The 6% gas tariff hike in 2H16 will have neutral impact to GASMSIA’s bottomline given the IBR framework which fixes profit margin spread at c.RM1.58/mmbtu but will limit the profitability to asset base return of 8%. Nonetheless, we still continue to like the IBR framework as it offers better earnings visibility while the new non-regulated business will drive earnings growth in the future. Maintain OUTPERFORM with unchanged price target of RM2.62/DCF share.

A 6% gas price hike in 2H16. Yesterday, GAS Malaysia (GASMSIA) announced that the Government has approved the half-yearly natural gas tariff revision for non-power sectors in Peninsular Malaysia to RM27.05/mmbtu on average, a 5.95% or RM1.52/mmbtu increase from RM25.53/mmbtu, effective 15 Jul 2016. The price increment this round is lower than a RM3.73/mmbtu or 17.1% hike in 1H16. The tariff revision is in line with the national rationalisation plan and Gas Cost Pass-through (GCPT) mechanism that will see the revision of piped gas price taking place every six months.

Earnings neutral to GASMSIA. This is not a surprise as it is a scheduled half-yearly revision. With the implementation of GCPT in Jan 2016, which is similar to the Imbalance Cost Past-through (ICPT) for the power sector in Peninsular Malaysia, upward revisions in natural gas tariff are expected in the upcoming reviews until gas price reaches market price. Having said that, GASMSIA’s profitability would not be affected as its profit margin spread is determined under the Incentive Based Regulation (IBR) framework based on asset return of 8%, which is estimated at RM1.58/mmbtu currently. As such, any price hikes will have neutral impact to GASMSIA, via GCPT adjustment.

Non-regulated business to drive future growth. A new base of IBR for 2017 will be submitted to the authority by Aug this year which asset returns are still targeted at 7%-8%. Having said, the GCPT mechanism will ensure earnings certainty for the regulated gas business while the planned RM400m capex over 2016-2019 could boost earnings as returns are based on a higher asset base. Given that earnings growth for the regulated gas business will be capped by a fixed asset return, the ventures in non-regulated business, i.e. (i) Virtual Pipeline (VP), (ii) Combined Heat & Power (CHP), and (iii) BioCNG, which facilities started construction two years ago, are timely to lead earnings growth as these businesses will start operations by 2H16. However, the initial profit contribution to the group is immaterial of <5% in the first two years and a meaningful 25%-35% PAT contribution by 2020.

Retain OUTPERFORM. We are keeping our estimates for now as the tariff hike has been neutral to bottomline as profit margin spread is fixed at c.RM1.58/mmbtu. Target price is maintained at RM2.62/DCF share and OUTPERFORM call reiterated. We continue to like the stock for its earnings visibility on the back of the IBR framework. It also offers a decent yield of 4%. Risks To Our Call include a sudden change in gas cost-pass through mechanism with downward revision in margin spread and drop in sales volume.

Source: Kenanga Research - 30 Jun 2016