Tenaga ... Nov10

S & P Results Review & Earnings Outlook

 Tenaga’s 4QFY10 (Aug) results were broadly in-line with our forecast. Core net profit rose 1.6% YoY to MYR413.5 mln underpinned by a 5.9% YoY demand growth driven by the steel and the petrochemical
sectors, offset by higher depreciation charges (+13.8% YoY) and IPP costs (+5.8%). However, core profit fell 22.6% QoQ weighed down by higher depreciation charges (21.4% QoQ) and repair & maintenance
costs (+34.6% QoQ).

 FY10 net profit surged 249% YoY to MYR 3.2 bln due to the strong MYR656.0 mln forex gain. Core net profit growth remained respectable at 22.6% YoY excluding the forex gain, driven by the 8.4%
YoY power demand growth. Although average coal prices eased 2.2% YoY to USD88.2/ton, total fuel cost surged 5.6% YoY due to higher volume of coal consumed (17.8 mln tons vs 11.6 mln tons previously).

 A pleasant surprise came from a higher-than-expected final GDPS of 20.0 sen, bringing total GDPS to 26.0 sen, vs our forecast of 21.0 sen. Tenaga’s financials continued to improve with net gearing now at
0.45x down from 0.63x at end-FY09.

 We fine-tune our FY11 net profit forecast to MYR2.92 bln (from MYR2.91 bln) but maintain our key assumptions, including a 5% demand growth and average coal cost of USD100/ton, in line with management guidance. We also introduce our FY12 forecasts. Note that we have not incorporated a potential tariff increase in our forecasts.

Recommendation & Investment Risks

 We downgrade our recommendation on Tenaga to Hold (from Buy) but maintain our 12-month target price at MYR9.50, as valuations appear fair following its recent share price strength.

 The stock is trading at FY11 and FY12 PERs of 13.2x and 11.8x, a slight discount to its Asian peer group of 14.6x and 13.4x respectively. The discount is justifiable, in our view, due to its more moderate growth
prospects and the absence of a formal fuel cost-pass-through mechanism. The tariff is being reviewed every six months, but political considerations may take priority due to the sensitivity of the issue. In addition, we believe coal costs may rise further in the medium–term in line with the global economic recovery. This may increase the earnings risk of Tenaga.

 Our target price continues to be DCF-derived, using a WACC of 7.0% and terminal value of 3% (both unchanged). Our target price includes a projected FY11 net DPS of 20.3 sen.

 Risks to our recommendation and target price include: (i) an unexpected spike in coal price, (ii) a weakening MYR against major currencies, and (iii) slower-than-expected growth in electricity demand.