Investment Highlights

• We maintain our SELL recommendation for Petronas Gas (PGas) with an unchanged sum-of-parts-based (SOP) fair value of RM16.60/share, which implies an FY17F PE of 18x, a 20% discount to the 2-year average of 23x. This is due to the expected value erosion from the Energy Commission’s plan to implement Incentive-Based Regulation (IBR) tariffs on the group’s gas transportation tariff under the Gas Supply Act 2016, expected to be effective 16 January 2018.

• We maintain PGas’ FY17F-FY19F earnings as its 9MFY17 net profit of RM1,306mil was within expectations, accounting for 73% of our FY17F earnings and 74% of street’s RM1,772mil, similar to the proportion of 9MFY16 to FY16. The group declared a third interim dividend of 16 sen (flat QoQ), which raises 9MFY17 DPS by 5 sen to 50 sen, in line with our forecast.

• The group’s 3QFY17 revenue slid 1% QoQ to RM1.2bil due to lower demand for utilities as some of its clients were undertaking turnaround activities. Together with a 7% increase in depreciation, PGas’ 3QFY17 net profit slid 2% QoQ to RM417mil, partly cushioned by a 4.5x rebound in associates/joint venture contribution as the previous quarter registered unrealised fair value adjustments to 60%-owned Kimanis Power’s hedged repair and maintenance costs to USD.

• On a YoY comparison, the group’s 9MFY17 revenue rose 3% to RM3.5bil from higher utilities tariffs on 1 July 2016 and 1 January 2017 amid higher demand while regassification storage revenues on a stronger USD and throughput volume. Together with higher interest income and a 1ppt decrease in effective tax rate, this partly contributed to PGas’ 9MFY17 net profit increase of 3%.

• The group’s next phase of growth will stem from its LNG regasification terminal (RGT) in Pengerang, as its 490 mmscfd capacity recently started commercial operation progressively on 1 November 2017, which we have already incorporated RM300mil annually to the group’s EBIT from FY18F onwards.

• However, we highlight that our FY18F-FY19F return on regulated asset base of 15% for the gas transportation segment is higher than Tenaga Nasional’s 5.4% ROA in FY17, as management is working with the authorities to minimise the impact to its business operations.

• Based on management's guidance that its gas transportation segment’s depreciated replacement cost is 3x its current historical book value and assuming that transportation ROAs could drop all the way to 8% under the new third-party access tariff, PGas’ FY18F-FY19F revenue could fall further by 9%. This translates to an additional net profit drop of 24%.

• We will be providing more details following the analyst briefing later today. The stock currently trades at an FY17F PE of 20x, average while dividend yield is fair at 3%. However, these valuations are unjustified given that its recurring income and margins are likely to erode over the longer term due to the IBR implementation.

Source: AmInvest Research - 13 Nov 2017