2Q19 earnings, which rose 11% sequentially to RM507.7m, is well on track. However, the fear of tariff cut in the RP1, which takes effect next Jan, is the main reason for heavy selling pressure of late. However, with a 20% YTD contraction in share price, we believe the near-term negatives should have been priced in. As such, we keep our MP call with a revised target price of RM15.75/SoP share. The call is supported by decent yield of c.4%.

2Q19 matched expectations. 2Q19 core profit of RM507.7m came within expectation with 1H19 core income sliding 3% to RM965.5m making up 50%/52% of house/street’s FY19 full-year estimates. It declared 2nd interim NDPS of 16.0 sen (ex-date: 13 Sep; payment date: 27 Sep) in 2Q19, the same amount paid in 1Q19 and 2Q18. This brings 1H19 NDPS to 32.0 sen which is the same payment in 1H18.

Sequential results led by GP and Utilities. 2Q19 core profit leapt 11% QoQ to RM507.7m although revenue only inched up slightly by 1%. This was largely due to: (i) stronger operating profit from Gas Processing (GP) by 11% or RM22m on lower depreciation as certain assets ended their useful life, (ii) 8% or RM15.0m higher Gas Transportation’s (GT) earnings due to lower opex, and (iii) better Utilities earnings by 30% or RM13.8m on the back of better sales volume and prices. Meanwhile, RGT earnings were fairly flattish at RM158.5m while associate incomes rose 18% or RM7.1m to RM46.3m which we believe was due to better contribution from Kimanis IPP.

Tariff cut dented yearly earnings. On a YoY comparison, 2Q19 and 1H19 core profits fell slightly by 2% and 3% to RM507.7m and RM965.5m, respectively, primarily due to tariff rates cut for GT and RGT Pengerang for the Pilot Regulatory Period in 2019. As such, operating profit for both segments declined 19% and 10% in 2Q19, and 21% and 10% in 1H19, respectively. Nonetheless, GP posted stronger earnings by 27% in 1Q19 and by 24% and 1H19 owing to the abovementioned lower depreciation charges and higher revenue while Utilities also registered solid earnings, higher by 47% and 21% on better volume and prices.

TPA remains the only issue going forward. Although the Pilot Period of 2019 will see less severe impact to PETGAS, its earnings will be impacted by two step-downs; in Regulatory Period 1 (RP1) in 2020- 2022 and Regulatory Period 2 (RP2) in 2023-2025, before stabilising from 2026 onwards. We take the view that its ROA will eventually taper to 8% by 2026. Hence, we expect base-tariff for PGU to reduce sharply by 60% to RM0.502/GJ in 2026 from RM1.248/GJ in 2018. As such, this will continue to dent sentiment on PETGAS. In all, we keep our FY19-FY20 estimates unchanged where we have factored in a basetariff cut in 2020 as mentioned above.

Sell-down should have reflected negatives; keep MP. PETGAS continued to face heavy sell down in recent weeks with share price falling 20% YTD which we believe should have priced in near-term negatives, especially for the RP1 tariff cut. To reflect its latest risk profile, we adjusted WACC to 6.6% from 6.4% for core gas business as well as target price for GASMSIA (MP; TP: RM3.00) that reduced our SoP-driven target price to RM15.75 from RM16.55, implying FY20E PER of 19.2x which is at -0.5SD 3-year mean. Thus, we keep our MARKET PERFORM call unchanged, which is supported by a decent yield of c.4%.

Upside risk to our call is higher-than-expected return on regulated asset base.

Source: Kenanga Research - 28 Aug 2019