TNB ... Apr10

S & P Results Review & Earnings Outlook

 Tenaga’s strong 2QFY10 (Aug.) net profit (before forex gain) of MYR855.7 mln (+26.8% YoY) was driven by an 8.0% YoY electricity demand growth and lower generating costs (-5.8% YoY). The latter was partly due to a lower average coal cost of USD82/ton (from USD85/ton in 2QFY09) and the strengthening of the Ringgit (MYR).
As a result, net margin improved to 13.5% from 8.5% previously. This brings YTD net profit before forex gain to MYR1.61 bln, accounting for 52.2% of our previous FY10 forecast of MYR3.08 bln.

 In line with the improved results, Tenaga has declared a higher interim gross DPS of 6.0 sen (FY09: 2 sen gross and 2 sen net).

 The outlook remains positive as electricity demand is expected to remain strong. Tenaga’s long-term plan is to expand its existing 2,100MW Janamanjung plant by 2,000MW to be commissioned in 2016, in time with the drop in reserve margin to below 20% from 48% currently. This is in view of the fact that the power transmission from
Bakun to the peninsula is unlikely to take place now.

 We revise higher our 2010 net profit forecast by 8.1% to factor in a stronger 8% YoY (from 4.0%) electricity demand and an average coal cost of USD90/ton (from USD85/ton), as it has already secured 91% of its FY10 coal requirement. We also assume an 8% demand growth in FY11 and a higher average coal cost of USD100/ton, but the impact
will be partially offset by the stronger MYR.

Recommendation & Investment Risks

 We maintain our Buy recommendation on Tenaga but raise our 12-month target price to MYR10.00 (from MYR9.50).

 Our target price continues to be DCF-derived, using a WACC assumption of 7.0% and an unchanged terminal value of 3%. Our target price includes a projected FY10 net DPS of 27.7 sen.

 Tenaga’s earnings visibility has improved, given that coal cost is contained while electricity demand is recovering at a faster rate. Its valuations are undemanding with a FY11 PER of 10.4x, as compared with its forward PER range of between 10.3x-30.4x in the past five years, and its peer group average of 12.3x. Foreign shareholding in the company has also recovered slightly to 8.8% from the low of 8.5% in January 2010. As of one of the largest component stocks in the FBM KLCI, Tenaga has been a market laggard, underperformed the market barometer, rising merely 1.2% YTD vs. the index’s 5.0% YTD gain. Therefore, we believe Tenaga has ample upside potential, and therefore maintaining our Buy recommendation.

 Risks to our recommendation and target price include: (i) an unexpected spike in coal price, (ii) a weakening MYR against major currencies, (iii) slower-than-expected growth in electricity demand, and (iv) the absence of tariff adjustment to allow fuel cost pass-through.