OVERWEIGHTing this defensive sector. Despite relatively defensive earnings, the Power Utility sector is trading at undemanding valuations. This is fairly unwarranted, especially for TENAGA (OP; TP: RM17.17) given its index-linked heavyweight status and earnings quality profile where the ICPT mechanism free it from fuel cost movement risk. Meanwhile, MALAKOF (OP; TP: RM1.30) continued to face heavy selling pressure on expectations that upcoming results starting 2H17 are set to be weaker as SEV faces substantial cut in capacity payment as well as on-going scheduled maintenance. Having said that, the stock is now trading at 34% discount to its SoP valuations, which appears to be attractive, in our view. On the other hand, we are neutral on YTLPOWR (MP; TP: RM1.50) as it is expected to distribute lower dividend pay-out at least in the next 3-4 years as it needs to conserve cash for two greenfield projects namely PT Tanjung Jati coal-fired power plant in Indonesia and Attarat Power’s oil shale-fired power plant in Jordan. Elsewhere, we continue to like alternative play PESTECH (OP; TP: RM2.00) for its earnings growth story.

TENAGA eyeing fast-track project? TADMAX submitted feasibility study. It was reported in the news that TENAGA is eyeing for fast-track power plant to install 600MW to 800MW of additional capacity at Connaught Bridge Power Station in Klang. This could get the additional supply online as early as 2020 to meet the demand growth as well as maintain a comfortable reserve margin of at least 20% which the reserve margin is currently close to. This is not unjustified given that TENAGA had signed an agreement last week to purchase of up to 100MW from Electricite Du Laos (EdL) of Laos via existing transmission grid of EGAT, Thailand over a 2-year period starting January 2018. The positive point from the agreement is that TENAGA is under no obligation to purchase any minimum amount of energy from EdL. Meanwhile, TADMAX (Not Rated) finally submitted a detailed feasibility study to EC in end-July for the development of a new 1,000MW combined cycle gas-fired power plant in Pulau Indah, before the due date of 1st of August. To recap, the award of the said greenfield project was awarded to TADMAX in August last year, which caught the market by surprise given that TADMAX has no prior experience in power generation. For now, TADMAX still has to wait for EC’s final approval before commencing the power plant.

A higher new base tariff next year? Although it was an ICPT under-recovery situation in 1H17, consumers are still enjoying 1.52 sen/kWh rebate in 2Q17 currently as the government decided to subsidise a total of 2.54 sen/kWh which include 1.02 sen/kWh surcharge and 1.54 sen/kWh rebate. This 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, the first surcharge since the implementation of ICPT in January 2014, attributed to the rising fuel costs. We believe this could be due to the upcoming 14th General Election, which could be held any time before August next year. 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. However, while the balance of PPA savings fund of RM500m currently is unlikely to be sufficient to net off the rising fuel costs, question remains on whether the government will allow TENAGA to raise tariff rates in the future. Nonetheless, under the principle of ICPT framework, fuel cost risk is passed through to end-consumer; thus, with neutral impact to TENAGA’s earnings. In our view, we believe TENAGA will be allowed to continue passing through fuel cost risk to end-consumer in the future. As such, a new higher base tariff from 38.53 sen/kWh currently is likely from next year.

A mixed earnings outlook. The recent 2QCY17 results reporting card was satisfactory with three in-line results and the only outperformer PESTECH which posted yet another record year in FY17, which beat our estimates by 15% on higher-thanexpected financial incomes from DPL. Meanwhile, TENAGA registered a strong 20% QoQ growth in 3Q17 due largely to ICPT under-recovery reversing from ICPT over-recovery in 2Q17 while MALAKOF’s 2Q17 results fell 16% QoQ due to higher capacity payment by RM48.8m for TBE due to unplanned outage in May, as well as lower fuel margin. YTLPOWR’s FY17 earnings were well within expectations. The dividend cut in 4Q17 was not a total surprise given the two new greenfield projects. Going forth, earnings of TENAGA in 4Q17 are expected to be stronger given the expected ICPT under-recovery which will boost its top-line; thus, flowing through to its bottom-line as well. However, both MALAKOF and YTLPOWR will see their Gen 1 IPPs, namely Segari Energy and Paka Power Plant receiving lower capacity payment, at least by half, when the new PPA Extension takes place in 2H17. Furthermore, it will be a low season for PESTECH given the raining season in Cambodia that is slowing down work progress.

Source: Kenanga Research - 4 Oct 2017