1H2024 Recap

KL Utilities Index (KLUTL) has massively outperformed the FTSE Bursa Malaysia KLCI Index (FBMKLCI) in 1H2024 (Figure 1) as it was up 34.9% compared with the latter’s 9.3%. The outperformance was mainly due to earnings improvement from stabilisation of coal prices and expectations of better outlook from energy transition and demand for data centres.

Stocks under our coverage generally performed well in 1H2024 (Figure 2). YTLPOWR, RANHILL and TENAGA surged 89.8%, 56.7% and 37.3% respectively since the start of 2024 on the back of improvement in earnings and growth prospects. MALAKOF surged 20.5% as it returned to the black from easing of negative fuel margins. Note that TENAGA and MALAKOF are our stock picks in our 2024 annual strategy. PETGAS (+2.4% YTD) largely tracked the performance of the index. Meanwhile, PETDAG (-20.1% YTD) underperformed due to expected volume decline from subsidy rationalisation.

2H2024 Sector Outlook

We expect the following factors to be the main drivers for the sector in 2H2024:

i) Growing demand from data centre;
ii) Third party access a boon to independent power producers;
iii) NETR remains the main growth driver.

i) Growing Demand from Data Centre

According to Mordor Intelligence, the Malaysia Data Centre Market size is estimated at 710 MW in 2024, and is expected to reach 1360 MW by 2029, growing at a CAGR of 13.7%. Demand for electricity and water are expected to grow significantly in tandem. The forecasted data centre growth of 650MW from 2024 to 2029 is 2.4% of generation capacity in peninsular Malaysia as of 30 April 2024. Greater demand from data centre would necessitate the growth of TENAGA’s regulated asset base (RAB), boosting its regulated return.

1 MW data centre using a traditional cooling process can potentially use 25.5mn litres of water each year. 650MW demand growth translates into 45.4mn litres of water per day (MLD) or 0.5% of total water consumption in Peninsular Malaysia and Labuan in 2022. Johor as the hub for data centre would see increase in water demand, hence benefiting state water operator RANHILL. With increasing demand from data centre, we believe YTLPOWR Will Have Its Earnings Boosted by Its 500MW Green Data located Strategically in Kulai, Johor.

ii) Third Party Access a Boon to Independent Power Producers

In May this year, Energy Transition and Water Transformation Minister Fadillah Yusof announced that independent power producers (IPP) will be allowed to start selling electricity directly to customers from September. With the implementation of third-party access (TPA), IPPs can sell electricity to customers without going through TENAGA but would need to use TENAGA’s transmission lines and pay TENAGA the associated wheeling charges.

TPA will be largely neutral to TENAGA’s transmission and distribution business as it is regulated under incentive-based regulation. It is unclear whether TPA will include only renewable energy (RE) or both RE and non-RE. Regardless, we believe that TPA is a boon to IPPs such as MALAKOF and other RE asset owners as this allows them to negotiate better tariffs with offtakers, similar as Corporate Green Power Programme (CGPP). This is in contrast with Large Scale Solar (LSS) Programme which has seen tariffs dropping every year as each developer bids at lowest tariff possible.

iii) National Energy Transition Remains the Main Growth Driver

The unveil of National Energy Transition Roadmap last year marks Malaysia’s commitment to achieve 70% RE generation capacity by 2050. Along the way, several key announcements were made to support Malaysia’s energy transition agenda.

In April 2024, the competitive bidding process for Malaysia’s LSS5 has kicked off, with a total capacity of 2GW being offered. The only concern will be that whether LSS5 will be another race to the bottom where the developers try to outbid others by submitting extremely low tariffs. Nonetheless, the estimated total EPCC contract value of RM4.3bnRM6.3bn will benefit EPCC contractors such as SLVEST (Not Rated), SUNVIEW (Not Rated) and SAMAIDEN (Not Rated).

In mid-April, Malaysia has also set up the Energy Exchange Malaysia, or ENEGEM, for trading in green electricity supply to Singapore and is inviting bids for a 100 MW pilot project using existing infrastructure between the two countries. The pilot project is a positive move for Malaysia’s RE sector as it paves way to Malaysia exporting RE to Singapore. The latest LSS4 had tariffs between 17.68 sen to 24.81 sen/kWh. In Singapore, regulated electricity tariff stands at SGD0.2988/kWh before GST (c.RM1.039/kWh) for 3Q2024. In our opinion, the export of RE to Singapore will increase the tariffs for solar asset owners in Malaysia vis-à-vis those of LSS Programme. Other than solar EPCC contractors, ENEGEM will benefit asset owners such as TENAGA and MALAKOF due to the arbitrage opportunities.

Note that Energy Market Authority (EMA) of Singapore has announced a target to achieve up to 4GW of low-carbon electricity import (30% of Singapore's electricity supply by 2035). Additional interconnection grid is likely required on top of the existing 1GW Plentong-Woodlands Interconnector to facilitate export of RE to Singapore. It is unsure whether the new interconnection grid will be under RAB. Even if not placed under RAB, TENAGA could potentially enjoy better returns from wheeling charges from the grid.

Recommendations

We maintain Overweight on the sector as we believe P&U players stand to gain from higher demand from data centres and Malaysia’ energy transition. We believe the government will continue to provide support for the energy transition via incentives such as the Solar for Rakyat Incentive Scheme (SolaRIS), favourable legislations and project tenders such as LSS. These encourage a healthy and sustainable ecosystem for P&U players involved in the energy transition.

We take this opportunity to downgrade TENAGA and MALAKOF to Hold from Buy following the recent surge in their share prices. Due to poor outlook from fuel subsidy rationalisation, we also lower our PE valuation for PETDAG to 19.5x (from 22x) which is 1 standard deviation below its 5-year mean, hence arriving at a lower TP of RM18.10 based on 19.5x CY25 EPS. However, we upgrade PETDAG to Hold from Sell following the recent plunge in its share price as we believe the share price has priced in the sales volume decline from subsidy rationalisation.

Our top pick for the sector is YTLPOWR. We like YTLPOWR due to the following reasons: i) growth from its 500MW green data centre; ii) Higher allowable return at Wessex Water following expectations of tariff adjustment in the PR24 (2025-2030 business plan); and iii) earnings growth via synergy from acquisition of RANHILL. Risk to our call include drop in electricity demand in Singapore leading to narrowing of Power Seraya’s margins. We value YTLPOWR at RM6.35 based on SOP valuation (implying 17.3x CY25 EPS, compared with peer average of 16.8x CY25 EPS).

Source: TA Research - 2 Jul 2024