YTD, the Power Utilities sector has been underperforming the FBMKLCI, especially the sector heavyweight TENAGA albeit its resilient earnings quality. We believe the market is anticipating weaker results ahead for TENAGA given the rising coal prices coupled with the weakening of MYR. In our opinion, any earnings weakness is only a short-term phenomenon as the higher cost will be eventually passed through in the coming Jun Review window. Likewise, MALAKOF is also facing selling pressure despite reporting two straight quarters of consistent earnings as investors may want to see more consistent results before committing to the IPP. We maintain our view that this sector which offers good earnings visibility is a defensive sector which can sail through all economic weather conditions. Thus, the price weakness offers a good opportunity to accumulate, in our view. Going forth, 2017 will be a better year for all sector players while TENAGA remains our sector TOP PICK 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.

Remain OVERWEIGHT, defensive is key. We believe the Power Utilities Sector is the right sector for investors looking for 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 11.5x PER which is below the FBMKLCI’s 15.5x.

TENAGA (OP; TP: RM17.50) 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 (OP; TP: RM2.00) as our alternative sector play for its explosive earnings growth story, with near-term strong contract flows expected.

Still no updates on new plants; but more RE. There was no further developments in 1QCY17 on Track 4A, TADMAX’s (Not Rated) 1,000MW power plant in Pulau Indah as well as the dispute between YTLPOWR (MP; TP: RM1.50) and TENAGA on the PPA Extension contract for Paka Power Plant. Nonetheless, after years of lull, YTLPOWR is finally seeing its first power asset venture in more than a decade as it has secured USD1.58b financing for its 45%-owned oil shale power plant in Jordan that will start operation by mid-2020. On the other hand, there were more updates on renewal energy (RE) where TENAGA has signed five Large-scale Solar PPAs with five RE players to build up 30MWac to 50MWac plants to generate power over 21 years starting from 2H18. Among the five RE players, two players are listed companies namely MUDAJYA (Not Rated) and TENAGA. Meanwhile, the EC has withdrawn its Letter of Offer to MALAKOF (MP; TP: RM1.66) in mid-March to undertake a 50MWac solar photovoltaic plant in Tanjung Malim as the EC rejected MALAKOF’s appeal to change the project land site.

Coal price stabilises; tariff rebate of 1.52 sen/kWh to stay? The once fast rising coal fuel prices have stabilised in the past three months hovering around USD80/mt-level after skyrocketing to above USD100/mt in the second half of last year. On the other hand, MYR against the USD has also stabilised at around 4.40-4.50 levels which reduce the shock to overall coal fuel cost in MYR term. Does this mean that the tariff rebate of 1.52 sen/kWh which was maintained since Jan 2015 is here to stay? We believe maybe not as the piped gas price was scheduled to increase to RM21.20/mmbtu in 1H17 and expected to increase another RM1.50/mmbtu in 2H17 to RM22.70/mmbtu, which indicates that overall fuel costs are set to rise higher assuming other non-gas fuel costs remain unchanged. In addition, the surprise government’s decision to maintain the tariff rebate at 1.52 sen/kWh in 1H17 probably due to the actual cost incurred in 2H16, which was partly hedged, was lower than the spot price, in our opinion, which was already up substantially. As such, the higher cost could be reflected in 1H17, which could lead to lower tariff rebate in 2H17 in the next review window in June this year. 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.

Overall a better 2017. The recent 4QCY16 results reporting card was satisfactory except for YTLPOWR owing to continued losses incurred by Paka on on-going dispute with TENAGA. In fact, except TENAGA which saw sequential declining earnings that was well expected, the three other players reported improved results. Going forth, 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 expected to grow by 2.7%. Meanwhile, earnings of MALAKOF are expected to rebound after three-straight quarters of disappointment in first 9M of 2016, 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 is expected to post another new high in FY17 with earnings set to rise 16% on the back of its current order book of RM1b. PESTECH is expecting its first recurring income running over 25 years, when the BOT asset in Cambodia is ready by this year-end. On the flipside, we expect YTLPOWR’s earnings to decline further by 16% in FY17 due to the delay in Paka Plant as well as PowerSeraya’s continuing lacklustre outlook.

Source: Kenanga Research - 28 Mar 2017