(PETD MK) NR Market Cap: USD7,402m Price: MYR23...Jun 23, 2014 · commanded a ~40% combined market share, with market leadership in the commercial segment (68.2%) and LPG (57.2%),

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Not-Rated Company Report, 23 June 2014

m

Petronas Dagangan (PETD MK) NR Energy & Petrochemicals - Oil & Gas Services Target Price: -

Market Cap: USD7,402m Price: MYR23.90

An O&G Brand With Long-Term Value

Macro

2.00

Risks

2.00

Growth

2.00

Value

2.00

83

91

98

106

113

121

128

22

24

26

28

30

32

34

Petronas Dagangan (PETD MK)Price Close Relative to FTSE Bursa Malaysia KLCI Index (RHS)

1

2

3

4

5

6

7

Jun-1

3

Aug

-13

Oct-

13

Dec-1

3

Feb

-14

Ap

r-14

Vo

l m

Source: Bloomberg

Avg Turnover (MYR/USD) 19.4m/6.00m

Cons. Upside (%) -1.3

Upside (%)

52-wk Price low/high (MYR) 23.3 - 31.8

Free float (%) 16

Share outstanding (m) 993

Shareholders (%)

Petronas 69.9

EPF 5.3

Share Performance (%)

YTD 1m 3m 6m 12m

Absolute (23.9) (9.0) (20.3) (22.8) (5.2)

Relative (24.7) (8.7) (23.8) (24.7) (11.3)

Shariah compliant

Kong Ho Meng +603 9207 7620

[email protected]

Forecasts and Valuations Dec-11 Dec-12 Dec-13 Dec-14F Dec-15F

Total turnover (MYRm) 28,005 29,515 32,342 35,460 39,483

Reported net profit (MYRm) 876 837 812 826 1,061

Recurring net profit (MYRm) 863 864 829 826 1,061

Recurring net profit growth (%) (29.6) 35.1 (4.0) (0.3) 28.4

Recurring EPS (MYR) 0.87 0.87 0.83 0.83 1.07

Recurring P/E (x) 27.5 27.5 28.7 28.8 22.4

P/B (x) 4.98 4.94 4.97 4.57 4.23

P/CF (x) na 12.8 17.8 28.8 21.4

EV/EBITDA (x) 16.5 16.4 16.8 16.4 13.3

Return on average equity (%) 13.7 17.5 16.9 16.5 19.6

Net debt to equity (%) 12.5 4.4 4.6 6.9 7.8

Our vs consensus EPS (adjusted) (%) (4.4) 3.3

Source: Company data, RHB estimates

We have a Not-Rated call on Petronas Dagangan, which is trading at a 23x forward FY15F P/E. The 69.9%-owned subsidiary of Petronas is its marketing arm for downstream petroleum products. It has a significant local market share. While its recent high expansion costs have de-rated the share price, we see long-term growth boosted by its diversification into non-fuel services, high-margin products and overseas expansion.

Prominent petroleum retailer. Petronas Dagangan‟s wide spectrum of

petroleum products includes liquefied petroleum gas (LPG), kerosene, jet fuel, asphalt, diesel and lubricants. In FY13, the company commanded a ~40% combined market share, with market leadership in the commercial segment (68.2%) and LPG (57.2%), while its market shares in retail (>30%) and lubricants (24%) are also commendable. The operator has been adding 40-50 new petrol stations per annum, vs 20-30 stations for Shell – the biggest retail leader in Malaysia. Its commercial segment grows in tandem with manufacturing, upstream oil and gas (O&G) and transportation sectors. The aviation boom has benefitted its jet fuel/refuelling business as the company had a 77.6% domestic aviation market share in 2013.

Diversification to sustain long-term growth. Petronas Dagangan‟s

business model relies on a volume game amid tight margins. Nevertheless, we expect its domestic growth to be moderate as it operates in a saturated local market. We see diversification as crucial to sustain its long-term growth. Margins could see upside through: i) better non-fuel avenues at selected stations, Mesra convenience store franchises and other services, ii) high-street products in the commercial and lubricant segments, and iii) overseas expansion – it is riding on LPG growth in the Philippines and Vietnam and lubricants growth in Thailand.

Forecasts. We project flat growth for FY14F net profit but a strong 28%

FY15F profit growth, on the back of 10%/11% revenue growth (moderated from its 4-year historical CAGR of 12%). We expect the company to incur high operating and marketing expenses for expansion in FY13-14, but project a better FY15 on expected margins recovery.

Valuation. Despite the recent share price weakness due to higher

operating costs, the company is trading at a 23x forward FY15F P/E, similar to valuations of the listed Petronas subsidiaries that share the same patronage, as well as some large-cap O&G counters. There is no direct peer comparison for its core business. The stock has consistent quarterly dividend payouts, making it akin to a quality retail stock. However, its implied FY14F dividend yield is subdued at 1.7%.

Petronas Dagangan (PETD MK) 23 June 2014

See important disclosures at the end of this report 2

Executive Summary

Investment Highlights

o A prominent player with a significant combined market share of ~40%. Volume game is critical given that margins are thin

o A beneficiary of rising demand from the booming aviation, manufacturing, and power/energy sectors, with potential to capture new corporate accounts

o Non-fuel income has great potential to boost margins in the long run. The company‟s non-fuel income makes up merely 9% to its retail revenue, vs developed markets‟ 15-40%.

