Tenaga Nasional Bhd (TNB)
(Nov 3, RM13.50)
Maintain “outperform” with a raised target price (TP) of RM14.65: The financial year 2014 (FY14) core profit of RM5.43 billion came in above expectations, which beat our estimates as well as market consensus by 11% and 5% respectively.

The better-than-expected results were attributed to i) lower total fuel cost of RM17.99 billion vs our assumption of RM20.40 billion; and ii) lower taxation with actual adjusted effective tax rate of 19.1% vs our assumption of 22%.

A dividend of 19 sen of net dividend per share (NDPS) was declared, bringing the FY14 NDPS to 29 sen as per our assumption.

The fourth quarter of financial year 2014 (4QFY14) core earnings plunged 31% quarter-on-quarter (q-o-q) to RM961.8 million despite top line growing 2% over the period. This was mainly due to adjustment on revision of tax assessment in 4Q14.

In 4Q14, TNB wrote back a RM189 million provision for Liberty Power Ltd (LPL) with another RM52 million for a change in the corporate tax rate. In fact, at the pre-tax level, 4QFY14 core profit before tax jumped 19% q-o-q to RM2.15 billion from RM1.81 billion driven by: i) higher revenue on higher electricity demand; and ii) lower fuel cost as it burnt a higher amount of cheaper coal fuel.

Electricity demand in the peninsula rose 4.6% q-o-q which pushed total electricity sales in West Malaysia higher by 5% to RM10.51 billion.

This round, TNB benefitted from weaker coal prices as the two coal-fired independent power producers (IPPs) came back into the system. The generation mix for coal has increased to 45.6% from 38.2% while fuel mix for gas was reduced to 49.9% from 55.9%.

As such, TNB’s total fuel cost, which included IPPs energy payment, reduced 9% q-o-q as coal price continued to fall to US$72.9 (RM241) per tonne in 4Q14 from US$74.6 per tonne in the 3Q14 while the average requirement for the expensive gas was reduced 13% to 1,217 mmscfd from 1,405 mmscfd.

For FY14, core earnings leapt 12% to RM5.43 billion from RM4.84 billion in FY13, mainly driven by a 15% jump in revenue after a 15% tariff hike which took effect in January 2014.

The electricity unit sold in Peninsular Malaysia rose 2.5% in FY14, which was slower than 3.8% registered in FY13. During the year, total fuel cost surged 26% as it burnt more expensive gas/liquid natural gas (LNG) as the two problematic coal-fired IPPs were under heavy maintenance.

Fuel mix for gas rose to 54.5% from 47.3% while generation mix for coal was reduced to 39.8% from 44.5%. On the average, coal price was US$75.4 (RM250) per tonne in FY14 from US$83.6 per tonne in FY13.

On debt exposure, total debt dropped to RM25.5million (net debt: RM17.3 billion) as at August 2014 from RM26.4 billion (net debt: RM15.4 billion) three months ago. Thus, gearing was also reduced to 36.9% (net: 25.2%) from 40.0% (net: 23.3%) previously.

We expect a tariff revision in the December review window given that there was no adjustment in the June review period. We believe the chance of tariff revision is high this time around given that the government has just approved the gas tariff adjustment for the non-power sector last week.

In any case, although the authority/TNB claim that any tariff adjustment will have neutral impact to TNB, we believe the integrated utility will still see net growth impact in earnings.

In addition, as the two coal-fired IPPs, namely Tanjung Bin and Jimah are back into the system coupled with declining coal prices, TNB should be able to benefit from cheaper fuel cost.

Moving forward, when a new set of fuel cost pass-through mechanism is in place, TNB’s earnings are expected to stabilise. By then, its financial performance would depend mainly on its operational efficiency.

We have fined-tuned our earnings assumption for fuel cost and fuel mix to reflect the current operational dynamics. This includes the changes in: i) coal price to US$80  per tonne from US$95 per tonne for both FY15 to FY16; ii) oil price of US$95 per barrel from RM102/barrel to RM110/barrel for FY15 to FY16; iii) fuel mix for coal to 47.8% to 49.8% from 46.2% to 48.2% for both FY15E (earnings) to FY16E; iv) fuel mix for hydro to 4% from 5.6% for both FY15E to FY16E; and v) US$/RM to 3.25 to 3.28 from 3.05 to 3.15 for FY15E to FY16E. As such, our FY15E-FY16E estimates have been raised by 0.3%-3.6%.

At the same time, we launched our FY17E estimates where we expect earnings to grow at 3.6%. Key assumptions are: i) 4.5% electricity demand growth; ii) coal price of US$80 per tonne; iii) gas price of RM15.20/mmBTU, (iv) LNG price of RM41.68/mmBTU; v) oil price of US$95 per barrel; vi) coal fuel mix of 49.8%; vii) gas/LNG fuel mix of 46.0%; and viii) US$/RM of 3.32.

As we expect a tariff hike in this coming review, we decided to upgrade our targeted calendar year 2015 (CY15) price-to-earnings ratio slightly to 15 times from 14.3 times (five-year average) which we believe the valuation is not excessive given its sustainable earnings growth with index-linked heavyweight status while the market is currently trading at 17 times multiple.

As such, the new TP for TNB is raised to RM14.65 per share from RM13.77 per share previously. — Kenanga Research, Nov 3

This article first appeared in The Edge Financial Daily, on November 4, 2014.