Investment Highlights

• We maintain our SELL recommendation for Petronas Gas (PGas) with a lower sum-of-parts-based (SOP) fair value of RM15.35/share, which implies an FY19F PE of 16x, as the share price has fallen to our earlier target price of RM17.50.

• Our FY19F-FY20F earnings have been reduced by 2%-4% due to the pilot gas transportation tariff that will be effective from 1 January 2019 until 31 December 2019, and the new regulatory period (RP1) from FY20F-FY22F.

• Given the sharply lower transportation revenues for PGas if the guidelines were to be implemented immediately, the Energy Commission (EC) has allowed a 1-year pilot period from 1 January 2019 and two 3-year regulatory periods starting from 1 January 2020 to 31 December 2025, wherein the optimised replacement cost (ORC) valuation being employed currently will be replaced with historical cost over these transitional periods.

• As the weighting for optimised replacement cost (ORC) valuation for the transportation segment’s regulated asset base gradually phases out, the impact on RP1 will be lower compared to RP2 (FY23F-FY25F).

• Although details have not been provided on the ORC under the 2019 pilot tariff, we estimate that it could reach RM6.8bil – 2.6x the transportation segment’s NBV of RM2.6bil – assuming a WACC of 8%.

• Starting from FY25F, PGas’ revenues will be formulated on returns based entirely on the substantially lower historical net book valuation of the gas transportation segment.

• Assuming a WACC of 8%, we estimate that PGas will suffer a reduction in the transportation segment’s annual revenue requirement (ARR) by 5.6% in FY20F under RP1 and 17.9% in FY23F in RP2. This means that the EC has allowed PGas to significantly backload the impact of the ARR reduction towards FY23F onwards, which cushions the earnings impact in FY20F-FY22F.

• Overall, this translates to a minimal PGas’ annual earnings reduction of 2% in FY20F while FY23F earnings will drop by a larger quantum of 7.5%. Assuming a terminal growth rate of 2%, our DCF for the group’s gas processing and transportation business has fallen by 11% to RM29bil.

• The stock currently trades at an FY19F PE of 18x, 18% below its 3-year average of 22x. However, these valuations are unjustified given that PGas’ recurring income and margins will be declining progressively over a prolonged trajectory due to the new gas transportation framework. Assuming a payout ratio of 70%, this leads to DPS shrinking by 4 sen in FY23F with yields decreasing to 3% from 4% currently.

Source: AmInvest Research - 11 Jan 2019