• TNB Sepang Solar (TSS) successfully reached COD in 2018

• Estimated to generate low-teens IRR

• LSS2 project located up North with better irradiation levels

• LSS3 could entail stiff competition but larger packages help

• Re-affirm BUY at unchanged TP of RM14.40

Tenaga hosted a visit to its LSS1 plant, TNB Sepang Solar yesterday. Below are key takeaways from the visit;

Background of TNB Sepang Solar. TNB Sepang Solar (TSS) is a wholly owned unit of TNB Renewables, which in turn is a wholly owned unit of Tenaga. Other wholly-owned units under TNB Renewables include Tenaga Bukit Selambau Solar (Tenaga’s LSS2 SPV) as well as GSparx. To recap, Tenaga via TSS won the LSS1 bid to build and operate a 50MW solar plant at a 243acre site in Kuala Langat (leased from Tenaga at market rates) under a 21-year PPA. TSS entails maximum capacity of 78MWdc (50MWac) with agreed annual output of no less than 95,134MWh. The plant reached COD recently in Nov18. TBS entails some 243,000 solar PV modules (double glass 325w polycrystalline), 24 inverters and 2 step-up transformers. Connection to the grid injection point at Bukit Changgang is quite far at 11.7km away, but Tenaga utilises higher voltage cables (132kv) to minimise power loss (performance ratio of TSS is 80%). However, distance to the grid and size/quality of cables used affects capex - we estimate ~RM1m/km capex for cables, excluding costs for Right of Way.

Capex. While actual capex detail was not forthcoming, we estimate TSS to have incurred capex of around RM5.5m-RM6m/MW (or a total of RM275m-RM300m) as the project cost was locked in circa 2016. We expect costs to have come down since then to around RM3m-RM4m/MW now and this should be reflected in LSS2 (TNB Bukit Selambau) or LSS3 projects depending on when the costs are finalised.

Different vs traditional PPAs. The difference versus the traditional PPA is that LSS operators are on full energy payment (i.e. no capacity payment) and there is a penalty imposed if output falls short of the agreed output by more than 30% - this is reviewed on annual basis. On the other hand, excess production is sold to the SB (Single Buyer) at a much lower tariff (our checks suggests rates of <10sen/kwh, vs LSS 1 average tariff bid of 43sen/kwh, including 30MW packages). However, any excess production is already a bonus to TSS.

Relatively high capacity factor. TSS is currently able to generate 4 to 4.5 hours/day, which is a relatively good production rate. Irradiation however, is perhaps at the mid-point (in the country) as the area entails irradiation levels of 1668kwh/sqm/year compared to ~1800kwh further north of Peninsular Malaysia. To give another comparison, parts of the Middle East entail irradiation levels of up to 2200kwh.

Financing is a critical factor. TSS secured project financing from Affin. Though rates, tenure or debt-to-equity ratio were not revealed, we think finance rates (in 2016-2017) could be in the range of 8% with tenure ranging around 15 years. At the mean LSS1 bid rate, we estimate low-teens IRR for the project, but these levels of returns are unlikely to sustain for LSS2 projects in general, based on our checks. Finance rates are critical factors in determining tariffs for solar projects given most of cost is driven by capex. The majority of opex for a solar plant goes towards O&M (operation and maintenance), with another 10% going towards insurance and the rest for licensing requirements.

Risk factors. Risk factors are managed pretty well. The solar panels which are sourced from China (which is ~20% cheaper than local panels) comes with a 25 year product warranty and a 10 year performance warranty – guaranteed panel degradation limit of 0.5%/annum. Meanwhile the EPCC (TNB Engineering Corporation for TSS) provides a 2 year guarantee. The imported solar panels entail only slightly lower efficiency compared to locally-made ones i.e. circa 1%-2% lower watt/panel.

More favourable location for LSS2. TNB Bukit Selambau (TBS, won under LSS2, COD in Dec20) will be located further north of the country in Kedah, which entails better irradiation levels of ~1800kwh/sqm/year. Though we would expect better production, mean bid for LSS2 had come down to around 39sen/kwh. While some of these came from lower cost, due to competition, we estimate returns in the high-single digit for LSS2 projects. We also expect TBS finance rates to be lower, sourced from foreign financiers.

Increased competition for LSS3? For LSS3 (total package 500MW), we understand some 350 tender documents have been accepted by the regulators with increased competition from foreign players such Marubeni and Kepco. However, LSS3 entails much higher package limits i.e. maximum 100MW/project vs. 30MW for LSS2 and 50MW for LSS1, which can help bring down costs. Our channel checks suggest Tenaga could be looking at a potential site in Kedah for its LSS3 bid. Finance rates should have come down to less than 8% now and there is the option of issuing Green Sukuk for financing.

Recommendation. Re-affirm BUY on Tenaga at unchanged TP of RM14.40. Key catalysts: (1) Decent dividend yields of 4% while valuations are cheap at 12x FY19F earnings relative to the market’s 16x-17x. (2) Peaking capex suggests room for dividend upside or possible acquisitive growth (3) Monetisation of backbone fibre asset.

Source: MIDF Research - 19 Jul 2019