The government has agreed to maintain a 1.52 sen/kWh tariff rebate in 2H of 2016 making a lower tariff rebate in 2016 as opposed to 2.25 sen/kWh rebate in the whole of 2015. With the expected of a RM1.50/mmbtu hike in piped gas price once in every six months, future rebate in 2017 is likely to reduce further as the downside for other fuel prices is likely to be limited. Nonetheless, TENAGA is free from fuel cost risk as it is fully pass-through under the ICPT framework on a six-month laggard basis. Maintain OUTPERFORM rating with unchanged price target of RM17.50/share.

Tariff rebate to maintain at 1.52 sen/kWh in 2H 2016. Yesterday, TENAGA announced that the Government has agreed to maintain tariff rebate at 1.52 sen/kWh effective from 1 Jul 2016 until 31 Dec 2016 under the Imbalance Cost Pass-through (ICPT) mechanism. The rebate which amounts to RM758.0m is based on (i) lower LNG and coal prices, (ii) higher performance of coal power plants, (iii) lower usage of LNG, and (iv) a RM1.50/mmbtu increase in piped gas price to RM19.70/mmbtu. The new gas price will be effective from 1 Jul 2016.

Earnings neutral to TENAGA. Given the continued weak fuel costs in the past six months and the scheduled hike in piped gas price in Jul 2016, the tariff rebate to remain at 1.52 sen/kWh is not a surprise to us. For instance, average coal price in MYR term fell to RM237.4/mt in 2Q16 (period of Dec 15 to Feb 16) from RM254.1/mt in 1Q16 (Sep-Nov 16) while average gas/LNG volume dropped to 1,133mmscfd from 1,175mmscfd with LNG price increased to RM35.84mmbtu from RM33.07mmbtu. Having said that, the tariff rebate will have neutral impact to its earnings under the ICPT mechanism, which ensures earnings certainty as the fuel cost risk is fully pass-through on a six-month laggard basis.

Expecting another strong quarter in 3Q16. Operationally, we expect electricity demand to continue rising in the coming 3Q16 given the hot weather in the two months of the quarter. In fact, TENAGA reported another record peak demand in mid-April at 17,788MW after the all-time-high of 17,175MW in mid-March. On the other hand, with a few coal-fired plants back in action from their outages in 3Q15 coupled with the Janamanjung Unit 4 Plant already commenced in Apr 2015 and MALAKOFF’s (OP; TP: RM1.97) Tanjung Bin Unit 4 or T4 kick started in Mar 2016, coal generation mix should increase in the future, which should help to bring down fuel cost further.

Keep OUTPERFORM. We continue to like TENAGA for its earnings quality profile, which is free from fuel cost risk. Our price target of RM17.50/share which is based on CY17 14.4x PER (+1.5SD of 2-year moving average), is not excessive given its sustainable earnings growth with index-linked heavyweight status. It remains our TOP PICK for the sector. Risk to our OUTPERFORM call include a slowdown in economy growth, which will affect electricity demand.

Source: Kenanga Research - 30 Jun 2016