Utilities Sector is still a good investment avenue for its defensive quality given resilient regulated/concession earnings profiles which is proven during this pandemic period. Besides, the resilient earnings also ensure sustainable dividends from the players. Recently, we have upgraded PETGAS to OP following recent share price weakness while we turned positive on YTLPOWR after it reported profits for three straight quarters from PowerSeraya which could suggest that the worst is over from this Singapore unit while YES also registered consistent improving numbers on economies of scale. In all, we continue to rate the sector an OVERWEIGHT with TENAGA remaining as TOP PICK for the sector for its undemanding valuations and defensive earnings.

OVERWEIGHTing the sector for earnings defensiveness. In this difficult on-going pandemic period which has already lasted for more than a year, the Utilities industry players have proven their defensiveness, thanks to their regulated business environment. This makes their above average dividend yield of 4-7% sustainable. So far, the resilient earnings of TENAGA (OP; TP: RM11.76), PETGAS (OP; TP: RM17.06) and GASMSIA (OP; TP: RM2.91) are regulated under the IBR framework which fortifies their >4% dividend yield while IPPs MALAKOF (OP; TP: RM1.05) and YTLPOWR (OP; TP: RM0.90)’s earnings are backed by PPA with 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 (OP; TP: RM1.39) offers an exciting growth story in Cambodia coupled with promising rail electrification contract flow in the region. TENAGA remains our TOP PICK for the sector given its cheap valuation coupled with resilient earnings.

TENAGA is still attractive. Despite actively pursuing to expand its renewal energy (RE) portfolio which is to address ESG concerns, TENAGA’s share price has continued to come under pressure with foreign shareholding sliding to a 9-year low at 12.3% in end-Apr. This is despite its earnings resiliency as the COVID-19 financial hit last year is unlikely to be repeated this year. To recap, TENAGA reported a total of RM1.13b COVID-19 financial impact in 2QFY20 and 3QFY20 while we have imputed a RM500m charge of COVID-19 impact in 1HFY21 in our forecast. And, there was no COVID-19 impact in 1QFY21 but there will be likely a small RM13m contribution by way of tariff discount in the upcoming 2QFY21 which means our FY21 estimates is fairly conservative. Thus, the stock trading at 2.5SD below its 3-year mean is unwarranted, in our opinion. In addition, our target price of RM11.76 is already embedded with the ESG discount of RM2.82 to its mean valuation of RM14.58, which values the stock at -1.5SD to its 3-year mean. Nonetheless, the ESG concerns will continue to plague TENAGA until it builds enough RE assets to address the issue. So far, TENAGA has pledged not to invest in greenfield coal plant while target to expand its RE assets, including large hydro to 8,300MW by 2025 from 3,398MW currently.

Gas utilities earning remains resilient. Unlike power utilities TENAGA which requires providing COVID-related discount, PETGAS and GASMSIA have showed that their earnings are resilient even during this current on-going pandemic period given the IBR framework which safeguards their earnings. In fact, both companies reported solid 1QFY21 results with PETGAS’ core profit of RM554.3m beating expectations slightly on the back of continued cost rationalisation and interest cost savings from the capital restructuring exercise; while despite a seasonally low quarter, GASMSIA’s core profit rose 16% YoY to RM55.6m owing to a 9% hike in total gas sales volume. These two solid sets of results were the continuation of resilient FY20 results under the RP1 period and will remain till the end of RP1 in end-2022. While earnings growth for regulated business is unexciting, there are growth from nonregulated business to add value such as GASMSIA’s retail margin and PETGAS’ cost rationalisation exercise to enhance profit margin. Meanwhile, PETGAS has started to see good results from the cost rationalisation exercise in the recent quarterly results. The new RM541m gas pipeline project to cater for an IPP in Pulau Indah should be a new earnings growth avenue in RP2 when the project is ready in 1QFY23. On the other hand, the quarterly reviewed gas selling price will affect GASMSIA’s retail margin mildly which is by c.1% based on selling price but margin spread ex-retail margin remains at RM1.80/mmbtu-RM2.00/mmbtu. Going forth, we see little earnings risk for both stocks for the next 1.5 years on RP1 base tariffs for their regulated business.

YTLPOWR’s prospects turning positive. As opposed to supposedly stable IPP earnings, both MALAKOF and YTLPOWR reported sluggish results in the past few years as the former was hit by unplanned outages while the latter was pressured by losses from PowerSeraya and YES. However, the turnaround at PowerSeraya for three straight quarters could suggest that the worst could be over as the improvement from the Singaporean power producer seems sustainable give the improved business environment there. In addition, YTLPOWR also saw narrowing losses from YES as higher subscribers base boost economies of scale. On the other hand, MALAKOF registered three straight weaker quarters which was weighed down by both planned and unplanned outages that mitigated new earnings from Alam Flora and additional stake in Shuaibah. Having said that, both IPPs still need new asset to address their earnings gap caused by expiring old IPP assets. So far, YTLPOWR’s acquisition of Tuaspring is still yet to be completed while the two green-fields assets, 45%-owned 554MW oil shale-fired Attarat Power Plant in Jordan is delayed from the scheduled COD in June 2020 on lockdown and the 80%-owned 3x660MW coal-fired PT Jati Power Plant in Indonesia is still working on its financial close. Meanwhile, PESTECH’s 9MFY21 core profit of RM41.2m fell short of our forecast which was distorted by higher-than-expected MI. However, at PAT level, the earnings were fairly on track. Going forth, its outstanding order-book of RM1.92b will keep them busy for the next 2-3 years. We still like the stock as a niche utility infrastructure play.

Source: Kenanga Research - 1 Jul 2021