1QFY20 results were fairly inline albeit a 1.9% YoY demand slide that was covered by a recovery of revenue cap. Even with management projecting a 7%-15% decline in electricity sales in FY20, earnings have stayed neutral thanks to the revenue adjustment mechanism. In time of economic difficulty like this, TENAGA still offers resilient earnings with sustainable c.4% dividend yield. Thus, OP reaffirmed with revised TP of RM13.95.

1QFY20 no surprises. Without MFRS 16 impact, 1QFY20 core profit of RM1.39b matched our expectation which accounted for 25% of our FY20 estimate or 27% of consensus which we believe should have made adjustment for MFRS 16. With MFRS 16 adjustment, 1QFY20 core profit came to RM1.23b while all comparisons coming below are adjusted for MFRS 16 impact. Meanwhile, no dividend was declared during the quarter as it only pays half-yearly dividend.

Lower opex led sequential earnings growth. 1QFY20 core profit, which was partly adjusted for RM99.1m provision for doubtful debts beside the unrealised forex of RM388.0m, jumped 40% to RM1.23b from RM0.88b in 4QFY19 largely attributable to lower opex by 15% or RM1.75b. Total fuel costs fell 15%, repair & maintenance declined 27% and staff cost contracted 12%. The drop in fuel costs was due to the fall in average coal price by 1% to RM289.3/mt and average piped gas/LNG prices fell 15%, on top of a 2.8% decline in demand growth. As such, the decline in demand growth also partly attributed to the 4% decline in revenue on top of a higher ICPT rebate of RM307.5m from RM80.8m in 4QFY19. YoY, 1QFY20 core profit, however, plummeted 24% from RM1.63b as top-line contracted 12% as there was RM1.37b ICPT surcharge from RM307.5m rebate as mentioned above while depreciation was higher by 5% and interest expense steeper by 27%.

Demand growth to drop in FY20 on the lock-down effect... Demand fell 1.9% YoY in 1QFY20 and management expects overall electricity consumption to drop between 7%-15% this year on the MCO-led slowdown. It had already registered demand decline of 10.0% in Mar when the MCO started and fell sharply by 22.4% in Apr before recovering to fall slower by 10.6% in May as some business resumed. However, this is earnings neutral to TENAGA as any excess or shortfall in revenue cap will be passed through to the customers via revenue adjustment mechanism and this is the same mechanism for price cap for ASP. In 1QFY20, it reported a recovery revenue of RM119.8m for revenue cap and excess revenue of RM219.7m for price cap.

...but it will recover by revenue cap. Given the revenue adjustment mechanism, there is no earnings risk for regulated business even as demand is dropping during this depressed market condition. To recap, the regulated business generates c.RM3.7b a year while the remaining c.RM1.5b is from non-regulated business. On the other hand, management maintained that it will continue to honour dividend payout policy of 30%-60% which makes it a decent dividend income stock offering c.4% yield. Aligning with MFRS 16 reporting standard, we adjusted FY19 actual core profit to RM5.19b from RM5.45b while our forecast FY20-FY21 numbers also adjusted downward by 6% and 7% to RM5.21b and RM5.31b, respectively.

Keep OUTPERFORM, for its undemanding valuation of 12.8x FY21 PER which is at -1.5SD of its 3-year mean of 14.9x at 12.9x. For the security of earnings and status as one of the largest liquid heavyweight index components, Tenaga should trade at least at mean if not a premium to its history in this still uncertain environment, And, at 12.8x FY21, it currently undeservedly trades well below the FBMKLCI’s 17.8x. As such, our target price is now raised to RM13.95 based on 3- year PER mean of 14.9x from RM13.00 previously which was based on -1SD 5-year PBV mean of 1.27x as we believe the COVID-19-led slowdown will not affect its earnings. Risk to our recommendation is weaker-than-expected earnings from non-regulated business.

Source: Kenanga Research - 11 Jun 2020