It was a good set of 1Q18 results, which saw improving profit margins on lower opex. However, the ICPT underrecovery persisted on rising fuel prices, which may raise question of its ability to transfer costs to end-user that goes against the new government’s populist policy. We maintain that the ICPT framework is a good and transparent mechanism which should be kept. OUTPERFORM retained at revised target price of RM17.90.

1Q18 matched expectations. At 26.5%/23.6% of house/street’s FY18 estimates, 1Q18 core profit of RM1.71b came within expectations. There was no dividend declared in 1Q18 as expected as it usually pays half-yearly dividend. Given the change of financial year-end to December from August period, this quarterly result is for the new year- end for the Jan-Mar 2018 quarter. Therefore, there is no comparison.

A good quarter. TENAGA reported 1Q18 core profit of RM1.71b on the back of RM12.27b revenue. As there is no comparable quarter, we examine its performance based on profit margins. 1Q18 EBITDA of 34.5% was the highest since 3Q16 for the period of Mar-May in 2016, which was recorded at 34.8%. This was partly due to lower opex where 1Q18 opex ex-fuel costs of RM3.62b is at the low-end of the RM3.6b to RM4.6b opex ex-fuel costs recorded in the past eight quarters under the old financial year-end of August.

ICPT under-recovery in 1Q18. The fuel costs incurred in 1Q18 under the ICPT framework had an under-recovery of RM634.1m as fuel prices were higher than the reference prices set in Regulatory Period 2 (RP2). This is especially for average coal price in MYR term of RM361.50/mt in 1Q18 vs. reference price of RM315.90/mt. Going by the fuel price trend, one should expect that the upcoming tariff rate for 2H 2018, which is under review in June, to be likely higher than the base-tariff rate of 39.45 sen/kWh.

ICPT mechanism at risk? Share price of TENAGA has been under pressure post-GE14 on concerns that the new government’s populist policy may affect the ICPT framework which started since 2014. The management believes that the new PH government should continue with ICPT as it is a transparent mechanism. It is also in the opinion that the current fund available of RM1.5b should be sufficient to offset the case of ICPT under-recovery for 2H 2018. In our opinion, we believe that the government should adhere to this mechanism given it is fair to TENAGA as a public listed company which is answerable to shareholders and their profit expectations.

Again, it is the confidence and honouring the ICPT that count! TENAGA has always traded below FBMKLCI’s valuation, despite its heavyweight status and earnings quality profile. This is because investors’ perception of it having to share government’s “burden” on financing the power supply to the public. And, the populist policy of the PH government may work against the principle of ICTP mechanism. However, as the RM1.5b fund available to offset tariff subsidy is at least sufficient for 2H 2018, the authority should have six months to resolve the issue.

Maintain OUTPERFORM as we believe the ICPT framework is here to stay. Thus, we keep our FY18-FY19 estimates unchanged for now. As we roll over our valuation base-year to CY19, we raised target price to RM17.90 from RM17.17 based on 14x CY19 PER or +1.0SD 2-year mean from 14.4x CY18 PER or +1.5SD 2-year previously. The lower 0.5SD is to account for the recent volatility post-GE14. Main risk to our OUTPERFORM call is the change of ICPT mechanism, which will change the entire operating cost structure.

Source: Kenanga Research - 28 May 2018