Impending IBR impact likely to dampen Petronas Gas results

This article first appeared in The Edge Financial Daily, on August 17, 2018.
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Petronas Gas Bhd
(Aug 16, RM18.38)
Maintain sell with a higher fair value (FV) of RM17.50:
We maintain our “sell” recommendation for Petronas Gas Bhd (PetGas) but with a higher sum-of-parts-based FV of RM17.50 per share (from an earlier RM16.80 per share), which implies a financial year ended 2018 forward (FY18F) price-earnings ratio (PER) of 18 times, a 20% discount to the two-year average of 23 times.

This is due to the expected value erosion from the Energy Commission’s (EC) plan to implement incentive-based regulation (IBR) tariffs on the group’s gas transportation tariff under the Gas Supply Act 2016, scheduled to be effective by January 2019. We do not expect any changes to the existing gas policy as the proposed third-party access mechanism will ultimately lower gas transportation costs and benefit consumers.

Based on management’s continuing guidance that its gas transportation segment’s depreciated replacement cost is three times its current historical book value, our FY18F-FY19F return on regulated asset base translates into 9% for the gas transportation segment versus Tenaga Nasional Bhd’s 7.3%, as guided by the EC.

PetGas is still in discussion with the EC on the framework and quantum of the tariff beyond 2018, which includes a plan to mitigate the impact by phasing the reduction in asset return over a number of years.

However, we have raised PetGas’ FY18F-FY20F earnings by 6% on a four percentage points (ppts) cut in effective tax rate assumptions as its first half of FY18 (1HFY18) core net profit of RM993 million was above expectations, accounting for 53%-54% of our and consensus forecasts.

As a comparison, 1HFY16-1HFY17 net profits accounted for 49%-50% of their respective years. The group declared a second interim dividend of 16 sen (flat quarter-on-quarter [q-o-q]), which leads to a 1HFY18 dividend per share of 32 sen — 48% of our forecast.

The group’s 2QFY18 core net profit rose 8% q-o-q to RM516 million, mainly due to a 5.5 ppts contraction in effective tax rate to 15%, due to initial allowances from the Pengerang LNG regasification terminal, which commenced operation in November last year.

On a year-on-year (y-o-y) comparison, the group’s 1HFY18 core net profit rose 13% from the 490 million standard cu ft per day capacity Pengerang Regasification Terminal  commencement together with higher utilities tariffs, and increased operations and maintenance revenue from the Sabah-Sarawak gas pipeline.

The stock currently trades at an FY18F PER of 19 times, 17% below its two-year average, while dividend yield is fair at 4%. However, these valuations are unjustified given that its recurring income and margins are likely to erode over the longer term due to the IBR implementation, even though management hopes to cushion the impact of the lower tariffs over an undisclosed duration, which is currently under negotiation with the EC. — AmInvestment Bank, Aug 15