Does the rally of Petronas-linked counters still have legs?

This article first appeared in The Edge Malaysia Weekly, on August 27, 2018 - September 02, 2018.
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THE FBM KLCI breached the psychologically critical level of 1,800 points last week. The benchmark index has risen nearly 9% from this year’s low of 1,663.9 on July 6 and has been on an upward trend since the start of the second half of the year.

The climb of three Petronas-linked counters — Petronas Dagangan Bhd (PetDag), Petronas Chemicals Bhd (PetChem) and Petronas Gas Bhd (PetGas) — has added fuel to the rally.

Since July, PetDag has risen 8.5%, PetChem 11.3% and PetGas 9.4%. And analysts who track the stocks believe there is room for the three to go even higher.

MIDF Research analyst Aaron Tan says the run-up in the share prices of these companies has been supported by the generally improved sentiment on the local market.

Tan says there is no direct relationship between oil prices — Brent crude was trading at US$74.48 per barrel as of Aug 25, up 12% year to date — but the continued climb of crude oil prices is helping to boost sentiment in oil and gas counters on Bursa Malaysia. However, these factors are not the only impetus for these counters, as each company has its own drivers as well.

PetDag, which operates the country’s largest petrol station chain, reported a 28% year-on-year increase in net profit to RM314.42 million for the second financial quarter ended June 30 (2QFY2018), while revenue grew 10% to RM7.28 billion.

Earnings from its retail segment — the petrol stations — were boosted by the 5% increase in average selling prices (ASPs), an increasing Mean of Platts Singapore (MOPS) price trend and lower product and freight costs, which contributed to higher margins.

Its commercial segment was also helped by higher ASPs, although sales volume fell 1% due to lower demand for Jet A1 amid the usage of fuel-efficient aircraft and refuelling optimisation initiatives by the airlines.

Kenanga Investment Bank analyst Teh Kian Yeong says the results mark a strong rebound after the sharp decline in the preceding quarter, amid higher costs and lower sales volume.

Despite the latest strong set of results, Teh says there is not much upside to PetDag’s share price, in view of the 13.5% gain since the start of the year. “We maintain our view that most positives have been priced in following its share price run-up YTD as earnings growth potential is rather unexciting,” he says.

MIDF’s Tan begs to differ. He believes that there is still room for the counter to rise, at least in the near term.

“I am sure there is still headroom for PetDag’s share price to climb. At the end of the day, I think investors would not mind paying a premium for a counter they are comfortable with,” says Tan.

However, there is concern over falling sales volume — an unsurprising outcome as vehicles become more fuel efficient — although Tan says management has effectively reduced costs through upgrading the IT infrastructure and inventory optimisation to preserve margins.

PetChem’s share price, meanwhile, has been heading north, hitting a record high of RM9.44 on Aug 25, thanks to wider margins and the sale of its 50% stake in PRPC Polymers to Saudi Aramco, which was completed in March this year. YTD, the counter has gained more than 20%, closing at RM9.35 last Thursday.

For 2QFY18, the group posted a 42% jump in net profit to RM1.37 billion compared with the previous corresponding quarter. Quarterly revenue grew 20% y-o-y to RM4.73 billion.

Affin Hwang Capital analyst Tan Jianyuan says the better-than-expected performance was due mainly to higher overall product ASPs and improved plant utilisation in the fertiliser and methanol division as a result of lower maintenance activities at the ammonia and urea plants.

“Despite the share price having already appreciated by 21% YTD, we believe PetChem will see more upside as it benefits from favourable product spreads, which will help to partly offset the anticipated weaker 2H plant utilisation,” he writes in a recent note.

The research house has a “buy” call on the stock with a target price of RM10.

An analyst who declines to be named says PetChem’s sale of its 50% stake in PRPC Polymers was one of the main drivers of the increase in the share price.

“There are reports speculating that it might pay out a special dividend following the sale of the stake. But, in our base case scenario, we did not price in any potential special dividend, although its cash pile will be bigger,” he says.

The analyst expects the group’s margins to be sustained until year end, supported by growing Chinese demand for methanol products, which is expected to improve margins from the second half onwards.

“There will be some major maintenance works in the third and fourth quarters but PetChem is doing it in phases so I don’t think it will affect its earnings significantly. Moreover, the group will benefit from the strengthening of the US dollar against the ringgit as well, because its sales are denominated in the US dollar,” he adds.

On the other hand, the outlook for PetGas is not as positive as the two other Petronas units, in view of the expected erosion from the Energy Commission’s (EC) plan to implement incentive-based regulation (IBR) tariffs from January next year.

Although its 2QFY2018 results were in line with expectations — 20% y-o-y increase in net profit to RM509.33 million — AmInvestment Bank analyst Alex Goh maintains a “sell” call on the stock, with a fair value of RM17.50, due to the implementation of the IBR tariffs.

Goh highlights that the stock currently trades at a price-earnings ratio of 19 times, which is 17% below its two-year average with a “fair” dividend yield of 4%, but says these valuations may not be justified.

“These valuations are unjustified given that its recurring income and margins are likely to erode over the longer term due to the implementation of IBR, even though management hopes to cushion the impact of the lower tariffs over an undisclosed duration, which is currently under negotiation with the EC,” he says.

Affin Hwang Capital Research has also downgraded its call on the stock to “hold” from “buy”, following the 2QFY2018 results, as the counter approaches its target price of RM20.10 with limited near-term catalysts.



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