6 July 2015 Positives priced in Initiate Coverage We initiate coverage on Malakoff, the largest independent power producer in Malaysia with a HOLD rating and a DCF-based target price of RM1.92. While we forecast a 2014-17 earnings CAGR of 17%, Malakoff we believe these positives are already priced in. Nonetheless, we see MLK MK Malakoff as a decent dividend yield play with management guidance Sector: Utilities of at least 70% dividend payout. Reliable cash flows supported by long term PPAs RM1.79 @ 6 Jul 2015 Malakoff exhibits stable and defensive earnings as its power generation capacity is fully contracted for based on long term power purchase HOLD agreements (PPAs) that feature fuel cost pass through and scheduled Upside 7% escalations in relation to operating rates. TNB is the key offtaker for output of power generation and contributes c.90% to Malakoff’s revenue. Price Target: RM1.92 Potential expansion from longer term opportunities Previous Target: New Coverage Management intends to grow Malakoff’s total effective power generation capacity from 7,036MW in 2016 to 10,000MW by 2020. However, most of (RM) 1.90 the plant-ups for Peninsular Malaysia have already been awarded by the 1.85 EC and thus may present a challenge to Malakoff’s medium term growth 1.80 plans. Malakoff’s plan to export power also comes with regulatory and 1.75 political hurdles. Nonetheless, we do not rule out Malakoff pursuing M&A 1.70 as they have demonstrated in the past to achieve their targets. 1.65 Ample room to gear up for expansion and more foreign ventures 1.60 With a healthier balance sheet now, Malakoff is better positioned to May-15 Jun-15 undertake new power projects as well as pursue M&A to grow. Malakoff Price Performance has established a good M&A track record since privatisation in 2006, notably the Macarthur Wind Farm which is a key foreign earnings driver. 1M 3M 12M Absolute -4.3% NA NA Tapping into electricity and water demand growth in foreign markets Rel to KLCI -2.7% NA NA Malakoff has an existing presence in foreign markets namely Saudi Arabia, Algeria and Bahrain which are expected to show high growth in Stock Data electricity and water demand. While Malakoff has relatively small minority Issued shares (m) 5,000.0 stakes in many of its foreign ventures, it intends to consolidate and Mkt cap (RMm)/(US$m) 8,950.0/2,374.8 Avg daily vol - 6mth (m) 24.0 increase market share in the MENA region. 52-wk range (RM) 1.63-1.91 Initiating coverage with HOLD and TP of RM1.92 Est free float 25% BV per share (RM) 10.07 We initiate coverage on Malakoff with a HOLD rating and 12-month TP of P/BV (x) 0.18 RM1.92 based on DCF (WACC: 6.3%). While we like Malakoff for its Net cash/(debt) (RMm) (1Q15) (14,863.5) decent dividend yield of 3-4% and stable cash flows, we believe most of ROE (2015E) 7.2% the positives are already priced in. Derivatives Nil Shariah Compliant Yes Earnings & Valuation Summary FYE 31 Dec 2013 2014 2015E 2016E 2017E Key Shareholders Revenue (RMm) 4,717.4 5,594.5 5,713.4 6,196.6 6,211.1 MMC Corp 37.6% EBITDA (RMm) 1,589.5 2,327.3 2,438.1 2,512.5 2,492.6 EPF 19.1% Pretax profit (RMm) 84.1 595.5 658.1 824.4 827.2 LTH 10.0% Net profit (RMm) 161.5 341.5 434.3 544.1 545.9 Source: Affin Hwang, Bloomberg EPS (sen) 3.2 6.8 8.7 10.9 10.9 PER (x) 55.4 26.2 20.6 16.4 16.4 Core net profit (RMm) 161.5 341.5 434.3 544.1 545.9 Lim Tee Yang, CFA Core EPS (sen) 3.2 6.8 8.7 10.9 10.9 (603) 2145 9616 Core EPS growth (%) (65.5) 111.4 27.2 25.3 0.3 [email protected] Core PER (x) 55.4 26.2 20.6 16.4 16.4 Net DPS (sen) 0.0 0.0 6.1 7.6 7.6 Dividend Yield (%) 0.0 0.0 3.4 4.2 4.2 EV/EBITDA (x) 15.2 10.1 9.0 8.2 7.8 Chg in EPS (%) - - - Affin/Consensus (x) 1.0 0.9 1.0 Source: Company, Affin Hwang estimates, Bloomberg Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 1 of 24 6 July 2015 Investment thesis Reliable cash flows supported by long term PPAs Malakoff exhibits stable and defensive earnings as its power generation capacity is fully contracted for based on long term power purchase agreements (PPAs) that feature fuel cost pass through and scheduled escalations in relation to operating rates. The offtakers for Malakoff’s power generation output consist of high credit government or government-linked entities, which suggests that there is minimal risk to earnings. The key offtaker for Malakoff