Investment Highlights

• We maintain our SELL recommendation for Petronas Gas (PGas) with unchanged forecasts and sum-of-parts-based (SOP) fair value of RM15.35/share, which implies an FY19F PE of 16x.

• These are the salient takeaways from PGas’ analyst briefing yesterday:

• Management did not provide estimates nor guidance for the new gas transportation tariffs under the current pilot structure, which has been effective since the beginning of this year.

• PGas affirmed that the gas transportation segment's regulated asset base (used to compute the base tariff) of 2.5x–3x vs. historical book value was generally in line with our estimate of 2.6x currently.

• Our return on asset or WACC of 8% used in the computation of the transportation base tariff is in line with management's range of 7%–9% for Tenaga Nasional and Gas Malaysia.

• Given that the RM32.92/mmbtu price of local natural gas is still at a 23% discount vs. the Malaysia's LNG export price of RM43/mmbtu (US$10.45/mmbtu) to Japan, Petronas will remain the only off-taker for PGas' pipeline capacity until the subsidies are removed under the progressive 6-month programme.

• Given Petronas' utilisation of PGas' pipeline of 73% currently, its facilities are able to accommodate third-party suppliers, who will need to sign regasification and third-party access transportation agreements with the group.

• Management indicated that PGas aims to provide a sustainable FY18 DPS of 72 sen, which translates to a payout of 79% or 74% based on core earnings vs. 71%–73% in FY16– FY17.

• Recall that under the Energy Commission’s new guidelines for the two 3-year regulatory periods (RP) starting from 1 January 2020 to 31 December 2025, the optimised replacement cost valuation being employed to calculate the base tariff currently will be phased out and replaced with historical cost over these transitional periods.

• Our forecasts have already incorporated the backloaded value erosion from the new gas transportation tariff structure, which translates to a decrease in the gas transportation revenue by 5.6% in FY20F under RP1 and 17.9% in FY23F in RP2. Overall, this translates to an annual earnings reduction of 2% in FY20F while FY23F earnings drop by a larger quantum of 7.5%.

• The stock currently trades at an FY19F PE of 19x, 14% 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.

Source: AmInvest Research - 20 Feb 2019