PETRONAS Gas’ (PGas) third quarter results for this financial year (3QFY09) disappointed at both throughput services and utilities divisions.

The former’s gross profit fell a sequential 3.5 per cent due to lower feed gas charges, chemical production and efficiency, while the latter reported a loss of RM11.2 million (2QFY09: +RM1.7 million).

We suspect the utilities division suffered lower demand as several petrochemical/industrial plants in Kertih, Terengganu and Gebeng, Pahang shutdown operations from October to December last year.

Consequently, blended earnings before interest and tax (EBIT) margin contracted 0.4 percentage points (ppt) quarter-on-quarter (QoQ) to 29.3 per cent in 3QFY09.

Year-to-date (YTD), net profit fell 15.8 per cent year-on-year (YoY).

Meanwhile, following the government’s decision to reduce industrial gas prices by 32 to 36 per cent to RM15 to 15.35 per mmBtu from March this year, we await Petronas’ announcement for a gas price revision to Gas Malaysia (PGas’ off-taker).

Recall that Gas Malaysia began purchasing gas solely from PGas at a locked in RM17.99 per mmBtu from July last year.

The FY09 to FY11 net profit forecasts have been cut by nine to 16 per cent, following the weak 3QFY, as we now assume a lower EBIT margin of 42 per cent (-3 per cent) for throughput services.

We expect the utilities division to incur losses of RM40 million per annum in FY10 to FY11 versus a profit of RM68 to RM168 million per annum in FY05 to FY08.

Operations are also expected to be curtailed by gas supply limitations.

We stress that we are more concerned of less favourable terms for PGas’ Gas Processing Transmission Agreement (GPTA) with Petronas, which will be renewed in April next year.

Taking a view that PGas’ capital expenditure (capex) and finance costs would be lower under the GPTA 4 period in FY11 to FY15 vis-à-vis GPTA3’s FY06 to FY10, there is less incentive for PGas to get similar Reservation Charges (RC) and Flow rate charges, if Petronas decides to retain operating internal return rates (IRRs).

Our sensitivity analysis suggests that a 10 per cent cut in RC would lead to a 19 per cent and two per cent fall in net profit and return on equity (ROE) respectively.

We have downgraded PGas to SELL, as we lock in our views ahead of the next GPTA review. We have cut our discounted cash flow (DCF) target price (TP) by 10 per cent to RM8.80 as we reduce our terminal growth rate assumption by 1.3 ppts – from 2.5 per cent to 1.2 per cent.

Generating an estimated RM1.7 billion per annum in free cash flows, we think PGas can sustain its 70 per cent net dividend payout, translating into a five per cent yield.

However, the downside risk to share price should build up, as the date of the GPTA review draws near.