We walked away from yesterday’s briefing with a clearer picture of the MOPS and APM mechanism but believe that falling crude oil prices would likely hurt its upcoming 4Q14 earnings. Oil price has fallen 28% in the past four months to a 4-year low that could possibly drive PETDAG’s product cost significantly higher should the oil price continue to dive south; which it already suffered a loss of RM71m in 3Q14. On a positive note, its Commercial segment saw better performance on its margin maximising program to enhance profitability while opex came off as expected after higher ICT cost previously. In all, we trim our FY14-FY16 estimates by 6%-12% to account for higher product cost. Our new target price is now RM18.54/share, based on CY15 22.7x PER which is at a 50% premium to the market valuation. We also cut our rating to UNDERPEFORM from MARKET PERFORM.

Falling oil price not in its favour. Yesterday, we attended the post-3Q14 results briefing for analysts where management shed some light on the disappointing 3Q14 results which was hit by higher product cost on falling Mean of Platts Singapore (MOPS) prices. Under the Auto Pricing Mechanism (APM), the calculation of subsidy to be paid by the government to PETDAG is based on monthly basis, on the average MOPS price of the month. Due to timing difference where some inventory could be from the previous month, a sharp decline in MOPS price will result in a loss to PETDAG as it was holding older and more expensive inventory. Having said that, the upcoming 4Q14 results could be worse than 3Q14 should the oil prices keep falling for the remainder of the year. In 3Q14 alone, PETDAG reported a loss of RM71m in higher cost.

Retail segment hit badly. The Brent oil prices were hovering between USD105/bbl and USD115/bbl in the 1H of this year, but it started to decline since then and fell to USD95/bbl in Sep and currently reaches USD82/bbl which is its 4-year low. With the fall in MOPS price, the ASP of PETDAG’s overall businesses dipped 1.6% QoQ in 3Q14, which led to 3Q14’s topline contracting 1.7% after a meagre 0.1% dip in volume. This was mainly driven by the Retail segment which saw the subsidised retail operating profit plunging 32%. On the flipside, the focus on margin maximising in Commercial unit paid off in 3Q14 where the segmental operating margin improved to 3.1% from 2.2% in 2Q14 although the unsubsidised Commercial segment reported lower revenue by 1.3% QoQ on lower volume.

How 4Q14 would fare? Taking cue from 3Q14 and the continued southbound oil prices, PETDAG may face higher product cost as the inventory costing could be at the high side if oil prices do not see a meaningful rebound. As such, 4Q14’s bottom-line may be at stake although business volume may improve in this seasonally busier travelling period. While MOPS movement is beyond anyone control, the company’s focus to product branding like the new PRIMAX 95 and margin maximising on Commercial segment should help to lead its top-line growth. In all, we maintain our revenue assumptions as we believe with the company’s effort, the topline growth is achievable. However, we have trimmed our FY14E estimates by 12% after adjusting lower overall operating margin to 5.85% from 6.5% previously to account for higher product cost on falling MOPS price in wich we also expect a weak 4Q14. For FY15E-FY16E, we cut EPS by 6% as we reduced operating margin to 6.5% from 6.9% previously for the same reason.

Cut to UNDERPERFORM. With the lower earnings forecasts, our new price target is now reduced to RM18.54/share, which is based on unchanged CY15 22.7x PER which is at a 50% premium to market valuation, from RM19.64/share previously. Although its share price has declined 37% YTD, valuations remain stressed thus we downgrade the stock to UNDERPERFORM from MARKET PERFORM. We believe our target price is near the floor level which is close to its recent low of RM18.26/share.

Source: Kenanga