014 and Jun 2015 Reviews. Nonetheless, we remain positive on the ICPT mechanism, which ensure earnings certainty for TENAGA as the fuel cost risk is fully pass-through on a six-month laggard basis. Thus, future earnings will depend mainly on its operational efficiency. Still NEUTRAL for the sector. But, a re-rating is expected once the 1MDB saga is over. This is especially so for TENAGA as we expect it to re-rate to previous targeted valuation of +0.5SD 5-year mean of 15.8x which derive ceiling valuation of RM15.78/share. However, should the 1MDB asset sale turns out to be a bad deal for TENAGA, this could pose a downside risk at RM9.88/share which is a -0.5SD 5-year mean of 9.9x. Again, we have no sector pick for this quarter, but we continue to like small cap PESTECH (OP; TP: RM6.49) as our alternative sector play for its explosive earnings growth story, with nearterm strong contract flows expected. 

Source: Kenanga Research - 7 Oct 2015