o Expanding in the niche market with high-street brands and services in LPG and commercial segments

o Overseas expansion – it is riding on the LPG growth in the Philippines and Vietnam, and the lubricants growth in Thailand. The company‟s LPG business is severely under-represented in Luzon, the Philippines

o Ample free cash flow vs moderate gearing

o Consistent quarterly dividend payouts

Key risks

o Credit risks from suppliers and customers. In addition, an unexpected surge in subsidy receivables could complicate its cash flow management and dividend payouts

o The commercial segment could see lower sales on weakening economy growth

o The local retail market is saturated – expansion in margins and petrol stations is likely to be moderated

o Customers switching to alternative energy sources and public transportation are longer-term uncertainties for its retail business

o Any deregulation of the local market could create uncertainties in pricing power. The company is facing intense competition in its overseas business due to deregulations

o Increased operating and marketing costs in the near term have depressed its share price

o Massive fluctuations in crude oil prices can negatively impact its margins

Forecasts

o We project 10%/11% revenue growth for FY14/15, due to: i) non-fuel income growth, and ii) expectations of stable GDP growth. Nevertheless, we took into account moderation in organic growth, given little room to expand its local market share.

o We however project a flat growth in FY14F net profit, followed by a 28% FY15F profit growth. This is mainly due to our expectations of weakened margins and higher operating expenses

o Our dividend payout forecast is at 50-60%, in line with its minimum dividend policy payout of 50%.

Valuations

o We have a Not-Rated call

o Petronas Dagangan had traded as high as 25 P/E, at the top range of the P/E valuations attributed to the listed subsidiaries of Petronas group of companies.

o Its valuations are also in line with the P/E valuations of some of the large-cap O&G stocks in our universe

Catalysts and opportunities

o Further overseas expansion

o Domestic business grows stronger-than-expected, driven by better economic growth or a further gain in market share

o Higher-than-expected contributions from non-fuel revenue and high-street brands

o Higher-than-expected dividend payouts

o M&A opportunities to take over smaller players in Malaysia and in the region

Trend-setter on retail petroleum

o Established in 1982 as the principal retail petroleum marketing arm of Petronas, which owns 69.9% of the company

o Segmental revenue breakdown in FY13 – retail (41%), commercial (51%), LPG (5%) and lubricants (2%)

o Market share breakdown in FY13, based on estimates – retail (31%), commercial (68%), LPG (57%) and lubricants (24%)

Overseas units

o The Philippines. Currently engaged in the LPG segment, predominantly in the Mindanao and Visayas regions

o Vietnam. Currrently engaged in the LPG segment

o Thailand. Currently engaged in the lubricants segment

Multi-distribution capability

o Petrol stations (>1000)

o Kedai Mesra (725)

o LPG bottling plants (8)

o Aviation depots (13)

o Fuel terminals (18)

o Bunkering facilities (13)

Automatic Pricing Mechanism – calculation of pricing for RON95 petrol in Oct 2013 (sen/litre), in Peninsular Malaysia

o Product cost + alpha (+235.9)

o Operational costs – include marketing and transportation costs

(+9.54)

o Oil company margin (+5.00)

o Station operator/dealer commission (+12.19)

o Actual price (244.82)

o (-) Subsidy (-52.63)

o Retail price (162.00)



Company Profile Background. Established in 1982, Petronas Dagangan was listed on the Main Board

of Bursa Malaysia in 1994. Being the principal domestic marketing arm of Petroliam Nasional (Petronas) (PET MK, NR), Petronas Dagangan offers a wide array of downstream O&G products across all its four core businesses of retail, commercial, LPG and lubricants. Petronas holds a 69.9% stake in Petronas Dagangan.

Figure 1: Petronas Dagangan's corporate structure

PETRONAS Dagangan

PS Pipeline SB (50%)

Lub DaganganSB (100%)

PetronasAviation SB

(100%)

Kuala Lumpur Aviation Fuelling

System SB

PS Terminal SB (50%)

IOT Management

SB (20%)

Tanjung ManisOil Terminal Management

SB (20%)

PDB (Netherlands)

B.V.

PetronasEnergy

Phillipines Inc (100%)

Duta Inc (40%)

Kaparangan Inc (100%)

PetronasInternational Marketing

(Thailand) Co Ltd

Petronas(Vietnam) Co

Ltd (100%)

Thang Long LPG Co Ltd

(100%)

Source: Company data

Figure 2: Petronas Dagangan’s core business segments

Business segments Types of products Usage

Main clients/ sectors

Revenue breakdown FY13 (%)

Estimated market

share (%)

Retail Motor vehicle gasoline (Mogas), fuel For passenger vehicles and motorcycles Household 41 31

Diesel For diesel-engine passenger vehicles Transportation

Petrol stations, convenience stores

Commercial Aviation fuel Aviation fuel for turbine engine aircraft Aviation 51 64

Diesel Industrial purposes (direct burning, ie boiler, furnace, dryer, among others)

Manufacturing

Kerosene For heating, lighting, cooking and small stationary internal combustion engine

Power

Fuel oil Boilers, furnaces, ovens and bunker-fired diesel engines

Transportation

Bitumen, asphalt Materials in road construction, water proofing and insulation

Fishery

Gasoline Fuel for bulk transportation Agriculture

LPG Cooking gas cylinder Sizes available are 12kg, 14kg, 50kg and bulk Household 5 57

For household usage of heating appliances Bulk sales

Lubricants Motorcycle lubricants For lubrication, cleaning , corrosion prevention, and Household 2 24

Commercial vehicle heat insulation of internal combustion engines Automotive

Passenger vehicle lubricants OEM

Industrial and marine Fishery

lubricants Marine


Management team. Petronas Dagangan is led by managing director and chief

executive officer (CEO) Mohd Ibrahimnuddin bin Mohd Yunus, Prior to his appointment on 1 Feb 2014, he assumed a few CEO roles across Petronas‟ subsidiaries such as Petronas LNG SB and PT Petronas Niaga Indonesia. Puteri Liza Megat Rus Kamarani is Petronas Dagangan‟s CFO, while its investor relations affairs are handled by Raja Zera Raja Zaib Shah. We do not see risk in the company‟s succession plan, since the majority of the management committee had previously assumed various roles within Petronas Group. Their roles will help to ensure the company‟s business direction is aligned with Petronas‟ objectives.



