FY18 results beat our forecast as there was no prolonged problem at TBE in 4Q18 after an unplanned outage in 3Q18. On a positive note, lower depreciation and interest costs arising from changing of accounting treatment led earnings higher. However, it needs to find new source of earnings to fill up the earnings gap from PD Power’ expiration for which we believe Alam Flora is a good fit. Keep OP at TP of RM1.00, supported by 4%-5% yield.

Above expectations. MALAKOF reported 4Q18 results, which beat our estimates with core profit rising 200% sequentially to RM85.5m, bringing FY18 core profit to RM219.4m which is 25% above our forecast but on the spot of market consensus. The main discrepancy is because we had earlier expected TBE’s boiler wall tube leak in 3Q18 to be prolonged, but it was resolved promptly and did not affect 4Q18 results. It declared a final NDPS of 3.5 sen, which took FY18 NDPS to 5.6 sen vs. 6.2 sen in FY17. The 5.6 sen NDPS, which is based on reported FY18 earning similar to FY17, is higher than our forecast of 4.6 sen.

Lower depreciation charges led sequential earnings growth. 4Q18 core profit jumped 200% QoQ to RM85.5m from RM28.5m in 3Q18, largely led by 20% or RM56.8m reduction in depreciation, a 10% or RM25.4m lower in interest expense and RM57m lower O&M costs. Note that 3Q18 results were impacted by the abovementioned TBE issue. Meanwhile, the lower depreciation charges were due to lower amortisation of c-inspection costs while the capitalisation of finance cost of jetty construction led to lower interest costs.

SEV’s capacity payment cut hurt yearly results. YoY, 4Q18 core profit surged 188% from RM29.7m in 4Q17 which was due to the depreciation and interest costs mentioned above as well as 4Q17 results were hit by an unplanned outage at TBE, which saw a lower capacity payment of RM112.1m vs. RM124.3m in 4Q18. YTD, FY18 core profit plummeted 20% to RM219.4m from RM275.9m largely due to a capacity payment cut by 69% or RM304.6m at SEV after the PPA Extension took effect in Jul 2017. However, lower depreciation and interest cost helped to cushion earnings decline.

Awaiting new business to fill up earnings gap. Following the tariff cut for SEV, earnings may decline further as the PPA Extension for PD Power is expiring in this month albeit the small yearly capacity payment of c.RM45m. As such, MALAKOF is in urgent need to get new source of earnings to fill up the gap. In this respect, we are so far positive on the acquisition of Alam Flora, albeit a related-party transaction, as it jives well with the group’s long term aspirations of venturing into the waste-turn-energy and RE sectors. Meanwhile, the completion of the acquisition is expected by 3Q19 given the extension of fulfilling the conditions precedent of the SSA to 31 Jul from 31 Jan, pending approval from the authorities.

Reiterate OUTPERFORM. Post results, we upgrade FY19 estimates by 26% as we (i) added back TBE’s capacity payment as we believe the outages in 3Q18 is a one-off event, (ii) lowered depreciation and interest costs for the abovementioned reasons, and (iii) adjusted for FY18 actual results. Meanwhile, we introduced FY20 forecast in which we expect earnings to grow 4.5%. Our NDPS assumption is based on 80% payout as we believe the 100% payouts in FY17-FY18 are not sustainable as it is in an expansionary mode. Nonetheless, its yield of 4%-5% remains attractive. We keep our OUTPERFORM rating and target price of RM1.00 (based on 30% discount to its SoP valuation) unchanged. Risks to our call include unplanned outages, higher O&M costs and higher-than-expected KEV’s losses.

Source: Kenanga Research - 25 Feb 2019