In this uncertain time, the Utilities Sector is still a good investment avenue for investors looking for defensive earnings with decent yield incomes. Even during this pandemic time, utilities players are still producing resilient earnings thanks to regulated/concession mechanism that also ensures sustainable dividend payout. TENAGA is entering a new RP3 in 2022 which based on past trend should see a lower rate of return but is unlikely to affect its earnings negatively given the growing RAB value. Meanwhile, gas utilities PETGAS and GASMSIA are in their final year of RP1 and we still expect resilient earnings even in the coming RP2. On the other hand, 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. In all, we continue to rate the sector an OVERWEIGHT for the players’ defensive earnings.

Power utilities’ RP3 is likely to be at lower rate of return. Despite effort to address the ESG issue, TENAGA (OP; TP: RM11.41) saw its share price falling to 52-week low again recently as foreign funds turned net seller again, after merely two months of net buying in Aug and Sep, as overall market sentiment turned negative again. Nonetheless, besides expanding its RE portfolio, aiming to reduce its dependency on coal-fired plants by 50% capacity by 2035 before being coal-free by 2050, TENAGA continues to demonstrate its earnings resiliency which is backed by the IRB framework even during this COVID-19 period. 2022 will be under a new RP3 for three years until 2024. We expect a potentially lower rate of return for RAB based on past record in RP1 and RP2. However, even so, this is unlikely to affect its regulated asset’s earnings negatively given that value for RAB would increase yearly in view of new annual capex each year. As such, regulated business earnings in RP2 were higher than RP1 although rate of return reduced to 7.3% from 7.5%. This leads us to believe TENAGA’s earnings will remain resilient in the future as long as IBR is in place.

Gas utilities are in final year of RP1 in 2022. Similarly, both PETGAS (MP; TP: RM17.02) 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 solid results in this RP1 period which started in 2020, attributable to stronger-than-expected margin spread partly due to new retail margin. This is despite lower sales volume on revenue cap adjustment to make up the shortfall in sales volume under the IBR framework. On the other hand, PETGAS also registered fairly consistent earnings over the same period. As such, both PETGAS and GASMSIA are still expected to report resilient earnings with minimal impact from the one-off prosperity tax in the last year of RP1 in 2022. Having said that, the expected step-down tariff rate in RP2 over 2023-2025 for PETGAS would face earnings downside risk. However, a new RM541m gas pipeline project to cater for an IPP in Pulau Indah by 1QFY23 and the RM460m gas compressor station project in Kluang by 1QFY24 should add new value to its already aging book value to improve profitability as these assets are mostly 20-30 years old assets with low carried value. Similarly, the market liberalisation for gas market which starts Jan 2022 may normalise GASMSIA’s margin spread from high margin that experienced in 2QFY21-3QFY21. Nonetheless, we still expect GASMSIA’s total margin spread to maintain at RM2.20/mmbtu.

Continue to see stable IPPs earnings in 2022. Apart from a mild impact on MALAKOF (OP; TP: RM1.01) arising from the one-off prosperity tax, both IPPs MALAKOF and YTLPOWR (OP; TP: RM0.89) will continue to see its stable earnings extending into 2022 and beyond. This was demonstrated in 2021 after MALAKOFF reported normalised local IPP earnings in 2021 from planned and unplanned outages in 2020 while YTLPOWR reported three upbeat quarterly results out of four results in the past year due to the turnaround of PowerSeraya on improved business environment in Singapore and continued narrowing losses from YES as higher subscribers base boosted economies of scale. Nonetheless, MALAKOF will still need to build up new assets to bridge earnings gap as its 75%-owned 640MW GB3 will see its PPA expiring in Dec 2022 while Prai Power’s PPA will end in Jun 2024. On the other hand, YTLPOWR’s acquisition of Tuaspring has not been completed yet, while green-field Attarat Power Plant in Jordan is still pending COD and PT Jati Power Plant in Indonesia is still working on its financial close. Meanwhile, PESTECH’s (OP; TP: RM1.11) key projects namely ODM and Tatay projects in Cambodia, and MRT locally are advancing to higher stages which mean overall better margins in FY22. Going forth, current order-book of RM1.58b will keep them busy for the next 2-3 years. We still like the stock as a niche utility infrastructure play.

OVERWEIGHT for its defensive earnings. In this uncertain time, the Utilities Sector is a good investment avenue given their defensive earnings which is proven during this difficult on-going pandemic period, thanks largely to their regulated business environment. This also helped sustain their above average yield of 4%-7%. So far, earnings of TENAGA, PETGAS and GASMSIA, which are fairly resilient, are regulated under the IBR framework 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. Meanwhile, niche utility infrastructure play PESTECH offers an exciting growth story in Cambodia coupled with promising rail electrification contract flows in the region.

Source: Kenanga Research - 28 Dec 2021