Investment Merits Trend-setter with market leadership. We see Petronas Dagangan as an incumbent

in the domestic market with an overall ~40% market share. It is the leader in the commercial and LPG markets, while it aims to be a leader across the retail and lubricant segments. Petronas Dagangan has the parental advantage to compete on branding, network scale and supply. About 75% of its petroleum products are from Petronas‟ refineries in Terengganu and Melaka.

Retail (31% market share). In FY13, the company owned >1,000 petrol stations and 725 Kedai Mesra. The stations are operated by commissioned dealers under the “company owned/dealer operated” business model. Since the retail segment is the key revenue driver, the company is targeting to open around 40 stations per annum to maintain or increase its market share from ~30%. We see vehicle demand to drive expansion in petrol stations. Demand for vehicle fuel remains positive, as the Malaysian Automotive Association (MAA) projects a 2.2% growth in total industry car volume over the next five years.

The market leader in this segment is Shell Malaysia Trading SB with >900 retail stations. Based on news reports, Shell had expanded at the rate of 20-30 stations per year, which implies a relatively less aggressive appetite vs Petronas Dagangan‟s 40-50 stations per year. According to Shell Malaysia, it currently caters to one-third of Peninsular Malaysia‟s and half of East Malaysia‟s petroleum retail market, thereby fulfilling its minimum target requirements. It remains to be seen if Petronas Dagangan can eventually dethrone Shell‟s leading position in the retail market.

Figure 3: Vehicle growth in Malaysia

2008 2009 2010 2011 2012 2013 2014F 2015F 2016F 2017F 2018F

Passenger cars 497,459 486,342 543,594 535,113 552,189 576,655 589,600 602,000 615,200 629,400 644,500

Commercial vehicles 50,656 50,563 61,562 65,010 75,564 79,136 80,400 82,000 83,900 85,800 87,900

Total 548,115 536,905 605,156 600,123 627,753 655,791 670,000 684,000 699,100 715,200 732,400

Passenger cars growth (%) -2.2% 11.8% -1.6% 3.2% 4.4% 2.2% 2.1% 2.2% 2.3% 2.4%

Commercial vehicles growth (%) -0.2% 21.8% 5.6% 16.2% 4.7% 1.6% 2.0% 2.3% 2.3% 2.4%

Overall growth (%) -2.0% 12.7% -0.8% 4.6% 4.5% 2.2% 2.1% 2.2% 2.3% 2.4%

Source: Malaysia Automotive Association Jan 2014, RHB estimates

Commercial (64% market share). Petronas Dagangan is able to leverage on its

long-standing business relationships with corporate customers in manufacturing, upstream O&G, power and transportation sectors. The company‟s high success rate in fuel oil supply aided the energy sector during 2013‟s gas shortages. Petronas Dagangan also saw its market share rising to 25% from 5% in the marine bunker business. Meanwhile, the aviation fuel business is expected to ride on the growth in the aviation sector, which saw global air travel passenger CAGR of 4.3% in 2008-2013. The company has secured new corporate accounts from airlines such as Turkish Air, Malindo Air and Air France. It has also secured additional sales internationally in Heathrow, London, Hong Kong and Indonesia. In May 2013, Petronas Dagangan was recognised as the best regional jet fuel marketer in Asia-Pacific by the ArmBrust Aviation Group at the International Air Transport Association (IATA) Fuel Forum in Berlin.

LPG (57% market share). Petronas Dagangan became the main proxy to cooking

gas demand in Malaysia due to its 57.2% market share. The strong growth of its LPG segment is attributed to: i) its efforts to increase cylinder turnaround time through better understanding of customer profiles, ii) consistent cylinder injections and fewer idle cylinders at major LPG terminals, and iii) higher dealer network (+13 in FY13). We think that its higher market penetration was also partially due to a change in the competitive landscape. Shell Malaysia Trading SB, which was the second-largest LPG player with a 25% market share, exited the business after it sold its assets to NGC Energy SB in 2012.



Lubricants (24% market share). Petronas Dagangan is the second-largest local

player in the lubricant segment, as players like Petron Malaysia Refining and Marketing had exited the business due to challenges in the local market. The company aims to grow the business into one of the world‟s top five and the largest in Malaysia by 2016. According to management, to achieve the target, Petronas Dagangan has to grow its market share to about 32% from 24% currently. The company has introduced a new product Syntium 7000 in the high-street segment and is expanding its LubeXperts outlets (ie premium lubricant workshops) to offer comprehensive automobile care solutions. The number of LubeXperts outlets increased to 48 outlets as of 1Q FY14, from 41 in FY13. Market share is all about volume. The company‟s margins are protected by the

Automatic Pricing Mechanism (APM), which was in place since 1983. The APM stabilises prices for RON95 Mogas, diesel and LPG in Malaysia by ensuring that the differential between the retail price and product costs is made up of subsidies. RON97 Mogas has a smaller APM application as it is on a managed float mechanism. The operating margins for both the retail and commercial segments are very thin (the former averages about 2-5%, while the latter 2-3.5%). As the company‟s topline is largely driven by APM-based products, business expansion is its top priority by opening more petrol stations to capture volume.

