• We view GMB’s income deliverable as more stable under RP1 structure – this was proven in its 6MFY20 earnings despite the MCO.
   
• GMB remains committed on its expansion plan, including RM650m allocation under RP1 period, translating into RM200m capex annually

• We foresee GMB to continue its attractive dividend payment on the back of stable earnings under the RP1 structure.

• Maintain BUY rating on GMB based on SOP-derived TP of RM3.05.

Income shielded under RP1 structure

We view that Gas Malaysia’s (GMB) income deliverable as more stable under regulatory period 1 (RP1) structure which was effective 1st January 2020 despite the uncertainty surrounding its margin spread. Under this structure, GMB’s effective base tariff was set at RM33.65 per MMBtu for GMES from 1st January 2020–31 December 2020, while GMB will be compensated at RM0.520/GJ/day for the variation in gas costs incurred. To recap, under the previous structure GMB’s margin spread is capped at RM1.80-RM2.00/MMBtu.

Earnings stability under RP1 implementations

Under the previous incentive-based regulation (IBR) regime, gas cost and distribution tariffs were bundled as one tariff, and fluctuations in gas cost were passed through under the Gas Cost Pass Through (GCPT) mechanism. In RP1, the GCPT mechanism is no longer relevant and shippers such as GMB could earn between 1% - 2% shipping margins (versus 0% previously in RP0) activities which not regulated under the IBR. The additional margin from its shipping division will likely offset lower regulated earnings from its pipeline assets. Given this, we believe this has removed uncertainty arising from fuel cost volatility for GMB and gas sales volume will be the key earnings growth driver.

Sufficient gas supply to meet demand

The current gas supply agreement (GSA) with Petronas will expire in 2022 with an option to extend for another 5 years. We understand that GMB has started negotiation with Petronas for the renewal of the supply contract. Given the importance of GMB as the main supplier of natural gas to industrial customers using five mmscfd and below, we expect GMB to be able to secure sufficient gas supply to meet the demand. We understand that GMB is able to procure an additional gas supply from PetGas (with advanced notice) should the gas allocation nears exhaustion.

Expansion plan remains intact.

GMB remains committed to its expansion plan ‒ this includes RM650m allocation under RP1 period, which translates into approx. RM200m capex annually. Majority of the capex is to boost its pipeline network to reach more industrial customers’ zone. GMB will be collaborating with states that intend to build an area similar with Kinta Valley in Perak which GMB had previously constructed 117km of gas pipeline. Capex investment will be funded via external means, namely debt. However according to our estimate, we do not expect debt ratio to escalate excessively given the ability to generate positive cash flow as well as having a cash reserve of RM103m as at June 2020.

Attractive dividend yield continues

We foresee GMB to continue its attractive dividend payment on the back of stable earnings under the RP1 base tariff implementation. GMB has been consistently made payouts of 90% of its earnings – derived from its healthy free cash flow (FCF) generation that allowed GMB to sustain this high dividend payment. We expect GMB to continue to pay at least RM0.133 DPS every year in the future hence continuing to reward shareholders while pursuing sustainable growth.

Half year 6MFY20 results review

GMB reported 2QFY20 earnings of RM44.6m. This brought its 6MFY20 reported earning to RM92.5m. During the quarter, revenue contracted by -11.3%yoy to RM1,539.6m driven by lower volume of gas sold and; lower average gas tariff. As such, earnings declined by -8.9% yoy during the quarter due to the implementation of MCO to curb the spread of Covid19. Meanwhile, on a quarterly sequential basis, revenue declined by -4.1% whilst earnings contracted by -6.8% qoq attributable to the similar reasons coupled with higher overheads and depreciation incurred during the quarter.

Financial forecast

Despite lower gas volume in FY20, we believe GMB will be able to cushion this by securing more industrial customers, especially in the highly populated industrial area. We expect GMB’s FY20 earnings growth to soften marginally by 3.1% to RM189m and by 1% to RM191m in FY21.

Maintain BUY Rating

We maintain our BUY rating on GMB with TP of RM3.05 based on Sum of Parts (SOP) method (Table 1). We estimate that GMB would continue to deliver steady recurrent earnings and steady cash flow generation. While it is currently trading below its 5-year average PE of 22x, we believe this is fair given the undisclosed spread as opposed to the previous practice. Maintain BUY.

Source: BIMB Securities Research - 21 Oct 2020