We were largely neutral on Petronas Dagangan’s (Pet Dag) 4Q16 results briefing. Key takeaways include:- 1) Pet Dag will increase inventory days to 5-6 days (previous: 4-5 days), 2) retail competition remains heightened, 3) volumes continued to be subdued for both retail and commercial segments, and 3) capex spend and expansion plans stay muted. Maintain Sell with TP of RM20.19. Rerating catalysts include:- 1) enhanced balance sheet efficiency (e.g. higher dividends and M&As), 2) restructure of APM mechanism resulting in higher returns, and 3) reversal of cautious expansion plans.

• Management alluded that 2016 overall industry retail volumes likely experienced sluggish growth of <1% YoY. Therefore, this implies that the group likely ceded market share as FY16 retail volumes contracted by 12% YoY. This was not surprising given limited expansion of 7-8 new retail stations in 2016 versus historical run rate of 30-40 new outlets p.a. For 2017, Pet Dag targets to exceed or match industry volume growth. Whereas for the commercial segment, Pet Dag expects sustained soft volumes as demand from O&G exploration activities are unlikely to recover in the near-to-medium term.

• Overall, management attributed the stronger FY16 results to a combination of cost-cutting initiatives and higher volumes (+2% YoY). In addition, higher contribution from Mesra outlets (+5% YoY), which carry stronger margins helped to boost bottomline. Cost-cutting initiatives include road tanker fleet optimisation, workforce rightsizing, renegotiation of freight rates, etc. However, total opex in FY16 climbed by circa 5% YoY, driven in part by higher depreciation following capitalization of capex spend in 4Q16. Nevertheless, for 2017, management expects to maintain current cash opex levels.

• Pet Dag has plans to increase inventory days to 5-6 days (FY15-16: 4-5 days). This is on the back of expectations that retail volumes are likely to pick-up in 2017. This will enable uninterrupted supply during periods of high demand.

• Pet Dag maintained its annual capex guidance of circa RM400mn p.a. Similar to FY16, this will largely be driven by investments at existing stations. This includes refurbishment of aged infrastructure, upgrade of payment systems, ICT spending, enhancement of facilities at Mesra outlets etc. However, we note that the actual FY16 capex spend of RM230mn (FY15: RM315mn) fell short of guidance. Nevertheless, management provided reassurance that capex spend will ramp up in FY17 as Pet Dag has now completed the review of its business strategy.

Impact

• Major changes to our forecasts include:- 1) increase FY17 capex spend assumption as per renewed guidance, 2) assume higher non-fuel income from Mesra on the back of investments to upgrade outlets, 3) reduce tax rates, 4) assume lower overheads following successful cost optimization measures in FY16, 5) incorporate higher depreciation to account for higher capex spend. Following this, our FY17/18 forecasts are raised by 9%/11%.

Valuation

• Following our forecast revision, our TP for PetDag is raised to RM20.19 (previous: RM18.51) based on unchanged 21x FY17 P/E. Rerating catalysts include:- 1) enhanced balance sheet efficiency, including higher dividend payouts and value accretive M&As, 2) government restructures retail managed float APM mechanism resulting in higher returns, and 3) reversal of cautious expansion plans. Note that current valuations are expensive at 1SD above historical average forward P/E. Maintain Sell.

Source: TA Research - 23 Feb 2017