Figure 4: APM component breakdown of subsidised petroleum items in Peninsular Malaysia, as at Oct 2013 APM Components Definition Determinant

RON95 value, (MYR)

Diesel value, (MYR)

(A) Product cost

Based on Mean of Platts Singapore (MOPS), an index used by many Asean countries that computes the daily average of transactions of downstream petroleum products. The MOPS price takes into account the refinery costs

Variable, based on MOPS (average)

(+) 2.359 (+) 2.5404

(B) Alpha

This refers to a fixed buffering gap between MOPS price and purchase price of Malaysian oil companies. If the price of the petroleum product is higher than the MOPS price by an amount greater than Alpha, the oil company bears the extra cost

5 sen/litre for Mogas 4 sen/litre for diesel

Included in A Included in A

(C) Operational costs

This covers transport and marketing costs of petroleum products. They are set at MYR0.0954 (USD0.03) per litre for peninsular, i.e. MYR0.0692 for marketing and MYR0.0262 for distribution

Peninsular–9.54 sen/litre Sabah – 8.98 sen/litre Sarawak – 8.13 sen/litre

(+) 0.0954 (+) 0.0954

(D) Oil company margin

This represents the fixed margins earned by the oil companies to undertake transactions of APM products to the retail segments

5 sen/litre for Mogas 2.25 sen/litre for diesel

(+) 0.05 (+) 0.025

(E) Station operator margin

This represents the margins made by station operators as well as dealers 12.19 sen/litre for Mogas 7.00 sen/litre for diesel

(+) 0.1219 (+) 0.07

(F) Duty/ (subsidy)

The balancing item. Duties can be imposed by the government or subsidies to be borne by the government, either way will depend on the movement of product costs as detailed in (A).

58.62 sen/litre for Mogas 40.00 sen/litre for diesel (maximum tax each)

(-) 0.5263 (-) 0.7283

Actual price Formula = A + C + D + E 2.63 2.73 Retail price Formula = A + C + D + E – F 2.10 2.00

Source: The Ministry of Domestic Trade, Cooperative and Consumerism (KPDNKK), Shell Malaysia

Figure 5: Save for RON97 petrol, RON95 and diesel remain subsidised

Source: Galvintan (n.d.)



Figure 6: MOPS, Jan-Dec 2013 Figure 7: MOPS, Jan-Dec 2012

Source: Company Source: Company

Expanding to capture regional demand. On average, Petronas Dagangan

allocates MYR500m capex domestically, the bulk of which is for the retail segment, mainly to increase the number of petrol stations and for infrastructure upgrades. Another MYR200m is committed to overseas expansion. In Dec 2012, the company acquired from its parent company six downstream companies with lubricant and LPG operations in the Philippines, Vietnam and Thailand. Currently, profits from overseas operations are negligible as they are still at infancy stages.

Philippine operation. The LPG market in the Philippines holds promising growth.

Petronas Energy Philippines Inc (PEPI) sells LPG (in cylinders and bulk) and autogas – an environment-friendly alternative fuel for vehicles – in Visayas and Mindanao. In 2013, PEPI saw its LPG market share improved to 9.4% from 7.8% in 2012. The changing competitive landscape and higher barriers of entry were positive to its Philippine venture. In Jan 2014, barriers of entry increased as the local Department of Energy imposed tighter licensing requirements on LPG industry players. There was also a change in competitive landscape prior to 2013, with Philippines Shell Petroleum Corp exiting the market in 2012 (succeeded by Isla LPG, a JV between Itochu Japan and Citadel Holdings). Petronas Dagangan is still under-represented in the Luzon region, where it mainly serves the autogas market. LPG demand is understood to be the biggest in Luzon due to urbanisation in the region. As 60% of the local population is concentrated in Luzon, it accounts for 80% of overall LPG demand in the Philippines. The company aims to improve LPG‟s cost competitiveness in Luzon.

Figure 8: Philippine LPG market share 2012 Figure 9: Philippine LPG market share 2013

Isla LPG, 16.4%

Total Pet., 4.0%

Liquigaz, 25.3%

Prycegas, 4.8%

Shell, 0.1%

Petron, 41.7%

Petronas, 7.8%

Isla LPG, 15.3%

Total Pet., 3.4%

Liquigaz, 31.0%

Prycegas, 5.8%

Shell, 0.3%

Petron, 34.5%

Petronas, 9.4%

Seaoil, 0.03%Filoil, 0.01% Eastern, 0.3%

Source: Republic of Philippines, Department of Energy Source: Republic of Philippines, Department of Energy



Vietnam operation. Vietnam is another market for which LPG consumption is

projected to grow aggressively along with its economy. However, the industry is severely fragmented. PetroVietnam Gas is the dominant player in the LPG market with a 70% share. With two existing bottling plants in the nation, the company remains focused on selling LPG cylinders. Thailand operation. Thailand‟s lubricant market is estimated to be the second-

largest in South-East Asia. The production of new motor vehicles is expected to increase annually to reach five million units in 2020 (i.e. a CAGR of 12%). The company is expanding cautiously by growing sales and corporate accounts in the high-street segment. In 2013, Petronas International Marketing (Thailand) secured its first major regional contract with Toyota Thailand as one of its lubricant suppliers for factory fill.

Figure 10: LPG demand in Vietnam Figure 11: Thailand’s motor vehicle production

0

500

1,000

1,500

2,000

2,500

To

tal L

PG

De

ma

nd

(K

t)

Year

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

Nu

mb

er

of

mo

tor

ve

hic

les

Year Source: Petro Vietnam Gas Source: Organisation Internationale des Constructeurs d’ Automobile,

Thailand Automotive Superhub 2015

Non-fuel revenue the way forward. Petronas Dagangan‟s non-fuel business

contributed 9% of FY13 retail margin, with an 11.3% growth (1Q14: +15%). This ancillary business has been expanding through its 725 Kedai Mesra convenience stores nationwide, 1,400 ATM machines, 750 Touch ‘n Go reload terminals and 980 e-Pay terminals. Petronas Dagangan also has key partnerships with Starbucks Coffee (three outlets), Baskin Robbins (two outlets), Pizza Hut and Malaysian Electronic Payment System (MEPS) (100 ATMs) located in its petrol stations. For petroleum operators, the footfall from vehicle refueling at petrol stations provides encouraging avenues for non-fuel retailing despite increasing competition. For instance, Petronas Dagangan‟s competitor Shell Malaysia has been expanding its non-fuel revenue through its 350 Shell Select convenience stores.

