Watts in for Tenaga?

TheEdge: Tenaga Nasional Bhd expects to rake in an additional RM4.8 billion through its financial year ending Aug 31, 2009 (FY09) from its tariff revision on July 1 but the utility will still see its earnings trimmed. The new tariff would allow the company to recover the increase in gas price and part of coal price, said Tenaga's president and chief executive Datuk Seri Che Khalib Mohamad Noh at a media conference yesterday. “The other increases such as labour, material and independent power producer (IPP) costs are being absorbed by TNB. It is only a fuel cost adjustment,” he said, adding that it was not right to say that Tenaga was passing all the costs to consumers.

On Wednesday, the government announced a 123% increase in the price of gas for power generation to RM14.31 per mmBtu from RM6.40 per mmBTU. The price increase would add approximately RM4.2 billion to Tenaga's gas bill, raising the cost to about RM7.5 billion.
The recent increase in coal prices to about US$130 (RM422.50) per tonne would add a further RM1.4 billion to Tenaga's annual fuel costs, which account for 30% to 40% of the utility's annual operating costs. Gas and coal-fired power plants constitute 68% and 26% of Tenaga's total generation capacity. “There will be a reduction in profits this year compared to last year. For gas, our bottom line will be neutral but for coal, because we have to bear part of the cost, definitely it will have a downward effect on our profits,” said Che Khalib. He said Tenaga anticipated a surge in coal prices in its next financial year and it had neither secured a new supply contract nor catered for the increased price. Tenaga would absorb as much labour and material costs as it could by increasing efficiencies, he added. “We don't want to sacrifice the maintenance. We have to continue investing in new infrastructure to ensure the reliability of power supply in this country remains stable and strong,” said Che Khalib.

Households that consume 201-400kWh per month, which represent 26.7% of total household consumers, are expected to see their electricity bills increase by 1% to 11%, while those consuming less than 200kWh may not see any increase. The electricity bill for commercial and industrial consumers are expected to increase by about 26%, while low-voltage commercial and low-voltage industrial consumers who use up to 200kWh per month could expect an increase of 18%.

Tenaga, however, would maintain the 10% discount for government schools, government institutions of higher learning, welfare homes and places of worship. On whether there would be a revision on the tariff to reflect the change in gas prices, Che Khalib said: “When there is a movement in gas price, whether upward or downward, there would be adjustments to tariffs.” He said he would not guess when a tariff revision could be expected, adding that the newly adjusted gas price was still heavily subsidised. The current market price for gas is between RM35 and RM40 per mmBtu. “Since the government is fixing the gas price, we don't think there would be a need for a three-month revision,” he said. Che Khalib also said Cabinet had directed Tenaga to begin talks with IPPs to find solutions on how to share the burden of high cost in generating power. “We will start talks with IPPs as soon as possible. From the feedbacks that we got, they are ready to discuss and look for the best solutions.”

MyTake: Tenaga's share price has during the year dropped to RM6.55 (a 5 1/2 year low) due to heavy downgradings from research analysts who were concerned of its ability to passed on the rising gas and coal prices to consumers due to Tenaga's social obligations. The share price shot up to RM9.10 from RM7.30 on Friday after the tariff announcement. However, the share ended down 75sen today at RM8.25 due to profit taking. Many analysts were of the opinion Tenaga will warrant a relook and rerating if it gets 2 types of tariff revisions 1) Base Tariff Revisions(revisions based on inflationary factors on non-fuel related cost components such as equipment costs, salaries and petrol prices amongst others) and 2) Cost -Pass -Through mechanism for gas and coal. It seems that Tenaga has already be given some sort of "Cost-Pass -Through Revisions" which is subject to revision as the gas prices for the next 15 years will be revised upwards at 5% yoy but no such luck in the coal prices. Tenaga is set to ask but not guaranteed to get a portion of IPP's windfall tax and possibility of enjoying the Base Tariff review in June 09. What are the brokers' view on Tenaga after this "Cost-Pass-Through" tariff revision? Below are some of the brokers recommendations with their Target Price(TP) and a short summary of the basis used for the call.

Positive

Macquire(TP RM13.90) - "across the board price deregulation for energy prices is long-term positive as a move towards proper allocation of resources".

