• PPA savings to rise to RM1.7b by Dec17

• Shortfall in capex spend will be carried over into RP2

• Market price looks to have factored in worst case scenario

• Re-affirm BUY at unchanged DCF-derived target price of RM16.80/share

We met up with Tenaga’s management yesterday. Below are key takeaways from the meeting: More PPA savings to be accumulated. Based on scheduled accumulation, PPA savings up till Dec17 should be around RM1.7b versus the RM1.4b accumulated up till end 2QFY17 (FYE Aug). The savings originate from the renegotiation of first generation PPAs which will be accumulated up till December 2017. Currently, Tenaga is still booking in the higher, old rates in its P&L and the difference is accounted for as amounts payable to the Government. After Dec17, Tenaga will start booking in the lower, new rates and as such will stop accumulating the PPA savings.

On the allowable returns. Tenaga is of the view that the upcoming IBR review which will coincide with the end of the current ICPT period will reflect the current fuel cost and forex rates. On allowable returns, Tenaga admits that its cost of debt of 4% is lower than the 6% stipulated in the IBR – this was partly driven by a bullet repayment of one of its USD debt which carried high interest rates. However, the IBR allows rewards for efficiency, including financial efficiency. From a different (and opposite) perspective, Tenaga’s debt to equity is actually lower than the stipulated 55% in the IBR (which effectively increases its actual WACC), and in this case, Tenaga’s profit is technically deflated against the actual assumptions in the IBR. Nonetheless, as we had argued in our previous sector report, share price has already more than reflected the worst case scenario of allowable ROAs falling to 6.5%-7%.

Any shortfall will be carried over. On concerns in the market that Tenaga is falling behind in capex spend relative to the IBR forecast of RM23.3b over the RP1 (Regulatory Period 1), Tenaga is catching up. But in a scenario where it falls short, the shortfall in capex spend will be rolled over into RP2, which is in addition to the underlying capex already planned for the RP2.

Source: MIDF Research - 6 Jul 2017