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 Here is my long write-up of PETRONAS Gas (国油气体). This blue chip stock is mainly hold by large fund houses including EPF.

Introduction of PETGAS
⚑ PETRONAS Gas Berhad (PETGAS, 6033) was listed at issue price of RM5.30 in 1995. It is 60.6% owned by its parent, PETRONAS.

⚑ PETGAS dominates the natural gas industry in Malaysia. Gas Malaysia (GASMSIA) is its peer in the gas supply industry. Gas Malaysia is much smaller than PETGAS in terms of market capitalisation which Gas Malaysia is merely about 10% of PETGAS.

- Interestingly, Gas Malaysia is partly owned by PETGAS with close to 15% ownership.

- When I said Gas Malaysia is its peer, it is actually not PETGAS competitor. PETGAS distributes gas on behalf of PETRONAS to Gas Malaysia. Means, Gas Malaysia is PETRONAS customer.

- PETGAS also delivers to PETRONAS other customers in Malaysia and Singapore.

- In short, PETGAS is the distributor of gas throughout Malaysia.

PETGAS Business
To be exact, PETGAS has 4 segments of business:
1. Gas Processing
2. Gas Transportation
3. Utilities
4. Regasification

1. Gas Processing
⚑ It has 6 gas processing plants which have the capacity to process more than 2 billion standard cubic feet per day (mmscfd).

⚑ PETGAS takes natural gas from offshore platform and process them into salesgas (methane), ethane, propane and butane. Some of you may still recall these terms taught during your secondary, college or university days.

⚑ Once processed, they are supplied to PETRONAS customers through Peninsular Gas Utilisation (PGU) pipeline network. PETGAS is paid by PETRONAS for the gas processing fees, comprising mainly fixed reservation charges.

2. Gas Transportation
⚑ PETGAS charges PETRONAS customer transportation fee to transfer gas across Malaysia.Malaysia has an extensive gas pipeline network. In fact, probably it has one of the most extensive ones in Asia.

⚑ PETGAS distributes the output of its processing to PETRONAS customers (power & non-power sector like petrochemical plants). They include Gas Malaysia, independent power producers (IPP), petrochemical plants and industrial customers. It also supplies gas to Senoko Energy and Keppel Gas in Singapore.

⚑ In Peninsular Malaysia, there is PGU network which was completed in 1998. It is about 2,500 kilometers. There are also pipelines run from offshore gas fields to gas processing facilities at Kertih.

⚑ In Sabah and Sarawak, there is 510-kilometer onshore Sabah-Sarawak Gas Pipeline (SSGP). It transport gas from Sabah offshore fields to PETRONAS LNG complex in Bintulu for liquefaction (for export). There are also other pipelines connecting natural gas fields from Sabah offshore to Labuan Gas Terminal.

⚑ PETGAS is paid by PETRONAS for the gas transportation fees.

3. Utilities
⚑ PETGAS runs some plants to supply electricity, industrial gas and water to its petrochemical and industrial customers in Kertih (Terengganu) and Gebeng (Pahang)
- Power cogeneration plant
- Air separation unit (ASU)
- Water plant
- Nitrogen generation unit

⚑ PETGAS has built a air separation unit in Pengerang, which is scheduled to start operating in last quarter of 2018. It generates oxygen and nitrogen for the plants in RAPID.

⚑ While it operates a handful of power plants that supply power, steam and industrial gases, it is not a key power plant operator in Malaysia.

4. Regasification
⚑ PETGAS has an offshore LNG Regasification Terminal in Sungai Udang (RGTSU) in Melaka. When PETRONAS imports Liquid Natural Gas (LNG), PETGAS stores it in floating storage and convert it to salesgas with regasification. Melaka unit has capacity of 530 mmscfd.

⚑ PETGAS second regasification terminal is with RAPID project in Johor. This terminal, RGTP, has 490 mmscfd capacity. It started operation on 1 November 2017.

⚑ PETGAS is paid by PETRONAS for the regasification fee based on capacity underwritten from the agreements with PETRONAS.

As you can see, besides Utilities segment, 3 out of its 4 business revenue is assured as its customer is PETRONAS.

PETGAS Financial Performance for the Past 10 Years
Based on PETGAS past 10 years of financial records:
- Its average Returns of Equity (ROE) is about 15%. Very good.

- Net profit margin wise, it has average figure of 39.11%. Again, very good.

- However, its average earnings per share (EPS) growth rate is about 9%. It used to grow much faster during 90s, but it has slowed down a lot. Means, it is still making profit, but no longer on an exponential trajectory type of growth.

- Its debt to equity (D/E) ratio is lower than 0.5. Good.

