Investment Highlights

• We maintain our SELL recommendation for Petronas Gas (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.

• Our forecasts are unchanged for now following the group’s announcement of the new transportation and processing agreements.

• The new transportation tariff will be under a 1-year IncentiveBased Regulatory (IBR) pilot period from 1 January 2019 until 31 December 2019, which translates to a 14% reduction in the Peninsular Gas Utilisation tariff to RM1.072/GJ from RM1.248/GJ previously.

• It also stipulates the regassification tariffs have been set for RM3.518/mmbtu for the Sungei Udang, Melaka plant and US$0.637/mmbtu for Pengerang, Johor. Assuming a conversion rate of 1mmscfd=1,040mmbtu, the new tariff structure translates to an increase of 6.9% from the 530mmscfd-capacity Sungei Udang facility’s FY17 revenue of RM774mil.

• Hence, the lower revenues from the transportation agreement are mostly offset by the regasification and new gas processing arrangements, which have raised the fixed processing reservation charge by 8.3% to RM2,524/mmscfd from an earlier RM2,330/mmscfd.

• Under the 2nd gas processing agreement, which will last from 1 January 2019 to 31 December 2023, the flow rate charge of RM0.20/GJ above 1,750mmscfd is largely unchanged, as are the performance-based structure for the production of ethane, propane and butane. Also, Petronas will continue providing internal gas consumption at no cost to PGas.

• However, we note that the all-in revenue decline could reach only RM22mil for FY19F, which is below our assumptions of a 2.5% revenue decline. However, the worse may not be over as the transportation tariffs may yet decline further post-2019 pilot period as the IBR revenue structure will be based on the a yetto-be revealed rate to transportation segment’s historical book value, NOT depreciated replacement cost.

• As we have been consistently forewarning since Nov 2016, the transportation segment’s returns on historical book value have been over 20% from 2015–2017, well above Tenaga’s 7%. Even applying a higher rate of return for PGas’ risk profile is unlikely to fully mitigate the upcoming value erosion.

• The stock currently trades at an FY19F PE of 20x, 10% below its 2-year average while dividend yield is fair at 4%. However, these valuations are still unjustified given that concerns over PGas’ recurring income and margins over the longer term due to the IBR implementation have not receded as the current transportation tariff is only for 1 year.

Source: AmInvest Research - 2 Jan 2019