Market Strategy - Cut in subsidies

The government announced that it would cut subsidies for sugar, petrol, diesel and liquefied petroleum gas (LPG). This would result in higher prices: sugar (+25 sen/kg or 15%), LPG (+10 sen/kg or 5.7%), RON95 (+5 sen/litre or 2.8%), RON97 (+5 sen/litre or 2.4%), diesel (+5 sen/litre or 2.9%). According to The Star, the subsidy cuts would amount to RM750m savings for the government this year. This works out to 0.5% of the estimated federal government operating expenditure (or 3.6% of initial estimates of subsidies for 2010).

Although small at this time relative to the total government expenditure at this point, this could signal a gradual reduction in subsidies. It could indicate that a tariff hike for Tenaga (Buy; RM10.80 TP) could be forthcoming. The subsidy cuts would also allow funds to be channelled to projects that help improve public transportation such as the MRT. The price increases could result in a lift in inflation and dent consumer sentiment but the extent should not be significant at this point. We expect some minor disruption in traffic volume growth for PLUS in 2H with the marginal increase in fuel and diesel prices. PLUS has already chalked up an impressive YTD
traffic volume growth to May 2010 of 9.8% y-o-y for its core highways of North-South Expressway; New Klang Valley Expressway; Federal Highway Route 2 and Seremban- Port Dickson Highway. Management is guiding for traffic volume growth of 3-4% for 2010 while our forecast is more conservative at 2%.

We are already expected a slower 2H on the back of this fuel price hike and the higher base effect in 2009. Reiterate Buy with an unchanged target price of RM4.00. For Gamuda (Buy, TP RM4.35), we see the gradual cut in subsidies as a potential signal that the government is serious
in implementing the RM36bn MRT project. Recall, that the MMC-Gamuda JV has said it will commit RM3bn in funding together with a RM1.8bn performance bond to see initial works of this MRT take off. But balance of the funding has to be from the government which will likely be from the eventual cut of subsidies.

Report from
HWANGDBS Vickers Research Sdn Bhd (128540 U)

Tenaga Nasional - Proxy for stronger GDP growth

Proxy for stronger GDP growth
• 3QFY10 result was within expectation
• Demand growth and locked-in coal cost support stronger earnings
• Maintain Buy for attractive valuation and potential upside from tariff hike

Stronger 3Q on power demand growth. TNB’s 3Q revenue improved 10.3% y-o-y following 5.3% power demand growth supported by improvements at petrochemical and steel sectors. However, EBIT was flat due to a 12% rise in operating expenses as a result of higher offtake from coal fired plant, higher IPP payment (+6%), and RM63m provision in 3Q for general expenses. TNB recorded RM569m forex translation gain in 3Q as a result of a stronger ringgit against the US$ and Yen (+5%). Excluding the forex impact, 9M10 core net profit of RM2.1b is within our expectation, but at the lower end of market estimates.

Tariff hike is imminent, but timing uncertain. A tariff hike is imminent for TNB given higher coal costs and potential cuts in gas subsidy, but the timing is uncertain. Gas price to the power sector is currently subsidized at RM10.70/mmbtu (37% below current price of RM17/mmbtu); the government is looking at cutting this. We expect 2% net tariff hike to cater for higher capacity payment, an increase in gas cost to be fully passed-on, but coal cost will rise by 10% for FY11F due to limited supply. We estimate every 1ppt increase in gas cost will erode FY11F EPS by 1.6%, while a 1ppt increase in tariff will raise EPS by 9.1%.

Attractive valuation. Maintain Buy for TNB with a target price of RM10.80/share based on last 3-year average forward PE of 14x. TNB is trading at attractive 11x FY11F PE and 1.2x P/BV against its 10-year historical averages of 20x and 1.5x, and peers’ averages of 14x and 1.4x. Foreign shareholding in TNB has improved from 9.4% in Dec 09 to 10.7% in Jun 10.

Analyst
June Ng +603 2711 2222
june@hwangdbsvickers.com.my

From
HWANGDBS Vickers Research Sdn Bhd (128540 U)

KNM Group - Signs of better times?

New orders picking up

• Order book at year-high of RM2.4b; eyeing several sizable contracts in SEA and Europe
• To take advantage of tax incentives by bringing more production home
• Maintain Hold; re-rating hinges on contract flows in 2H10

Signs of better times? KNM has secured RM1.0b worth of jobs thus far, double what it secured in 1H09. Its current order book is at the year-high of RM2.4b compared to RM1.8b in the beginning of the year. Its average selling price (ASP) has also improved moderately to close to RM20,000/MT from a low of RM18,500 in 2009 (record high of RM22,500 in 2008). We understand KNM is eyeing several sizable contracts (>RM100m) in South East Asia and Europe. We expect accelerating oil & gas activities for the rest of this year to drive future demand for process equipment.

Extending market reach, benefit from tax incentive. KNM may add two more plants to extend its global market presence. But the investments would be small at c.RM40m with a potential JV local partner. KNM expanded its Saudi Arabia capacity recently, bringing total group capacity to 157,300MT/year (+6.8%). Meanwhile, works are currently underway to upgrade its Kuantan plant to undertake manufacturing of BORSIG’s boilers for the global market. There is also a plan to package BORSIG’s membrane equipments in Malaysia to take advantage of the RM1.4b tax incentive and improve overall cost efficiency.

Maintain Hold and RM0.55 TP. We are maintaining our earnings assumptions at this juncture, as utilisation rate remains low at 60% and margins are still expected to be sluggish in 2Q10. Re-rating catalyst for the stock would depend on job orders in 2H10. We reiterate our Hold rating for KNM with a target price of RM0.55, pegged to 9.0x FY11F PE. The counter is currently trading at 8.4x FY11F PE against the sector’s 8.8x and the region’s 15.0x.