The highly anticipated RP1 base tariff rates are finally revealed, last Friday. But, to everyone’s surprise, PGU base tariff is to be raised 5.3% in 2020-2022 as opposed to market expectation of a severe cut given the change of RAB valuation method coupled with lower RAB return rate. While this is an impactful price catalyst, we keep our recommendation of MP and TP of RM15.75 for now pending clarification from management later today.

RP1 base tariff rates revealed. Last Friday, PETGAS announced that the government through Energy Commission (EC) has approved the Incentive Base Regulation (IRB) Tariffs for the Regulatory Period 1 (RP1), which cover Jan 2020 to Dec 2022, for: (i) Peninsular Gas Utilisation (PGU) at RM1.129/GJ, (ii) Melaka RGT at RM3.455/GJ, and (iii) Pengerang RGT at RM3.485/GJ. However, there was no mention of return rate for regulated asset base (RAB), any changes of fixed Reservation Charge, flow rate charge, performance incentive and penalty.

A surprisingly higher PGU tariff rate. This news took us by surprise given that the new PGU base tariff rate is 5.3% higher compared to RM1.072/GJ in 2019 as the base tariff rate was highly expected to be reduced severely over the next six years. This is given the change of RAB’s valuation method to net book value (NBV) from optimised replacement cost (ORC, or depreciated replacement cost) currently as the pipelines are mostly 20-30 years old assets with low carried values. In addition, the introduction of RAB return rate, which is currently used to gauge profitability of TENAGA and GASMSIA, will suppress PETGAS’ earnings as it enjoys superior margin currently as opposed to these two companies. On the other hand, base tariff rates for Melaka RGT and Pengerang RGT are also higher by 3.6% and 39.1% as compared to RM3.51/mmbtu and USD0.637/mmbtu, assuming GJ/mmbtu: 0.947817 and USD/MYR: 4.15, in 2019.

Back to old days - minimal earnings impact. We have contacted their Investor Relations team over the weekend but it was communicated that management would only be able to share more details after clarifying with EC later today. Based solely on the tariff rates, this means its earnings trend will revert back to the previous organic growth rates 1%-2% instead of sharp declines over RP1 and RP2 before the base tariff rate stabilises after 2026 when the RAB is fully valued based on NBV. The new higher tariff rates would lead us to upgrade FY20E earnings by 19% as our current earnings assumption is based on PGU tariff rates going down sharply by 60% over the next six years. In addition, the new tariff rates would also lift our target price to RM20.36/SoP share from RM15.75/SoP share. Given that PETGAS is a major component of the FBMKLCI at 2.56% weight, upgrading its EPS by 19% from 83.2 to 99.0 sen would lead to raising the FBMKLCI EPS from 101.6 to 102.0. CY20 EPS growth would be raised from 6.7% to 7.1%. And, raising its target price by 30% from RM15.75 to RM20.40 would impact the FBMKLCI positively by 11 points based on a bottom- up computation, or 0.7% upside from the current level of 1610.18.

Keep MARKET PERFORM for now. We reckon that the new tariff is an impactful price catalyst, as its share price has been suppressed for the past three years on expected tariff cuts. Further information and clarity from management will guide us to make appropriate recommendations. For now, we keep our MARKET PERFORM, target price of RM15.75/SoP share and FY19-FY20 earnings estimates unchanged for now. Upside risk to our call is higher-than-expected return on regulated asset base.

Source: Kenanga Research - 23 Dec 2019