We still see the Utilities Sector as a good defensive sector under these uncertain times for its resilient earnings profile thanks to regulated asset returns for TENAGA and gas-based players, and PPAbound income for the IPPs. This also ensures sustainable dividends from the players, at above average yields of 4-7%. TENAGA’s earnings are set to normalise in FY21 with minimal impact from COVID-19 while gas-based players as well as local IPPs have proven their earnings resiliency during this pandemic. As such, we continue to rate the sector an OVERWEIGHT with TENAGA as our TOP PICK for our 2QCY21 strategy given its undemanding valuations and defensive earnings.

TENAGA committed to green energy. In recent months, TENAGA (OP; TP: RM12.70) has been actively pursuing to expand its renewal energy (RE) portfolio which is partly to address ESG concerns. In early Mar, TENAGA formed a JV with Singapore’s leading solar energy provider Sunseap Group to participate in a trial by Singapore to import 100MW of electricity from Malaysia. Separately, TENAGA is also acquiring a 39% stake in a 21.6MW project comprising five roof-top solar power plants in Vietnam from Sunseap Group at an undisclosed amount. This is to show its commitment to transform the integrated utility into a regional RE and utility player. Meanwhile, TENAGA had also won one of the LSS4 tenders to build a 50MW large scale solar photovoltaic plant in Bukit Selambau, Kedah. In addition, it has set a target to increase its RE assets, including large hydro to 8,300MW or 32% of group’s capacity by 2025 from 3,398MW or 17% currently. TENAGA has pledged not to invest in greenfield coal plant, with Jimah East Power which was commissioned in 2019 to be the last new coal plant for TENAGA. Based on this, it will see its coal-generated revenue falling to 20% by 2025 from 24% currently while RE revenue would increase to 10% from 4% currently.

Gas utility remains resilient. Both PETGAS (MP; TP: RM16.97) and GASMSIA (OP; TP: RM2.91) have continued to report resilient earnings before and after the pandemic given the IBR framework which safeguard their earnings. In fact, GASMSIA’s 4QFY20 results beat expectations on the recognition of revenue cap adjustment for full-year FY20 as COVID-impacted demand volume dipped slightly by 0.6% in 2020. Nonetheless, demand growth in 4QFY20 had already normalised back to pre-COVID level. Meanwhile, while PETGAS’s RP1 base tariff will remain unchanged over 2020-2022, the quarterly reviewed gas selling price will affect GASMSIA’s retail margin mildly which is 1% based on selling price but margin spread ex-retail margin remains at RM1.80/mmbtu-RM2.00/mmbtu. The latest average gas selling price of RM22.14/mmbtu in 1QCY21 is 34.2% or RM11.51/mmbtu lower than the average gas selling price of RM33.65/mmbtu in 2020. This would impact GASMSIA’s FY21 earnings by RM12m or 6%. Nonetheless, our total margin spread assumption of RM2.10/mmbtu is fairly conservative. Going forth, we see little earnings risk for both stocks for the next three years on RP1 base tariffs for their regulated business. Meanwhile, oil & gas outfit UZMA (OP; TP: RM0.83) was granted two licences from the EC which allows it to import and distribute LNG in Malaysia under the TPA system. While this could help to diversify its earnings stream, these licences are not exclusive as utility players like TENAGA and GASMSIA were also granted such licences from the EC. TENAGA had the country’s maiden LNG trial cargo shipped under the TPA in Oct 2019. This was one and the only time TENAGA had imported LNG into the country while GASMSIA has not imported any so far. In our opinion, shippers require constant and bulk volume off-take in order to make such import economically viable which is not easy.

Improved prospects for IPPs. While earnings for IPPs are supposed to be fairly stable which was covered by the PPAs, MALAKOF (OP; TP: RM1.05) reported yet another disappointing 4QFY20 results which was hit by unplanned outage at TBE which extended from 3QFY20. Nonetheless, with the completion of the forced outage work at TBE, and KEV losses eliminated since 1QFY20, earnings volatility is fairly low here forth taking it back to concession-type stable earnings mode. Meanwhile, YTLPOWR’s (MP; TP: RM0.72) 2QFY21 results beat estimates, boosted by 2nd quarterly surprise from PowerSeraya as it remained in the black after a turnaround in the preceding quarter which seems sustainable with the improved business environment there. In addition, with the yet to be completed Tuaspring acquisition, it will help PowerSeraya capture more from the value-chain from generation to wholesale to distribution for better profit margin and we expect PowerSeraya to turn profitable going forward. However, its mobile unit is expected to remain loss-making, Wessex Water’s weaker earnings on new rate structure coupled with the local IPP’s Extension PPA contract expiring June this year, YTLPOWR’s near-term earnings are set to be lacklustre until earnings from its new assets - greenfield power plant in Jordan and the acquisition of Tuaspring, kick in. Meanwhile, despite a seasonally weak quarter, PESTECH (OP; TP: RM1.46) reported 2QFY21 core profit which rose 5% QoQ to RM17.4m which met expectations, owing to higher construction profit from BT concession asset. Going forth, the delayed claim in 2HFY20 will be pushed forward to FY21 and together with BT construction profit, this should lead earnings higher.

Defensive is key quality; OVERWEIGHT maintained. In these uncertain times, the Utilities sector is a good investment avenue given their earnings defensiveness coupled with above average dividend yield of 4%-7%. The resilient earnings of TENAGA, PETGAS and GASMSIA are regulated under the IBR framework which fortified their 4% dividend yield while IPPs MALAKOF and YTLPOWER’s earnings are backed by PPA and new assets helping to bridge earnings gap as certain old IPP assets are expiring. These IPPs also offer attractive dividend yields of >6%. Meanwhile, niche utility infrastructure play PESTECH offers an exciting growth story in Cambodia coupled with promising rail electrification contract flow in the region. TENAGA remains as our TOP PICK for 2QCY21 for its cheap valuation coupled with resilient earnings. In addition, after a hit by COVID-19 impact of RM1.13b in 2QFY20 and 3QFY20, TENAGA earnings are set to be normalised in FY21.

Source: Kenanga Research - 2 Apr 2021