Figure 12: Studies show potential non-fuel revenue per customer

Source: Cedar Management Consulting



Nevertheless, the company is cautious on the expansion of its Kedai Mesra outlets and new partnerships. The former depends on the target market, consumer spending pattern and location. For instance, the suitability of ancillary services could be very different between: i) urban and suburban petrol stations that are characterised by having close proximity to populated areas or areas with condensed vehicle ownership („short-stops‟), and ii) stations on highways that are characterised by high intensity of freight volume („long/destination stops‟). We believe non-fuel services are important to diversify away from the core fuel business with tight margins. Including the non-fuel business, retail margins have improved by 80-120bps on average (see Figure 13). We see ample potential for margin accretion in this business segment. Its 9% non-fuel retail revenue contribution is relatively lower than those of petroleum retailers in the US (39%), France (25%), Europe (15%) and the Middle East (12-15%).

Figure 13: Distinct retail margin accretion from non-fuel services

5.4%

4.0%4.3%

3.3%

4.7%

2.1%

3.5%

3.1%

2.4% 2.3% 2.5%

1.9%

6.3%

4.8%5.2%

4.4%

6.0%

3.1%3.5%

3.1%

2.4%

2.4%

2.5%

1.5%

2.5%

3.5%

4.5%

5.5%

6.5%

7.5%

FY10 9M2011 2012 2013 1Q13 1Q14

Retail - operating margin (excluding other income)

Commercial - operating margin (excluding other income)

Retail - operating margin (and other income)

Commercial - operating margin (and other income)

Source: RHB, Company data

Figure 14: Ancillary services available at Petronas Dagangan’s stations

Source: Company



Investment Risks Weak economic conditions could slow growth given market saturation.

Petronas Dagangan‟s topline growth is dependent on the local economy. As the company already has a significant share in a saturated market, we see little room for further market share gains. We believe the company will retain its LPG market share at <60%. The commercial segment relies on a volume game with tight operating margins. Product demand is sensitive to economy cycles and the implementation timeline of key Economic Transformation Programmes (ETP). Delays in planned road construction projects by the Federal Government could slow sales of bitumen and asphalt. Slower growth in the industrial sector could see lesser demand for diesel and lubricants. Meanwhile, its jet fuel business is highly correlated to growth in the aviation sector. Should there be termination of contracts with its key customers eg Malaysia Airlines (MAS MK, NEUTRAL, FV: MYR0.19), we understand that the company can sell jet fuel to other airlines or secure new supply contracts. We expect demand in the retail segment (the biggest revenue contributor) to remain robust despite ongoing subsidy rationalisation programmes. Consensus estimates that the Government could further cut petrol subsidy in late 2014. Nevertheless, we believe Petronas Dagangan‟s margins should continue to be protected by the APM mechanism. However, the retail segment‟s organic growth is expected to be moderate – the company may add just 30-40 new stations per annum, vs 50-60 stations per annum for the past 10 years. We think the bigger risk to the retail segment is alternative sources of petrol – which is highlighted in our next point.

Alternatives could affect future demand and supply. While alternative energy and

travelling solutions are new threats to Petronas Dagangan‟s existing businesses, these could also provide new revenue sources for the group. A global trend of higher acceptance of natural gas for vehicles (NGV) and marine fuel could displace demand for the company‟s conventional products. According to the International Gas Union (IGU), global NGV usage has been growing rapidly by an average 23% over the last 10 years. The number of NGV filling stations has also grown at a similar pace. Petronas Dagangan has positioned itself to capture this market share. We understand that ~158 of the company‟s service stations have NGV facilities. However, the company continues to face competition from natural gas providers in the commercial segment, specifically in the energy and power sectors. Meanwhile, an improved public transportation system could encourage retail customers to switch to public transportation, thereby reducing demand for petrol stations. The Light Rail Transit (LRT) extension, the construction of the Greater KL Mass Rapid Transit (MRT) and, on a longer term, the Penang-Singapore High Speed Rail (HSR) are among the Government‟s efforts to boost public transportation. However, customers in Malaysia are expected to have a stronger preference for vehicle ownership and air travel as opposed to public transportation. Massive fluctuations in crude oil prices could affect costs of its non-APM

products. Although the company‟s margins for subsidised fuel are protected by the APM mechanism, rapid fluctuations in crude oil prices could still affect its profitability due to the time effect between selling prices vs inventory costs. This is because product costs are dependent on variable changes in MOPS prices. Near-term profitability to be hampered by costs. While Petronas Dagangan is not

expanding its petrol stations as aggressively as in the past, it is incurring more costs relating to personnel, transportation and promotional activities for its new products. We view this ongoing programme part of the company‟s transformation of its equity branding. Going forward, we expect FY13-14 to be challenging amid dampened consumer sentiment and the company‟s higher expansion costs.



Credit risk and cash flow management. Petronas Dagangan is exposed to credit

risk, which arises mainly from the commercial segment. The company may encounter non-performing receivables, which could complicate its cash flow management and potentially affect its dividend payouts. In addition, the company‟s subsidy receivables had been increasing due to the high product cost arising from the elevated MOPS price. Subsidy receivables, representing subsidy claims to be paid by the government, are typically 2-3 months outstanding. In the past, the company manages its funding requirements with a MYR2bn sukuk programme to address subsidies as part of its risk management policies.

