Petronas Gas - Strong and steady but priced in

From just an initial gas processing and transportation company, PetGas is coming of age. The group is will transform soon into an integrated utility group with stakes in power generation and regasification. There is little doubt on the expertise of the company or the fundamentals of its gas business, but this is hardly the angle one should see the stock from. The real story plays to us is this - PetGas is not just another staid utility relying on its oligopoly status – which tends to breed complacency. On the contrary, it is actually a fast-growth player under its expansion plan and that’s where things get interesting fast, especially when it practically controls most of the growing gas industry. In fact, its growth is already secured in the bag for the next three years, led by Melaka RGT (FY13), Kimanis IPP (FY14) and Lahad Datu RGT (FY15). To be sure, the same strong catalysts have also pushed the share price to double since Jan 2010, putting its current PER valuation at an all-time high and likely close to fair value already. Be that as it is, we continue to like PetGas’ sustainable earnings story and its rising opportunities. We are initiating coverage with a MARKET PERFORM call and a price target of RM19.90/SOP share.

An integrated utility group. From a gas processing and transportation company, Petronas Gas Bhd (PetGas) will turn into an integrated utility group when its Melaka Regasification Terminal (RGT) comes on stream in Jan 2013 and later, when its power plant in Kimanis kick starts in Jan 2014. In addition, PetGas will also own another RGT in Lahad Datu that will be ready by end-2014, which will supply the gas to the Kimanis plant.

The largest gas distributor. The company is one of the only two players in the oligopoly gas distribution industry in Peninsular Malaysia. PetGas controls the market with an 87% distribution share while the remaining 13% held by Gas Malaysia Bhd (“GMB”, OP; TP: RM2.94). Earnings from this segment are fairly sustainable with good visibilities. In view of the continued shortage in gas supply, especially to the power industry, gas demand should continue to grow. In this case, its RGT business model will also help to boost its competitive edge in the industry.

RGT the new earnings driver. PetGas will own the first LNG RGT in Melaka when it becomes operational officially in the next two months. This will be its new earnings kicker for FY13. To be sure, the completion date has been delayed twice from the initial targeted Aug 2012 to Jan 2013 due to technical issues. We estimate that this RGT will contribute RM224m net profit (+15%) per year, at full capacity, to the group. Meanwhile, the Lahad Datu RGT will be the new source of income for the group in FY15. In addition, the proposed RM60b RAPID project in Pengerang will also see a RGT, which likely could involve PetGas’ involvement as well.

IPP is its latest venture. PetGas will become an Independent Power Producer (IPP) when the Phase 1 of its 300MW gas-fired power plant in Kimanis kick starts in end-2013. PetGas holds an 80% stake in this IPP with the remaining by Sabah Energy. For a start, Kimanis IPP will get its gas supply from Sabah Onshore Gas Terminal (SOGT) before the Lahad Datu RGT starts at the end of 2014. This IPP is expected to contribute RM80m in net profits (+6%) a year to the group.

Earnings to grow at a 3-year CAGR of 10%. The Melaka RGT will be its key earnings catalyst in FY13 while the Kimanis IPP will take PetGas’s earnings to a new height in FY14. In all, we expect a 3-year CAGR of 10% in earnings over FY11-FY14E. The Lahad Datu RGT will be the next catalyst to earnings when it starts operating in early 2015. Assuming a 70% earnings payout, we forecast 53 sen to 72 sen in GDPS for FY12E-FY14E, implying 3%-4% yields.

New coverage at a MARKET PERFORM rating. While we like the company due to its sustainable income stream, we believe that all its positive catalysts are already reflected in its current price. Due to its high FBMKLCI weighting, PetGas will likely be a core holding for most institutional investors. Thus, we are initiating coverage on the stock with a MARKET PERFORM rating and a price target of RM19.90/SOP share.

Source: Kenanga