Tenaga Nasional hit by higher tax rate

KUALA LUMPUR: Tenaga Nasional’s core net profit for the nine months ended May 31, 2017 was slightly below expectation at 73% of CIMB Equities Research’s full year and 71% of consensus due to higher-than-expected effective tax rate in 3QFY17. 
 
It said on Friday core net profit 9MFY8/17 fell 8% on-year due to higher finance cost and effective tax rate of 15.5% (vs. 9.8% in 9MFY8/16) as a result of higher deferred tax expense.

“We cut our FY17-19F EPS by 3%-5% to account for a potentially higher effective tax rate in view of a reduction in tax reinvestment allowance.  Maintain Add with a lower RM15.70 target price, based on 12.5 times CY18 P/E, five-year mean,” it said.

To recap, CIMB Research said Tenaga’s revenue in 3QFY8/17 grew by 3.5% on-year due to an under-recoverability of Imbalance Cost Pass-Through (ICPT) of RM507mil. 

However, Tenaga’s core net profit in the third quarter fell by 17.8% on-year due to higher depreciation charges, finance cost and effective tax rate of 20% (vs. 9.8% in 3QFY16) mainly due to an increase in deferred tax expense recognised, resulting from higher capital expenditure in the past two years.  

“Tenaga’s core net profit in 9MFY8/17 fell by 8% on-year after stripping out the one-off accrued interest of RM150mil from the power purchase agreement (PPA) Savings Fund.

“The group highlighted that the interest payment is in line with the newly gazetted Federal Government Electricity Supply Order 2017 in April 2017. 

Tenaga also highlighted that profit after tax of the regulated asset under the Incentive Base Regulation (IBR) framework that mainly consists of the transmission and distribution (T&D) division was at RM3.09bil or 60% of 9MFY17 profit after tax.

“Following the higher-than-expected deferred tax expense in 9MFY8/17, we cut our FY1719F EPS by 3-5% to account for a higher effective tax rate going forward in view of a reduction in reinvestment allowance from 2018 onwards. 

“Although we expect electricity demand to improve on-year in 4QFY8/17, in line with stronger domestic economy growth, we see weaker earnings in 4Q17 due to increasing tax expense and seasonally higher opex,” it said.

Under the IBR framework regulatory period from 2014-2017 (RP1), Tenaga earns a 7.5% return on its T&D assets. But, its actual average tariff is about 2% higher than the base tariff set by the IBR due to higher electricity consumption by the commercial sector. 

However, when the regulator revises the IBR parameters for RP2 starting in 2018, the allowable return may be lowered and CIMB Research sees potential earnings risk and Tenaga may no longer enjoy the additional 2% tariff. 

“Nevertheless, assuming Tenaga is only allowed to earn a 6.5% return (its WACC, based on our estimates) on its T&D assets and the 2% mark-up in tariff is entirely removed, we estimate that Tenaga’s net profit could be lowered by as much as RM1bil per annum. 

“This, plus the risk of a higher effective tax rate, may lead to a RM2bn reduction in Tenaga’s annual net profit. However, even if all these risks materialise, Tenaga would trade at 16x CY18 P/E, below PetGas’s 18 times, Malakoff’s 26 times and Gas Malaysia’s 21 times.  

“Following the earnings revision, we keep our Add call with a lower RM15.70 TP, still based on 12.5 times CY18 P/E, five-year historical mean. 

“We still believe its earnings will not be affected by the rising fuel cost. The stock trades at 11 times CY17 P/E, making it the cheapest big-cap utilities stock in our coverage.

“Potential catalysts are stronger organic earnings growth and acquisition of new assets. The key downside risk to our call is a sell-down of Malaysian equities as Tenaga is often seen as a proxy for the Malaysian stock market,” it said.