Although 9M16 results came way below expectations, in fact the adjusted 3Q16 numbers are actually not that bad as it seems and it is also the second best results since 1Q15. While sentiment may not work in its favour after three quarters of disappointing results, we believe the worst could be over after the strings of costs incurred. Furthermore, the share price has fallen 16% in the past one month which indicates that the market has priced in all the negatives. Thus, we upgrade the stock to OUTPERFORM with a revised target price of RM1.66.

9M16 below. At 45%/43% of house/street’s FY16 estimates, 9M16 core profit of RM211.2m came way below expectations owing to: (i) higher depreciation of RM70m QoQ in 3Q16 due to a RM82m (or after tax of RM53m) additional depreciation for 9M16 for change of residual values for all the gas-fired power plant, and (ii) one-off RM38m additional taxation charges for T4 pursuant to the completion of the power plant. No dividend was declared in 3Q16 vs. 3.5 sen and 2.0 sen paid in 2Q16 and 3Q15, respectively.

3Q16 in fact not too bad. On the surface, the reported 3Q16 net profit of RM51.5m, which plummeted 32% QoQ, looked fairly weak due to the abovementioned depreciation and taxation charges. But the adjusted 3Q16 normalised profit was actually not too bad at c.RM125m which is the second best quarter since 1Q15. Meanwhile, share of associate earnings turned profitable to RM22.2m from loss of RM7.7m as losses at KEV was reduced to RM1.1m in 3Q16 from RM27.4m in 1H16 due to the resetting of UOR to 0% for GF2 and GF3 in June resulting in higher revenue and lower O&M cost compared to 2Q16.

YoY numbers hit by T4. Despite having a new power plant T4 since Mar 2016, the group reported weaker results than last year with 3Q16 and 9M16 core earnings, which fell 67% to RM51.5m from RM156.0m and 39% to RM211.2m from RM346.2m for the same period last year. In addition to the mentioned above additional charges, the group also incurred higher T4’s interest and depreciation charges. On the positive note, share of associate profit income improved to RM22.2m from RM4.5m in 3Q15 and turned profitable with RM20.3m in 9M16 from loss of RM11.7m last year owing to the abovementioned KEV contributions.

Looking to a better 4Q16 and beyond. While T4 is expected to continue to incur barging cost until the new jetty is ready by end-2018 and higher depreciation for all the gas fired plant, the group is expected to post improved results from 4Q16 onwards, after three quarters of disappointment. This is based on the 3Q16 normalised earnings. In additional, KEV has started to show improving numbers after the resetting of UOR for GF2 and GF3 in June. Having said that, we trim FY16-FY17 estimates and dividends by 30%-15% to account for the said higher depreciation and taxation charges as well as all the capacity payments based on latest updates.

Upgrade to OUTPERFORM. Post earnings revision, our new price target is now reduced to RM1.66/share from RM1.79/share previously, which is based on an unchanged 10% discount to its SoP valuation. Although the past three quarters of disappointing results owing to higher costs incurred by T4 as well as the higher depreciation for all the gas-fired power plants, we believe the worst could be over. All negatives could have been pricedin as the share prices have fallen 16% in the past one month. As such, we upgrade the stock to OUTPERFORM from MARKET PERFORM previously. Risks to our upgraded call include unexpected plant outages, other unexpected costs incur by T4 and prolonged losses at KEV.

Source: Kenanga Research - 22 Nov 2016