TNB biz revamp will not have impact on earnings

by SHAZNI ONG / pic by TNB

TENAGA Nasional Bhd’s (TNB) move to revamp its power generation and retail businesses is not expected to have any impact on near-term earnings ahead of possible liberalisation of the electricity market.

Analysts continue to be cautious on TNB ahead of the government decision on the sector, in expectation the retail business will be liberalised and open to competition.

To recap, TNB on Monday announced an internal restructuring to split its power generation and retail businesses into GenCo and RetailCo respectively, which would have their respective board and management teams.

The main objective of the exercise is to allow for greater focus in driving improvement in efficiency, agility and performance. The exercise will also allow TNB to better prepare for the continuous changes in the utility sector, while having the flexibility to raise new capital from the market.

The exercise is expected to be completed by the third quarter of 2020 and pave the way for the impending market reforms.

MIDF Research, in a note yesterday, reaffirmed its ‘Buy’ call on TNB with an unchanged target price (TP) of RM14.40.

The research outfit stated that the internal reorganisation in its current form does not impact current valuations and TNB’s peaking capital expenditure suggests room for dividend upside or possible acquisitive growth.

“Other key catalysts include decent dividend yields of 4%, while valuations are cheap at 12 times financial year 2019 (FY19) forecast earnings relative to the market’s 16 times to 17 times, monetisation of backbone fibre asset and positive outcome of the LSS3 (large scale solar 3) bidding.”

MIDF does not rule out the possibility of separate listings of the respective units, as each of the three units essentially carries distinctly different risk profiles, allowing for better valuation discovery.

The legacy regulated business — transmission and distribution (T&D) — entails very low risk (almost bond-like), steady earnings and returns (albeit just a 7.3% return) ,it added.

“GenCo and RetailCo are higher risk units which can carry higher returns. For example, GenCo internal rate of return is estimated to be in the high single digits, while RetailCo, even in its regulated form, allows for volume upside as it operates on a pricecap basis,” the research firm said.

MIDF added, based on regulatory period 2 projections, the legacy T&D business can generate average annual net earnings of RM3.8 billion and retail at RM21 million.

“The non-regulated units; GenCo and operation and maintenance are estimated to generate between RM1.7 billion and RM2.2 billion annual profits, making up 30% to 38% of TNB’s annual earnings.”

MIDF said T&D is likely to remain under TNB to avoid duplication of expensive infrastructure.

It expects the T&D business to remain the key driver of TNB’s earnings (accounting for 60% to 70% of group earnings).

“Should a liberalisation of the retail market and transition to a merchant market take place, we foresee a TPA-like (third party access) model taking place akin to the gas sector, for TNB’s T&D,” the research firm said.

Kenanga Research noted that contributions from the two entities are fairly small at the moment, with RetailCo’s earnings before interest and taxes Ebit x3 of RM200 million only made up less than 3% of the group’s FY18 Ebit of RM6.7 billion, while GenCo’s RM1.6 billion accounted for 5.4% of the group’s earnings.

“Fears of opening the retail business are seen as overly played. TNB aims to target Ebit of RM13 billion by 2025 with RetailCo’s earnings growing to RM700 million with GenCo’s earnings to increase to RM2.6 billion.”

“Given the regulated incentive-based regulation framework, this aim is a tall order which means it has to grow its non-regulatory asset base business tremendously, especially the international business, in order to double its earnings,” Kenanga stated, adding that TNB may lose out some earnings from RetailCo and GenCo as the segments are opened up.

The pro-forma FY18 book value for RetailCo was around RM1.84 billion against the group’s book value of RM59.05 billion, while GenCo had a book value of RM12.14 billion.

Kenanga said there is higher clarity now pertaining to RetailCo’s earnings, but believes the market may need time to digest while awaiting the Malaysia Electricity Supply Industry 2.0 to unveil.

It maintains a ‘Market Perform’ call on TNB with an unchanged TP of RM13.40, which is based on 13.6 times FY20 price-earnings ratio.

Kenanga forecasts the restructuring will pave the way for market reforms and the impending new structure could lead to two separate listing entities under two segments.