• Cut to NEUTRAL from Buy, new TP of MYR8.60 from MYR11.50, 5% upside. Our call is premised on the rising regulatory risk to uphold the Imbalance Cost Pass-Through (ICPT) framework, which could eventually challenge the incentive-based regulation (IBR) scheme. While TNB can claim c.MYR5.8bn from the Government in 2H, it is still unable to fully cover the generation cost incurred in the past year. ICPT receivables may still rise if fuel prices remain high, and operating cash flow will be under greater pressure if the Government does not pay the subsidy on time.

• Electricity tariff maintained. Last Friday, the Government decided to maintain the electricity tariff rates (a 2sen/kWh rebate for domestic users and a 3.7sen/kWh surcharge for commercial and industrial segments) in West Malaysia. Following that, Tenaga Nasional announced that the ICPT mechanism will remain in place in 2H22.

• Higher burden on the Government. This caught us by surprise – the market was anticipating higher tariff rates for the commercial and industrial divisions, while the domestic segment remained subsidised. The Government has upheld the ICPT framework in the past to ensure regulatory returns, but keeping the tariff rates unchanged will mean a higher burden – as fuel prices are still high. Although the previous subsidisation of domestic users was funded by the Electricity Industry Fund or KWIE, we are not certain about its sustainability under the current situation.

• ICPT receivables could escalate further. TNB incurred ICPT charges of MYR4.5bn in 2H21 and MYR3.5bn in 1Q22, with coal prices averaging USD165.50/tonne and gas prices tiered at MYR30.00-36.90/mmbtu in 1Q22. The ICPT charge in the past 12 months (Jul 2021-Jun 2022) could total c.MYR12bn, assuming the 2Q22 charge is higher than that of 1Q22. According to TNB, a 3.7sen/kWh surcharge in 1H22 could recover an estimated amount of MYR1.7bn – and keeping the tariff in 2H22 will double it up to c.MYR3.4bn for 2022. We were guided that TNB can claim c.MYR5.8bn from the Government in 2H22 (split into payments made each month) – leaving MYR2.4bn to be uncovered. As such, ICPT receivables could continue growing if fuel prices stay high in 2H22. Operating cash flow will be under greater pressure if the Government is unable to pay the subsidy on time. 1Q22 net gearing was at 0.8x, and TNB may increase its working capital via untapped credit facilities or a sukuk programme.

• We maintain forecasts, but think any further MYR1bn in borrowings will lead to MYR50m in financing costs pa (1% of FY22F earnings) at a 5% rate. Our new TP reflects a 25% discount to intrinsic value, and an unchanged 8% ESG discount. This is premised on the rising regulatory risk to uphold the ICPT framework, which could eventually challenge the IBR scheme. In the worst-case scenario where ICPT no longer holds, TNB’s defensive earnings could be at risk if it is vulnerable to volatile fuel prices without being able to fully pass the costs to end-consumers.

Source: RHB Securities Research - 27 Jun 2022