Investment Highlights

• Even though Petronas Gas’ (PGas) share price has recovered recently, we maintain our SELL recommendation for PGas with an unchanged sum-of-parts-based (SOP) fair value of RM16.80/share, which implies an FY18F 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 (EC) plan to implement Incentive-Based Regulation (IBR) tariffs on the group’s gas transportation tariff under the Gas Supply Act (GSA) 2016, expected to be effective by January 2019.

• Although the newly elected government has fixed oil prices for now, we do not expect any changes to the existing gas policy as the proposed third-party access mechanism will ultimately lower gas transportation costs and benefit consumers.

• Based on management's guidance that its gas transportation segment’s depreciated replacement cost is 3x its current historical book value, our FY18F-FY19F return on regulated asset base (RAB) translates to 9% for the gas transportation segment vs. Tenaga Nasional’s 7.3%, as guided by the EC.

• PGas is still in discussion with the commission on the framework and quantum of the tariff beyond 2018. We will be providing more details following the analyst briefing later tomorrow.

• We maintain PGas’ FY18F-FY20F earnings as its 1QFY18 core net profit of RM477mil was within expectations, accounting for 26% of our and consensus forecasts, similar to 1QFY17. The group declared a first interim dividend of 16 sen (+1 sen YoY and -3 sen QoQ), which was within our forecast.

• The group’s 1QFY18 core net profit slid 1% QoQ to RM477mil, as higher utilities prices, driven by fuel gas revision on 1 January this year, and increased contribution from the maiden LNG regasification terminal (RGT) in Pengerang were more than offset by higher deferred tax and halving of foreximpacted associate contribution.

• On a YoY comparison, the group’s 1QFY18 core net profit rose only 4% as higher utilities tariffs on 1 January 2018 coupled with the 490 mmscfd capacity Pengerang RGT commencement were largely offset by a 20% increase in capex-driven depreciation, 48% rise in capex-driven finance costs, 44% drop in JV contribution and RM17mil increase in deferred tax

• The group’s next phase of growth will stem from the full-year contribution of the Pengerang RGT, which we have already incorporated RM300mil annually to the group’s EBIT from FY18F onwards. The stock currently trades at an FY18F PE of 19x, 17% below its 2-year average while dividend yield is fair at 4%. 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 - 17 May 2018