The higher effective tariff rate of RM32.69/mmbtu in 2H18 will have neutral impact to GASMSIA’s bottom-line as it is a cost pass-through from higher gas costs. Nonetheless, we still continue to like the IBR framework as it offers better earnings visibility. We also believe that this framework will stay beyond 2019 as it is a fair and transparent mechanism. With share price rising 7% in the past two weeks and positives priced-in, we cut the stock to MP at RM3.05/DCF.

Flattish effective gas tariff rate in 2H18. Yesterday, Gas Malaysia Bhd (GASMSIA) announced that the Government has approved the half-yearly natural gas base-tariff rate revision for non-power sectors in Peninsular Malaysia to RM31.92/mmbtu on average for Jul-Dec 2018 from RM30.90/mmbtu in Jan-Jun 2018 which is in line with the national rationalisation plan and Gas Cost Pass-through (GCPT) announced in Dec 2016. In addition, under the GCPT framework, a surcharge of RM0.77/mmbtu will apply to all tariff categories due to higher actual gas costs against the reference gas costs, translating to an average effective tariff of RM32.69/mmbtu which is slightly higher than RM32.52/mmbtu for 1H18.

Earnings neutral to GASMSIA. This is not a surprise to us as it is a scheduled half-yearly revision while the tariff revision has neutral impact to GASMSIA on a 6-month lagged basis as it is a cost pass- through under the GCPT mechanism. Meanwhile, 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 Base Regulation (IBR) framework based on asset return of 7.5%, which is estimated between RM1.80/mmbtu and RM2.00/mmbtu currently. As such, any price hikes will have neutral impact to GASMSIA via GCPT adjustment.

We expect GCPT to stay beyond 2019. Like the other two regulated utilities companies, TENAGA (OP; TP: RM17.90) and PETGAS (OP; TP: RM22.80), GASMSIA also faces the concern of any changes in GCPT mechanism that may negatively affect it under the PH government’s populist policy. In our opinion, it is unlikely that the authority will review the base-tariff under the current GCPT’s regulatory period of 2017-2019 as it does not impact the public directly given that it deals only with businesses. And, we also believe that even beyond 2019, the base-tariff is likely to adjust according to market price as to lessen government’s burden since it is not involved with the general public directly.

Cut to MARKET PERFORM. We downgrade the stock to MARKET PERFORM from OUTPERFORM as we believe all positives have already been priced-in following a 7% run in the past two weeks. Nonetheless, we remain positive on GASMSIA’s outlook for its steady volume growth coupled with the margin spread certainty. Therefore, any price weakness would offer buying opportunity. We maintain DCF- driven target price of RM3.05. The MARKET PERFORM call is also supported by its decent yield of 3%-4%. Risks to our downgraded call include stronger-than-expected sales volume and higher margin spread.

Source: Kenanga Research - 14 Jun 2018