Tenaga will buy over a 70% stake in Project 3B from 1MDB. While we believe the 2,000MW greenfield coal-fired power plant project is viable on a standalone basis, the market may see it as a prelude to more deals with 1MDB. We maintain our BUY call and earnings forecasts, but cutour TP by 12% to MYR15.53 (23% upside). We like Tenaga for its earnings defensiveness, large market value and high share liquidity.

• Taking over Project 3B. Energy, Green Technology and Water Minister Datul Seri Maximus Ongkili was quoted by The Edge Market as saying that the Cabinet has given its approval for Tenaga Nasional (Tenaga) tobuy over a 70% stake in Project 3B from 1Malaysia Development Bhd (1MDB) for “an undisclosed sum”. The remaining 30% in the 2,000MW greenfield coal-fired plant project will stay with Japan’s Mitsui Co Ltd. The minister was also reported as saying that Tenaga has asked for “a small revision” to the tariff rate to reflect a 6-month delay in the project and a weakened MYR, and the new tariff rate has yet to be finalised.
• More to come? We believe Project 3B is viable on a standalone basis. Based on a project internal rate of return (IRR) of 5-6%, assuming a debt:equity ratio of 80:20, cost of debt of 5% and a tax rate of 25%, the equity IRR is still decent at 10-15%. We believe the market’s negative knee-jerk reaction to the news could be explained by concerns that the latest development could be a prelude to more deals with 1MDB going forward, particularly with regard to 1MDB’s brownfield power assets reported to be worth MYR16bn.
• Forecasts. We maintain our earnings forecasts.
• Risks. These include: i) its inability to automatically pass on higher fuel costs via tariff hikes, and ii) other regulatory risks.
• Maintain BUY. A good proxy to the economy, the national utilities company also appeals to investors due to its earnings defensiveness, large market value and high share liquidity. We also advocate owning Tenaga for its ability to gradually regain lost ground in the more lucrative power generation business (see Figure 1). We cut our TP by 12% to MYR15.53 (from MYR17.70) after we: i) roll forward our valuation base year to FY16F (from FY15F), but ii) reduce our forward P/E target to12.6x – at a 10% discount to the 5-year historical average of 14x (from a 10% premium), given the general cautious sentiment towards utilities stocks as 1MDB scouts for a buyer for its brownfield power assets