Key takeaways from Petronas Dagangan Bhd’s (Pet Dag) 3Q19 results briefing include: 1) management reassured that the incremental capex spend for the government’s new B20 biodiesel mandate will be minimal, 2) Pet Dag’s recent Mesra initiatives include installation of modular Mesra stores, expanded redemption of Mesra points to non-fuel rewards, expansion of Mesra-Tealive outlets to 61 stores (2Q19: 35 stores) etc, and (3) Phase 2 of Pet Dag’s capex program will emphasize on digital investments - which include back-end software upgrades etc. We factor in actual 3Q19 performance and management’s refreshed outlook. As a result, our FY19/20/21 forecasts are reduced by 3%-9%. Correspondingly, our target price (TP) for Pet Dag is lowered to RM21.90 based on unchanged 21x CY20 P/E. Maintain Sell.

Biodiesel Mandate Still Brewing. Pet Dag is still in discussions with the government on implementation of the new biodiesel mandate. To recap, Malaysia plans to double its biofuel programme to B20 by 2020 - which mandates fuel to be blended with 20% palm-biodiesel (current: 10%). Pet Dag’s negotiations also center on product subsidies, capex reimbursement for infrastructure (eg. blending facilities, storage) and timelines etc. Nevertheless, management reassured that the incremental capex spend will be minimal for this program. This is because Pet Dag’s existing infra are equipped with B10 capabilities. As such, the Group merely needs to tweak equipment settings to enable the upgrade to B20.

Mesra Keeps Management Busy. Management has been actively deploying strategies to boost non-fuel income from Mesra outlets. Recent implemented initiatives include: (1) installation of modular Mesra stores on existing landbank where demand shows traction, (2) new F&B partnerships (eg. Kyochan), (3) expanded redemption of Mesra points to non-fuel rewards from retail partners (current: circa 25) such as Tealive, AirAsia etc, (4) expansion of Tealive outlets within the Group’s retail network to 61 stores (2Q19: 35 stores), and (5) constant tweak of product offerings to match fluid market trends and demand. Pet Dag’s sustained thrust into Mesra sales have resulted in an impressive 22% YTD surge to Other Income for the retail segment in 9M19.

Phase 2 of Capex Program is Digital. Management unveiled its refined capex strategy - whereby Phase 2 of its capex program will emphasize on digital investments. The latter comprises, amongst others, software upgrades for back-end systems. For instance, Pet Dag will enhance its Point-of-Sales (POS) terminal at retail stations, which is long overdue (age: circa 15-years). Upgrade of cloud computing capabilities for Pet Dag’s POS terminals will enhance sales data analytics. In turn, this will propel Pet Dag’s thrust into nonfuel retail income. To recap, Phase 1 of Pet Dag’s capex program mainly centred on upgrades and refurbishment of physical infrastructure at retail stations. The latter includes Mesra outlets, station facilities (eg. surau, toilets, pump systems) etc.

Maintain Sell on Subdued Industry. For our forecasts, we factor in:- (1) actual 3Q19 performance which was weaker-than-expected, and (2) management’s refreshed outlook. Major tweaks to our assumptions include: (1) raising FY19 MOPS price by circa 5%, and (2) reducing margins for LPG and Lubricant products in FY19-21. As a result, our FY19/20/21 forecasts are reduced by 3%-9%. Correspondingly, our target price (TP) for Pet Dag is lowered to RM21.90 (previous: RM22.70) based on unchanged 21x CY20 P/E. Maintain Sell given that Pet Dag’s margins continue to be weighed down by heightened marketing and capex spend. This is to wrest volumes amidst the prevailing market trend of weak demand and intense competition. Given the latter, management has toned down expansion plans correspondingly. This alludes subdued growth prospects – and hence muted dividends. Furthermore, the removal of blanket fuel subsidies in Jan-20 may precipitate demand erosion. Nevertheless, we believe the latter would likely be a temporal knee jerk reaction, given fuel consumption elasticity.

Source: TA Research - 26 Nov 2019