We initiate coverage on PGB with a BUY recommendation and TP: RM19.22 based on SOP. Our thesis is premised on: (i) PGB’s protected stable earnings; (ii) strong balance sheet with net cash position (excluding finance lease liability) of RM1.4bn (71.1sen/share); and (iii) attractive dividend at 125 sen in FY20 (included 50 sen special dividend in 2QFY20) and 85 sen (with potential upside) for FY21-22, translating into 4.9-7.3% dividend yield. We projected PGB’s free cash-flow of RM2.1-2.3bn p.a. for FY20-22, supporting PGB’s attractive dividend payout.

Company background. Petronas Gas (PGB) owns strategic gas infrastructure assets in Malaysia, namely: (i) gas processing plants, (ii) gas transmission network and (iii) regasification plants. These assets are monopolistic in nature with important roles in the gas supply chain within Peninsular Malaysia. In addition, PGB also owns utility plants in supplying electricity, industrial gasses and steam to industrial users and national power grid.

Protected earnings. Given that PGB’s businesses are monopolistic in nature, the earnings are protected under long term contracts (for gas processing with Petronas and utilities with industrial users and power grid) and newly implemented IBR structure (for gas transmission and regasification). The short term impact of the transitioning of asset value from depreciated cost replacement methodology to net book value methodology is expected to rebound post 2025 as on-going capex spent outpaced the annual depreciation over the years.

Net cash position. PGB has a strong balance sheet with RM1.4bn net cash position (excluding RM1.6bn finance lease liabilities), translating into 71.1s/share as at 3QFY20. PGB will continue to register c. RM2.2bn free cash flow for FY20-22, due to its stable revenue and cost structure basis. Management is continuously re-assessing the group’s capital structure. We reckon management’s strategy is to partially reinvest the high cash position into new business ventures and pay out higher dividend (recently paid 50 sen/share special dividend in 2QFY20).

Strong dividend. PGB dividend payout has been on an increasing trend for the past 5 years from 55% in FY15 to 86% in FY19. We are imputing a conservative dividend payout of 125 sen/share (including special 50 sen/share) for FY20 and 85 sen/share for FY21-22 (c. 80% payout). We do not discount for higher dividend payout in FY21- 22, given PGB’s increasing net cash position and on-going assessment on capital structure.

Forecasts. We project stable earnings of RM2.1bn for FY20-22, a growth compared to FY19, mainly due to effective higher tariff approved for Gas Transmission and Regasification for RP 2020-2022 and lower depreciation charges.

Risk. Risks in our view include: (i) unscheduled outages (relatively low given ongoing capex maintenance); (ii) significant cut in allowable returns under IBR (relatively low based on Tenaga’s record); and (iii) forex fluctuation (limited to RGTSU for leasing of the terminal from MISC).

Initiate with a BUY. We initiate coverage on PGB with a BUY recommendation and TP of RM19.22 (upside 10.0%), based on SOP, supported by: (i) healthy balance sheet with net cash position (71.1sen/share); (ii) sustainable earnings and strong cash flow; and (iii) dividend yield of 4.9-7.3% (with potential upside from exceptional dividend).

Source: Hong Leong Investment Bank Research - 16 Dec 2020