While 4Q17 results were fairly in line, investors should cheer the surprise 44.0 sen final dividend declared as TENAGA revised its dividend pay-out to 30%-60% from 30%-50% previously. With fuel costs remaining high, concern remains whether the government will continue to honour the fuel-cost pass-through mechanism in the coming new regulatory period comes January. However, we still believe TENAGA will be allowed to continue passing through fuel cost risk to end-consumer in the future. It remains our TOP PICK for the sector at target price of RM17.17/share.

FY17 met expectation. At 97%/81 of house/street’s estimates, FY17 core earnings of RM6.07b came within our expectation. The higher consensus estimates could be due to the differences in recognising certain exceptional items. Meanwhile, the 44.0 sen final NDPS declared in 4Q17 is a pleasant surprise which is double the 22.0 sen paid in 4Q16 and totalled FY17 NDPS to 61.0 sen which is higher than our estimate of 44.6 sen and the 32.0 sen paid in FY16. In addition, it also revised its dividend policy of earnings pay-out ratio to 30-60% from 30-50% previously.

Improved sequential results. 4Q17 core profit grew 13% QoQ to RM1.72b from RM1.52b in 3Q17, which was largely attributable to the normalisation of interest cost after two quarters of high charges, especially payment to government on PPA Saving fund in 3Q17. The interest expense fell 39% to RM297.5m from RM489.3m previously. 4Q17 revenue fell marginally by 1% partly due to the deduction of ICPT under-recovery to RM61.8m from RM507.1m in 3Q17 but sales from Peninsular Malaysia rose strongly by 6% as demand growth rose 2.0% after a 2.3% decline in 3Q17. The drop in ICPT under-recovery was not surprising given the decline in fuel cost by 5% as average coal price fell 2% in MYR term to RM320.3/mt from RM327.9/mt while the usage of gas volume also declined by 7% to 968mmscfd from 1,045mmscfd. Meanwhile, share of profit of associate was RM68.4m from a loss of RM5.3m previously while taxation was also reduced by 14%.

Annual results hit by fuel costs and higher taxation. Despite revenue rising 11%, 4Q17 core profit contracted 8% from RM1.88b largely due to higher fuel costs by 19% on rising fuel prices, as well as higher taxation by 2-fold on the increase in deferred taxation expense after recognising the capitalisation of asset for FY16 and FY17. In fact, average coal price surged 37% to USD74.8/mt from USD54.7/mt or 45% in MYR term but gas/LNG consumption fell as the average daily gas volume fell 12% on the switch of generation mix toward coal-fired plants. YTD, FY17 core profit declined 9% to RM6.07b from RM6.69b given the same reasons of higher fuel costs and taxation charges mentioned above.

Undemanding valuation; keep OP. We are keeping our estimates unchanged for now but question remains if the rising fuel costs which will net off the PPA savings fund of RM1.1b currently; will the government allow TENAGA to raise tariff rates under new regulatory period starting next January. Nonetheless, in the principle of ICPT framework, fuel cost risk is passed through to end consumer, thus with neutral impact to TENAGA’s earnings. We remain bullish on TENAGA given its unwarranted low valuations despite its index-linked heavyweight status and earnings quality profile. It remains as our TOP PICK with OUTPERFORM rating and unchanged price target of RM17.17/share based on 14.4x CY18 PER, in line with its +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 - 27 Oct 2017