Malakof (5264) is a major player in the power, water, and environmental solutions industry on a global scale. As Malaysia's largest independent power producer, boasting a capacity of 5,342 MW, we expect Malakof to undergo a valuation re-rating as (i) its negative fuel margin is expected to narrow given stabilized coal prices and depletion of its existing high-cost coal inventories; (ii) it is transforming its asset portfolio to be more sustainable and ESG-friendly; (iii) solid balance sheet with decent dividend yield. BUY with a TP of RM0.72 based on 0.7x Price-to-Book, or a 30% discount compared to its peers' P/B.

In 2QFY23, Malakof registered its largest-ever quarterly net loss of RM354.8m due to substantial negative fuel margin recorded at its Tanjung Bin Power (TBP) coal plant of RM556.2m. The negative fuel margin was due to the Applicable Coal Price (ACP) being substantially lower than Malakof’s weighted average coal price (WACP) of its coal inventories. As the ACP is set by the Single Buyer on a monthly basis and tracks spot coal price closely, Malakoff benefitted from positive fuel margin in 1HCY22 when the Russian/Ukraine war caused coal price to surge 49% QoQ in 1QCY22 and 52.7% QoQ in 2QCY22. However, Malakoff reversed into negative fuel margin in 1HCY23 when coal price plunged 56.1% QoQ in 1QCY23 and 27.8% in 2QCY23 while it still has some legacy coal inventories with higher WACP. That said, coal price has rebounded 25% QoQ in 3QCY23 implying that the negative fuel margins will narrow substantially in the coming quarters.

To improve its business sustainability and ESG-profile, Malakof is (i) embarking on a pilot biomass co-firing project at its 2,100 MW coalfired TBP plant in FY24; (ii) working on the EPCC stage for its 3 hydropower projects with a total combined capacity of 84MW (iii) venturing into waste-to-energy business in Melaka with 22MW and 1,000 tons per day of collection capacity; (iv) considering building a new 2,250MW combined cycle gas turbine plant at the Tanjung Bin site once TBP power purchase agreements end in FY30; (v) targeting to grow its solar energy generation capacity from the current 40MW to 1,400MW by FY31. These initiatives will provide long-term earnings sustainability and will improve Malakoff’s ESG profile significantly going forward.

Despite 1HFY23's negative fuel margin, Malakof distributed RM119.7m of dividend or the equivalent of 5% dividend yield. As negative fuel margin diminishes in the coming quarters, we are confident that investors can continue to enjoy the attractive dividend yield while riding on Malakof’s long-term transformation towards a renewable energy company.

Source: Rakuten Research - 27 Oct 2023

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