Key discussions at Petronas Gas Berhad (PetGas)’s 4Q16 results briefing mainly centered on the upcoming gas infrastructure liberalization. We gather that discussions with EC are still fluid at this juncture, and implementation will stretch beyond 2017. In addition, we believe there is a material risk of potentially lower returns for the group postliberalization. On the back of this, we maintain Sell (TP: RM19.64) on Pet Gas. Furthermore, loss of Pet Gas’ business monopoly is a derating catalyst for valuations.

• Updates surrounding the new Gas Supply (Amendment) Act (GSA) that will liberalize gas infrastructure in Malaysia:- 1) Pet Gas is still awaiting the issuance of guidelines for tariff determination by the Energy Commission (EC), 2) management is still currently in informal discussions with EC, 3) the group is in the midst of preparing its tariff model for presentation to EC, 4) license submission date to EC is by Jul- 17, and 5) Pet Gas is granted a grace period until Jan-18 to meet EC’s requirements.

• Management is in discussions with EC on the valuation methodology to be used for its pipeline assets to derive allowable return (post-GSA). The options include: 1) depreciated replacement cost (DRC), or 2) net book value (NBV). Pet Gas’ internal study revealed that DRC is generally used for older pipelines, which is the case with Pet Gas’ assets. Whereas NBV methodology is typically applied on newer pipelines. Adoption of DRC is substantially more favourable for Pet Gas, translating to 2.5x- 3.0x of NBV.

• Pet Gas acknowledged that its current asset return of 9% (based on its WACC when the gas transmission agreement was inked), may be deemed high. Therefore, there is likelihood that returns may be revised downwards for GSA. Note that current tariffs for Pet Dag’s regulated peers (ie. Tenaga and Gas Malaysia) translate to lower returns of 7%- 8%.

• With regards to the 4Q16 revision for Pet Gas’ FSU charter hire opex terms with MISC:- 1) the revision is to reflect relevant costs after 1 year of operations, 2) it enables all cost savings or overruns, including FX risks, to be passed back to client, Petronas.

• Other updates:- 1) Taxation: Pengerang RGT’s (completion: 75%) pioneer status implies that this facility need not pay taxes for 15 years from its commencement date in 2018, and 2) Capex: the group will spend the bulk (~40%) of its 5-year RM4.3bn capex program in 2017. This will mainly be for growth projects, including Pengerang RGT.

Impact

• We maintain our forecasts.

Valuation

• We roll forward our valuation base year for our SOP valuation to FY17. Following this, our target price on Pet Gas is lowered to RM19.64 (previous: RM19.67). Maintain Sell.

• The looming liberalization of gas transportation in Malaysia may potentially result in lower returns for Pet Gas. On top of that, over the long run, loss of Pet Gas’ business monopoly is a derating catalyst for valuations.

Source: TA Research - 27 Feb 2017