The government has decided to subsidise 2.54 sen/kWh in 2H 2017, which could be due to the upcoming GE14. Without this, consumer could have to pay a surcharge of 1.02 sen/kWh. With the rising fuel costs, a higher new base tariff is likely to be introduced next January. Having said, this has a neutral impact to TENAGA’s earnings on a lagged basis as the fuel cost will be passed through to consumer eventually. TENAGA remains OUTPERFORM with unchanged price target of RM17.17/share.

Government to subsidise. Last Friday, TENAGA announced that the government has agreed to an Imbalance Cost Pass-through (ICPT) subsidy of 2.54 sen/kWh for Jul-Dec 2017. This includes: (i) the actual imbalance cost for Jan-Jun 2017 of RM523.23m or a surcharge of 1.02 sen/kWh, and (ii) the cost to continue the current ICPT rebate of 1.52 sen/kWh which amounts to RM780m. This also means that consumers will continue to enjoy the 1.52 sen/kWh rebate until the end of this year instead of paying a surcharge of 1.02 sen/kWh, first surcharge since the implementation of ICPT in Jan 2014, attributed to the rising fuel costs. We believe the government’s decision to bear a total cost of RM1.30b or 2.54 sen/kWh could be due to the upcoming 14th General Election, which could be held any time before August next year. The government will fund this by utilizing the PPA Saving Fund.

Fuel costs on the rise. We were not overly surprised by the indirect effective tariff increase of 2.54 sen/kWh given the rising fuel costs in view of higher coal prices coupled with the scheduled half-yearly increase of RM1.50/mmbtu in piped gas prices. In fact, the latest results showed that TENAGA’s total fuel costs rose 7% QoQ in 2Q17 to RM4.24b from RM3.96b as average coal cost jumped 31% in MYR term to RM347.7/mt while average LNG price grew 9% to RM27.14/mmbtu and there was a scheduled increase of RM1.50 /mmbtu in piped gas price to RM21.20/mmbtu in Jan 2017 and this was also further increased to RM22.70/mmbtu effective 1st of July, which was last Saturday.

A higher new base tariff for 2018-2021? The current regulatory period of base tariff of 38.53 sen/kWh will be ending at the end of this year. A new base tariff will be set for the next four years starting next January. As the current prices of coal and piped gas are much higher than in early 2014, a higher new base tariff is highly likely. The current base tariff of 38.53 sen/kWh is based on coal price of USD87.5/mt @ USD/MYR of 3.20 (c.RM280/mt) and piped gas price of RM15.20 /mmbtu and the latest coal cost was RM347.7/mt and piped gas price will further increase to RM24.20/mmbtu by next January. Even if the coal prices were to remain unchanged in the future, with the scheduled hike in piped gas price, a tariff surcharge is quite likely in the next regulatory period.

But earnings neutral; maintain OP. Despite having all these increases in fuel prices, it is still earnings neutral to TENAGA as it will be passed through to consumer eventually under the ICPT mechanism. We keep our estimates unchanged for now. TENAGA is still a laggard despite the relatively buoyant domestic market sentiment. In our opinion, this is unwarranted given its index-linked heavyweight status and earnings quality profile. It remains OUTPERFORM with unchanged price target of RM17.17/share based on CY18 14.4x PER which is 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 - 3 Jul 2017