is Tenaga Nasional Berhad (TNB), which is a 30%-government-owned entity and is the sole offtaker in Malaysia. TNB contributes c.90% to Malakoff’s revenue, which mainly comprises of capacity payments and energy payments. This is unsurprising, given that the bulk of Malakoff’s existing 6,036MW effective power generation capacity is derived domestically. Malakoff derives the bulk of its gross profits from capacity payments, which mainly cover the power plant’s fixed costs and capital costs. Note that TNB is required to pay the available capacity payment to Malakoff regardless of whether Malakoff despatches the power generated from the power plant, provided that the power plant makes available a daily available capacity (committed availability declared by Malakoff on a daily basis) to TNB and meets certain performance targets specified in the relevant PPA. Fig 1: High credit quality offtakers Country Offtaker S&P Credit Effective Rating Capacity Malaysia TNB BBB+ 5,346MW Australia AGL Energy Ltd BBB 210MW Algeria L’Algerienne Des Eaux NA 71,400 m3/day Bahrain Ministry of Electricity and Water BBB- 372MW 164,000 m3/day Saudi Water and Electricity Company NA 108MW Arabia 123.450 m3/day Source: Company data There is minimal risk to Malakoff’s cash flows from fluctuations in fuel costs due to the cost pass through mechanism, which is captured under the energy payments. The energy payments generally cover the power plant’s fuel costs as well as variable operation and maintenance (O&M) costs that are incurred when TNB despatches the power generated from the power plant. Under the PPAs for Malakoff’s CCGT power plants, the cost of gas is passed on to TNB pursuant to the formulas under the respective PPAs, which has historically fully covered the cost of gas. Should Malakoff’s CCGT power plants need to run on distillate oil upon direction from TNB, the cost of distillate oil is passed on to TNB as well. The cost pass through mechanism for fuel applies to Malakoff’s coal-fired power plants as well. Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 2 of 24 6 July 2015 Malakoff has good earnings visibility given that it has the longest PPA term remaining among the Malaysian independent power producers (IPPs), with a weighted average PPA term of about 13 years. With the inclusion of Tanjung Bin Energy’s PPA (due to start operation in March 2016) Malakoff’s weighted average PPA term increases to about 15 years. Fig 2: Longest remaining PPA term among Malaysian IPPs Years 14 13 12 11 10 8 6 4 2 1 0 Malakoff 1MDB YTL Power Source: Company data Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 3 of 24 6 July 2015 Beneficiary of continuing domestic shift in generation mix to coal Given Malakoff’s track record with the Tanjung Bin Power Plant, we believe that Malakoff would be well positioned to capture any future tenders for new power plants that use coal for fuel. While coal will remain as the dominant source of fuel for generation mix in Peninsular Malaysia, we note that the EC has largely planned out future plant-ups until 2024. Fig 3: Outlook of generation mix for Peninsular Malaysia Source: Energy Commission Malakoff has established a track record with coal-fired power plants with the successful development and operation of the 2,100MW Tanjung Bin Power Plant, one of the largest coal-fired power plants in South East Asia. According to management, Malakoff is on track to complete the 1,000MW Tanjung Bin Energy Power Plant by Mar16. Malakoff has ample room to expand its generation capacity with its existing land bank estimated at 400 hectares in total and with remaining leases of 47 years on average that have easy access to transmission infrastructure. For example, the Tanjung Bin site has a remaining lease of up to 33 years, which can be used to support further PPA extensions or new capacity expansion. Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 4 of 24 6 July 2015 Potential expansion from longer term opportunities Management intends to grow Malakoff’s total effective power generation capacity from 7,036MW in 2016 (with the addition of Tanjung Bin Energy Power Plant) to 10,000MW by 2020. However, most of the plant-ups in Peninsular Malaysia involving coal and gas have already been awarded by the EC and thus may present a challenge to Malakoff’s medium term growth plans.