Investment Highlights

• We maintain our SELL recommendation for PGas with an unchanged sum-of-parts-based (SOP) fair value of RM17.50/share, which implies an FY18F PE of 18x, a 20% discount to the 2-year average of 23x.

• This is due to the expected value erosion from the Energy Commission’s (EC) plan to implement Incentive-Based Regulation (IBR) tariffs on the group’s gas transportation tariff under the Gas Supply Act (GSA) 2016, scheduled to be effective by January 2019.

• During the analyst briefing later today, we look forward for improved clarity on the proposed third-party access mechanism which is likely to lower gas transportation costs and benefit consumers.

• Based on management's earlier guidance that its gas transportation segment’s depreciated replacement cost is 3x its current historical net book value, our FY18F-FY19F return on regulated asset base (RAB) translates to 9% for the gas transportation segment vs. Tenaga Nasional’s 7%, as guided by the EC. PGas is still in discussion with the commission on the framework and quantum of the tariff beyond 2018, which includes a plan to mitigate the impact by phasing the reduction in asset return over a number of years.

• We have maintained PGas’ FY18F-FY20F earnings as 9MFY18 core net profit of RM1,497mil was largely within expectations, accounting for 76% of our FY18F earnings and 79% of consensus forecasts.

• As a comparison 9MFY16-1HFY17 net profits accounted for 73% of their respective years. The group declared a second interim dividend of 18 sen (+2 sen QoQ), which leads to a 9MFY18 DPS of 50 sen, -76% of our forecast.

• The group’s 3QFY18 core net profit slid 2% QoQ to RM505mil, mainly due to a 2.4-ppt contraction in effective tax rate to 17.5% due to deferred tax adjustments for the initial allowances from the Pengerang LNG regasification terminal, which commenced operation in November last year.

• On a YoY comparison, the group’s 9MFY18 core net profit rose by 16% from the 490 mmscfd capacity Pengerang RGT commencement together with higher utilities tariffs commencing on 1 July 2017 and 1 January 2018 and increased operations and maintenance revenue from the Sabah-Sarawak Gas pipeline.

• The stock currently trades at an FY18F PE of 19x, 17% below its 2-year average while dividend yield is reasonable at 3%. However, these valuations are unjustified given that its recurring income and margins are likely to erode over the longer term due to the IBR implementation, even though management hopes to cushion the impact of the lower tariffs over an undisclosed duration, which is currently under negotiation with the Energy Commission.

Source: AmInvest Research - 30 Nov 2018