- As for its Price over Earnings per Share (PE) ratio, it is at the region of 20, which I consider high.

- Its average dividend yield is close to fixed deposit rate which is about average 3.4% for the past decade.

- Its management has been running the operation pretty well. One of the indicators is its capability to earn its performance based structure (PBS) income from PETRONAS for the third consecutive year. Second indicator is the completion of its second LNG regasification terminal in Johor, within schedule and budget.

My Thought
1. Third Party Access (TPA)
⚑ Gas Supply (Amendment) Bill has been passed in 2016. This bill introduced Third Party Access (TPA) which helps liberalise the industry with more gas suppliers coming into the market.

⚑ With TPA, third party other than the owner of a gas facility is allowed to access and utilise the capacity of such gas facility for the purpose of delivering gas to consumers. TPA regime was effective from 16 January 2018 for PETGAS gas transportation and regasification segments.

⚑ Implications:
- Once Energy Commission (EC) issues license to other players, TPA allows them to use PETGAS assets, sytems and process to provide gas supply to customers.

- The tariff of using using pipeline and regasification is currently being reviewed with ongoing discussion between PETGAS and EC. EC has agreed to maintain the current rate for now until end of year 2018. However, a new rate, which many expect it to be lower in 2019, will affect PETGAS.

- Once the tariff of using PETGAS resources is lowered, the gas prices may go down as any impact of gas prices normally will be passed through to end users. As such, I assume new rate may encourage higher consumption of gas compared to using other fossil fuel or coal for power generation.

- While the new tariff may hurt PETGAS in short term, PETGAS may gain when more players come into the game. These players will become PETGAS customers when they use PETGAS assets or services (regasification and transportation). Therefore, overall, the net effect could be neutral to PETGAS in long term.

- Depending on how drastic the rate may be adjusted, it is still unclear how it may affect the industry and PETGAS.

- PETGAS has long term agreements with PETRONAS with fixed returns on capacity reservation. In the best scenario, even with lower rate, PETRONAS may pay PETGAS for its fixed rate services according to their agreements by absorbing any shortfall. In the worst case, PETGAS may have to take the hit itself. Between the 2, it could be the latter.

2. Growth
⚑ Now, you may ask, under what circumstance that PETGAS EPS will grow rapidly again?
- PETGAS will grow when PETRONAS customers grow, either by having more customers, or same customers utilising more gas. I am referring to industrial customers.
- When more industrial factories are set up (by foreign investors or by local manufacturers) with higher production volume, they will consume more energy.
- As on how to make Malaysia a good destination for foreigners to do so, new government will have to find ways to do so.

⚑ The second potential growth engine may start when government seriously wants to reduce use of coal for power generation. In this case, it may opt for cleaner source which natural gas could be a preferred choice over others. However, the government may prefer renewable energy (solar, biogas, wind or hydro) instead. In my humble opinion, even in medium term (10 years), it may not be cost efficient (for government) to focus only on renewable energy. Natural gas remain the cleanest of all fossil fuels to complement and stabilise electricity grid.

⚑ Good news is the near term boost of profit from its LNG Regasification Terminal Pengerang.

3. Gas Industry
⚑ Natural gas price has been pretty stable for the past 2 years (since mid 2016) despite the crude oil price has been on the uptrend, partly due to abundance of supply. Low gas price will benefit gas based petrochemical companies as it widen their operating margins. It also encourages power plant and other industrial customers to continue to use it as a reliable clean energy.

⚑ Natural gas industry will stay. It will not go away in the next 20 years. The demand is there. The best, the supply is here too.

⚑ What do I mean "supply"?
- As of January 2017, Malaysia was estimated to have about 42 trillion cubic feet (Tcf) of proved natural gas reserves. Malaysia is the 5th largest natural gas reserve holder in the Asia-Pacific region (after China, Indonesia, Australia and India). More than half of the Malaysia natural gas reserves are located in offshore Sarawak.

- We have abundance of resources. It is a matter to extraction. It can be brought to market under the right terms and conditions. Malaysia actually exports LNG and we are the third largest exporter after Qatar and Australia.

⚑ Infrastructure (gas pipelines) is available. Piped gas from offshore, even onshore (Sabah-Sarawak) and regasification facilities are there.

5. My preference
⚑ I like PETGAS management team. I like its ROE. I like its net profit margin. But, at its current share price, due to uncertainty caused by TPA, based on my risk profile, I am holding back. Despite its share price has been on downward trend since 2016 (after TPA has been approved), I am still not comfortable.

⚑ As a long term value investor, I will wait patiently.

Ho Kok Mun
17 September 2018

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