We still believe that the Utilities Sector is a good investment avenue for investors looking for defensive earnings with decent yield incomes. The players have so far demonstrated resilient regulated/concession earnings during this pandemic period which also ensure sustainable dividends of 4-7%. TENAGA is completing its RP2 term this year end while PETGAS and GASMSIA are at half way of RP1 and all have showed consistent and resilient earnings. Meanwhile, prospect for YTLPOWR has turned brighter with the turnaround of PowerSeraya and YES’ losses narrowing. MALAKOF also saw the normalisation of IPP earnings with planned outages fully completed and its new asset Alam Flora fuelling new growth. On the other hand, after registering a good set of FY21 results, PESTECH’s order-book of RM1.8b will keep it busy for the next 2-3 years. In all, we continue to rate the sector an OVERWEIGHT with TENAGA remaining as TOP PICK for its undemanding valuations and defensive earnings.

TENAGA’s green journey. In the latest quarterly briefing, TENAGA (OP; TP: RM11.80) has revealed details of increasing its RE assets to 8,300MW by 2025 from 3,406MW currently, with RE making up 10% group revenue from 5% currently. Of 4,894MW expansion capacity, 97% of these are from two geographical areas, UK/Europe and Southeast Asia with only 361MW expansion locally. Meanwhile, our stress test shows that the RM6.5b RE expansion plan will not dent its balance sheet as its gearing is still at comfortable levels of 45-46% throughout FY22-FY25, well below its optimal level of 55%. On the other hand, TENAGA has also committed to reduce its dependency on coal-fired plants by 50% capacity by 2035 before being coal-free by 2050. We believe these commitments are achievable, based on the PPA expiration schedule of coal-fired plants. Overall, we are positive on these plans which help to address the ESG issue which has pressured its share price in the past year. Meanwhile, foreigners turned net buyers for the first time in 21 months in Aug with net buying of RM154m and this was continued into Sep with net buying of RM107.2m as at 28 Sep. But, we reckon that this is still too early to conclude that the foreigners are finally coming back to buy this index-link heavyweight stock. On the other hand, the latest foreign shareholding fell below the 12%-mark for the first time in Jul at 11.92%

Gas utilities defensive earnings remain. With the RP1 at half-time, PETGAS (OP; TP: RM17.06) and GASMSIA (OP; TP: RM3.00) have so far demonstrated earnings resiliency even during this pandemic period, thanks to the IBR framework which safeguards their earnings. In fact, GASMSIA reported an impressive 2QFY21 set of results with core profit rising 12% sequentially to RM62.3m, which beat our forecast, albeit sales volume fell 2%, on stronger-than-expected margin as opposed to our conservative margin assumption. The fall in sales volume was due to MCO 3.0 lockdown but with revenue cap accrual in 2QFY21 which could avoid a lumpy 4Q in the future. On the other hand, despite core profit contracting 21% QoQ to RM438.6m on higher opex across all business segments, PETGAS’ 2QFY21 results still met expectations. 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 non-regulated 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. Given the stronger-than-expected margin, we have raised our total margin spread to RM2.20/mmbtu from RM2.10/mmbtu previously. Going forth, we see little earnings risk for both stocks for the next 1.5 years on RP1 base tariffs for their regulated business.

Better IPPs earnings. In the past few years, MALAKOF (OP; TP: RM1.06) and YTLPOWR (OP; TP: RM0.89) have been reporting sluggish results as the former was hit by unplanned outages while the latter was pressured by losses from PowerSeraya and YES. However, MALAKOF saw its 2QFY21 net profit almost doubling sequentially to RM117.7m which beat expectations, owing to better than expected earnings from Alam Flora and associate, while local power earnings have normalised from planned and unplanned outages in the prior four straight quarters. On the other hand, YTLPOWR reported three straight quarters of results that beat expectations due to the turnaround of PowerSeraya since 1QFY21 coupled with continued narrowing losses from YES. With two wildcards, PowerSeraya and YES managing to consistently post substantially improved results in the past year, this may suggest that the worst could be over as the improvement from the Singaporean power producer seems sustainable given 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, we still need to see more consistency from local IPPs as MALAKOF only reported its first upbeat results after three straight weaker quarters. Meanwhile, PESTECH (OP; TP: RM1.39) also reported a solid 4QFY21 results with core profit jumping almost 3-fold to RM31.2m which topped our forecasts given the higher-than-expected profit margin arising from advanced stage job claims as well as lower taxation on exemption. Going forth, its outstanding order-book of RM1.82b will keep them busy for the next 2-3 years. We still like the stock as a niche utility infrastructure play.

Defensive earnings; OVERWEIGHT affirmed. In the past one and a half years during this difficult on-going pandemic period, the utilities players have demonstrated earnings defensiveness, thanks to their regulated business environment. This also makes their above average dividend yield of 4-7% sustainable. So far, earnings of TENAGA, PETGAS and GASMSIA, which are fairly resilient, are regulated under the IBR framework which fortifies their 4% dividend yields while IPPs MALAKOF and YTLPOWR’s earnings are backed by PPA with new assets helping to bridge earnings gap as certain old IPP assets are expiring. YTLPOWR’s PowerSeraya and YES have shown improving results which signal brighter earnings prospects while MALAKOF had also completed its planned outages, hence offering better earnings certainty. Meanwhile, niche utility infrastructure play PESTECH offers an exciting growth story in Cambodia coupled with promising rail electrification contract flows in the region. TENAGA remains our TOP PICK for the sector given its cheap valuation coupled with resilient earnings.

Source: Kenanga Research - 30 Sept 2021