• 1Q18 earnings in-line, seasonally strong margins
• Sufficient EIF to cover surcharge, uncertain about rebates
• Stock has taken quite a beating, value emerging
• TP unchanged at RM16.30 but stock upgraded to BUY

Earnings in-line. Tenaga reported 1Q18 core earnings of RM2b This is within expectations accounting for 27% of both our and consensus’ FY18F respectively. This is the first FYE Dec quarterly reporting hence no yoy or qoq comparison was available.

Margins frontloaded. Operational cost and capex are seasonally lower at the start of the year, hence EBITDA margins were pretty strong at 34.4% in 1Q18. We see this normalising to a range of 30%-33% in the coming quarters.

Strong volume growth. 1Q18 volume growth of 2.3%yoy was in line with recent years’ trend. Demand from the industrial segment was particularly strong at +4.4%yoy in line with the country’s manufacturing performance. However unlike RP1, RP2 entails a revenue cap mechanism eliminating volume/effective rate excesses or underperformance against RP2 parameters. At this point however, adjustments have yet to be made as the revised regulatory guidelines and mechanism for this have yet to be finalised.

Sufficient buffer for 2H18. Besides opex savings in RP1 and PPA savings, the EIF (Electricity Industry Fund) also entails financial savings from underspent capex (RM1.5b variance against forecast capex) in RP1. The EIF fund is estimated to amount to RM1.5b. The 1H18 is expected to utilise RM929m to subsidise an ICPT surcharge of 0.28sen and a 1.52sen rebate. While the EIF is sufficient to cover an ICPT surcharge for 2H18, it is uncertain if the amount is sufficient to maintain the 1.52sen rebate (estimated at RM785m). Elimination of the rebate could raise effective tariff by 4%.

A dilemma. While we acknowledge that the new Government aims to be business friendly (hence IBR is likely to remain intact), at the same time, policies so far have been populist. It is uncertain if the new Government is willing to bite the bullet to raise tariffs less than a year of taking office. To strike a balance (in the case the current EIF is run down) we think the Government might assume the role of subsidising consumers (via its own contribution to the EIF fund perhaps), much the same way petrol is (planned to be) subsidised and similar to Government compensation to toll operators in the past if a scheduled rate hike is delayed.

Source: MIDF Research - 28 May 2018