We upgrade the sector to OVERWEIGHT following our upgrading of TENAGA in end-Nov 2015 after the removal of the 1MDB overhang issue. With the government’s commitment towards the ICPT mechanism which has now become a scheduled half-yearly review, the sector is moving in the right direction with transparency in fuel cost structure coupled with the newly launched New Enhanced Dispatch Arrangement to reduce cost further. In view of this, TENAGA will be the prime beneficiary of this reform, but it could be a double-edged sword to end-user should fuel prices swing upwards. On the other hand, with the scheduled upward adjustment on piped gas price for every six months, future tariff rebate is likely to reduce further. TENAGA is now our sector’s TOP PICK again for its earnings quality profile and its index-weighting status. Furthermore, we still like small cap PESTECH as an alternative play for its explosive earnings growth story.

Upgrade the sector to OVERWEIGHT following our upgrading of Tenaga Nasional Bhd (TENAGA, OP; TP: RM15.42) in end-Nov 2015 after the removal of 1MDB overhang issue as the power assets were sold to a Chinese party, China General Nuclear Power Corporation (CGN) for RM9.83b. Thus, TENAGA is now our Top Pick again for the sector given its undemanding valuation, which is backed by quality earnings profile and its index weighting status. With the government’s commitment to the Imbalance Cost Pass- Through (ICPT) mechanism, fuel cost risk is largely being transferred to the end-user, thus TENAGA’s earnings will be efficiency-driven. Meanwhile, we continue to like small cap Pestech International Bhd (PESTECH, OP; TP: RM7.43) as our alternative sector play for its explosive earnings growth story, with near-term strong contract flows expected.

A disciplined ICPT schedule. We saw two tariff reviews in 2015, which were scheduled in June and Dec respectively with piped gas price hike of RM1.50/mmbtu for each review. The first review in the June window which saw the tariff rebate of 2.25 sen/kWh in 1H2015 being continued to Jul-Dec 2015 while the Dec review resulted in tariff rebate being reduced to 1.52 sen/kWh which will be applied for the period of Jan-Jun 2016. With the price of piped gas scheduled to increase RM1.50/mmbtu once every six months, coupled with the bottoming of other fuel prices, the ICPT over-recovery savings are likely to decline, which would translate into a lower tariff rebate to end-users in the future. Meanwhile, the current base-tariff of 38.53 sen/kWh is to be maintained until end-2017 and a new base-tariff will be implemented from 2018 onwards. In all, we laud the government’s commitment towards the ICPT framework. At current fuel prices which are still below the preference prices set in end 2013, end-users are likely to enjoy tariff rebate at least in the next review in Jun 2016. The key take away from the government’s commitment is that TENAGA is now freed from fuel cost risk.

NEDA to reduce cost further. The EC has launched New Enhanced Dispatch Arrangement (NEDA), an improved mechanism in Oct 2015 to allow short-term competition in daily generation dispatch among IPPs. This is to ensure effective power generation in the country as NEDA allows generators to compete based on their variable operating rates (VOR) in exchange for more dispatch thus higher returns. On the off-taker’s side, a lower VOR means lower operating cost and hence the savings will pass through via the ICPT mechanism to the end-user eventually. It was estimated that 1% generation efficiency translates into RM150m cost savings per year. So far, YTL Power International Bhd (YTLPOWR, OP; TP: RM1.66) has registered its interest to participate in the NEDA. We believe other IPPs especially the Gen1 IPPs are likely to participate in the NEDA system as all of them have received short-term PPA extensions. This new NEDA system, which will be fully implanted by Jan 2016, will offer these IPPs additional incomes after their PPAs expired.

A well-balanced demand and supply. We expect a 2.1% electricity demand growth in 2016 in the Peninsular, slightly lower than the 2.2%-2.5% growth in the past two years, to be led by commercial segment. On the supply side, the 1,071MW CCGT Prai Plant will kick start in Jan 2016 and should be able to support the organic power demand growth. On the other hand, Malakoff Bhd’s (MALAKOF, OP; TP: RM2.19) PD Power was the last Gen1 IPP to receive PPA Extension contract for the period of Mar 2016 to Feb 2019 in Dec 2015. The PPA Extension contracts awarded to PD Power, Paka Power Plant and Teluk Gong Power Plant, which is now sold to CGN, in the past three months, are not unexpected given the delay of new plants in Track 3B and 4A. As such, we believe there would be no problem of electricity supply in the next few years. 

Source: Kenanga Research - 6 Jan 2016