We hold the view that terms stipulated under the Regulatory Period 2 (RP2) will have neutral impact on PETGAS as a lower WACC is cushioned by a growing regulated asset base, while the yearly adjustments on forex fluctuation and gas prices will reduce earnings volatility. As such, PETGAS’s earnings will remain stable with >90% being safeguarded by the Incentive-Based Regulation (IBR) framework, anchoring a consistent and generous dividend payout. We keep our forecasts relatively unchanged, tweak our TP marginally up to RM17.13 (from RM17.00) and maintain our MARKET PERFORM call.

The key takeaways from PETGAS conference call last Friday pertaining to the RP2 are as follows:

1. Future earnings to remain neutral given a high asset base to mitigate a lower WACC. There was no disclosure of regulated asset base (RAB) by the company but it has guided for RM2b increment of RAB over the 3-year RP2 period, i.e., 2023 to 2025. Similarly, the quantum of WACC was not disclosed as well but we believe to be at the highest range of 7%. The company expects insignificant cut in WACC in the future which we believe could also indicate that the new rate is in line with other utilities players in the region.

2. A new component Tariff C of RM0.553/GJ for high-pressure gas via Peninsular Gas Utilisation (PGU) II Sector 3, on top of the Tariff T of RM1.063/GJ for RP2 via existing PGU network, from RM1.129/GJ in RP1. This Tariff C is for gas export to Singapore with reserved capacity of 200MMSCFD (total charges Tariff T plus Tariff C). To also note that Tariff T in 2023 is RM1.061/GJ. This additional tariff also helps to lower WACC as well as lower revenue expected in 2023 on the yearly forex adjustment from the strong USD in 2022. Meanwhile, the new Tariff T of RM1.063/GJ came slightly higher than our assumption of RM1.045/GJ.

3. Besides the yearly forex adjustment, the authority has also approved 100% cost pass-through on gas price (yearly adjustment) to shippers which will mitigate risk on opex fluctuations. To refresh, PETGAS’s earnings were hit by higher internal gas consumption (IGC) costs in FY22 given the escalating gas prices. With these two adjustments in place, PETGAS’s earnings will remain stable.

4. The approved tariff of RM3.455/GJ for regasification terminal Sg. Udang (RGTSU), which is the same as our assumption, remains unchanged from RP1 but the approved tariff for regasification terminal Pengerang (RGTP) is reduced to RM3.165/GJ from RM3.485/GJ in RP1. We had expected tariff for RGTP to remain at RM3.485/GJ.

Neutral on earnings. As expected, the RP2 has neutral impact given that the expected lower WACC will be negated by higher RAB while the gas price and forex pass-through help to stabilise earnings. We see mildly positive impact from the new tariff as Tariff T of PGU came slightly higher than our expectations. To align with the new tariffs coupled with new component of Tariff C from 2023, we upgraded FY23F earnings slightly by 0.5% while keeping FY22F’s unchanged. Accordingly, FY23F NDPS is also increased proportionally based on unchanged payout of 85%.

We continue to like PETGAS for its earnings stability of which >90% is safeguarded by the IBR framework, and the RP2 has reinforced its earnings stability, anchoring decent dividend yields of 4-5%. However, its valuation is already rich at current levels. Having reflected the terms under the RP2, we raise our SoP-based TP slightly to RM17.13 (see Page 4) from RM17.00. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 6).

Risks to our recommendation include: (i) regulatory risk, and (ii) a global recession hurting demand for power, steam and industrial gases.

Source: Kenanga Research - 30 Jan 2023