The ICPT surcharge of 2.55 sen/kWh in 2H19 is not unexpected given the high fuel costs, especially coal prices while the domestic residential customers continue to enjoy subsidy which will be funded by KWIE. Meanwhile, TENAGA rallied 19% in the past one month, after the stock being bashed down heavily, should have priced in near term positives. Thus, downgrade the stock to MARKET PERFORM with an unchanged target price of RM13.40.

ICPT surcharge of 2.55 sen/kWh in 2H19. Last Friday, TENAGA announced that the Government, via Energy Commission (EC), had approved the continued ICPT for 2H 2019, where (i) the average basetariff remains unchanged at 39.45 sen/kWh, (ii) domestic residential customers are not affected by the ICPT surcharge, as expected, and (iii) current ICPT surcharge of 2.55 sen/kWh will continue to be maintained for 2H 2019 for all non-domestic customers. The surcharge for domestic residential customers, amounting RM107m, is again funded by Kumpulan Wang Industri Elektrik (KWIE).

Effective tariff hike of 1%. We are not surprised with the surcharge given the high fuel costs, especially coal prices, which were USD99.235/mt on average in 1H 2019 as compared to the forecasted coal price set in base tariff for RP2 from 2018 to 2020, which was at USD75/mt. The 2.55 sen/kWh surcharge is the same as the surcharge for Mar to Jun 2019 while there was a surcharge of 1.35 sen/kWh for period Jan to Feb in 2019. The average surcharge in 1H 2019 was 2.15 sen/kWh, which implies 1% effective tariff hike in 2H 2019. On the other hand, the RM1.50/mmbtu half-yearly piped gas hike was already incorporated into the base tariff.

RM107m Subsidy for domestic customers. 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. Question remains on whether the government will allow TENAGA to raise tariff rates in the future should the ICPT under-recovery situation persist when the KWIE fund is fully utilised. With RM308m and RM107m subsidies in 1H 2019 and 2H 2019 and a balance of RM760m fund available for KWIE in last July, the KWIE balance is likely to be at least RM345m by year end. Thus, should fuel costs remain high at the current level, the fund is likely sufficient for 2020. In any case, we still believe any extra fuel costs will be transferred to all customers under the principle or spirit of ICPT mechanism.

19% price rally in a month; cut to MARKET PERFORM. We keep our estimates unchanged as the tariff surcharge is a fuel cost passthrough, which is already incorporated in our model. On the other hand, share price has risen sharply by 19% in the past one month which we believe near term positives could have been priced in for now. Thus, we cut the stock to MARKET PERFORM from OUTPERFORM with an unchanged target price of RM13.40, which is based on 13.6x FY20 PER, in-line with 1SD-band below its 2-year mean. Our recommendation is supported by 3%-4% yield.

Risks to our downgrading are (i) the stronger than expected earnings from non-regulated business as well as (ii) a higher dividend payout.

Source: Kenanga Research - 1 Jul 2019