We are positive on Tenaga entering into five long term Contracts of Affreightment (“COA”) worth USD537m with four shipping companies, as it partially insulates its opex. Its 2QFY16 earnings (to be announced later today) are expected to be favourable, as electricity sales in the first two months of the quarter rose 3.2% YoY. Maintain BUY with a DCF-derived MYR18.20 TP, as we advocate owning the stock for its defensive earnings, large market cap and high share liquidity.

Maintain BUY. Our positive view on Tenaga Nasional (Tenaga) also stems from the company regaining lost ground in the lucrative power generation business. This comes after it emerged as the biggest winner of new power plant projects in Malaysia in recent years. Our DCF-derived TP of MYR18.20 is unchanged, based on a WACC of 7.4% and terminal growth rate assumption of 1.5%. Against our earnings forecasts, it currently trades at 10.9x 1-year forward P/E, which is about 1SD above its 5-year mean P/E of 9.8x. However, we argue that this may not necessarily imply that Tenaga is expensive, as regulatory changes should see more stable earnings going forward (Figure 1). The Long Term COA. Tenaga’s subsidiary, TNB Fuel Services S/B, entered into five Long Term COAs worth USD537m with four local shipping companies namely PNSL, Prima Shipping S/B, Malaysian Bulk Carriers (MBC MK, NR) and Duta Marine S/B. The COA involves the shipment of 82.5m tonnes of coal over the next 10-15 years and averaging out to USD6.51/tonne, higher than current spot rates (Figure 2).

Our view on the COAs. Despite the premium rates secured, we view the agreement positively, given the volatility in shipping rates (Figure 3). Tenaga expects the agreements to constitute 18.75% of its total shipping services by 2019 when it is expected to consume 40m tonnes of coal per annum. Apart from the COAs providing some much needed support to the local shipping industry, the agreements also allow Tenaga to diversify its freight contracts to 60% term COAs, 20% spot contracts and 20% long term COAs.

What to expect for 2QFY16. Later today, Tenaga would be announcing its 2QFY16 (Aug) earnings, which we expect to be favourable. This is in view of the electricity sales growth rising 3.2% YoY to 17,583GWh and 44,429GWh in the first two months of the quarter and cumulative five months (ie Sep 2015 to Jan 2016) (Figure 4). While consumption growth was driven by the domestic segment, sales mix was largely unchanged with industrial and commercial segments still making up over 75% of electricity sales. Meanwhile, we expect it to recognise some unrealised forex losses, as JPY/MYR at end-February had weakened by 7.8% from end-Nov 2015. However, this would also be partially offset by MYR strengthening against the USD by 1.3% over the same period. This would roughly amount to unrealised forex losses of c.MYR180m based on the JPY and USD borrowings at end-1QFY16.

Source: RHB Research - 27 Apr 2016