Although FY18 earnings met expectations, the 7.3% asset base return will cap earnings from growing higher. Before we see new assets coming on-stream in 2020, consensus forecasts are 20% higher than FY18 earnings, which will lead to a big earnings downgrade. And, this compresses the already suppressed stock sentiment further. We cut our estimates by 17% to accommodate such change and downgrade the stock to MP at target price of RM13.30.

FY18 met expectations. 4Q18 results met our expectations with core earnings declining 15% QoQ to RM816.1m, bringing FY18 core profit to RM5.42b which is 4% below our estimate but missed consensus forecast by 14%. To recap, we had cut our FY18 estimate by 16% during last quarter’s results review due to higher fuel costs and finance costs. It declared a final NDPS of 23 sen in 4Q18 which took FY18 NDPS to 53.3 sen (56% payout) which beat our estimates of 39.7 sen (40% payout). Given the change of financial year-end to December from August, there is no YoY comparison.

Lower revenue and high opex capped earnings growth. Headline results were shocking with net loss of RM134.3m reported in 4Q18, which was largely due to: (i) RM304.7m impairment for GMR, and (ii) RM269.9m impairment of financial guarantee for GAMA. Ex-EI, 4Q18 core profit fell 15% QoQ to RM816.1m as revenue dropped 4% on the back of 2% decline in sales of electricity in Peninsular Malaysia. In addition, the weak set of results was also partly attributed to higher opex by 3% owing to 10% increase in depreciation charges and an 18% or RM369.1m higher subsidiary cost of sales & opex. Overall, fuel costs fell 8% or RM259.8m given the 3% decline in average coal price to RM411.1/mt from RM422.6/mt previously.

ICPT under-recovery doubled in 4Q18. It continued to incur higher fuel costs as fuel prices were higher than the reference prices set in RP2 with some lagged-effect as the ICPT under-recovery doubled to RM970.7m from RM479.6m in 3Q18. This also brought YTD FY18 total under-recovery to RM2.33b. The average coal price of RM411.1/mt for 4Q18 mentioned above was higher than reference price of RM315.9/mt. With the additional 2.15 sen/kWh ICPT surcharge to be imposed in 1H19, we should likely see higher revenue in the coming two quarters.

RM5.4b is the normalised earnings base for RP2. We understand that the core profit after tax of RM5.44b will be the earnings base for RP2, which runs from 2018 to 2020, where the regulated asset base return was lowered to 7.3% from 7.5% in RP1. The regulated asset base was c.RM50b in 2018 thus generating a fixed return of RM3.7b in FY18. This leaves the balance of RM1.7b for earnings derived from non-regulated assets as well as offshore assets. As such, the earnings base for the remaining years in RP2 will yield similar profits reported in FY18. In view of this, we cut FY19 estimates by 17% as we now expect a lower margin for regulated business, and we launched FY20 estimates of which earnings are set to grow by only 2%. Meanwhile, we raised our dividend payout assumption to 50% from 40% previously.

Bleak earnings outlook; downgrade to MP. We are no longer bullish on TENAGA given the tepid earnings prospects. With consensus FY19-FY20 earnings estimates that are c.20% higher than FY18 normalised earnings, we expect a big earnings cut post results release, which will compress the already suppressed sentiment towards the stock. Nonetheless, we believe the market has already priced in the negativity. Thus, we cut the stock to MP from OP with a lower target price of RM13.30 which is based on -1SD 2-year mean of 13.6x from RM16.65 previously. Risk to our downgrading is the stronger than expected earnings from non-regulated business.

Source: Kenanga Research - 1 Mar 2019