TENAGA posted a weaker set of 1Q17, which was well expected, given the rising coal prices. This is not alarming as the cost increase will be passed through to consumer eventually under the half-yearly tariff review. Thus, tariff rebate is likely to be reduced further in 2017. Nonetheless, we remain positive on TENAGA given that the ICPT mechanism will insulate it from fuel cost risk. It remains an OUTPERFORM for defensive earnings with price target maintained at RM17.50/share.

1Q17 within expectations. 1Q17 results came within expectation with 1Q17 core net profit of RM1.64b making up of 24%/22% of house/street?s FY17 full-year estimates. The core earnings were adjusted for the non- recurring RM231.2m forex translation loss as well as RM331.5m tax adjustment for reinvestment allowance. There was no dividend declared during the quarter which is usually done half-yearly.

Weaker sequential quarter on higher coal prices. Despite flattish revenue, 1Q17 core earnings fell 13% QoQ to RM1.64b from RM1.88b in 4Q16 mainly attributable to higher total fuel costs, including energy payments for IPPs by 8% to RM3.97b from RM3.68b as coal fuel costs jumped 23% to RM1.86b from RM1.51b owing to average coal price surging by 20% to RM264.7/mt from RM221.1/mt or +15% in USD term of USD63.0/mt from USD54.7/mt. However, LNG fuel costs contracted 19% as average LNG price fell 11% to RM24.84/mmbtu from RM27.95/mmbtu. Overall opex dipped 3% to RM9.01b from RM9.35b as capacity payment for IPPs declined 21% while staff cost contracted 26% on cost normalisation. During the quarter, electricity sales only inched up 0.4% while the ICPT over-recovery was lower at RM604.8m from RM856.0m previously.

Higher yearly revenue was offset by higher fuel costs. 1Q17 core earnings were fairly flattish, which fell slightly to RM1.64b from RM1.65b in 1Q16, albeit revenue growing 5% over the year. This was due to higher opex by 8%, mainly led by higher gas and coal fuel costs as well as higher capacity payment by 14%. Coal cost leapt 17% as average coal price rose 4% from RM254.1/mt or 7% by USD term from USD59.0/mt. Gas cost grew 5% due to the scheduled half-yearly tariff hike. However, LNG cost declined 70% due to lower average LNG price by 25% from RM33.07/mmbtu as well as lower average gas volume by 8% to 1,079mmscfd from 1,175mmscfd previously. Meanwhile, the higher revenue was attributable to higher electricity demand by 3.6% in the Peninsular. 1Q17 ICPT over-recovery fell 11% from RM681.8m to RM604.8m.

Still OUTPERFORM. The weaker 1Q17 is well expected given the rising coal prices but not alarming as the higher fuel cost will be adjusted in the half-year tariff review under the ICPT framework, to be passed through to the end-users eventually. Thus, it will be earnings neutral to TENAGA. We keep FY17-FY18 estimates for now. Our price target is maintained at RM17.50/share, based on CY17 14.4x PER (+1.5SD of 2-year moving average) which is not excessive given its sustainable earnings growth and index-linked heavyweight status. It remains our TOP PICK for the sector. Risks to our OUTPERFORM call include: (i) a slowdown in economy growth, which will affect electricity demand, and (ii) a sudden surge in fuel prices resulting in a short-term earnings weakness.

Source: Kenanga Research - 25 Jan 2017