We are more convinced with GASMSIA’s earnings prospects as we see two key notes from the briefing yesterday, i.e., a managed profit margin spread of RM1.58/mmbtu and potential additional gas supply from Petronas, which could propel future earnings. This is a stark contrast to 4Q14-1Q15 trends where profit margin spread was on a declining trend with no cost past-through framework while gas supply was capped firmly at 492mmscfd. An IBR mechanism is expected to be put in place from next January with profit margin spread fixed at RM1.58/mmbtu. Meanwhile, management believes that it should be able to secure additional gas supply as the off-take at the Melaka RGT is only 50% currently. As such, GASMSIA has put in a 5-year CAPEX budget of RM700m-RM800m for pipeline expansion. We realign our profit margin spread assumption to RM1.58/mmbtu from RM1.47/mmbtu previously. This raises our FY15-FY16 estimates by 12%-20% which also lifts our price target to RM2.68/DCF share from RM2.22/DCF share previously. With better earnings certainty, we upgrade our recommendation to MARKET PERFORM, from UNDERPERFORM previously, backed by fairly resilient 3%-4% yield.

A lower profit margin spread. Yesterday, we attended Gas Malaysia Bhd’s (GASMSIA) analyst briefing following the new tariff revision which was announced last week. To recap, the government has approved the half-yearly natural gas tariff revision for non-power sectors in Peninsular Malaysia to RM21.80/mmbtu from RM19.77/mmbtu, effective 1 July 2015. Management guided that the profit margin spread will be fixed at RM1.58/mmbtu, from RM2.02/mmbtu previously, which is higher than our assumption of RM1.47/mmbtu. Although the new profit margin spread is 22% lower than the previous one, we are still positive as a fixed margin spread will provide earnings certainty unlike the 4Q14 and 1Q15 results which were badly hit on the back of unregulated margin spread.

IBR to be implemented from 2016. Given the uncertainty of LNG prices coupled with higher LNG consumption as demand rises, preservation of profit margin spread is topmost important. On this front, management revealed that the authorities are agreeable to an Incentive Based Regulation (IBR) framework with a review for every six months, similar to that of TENAGA (MP; TP: RM14.32), in setting the pricing mechanism guided by a fixed profit margin spread of RM1.58/mmbtu which will take effect from Jan 2016. As such, any price hike will have neutral impact to GASMSIA based on the IBR mechanism which will be cost past-through in natural. Thus, going forward, earnings growth will be volume driven.

To spend 5-year capex of RM700m-RM800m. We took a positive stance on management guiding a RM700m-RM800m capex over the next five years on pipeline expansion to c.2,800km by 2019 from 2,065km currently. This means that GASMSIA is confident of securing additional new gas supply from its current 492mmscfd guaranteed supply from Petronas. Management believes that the company should be able to source additional supply from Petronas as the 530mmscfd Melaka RGT is currently running at 50% capacity only. On the other hand, new ventures, such as Virtual Pipeline, Combined Heat & Power and BioCNG, are expected to contribute positively only by end-2016. As such, any growth is mainly driven by existing gas business.

Raise to MARKET PERFORM. With the new profit margin spread fixed at RM1.58/mmbtu and unchanged 492mmscfd capacity at 90% utilisation rate, we raise FY15-FY16 estimates by 12%-20% with NDPS upgrading proportionally with unchanged 75% payout assumption as we believe with higher capex in the next five years, a near-100% payout like the past three years is unlikely. Thus, our new price target is now upgraded to RM2.68/DCF share from RM2.22/DCF share. Upside risk to our call would be additional gas supply from Petronas. Our sensitivity analysis shows that a 50mmscfd extra gas supply could lift FY16 EPS by 12% and TP by 9% to RM2.93/DCF share. However, downside risk will be its failure to maintain a RM1.58/mmbtu profit margin spread. 

Source: Kenanga Research - 18 Jun 2015