- We maintain BUY on Tenaga Nasional but lower our DCF-derived fair value from RM18.40/share to RM17.00/share. Our fair value implies an FY15F PE of 15x and a P/BV of 2.0x.

- This follows the government’s decision yesterday to lower power tariffs for Peninsular Malaysia (-2.52sen/kWh or -5.8%) and Sabah (-1.20sen/kWh or -3.5%) effective 1 March to 30 June, 2015. We expect the next review to take place in July this year, as scheduled.

- Residential consumers who utilise more than 300kWh per month (~29% of total domestic consumers) as well as commercial and industrial consumers will stand to benefit from the cut.

- The tariff reduction stems from the availability of Imbalance Cost Pass Through (ICPT) savings of RM727mil, amid lower feedstock costs (mainly coal, which is now ~29% below the tariff threshold of USD87.50/tonne; LNG prices remain elevated, at ~12% above the reference rate of RM41.68/mmbtu).

- We opine that the tariff reduction will be earnings neutral to Tenaga premised on its fuel/tariff benchmark rates given that adjustments are now determined through the Incentive Based Regulation (IBR) framework and ICPT mechanism.

- This essentially means that the government can increase or reduce electricity rates based on the underlying prices of coal and gas. In other words, it will not only shield Tenaga’s earnings from spikes in fuel prices (e.g. higher use of distillates during the gas curtailment in 2011), but also removes its “supernormal” profits in times of low input costs, as presently.

- The government’s latest move signifies its commitment to fully implement the mechanism. As such, we have revised upwards our fuel cost assumptions from market prices to the benchmark rates – from USD65/tonne to USD87.50/tonne for coal and from RM40/mmbtu to RM41.68/mmbtu for LNG.

- That said, we anticipate the decline in earnings from the costs revision to be mitigated by a potential rise in electricity demand. We have thus increased our demand growth assumption from 3% to 4%.

- Accounting for both adjustments, we have cut Tenaga’s FY15F-FY17F earnings by 16%-21%. We believe the sharp plunge in share price yesterday was a knee-jerk reaction, given the lack of clarity about the impact of the tariff reduction on Tenaga’s earnings.

- The stock currently trades at a P/BV of 1.7x. It also offers an attractive FY15F PE of 12.5x, which is in the mid-range of its 3-year PE band of 10x-16x. We believe that Tenaga’s valuation will be well supported by its more stable and smoother earnings profile moving forward.

Source: AmeSecurities