The Government has agreed to maintain the ICTP base tariff of 39.45 sen/kWh for 2H18 with a surcharge of 1.35 sen/kWh for non-domestic customers. This is highly positive for TENAGA as the first surcharge shows the utility is able to pass through higher fuel costs to consumer albeit the domestic segment remains subsidized. It remains our TOP PICK for the sector at target of RM17.90. OUTPERFORM maintained.

Maintain 39.45sen /kWh base tariff in 2H18. Last Friday, TENAGA announced that the Government, via Energy Commission (EC), had approved the continued ICPT for 2H 2018, where (i) the average basetariff remains unchanged at 39.45 sen/kWh and (ii) due to higher fuel and generation costs for 1H 2018, additional cost of RM698.19m or 1.35 sen/kWh ICPT surcharge will be passed through. Meanwhile, the surcharge will be applicable to non-domestic customer, but it has not affected domestic customers where monthly consumption below 300kWh will be not affected by this ICPT implementation whereas for monthly consumption above 300kWh, the surcharge will be funded by Kumpulan Wang Industri Elektrik (KWIE).

First ICPT surcharge. This is highly positive for TENAGA as it shows the utility is able to pass through higher fuel costs to consumer albeit the domestic segment remains subsidized. In fact, this is the first surcharge being charged to consumer since the implementation of ICPT in Jan 2014. In 2H 2017 and 1H 2018, there were supposed to have been surcharge of 1.02 sen/kWh and 0.28 sen/kWh, respectively, but both were absorbed by the previous IPP Savings Fund. Meanwhile, the higher fuel and generation costs in 1H 2018 were largely due to higher average coal costs of USD91.66/mt as compared to reference price of USD75/mt whereas the RM1.50/mmbtu half-yearly piped gas hike was already incorporated into the base tariff.

Main concern of not able to transfer cost cleared? Share of TENAGA took a beating after the PH coalition took over as federal government last month, resulting its share price hitting new low last week, down by 17% from its 52-week high. There were concerns affecting 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 could work against the principle of ICPT mechanism. However, with this first surcharge of 1.35 sen/kWh, it could indicate that the PH government allows hike if it is not directly charged to the public. We learnt that the subsidy portion of the RM698.19m additional cost is c.RM100m for domestic customers. With fund available of RM1.5b under KWIE as of early of the year, we believe the fund is sufficient to offset any higher cost for many years should cost remains at 1H 2018 levels.

It remains undervalued. We continue to like TENAGA for its earnings quality while the latest ICPT surcharge should boost investors’ confidence as the PH government is committed to the ICPT framework as well. With its heavy index-weighted status, we still believe it is still undervalued at current CY19 PER level of 11.4x. It remains OUTPERFORM with unchanged price target of RM17.90 based on CY19 14x PER which is based on +1.0SD of 2-year moving average. Risks to our call include: (i) a slowdown in economy growth, which will affect electricity demand, and (ii) a sudden surge in fuel prices resulting in short-term earnings weakness.

Source: Kenanga Research - 2 Jul 2018