We continue to OVERWEIGHT 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 4%. TENAGA (OP; TP: RM17.00) has guided for a higher demand growth of 3%-4% from 2%-3% due to robust electricity sales that is driven by demand from data centres. In turn, this should improve plant efficiency and hence better earnings. Higher capex on transmission and distribution (T&D) investment is also expected, propelled by data centre, and this adds to 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: RM5.20) where we continue to watch for its AI data centre execution.

Demand growth to stay strong… Electricity demand growth is expected to stay strong given the increasing demand trend from data centres. This is on the back of past two quarters of record demand which jumped 9.6% YoY and 6.3% YoY with 150MW and 190MW of energy required in the data centres in 1QFY24 and 2QFY24, respectively. This was merely 11% of the completed 1,700MW data centres as of June 2024, thus the demand from this segment is expected to grow further going forward. As such, TENAGA has raised its demand growth assumption to 3.0%-4.0% against our assumption of 3.5%. In addition, there exists demand growth opportunity of 7,200MW, of which 26 projects or 4,000MW of Electricity Supply Agreements (ESA) have been signed while there are 21 projects in the pipeline with an additional demand of 3,200MW currently at the application stage.

…leading to impressive growth at TENAGA. Although demand growth is embedded in the IBR mechanism which is subjected to a revenue cap, where a higher actual electricity sales leads to an amount to be returned via revenue adjustment mechanism, we expect two positives from this strong electricity demand growth for TENAGA i.e., plant efficiency and higher capex. Firstly, higher demand growth should improve plant efficiency further and hence better earnings and this was witnessed in its 1HFY24 results. Secondly, to cater for developing data centres, higher capex on T&D investment is expected and this adds to RAB for RP4 over 2025-2027, which could translate to higher earnings. On the other hand, with the reduced volatility on stabilising coal prices, we no longer expect fuel margin shock to persist for TENAGA and IPPs.

All eyes on YTLPOWR’s AI data centre delivery as the Blackwell Nvidia chip housed in the 20MW AI data centre is scheduled to be delivered in 1QCY25. However, we expect PowerSeraya’s earnings to continue to decline more gradually from its peak as retail price normalises while it continues to enjoy favourable gas input costs locked in at low cost till end 2025 (low gas cost was locked for three years during the early days during the pandemic). Meanwhile, the turnaround of the telco unit was mainly due to construction profit from the RM950m Sabah Point of Presence (PoP) project for laying of fibers over three years. Wessex Water’s turnaround in 4QFY24 was largely due to a higher tariff rate which came into force in April over the next 12 months before a new tariff is set for the new regulatory period commencing April 2025. As such, the UK unit is expected to remain profitable in FY25.

Earnings for gas utilities remain resilient. While the movement of gas prices has neutral earnings impact in the long run under the regulated framework, soft gas price is positive on PETGAS (MP; TP: RM17.87) over the short term as it translates to lower internal gas consumption (input cost) for its regulated business as well as non-regulated utilities segment. The utilities segment uses gas as fuel to generate and supply power, stream and industrial gasses to industries. However, weak gas price works against GASMSIA’s (MP; TP: RM3.61) non-regulated retail margins, which are calculated based on a fixed percentage on the gas selling price. This will be cushioned by gas sales volume growth of 4% to 5% in FY24, driven largely by 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 4%. 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

Source: Kenanga Research - 2 Oct 2024