• 1QFY17 not as weak as expected

• Lag in impact of coal price uptrend and resilient demand

• Government might utilise PPA savings to offset impact on tariff but this is a finite amount

• Re-affirm BUY at unchanged DCF-derived target price of RM16.80/share. 4% yield is attractive

Earnings not as weak as expected. Tenaga reported core net profit of RM1.97b for its 1QFY17. This is broadly in line with expectations accounting for 28% of our FY17F earnings and 27% of consensus. The group’s earnings were not as weak as expected but we think earnings over the next two quarters could start reflecting the impact of higher fuel cost. Tenaga’s 1QFY17 earnings were only 3% lower year-on-year while revenues were up 5%yoy on the back of a healthy 3.6%yoy demand growth, mainly from the commercial (+7.3%yoy) and domestic (+6.1%yoy) segments while the industrial segment recorded a marginal 1.1%yoy contraction. Average tariffs remained largely flat.

Lag impact from higher coal price. A key reason for the stronger than expected 1QFY17 was a circa 2-month lag in the impact of higher spot coal price as Tenaga runs down cheaper inventories. Coal cost consumed in Sep/Oct/Nov 2016 was USD52 / USD57 / USD62 compared to spot price which was already USD60/mt levels in Sep 2016. The higher coal price will eventually filter into Tenaga’s earnings in the next quarter on top of the impact of higher piped gas price form Jan 2017, and as such, we retain our forecasts. On a positive note, spot coal price has eased to around USD63-64/mt from the peak of USD88/mt seen in November 2016. Our FY17F has already factored in an 8% contraction to reflect the lag in passing on the additional fuel cost to consumers.

PPA savings is finite. While there is the possibility of Tenaga turning into an under-recovery position given that the high coal price comes together with a weak RM, the ICPT allows Tenaga to seek a review on the current ICPT rebate (of 1.52sen/kWh), which is likely to turn into a surcharge at current coal price and forex. However, if the Government decides to utilise the remaining RM1.4b in PPA savings to buffer the impact on tariffs, our forecasts could be trimmed slightly. Note however that the PPA savings is a finite RM1.4b amount and if fuel prices continue to remain elevated, tariffs will eventually be adjusted upwards, regardless. If fuel price and forex stays at current levels, we estimate Tenaga will turn into an under-recovery position of ~RM800m vs. the RM1.4b PPA saving and an over-recovery of RM766m in the last review.

Recommendation. We re-affirm our BUY call on Tenaga at unchanged DCF-based TP to 16.80/share for now with potential upside bias from this acquisition. We like Tenaga for: (1) Dividend catalyst on the back of FCF yield of ~7% over FY17F/18F, a relatively under-geared balance sheet at 0.35x and Tenaga’s capital optimisation exercise (2) Overseas expansion provides scope for stronger growth in the mid-term (3) Strong earnings visibility post-ICPT implementation. Capital management, M&As and the resolution of its RM2b tax issue with the Inland Revenue Board are key catalysts over the next 12 months.

Source: MIDF Research - 25 Jan 2017