KEY INVESTMENT HIGHLIGHTS

• Tenaga reported to be looking to list generation unit next year

• Internal restructuring which separates generation and retail from T&D paves the way for such as exercise

• Though still early days, a spin-off could unlock value in Tenaga and partly alleviate ESG-driven valuation discount

• Maintain BUY at unchanged TP of RM13.10; significant share price retracement presents value, coupled with reasonably attractive yields

What’s new? It was reported in the news that Tenaga is considering listing its generation unit in 2021, post-completion of its internal reorganization which was initiated in July 2019. To recap, the internal reorganization essentially splits the group’s generation and retail units into separate subsidiaries, while the T&D operation remains under the main group. While it was also reported that the deliberations are still at an early stage and that Tenaga’s focus currently is on driving operational efficiency of the generation unit, we think the idea is not too far-fetched and the reorganized structure of operations positions the group well for such an exercise.

ESG drag? Tenaga’s valuations have been partly weighed down given increasingly ESG-focused investors, we believe, given its large exposure to coal-fueled power plants. Foreign shareholding has dropped to a low of 14.9% as at end-August 2020, vs. 22%-27% in 2014-2018. We estimate ~55% of Tenaga’s generation capacity (50% if we include Southern Power Generation in the total capacity base) is coal-based, with most of the coal capacity coming from the Manjung power plants and the latest Jimah East plant. The majority of the country’s coal-based PPAs are only expected to fall off from FY29F onwards, but Tenaga has committed that Jimah East will be the last greenfield coal power plant in the country. Upcoming traditional-fuel power plants over 2020/21/24 (Southern Power Generation/Track 4B/Tadmax Pulau Indah) will be gasbased, which will further dilute coal contribution in the overall capacity mix in the system.

Value unlocking potential. A separate listing of the generation business would allow the ESG-focused funds to own Tenaga’s T&D unit, hence potentially removing the drag on Tenaga’s groupwide valuation. At an annual regulated profit of RM3.8b (FY18)-RM4b (FY20F), we estimate that Tenaga’s T&D unit could fetch a valuation of RM68bRM70b if valued at par to peers (See Exhibit 3), relative to Tenaga’s current market cap of RM64b.

Deep undervaluation. A break-up of valuation of Tenaga (valuing the generation and T&D units at par to peers’ average) suggests a potential valuation of RM77b (RM13.60/share), on our estimates, ~21% higher than Tenaga’s current market value. In fact, at current market cap of RM64b, investors are essentially getting the generation business for ‘free’ (See Exhibit 2), as the T&D and Retail units alone could already potentially fetch a valuation of RM68b (based on FY19 net profit split).

Recommendation. Maintain BUY on Tenaga at unchanged DCF-based TP of RM13.10. Tenaga’s share price has retraced significantly by some 15% in the past 12 months and now trades at just 13x FY21F earnings. Dividend yields of 4% (FY21F, assuming a conservative 50% payout) are reasonably attractive in the current low interest rate environment, underpinned by: (1) Easing capex for generation in the near-to-mid-term, which suggests base dividends of at least at the higher end of the group’s 30%-60% payout policy (2) Stretched Government fiscal position suggests potentially higher cash upflow requirement from key GLCs.

Source: MIDF Research - 11 Nov 2020