We are not worried about the disappointing 2Q17 results due to bad debt provision is a prudent measure under current market conditions while higher interest costs are for new projects financing. Meanwhile, the high fuel cost in 1H17 will adjust in the coming Tariff Review in June which will be passed through to end-users eventually. TENAGA remains an OUTPERFORM for defensive earnings and TOP PICK for the sector with a revised price target of RM17.17/share.

2Q17 missed forecasts. At 42%/38% of house/street’s FY17 full-year estimates, 6M17 core earnings of RM2.91b fell short of expectations. The main discrepancy was due to higher costs incurred in 2Q17 by: (i) RM255.5m or 3% QoQ in opex partly due to provision of bad debts for steel industry, and (ii) RM112.6m or 40% QoQ for interest expense on financing for new projects. A first interim NDPS of 17.0 sen was declared in 2Q17 which was higher than 10.0 sen paid in 2Q16 due to the change of dividend policy of 30%-50% earnings distribution from previously 40%-60% pay-out based on operating cash-flow post-capex.

Sequential results hit by fuel costs again. Despite top-line dipping only 1%, 2Q17 core earnings contracted by 23% QoQ to RM1.27b from RM1.64b largely due to higher fuel costs by 7% to RM4.25b as coal cost rose 12% to RM2.07b besides the abovementioned provision and interest costs. Average coal price surged 24% in USD term to USD78.1/mt and 31% in MYR term to RM347.7/mt while LNG price also rose, by 9% to RM27.14/mmbtu. During the quarter, total electricity sales fell 3% to RM11.15b while ICPT over-recovery was reduced to RM191.1m from RM604.8m in 1Q17.

Higher yearly revenue offset by higher fuel costs. Although revenue rose 6% largely thanks to lower ICPT over-recovery adjustment, 2Q17 core earnings fell 12% YoY from RM1.45b in 2Q16 which was primarily due to 14% jump in total fuel from RM3.74b last year. This was led by: (i) 6% increase in gas cost on the scheduled half-yearly RM1.50/mmbtu hike in piped gas prices, and (ii) 12% hike in coal cost. In MYR term, average coal price soared 46% or 39% in USD term. However, LNG cost fell as average LNG price declined 24% coupled with lower requirement of average daily gas volume by 5%. YTD, 1H17 core earnings fell 6% to RM2.91b from RM3.09b previously, although revenue rose 6%, for the same reasons as mentioned above.

Tweak earnings lower. Post 2Q17 results, we revised FY17 estimates downward for period ending Aug 2017 by 8% to account for: (i) assumption of additional RM600m bad debt provision and, (ii) higher interest costs. We also made new earnings pay-out assumption to 40% from 30% previously following the new dividend policy. Thus, FY17 NDPS assumption is raised by 22% to 44.6 sen from 36.5 sen. Lastly, as there is change of financial year-end, we have aligned our estimates accordingly. Hence, we have a 4- month period ending in Dec 2017 and a 12-month period ending in Dec 2018 for FY18. We did not change our assumptions for these two new financial years except for higher interest cost as mentioned above.

A cheap index-heavyweight, OP maintained. TENAGA is clearly an underperformer in the current buoyant market as the stock dipped slightly by 0.3% YTD against FBMKLCI’s +7.7%. In our opinion, this is unwarranted given its index-linked heavyweight status and earnings quality profile. It remains as our TOP PICK with OUTPERFORM rating. Our new price target is now lowered to RM17.17/share from RM17.50/share post earnings revision as well as we rolled over valuation base-year to CY18 with unchanged targeted PER of 14.4x based on +1.5SD of 2-year moving average. 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 - 28 Apr 2017