Review

Malakoff’s 9M16 core profit of RM263m (-25% YoY) was below our expectations and consensus, accounting for 50%/54% of ours/street’s full-year forecasts.

The variance was primarily due to unexpected costs from the following:- 1) additional lumpy 9M depreciation in 3Q16 due to change in estimate of residual values for gas-fired power plants, 2) one-off tax charge at Tg. Bin Energy (TBE) in 3Q16 following the completion of the plant, and its subsequent transfer, and 3) additional barging and demurrage costs for coal supply.

YTD earnings were weaker due to the above, and was exacerbated by:- 1) higher maintenance costs, and 2) lower contribution from PD Power following circa 1 month delay in PPA renewal. This more than offset increased associate contribution.

9M16 core profit excludes the following exceptional items: 1) insurance claim on rotor replacement for Prai Power Plant (RM56mn), 2) forex translation loss (RM40mn), and 3) provision for delayed start-up of TBE (RM12mn).

QoQ, there was a convincing turnaround in associates’ contribution to RM22mn (2Q16: 8mn loss). This was mainly driven by the reset of Kapar Energy Venture’s (KEV) rolling Unscheduled Outage Rate (UOR) to zero for GF2 and GF3 thermal plants back in Jul-16. In addition, there was also a turnaround at Oman and Algeria operations, coupled with improved contribution from Saudi Arabia and Bahrain.

Key Takeaways from Analyst Briefing

The group estimates FY16-17 depreciation to increase 17% due to a revised accelerated depreciation policy for its gas plants (ie. Segari, GB3, Prai Power). This translates to additional annual depreciation after tax & MI of RM82mn. In 3Q16, management recognised additional retrospective 9M depreciation costs of RM53mn.

Management will now take the prudent stance in slashing the residual value of its gas plants. This is underpinned by expectations that it will be challenging for the gas plants to secure PPA extensions at favorable rates. This is on the back of:- 1) increased competition as EC’s new planting up program in 2016-25 will mainly (38%) consist of gas plants with significantly higher thermal efficiency of 60% (existing: 45%-50%), and 2) bias towards cheaper coal plants to 58% (2015: 48%) of 2025 generation mix at the expense of gas plants at 23%(2015: 46%).

The additional barging and demurrage costs will recur until completion of TBE’s new jetty extension by end-2018. According to management, existing jetty facilities are insufficient to cope with increased coal demand for TBE. Therefore, EC had recently commissioned the construction of a new RM310mn extension, which will be financed via construction cost savings from the plants. In the interim period, the group will incur additional logistics costs to charter coal barges.

TBE’s monthly capacity factor has recovered to 85% after having resolved several teething issues. Management will take the opportunity to rectify other identified issues during the Mar-17 scheduled outage window period. Nevertheless, the plant is currently operating within contractual UOR parameters, and is expected to sustain this level by end-16. We are encouraged by stabilizing operations at TBE, which is one of our main concerns.

Since TBE commenced operations in 21-Mar, it has generated PAT loss of RM20mn and cash of RM91mn. To recap, due to IC4 accounting methods, there will be lower revenue recognition in early years. Coupled with high depreciation, this translates to minimal net profit accretion at inception.

Impact

We incorporate the following to our forecasts:- 1) higher depreciation for gas-fired plants (Segari, GB3, Prai Power), 2) higher operating costs to account for additional coal demurrage costs, 3) higher taxes to reflect the one-off tax charge following completion and transfer of TBE. As a result, our FY16-18 forecasts are lowered by 22%-25%.

Outlook & Valuation

Key earnings headwinds for the group has largely dissipated on the back of stabilizing operations at TBE and the group’s associates. Meanwhile, Malakoff’s new accelerated depreciation policy for gas plants reflect prudence and are non-cashflow items. Therefore, the latter will not impede the group’s capacity to pay out dividends.

We believe the stock was oversold earlier due to concerns that the group was unable to meet heightened earnings forecasts. This was largely underpinned by consensus’ expectations of higher contribution from TBE. Nevertheless, now that expectations have normalized, we see value in the company. The stock is currently trading at 7.9x FY17 EV/EBITDA, which is at a discount to peers average of 8.6x.

Following the earnings downgrade, our SOP target price for Malakoff is now reduced to RM1.70 (previous: RM1.90). On the back of macro headwinds, we believe investors will likely seek refuge in blue chip counters such as Malakoff. The group’s decent dividend yield, robust cash flows, ample liquidity, and subdued capex render it a superior cash proxy. Maintain Buy.

Source: TA Research - 22 Nov 2016