With the Umno party election now concluded, we believe investors will turn  their  attention  to  the  2014  Budget,  which  will  be  tabled  in parliament on Friday. In view of the Government’s affirmative stance on rationalising  subsidies, we maintain  our BUY  call  and  MYR10.13  FV  as TNB stands to benefit from the budget, especially if the fuel cost pass-through (FCPT) formula is approved.

- Deficit reduction the main priority.  The Government has set target of reducing the budget deficit to 4% for 2013, 3.5% (2014) and 3% (2015) (from 2012’s 4.5%). We understand that the country’s subsidies amount to  MYR50-60bn  currently.  Of  the  total,  some  MYR25bn  was  spent  on petrol  and  diesel  consumption,  followed  by  MYR10-12bn  for  the  power sector.

- MYR16-17bn subsidy per annum. The total installed capacity of natural gas-fired power plants stands at 13,309 megawatts (MW) currently. We estimate  that  the  natural  gas  required  for  power  generation  hovers  at around  1,200-1,300m  standard  cu  ft  per  day  (mmscfd).  Given  that  the current market price of natural gas  is MYR50 per million British thermal units  (mmbtu)  vis-à-vis  the current  fixed  price  of  MYR13.70  per mmbtu, we estimate that the Government (via Petronas) will have to fork out an annual subsidy of MYR16-17bn.

- A  quantum  too  big  to  ignore.  Considering  the  quantum  involved,  we believe  that  a  rationalisation  of  the  existing  subsidy  is  likely.  Based  on our calculations, every MYR3 per mmbtu hike in natural gas prices could save the Government some MYR1.3-1.5bn annually.  

- Tariffs to be revised accordingly. Conversely, every MYR3 per mmbtu hike  in  natural  gas  prices  will  erode TNB’s earnings by some 26.8-31.1%, assuming tariffs are not similarly revised. Taking into account the magnitude  involved,  we  believe  that  the  Government  will  have  to compensate TNB for the additional fuel costs incurred. Hence, we expect the former to revisit the existing tariff structure should there be a revision in natural gas prices, which we believe is more likely than not.

Source: RHB