• Tenaga and IRB agreed to substitute judicial review on its RM2.1b tax dispute with an appeal to the SCIT

• In worst case scenario that Tenaga fails in the appeal, our valuation is impacted by just 4%

• At current depressed share price, we reckon much of the negatives surrounding the issue have largely been priced in

• Re-affirm BUY at unchanged TP of RM16.80/share

Agrees to settle tax dispute. Tenaga and the Inland Revenue Board (IRB) have agreed to settle the dispute over its RM2.1bil tax bill. Tenaga will instead file an appeal to the Special Commissioners of Income Tax (SCIT) to state its case for qualifying for the Reinvestment Allowance (RA). Tenaga and the IRB had basically entered into a consent judgement before the Kuala Lumpur High Court to substitute the judicial review proceedings on the tax dispute by filing the appeal. The consent judgement also provides that the IRB will not commence any proceedings until the matter is determined by the SCIT and the High Court on a subsequent appeal. The SCIT is an independent tribunal which consists of panel members appointed by the Yang Dipertuan Agong to handle tax appeals.

As a recap, Tenaga received notices of additional assessment in the amount of RM986m and RM1b for years of assessment 2013 and 2014. The total RM2.1b amount includes a penalty of RM600m for both years of assessment. The additional tax assessment followed IRB’s decision to disallow Tenaga’s reinvestment allowance claim (which it had earlier approved in Jan13) on the grounds that Tenaga is not in the business of manufacturing. Our chat with Tenaga previously suggests that the IRB then was only focusing on Tenaga’s distribution unit when it came about the decision, and not Tenaga’s generation unit. To strengthen Tenaga’s argument, there was also a precedent case in Northern Malaysia which determined Tenaga as a manufacturer.

Minor impact in worst case scenario. Nevertheless, in the worst case Tenaga fails in its appeal, the RM2.1b additional tax is equivalent to 37sen/share or 2.2% of our RM16.80 TP. The impact of tax rates normalising in subsequent years (up till FY17F, which is when we assumed the existing RA will expire and revert to a normalised tax rate of 20%-21%) will take out another 30sen/share off our valuations, i.e. another 1.8% impact to our TP. So all in, the worst case scenario means our TP will be cut by 4% to RM16.10 from RM16.80. Even at RM16.10, Tenaga would still remain a BUY against its depressed share price of RM14.00 currently.

Recommendation. We keep our BUY on Tenaga at unchanged TP of RM16.80 for now. We like Tenaga for: (1) Dividend catalyst on the back of FCF yield of ~7% over FY16F/17F, a relatively under-geared balance sheet at 0.35x and the upcoming capital optimisation exercise, (2) Overseas expansion provides scope for stronger growth in the mid-term, and (3) Strong earnings visibility post-ICPT implementation. Capital management and the favourable resolution of its RM2b tax issue with the Inland Revenue Board are key catalysts over the next 12 months. Finally, 4% dividend yield looks attractive.

Source: MIDF Research - 8 Dec 2016