• Core 1H18 earnings in-line, 30sen dividends declared

• Impairment for Gama, no cashflow impact

• Capex looks to have peaked, room for higher dividends

• Re-affirm BUY at higher TP of RM16.90

Earnings in-line. Tenaga reported 2Q18 core earnings of RM1.8b, bringing 1H18 core earnings to RM3.8b This is within expectations accounting for 52% and 53% of our and consensus’ FY18F. Given a change to FYE Dec reporting, no year-on-year comparison was available. An interim dividend of 30.27sen/share was declared. At 51% payout, this is at the higher end of Tenaga’s policy of 30%-60%.

Solid demand. Demand sale was strong in 2Q18 (+7.2%qoq, +3%yoy) and is likely to continue into 3Q18 having seen the industry hitting new peak demand in June (18,010MW) and again, in August (18,338MW). 2Q18 demand growth was across the board - domestic (+10%qoq), industrial (+5.6%qoq) and commercial (+7.5%qoq). Average tariff increased 0.5%qoq to 39.76sen/kwh; the excess earnings from higherthan-IBR reference tariff of 39.45sen/kwh will have to be returned yearend but is a negligible amount at this point.

But higher cost eats into margins. Although Tenaga’s revenue was up 2%qoq, EBITDA fell 16%qoq as margins were hit by: (1) Impairment for GAMA Enerji of RM206m, and (2) Provision for doubtful debt and delinquent accounts of RM170m. Excluding these, margins would still have been impacted by higher fuel cost (+2.7%qoq on per unit basis), and general expenses (See Exhibit 3). The latter is more seasonal in nature and generally picks up through the year while higher fuel cost should be reflected in 1H19 ICPT adjustments to compensate Tenaga.

Impairment for Gama Enerji. A RM206m impairment for the Tenaga’s carrying value of Gama was taken given sharp depreciation of the Turkish Lira (TRY) – valuations marked at USD:TRY of ~TRY4.6 (end-June rates). The TRY has depreciated further since then to USD:TRY6.55, which might suggest further impairment. These are merely accounting adjustments with no cashflow impact. Postimpairment, carrying value of Gama stood at RM600m-RM700m. Carrying value of Gama stood at RM961m at Dec17.

Forex loss. Associates registered a loss of RM93m in 1H18 with the bulk coming from Gama - driven mainly by forex losses as the bulk of Gama’s debt are USD debt. The weaker TRY now against end-June levels suggests further forex losses might be recognised. Gama is examining options to refinance some of its USD loan for more favourable terms. Overall associate contribution to bottomline is small at just 2%.

Underlying fundamentals look good though. Currency volatility factors aside, underlying fundamentals in the Turkey power sector looks good: (1) Decreasing reserve margins bodes well for merchant market pricing, (2) Consumption is outgrowing new capacity additions. Gama has been posting positive EBITDA in at least the past 5 quarters (See Exhibit 1).

Capex looks to have peaked. Tenaga’s capex in FY16/17 stood at RM11b/RM12b, whilst this year’s 1H18 capex stood at RM5.3b; comprising RM2b for generation capex and the rest (RM3b) for T&D recurring capex. Tenaga spends ~RM7b capex on T&D annually. With minimal new generation projects in the pipeline (and given the new Govt’s indication of already high reserve capacity), we think Tenaga’s capex (generation capex) is already past peak - most of the existing projects have progressed well as of 2Q18 (1) Jimah East 92% completed, (2) Sepang Solar (83%), and (3) SPG (41%). This suggests room for further growth in dividend payout.

Recommendation. We re-affirm our BUY call on Tenaga at a higher TP of RM16.90 (from RM16.30) as we rollover our valuations to FY19F. Key catalysts: (1) Solid dividend yields of 4.6% (+ve spread against 10yr MGS of 4.04%) while valuations are cheap at 12x FY18F earnings, a substantial discount to the market’s 16x-17x, (2) Peaking capex suggests possible further improvement in dividend payout, and (3) Possible monetisation of backbone fibre asset via a partner.

Source: MIDF Research - 3 Sept 2018