Figure 15: Subsidy receivables (in MYRm) has some correlation to MOPS prices

Source: Company

Deregulation. The removal of APM could create uncertainties in Petronas

Dagangan‟s retail revenue. In this scenario, petroleum operators would be able to set prices according to market forces. Any industry player that undercuts the market by charging pump prices significantly below market prices could affect overall industry margins. This risk is likely to be partially mitigated as we believe Petronas Dagangan has the scale and good service quality to compete with its retail peers. Globally, the company is still facing intense competition given the lack of scale to compete evenly with foreign competitors. The LPG market in Vietnam and the Philippines is deregulated.



Financials And Forecasts Stable revenue growth. Petronas Dagangan enjoyed a 4-year revenue CAGR of

11.8% in FY09-13, in tandem with growth in sales volume and distribution channels (increment of 40 petrol stations a year). We project 10%/11% revenue growth for FY14/15. We see revenue to be driven by: i) non-fuel income growth, and ii) rising demand for petroleum, which is expected to grow in tandem with higher GDP growth. Nevertheless, our conservative growth assumptions took into account: i) moderate organic growth, especially in its expansion of petrol stations and ancillary services, and ii) little room to expand its local market share. Its overseas business is at best a long-term picture. In the near term, the company is facing severe competition as well as the lack of scale.

Figure 16: We project stable revenue growth, slightly moderated from its 12% historical CAGR (FY09-13)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0.0

5,000.0

10,000.0

15,000.0

20,000.0

25,000.0

30,000.0

35,000.0

40,000.0

45,000.0

FY10 9M2011 FY12 FY13 FY14F FY15F

MYRm

Retail (LHS) Commercial (LHS) Others (LHS) Growth (%) (RHS)

Source: Company, RHB estimates

Margins to remain compressed in near term. We project flat growth in FY14F net

profit followed by a 28% FY15F profit growth. This is mainly due to our expectations of weakened margins. The company‟s margins were compressed in recent years, attributed to higher operating expenses for personnel and marketing efforts. The company has been spending aggressively on marketing (eg LubeXperts, Petronas Xmas and advertisements with F1) to promote its high-street brands. It is also enhancing its transportation and distribution network, a move we deem in line with its competitors like Shell Malaysia. We project further compression in EBIT and PAT margins for FY14, but expect a turning point from FY15 given contributions from its high-margin revenue streams (target niche segments) and non-fuel income, and ii) better margins as we believe operating costs is likely to be high for FY14.

Figure 17: EBIT margin and PBT margin forecasts

5.3%

4.0% 4.0%

3.5%3.2%

3.7%3.9%

2.9% 3.0%2.6%

2.4% 2.7%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

FY10 9M2011 FY12 FY13 FY14F FY15F

Operating margin PAT margin Source: Company, RHB estimates

Low gearing arising from strong cash flow. Petronas Dagangan‟s balance sheet

is healthy with its net debt-to-equity ratio at a safe level of around 5% as at FY13. Its operating cash flow generation is also stable. This provides room for future growth as the company can increase its gearing to expand its businesses.



Figure 18: Cash flow from operations & capex (MYRm), net gearing level (%)

1,043.9

-644.0

1,858.0

1,335.31,135.3

1,361.1

-289.2 -238.9

-488.3

-466.2

-500.0 -500.0

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

-1,000.00

-500.00

0.00

500.00

1,000.00

1,500.00

2,000.00

FY10 9M2011 FY12 FY13 FY14F FY15F

Cash f low f rom operations (LHS) Capex (LHS) Net gearing (RHS)


1QFY14 results snapshot. Petronas Dagangan reported 1QFY14 revenue of

MYR8.3m (-1.1% q-o-q, +9% y-o-y) and PBT of MYR223.1m (15.1% q-o-q, -32% y-o-y). Y-o-y, PBT numbers appeared to be disappointing because Petronas Dagangan incurred higher operating expenses such as marketing and personnel costs. Consensus has downgraded its FY14 earnings estimate by 2% to take into account higher cost assumptions.

Figure 19: 1Q14 results snapshot

FYE Dec (MYRm) 1Q

FY13 4Q

FY13 1Q

FY14 q-o-q

(%) y-o-y

(%) Comments

Revenue 7,619.0 8,386.0 8,293.6 (1.1) 8.9 Retail – revenue grew 3.7% y-o-y, with sales volume up 1.3%. This is

backed by 12 new petrol stations, making up ~1041 stations nationwide.

EBITDA 399.8 311.4 301.8 (3.1) (24.5) Additional quota approved by KPDNKK also increased diesel sales

Depreciation (67.7) (110.6) (72.9) (34.1) 7.6 Volume. We understand there was a delay of 18 stations from the target

EBIT 332.0 200.8 228.9 14.0 (31.1) of 60 stations to be opened in FY13, as they need to get approval

EBITDA Margin (%) 5.2 3.7 3.6 from regulators. Those 18 stations are now operational (excluded from the

planned 30-40 stations to be opened this year).

Net interest expense (6.2) (7.1) (5.9) (16.6) (4.4)

Other operating income 0.0 0.0 0.0

Associates 1.2 0.1 0.2 26.5 (85.2) Commercial – revenue dropped by 2% y-o-y, following a 2% decline in

EI/Others 4.5 (35.5) (1.7) (95.1) (138.4) sales volume. Aviation fuel saw a 5% rise in volume due to contributions

Pretax profit 327.0 193.8 223.1 15.1 (31.8) from more corporate accounts. However, fuel oil and bitumen sales

Pretax Margin (%) 4.3 2.3 2.7 declined by 14% and 19% respectively due to weaker demand. We

understand that some planned road construction projects were delayed.

