We raised FY20 earnings estimate by 16% as the effective tariff cut in RP1 is smaller than expected. Headline tariff for PGU hike of 5.3% is largely due to the inclusion of IGC and hence causing a lower EBIT by 8%-10%, which is now part of its operating costs while RGT should see higher EBIT by 3%-5% with the inclusion of Pengerang Jetty into RAB. Share price has jumped post-announcement which is pricing it to perfection, in our view. Thus, we keep our MP call but at higher TP of RM17.60.

Higher tariffs to cover additional costs. The announcement of Regulatory Period 1 (RP1) at the end of last year which took us by surprise saw the base tariff rate for Peninsular Gas Utilisation (PGU) rising 5.3% to RM1.129/GJ for 2020-2022 from RM1.072/GJ in 2019 while base tariff for Melaka Regasification Terminal (RGT) and Pengerang RGT were also raised 3.6% and 39.1% respectively. (refer to our report “Back To Square One” dated 23 Dec 2019) We gathered that the higher tariffs are mainly to cover additional costs, such as Internal Gas Consumption (IGC) for both Gas Transportation (GT) and RGT which was previously borne by parent company Petronas while the signification jump in Pengerang RGT’s tariff is largely due to the inclusion of jetty facility into its Regulated Asset Base (RAB). While there is no disclosure of return rate for RAB, we understand PETGAS’ return of rate for RP1 is higher than TENAGA’s (OP; TP: RM14.30) RP1 of 7.5% and GASMSIA’s (OP; TP: RM3.00) RP1 of 7.3%-7.5%, at the higher range of 7%.

But lower earnings effectively. Nonetheless, PETGAS expects to see operating profit for GT to drop 8%-10% in RP1 as opposed to the IGC which is now absorbed by shipper like PETGAS and GASMSIA, is part of the operating cost. This implies an estimated effective tariff cut of 5.8% to RM1.009/GJ against our previous assumption of a 15.1% cut to RM0.091/GJ. Nonetheless, the overall RGT’s operating profit is set to rise by 3%-5% as the higher contribution from the inclusion of Pengerang Jetty more than offset IGC for both Melaka RGT and Pengerang RGT. Based on the operating profit guidance, we expect base tariff rate for PGU to decline to RM1.0450/GJ in RP2 (2023 to 2025) and drop further to RM1.000/GJ in RP3 (2026 to 2028) given the RAB’s valuation method that gradually migrates to net book value (NBV) from optimised replacement cost (ORC, or depreciated replacement cost) from 2020 to 2025. As such, this implies that PGU’s base tariff is expected to fall by 20% from the pre-RP of RM1.248/GJ in 2018 to RM1.000/GJ in 2026.

Upgrade FY20 earnings by 16%. Given the effective base tariff rate cut is better than expected as the return rate for RAB is higher than what we had expected at 7.5% in RP1, we raise FY20 earnings estimate by 16% while NDPS forecast is also upgraded proportionally based on unchanged earnings payout assumption of 70%. There is no change in FY19 estimates as it is not affected by the RP1. Meanwhile, our SoP valuation for PETGAS is also upped to RM17.60/share from RM15.75/share based on abovementioned assumption for PGU over RP1 to RP3 and beyond while we have assumed that there is no change in RGT’s base tariff from RP1.

Still in the price; MARKET PERFORM maintained. Share price jumped immediately by 6% on the RP1’s announcement in end-Dec to reflect the impact fully. On a positive note, the official announcement of RP1, albeit not a full disclosure, at least offers earnings clarity. Given the price to perfection, we maintain our MARKET PERFORM call but with a higher target price of RM17.60 from RM15.75 which is backed by a decent net yield of 4%. Upside risk to our call is higher-than-expected earnings.

Source: Kenanga Research - 17 Jan 2020