According to the Energy Commission (EC), electricity demand growth has been declining due to structural changes in the economy and increases in the electricity tariff.
KUALA LUMPUR: CIMB Equities Research has downgraded the utilities sector from overweight to neutral due to the muted earnings outlook and expected slower electricity demand.
In its outlook report issued on Friday, it said other factors were the uncertainty arising from sector reform and potential interest rate hikes in the medium term.
“The recent downgrade on the heavyweights – Tenaga in early 2018 also contributed to our sector downgrade. Gas Malaysia is our top pick given its stable earnings profile, undemanding valuation and lucrative dividend yield of c.6%,” it said.
CIMB Research expected the utilities counters under its coverage to continue posting negative earnings growth in CY18-19 (-1%) after charting a 5% earnings decline in CY17.
The expected earnings step-down in Tenaga due to the normalisation of tax rates and in Malakoff due to revisions in its Segari Energy Ventures (SEV) power purchase agreement (PPA) are likely to weigh on the sector’s earnings growth potential, it pointed out.
The research house said the FBM KLCI outperformed the MSCI Malaysia Utilities Index in 2017 by c.8%.
It believed this was due to major sector reforms in 2017, where there was gas sector liberalisation (implementation of the third party access) and uncertainty around the revision of the incentive-based framework (IBR) for the utilities sector.
Year-to-date, the MSCI Malaysia Utilities Index has underperformed the market by 1%.
CIMB Research said there were three factors that may become major disruptors to the overall utilities industry in 2018-2019.
Sector disruptor 1 – sector transformation:
It said there was a correlation between utilities counters’ share price performance and sector transformation events.
Although the overhang on Tenaga due to uncertainty over the IBR regulatory period 2 (RP2, 2018-2020) was lifted following the disclosure of the RP2’s parameters, it still sees risks as the framework has yet to be tested in the rising fuel prices environment.
“Furthermore, we see earnings risk for Petronas Gas as the current tariff under the third party access (TPA) may be lowered in the next review period (2019),” it said.
Sector disruptor 2 – demand:
CIMB Research expects electricity demand growth to stay uninspiring at c.2% in 2018.
The Demand Forecast Study 2016 revised the average demand growth forecast downward to 1.8% from 2.96% for the period 2016-2025.
According to the Energy Commission (EC), electricity demand growth has been declining due to structural changes in the economy and increases in the electricity tariff. The slower demand growth will likely cap Tenaga’s earnings upside in the medium term.
Sector disruptor 3 – interest rate:
From CIMB Research’s observation, the defensive counters with steady earnings profiles and decent dividend yields will likely under perform the market in a rising interest rate environment and, vice versa, typically perform better than the market during interest rate cuts.
“Our house view is that the overnight policy rate (OPR) will remain at 3.25% in 2018F and that 2019 will bring the next OPR hike. Given the potential interest rate hike, we see downside risks to the utilities sector’s performance in the medium term,” it said.
