Hong Leong Investment Bank [Utilities: Earnings to sustain in 2H25]

OVERWEIGHT

(Maintain)

Stock Rating

Utilities

Earnings to sustain in 2H25

The utilities sector is expected to remain resilient in 2H25, supported by the continuation of RAB frameworks, which ensure stable returns on a growing asset base – driven by elevated capex spending. Demand for utility services, particularly electricity, gas, and REs, is set to grow further, underpinned by the rapid expansion of DCs in Malaysia. Earnings visibility for the sector has improved, thanks to stable commodity fuel prices and favorable RM movement. We maintain our BUY ratings on YTLP (TP: RM5.02) and Tenaga (TP: RM16.20). YTLP continues to trade at an attractive valuation, with strong catalysts including expanding DC contributions, improving performance from UK WessexWater, and potential new gas-fired PPA award. Tenaga is also expected to deliver stronger earnings, improved cash flow, and a healthier balance sheet under RP4, supported by its enlarged capex program and the new AFA mechanism. Conversely, we maintain HOLD on PGB (TP: RM17.86) due to its relatively rich valuation and less compelling dividend yield, despite stable earnings supported by regulated frameworks.

RAB intact. The recent tariff restructuring under RP4 (2025–2027), which raised the average base tariff to 45.4 sen/kWh (up from 39.95 sen/kWh under RP3), underscores the government’s continued commitment to power sector reform in Malaysia. Tenaga’s allowable return remains unchanged at 7.3%, while the total allowable capex has significantly increased to RM42.9bn (comprising RM26.6bn in base capex and RM16.3bn in contingent capex). Meanwhile, the Regulatory Asset Base (RAB) framework for PetGas (PGB) covering gas transportation and regasification continues to apply, with lower adjusted rates for GPTA and RGTP Regasification, and a higher rate for RGTSU Regasification starting in 2025 (see Figure #2). Additionally, YTL Power’s UK WessexWater has been approved to raise average tariffs by 13.1%-20.8%, commencing April 2025, under the new RP 2025 – 2030 framework. These regulatory mechanisms help shield utility companies from fluctuations in demand and input costs – such as fuel prices, forex, and inflation – with any shortfalls or surpluses adjusted in subsequent review periods.

Figure #1: Further reform in electricity tariffs in 2H25

Figure #2: Further reform in gas transportation and regasification tariffs in 2025

Figure #3: Wessex Water projected annual average bills under RP 2025-2030

Strong demand for utilities.

Electricity demand in Malaysia is expected to continue its upward trajectory, driven largely by the rapid development of data centres (DCs). As of March 2025, Tenaga has completed the infrastructure to support 2.8GW of DC capacity, with an additional 3.6GW currently under construction or in the planning stage (targeted for completion within the next 12 months under Greenlane Pathway). In total, Tenaga has signed Energy Supply Agreements (ESAs) covering 6.4GW for DC developments. In 1Q25, DC load utilization was only 484MW, and Tenaga guided the utilization will be gradually ramp up in accordance to the signed ESAs. According to projections by the Energy Transition and Water Transformation Ministry (PETRA), DC capacities is expected to further rise to 12.9GW by 2030 and 20.9GW by 2040 (Bernama) vs recent peak demand of 21.0GW in May 2025. In line with Malaysia’s net-zero emissions target by 2050, coal-fired power plants are set to be phased out by 2044 or earlier, subject to early retirement. This reinforces HLIB’s expectation of strong long-term electricity demand, to be met increasingly through a mix of gas-fired power generation, renewable energy sources (RE), and energy storage systems (BESS).

New power plants (including REs).

The recent peak electricity demand of 21.0GW in May 2025 has already exceeded the Energy Commission’s (EC) earlier forecast of 19.4GW for 2025 (including REs), as outlined in the Peninsular Generation Development Plan 2021–2039. The EC’s projections from 2020 were relatively conservative and did not factor in the rapid growth of DC developments, contributing to a declining power reserve margin now estimated to be c.30%. In response to tightening supply-demand conditions, EC has initiated tenders to secure additional capacity: (i) Category 1 – extension of power purchase agreements (PPAs) for expiring/expired gas-fired plants; and (ii) Category 2 – development of new gas-fired power plants with a combined capacity of up to 8GW; targeted for commissioning 2025-2029. Key contenders for these tenders include Tenaga and Malakoff for both categories; while YTLP, PGB, and KAB are expected to compete for Category 2. At the same time, RE development is expected to accelerate under RP4 due to the higher effective tariff for conventional energy now provides stronger incentives for DCs to explore RE options, not only to manage costs but also to benefit from green carbon credits.

Declining commodity fuel costs.

Global commodity fuel prices have been on a gradual downward trend since 2H23. Newcastle coal price is now at USD110mt (RM470/mt) while gas price has eased to RM40/mmbtu (M’sia LNG price).

