• 1QFY18 within estimates

• RP1 earnings inflated by favourable customer mix

• “Bonus” regulated earnings not sustainable in RP2

• Downgrade to HOLD from BUY; TP trimmed to RM16.30

Within expectation. Tenaga reported earnings of RM1.8b for its 1QFY18, which was within expectations accounting for 27% of ours and 25% of consensus. Tenaga is changing its year end to Dec from Aug and as such will announce a Dec17 quarter result soon.

Result takeaways. Despite strong demand growth of 3.6% in the same time last year, 1Q18 demand grew by a further 1.2%. Operating earnings were flattish while net profit was down given higher finance cost, mainly from 51%-owned SPG’s (Southern Power Generation) Sukuk issuance for Project 4A.

Enjoyed “bonus” earnings in RP1. Average 1QFY18 rates achieved was 39.46sen/kwh against RP1’s base rate of 38.53sen/kwh given a more favourable customer mix than RP1 forecast (See Exhibit 2); industrial consumers are charged lower tariffs while commercial and domestic segments are charged higher. As the proportion of higher priced commercial and residential segment volumes were higher than forecast, Tenaga enjoyed “bonus” earnings in 1QFY18 and also for the most part of RP1 (2015-17). After getting more clarity from management on RP2, we see possibilities of negative earnings impact on Tenaga, in the sense that the “bonus” earnings explained above is unlikely to sustain into RP2. This is because the reference price in calculating Tenaga’s revenues for RP2 is based on the actual average tariff achieved at end RP1 which is 39.45sen instead of RP1’s 38.53sen.

Inflated earnings not sustainable. As such, while average allowable returns are higher for RP2 as we had argued previously (by circa 11% on our estimates given a higher asset base), the “bonus” earnings which inflated Tenaga’s profits in RP1 is unsustainable. Tenaga’s RP1 regulated earnings was inflated by the “bonus” earnings coming from higher than forecast average rates – average RP1 allowable return was RM3.4b/annum (7.5% WACC, average asset base: RM46b) but actual regulated earnings achieved is estimated to have been around RM4.4b given the more favourable average rates. Given the absence of the “bonus” earnings in RP2 (partly offset by higher RP2 allowable return of an average RM3.8b, 7.3% WACC, average asset base: 53b), we estimate Tenaga’s regulated earnings to be impacted by RM500-600m/annum or circa 7% per annum.

Source: MIDF Research - 29 Jan 2018