The News

• Tenaga Nasional Bhd (Tenaga) has proposed to acquire a 50% stake in Vortex Solar Investments S.a.r.l. (VSI) for £86mn (RM474mn).

• VSI owns and operates 24 solar photovoltaic (PV) farms in the United Kingdom (UK) with a combined net installed capacity of 365MW. This translates to the 3rd largest solar power business in Great Britain. The operating assets will be earnings accretive to Tenaga post-acquisition.

• This transaction is expected to be completed by 3QCY17. It will be funded via a combination of internal funds and/or borrowings. VSI will be a 50:50 joint venture with EFG Hermes Group (EFGH), an investment bank based in the MENA region. EFGH is listed on the London Stock Exchange (LSE) and Egyptian Stock Exchange (EGX).

• Meanwhile, the Vortex Group is a Europe-based Renewable Energy (RE) investment platform managed by EFGH's private equity (PE) arm with total net capacity of 822MW.

• This proposal is subject to approval from Bank Negara Malaysia and Malaysia's Ministry of Finance.

Our Take

• We are positive on this news as we are optimistic on the prospects of RE in Europe. This is supported by high demand backed by an accommodative regulatory environment, and high degree of corporate social awareness.

• To recap, TNB's Five-Year International Expansion Road map (IER) targets up to 5000MW new generation capacity internationally by 2020. This includes up to 250MW of renewable energy (RE) projects.

• Therefore, the additional net RE capacity of 182MW (50% stake) enables TNB to achieve its RE target ahead of schedule. This is because VSI will increase TNB’s RE portfolio to 252MW, surpassing the 250MW renewable target of its IER, after factoring in TNB’s RE net capacity in Turkey and India of 70MW.

• Tenaga’s strategy of international diversification largely stems from management’s expectations of subdued demand in the mature local electricity market. This is underpinned by the transition of Malaysia’s economy from industry-based to service-based.

• Furthermore, the assets have immediate and long term earnings visibility, given that they are backed by 15-year Power Purchase Agreements (PPA) and government-backed Renewable Obligation Certificates for 20 years. On top of that, the solar energy assets comprise a portfolio of young assets with average age of 2 years and estimated useful life of 30 years.

• Tenaga's acquisition of VSI translates to USD582K per MW. At first glance, if we confine strictly in terms of USD/MW, this compares favorably to other recent acquisitions of solar assets in Europe, comprising:- 1) 2Q15: Abengoa Yield plc acquired Abengoa SA’s 450MW solar thermal portfolio in Spain for USD669mn. This implies USD1.49mn per MW. 2)2Q15: Capital Stage AG purchased Treia and Oria solar plants in Italy (29.1MW) for USD113mn. This is equivalent to USD3.9mn per MW.
   
• Execution risk for Tenaga is minimal, given that VSI's O&M partner is Lightsource Renewable Energy Ltd (LRE) group. The group is the largest developer and operator of solar PV projects in Europe, with more than 1.3 GW of capacity under management in the UK.
   
• Tenaga has more than ample balance sheet capacity to stomach this acquisition. The group currently has cash of RM3.9bn in-hand with net gearing of 0.6x. As such, we believe this acquisition would not hamper Tenaga's capability to dish out dividends.

• Furthermore, capex is expected to be subdued in the near-to-medium term. This is given no major upcoming pipeline capacity following completion of the 1,000MW Janamanjung 5 plant in 2017. Recall that a chunky Sukuk issuance amounting to RM9bn for Jimah East was completed earlier in Dec-15.

Impact

• We do not incorporate VSI's contribution to our forecasts for now, pending more information from management about the tariffs, IRR, expansion plans, borrowings, capex, etc. However, we tweak our dividend assumptions upwards in view of the potential higher payout on the back of robust cash flows.

• Also, we perform housekeeping to our forecasts following the release of annual audited figures and change of financial year end to Dec (previous: Aug). In addition, we also nudge demand lower for FY18-19 on the back of management’s guidance of a widening disparity between demand and GDP growth. This results in a change of 2.1%/-2%/-4% to our FY17/18/19 forecasts.

Valuation

• Following the revision to our forecasts, our TP on Tenaga is raised to RM17.19 (previous: RM16.87) based on DCF (WACC: 8.6%, terminal growth: 1%).

• Our Buy recommendation is mainly underpinned by:- 1) attractive valuations – currently 1SD below historical average of forward P/E, 2) potential for upside to dividend yields, and 3) defensive qualities render it a safe refuge from macro headwinds.

Source: TA Research - 9 Jan 2017