This article first appeared in The Edge Financial Daily on January 9, 2018

YTL Power International Bhd
(Jan 8, RM1.33)
Maintain sell with a lower target price (TP) of RM1.17: The Singapore government will implement an Open Electricity Market (OEM) for 1.3 million households in the second half of 2018 (2H18). The OEM will enable consumers to purchase electricity from a retailer of their choice. Currently, domestic households in Singapore buy electricity at regulated tariffs from SP Services. The latter is part of the government-owned Singapore Power Group, which took over the Public Utilities Board’s electricity and gas businesses. OEM is the culmination of the efforts to liberalise the market by the regulator, Energy Market Authority (EMA), which started back in 2001. OEM’s aim is to promote greater competition among electricity retailers, and encourage new market entrants. Correspondingly, consumers will benefit via competitive pricing, enhanced service standards, and innovative product bundling. Additionally, to stabilise prices and for hedging purpose, the Electricity Futures Market was launched in 2015.

We expect heated competition in the retail segment, as a crowded pool of retailers compete on prices. In 2016, the government approved licences for six new energy retailers in the contestable retail segment. As a result, current market players have now increased to 15 retailers, from six back in 2011. Correspondingly, licensed electricity retailer Seraya Energy Power Pte Ltd’s (subsidiary of YTL PowerSeraya Group) market share for industrial and commercial users also dwindled to 13% (2011-16: 16%). We believe that Seraya has an edge over new and smaller retailers that are not vertically integrated with established marketing and back-end systems. Out of the 15 retailers, only six players have generation capacity, excluding SP Services. Nevertheless, in line with OEM’s objective, we believe that smaller players may disrupt the market via price competition that crimps margins. On the back of this, there is a possibility that SP Services’ users may migrate to Seraya, thus boosting the top line. However, we believe this will have limited-to-moderate impact on Seraya’s profits. This is underpinned by expectations that margins will be razor-thin, coupled with subdued volumes. Based on Sapere Research, equivalent net consumer benefits from OEM would amount to about S$435 million (RM1.3 billion) over five years.

Given subdued margins, the retail business is essentially a volume game. However, residential homes merely account for 16% of total industry demand. Businesses and industries with an average monthly electricity consumption of at least 2,000 kilowatt-hour (kWh) (monthly bill: more than S$400) are existing contestable retail customers. Furthermore, growth prospects are tepid, as EMA projects system demand to grow at a 10-year compound annual growth rate (CAGR) of 1.5% per annum from 2017 to 2027. Based on our back-of-the envelope estimates, under the best case scenario, new household accounts will boost Seraya’s annual financial year 2019 (FY19) revenue and pretax profit by 17% and 15% respectively. Our underlying assumptions for the household segment include the following: The migration of all of SP Services’ customers to new retailers; Seraya to replicate its current retail market share of 18%; low tension tariff of 22.1¢ per kWh (2014 to 2016 average; and annual consumption of 7,589 gigawatt hours (GWh). However, this would translate to a marginal 2% boost to YTL Power International Bhd’s (YTLP) pre-tax profit.

We maintain YTLP’s sum-of-parts valuation at RM1.17 per share and reiterate “sell” on YTLP (TP: RM1.17) at this juncture, given YTLP’s diminished dividend capacity. This is because near-term cash flows would be stretched by major pipeline projects, including the Attarat Shale (45% stake) plant, and the US$2.7 billion (RM10.8 billion) Tanjung Jati (80% stake) coal plant. This is exacerbated by a highly leveraged balance sheet (net gearing: 1.4 times, net debt/earnings before interest, taxes, depreciation and amortisation: 6.5 times), coupled with the group’s strategy to conserve cash for future mergers and acquisitions. On the back of this, we believe YTLP has limited dividend capacity, as evident from the slash in financial year ending June 30, 2017 (FY17) dividend per share to five sen (FY14 to FY16: 10 sen). Moving forward, we opine the group will likely maintain, if not reduce, its dividend payout. — TA Securities, Jan 8