This article first appeared in The Edge Financial Daily on October 6, 2017

Gas Malaysia Bhd
(Oct 5, RM2.92)
Reiterate hold with a target price (TP) of RM2.90: Against the backdrop of healthy natural gas demand, we raise our financial year 2017 (FY17) to FY19 core net profit forecasts by 4.5% to 6.5%.

This will be supported by an additional 200 new industrial customers within the oleo-chemical, glass and steel sectors. A strong balance sheet will pave the way for Gas Malaysia Bhd (GMB) to pay out at least 75% of earnings to shareholders.

Going forward, management guides that natural gas will be the key earnings growth driver with an expected 6% to 6.5% gas volume growth per annum. This will be supported by 200 new industrial customers (within the oleochemical, glass and steel sectors) in the next three years.

At this juncture, GMB services 837 industrial customers with the rubber, and food and beverage segments accounting for 57% of gas sales volume.

Separately, we view the group’s venture into the unregulated gas distribution business, that is, combined heat and power (CHP) and virtual pipeline operations, as a longer-term growth story. At the moment, customer take-up is low due to persistent low oil prices (key fuel substitute for industrial customers is either diesel or electricity).

From a recent site visit to the Prai CHP plant (Malaysia’s largest CHP plant of 30mw for a Japanese customer), we understand the ability to replicate CHP plants in Malaysia is hampered by: i) high standby charges of RM14/kwh versus RM3 to RM4/kwh in Thailand; and ii) continuing NG subsidies in Malaysia, albeit gradual reduction in the subsidised quantum.

That said, we note that GMB’s unregulated business contributed RM161,000 in profit for first half FY17 with little risk of provisions in the near term. A more meaningful turnaround is expected in FY19, when the group’s unregulated business is expected to account for 5% of group revenue, or about RM300 million.

The company’s incentive-based regulation (IBR) framework sets the base tariff for a regulatory period of three years from January 2017 to December 2019. Importantly, the framework allows for changes in gas costs to be passed through via the gas cost pass-through (GCPT) mechanism every six months.

We gather the gas base tariff reflects: i) 4.5% year-on-year [y-o-y] gas volume growth; ii) the gradual removal of gas subsidies when gas prices increase by RM1.50/mmbtu every six months; iii) higher liquefied natural gas (LNG) mix; and iv) rising LNG prices indexed to crude oil price forecast.

Given these factors, gas prices for the non-power sector are expected to rise from RM26.71/mmbtu in 2017 to RM32.74/mmbtu in 2019. Any sharp spike in LNG prices or volume will be adjusted via a six-month GCPT review. Importantly, GMB remains earnings- and cash flow-neutral despite changes to natural gas prices announced by the government.

We gather from a recent Energy Commission meeting that a third-party access (TPA) framework for the gas sector is underway. In principle, the TPA framework will help liberalise the gas market and provide scope for “cheaper” gas supply from third-party oil majors like Royal Dutch Shell plc and Mitsui Oil Exploration Co Ltd.

Furthermore, a TPA will help reduce customers’ reliance on a single supplier, that is, Petroliam Nasional Bhd. More importantly, the TPA will allow GMB to supply NG directly to customers (playing the role of a gas retailer).

To recap, the group experienced 10% y-o-y gas volume growth in six months of FY17, primarily driven by demand from the rubber, oleochemical, consumer products and glass sector. The group also added 21 new industrial customers. — UOBKayHian, Oct 5