Recent weakness in both coal and gas prices to the tune of 20%- 25% off their recent peaks have confirmed lower Imbalance Cost Pass-Through (ICPT) receivables for the national utility company. This significantly eases its financing burden. We see value in TENAGA after the recent weakness in its share price. We maintain our forecasts and TP of RM10.00 (WACC: 7.1%; TG: 2%) but upgrade our call to OUTPERFORM from MARKET PERFORM.

Fuel costs easing. We believe fuel costs for both coal and gas have already peaked in 4QCY22. For example, the Indonesian benchmark coal price has retraced by 20% from the peak of USD330.97/MT in October last year to USD265.26/MT currently. Meanwhile, the latest Department of Statics Malaysia (DOSM) data showed that the price of LNG fell 25% in March to RM46.35/mmbtu from its peak of RM61.83/mmbtu in September 2022. (see charts in page 2)

ICPT receivables to decline accordingly. As fuel costs decline, TENAGA during its recent analysts briefing guided for a lower ICPT of RM12b for 2HFY23 from RM16.2b in 1HFY23. As a result, ICPT receivables are likely to decline to RM12b by 2QFY23 from RM16.9b in 4QFY22. These receivables will be fully recovered by TENAGA through the ICPT surcharge or direct payments by the government. For instance, the RM16.2b ICPT in 1HFY23 will be recovered via: (i) a 20 sen/kWh ICPT surcharge from non-domestic customers, and (ii) a RM10.4b payment from the government.

Borrowings to trend lower as well. As ICPT receivables decline, TENAGA’s borrowings are likely to decrease accordingly in the coming quarters. TENAGA’s borrowings rose to RM63.88b in FY22 from RM51.73b in FY21 as ICPT receivables surged to RM16.90b from RM4.78b over the same period. As a result, FY22A interest expense jumped 15% to RM4.34b from RM3.79b, previously. Assuming ICPT receivables will be RM4b lower for the entire year, this will result in interest cost savings of c.RM180m-RM200m to TENAGA in FY23.

Forecasts. Maintained, as we have reflected the downtrend in fuel costs in our forecasts. Having said this, over a longer period of time, the volatility in fuel costs has a neutral impact on TENAGA as the over or under-recovery of fuel costs will eventually be passed through to the end-user or the government within a 6-month time lag via the Incentive-Based Regulation (IBR) framework.

We continue to like TENAGA for: (i) its dominant position in power generation, transmission and distribution in Malaysia; (ii) its earnings defensiveness backed a resilient domestic economy and its assets that are largely regulated, and (iii) its heavyweight index-linked stock status. To address the concerns over its coal-fired power capacity, it will completely phase out coal-fired plants by 2045 from 48% gen-mix currently. It will repower certain retired coal plants using highly efficient combined cycle gas turbine (CCGT) with cleaner fuel, i.e., gas, and hydrogen-ready technology (green tech). At the same time, the group also has an aggressive expansion plan for its renewable energy business with installed capacity target of c.14GW by 2050 from 0.4GW currently.

We see value in TENAGA after the recent weakness in its share price. We maintain our forecasts and TP of RM10.00 but upgrade our call to OUTPERFORM from MARKET PERFORM.

Our TP is based on: (i) DCF model with a WACC of 7.1% and a TG of 2%, and (ii) a 5% discount to reflect a 2-star ESG rating as appraised by us (see Page 5). It also offers a decent dividend yield of >4%.

Risks to our recommendation include: (i) ballooning under-recovery of fuel costs, straining its cash flow, (ii) a global recession hurting demand for electricity, and (iii) non-compliance of ESG standards set by various stakeholders.

Source: Kenanga Research - 9 May 2023