TENAGA reported its shortened financial period of 4-month with core profit of RM2.04b coming within expectations. However, dividend pay-out of 50% is higher than our assumption of 40%. Going forth, with ICPT framework in place, fuel cost risk is being transferred to end users, which augurs well for them. It remains our TOP PICK for the sector at target price of RM17.17/share.

FYE Dec 2017 results in line. At 102% of house’s estimate, FYE Dec 2017 core earnings of RM2.04b came within expectation. Meanwhile, the 21.41 sen NDPS declared in this shortened financial period of four months, representing 50% earnings payout, is higher than our estimate of 14.2 sen which based on 40% pay-out. This is within its dividend policy of earnings pay-out ratio of 30-60%. Given the change of financial year-end to December from August period, this result is for the new year-end for the period 4-month from Sep-Dec 2017. Therefore, there is no comparative quarter.

Marginally higher on annualised basis. TENAGA reported 1-month period in December for FYE Dec 2017 with core profit of RM567.0m for the accumulative current period to RM2.04b on the back of revenue of RM15.83b. On an annualised basis, core profit of RM6.11b was 1% marginally higher than RM6.07b recorded in FYE Aug 2017. Overall, profit margins for this 4-month period were fairly similar to last FYE Aug 2017 where EBITDA margin was maintained at 33% while pre-tax margin improved to 19% from 17% previously. However, effective tax rate was lower at 24% from 27% for the 12-month period.

2% demand growth to drive earnings. With the ICPT framework in place, fuel cost risk is passed through to end consumer. Thus, in our opinion, demand growth is the key to determine drive top-line growth and eventually flow through to bottom-line. On the other hand, under the rising fuel costs environment, does it beg the question whether this allows TENAGA to surcharge end-users should ICP under-recovery situation persist as the availability of PPA Saving Fund was below c.RM100m at the end of 2017. We keep our FY18 estimates unchanged based on 2.1% demand growth assumption, while introducing FY19 forecast where earnings are expected to grow at 8% based on the same demand growth of 2.1%. Despite higher pay-out of 50% for this shortened period, we keep our dividend pay-out ratio of 40%.

Still undemanding valuation; OUTPERFORM retained. We remain bullish on TENAGA for unwarranted low valuations despite its indexlinked heavyweight status and earnings quality profile. It remains as our TOP PICK with OUTPERFORM rating and unchanged target price of RM17.17/share based on 14.4x CY18E 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 - 1 Mar 2018