We expect a better year in 2017 as earnings of TENAGA are resilient being tracked to electricity growth while MALAKOF is set to rebound from the high-cost hit last year coupled with improving KEV numbers. Needless to say, PESTECH is poised for another record year. YTLPOWR is likely to be the only one which could see weaker earnings this year as the Paka issue has yet to be sorted out while the outlook for PowerSeraya remains challenging. On the other hand, with rising fuel costs, such as high coal prices and the scheduled half-yearly hike in piped gas price, TENAGA may face near-term earnings weakness. However, this is expected to be earnings neutral to TENAGA as it will be automatically adjusted every half-yearly under the ICPT framework. Thus, tariff rebate is likely to be reduced further from 1.52 sen/kWh in 2H17. As such, TENAGA remains our TOP PICK for the sector for its earnings quality profile and index-weighting status. Besides, we also like small cap PESTECH as an alternative play for its explosive earnings growth story.

No updates on new plants; more RE. Since the signing of a PPA agreement for Track 4A between TENAGA (OP; TP: RM17.50) and SIPP Energy Sdn Bhd in last August, there has been no update of SIPP’s new partner for this project. In order to meet the COD dateline, we believe it has a tight dead-line to find a new partner as the plant has to start construction, at least by mid-2017. Meanwhile, there is limited update on TADMAX (Not Rated)’s 1,000MW power plant in Pulau Indah, which has given until Aug 2017 to implement a detailed feasibility study of the whole project development. Based on the timeline, the power plant is expected to come on-stream by 2021 or 2022. On the other hand, the dispute on PPA Extension for

YTLPOWR's (MP; TP: RM1.54) Paka Power Plant has yet to be solved pertaining the land lease agreement with TENAGA. TENAGA has taken this to court, thus the PPA Extension which was supposed to start in Mar 2016 to Dec 2018 is expected to be further delayed. Elsewhere, in mid-Dec, both TENAGA and MALAKOF (OP; TP: RM1.66) have won separate competitive bids from Energy Commission to build Large Scale Solar Photovoltaic Plant. TENAGA will build its solar plant in Kuala Langat, Selangor while MALAKOF is partnering with DRBHCOM (UP; TP: RM0.95) on a 51:49 consortium to build the plant in Tanjung Malim, Perak with COD of July 2108 over a 21-year PPA. With the authority’s quest to lessen reliance on coal/gas fuels, we believe more green energy plants will roll out in the future.

Tariff rebate to stay at 1.52 sen/kWh in 1H17. The government’s decision to maintain the tariff rebate at 1.52 sen/kWh, which was announced in the middle of last month, is rather a surprise as we expected it to be reduced further given the rising coal prices which surged more than 50% in 2H16 to above USD80/mt level and the sharp weakening of MYR against the USD, not to mention that the scheduled piped gas price increase of RM1.50/mmbtu for every half-yearly, which has been increased to RM21.20/mmbtu, effective 1st Jan 2017, from RM19.70/mmbtu in 2H16. The unchanged rebate could be due to the actual cost incurred in 2H16, which was partly hedged, was lower than the spot price, in our opinion. Having said that, with the coal prices closing in to the preferred price of USD87.50 sat in 2014; based on an exchange rate of RM3.12/USD, and the exchange rate weakened to RM4.50/USD levels, coupled with piped gas price to increase another RM1.50/mmbtu from RM21.20/mmbtu in 2H17, the tariff rebate is likely to be reduced from the current level of 1.52 sen/kWh in the next review window in June 2017. Nonetheless, these changes are earnings neutral to TENAGA on a lagged basis under the ICPT framework as fuel cost will be passed through to end-user eventually.

A better 2017. Electricity growth in the Peninsular is expected to grow at a normalised rate of 2.1%, after a strong growth in 2016 estimated at 3.4%, which was led by the abnormal hot weather. On the back of this, TENAGA is set to record another record year in FY17 with earnings expecting to grow by 2.7%. As we mentioned above, the rising fuel costs, mainly led by coal and piped gas prices, are earnings neutral to TENAGA but its earnings are expected to be impacted in the near-term before these costs are adjusted in the half-yearly review and pass through to end-user eventually. Meanwhile, earnings of MALAKOF are expected to rebound after three-straight quarters of disappointment, which were hit by higher-than-expected costs, including depreciation, interest cost and barging cost incurred by the new T4 plant. With KEV starting to show improving results and better T4 earnings, FY17 earnings are set to rebound by 34% after a 27% plunge in FY16. On the other hand, PESTECH (OP; TP: RM2.00) is expected to post another new high in FY17 with earnings to rise 16% on the back of its current order book of RM1b. PESTECH is expecting its first recurring income which over 25 years, when the BOT asset in Cambodia is ready by this yearend. On the flipside, we expect YTLPOWR’s earnings to decline further by 16% in FY17 as the delay in Paka Plant as well as PowerSeraya’s continuing lacklustre outlook.

Still OVERWEIGHT, defensive is the key. We believe the Power Utilities Sector is the right sector for investors looking for a defensive play. Earnings of TENAGA are fairly defensive with the ICPT framework which has a fuel cost pass-through mechanism eliminating fuel cost risk while profitability of IPPs is backed by PPAs which guarantee capacity payment as long as requirements are met. On the other hand, valuation for the overall sector is also not demanding at CY17 13.7x PER which is below the FBMKLCI’s 16.4x. TENAGA remains as our Top Pick for the sector given its undemanding valuation, which is supported by its quality earnings profile and index weighting status. Meanwhile, we continue to like small cap PESTECH as our alternative sector play for its explosive earnings growth story, with near-term strong contract flows expected.

Source: Kenanga Research - 5 Jan 2017