This article first appeared in The Edge Financial Daily on November 29, 2018

Tenaga Nasional Bhd
(Nov 28, RM14.26)
Maintain hold with a lower target price (TP) of RM15.60: Tenaga Nasional Bhd’s (TNB) nine months of financial year 2018 (9MFY18) results were below expectations. We had accounted for the non-recurring “excess tariff” from the first regulatory period’s (RP1) improved  demand mix, but had not factored in RP2 reference gas price hikes. Our earnings forecasts have now been recalibrated lower.

TNB shifted its financial year end from August to December in 2017, thus year-on-year comparisons were not available. Third quarter of financial year 2018 (3QFY18) core net profit (excluding foreign exchange) of RM676 million (-52% quarter-on-quarter) brought 9MFY18 core net profit to RM4.12 billion, 63%/58% of our/consensus full-year forecasts. The variance was due to us not having incorporated the step-up in reference gas prices for the second half of FY18 (2HFY18), further associate/joint venture (JV) losses and higher-than-expected taxes. Its 3QFY18 non-fuel costs trended higher sequentially, and included another RM292 million impairment charge for Turkey associate Gama Enerji (now fully impaired).

The main contention in the results call was the seemingly “insufficient” imbalance cost pass-through scheme adjustment (RM480 million credit to revenue) for 3QFY18. Now after the fact, this is likely due to the reference gas price hikes embedded in the RP2 base tariff (by RM1.50 per million British thermal unit each for 2HFY18 and 1HFY19). Reference generation cost would thus have increased sequentially, resulting in lower cost under-recoveries, all else being equal. In RP1, a single reference gas price was used, thus higher gas costs from price hikes were passed on.

We have lowered our FY18, FY19 and FY20 net profit forecasts by 14%, 13% and 11% as we incorporated the two step-ups in reference gas prices, and reflected the latest run rates for costs, associate/JV losses and taxes. Our discounted cash flow-based TP (assuming a 7.5% weighted average cost of capital and 1% long-term growth) has been lowered to RM15.60 (from RM16) in tandem with our 2% to 4% earnings before interest, taxes, depreciation and amortisation cuts. The earnings step-down in RP2 has now played out. Next up, there is a possible price-earnings ratio expansion if doubts over the pass-through mechanism dissipate. — Maybank IB Research, Nov 28