Utilities - OVERWEIGHT - 26 June 2012

Maintain OVERWEIGHT on the Power Sector. We continue to like Tenaga (OP; TP: RM7.50) for being the key beneficiary of structural sector reforms. We are confident the government will continue to lend support to Tenaga in terms of fuel cost burdens as indicated by the quick resolution of its compensations, which should continue up to Sep 2012. Thereafter, the government will likely be looking to gradually pass on the costs to consumers. YTLPOWR’s (MP; TP: RM1.71) share price will continue to be capped as the market adjusts its perception on the stock from a dividend angle to an entrepreneurial one. Its dividend payouts will be weak although the group is likely to break even with its 1Bestarinet contract as it positions itself for bargain acquisitions amidst the global economic uncertainties. MMC (OP; TP: RM3.11) is also a worthwhile bet because we anticipate new asset acquisitions from its proceeds from Gas Malaysia’s  listing. The Water sector remains on a NEUTRAL outlook given uncertainties on the Selangor water industry restructuring, in especially the Langat 2 project.  However, we are maintaining OUTPERFORM and TP of RM2.70 on Puncak Niaga given new contributions from its O&G segment and a higher 25% tariff hike computation in FY12.

Mixed bag of 1Q12 results. Tenaga and Puncak exceeded our expectations while YTLPOWR and MMC came in below. Tenaga enjoyed lower fuel costs given its less usage of expensive MFO/diesel and it also paid a surprising interim dividend 6.7 sen as its cash flow recovers. Puncak’s earnings were buoyed by margin improvements from increased water tariffs and O&G contributions. MMC was hurt by declining construction earnings and Gas Malaysia’s lower margins. YTLPOWR earnings were meanwhile dragged down by fair value losses on quoted investments. Its 3Q12 NDPS remained weak at 0.9 sen (-50% YoY) and we estimate a weaker FY12E NDPS of 6.0 sen (-36% YoY) as it conserves cash for expansion. 

2H12 to be fueled with news flows. By end Jun-12, the government is expected to finalise the gas pricing to the power sector as the Melaka RGT will be commissioned in Aug-12. The pricing will address the power sector’s concerns of importing gas at market prices (RM45/mmBtu vs. a subsidised RM13.7/mmBtu). We share Tenaga’s confidence that the additional fuel cost burden arising from the market pricing of gas will be borne by the government and gradually passed on to consumers.  There will also be more concrete news on the 1^st  Gen IPPs rate cuts (by min. of RM6/kWh/mth for 48 months) as it will be tied in with the new capacity bid (Track 2: 1000MW). However, savings from the rate cuts will be Neutral to Tenaga and will be used to minimise government compensations to the power sector or to tone down tariff hikes to ensure a neutral impact to Tenaga at the least. Oct-12 will see the award of Track 1 (Prai; up to 1400MW). We reckon 1^st  Gen IPPs like YTLPOWR are in the lead to win the Track 1 bid as they enjoy costs advantages which enable them to bid competitively. 1^st  Gen IPPs like YTLPOWR enjoy costs and ‘natural’ advantages, which enable them to competitively bid for new capacity. The risk remains that negative news flow impact on Tenaga may cap sustainable upsides. 

Revisiting PEMANDU’s subsidy rationalisation plans? We estimate that the additional fuel costs arising from Melaka RGT (excl. subsidized portion) is equivalent to 20% of FY13E core earnings. Since it will be too burdensome for the government to continue bearing these subsidies, we believe that PEMANDU’s proposal in this case (increasing gas cost by RM3/mmBtu every 6 months with corresponding tariff hikes) will be revisited. There is a strong case because Suruhanjaya Tenaga (ST) is working towards an Incentive Based Regulation (IBR) tariff framework, which will help determine the fair return for Tenaga although the framework will need a consistent fuel cost pass-through formula. We also like to highlight that Tenaga did get its electricity tariff hike three months after GE 2008.   

Source: Kenanga