We hold firm on our OVERWEIGHT rating on the utilities sector for its earnings defensiveness and resilience supported by regulated assets that generate recurring cash flows, anchoring decent dividend yields of up to 3%. TENAGA's (OP; TP: RM17.00) earnings are expected to be led by higher demand from new data centres which boost its plant efficiency that drives the bottom line. Higher capex on transmission and distribution (T&D) investment is also expected, propelled by data centres, and this adds to its regulated asset base (RAB) for Regulatory Period 4 (RP4) from Jan 2025 onwards. TENAGA remains our sector TOP PICK. Our other OUTPERFORM pick is YTLPOWR (OP; TP: RM5.00) where we continue to watch for its AI data centre execution.

Demand growth to remain strong in 2025. Electricity demand growth for 2025 has yet to be disclosed. However, TENAGA has raised its guidance for 2024 demand growth to 5.8%−6.3%, compared to the 1.7% embedded in the IBR mechanism for RP3. This projection, exceeding the country's GDP growth forecast of 4.8%-5−3% (as revealed in Budget 2025), is notable, as electricity demand growth has historically lagged behind GDP growth since the 2000s. Looking ahead, demand growth in 2025 is expected to remain robust, driven by increasing demand from data centres. This is supported by three consecutive quarters of record electricity demand, which grew 9.6% YoY, 6.3% YoY, and 6.1% YoY, with data centres requiring 150MW, 190MW, and 248MW of energy from 1QFY24 to 3QFY24, respectively. However, this represents only 15% of the completed 1,700MW capacity of data centres as of September 2024. Therefore, demand from this segment is expected to surge in the future. Additionally, there is a potential demand growth opportunity of 7,200MW, including 31 projects (equivalent to 4,700MW) for which electricity supply agreements (ESAs) are already signed.

Rate of returns to remain in RP4, but RAB value higher. Although demand growth is embedded in the IBR mechanism and subject to a revenue cap, where higher actual electricity sales result in adjustments through the revenue adjustment mechanism, we see two key positives from this strong electricity demand growth for TENAGA; improved plant efficiency and increased capex. Firstly, higher demand growth is expected to further enhance plant efficiency, leading to better earnings for TENAGA's non-regulated business, such as GenCo. This improvement was already evident in its 9MFY24 results. Secondly, to support the development of data centres, increased capex on T&D investment is anticipated. This will add to the RAB for RP4 (2025-2027), translating to higher earnings for the regulated business. The rate of return for RAB is maintained at 7.3% in RP4, with a base capex of RM26.6b compared to RM21.8b in RP3. As such, the higher capex increases the RAB value, leading to higher regulated earnings over the next three years. This is reflected in a 14% increase in the base tariff, from 39.95 sen/kWh in RP3 to 45.62 sen/kWh in RP4.

All eyes on YTLPOWR's AI data centre delivery as the Blackwell Nvidia chip housed in the 20MW AI-focused data centre is scheduled to be delivered in 1QCY25 while the delivery of building for the remaining 80MW AI data centre will be ready by 2QCY25. YTL AI, a separate entity from YTL DC, and partnered with Nvidia, is the off-taker for this AI-focused data centre.

According to Nvidia's website, YTL Communications holds the status of a Preferred Cloud Partner. On another front, PowerSeraya's earnings are projected to decline gradually from their peak as retail prices normalize. However, it continues to benefit from favourable gas input costs secured at low rates until the end of 2025. These low gas costs were locked in for three years during the early days of the pandemic. Meanwhile, the telco unit remains unprofitable, primarily due to low revenue generation. Elsewhere, Wessex Water has been allocated a GBP4.2b capex for 2025-2030 under the new regulatory period beginning in April next year. This includes a 20% tariff hike over the next five years, which will increase average household bills from GBP508 (2024-2025) to GBP614 (2029-2030). This tariff adjustment is expected to bolster YTLPOWR's earnings. Overall, the successful delivery of the AI data centre over the next 12 months remains pivotal to YTLPOWR's earnings performance. In a blue-sky scenario, YTLPOWR's fair value could rise to RM6.53, compared to our TP of RM5.00, if the AI data centre project is executed successfully.

Earnings for gas utilities remain resilient. Gas utilities' earnings are expected to remain stable in the long term under the regulated framework, as fluctuations in gas prices have a neutral impact. In 2024, the Malaysia Reference Price (MRP) has been relatively stable, ranging between RM41/mmbtu and RM44/mmbtu. With our crude oil price assumption of USD77 in 2025F compared to USD80 in 2024F, we expect the MRP to remain stable in 2025. This stability has a neutral effect on PETGAS's (MP; TP: RM17.87) internal gas consumption costs for both its regulated business and non-regulated utilities segment. The utilities segment relies on gas as fuel to generate and supply power, steam, and industrial gases to industries.

Similarly, the stable MRP has a neutral impact on GASMSIA's (MP; TP: RM3.85) non-regulated retail margins, which are calculated as a fixed percentage of the gas selling price. Going forward, GASMSIA's earnings growth will be driven by an anticipated 3% increase in gas sales volume for FY25. This growth is primarily attributed to strong demand from the rubber glove, consumer product, and F&B sectors.

Maintain OVERWEIGHT rating on the sector. We continue to like the sector for its earnings defensiveness and resilience backed by regulated assets that generate recurring cash flow to anchor decent dividend yields of up to 3%. Our top pick for the sector is TENAGA as it is a long-term beneficiary of the influx of FDI to build data centres in the country while we see value in YTLPOWR for its AI data centre venture.

Source: Kenanga Research - 6 Jan 2025