3QFY19 results beat expectations thanks to lower generation costs as coal prices declined. In addition, solid demand growth of 3.2% in 9MFY19 kept earnings sustainable. With declining coal price, 4QFY19 could enjoy further lower generation costs but this could result in a lower effective tariff rate in 1HFY20. Given limited earnings growth and market fears of industry reform, we keep the stock at MP with revised TP of RM14.30.

9MFY19 above expectation slightly. At 80% each of house/street’s FY19 estimates, 9MFY19 core profit of RM4.49b came in slightly above expectations given the lower-than-expected opex which saw 3QFY19 total opex falling 4% QoQ, largely led by generation costs that contracted 6% as fuel costs declined while non-generation opex was generally flattish. Meanwhile, no dividend was declared during the quarter as expected as it usually pays half-yearly dividend.

Lower opex led earnings lower. 3QFY19 core profit contracted 10% QoQ to RM1.37b on the back of 2% dip in revenue. The drop in revenue was driven by a 2.7% decline in demand growth while the decline in earnings was attributable to: (i) higher taxation at RM336.9m against a positive tax of RM47.3m in 2QFY19 which was due to reversal of over-provision of tax for FY18, and (ii) higher depreciation charges by 3% or RM83.9m. However, at EBITDA level, earnings jumped 10% primarily due to the abovementioned lower generation costs. Average coal price dropped 11% to RM301.9/MT from RM340.5m while average LNG price fell 8% to RM32.75/mmbtu from RM35.73/mmbtu. The daily average gas volume declined 8% to 973mmscfd from 1,059mmscfd which mean it required less expensive LNG. Meanwhile, associate income declined to RM29.7m from RM88.2m as the preceding quarter reported a recovery from coal cost pass-through at GMR.

Volume growth led yearly earnings growth. YoY, 3QFY19 and 9MFY19 core profit leapt 43% and 12% to RM1.37b and RM4.01b respectively partly thanks to higher electricity demand by 1.1% and 3.2%. While lower generation opex by 6% or RM417.0m in 3QFY19 as mentioned above also attributed to higher YoY earnings, higher generation opex by 9% or RM1.75b in 9MFY19 capped YTD earnings from growing higher. This was due to higher requirement mix for the expensive LNG as gas volume rose 7% for 9MFY19 to 1,030mmscfd with average LNG price jumping 13% to RM35.03/mmbtu. On the other hand, coal prices were generally on the downtrend with average coal costs falling 29% YoY in 3QFY19 and 11% YoY in 9MFY19.

Lower fuel costs will pass through in 1HFY20. With fuel prices trending downward especially coal which fell 11% YoY in 9MFY19, TENAGA is likely to register lower generation costs in the coming 4QFY19 which could post resilient numbers although 2H is traditionally a weaker period. However, the benefit of lower fuel costs would result in a lower effective tariff rate in 1HFY20 under the ICPT mechanism. Post-results, we raised FY19-FY20 earnings estimates by 4%-2% as we adjusted for lower generation costs in FY19 and fine-tuned interest cost/depreciation charges for both years. NDPS is also upgraded proportionally based on 50% payout.

Still MARKET PERFORM. With the new earnings guidance of c.RM5.5b since Feb 2019, we believe market has already adjusted to the lower earnings base. Thus, we decided to value the stock based on 3-year mean instead of -1SD 2-year mean. This increases our TP to RM14.30 based on 14x FY20 PER from RM13.40 at 13.6x FY20 PER. Our MP recommendation is supported by >3% yield. Upside risks to our recommendation are: (i) stronger-than-expected earnings from non-regulated business, and (ii) a higher dividend payout.

Source: Kenanga Research - 28 Nov 2019