Rise in energy demand boon for utility sector

Kenanga Research has maintained its “overweight” rating on the sector given its resilient earnings thanks to regulated asset returns for Tenaga Nasional Bhd (TNB) and gas-based players, as well as PPA-bound income for the IPPs.

PETALING JAYA: The outlook for the utility sector is bound to improve this year with the expected increase in energy demand due to a gradual pick-up in economic activity.

Utility players have generally remained resilient throughout the pandemic despite the drop in energy dispatch during the movement control order as independent power producers (IPPs) are covered under the power purchase agreements (PPA).

This makes them a darling among analysts.

Kenanga Research has maintained its “overweight” rating on the sector given its resilient earnings thanks to regulated asset returns for Tenaga Nasional Bhd (TNB) and gas-based players, as well as PPA-bound income for the IPPs.

“This also ensures sustainable dividends from the players, at above average yields of 4% to 7%.

“We reckon that TNB’s non-regulated segment was affected by Covid-19 but it will improve once the pandemic is over. Even during such times, the stock is still trading attractively at a 20% discount to the market with a decent dividend yield of 4%, ” it said in a report yesterday.

In its recent Q3FY20 results, TNB posted disappointing results with core profit falling 31% year-on-year to RM903mil as the Covid-19 impact on non-regulated business persisted.

However, the pandemic’s impact on its non-regulated business plus sales discount and contribution was reduced to a smaller quantum of RM425.8mil in Q3FY20 from RM703.8mil in the preceding quarter.

But Kenanga opined that this is an isolated event and noted that business should be back to normal in H2FY21 as the bulk of its earnings are covered by the Incentive-Based Regulation (IBR) framework.

As such, the stock remained Kenanga’s top pick for its first quarter 2021 strategy.

In uncertain times, it said the sector makes for a good investment case with their earnings defensiveness. Additionally, valuation remains attractive as utility stocks are trading at a discount to the overall market.

Gas-based players have also proven their earnings resiliency in the past two quarters during this difficult period.

While earnings for local IPPs are fairly stable, new assets will help to address their earnings gap caused by expiring old IPP assets.

“Despite the pandemic, Petronas Gas Bhd and Gas Malaysia Bhd reported impressive Q3FY20 results which beat expectations two quarters in a row, thanks to IBR framework which safeguard their earnings.

“We see little earnings risk for both stocks for the next three years on Regulatory Period one base tariffs but we believe most, if not all, near-term catalysts are already priced in for both stocks, ” said Kenanga.

The research house has a “market perform” rating for both Petronas Gas and Gas Malaysia with target prices of RM16.85 and RM2.85, respectively.

Meanwhile, IPPs are looking positive despite their mixed performances last year.

Malakoff Corp Bhd’s Q3FY20 results came in slightly below expectation owing to a one-off outage maintenance costs estimated at more than RM22mil, while YTL Power International Bhd’s Q1FY21 results matched expectations with a surprise profit from Singapore’s PowerSeraya, due to a low fuel price environment.

“We are not too concerned over Malakoff’s disappointing Q3FY20 results, as with Kapar Energy Ventures Sdn Bhd losses eliminated since Q1FY20, its earnings volatility is fairly low taking it back to concession-type stable earnings mode.

“Separately, with the expected losses from PowerSeraya and its mobile unit, and weaker earnings from UK’s Wessex Water on new rate coupled with the local IPP’s extension PPA contract expiring in June this year, YTL Power’s near-term earnings are set to be lacklustre until earnings of its new assets, a greenfield power plant in Jordan and the acquisition of Tuaspring of Singapore, kick in, ” it noted. Malakoff has an “outperform” rating with a target price of RM1.15 while YTL Power has been rated “market perform” with a target price of 67 sen.

Meanwhile, Kenanga added that niche utility infrastructure play Pestech International Bhd offers an exciting growth story in Cambodia coupled with promising rail electrification contract flow in the region.

It has an “outperform” call on Pestech with a target price of RM1.15.

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