Investment Highlights

• We maintain our SELL recommendation for PGas but with a higher sum-of-parts-based (SOP) fair value of RM17.50/share (from an earlier 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, scheduled to be effective by January 2019. 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 continuing 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, which includes a plan to mitigate the impact by phasing the reduction in asset return over a number of years.

• However, we have raised PGas’ FY18F-FY20F earnings by 6% on a 4ppt cut in effective tax rate assumptions as its 1HFY18 core net profit of RM993mil was above expectations, accounting for 53%-54% of our and consensus forecasts.

• As a comparison, 1HFY16-1HFY17 net profits accounted for 49%-50% of their respective years. The group declared a second interim dividend of 16 sen (flat QoQ), which leads to a 1HFY18 DPS of 32 sen — 48% of our forecast.

• The group’s 2QFY18 core net profit rose 8% QoQ to RM516mil, mainly due to a 5.5ppt contraction in effective tax rate to 15% due to initial allowances from the Pengerang LNG regasification terminal, which commenced operation in November last year.

• On a YoY comparison, the group’s 1HFY18 core net profit rose 13% from the 490 mmscfd capacity Pengerang RGT commencement together with higher utilities tariffs, which commenced on 1 July 2017 and 1 January 2018, and increased operations and maintenance revenue from the Sabah-Sarawak Gas pipeline.

• 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, even though management hopes to cushion the impact of the lower tariffs over an undisclosed duration, which is currently under negotiation with the Energy Commission.

Source: AmInvest Research - 15 Aug 2018