INVESTMENT HIGHLIGHTS

• Petronas Gas Bhd (PetGas) has entered into a pilot period of the newly introduced Third Party Access (TPA)

• Gradual migration to new asset-based model NBV from DCR

• Earnings growth to be CAPEX-driven

• Continued sustainable dividend payout expected going forward

• FY19F earnings revised down slightly by -3.1%

• Maintain NEUTRAL with a revised TP of RM19.13 per share

TPA pilot period begins. PetGas announced that it has entered into the pilot period for the implementation of Third Party Access (TPA) under the Gas Supply Act. TPA is introduced by the Energy Commission (EC) as part of its ongoing effort to liberalise gas market in Malaysia. TPA’s impact on PetGas will be seen in three forms i.e: (i) third party utilisation of Peninsular Gas Utilisation (PGU) pipelines and regasification infrastructures; (ii) regulation of tariff on gas transportation and regasification by EC and; (iii) licensing of gas transportation and regasification application by EC.

Gradual migration to new asset-based valuation model NBV. While the TPA pilot period has begun, the migration of PetGas’s asset-based valuation from the current depreciated replacement cost (DRC) will happen gradually during Regulatory Period 1 and Regulatory Period 2 which starts in FY20. The full-migration to NBV is expected to complete in FY25. Hence, going forward we are expecting the tariff especially on its PGU to gradually decline with the progress of the migration. Recall that, PetGas received a letter from the date 26th December 2018 where EC has prescribed the Incentive Based Regulation (IBR) framework in setting the base tariff for the Peninsular Gas Utilisation (PGU), Regasification Terminal Sg. Udang (RGTSU) and; Regasification Terminal Pengerang in Johor (RGTP). The newly revised tariff are as follows:

Earnings growth to be CAPEX driven. Due to the nature of the business, PetGas operates on “Guaranteed Revenue Cap” where its revenue is guaranteed based on the capacity reserve requirement set out by its parent company Petroliam Nasional Berhad (Petronas) regardless of the utilisation rate. That will however change as new shippers (players) are allowed to use PetGas’s services i.e: gas processing, gas transportation and regasification under the TPA and Petronas is obliged to let go of unutilised reserve to other shippers should the need arise, which will in turn contribute to higher revenue for PetGas.

In addition, under the new IBR framework, an expected rate of return on PetGas’s assets will be determined and benchmarked by the EC. Investments in CAPEX is expected to drive PetGas’s growth going forward as it will increase the rate of return on its assets. PetGas is planning to invest in CAPEX on its gas pipelines going forward as the part of its ongoing effort to refurbish and maintain the 30 years old pipeline.

Sustainable dividend payout. PetGas announced a total dividend of 72sen for the financial year FY18, which is the company’s record high payout so far at 78.7% (or 73.6% after stripping out tax from Kimanis Sdn Bhd) of its total FY18 earnings. This translates to a yield of 4.0% to yesterday’s closing price. Going forward, management stated that it will continue to declare sustainable dividend that is in line with the company’s earnings growth. Historically, PetGas has been paying out about 70% of its earnings as dividend.

Impact on earnings. We are reducing our earnings estimate for FY19F by -3.1% to account for the expected lower revenue coming from the gas transportation segment as we input the new tariff of RM1.072/GJ from RM1.248/GJ. This new tariff however, is still based on the DRC therefore further downward revision of the tariff is expected once the Regulatory Period 1 comes on stream in FY20.

Maintain NEUTRAL. We are maintaining our NEUTRAL recommendation on PetGas with a lower TP of RM19.13 (from RM19.75). Our valuation is premised on forward PER19 of 21x pegged to EPS19 of 91.1sen. The target PER is based on PetGas’ rolling four-quarter average PER over six years. Our call is premised on the expected adverse impact on the revenue and earnings of PetGas arising from the new reduced tariff as PetGas gradually migrates to net book value (NBV) valuation from the current DRC method for its asset base. That said, we do expect the impact from the reduced tariff to be cushioned by the increase in gas volume transported and processed going forward as a result of the second GPA term as well as; the CAPEX investment on the gas pipelines going forward.

Source: MIDF Research - 20 Feb 2019