2Q17 results were well within expectations. With fears of vulnerable results in the coming quarters as SEV faces substantial cut in capacity payment coupled with on-going scheduled maintenance, MALAKOF has been facing severe selling pressure in the past one year. However, we believe the selling is overdone for the shares which had fallen 26% YTD as the stock is now trading at 37% discount to its SoP valuations. As such, we upgrade the stock to OUTPERFORM with an unchanged target price of RM1.30.

2Q17 in line. At 54%/53% of house/street’s estimates, 1H17 core profit of RM182.1m came within expectations as the coming quarters are expected to be weaker given the anticipated lower rate under the PPA Extension contract for Segari Energy (SEV), starting July 2017. It declared a first interim NDPS of 2.5 sen in 2Q17, (ex-date: 08 Sep; payment date: 06 Oct) which was lower than 3.5 sen paid in 2Q16, with earnings pay-out of 62%, which is lower than its targeted dividend payout of 70% for FY17.

Sequential results remained weak. Stripping out a RM20m one-off insurance claim for associate Kapar Energy (KEV), 2Q17 core profit fell 16% QoQ to RM83.3m from RM98.8m previously. The decline in earnings was largely due to: (i) lower capacity payment by RM48.8m for Tanjung Bin Energy (TBE) due to the unplanned outage in May, and (ii) lower fuel margin. However, lower maintenance costs and lower taxation by 39% as effective tax rate dropped to 24% from 34% helped to mitigate earnings decline. Meanwhile, on adjustment for KEV by RM20m as mentioned above, share of profit for associate incomes fell to RM8.3m from RM32.7m in 1Q17.

Better YoY numbers on associate incomes. 2Q17 and 1H17 core earnings rose 10% and 14% to RM83.3m and RM159.7m, respectively. The main earnings drivers were: (i) higher associate incomes as KEV and AA were being rectified, which turned the two problematic associates profitable, and (ii) higher capacity payment by RM71.6m at TBE as the new power plant started operational in end-1Q16. Meanwhile, depreciation for this year was higher than last year due to the start-up of TBE as well as the change of residual value for gas-fired power plants this year.

The going remains tough. With on-going scheduled maintenance into 2H17 coupled with the expected lower capacity payment arising from the PPA Extension contract for SEV, forward earnings are likely to be weaker than 1H17. We keep our estimates unchanged for now which we have assumed a 50% cut in capacity payment at SEV. Although 1H17 NDPS is lower than its targeted earnings pay-out of 70%, we also keep our assumption unchanged as we already assumed a 70% payout.

Upgrade to OUTPERFORM. Share price of MALAKOF has contracted 15% since our downgrade three months ago and it is now trading at 37% discount to its SoP valuation of RM1.61/share. We believe the sell-down is overdone and it currently appears attractive. Thus, we upgrade the stock back to OUTPERFORM from MARKET PERFORM with an unchanged target price of RM1.30/share which is at a 20% discount to its SoP valuation. Risks to our upgrading call include bigger-than-expected cut in SEV’s capacity payment, unplanned outages and higher O&M costs.

Source: Kenanga Research - 22 Aug 2017