Macquarie Equities Research (MQ Research) reduced its target price (TP) on Tenaga by 20% to RM12.20 (16% above yesterday’s close) and cut its 2020/21/22E core profit estimates by 16.0%/8.7%/-5.5% respectively due to Tenaga’s update on the delayed split in its generation and regulated businesses. Nonetheless, MQ Research maintains an Outperform rating and foresees that the split would take place in 2021/22 vs Tenaga’s 2-3-year timeline as stated in its 3Q20 results.
 
Key points

• Delayed split set to hurt shareholdings and valuations; MQ Research ascribes 20% environmental, social and governance (ESG) discount to previous 15x price-earnings based target for generation ops split.
• RM33bn international renewable energy asset target doesn’t change dividend theme.
• MQ Research cuts 2020/21/22E core profit -16.0/-8.7/-5.5%; TP cut 20% to RM12.20.

 
Event

• Management’s clarification that it will take Tenaga 2-3 years to physically split its generation and regulated businesses suggests that the combined entity will continue to attract an ESG discount until the exercise is completed. In the meantime, efforts to right-size its under-leveraged balance sheet should see special dividends supporting overall dividend yields, at 6.5%, even as Tenaga embarks on a 5-year strategy to expand its international renewable energy (RE) exposure to 5GW. MQ Research maintains Outperform recommendation on Tenaga, albeit with a reduced price-to-earnings ratio (PER) derived price target of RM12.20, as MQ Research incorporates a 20% ESG discount to its target PER (previously 15x).

 
Impact

• ESG drag to persist. Delays in separating its generation operations – as management awaits capital allowances for two hydro plants and the debt novation of a gas plant – will prolong ESG-related discounts placed on its shares, in MQ Research’s view. MQ Research has ascribed a 20% PER discount to its previous target PER of 15x to account for this, resulting in a target market cap of RM69bn. A separation of the generation business from the “ESG friendly” regulated business would, in MQ Research’s view, allow for a combined value of RM87bn based on regional peer valuations for generation and transmission & business (T&D) businesses. There has been a clear underperformance of power sector players with exposure to thermal coal vs their “cleaner” peers. MQ Research expected this split to take place in 2021/22 vs management’s 2-3-year timeline stated during 3Q20 results.

• RE push doesn’t change capital management thesis. Management’s aim of 5GW of international renewable energy (RE) capacity, worth RM33bn, contributing RM2bn in earnings before interest and taxes (EBIT) by 2025, does not change MQ Research’s thesis around Tenaga returning excess capital to shareholders – and helps its ESG situation. Assuming a 50% equity stake in these projects, with 70% debt funding, the cash outlay would be RM5bn over the period. Given the competition in RE, achieving this aim will not be easy.

 
Earnings and target price revision

• MQ Research reduces its core profit 20/21/22 estimates by 16.0/8.7/5.5% on lower subsidiary revenues and higher opex and net finance costs. TP cut by 20% to RM12.20 on a lower target PER (15x to 12x) as we roll forward to 2022E.

 
Price catalyst

• 12-month price target: RM12.20 based on a PER methodology.

• Catalyst: Special dividends to be announced with 4Q20 results in Feb 21.

 
Action and recommendation

• Maintain Outperform, with an implied 24% total shareholder return (TSR).

 
12-month target price methodology

• TNB MK: RM12.20 based on a PER methodology