We gained better clarity on MESI 2.0 post a company visit yesterday. There is potentially fuel saving arbitrage should it manage procurement efficiently while fees from the new TPA should have neutral impact, being covered under the RAB regime. We still see little impact from the opening up of the retail segment which makes up only <3% of group’s earnings. New broadband venture is insignificant too. On lack of catalysts, MP retained along with TP of RM13.40.

TENAGA can benefit from fuel savings too. We met up with management yesterday to obtain further details on the MESI 2.0 for which guidelines were approved by the Cabinet recently. We understand that besides IPPs, TENAGA will also get to benefit from fuel savings should fuel costs fall below the benchmark price. Currently, all coal and gas fuel procurements are handled by TENAGA, with cost pass-through under PPA for IPPs, and ICPT for TENAGA. In the future, IPPs are allowed to source for their own fuel to optimise cost and lock in profit from fuel cost savings. Otherwise, the IPPs can continue to source from TENAGA which similarly can book in profit from any fuel savings. MyPower is expected to come up with draft on rules, incentive mechanisms and amendments to regulatory control by 3Q20 before EC’s approval in 4Q20. It is expected to have pilot trial in 1Q21 and full roll-out in 2Q21.

Shorter PPA tenure without lock-in energy payment. In the future, new IPPs will see shorter PPA tenure with only capacity payments, as opposed to existing 21-year for gas-fired and 25-year for coal-fired plant, moving toward capacity market with EC holding first auction in end-2023. Eventually, generators with excess capacity or with expired PPAs can utilise the improved New Enhanced Dispatch Arrangement platform (NEDA+) to sell energy via spot contract to single buyer. MyPower is expected to draft the design and rules from now till 4Q21 before EC’s approval in 2022. EC will roll out the NEDA+ by 3Q20. By 2029, it will mark the entry of the capacity market, and the beginning of the hybrid market till 2045.

TPA and retail market to start in RP3. A 3rd Party Access (TPA) framework and network charges should be ready in time for RP3 in 2021 for grid to allow for 3rd party usage of the infrastructures. This is to allow trading of green energy, future export of electricity under ASEAN Power Grid, and to open market up for non-RE power producers. As such, TENAGA will be paid a certain network charges, which is covered under IBR. On the other hand, MyPower will detail and complete a retail regulatory framework to be approved by EC by 4Q20 before the pilot opening up of retail in 2Q21. Meanwhile, the single buyer and grid system operator should start in 1Q21. On the other hand, management indicated that its venture into the wholesale broadband sector in Melaka is not going have material impact to the group’s earnings with targeted return of at least 7.3%. It had completed setting up 1,100 homes with capex of RM4m in Jasin, and expects to roll out another 15,000 homes in Jasin, Alor Gajah and Melaka Tengah, all in Melaka. TENAGA is only involved in the wholesale sector in the areas which are currently without broadband service.

More clarity but MP for now. We take comfort with the better clarity on MESI 2.0 where its earnings’ certainty remains high with potential earnings accretion from fuel saving arbitrage while other business segments like GenCo and RetailCo will work on the merit of efficiencies and the T&Ds are covered under RAB. However, the lack of near-term catalyst coupled with expected weak 2H19 earnings compelled us to keep our MP call on the stock with unchanged TP of RM13.40 based on 1SD below its 2-year mean, at FY20 PER of 13.6x. Risks to our recommendation are: (i) the stronger-than-expected earnings from nonregulated business as well as (ii) a higher dividend payout.

Source: Kenanga Research - 24 Sept 2019