Investment Highlights

• We maintain BUY on Petronas Gas (PGas) with an unchanged sum-of-parts-based (SOP) fair value of RM20.05/share, which reflects a 3% premium for our ESG rating of 4 stars (Exhibit 5). This implies a FY23F PE of 22x, 1 standard deviation above its 5-year average.

• Our FY22F earnings have been slightly reduced by 4% as we penciled in lower profit margins for the group’s gas transportation and regasification segments. This is to account for higher operating costs from increased fuel costs and to factor in lower foreign exchange assumptions.

• However, we retain our FY23F-24F earnings on expectation that the new tariffs under the regulatory period 2 (RP2) will be able to fully compensate for the higher operating costs within the 2 regulated segments.

• Recall that the group’s earnings within the gas transportation and regasification segments (which collectively accounted for 61% of the group’s operating profit) have been impacted by higher fuel costs via internal gas consumption in 1HFY22. We expect the increase in costs to be recovered through a revised 3-year tariff under regulatory period (RP) 2, which will commence next year.

• As the Malaysia Reference Price (MRP), a primary benchmark for liquefied natural gas prices in Malaysia, has increased by 14% QoQ in 3QCY22 (Exhibit 2), gas prices are widely anticipated to remain elevated moving into 4QCY22.

• Hence, assuming that internal gas consumption account for 5%-8% of the total costs within gas transportation and regasification segments, we project a further deterioration of EBIT margins by 2%-3% for the 2 regulated segments in the 2HFY22. On a positive note, its gas processing segment will be shielded from higher gas prices as its parent company Petronas bears all the internal gas consumption cost under the long-term gas processing agreement.

• We also highlight that the regasification segment’s earnings will be susceptible to the decline in MYR against USD as the leasing charges for its regasification terminal in Sungai Udang are mainly denominated in USD. Hence, a weaker MYR will increase the leasing expenses, compressing the segment’s profit margins.

• Meanwhile, the group’s earnings growth in the near to medium term will be anchored by robust capex of above RM1bil per annum over the coming years. As at end-1HFY22, the group has spent RM430mil for capex, with a target to step up investment expenditure for the remainder of FY22.

• The group has yet to reach its final investment decision for its third LNG storage tank in Pengerang. The outcome is expected to be finalised by end-2022. We had earlier estimated that the investment would translate into a negligible NPV accretion to our SOP valuation based on: (i) a storage tank capacity of 160K cubic metres, (ii) a capex of RM1bil, as well as (iii) a conservative project IRR of 5.5%.

• Recall that PGas intends to optimise its capital structure over the next 3 years by gradually increasing its net gearing ratio from 3% currently to the Energy Commission’s (EC) guided optimal ratio of 55%, a level which is comparable to the other infrastructure companies. To comply with EC’s recommended optimal gearing ratio which would lead to lower WACC, PGas could increase its debt financing for future capex, as well as distribute higher dividends to its shareholders. Hence, we do not discount the possibility of special dividends that could potentially raise our FY22F–FY24F DPS by 53% to RM1.94/share, implying an eye-watering yield of 11%. Nevertheless, we caution that the likelihood of special dividends could be moderated by higher-than-expected capex as the company channels capital to fund new investments or acquisition propositions.

• The stock currently trades at an attractive FY23F PE of 18x, below pre-FY20 peak of over 20x. This is supported by compelling dividend yields of 5% which could potentially be even higher if the group’s capital structure has been further optimised.

Source: AmInvest Research - 18 Oct 2022