KEY INVESTMENT HIGHLIGHTS

• ICPT turns into a rebate position for 1H21 following drop in global fuel price

• ICPT rebate essentially funded by fuel cost savings, earnings neutral to Tenaga

• ‘Gap year’ approval by the Government is a positive; underpins near-term regulated earnings visibility

• Maintain BUY at unchanged TP of RM13.10

What’s new? The Imbalance Cost Pass Through (ICPT), which essentially reflects fuel and generation cost variations against RP2 parameters, has turned into a rebate position of 2sen/kwh for the 1H21 period (from a neutral position of 0sen/kwh in 2H20), following a drop in fuel prices during 2H20 (ICPT is determined on a 6-month retrospective basis). Reflecting the lower fuel price; average coal price stood at USD58.6/MT in 2H20 versus Regulatory Period 2 (RP2) benchmark coal price of USD75/MT (CIF Price), while power sector gas price stood at RM21/mmbtu vs. RP2 benchmark gas price of RM27.20/mmbtu. The ICPT rebate is essentially funded by these savings and is neutral to Tenaga’s earnings.

‘Gap-year’ in FY21F. The Government has also approved an extension of RP2 for FY21 (originally scheduled to run from Jan 2018 till Dec 2020). This means that the RP2 base tariff of 39.45sen/kwh will be maintained for another year. RP3 meanwhile, is shifted to FY22 instead (2022-2024) given the uncertain demand and global fuel price outlook following the pandemic. The one-year RP2 extension will allow Tenaga and the Energy Commission (EC) to better determine the starting base of demand and capex for RP3 as well to better forecast fuel prices to minimize huge fluctuations in the ICPT. Broadly, the extension of RP2 into FY21 is a positive for Tenaga as it underpins near-term regulated earnings visibility, which is estimated to account for ~80% of Tenaga’s overall group earnings.

Potential clawback of ADD. To recap, the retail segment suffered a loss of RM200m in 9M20 due to significantly higher allowance for doubtful debt (ADD), taken as a prudent measure in view of the pandemic’s potential impact on Tenaga’s customers. While ADD is provided for as part of Tenaga’s regulated cost, the amount is capped based on the pre-agreed RP2 parameters, and is much smaller relative to the actual amount that had to be taken. Tenaga has been in talks with the EC to renegotiate the levels of ADD allowable and for a clawback of the exceptionally high amount this year (perhaps via periodic regulatory adjustments). Though there is no specific mention of this so far, any development on this front should be a positive earnings catalyst for Tenaga.

Recommendation. Maintain BUY at unchanged DCF-based TP of RM13.10. Tenaga’s share price has retraced significantly by some 16% in the past 12 months and now trades at just 13x FY21F earnings, reflecting deep undervaluation, notwithstanding the persistent ESG valuation drag. Dividend yield of 4% (FY21F, assuming a conservative 50% payout) are reasonably attractive in the current low interest rate environment, underpinned by easing capex for domestic 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. Other catalysts: (1) RE expansion drive internationally with a target capacity of 8300MW by FY25F from 3390MW currently (2) Positive outcome from LSS4 bidding (3) Recovery in FY21F earnings from absence of unscheduled plant outages, BPE discounts and inflated ADD provisions, that were experienced in FY20F.

Source: MIDF Research - 24 Dec 2020