The Power Utilities sector faced selling pressure post-GE14, in line with the overall market trend. Nevertheless, the sell-down offers a good opportunity to accumulate stocks with quality assets, in our view. With the PH government agreeing to maintain ICPT tariff in 2H18 with a surcharge of 1.35 sen/kWh for non-domestic consumers, the government is showing commitment towards the mechanism as long as it does not involve the public directly. On the back of this ICPT mechanism coupled with its earnings quality, trading at 11x CY19 PER is highly unwarranted for a heavy-weight index stock like TENAGA. Elsewhere, the IPPs namely YTLPOWR and MALAKOF as well as PESTECH are also trading at fairly attractive valuations despite possessing quality assets as well as sizeable order-book. In all, TENAGA remains our sector TOP PICK while PESTECH is an alternative small cap play. Maintain OVERWEIGHT for the sector.

Deep valuation after being bashed down; OVERWEIGHT maintained. The Power Utilities sector faced heavy selling post GE14 on concerns over the new government’s commitment on the ICPT framework while cancellations of rail projects such as KL-Singapore HSR and ECRL also put pressure on YTLPOWR (OP; TP: RM1.10) and PESTECH (OP; TP: RM2.15). In fact, YTLPOWR sank to all-time low of RM0.75 on 24th of May after the HSR project was scraped. Subsequently, the government said the project is only put on hold and under study instead of cancellation. This coupled with share buyback program pushed the share price back to above RM1.00. On the other hand, TENAGA (OP; TP: RM17.90) also saw its share price hitting 52-week low of RM13.66 on 28 June on concerns that the new government may not continue with the ICPT framework. However, to our surprise, the government agreed to continue the ICPT albeit with a surcharge to non-domestic customer. Following the sell-down, except MALAKOF (OP; TP: RM1.20), all stocks are trading at CY19 10x-12x PER which appear to be fairly attractive. TENAGA remains as our Top Pick for the sector given its undemanding valuation, which is supported by its quality earnings profile and index weighting status. Meanwhile, we continue to like small cap PESTECH as our alternative sector play for its explosive earnings growth story, with near-term strong contract flows expected.

First ICPT surcharge. The PH government, via the Energy Commission, has agreed to maintain the ICPT 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 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 2H17 and 1H18, 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 Saving Fund. Meanwhile, the higher fuel and generations costs in 1H18 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. Overall, we are positive with this latest development as 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 RM698.2m additional cost is c.RM100m for domestic customers. With fund available of RM1.5b under Kumpulan Wang Industri Elektrik as of early of the year, we believe the fund is sufficient to offset any higher cost for several years should it remains at 1H18 levels.

Values in IPPs? Both IPPs - YTLPOWR and MALAKOF were badly hit in the past years, largely due to disappointing results as well as earnings uncertainties as their PPAs approach expiration. Post-GE14, YTLPOWR was the worst performing IPP which saw its share price tanking >40% YTD by end of May. This was especially when the PM said the KL-Singapore HSR project was cancelled as the YTL Group was one of the consortium members to build the HSR. However, it had rebounded strongly since then on the back of share buyback program as well as government’s latest decision to delay the HSR. Elsewhere, PESTECH also faced selling pressure as it is involved in the rail electrification in double track, KVDT, HSR and ECRL projects, which are currently under review. On the other hand, MALAKOF does not seem to have found the bottom of its decline given on a string of disappointing quarterly results. In the latest 1Q18 results, its earnings were hit by unplanned outages in TBE as well as lower associate income. In fact, it hit an all-time low of RM0.825 on 29th June. All in, we believe the recent weakness in share prices provide buying opportunities as the companies are backed with quality assets for IPPs and sizeable order-book for PESTECH.

Overall a better 2018. The recent 1QCY18 results reports card was a mixed bag with YTLPOWR’s 3Q18 falling short of expectations due to weak earnings of Paka and PowerSeraya as well as wider losses at Yes, while MALAKOF’s 1Q18 missed forecast on unplanned outages in TBE and lower associate earnings. TENAGA’s 1Q18 and PESTECH’s 3Q18 were within expectations. Going forth, we expect TENAGA`’s earnings to grow further on the back of 2.1% electricity demand growth in 2018, to be led by domestic and commercial segments, while YTLPOWR should see a rebound in earnings as the Paka Power Plant recommenced in September last year after it resolved the dispute with TENAGA pertaining to a land issue. Meanwhile, MALAKOF’s earnings are likely to be flattish given that upside is capped by cut in SEV’s capacity payment following the PPA Extension Contract. Elsewhere, PESTECH should see earnings growth on the back of its RM1.5b order-book coupled with new contract flows to sustain earnings momentum. However, YTLPOWR’s dividend payout could be lower 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 over the next 3-4 years.

Source: Kenanga Research - 4 Jul 2018