PETGAS reported a satisfactory set of 1Q17 results which saw a broad-base improvement across all business segments on lower opex. On the other hand, the stock faces heavy selling pressure on fears of new TPA, which could crimp its earnings severely. Our preliminary studies show a worst-case rate reduction of 15%, FY18 EPS and SoP valuation would reduce by 9% and 8% respectively. As such, we believe the sell-down is overdone, thus upgrade the stock to OUTPERFORM with revised target price of RM22.00/SoP share unchanged.

1Q17 within expectations. PETGAS reported 1Q17 results, which came within expectations with core profit of RM460.4m, accounting for 27%/26% of house/street’s FY17 estimates. It declared 1st interim NDPS of 15.0 sen (ex-date: 26 May; payment date: 14 Jun) in 1Q17 as opposed to 14.0 sen paid in 1Q16 and 19.0 sen paid in 4Q16.

Weaker sequential as taxation normalised. Despite revenue inching up 1%, 1Q17 core profit dipped 3% QoQ to RM460.4m from RM474.2m primarily due to normalisation of taxation as the preceding quarter was adjusted for a reversal of over-provision in the prior year for a total of RM77.1m. Operational-wise, PETGAS saw a broad-base improvement in segmental earnings on higher revenue and lower opex due to phasing of repair and maintenance activities. Earnings for Gas Processing (GP) rose 27%, Gas Transportation (GT) grew 10%, Utilities leapt 19% and RGT gained 2%. In additional, share of income from JV tripled to RM30.5m from RM9.4m previously.

RGT led YoY earnings higher. On yearly comparison, 1Q17 core earnings grew 4% from RM442.2m on a 3% hike in revenue which was largely led by Utilities on the half-yearly fuel gas price revisions. Segmental earnings were mixed where earnings for GP, GT and Utilities were hit by one-off staff costs adjustment while RGT was the only segment that saw earnings improved due to lower opex. The improvement in bottom line was mainly attributed to higher share of income from JV as well as lower taxation.

TPA a concern? Its share price has faced heavy selling down recently on concerns of a new Third Party Agreement (TPA) which could severely impact its earnings on lower rate while processing income would be lower as customers may opt to import their own gas supply. Currently, the authority is still working on a new guideline to allow any party to import their own gas under TPA starting in 2018. However, negotiation is still ongoing and it could be delayed to 2019. We believe this TPA may not be applicable to everyone unless the offtake has huge gas requirement like TENAGA to make the import economically workable as it needs certain size of order plus storage facility. Furthermore, current piped gas is still subsidised by Petronas. Based on TENAGA’s and GASMSIA’s asset returns of 7.5%-8%, a worst case of rate reduction for PETGAS would be 15% to bring down its current asset returns of >9% and that could impact its FY18 earnings by 9% and SoP by 8% respectively.

Upgrade to OUTPERFORM. We believe the sell-down on the stock of 13% YTD, could be overdone as it is more than the worst-case scenario impact on SoP of 8% and affect FY18 earnings and beyond by c.8%, if any. Hence, we upgrade the stock to OUTPERFORM with higher target price of RM22.00/SoP share from RM21.35/SoP after rolling over valuation base-year to CY18. We maintain our earnings forecast for now. Risk to our upgrading call includes severe reduction of rates under the TPA.

Source: Kenanga Research - 16 May 2017