Tenaga Nasional Bhd
(Sept 12, RM12.48)
Maintain buy with a target price of RM14: Our compilation of plant availability indicates significantly improved performances at the major peninsular coal-fired plants since May this year. From June 1 to Aug 26 (last available data point), the average availability of Tanjung Bin was 95%, Jimah 95% and Janamanjung 93%, all healthily above the 85% threshold expected of coal plants.

In comparison, the average availability of the three coal plants from March to May 2014 was 93%, 51% and 87% respectively.

The improvement in availability is consistent with TNB’s guidance of higher sequential coal-fired generation made during its most recent results call. Recall that both Tanjung Bin and Jimah have been suffering from boiler tube leakages since early 2013. These issues appear to be finally resolved.

The higher coal plant availability means the proportion of coal-fired generation would have trended up significantly. From June 1 to Aug 26, coal accounted for about 46% of total generation on the peninsula, an eight percentage point increase from the third quarter ended May of financial year 2014 (3QFY14), essentially reflecting pre-outage (FY12) levels.

In terms of sensitivity, every one percentage point increase in the percentage of coal generation (with coal at US$85 [RM272] per tonne) raises FY15 net profit by 4.5%.

The consequences of higher coal-fired generation are two-pronged: (i) TNB’s usage of costlier LNG-sourced gas is coming down and; (ii) TNB is benefiting more from falling coal prices.

Recall, the first 1,000 million standard cu ft per day (mmscfd) of gas used is charged at a subsidised price of RM15.20 per million metric British thermal units (mmBTU), while any incremental gas volume is charged at market prices (about RM45 per mmBTU), of which the January 2014 tariff hike had covered for the cost of approximately 300 mmscfd.

The financial impact of any major deviation in actual gas consumption (from the 1,300 mmscfd threshold) is meant to be neutralised every six months via the fuel-cost pass-through mechanism under the new tariff framework (incentive-based regulation, or IBR). There were no adjustments in July 2014, possibly because the IBR has not formally begun and the coal plant issues were close to being resolved.

Average gas volume to the power sector dropped below the 1,300 mmscfd threshold in June this year and has continued to trend down in the subsequent months. If this continues, TNB would soon (we estimate by next month) claw back the higher than budgeted costs incurred in the first five months of 2014, thus negating the need for a subsequent tariff hike.

Thermal coal prices have declined sharply, with the Newcastle spot down 21% year-to-date, averaging US$73 per tonne. This is significantly below the US$87.50 per tonne reference price stipulated in the January 2014 tariff hike.

TNB, unfortunately, has not been able to benefit fully from the lower coal prices in FY14 due to the earlier mentioned outages at the coal-fired plants.

In terms of sensitivity, every US$1 per tonne decrease from our assumption of US$85 per tonne (assuming coal accounts for 40% of generation) raises FY15 net profit by 0.9%.

TNB is effectively benefiting from the lack of a fuel-cost pass-through mechanism. At the current run rate (46% coal-fired generation and US$67 per tonne coal price), we estimate TNB’s FY15 net profit to be 47% higher than our current RM5.3 billion forecast (based on 40% coal-fired generation and US$85 per tonne coal price).

We caution that the 47% earnings accretion is almost a “best case” basis, as (i) coal prices seasonally trend up towards the year-end; and (ii) sustaining this fuel mix requires an almost flawless operational performance by all the coal plants. Nevertheless, the key point to note is that TNB’s earnings risk is likely skewed to the upside.

Before the fuel-cost pass-through came into play, TNB’s share price essentially tracked earnings. TNB’s current earnings trajectory (based on our present forecasts) already suggests further upside to its share price, in our view.

The fuel-cost pass-through mechanism would likely take effect in 2015, the first year of the IBR (2014 represents the trial year). This would mean the current “supernormal” level of profit could potentially be clawed back via lower tariffs. Should this happen, we believe TNB’s valuation multiples would then expand to account for the newfound earnings stability. Investors are hedged either way for now, in our view.

We value TNB using a discounted cash flow methodology, assuming 7.2% weighted average cost of capital and 1% long-term growth. Our target price implies a FY15 price-to-book value of 1.9 times and price-earnings ratio of 14.8 times. — Maybank IB Research, Sept 12