The government has approved a 0.5% natural gas tariff hike for the non-power sector. This is overall positive as the IBR framework is upheld. This is a critical move for gas subsidy rationalisation and alleviates concern over the government’s commitment to carry out energy reforms. The tariff hike is earnings-neutral for Gas Malaysia. TNB is likely to benefit from policy clarity. Glove players will experience higher costs but will eventually pass on the cost.

WHAT’S NEW

• Spirit of the Incentive Base Regulation remains intact….Gas Malaysia announced that the government has approved, via a letter from Suruhanjaya Tenaga, for Gas Malaysia to effect the revision of the natural gas (NG) tariff for non-power sector in Peninsular Malaysia from 1 Jul 18 to 31 Dec 18. The government has prescribed the Incentive Based Regulation (IBR) framework which sets the base tariff for a regulatory period of three years from Jan 17 and allows changes in the gas costs to be passed through via the Gas Cost Pass Through (GCPT) mechanism every six months.
• …as Gas Malaysia gets government approval to raise tariff and claw back higher gas cost incurred in 1H18. In essence, the gas base tariff will be adjusted to RM31.92/MMBtu for 2H18. Also, a surcharge of RM0.77/MMBtu will apply to all tariff categories (under GCPT). This translates into an average effective tariff of RM32.69/MMBtu. This represents a 2% variance to its average base tariff and 0.5% increase to the previous average effective tariff of RM32.52/MMBtu.

ACTION

• Utilities: OVERWEIGHT. Overall positive as the government is seen to subscribe to the spirit of the IBR framework. This is also a critical move for gas subsidy rationalisation, and there should not be any concern over the government’s commitment to carry out energy reforms. Broadly, we note that the government has approved: a) higher base NG prices under the IBR schedule (see table overleaf), and importantly, b) approved a 77- sen/MMBtu surcharge for higher actual NG cost against the reference gas cost under the base tariff (or more commonly known as an under-recovery of gas cost for Gas Malaysia for 1H18). The NG tariff hike is earnings-neutral for Gas Malaysia while gas volume growth is a key earnings driver for the stock. Maintain HOLD on Gas Malaysia as valuations are stretched at 20x 2019F PE.
• Government continues to honour the IBR framework, lifting policy uncertainty for TNB. As TNB is also currently experiencing under-recovery of fuel cost (arising from higher global coal prices in 1H18 vs reference price of US$75/MT), we believe the NG tariff hike for Gas Malaysia will be a precedent for TNB to follow suit. We expect an electricity tariff decision to be announced by end-June. Additionally, we believe the government can continue to care for its citizens as the ICPT does not apply to domestic consumers who consume less than 300kWh (RM77). This in itself is a subsidy mechanism, we opine. BUY TNB with a DCF-based target price of RM17.70, given: a) attractive valuations, b) liquidity exposure, and c) 5% dividend yield.
• Glove Manufacturing: UNDERWEIGHT. Energy makes up 12% of glove makers’ production costs; every 10% increase could reduce glove makers’ FY18-20 earnings by 6- 7% (this assumes additional costs are not passed on to customers). We have largely factored the additional cost into our forecasts; note that impact on sector earnings should be minimal (except for some volatility in quarterly earnings trend), given sufficient time to carry out an effective cost pass-through. All in all, we stay tactically bearish on the sector on valuation grounds (+2SD above 5-year forward mean PE) and we have SELL calls across the board: Top Glove (Target: RM8.00), Hartalega (Target: RM4.02) and Kossan (Target: RM6.56). There is a budding risk of short-term earnings disappointment and this will not bode well with the market.

ESSENTIAL

• End-18 FBMKLCI forecast of 1,800, which still pegs the market at 15.3x above historical mean PE. While we expect the domestic political risk premium to ease, which suggests nearterm upside, we continue to be defensive in our 2H18 outlook on expectations of continuing global liquidity contraction.
• Our top picks include large-caps Bumi Armada, CIMB Group, DiGi.com, Genting Malaysia, Inari and Tenaga, and mid-caps Serba Dinamik, VS Industry and Yong Tai. Defensive high yielders like Berjaya Sports Toto and Magnum should also appeal.

Source: UOB Kay Hian Research - 14 Jun 2018