1. Tenaga: Under RP4, Tenaga’s transmission and distribution segment is now safeguarded by the Automatic Fuel Cost Adjustment (AFA) mechanism, which enables monthly pass-through of fuel costs. This is expected to improve Tenaga’s cash flow and reinforce its balance sheet. With fuel prices remaining relatively stable, despite a gradual downward trend, we anticipate steady contributions from power generation segment (under PPA) to continue deliver stable contributions.
2. YTLP: The group’s earnings are largely insulated from fuel price volatility. In the recent tariff review, UK WessexWater secured a 13% tariff increase effective April 2025 under the new RP 2025-2030. SG SerayaPower, which operates both generation and retail businesses, is exposed to imported gas and LNG prices. However, management has indicated that long-term fuel contracts at favorable rates have been secured. YTLP’s DC operations in Malaysia are subject to Tenaga’s monthly electricity tariffs adjustment under RP4, but these costs are believed to be directly passed through to end customers.
3. PGB: With gas prices stabilising and the government allowing electricity surcharges for commercial and industrial users (benchmarked to Tenaga’s approved tariffs), PGB’s utility segment margins are expected to remain resilient. Costs related to internal gas consumption for transmission and regasification are generally passed through to customers on a periodic basis.

RM movement.

In 1H25, RM appreciated against US$, while it weakened against the GB£ and remained relatively stable against the SG$. Looking ahead, we expect the RM to strengthen further against the US$ to around 4.10 by end-2025, while staying broadly flat against the GB£ at 5.75 (Bloomberg) and the SG$D at 3.30 (Bloomberg). Implications:

1. YTLP stands to benefit from a weaker RM, as a significant portion of its earnings is denominated in SG$ and GB£. The currency translation effect results in higher reported earnings in RM.
2. Tenaga and PGB, on the other hand, generally benefit from a stronger RM against US$, as it helps reduce imported fuel and lease costs, respectively. However, both are largely insulated from currency fluctuations due to regulatory mechanisms. Under RP4, Tenaga’s transmission and distribution segment and PGB’s regasification segment are covered by AFA mechanism, which passes cost savings or increases through to end users – limiting the direct impact on their margins.

Maintain OVERWEIGHT.

We maintain our OVERWEIGHT call on Utilities, given the earnings and dividend sustainability of the sector. Our top picks are YTLP (TP: RM5.02) and Tenaga (TP: RM16.20). Maintain HOLD on PGB (TP: RM17.86).

Stock Ratings

YTL Power (BUY, TP: RM5.02).

While contributions from SG PowerSeraya have softened in recent quarters, we have turned more constructive on YTLP, supported by a strong recovery at UK WessexWater (delivered core PBT of RM150-160m in the latest quarter) and the anticipated commissioning of the 20MW YES Al data centre in 1QFY26. Key catalysts ahead include: (i) the progressive commissioning of new data centre capacities; (ii) potential award of a new gas fired power plant PPA in Malaysia; (iii) the start-up of the 500MW large-scale solar (LSS) project; and (iv) increased capex and asset base expansion at Ranhill. Following the recent bonus issue, we have revised our TP to RM5.02 (from RM5.60), reflecting a 15% discount to our SOP valuation of RM6.69, to account for dilution. We reiterate our BUY recommendation, as we believe the stock remains attractively valued with a forward P/E of just 12x – well below peers such as Tenaga and PGas (at 16-19x) and the broader KLCI average.

Figure #9: YTLP’s PE valuation remains cheap relative to peers and KLCI benchmark

Figure #10: YTL Power Sum-of-Parts

Tenaga (BUY, TP: RM16.20).

The newly implemented tariff structure effective July 2025 has further reinforces our positive long-term outlook for Tenaga under RP4. We expect earnings growth to be supported by a larger regulated asset base, underpinned by the substantial allowable capex of RM42.9bn. Additionally, the AFA mechanism and new tariff structure are expected to enhance Tenaga’s cash flow and balance sheet. Tenaga is also well-positioned as a leading contender for EC’s recent tenders for gas-fired power plants, as well as accelerating RE developments (including BESS). Maintain BUY rating on Tenaga with an unchanged DCF-derived target price of RM16.20. We are not overly concern on recent court rulings, as we believe Tenaga will seek an amicable resolution with relevant authorities, particularly the Inland Revenue Board, to mitigate any adverse effects on its financials while defending its entitlement to the Investment Tax Allowance. We view any short-term share price weakness as a buying opportunity for long-term investors.

PGB (HOLD, TP: RM17.86).

PGB’s earnings are expected to remain resilient over the coming quarters, supported by the ongoing Gas Processing Agreement (GPA) and RAB framework for its Gas Transportation and Regasification segments. Additionally, internal gas costs (IGC) are effectively passed through to customers, minimising margin volatility. As Malaysia moves toward phasing out coal-fired power and increasing reliance on gas-fired generation, PGB is actively exploring new gas-related project opportunities to capture future growth. Maintain HOLD rating on PGB with an unchanged target price of RM17.86, based on SOP valuation. While near-term upside may be limited, the stock offers a respectable dividend yield of 4.0% for FY25-FY27.

Figure #11: Petronas Gas Sum-of-Parts

Figure #12: Peers comparison