Highlights

• Strong retail franchise... PetDag’s retail business has grown to the largest petroleum retail network In Malaysia with over 1,000 stations (vs. Shell’s 950 stations and Petron’s 560 stations) and 750 full-fledged Kedai Mesra. In term of market share, PetDag is no 2 and commands about 31-32%, not far behind from Shell.

• Worst quarter is Over?… Under APM, PetDag margins are fixed but the actual margins are affected by the movement in oil price. As shown in 4QFY14 earnings result, PetDag’s EBIT margin fell QoQ from 2.8% to only 0.2% as Brent oil price fell by circa 40% in that quarter. This margin compression also happened i n 4QFY08 when P etDag’s EBIT margi n fell QoQ from 2.4% to 1.2% as Brent oil price dropped by 51%. Given that oil price bottomed in Jan 15 and rebounded 17% MoM in Feb, we expect upcoming 1QFY15 result to improve QoQ.

• Higher free cash flow… Under the managed float mechanism, subsidy receivables (2-3 months delay payment) from government will be effectively removed from Pet Dag’s balance sheet, resulting in increasing free cash flow. In 4QFY14 result, PetDag’s cash balance has increased by RM1.5bn to RM1.8bn (RM1.85 per share or 9% of market cap) with account receivable days fell from 47 days to 24 days. Overall cash conversion cycle has turned from +10 days to -10 days.

• Potential higher dividend payout?... With annual operating cash flow of more than RM1bn and capex of about RM450m, we assume dividend payout ratio of 70 % (vs. 119% in FY14 and minimal dividend policy of 50%), which translate to 2.3% and 2.7% dividend yield in FY15 and FY16 respectively.

• Good thing s don’ t come cheap… Given its solid business model with sustainable recurring income, PetDag is trading at premium valuation of 31x FY15 P/E and 26x FY16 P/E. This is inline with Nestle’s valuation which currently trading at 27x FY16 P/E given both also focusing on consumer products.

Catalysts

• Oil price to stabilise which provide margin visibility.

• Successfully expansion at oversea market.

• Higher dividend payout.

Risks

• Fluctuation in the oil price
• Cost escalation due to aggressive expansion plan

Valuation

We like the company business model with sustainable recurring income, however we believe the positive factors (rebounded in oil price and solid business model) has been largely reflected in share price performance. Hence, we initiate the company with a HOLD call and target price of RM21.14 based on 26x FY16 P/E (inline with historical average P/E) with projected dividend yield of 2.7%.

Source: Hong Leong Investment Bank Research - 14 Apr 2015