Avoid TNB equity and debt.
- In spite of being a monopoly, TNB is a price-taker, not a price maker
- Persistent mid single-digit Government deficits make it difficult for the Government to continue with subsidies, but to remove them would be political suicide, and the incumbent party's hold on power is tenuous
- Malaysian's ever-growing addiction to cheap energy and the country's dwindling energy resources may imminently make Malaysia a net importer of both gas and oil.
- TNB (and Petronas) are therefore in straight-jackets
- TNB's debt could be an attractive alternative to owning equity, but only if held to maturity, as Malaysia is at risk of having its cost of borrowing re-rated when buyers re-evaluate the wisdom of taking such low yield from a country that derives nearly half its revenue from Petronas, which in turn is forced to subsidize ever greater amounts of oil and gas for domestic consumption
Discussion:
Tenaga Nasional Berhad ("TNB") is Malaysia's largest electric utility, with monopolies on transmission and distribution, and ownership of over 50% of Malaysia's generating assets (with the remainder of generation supplied to it by IPPs). TNB's controlling shareholders are Khazanah Nasional (38%) and Employees Provident Fund (15%) and it has a 36% free-float. TNB's generating assets are powered by a supposed mix of gas (58%), coal (33%) and hydro (9%); however gas shortages in Malaysia have reduced the gas contribution to 45% in FYE08-2011 with TNB and IPPs forced to obtain the balance of fuel from coal and oil.
TNB's gas is supplied at a subsidized price by Petronas (Malaysia's NOC); however, TNB is forced to buy coal at open-market rates. Malaysian IPPs that supply TNB with the balance of Malaysia's power needs are likewise eligible for subsidized gas from Petronas, but not for coal. However, while Malaysian IPPs are contractually able to pass-through fuel price increments to TNB; TNB is not (so far) able to pass-through fuel increments to either household or commercial end-users. TNB and Petronas have separately been lobbying the Government for an end to subsidies and the ability to pass-through energy prices. While the Government has agreed that pass-through will eventually be implemented, implementation would be political suicide. In Malaysia, except for coal, all energy sources (including sugar, which is resulting an obesity epidemic) are subsidized by the Government.
Predictably, TNB's margins have been declining, cash is being burned and dividends have declined considerably. For anything other than a short-term punt, I would avoid the shares; alternatively, TNB's debt (yielding approximately 6%) could be nice to own, but only if held to maturity, as I don't believe Malaysia's attractive cost of borrowing is sustainable in the medium-to-long term.
If you have a predisposition to short-term trading, there may be an opportunity to buy TNB shares on the basis of Petronas reinstating TNB's full gas supply by mid 2012 when a new LNG facility in Malacca is due for completion. This will once again provide TNB with its full negotiated supply of subsidized gas. Additionally, recent drops in the cost of other fuels (coal and oil) may also benefit TNB in the short term.
However, the medium to long-term premise for holding TNB equity or debt (unless to maturity) is weak for the following reasons:
- Malaysia is on the brink of becoming a net importer of gas and this problem will only be resolved with two unlikely miracles: gas consumption declines, or technology is developed to affordably capture huge amounts of CO2 found in vast undersea fields such as Natuna.
- Malaysia is also on track to become a net importer of oil, possibly by 2020. The Government has been politically incapable of removing petrol subsidies.
- Petronas, Malaysia's NOC, contributes close to 50% of the country's tax revenues (it is also a significant contributor to Government above the tax and dividend lines). Funding within Petronas for capex, skills development and strategic acquisitions is probably already impaired.
- Cheap energy is a key attraction used to lure foreign investment to Malaysia.
- Malaysia's incumbent political party retains a tenuous grip on power. To retain or strengthen their position, more wealth will need to be transferred to households and inflation will need to be kept in check. This will make it extremely difficult for the Government to remove energy subsidies. Transfer of wealth will be difficult, given the Government's high dependence on revenues from government-linked companies ("GLCs") such as Petronas.
- The subsidies result in the Government operating in a persistent mid single-digit deficit over the last decade.
- Given all of the above points, it is somewhat surprising to see the low borrowing cost Malaysia is able to command for its debt. Unless the Government radically changes its economic and social contract with its electorate, I think it is only a matter of time before borrowing costs escalate and Malaysia's rating is put on watch. Any changes in the sovereign cost of borrowing will also trickle through to the debt of GLCs; hence my belief that TNB debt should only be purchased if the intention is to hold to maturity (and you don't have to worry about mark to market accounting).
From a CIMB report dated 31 October 2011. This monopoly is a price-taker, not a price-maker. Don't let the 1x P/BV fool you.
