Review

• Petronas Gas Berhad’s (Pet Gas) 9M19 core profit of RM1.4bn (-6% YTD) was within our expectations and consensus’ - accounting for 73%/75% of full-year estimates respectively.

• There were no surprises, as quarterly trends largely prevailed. YTD profit was mainly dragged by the Transportation segment due to: (1) lower tariffs under the 2019 Third Party Access (TPA) pilot period, and (2) higher opex.

• To a lesser extent, YTD bottomline was also dragged by the Regasification and Utilities segments. The latter was underpinned by: (1) higher depreciation given that jetty facilities at Regasification Terminal Pengerang (RGTP) are now recognized under new accounting standards, (2) increased opex, (3) lower sales volumes following planned statutory turnaround at Kertih Air Separation Unit (KASU) in 3Q19, and (4) higher Utilities gas feedstock prices.

• Additionally, higher taxes exacerbated YTD profit decline. This was due to (i) expiry of tax incentives for the Utilities segment, and (ii) RGTP tax incentives granted were recognized in 9M18.

• The above more than offset YTD profit drivers in the form of:- (1) higher reservation charge for Gas Processing (GP) under the new 2nd term GP Agreement (start: Jan-19), (2) maiden contribution (start: Mar-19) from Pengerang Air Separation Unit (PASU), and (3) lower depreciation for GP assets.

• Meanwhile, QoQ weakness was mainly attributed to: (1) KASU’s shutdown, and (2) lower contribution from PASU. Additionally, sequential gross profit from all other segments were also lower. Nevertheless, bottomline decline was partially mitigated by lower taxes.

• Pet Gas declared 3rd interim DPS of 18 sen (3Q18: 18 sen), which brings 9M19 DPS to 50 sen (9M18: 50 sen).

Impact

• Maintain earnings forecasts pending a results conference call later today.

Outlook & Valuation

• We await details on actual 2020-22 Regulatory Period 1 (RP1) transportation and regasification tariffs. The latter will likely be revealed before end-2019. In particular, for transportation assets, we are concerned of sizeable earnings erosion via reduction in allowed asset return. This was evident from lower transportation TPA tariffs (16.4% reduction versus prior rates) during the 2019 pilot RP. Therefore, this may prelude lower rate of return (or WACC) for Pet Gas’ TPA assets in RP1.

• Furthermore, valuation of regulated TPA assets will transition progressively from Optimized Replacement Costs (ORC) to Historical Cost (HC) by end of RP2 (estimate: 2024-26). Given that ORC translates to circa 3x of HC, this alludes potentially lower TPA asset base (assuming no new investments), and hence reduced income.

• Given risk of earnings uncertainty, we prefer to hold back until regulatory clarity emerges. Maintain Sell on Pet Gas with unchanged target price (TP) of RM15.50 based on Sum-of-Parts (Figure 4).

Source: TA Research - 20 Nov 2019