• 2Q19 within expectations

• Associates returned to the black

• Strong demand growth domestically but unlikely to be sustainable; excess demand returned to consumers

• Following strong share price recovery, we downgrade Tenaga to NEUTRAL from BUY; TP unchanged at RM14.40

2Q19 within expectations. Tenaga reported 2Q19 core earnings of RM1.4b, bringing 1H19 core earnings to RM3b. This is within both our and consensus estimates accounting for 53.7% and 53.4% of FY19F respectively. Tenaga declared an interim dividend of 30sen/share slightly lower than 1H18’s 30.27sen/share.

Lower earnings year-on-year. Core earnings were lower (-22%yoy) given that Tenaga only started to reflect the annual revenue adjustment (ARA) on a quarterly basis from 1Q19, whereas in FY18, ARA was only recognised in the final quarter. Secondly, Tenaga’s reinvestment allowance (RA) has fully expired hence, higher effective tax rates in 1Q19 and for the full year (the higher tax rate is already reflected in analyst forecasts generally). Effective tax rate however, was lower in 2Q19 due to reversal of an over-provision in FY18. Management guides for a 22%-24% effective tax rate for FY19F.

Strong demand growth. Demand growth was strong increasing 4.4%ytd and up 3.6%yoy in 2Q19. Management attributes this to weather factors, which could be temporary. However, any excess demand beyond the 1.8%-2% growth stipulated under RP2 parameters has to be returned to consumers via the ARA mechanism.

Associates back in the black. Associates are now profitable, registering an RM82m contribution in 1H19 versus losses of RM79m in 1H18. This was largely driven by earnings improvement at all the overseas associates, particularly Vortex Solar (See Exhibit 1), driven by higher generation and increased electricity price. Additionally, following heavy impairments taken last year, Tenaga has fully impaired its carrying value in GAMA. GMR was impaired in 1Q19 and there is a balance 40% remaining carrying value in Tenaga’s books.

Recommendation. Following a strong 23% share price recovery (after hitting a low of RM11.36/share back in May19), we now downgrade Tenaga to NEUTRAL from BUY. Our TP remains unchanged at

RM14.40/share. At 14x FY19F PER (and a 3.5% dividend yield), Tenaga is already priced to perfection and is no longer an exceptionally cheap index proxy.

Source: MIDF Research - 3 Sept 2019