The continued ICPT surcharge in 1H19 is not unexpected given the rising coal prices. This reaffirmed the government’s commitment towards the fuel cost pass- through mechanism, which is positive to sentiment. Meanwhile, we believe the recent sell-down on industry reform concerns is excessive. Keep OUTPERFORM at RM16.45 for its earnings quality profile.

1H19’s base-tariff maintained at 39.45 sen/kWh. Last Friday, TENAGA announced that the Government, via Energy Commission (EC), had approved the continuation of the ICPT for 1H 2019, where (i) the average base-tariff remains unchanged at 39.45 sen/kWh and (ii) due to higher fuel and generation costs for 2H 2018, additional cost of RM948m or 2.15 sen/kWh ICPT surcharge will be passed through. Meanwhile, the surcharge will only be applicable to non-domestic customers while the surcharge for domestic customers amounting to RM308m will be funded by Kumpulan Wang Industri Elektrik (KWIE).

ICPT surcharge to continue, on higher fuel costs. We were not surprised with the surcharge given rising fuel costs, especially coal prices in the past few months. The applicable coal prices in 3Q18 and 4Q18 were RM359.87/mt and RM428.42/mt, respectively, much higher than the benchmark coal price of RM315.9/mt for RP2 in 2018-2020. Thus, the additional generation cost in 2H 2018 was RM1.82b. With RM308m subsidy for domestic customers from KWIE and cost & revenue adjustment of RM564m, this resulted in the ICPT surcharge of RM948m mentioned above. This surcharge will be staggered across (i) 1.35 sen/kWh in Jan-Feb 2019, and (ii) 2.55 sen/kWh in Mar-Jun 2019.

ICPT framework to stay at all times? We are not overly excited about the ICPT surcharge as this is not the first surcharge while the available fund in KWIE to offset subsidy for domestic customers had also led us to anticipate a surcharge. We are more interested to see the situation after the KWIE fund is fully utilised. Earlier in July, it was announced by the Energy Ministry that the fund available for KWIE was RM760m. Should fuel costs remain high at the current level, the KWIE is likely to be exhausted by 1H2020. In any case, we still believe any extra fuel costs will be transferred to all customers under the principle or spirit of ICPT mechanism.

Is power industry reform a threat? Share price of TENAGA came under pressure falling 11% in the past one month following the Energy Minister’s comment of disrupting the power industry by not limiting the focus to generation segment but improving efficiency across the supply chain, including transmission and distribution. We opine that efficiency- driven industry reform will benefit consumers while the opening of market to new players will help to achieve this aim. However, we believe TENAGA should be able to face the challenges given its entrenched position with existing extensive infrastructures that should give it a cost-advantage over the new-comers. In addition, with its efficiency record, TENAGA should be able to stand up to the competition.

OUTPERFORM maintained. 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 believe it is still undervalued at current CY19 PER level of 11x. As such, we keep the stock at OUTPERFORM with an unchanged price target of RM16.45 based on CY19 14x PER which is based on +1.0SD of 2-year mean.

Main risk to our call is the change of ICPT mechanism, which will change the entire operating cost structure.

Source: Kenanga Research - 17 Dec 2018