Tax (87.6) (41.2) (65.9) 60.0 (24.7)

Effective tax rate (%) 26.8 21.3 29.6

LPG – sales volume was up 2.5% y-o-y, supported by new cylinder Minority Interest (2.3) (1.2) (2.1) injections and improved cylinder turnaround time, especially in the northern regions

Net Profit 237.1 151.3 155.1 2.5 (34.6)

Core Profit 232.6 186.8 156.8 (16.1) (32.6)

Net Margin (%) 3.1 2.2 1.9 Lubricants – sales volume increased by 12.1% y-o-y. The increased volume

was mainly attributed to the sale of the newly-introduced Syntium 7000

Segmental revenue product, trade promotion activities in the high-street market, as well as good

Retail 3,449.0 3,788.6 3,929.2 nm 13.9 sales from the original equipment manufacturers (OEM) by vehicle makers

Commercial 4,166.8 4,359.7 4,360.0 0.0 4.6 like Perodua

Others 3.2 (29.7) 4.3 nm 35.3

Elimination 0.0 267.4 0.0 nm nm

Operating profit

Retail 162.1 53.6 83.5 nm (48.5)

Commercial 105.5 85.5 83.5 (2.4) (20.9)

Others 7.1 4.8 8.0 67.9 12.7

Elimination 0.0 (0.0) 0.0 nm nm

Margin (%)

Retail 4.7 1.4 2.1

Commercial 2.5 2.0 1.9

Others 222.6 (16.0) 185.5

Source: Company



Valuations Not Rated. Despite the recent share price weakness due to higher operating costs,

Petronas Dagangan is trading at a 23x FY15F P/E, similar to valuations of the listed subsidiaries of Petronas group of companies that share the same parental patronage. We believe this is the fairest peer comparison, as we think Petronas Dagangan‟s exposure has little correlation to the O&G sector valuations in our coverage universe given that: i) the O&G sector is largely driven by Petronas‟ upstream capex, ii) Petronas Dagangan is predominantly involved in the retail business, not in offshore activities and refinery businesses, and (iii) the company‟s business model is not capex-heavy and is relatively risk-averse. Nevertheless the stock is trading in line with the P/E valuations of some of our large-cap O&G stocks. There is also no direct peer comparison for the company‟s core business. Other retail downstream petroleum operators in the region, such as BangChak Petroleum (BCP TB, NR) and Petron Corp (PETRONM MK, NR) and Shell (SHELL MK, NR) are trading at single-digit P/E valuations. However, we believe that they are not directly comparable as some of the regional peers have upstream and downstream refinery businesses. In Malaysia, Petron and Shell are relatively under-covered.

Figure 20: Peer valuations

Peers (FY15F valuations) Market cap

(USDbn) P/E (x)

Dividend yield (%)

Bloomberg ticker

Petronas subsidiaries

MMHE 1.9 20.0 2.7 MMHE MK

Petronas Chemicals 17.0 14.4 3.5 PCHEM MK

Petronas Gas 14.9 27.0 2.6 PGAS MK

Gas Malaysia 1.4 22.0 4.3 GMB MK

MISC 8.9 11.9 3.9 MISC MK

Petronas Dagangan 7.5 22.7 1.7 PETD MK

Other large cap O&G counters

Sapurakencana Petroleum 7.9 15.8 - SAKP MK

Bumi Armada 3.3 17.5 1.5 BAB MK

Dialog 2.8 39.5 1.3 DLG MK

Regional downstream petroleum players

Petron Malaysia Refining & Marketing 0.8 - - PETRONM MK

Shell Malaysia 0.5 - - SHELL MK

Bangchak Petroleum 1.3 7.6 5.1 BCP TB

Petrovietnam Gas 9.3 13.8 3.7 GAS VN

Source: Bloomberg, RHB estimates

Dividends. In our forecast, we assume an 60-60% net dividend payout, which is in

line with its minimum 50% dividend payout policy. The implied FY14F dividend yield is subdued at 1.7%, vs 4-5% historically, as we believe the company may see the need to reserve earnings for further expansion.

Figure 21: Dividend payout trend

61%

85%

91%94%

74%

50%

60%

45%

55%51%

63%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

FY09 FY10 9M2011 FY12 FY13 FY14F FY15F

Payout, with special dividend Normal dividend payout




Appendix

Figure 22: Petronas Dagangan’s presence in Malaysia


Figure 23: Final consumption of petroleum products, Malaysia (kilo tonne of oil equivalent (ktoe))

0

2000

4000

6000

8000

10000

12000

Commercial Residential Transport Industrial Non-Energy Total

Source: Malaysia Energy Information Hub



Figure 24: Petronas Dagangan’s overseas presence


Figure 25: Final consumption of petroleum products by sector, Malaysia (ktoe)

0

2000

4000

6000

8000

10000

12000

Commercial Residential Transport Industrial Non-Energy Total

Source: Malaysia Energy Information Hub



Financial Exhibits Profit & Loss (MYRm) Mar-11 Dec-11 Dec-12 Dec-13 Dec-14F Dec-15F

Total turnover 23,268 22,268 29,515 32,342 35,460 39,483

Cost of sales (21,167) (20,579) (27,297) (30,106) (32,994) (36,540)

Gross profit 2,101 1,688 2,218 2,236 2,466 2,943

Gen & admin expenses (240) (215) (292) (353) (532) (592)

Other operating costs (651) (579) (752) (757) (791) (880)

Operating profit 1,209 894 1,174 1,125 1,143 1,471

Operating EBITDA 1,505 1,113 1,468 1,442 1,484 1,834

Depreciation of fixed assets (296) (219) (294) (317) (341) (363)

Operating EBIT 1,209 894 1,174 1,125 1,143 1,471

Net income from investments 1 1 2 4 4 4

Interest expense 26 4 (11) (19) (15) (19)

