TNB’s 9MFY15 results met expectations. We maintain our earnings forecasts, BUY call and TP of MYR15.53 (27% upside). A good proxy to the economy, TNB also appeals to investors due to its earnings defensiveness, large market value and high share liquidity. We advocate owning TNB for its ability to gradually regain lost ground in the more lucrative power generation business.

ICPT adjustments in 3QFY15 (Aug). Tenaga Nasional Bhd’s (TNB) 9MFY15 core net profit met expectations. In 3QFY15, it recognised the imbalance cost pass-through (ICPT) adjustments accumulated for 17 months from Jan 2014 to May 2015, including writebacks of “under-recovery” of fuel costs in FY14. This was carried out by way of deducting MYR1.82bn from its 3QFY15 topline, which was effectively an accounting entry to “rectify” TNB’s actual earnings.

Fuel costs remain benign. In 9MFY15, TNB’s average coal cost came in at USD67.30/tonne, which was way below the base price of USD87.50/tonne. Similarly, Petronas has set the Jul-Sep 2015 unsubsidised gas cost at MYR36.57 per million British thermal unit (mmBtu), which is sharply lower than MYR46.60/mmBtu in Jan-Jun 2015. The base price for gas under the ICPT is MYR41.68/mmBtu. In any case, the savings in fuel cost have since Mar 2015 been passed back to consumers via a reduction in power tariffs.

Forecasts. We maintain our earnings forecasts.

Risks. These include: i) TNB’s inability to automatically pass on higher fuel costs via tariff hikes, ii) MYR’s weakness against the USD will result in higher fuel costs (which are effectively priced in the USD), and iii) 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 TNB for its ability to gradually regain lost ground in the more lucrative power generation business. We keep our TP at MYR15.53 based on 12.6x FY16F EPS. At the current price, the stock trades at a highly attractive 9.9x FY16F P/E.

9MFY15 “Rectified” By ICPT Adjustments

ICPT adjustments in 3QFY15. TNB’s 9MFY15 core net profit of MYR5.47bn (excluding MYR172.9m forex losses) came in at 84% of both our full-year forecast and consensus estimates respectively. We consider the results within expectations as 9MFY15 core net profit was inflated by recognition in 3QFY15 - for the first time -of the ICPT adjustments accumulated for 17 months from Jan 2014 to May 2015,including writebacks of “under-recovery” of fuel costs in FY14. The accumulated ICPT adjustments were recognised by way of deducting MYR1.82bn from TNB’s 3QFY15 topline. This was not as negative as it appeared to be as it was effectively an accounting entry to “rectify” TNB’s actual earnings. To recap, TNB’s 6MFY15 results announced three months ago (before the ICPT adjustments) still included a MYR1.5bn “over-recovery” of fuel costs, which was not part of its actual earnings.

TNB’s 9MFY15 revenue grew by 1.5% YoY, backed by a 2.5% growth in unit sales and the impact from an average 14.9% hike in electricity tariffs (from 1 Jan 2014), but partially eroded by a MYR1.82bn hit to 3QFY15 topline pursuant to the ICPT adjustments.

Operating expenses contracted 3.0% YoY as key operating expense items, ie fuel costs (25% of total operating expenses) declined 17.3%, while payments to independent power producers (IPPs) (37% of total operating expenses) were flat. The lower fuel costs were due to: i) lower usage of costlier gas but higher usage of cheaper coal (as two coal-fired plants ie Jimah and Tanjung Bin, which were hit by unscheduled outages, were back online), and ii) lower gas and coal prices. In 9MFY15, the industry’s total gas cost decreased by 11.1% to MYR7.4bn while total coal cost rose by 17.2% to MYR4.0bn. In terms of industry generation output, 48.8% was gas-based (from 56.1% in 9MFY14) and 46.1% was coal-based (from 37.8% in 9MFY14).

Fuel costs remain benign. In 9MFY15, TNB’s average coal cost came in at USD67.30/tonne, which was way below the base price of USD87.50/tonne. Similarly, Petronas has set the Jul-Sep 2015 unsubsidised gas cost at MYR36.57/mmBtu, which is sharply lower than MYR46.60/mmBtu in Jan-Jun 2015. The base price for gas under the ICPT is MYR41.68/mmBtu. To recap, Tenaga sources its gas requirements from Petronas via a two-tier pricing scheme. The first 1,000 million standard cu ft per day (mmscfd), also known as “piped gas”, is subsidised by Petronas at a fixed price of MYR16.70/mmBtu (raised from MYR15.20 on 1 Jul 2015). The remaining 200-400mmscfd is unsubsidised at a “base” market price of MYR41.68/mmBtu.

In any case, the savings in fuel cost have since Mar 2015 been passed back to consumers via a reduction in power tariffs by 5.8% or 2.25 sen/kWh to 36.28 sen/kWh in Peninsular Malaysia and 3.5% or 1.20 sen/kWh to 33.32 sen/kWh in Sabah. The reduction applies to all users, ie domestic, commercial and industrial, other than domestic users with electricity consumption of 300kWh/month or less. This is in accordance with the ICPT mechanism as stipulated in the new energy policy effective 1 Jan 2014.

Forecasts. We maintain our forecasts that assume the ICPT mechanism is operational – at least when it comes to passing back savings in fuel costs to consumers. Our coal and unsubsidised gas cost assumptions are in line with the ICPT base prices of USD87.50/tonne and MYR41.68/mmBtu respectively. Risks. These include: i) TNB’s inability to automatically pass on higher fuel costs via tariff hikes, ii) MYR’s weakness against the USD will result in higher fuel costs (which are effectively priced in the USD), and iii) 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. TNB no longer stands to gain directly from lower fuel costs. This is following the Government’s decision in Feb 2015 to cut power tariffs to pass back the fuel cost savings to consumers. On the other hand, it is unclear if there is political will to evoke the fuel cost pass-through (FCPT) mechanism to raise power tariffs if fuel costs go up. Nonetheless, the continued slump in fuel costs is surely a respite to TNB.

We also advocate owning TNB for its ability to gradually regain lost ground in the more lucrative power generation business vis-à-vis transmission and distribution, having emerged a big winner of new power plant projects in Malaysia in recent years (see Figure 1)

We keep our TP of MYR15.53 based on 12.6x FY16F EPS – at a 10% discount to the 5-year historical average of 14x, given the uncertainty arising from the potential acquisition by TNB of power assets of a Finance Ministry strategic investment company. At the current price, the stock trades at a highly attractive 9.9x FY16F P/E.

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Tenaga Nasional Bhd (TNB) is engaged in the generation, transmission and distribution of electricity in Peninsular Malaysia and Sabah, in which the national utilities company has a near-monopoly in the transmission and distribution.

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Source: RHB Research - 31 Jul 2015