• 2QFY17 earnings within estimates

• Resilient demand despite higher fuel cost

• Dividends 70% higher year-on-year

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

Results within. Tenaga reported core earnings of RM1.6b for its 2QFY17 which brought 1HFY17 core earnings to RM3.9b (excluding RM469m of provision for receivables/inventories). This is within estimates accounting for 55% of ours and 52% of consensus’ FY17F. While the 1H results were at the high end of our numbers, average coal price should be higher for subsequent quarters while the 4Q entails seasonally weakest demand.

Solid dividends. Tenaga announced interim dividend of 17sen/share; 70%yoy increase and represents some 30% payout ratio (of 1H17 earnings). This underpins Tenaga’s capital management initiative which should see higher dividend payout vs. historical years on the back of a lean balance sheet (21% net gearing: 1HFY17). The 1H17 payout is at the lower end of Tenaga’s 30%-50% range and management will review this as the year progresses. Still, the lowest end of the current dividend policy is much higher than prior years’ sub-30% payout.

Would have been stronger if not for higher coal price. 2QFY17 core earnings were up 6%yoy on the back of a 6.4%yoy increase in revenue – driven by a 1% demand growth and a marginal increase in average rates achieved of 39.4sen/kWh. Fuel cost was higher, in particular coal – at USD70/mt CIF (+22%yoy). Coal contribution in the mix dropped to 50% in 2QFY17 from 54% in 1QFY17 due to coal plant outages but fortunately this was buffered by lower LNG price (-25%yoy) and lower gas consumption (-6%yoy). Associates turned in positive earnings growth, mainly driven by Tenaga’s associate stake in an IPP.

Resilient demand growth. Overall demand growth was resilient at +1% (2Q17) and +2.3% (1H17) though we think growth could taper off into 2HFY17 off a stronger base last year. Industrial demand finally showed positive growth (+1.3%yoy) in the 2QFY17 period while the commercial segment was also up by 1.3%. We conservatively stick to our forecast demand growth of 2% vs. actual YTD growth of 2.3% for the time being but note that Tenaga should ultimately benefit from higher production and trade numbers.

Recommendation. We re-affirm our BUY call on Tenaga at unchanged DCF-based TP to 16.80/share. 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, overseas expansion and the resolution of its RM2b tax issue with the Inland Revenue Board are key catalysts over the next 12 months. Tenaga is a liquid proxy to the GDP growth outperformance and stronger trade, but share price has yet to move meaningfully relative to the broader market. At just 11.6x FY18F PE Tenaga trades at a discount to sector average of 13x and the index’s 16x-17x.

Source: MIDF Research - 28 Apr 2017