Pre-tax profit 1,236 899 1,165 1,110 1,132 1,455

Taxation (333) (240) (322) (290) (296) (381)

Minority interests (6) (5) (6) (7) (9) (13)

Profit after tax & minorities 896 655 837 812 826 1,061

Reported net profit 896 655 837 812 826 1,061

Recurring net profit 908 640 864 829 826 1,061


Cash flow (MYRm) Dec-11 Dec-12 Dec-13 Dec-14F Dec-15F

Operating profit 1,193 1,174 1,125 1,143 1,471

Depreciation & amortisation 292 294 317 341 363

Change in working capital (1,587) 545 275 (372) (349)

Other operating cash flow 15 179 34 34 34

Operating cash flow (88) 2,191 1,751 1,146 1,518

Interest paid (4) (10) (16) (23) (26)

Tax paid (295) (323) (399) (296) (381)

Cash flow from operations (387) 1,858 1,335 827 1,112

Capex (310) (488) (466) (500) (500)

Other investing cash flow (56) (208) (47) (46) (53)

Cash flow from investing activities (366) (697) (513) (546) (553)

Dividends paid (827) (764) (829) (413) (637)

Increase in debt 1,061 (610) 119 44 37

Other financing cash flow (10) (7) (8) 0 (0)

Cash flow from financing activities 225 (1,380) (717) (369) (599)

Cash at beginning of period 1,026 470 251 359 264

Total cash generated (528) (219) 105 (88) (41)

Implied cash at end of period 470 251 356 271 223


We project a flat growth in FY14F net profit, followed by a 28% FY15F profit growth



Financial Exhibits

Balance Sheet (MYRm) Dec-11 Dec-12 Dec-13 Dec-14F Dec-15F

Total cash and equivalents 470 251 359 264 223

Inventories 1,064 1,279 1,193 1,308 1,448

Accounts receivable 1,457 1,741 1,984 2,332 2,704

Other current assets 2,781 2,440 2,237 2,578 2,943

Total current assets 5,771 5,711 5,772 6,481 7,319

Total investments 9 13 7 7 7

Tangible fixed assets 3,616 3,766 3,892 4,083 4,254

Total other assets 404 434 496 522 548

Total non-current assets 4,030 4,213 4,395 4,612 4,808

Total assets 9,801 9,924 10,167 11,093 12,128

Short-term debt 1,000 325 443 453 463

Accounts payable 2,904 3,530 3,704 4,060 4,496

Other current liabilities 831 925 871 947 1,040

Total current liabilities 4,735 4,780 5,018 5,460 5,999

Total long-term debt 73 139 140 174 201

Other liabilities 181 160 180 208 238

Total non-current liabilities 254 299 320 382 439

Total liabilities 4,989 5,078 5,338 5,841 6,438

Share capital 993 993 993 993 993

Other reserves 3,785 3,817 3,797 4,210 4,634

Shareholders' equity 4,779 4,810 4,790 5,203 5,628

Minority interests 33 35 39 48 62

Other equity 0 (0) - (0) 0

Total equity 4,812 4,845 4,829 5,252 5,689

Total liabilities & equity 9,801 9,924 10,167 11,093 12,128


Key Ratios (MYR) Mar-11 Dec-11 Dec-12 Dec-13 Dec-14F Dec-15F

Revenue growth (%) 0.0 (4.3) 32.5 9.6 9.6 11.3

Operating profit growth (%) 0.0 (26.0) 31.3 (4.2) 1.6 28.7

Net profit growth (%) 0.0 (27.0) 27.8 (3.0) 1.8 28.4

EPS growth (%) 0.0 (27.0) 27.8 (3.0) 1.8 28.4

Bv per share growth (%) 0.0 (0.3) 0.7 (0.4) 8.6 8.2

Operating margin (%) 5.2 4.0 4.0 3.5 3.2 3.7

Net profit margin (%) 3.9 2.9 2.8 2.5 2.3 2.7

Return on average assets (%) 0.0 7.2 8.5 8.1 7.8 9.1

Return on average equity (%) 0.0 13.7 17.5 16.9 16.5 19.6

Net debt to equity (%) (20.9) 12.5 4.4 4.6 6.9 7.8

Recurrent cash flow per share 1.05 (0.65) 1.87 1.34 0.83 1.12




SWOT Analysis

Market leader in retail and commercial segments of downstream petroleum products

Competition

Supply constraint

More corporate accounts

Development of high-margin products

Managing counterparty risks in its overseas expansion

-10%

-4%

3%

9%

16%

22%

29%

35%

0

5

10

15

20

25

30

35

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

P/E (x) vs EPS growth

P/E (x) (lhs) EPS growth (rhs)

15.0%

15.7%

16.4%

17.1%

17.9%

18.6%

19.3%

20.0%

3.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

P/BV (x) vs ROAE

P/B (x) (lhs) Return on average equity (rhs)

Source: Company data, RHB estimates Source: Company data, RHB estimates

Company Profile Petronas Dagangan markets petroleum products and operates service stations domestically. Through its subsidiaries, the Company has operations in aviation fueling at Kuala Lumpur International Airport and bunkering facilities at West Port along with marketing and distributing lubricants. Petronas Dagangan Berhad markets petroleum products and operates petrol service stations domestically. Through its subsidiaries, it operates in four main divisions, namely retail, commercial, LPG and lubricants.



Recommendation Chart

6

11

16

21

26

31

36

Jun-09 Oct-10 Jan-12 Apr-13

Price Close

Source: RHB estimates, Bloomberg

20

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Documents

(PETD MK) NR Market Cap: USD7,402m Price: MYR23...Jun 23, 2014 · commanded a ~40% combined market share, with market leadership in the commercial segment (68.2%) and LPG (57.2%),