Power Utilities - Let’s Play Defense

The Power Utilities sector continued to underperform the FBMKLCI which we believe is due to the market pricing in the expected challenging 2HCY17. This is given that rising fuel cost will continue to cap TENAGA’s near-term earnings while the PPA Extension contracts for Gen1 IPPs effective in the 2H will impact MALAKOF and YTLPOWR’s earnings with lower capacity payments. Meanwhile, it will be a low season for PESTECH given the raining season in Cambodia. Having said that, we remain positive with the sector given its defensive earnings with good visibility. Thus, the price weakness offers a good opportunity to accumulate, in our view. TENAGA remains our sector’s TOP PICK for its earnings quality profile and index-weighting status. Besides, we also like small cap PESTECH as an alternative play for its explosive earnings growth story.

TENAGA took control of Track 4A; Paka-TENAGA dispute finally solved. In early May, TENAGA (OP; TP: RM17.17) returned as SIPP Energy’s partner in the Track 4A Project by acquiring a 51% stake in Southern Power Generation. With TENAGA taking up 51% stake, the project can start construction to meet the scheduled commercial operations date in July 2020. On the other hand,

YTLPOWR (MP; TP: RM1.50) finally resolved the dispute over the land lease issue in with TENAGA for its Paka Power Plant. Thus, both parties had signed the PPA Extension and Land Lease Agreement in mid-May to enable the IPP to start operation from September this year over three years and 10 months. Meanwhile, there is still no further development in the past three months on the construction of a 1,000MW power plant in Pulau Indah, which was awarded to TADMAX’s (Not Rated) in August last year. TADMAX was given until August this year to implement a detailed feasibility study of the whole project development. Meanwhile, there was no further contract awarding on the renewal energy in 2QCY17 after two quarters of busy contract flow previously.

Tariff rebate of 1.52 sen/kWh to stay in 2H 2017; how about next year? Last month-end, the government decided to subsidise a total of 2.54 sen/kWh, which include 1.02 sen/kWh surcharge and 1.54 sen/kWh, for Jul-Dec 2017. This also means that consumers will continue to enjoy the 1.52 sen/kWh rebate until the end of this year instead of paying a surcharge of 1.02 sen/kWh, the first surcharge since the implementation of ICPT in Jan 2014, attributed to the rising fuel costs. We believe this could be due to the upcoming 14th General Election, which could be held any time before August next year. We were not overly surprised by the indirect effective tariff increase of 2.54 sen/kWh given the rising fuel costs in view of higher coal prices coupled with the scheduled half-yearly increase of RM1.50/mmbtu in piped gas prices. Going forth, even if the coal prices were to remain unchanged in the future, with the scheduled half-yearly piped gas price hike of RM1.50/mmbtu, a tariff surcharge is quite likely next year. Nonetheless, these changes are earnings neutral to TENAGA on a lagged basis under the ICPT framework as fuel cost will be passed through to end-user eventually.

A challenging 2H17. The recent 1QCY17 results reporting card was disappointing with TENAGA hit by bad debt provision and higher interest cost while MALAKOF (MP; TP: RM1.30) was dragged by higher O&M costs. YTLPOWR’s results were affected by higher losses at Paka Power Plant and weaker Wessex Water earnings whereas PESTECH (OP; TP: RM2.00) experienced margin compression as the current projects were in early stages, which gave lower profit margin. Going forth, 2H17 could be challenging for the industry players given that TENAGA will continue to witness rising fuel costs, although this is earnings neutral to TENAGA on a lagged basis that will pass through to consumer eventually. The new PPA Extension for MALAKOF’s Segari Energy, which takes effect in July, will see its capacity payment at least reduced by half from the previous PPA term. Likewise, YTLPOWR will face the same fate for Paka Power Plant when the new PPA Extension starts in September. On the other hand, as the second half of the year is a raining season in Cambodia, this will affect PESTECH’s work progress tremendously. However, on a positive note, PESTECH is expecting its first recurring income running over 25 years, when the BOT asset in Cambodia is ready by this year-end.

Still OVERWEIGHT, nonetheless, defensive nature is the key. Although 2H17 could be challenging for the industry players, we believe it is still a good avenue for investors looking for defensive play. Earnings of TENAGA are fairly defensive with the ICPT framework which has a fuel cost pass-through mechanism eliminating fuel cost risk while profitability of IPPs is backed by PPAs which guarantee capacity payment as long as requirements are met. On the other hand, valuation for the overall sector is also not demanding at CY18 12x PER which is below the FBMKLCI’s 16x. TENAGA remains as our Top Pick for the sector given its undemanding valuation, which is supported by its quality earnings profile and index weighting status. Meanwhile, we continue to like small cap PESTECH as our alternative sector play for its earnings growth story in Indochina, with near-term strong contract flows expected.

Source: Kenanga Research - 5 Jul 2017