OSK(TP RM10.20) - "the clarification from TNB that it will be able to pass through some of its coal price as future adjustments leads us to revise up our tariff growth from 1.9% in FY10 to 6.6% given our expectation of a coal price of USD120/mth in FY09 as well as a base tariff adjustment in June 2009".

Kenanga (TP RM10.81) - Raising target price by 29% to RM10.81, or a 20% upside to last traded price of RM9.00, based on our DCF valuation (9.2% WACC, 4.8% long-term
growth), as we have some earnings enhancement derived from higher tariffs.

CIMB(TP RM11.90) - Maintain OUTPERFORM with a higher target price. Given the positive feedback from the briefing and the light thrown on future tariff adjustments, we now value Tenaga at a smaller discount of 10% (30% previously) to its historical average P/BV
multiple of 2.0x. This gives us a new target price of RM11.90, up from RM9.10 previously. At our revised target price, the implied forward P/E is 17x, 30% higher than our target market P/E in view of Tenaga's greater earnings upside potential resulting from a possible double tariff review in 2009. We maintain our OUTPERFORM recommendation, with the key share price triggers being i) newsflow on the base tariff review, ii) potential earnings-accretive M&A opportunities, including Genting Sanyen's power plants, iii) higher dividends, iv) positive feedback from Friday's briefing and v) possible upgrades by other brokers. Tenaga is now our top pick in the power sector.

RHB (TP RM9.57) - Clearly, sentiment has improved towards TNB. Policy risk appears to have been reduced but we highlight that political uncertainty may still cause the positive sentiment to unravel. Re-rating may continue in the short term. However, notwithstanding our concerns, we and the market were caught by surprise by the quantum of the tariff hike. Therefore, in the scramble to readjust portfolio weightings, we believe TNB may in the short term continue to trade higher. However, we believe most of TNB's “good news” is already in the price. Keeping in mind our expectations of continued earnings decline for FY09-10 even after this tariff hike, and the political uncertainty, we believe the stock should in the longer term trade in line with our KLCI target of 15x. On this basis, we thus raise our fair value to RM9.57 (based on 15x FY09 PER), and upgrade our call for the stock to Market Perform.

Negative

TA(TP not given) "price pressures would hurt demand for energy"

AmResearch (TP RM7.20) - No clear compensation plan for coal - Sell. We recommend investors to Sell into strength on Tenaga shares. Our target price of RM7.20 values the shares at 12x (at our target market PE) calendarised EPS for 2008. Tenaga currently trades at approximately 20% premium to market valuation. Policy wise, we are encouraged by the higher level of transparency in addressing the gas subsidy and electricity rates in the power sector going forward. However, the fact that the government stop short of fully compensating Tenaga on higher generation cost incurred from rising coal prices in its latest review does raise some uncertainty going forward. In addition, we believe investors should weigh the execution and implementation risks of the government and Tenaga's strategies. Lack of a committed schedule on gas and tariff review does not help. The aggressive removal of energy subsidies (i.e. higher petrol prices, etc) is likely to have a negative impact on the already weaker economic conditions. That could put pressure on demand growth outlook.

Some news on crude oil.

* Goldman Sachs: A full removal of subsidies such as those maintained by Malaysia on gasoline and diesel sales may cut global oil demand by just 20-30%. At least a dozen of countries in Asia (eg China, Indonesia, Sri Lanka, India and Taiwan) still keep fuel prices under some sort of state control.

* BP CEO: World has 42 years of oil reserves and 62 years of natural gas.

* Petronas: Global oil demand is expected to remain stable around 87 mil barrels a day.

* Malaysia's petrol price of RM2.70 is one of the highest among oil producing countries (UAE RM1.19 per litre, Egypt RM1.03, Saudi Arabia RM0.38, Iran RM0.35, Nigeria RM0.32, Venezuela RM0.16, Bahrain RM0.87 and Qatar RM0.68).

* Goldman Sachs: Oil price super spike likely to hit USD150 per brrl this summer season.

* Morgan Stanley: Crude oil may reach USD150 per brrl by July 4 2008.

* Lower income South Koreans will benefit from the USD10.2 b in handout over the next year to offset the rocketing price of oil.

* G8's strategy to counter higher oil prices is to invest more in energy efficiency and green technologies(partly to reduce carbon emission) and boost oil producers output.

* Lehman Bros: Oil prices could fall sharply towards the end of this year or early next year as evidence of eroding demand in Asian economies slowly materialised.