MARC ASSIGNS PRELIMINARY RATINGS OF MARC-1IS AND AAAIS ON GAS MALAYSIA BERHAD’S ISLAMIC CP PROGRAMME AND ISLAMIC MTN PROGRAMME RESPECTIVELY; OUTLOOK STABLE

MARC has assigned preliminary ratings of MARC-1_IS and AAA_IS to Gas Malaysia Berhad’s (Gas Malaysia) Islamic Commercial Paper (ICP) programme and Islamic Medium-Term Notes (IMTN) programme with a combined limit of up to RM700 million respectively. The outlook on the ratings is stable.

The ratings reflect Gas Malaysia’s very strong domestic competitive position in natural gas distribution, strong financial profile and liquidity position. The downside risks to the ratings stem mainly from potential weakening in operating margins and increase in leverage position.

Proceeds from the issuance under the programme are expected to be primarily utilised to fund Gas Malaysia’s planned capex of RM400 million for pipeline expansion over the next five years. However, MARC expects drawdowns to be gradual such that Gas Malaysia’s leverage position remains commensurate with the rating band. The rating agency also notes that Gas Malaysia has faced margin compression in recent years in tandem with subsidy reductions on gas purchases. Going forward, Gas Malaysia’s profit margin is expected to improve with the implementation of the Incentive-Based Regulation (IBR) framework. Under this framework, changes in gas price will be borne by customers through a gas cost pass-through (GCPT) mechanism. The first regulatory period of the IBR will start from January 2017 following a one-year trial period from January 2016.

Gas Malaysia owns and operates the natural gas distribution system (NGDS) comprising a 2,166 km-pipeline network across Peninsula Malaysia. Linked to the Peninsula Gas Utilisation (PGU) system, from which natural gas is drawn, the NGDS has enabled Gas Malaysia to maintain a near monopolistic position in the distribution and sale of piped natural gas of 5 MMScfd and below under a licence from the Energy Commission. The licences to supply and sell piped natural gas and liquefied petroleum gas (LPG) in Peninsular Malaysia expire on September 1, 2028 and December 31, 2020 respectively. MARC views the licence renewal risk to be mitigated by the group’s strong operating track record as well as high entry barriers for new players posed by the significant capital cost required to set up pipeline infrastructure. These factors notwithstanding, if Gas Malaysia breaches certain conditions, the Energy Commission may revoke the licence and acquire the pipelines and installations by providing adequate compensation. In the unlikely event of the licence being revoked, the value of Gas Malaysia’s regulated assets of about RM1.0 billion as at end-2015 is sufficient to cover the company’s financial obligations.

As a regulated entity, Gas Malaysia’s tariff rates are set by the Energy Commission which indicates that the company can grow its revenue primarily by increasing its customer base. To this end, Gas Malaysia adds approximately 80km-100km per year to its pipeline network to cater to new customers. MARC observes that Gas Malaysia has a fairly diversified customer base across different industrial sub-segments with no single customer contributing more than 3% of total sales. Accordingly, the group is not exposed to client concentration risk. In terms of supply, Gas Malaysia’s gas supply risk is protected by long-term contracts with PETRONAS, although the subsidised natural gas allocation of 382 MMScfd will be reduced gradually to 300 MMScfd by early 2018. Any gas supplied by PETRONAS above the allocated volume will be priced at market rates; however, the GCPT mechanism should ensure that Gas Malaysia’s profit margins will be unaffected by changes in gas costs.

Gas Malaysia’s regulated business has steadily grown, increasing by 7.8% y-o-y to 159,069 million British thermal units (MMBtu) in 2015. To increase its non-regulated business and diversify its revenue base, Gas Malaysia has developed three joint ventures and expects its non-regulated businesses to contribute 20% to 30% of the group’s pre-tax profit over the next five years.

For 1H2016, Gas Malaysia recorded a 24.3% y-o-y increase in revenue mainly due to the tariff revision on January 1, 2016 which saw an increase in the average selling price to RM25.53 per MMBtu from RM21.80 per MMBtu. In the same period, the company achieved a 9.9% y-o-y increase in its pre-tax profit to RM89.4 million. The operating margin improved to 4.4% (2015: 3.8%) and is expected to further improve to about 5.5% over the near term under the IBR framework. For 2015, owing mainly to a sizeable dividend payment of RM148.4 million (2014: RM158.7 million), free cash flow (FCF) was negative RM129.7 million. MARC is concerned that sizeable dividend payments, if continued, would weigh on Gas Malaysia’s financial metrics. The planned increase in leverage to achieve the desired capital structure under the IBR framework would lead to a debt-to-equity ratio and a cash flow from operations (CFO) interest coverage of approximately 0.3 times and 10.0 times respectively over the next three years. As of end-June 2016, Gas Malaysia’s debt-to-equity ratio stood at 0.01 times.

The stable outlook incorporates MARC’s expectations that Gas Malaysia’s business and financial risks will be sustained at the current level. However, any weakening in the company’s financial metrics would apply pressure on the current ratings and/or outlook.

Contacts: Neoh Jiun Yan, +603-2082 2263/ jiunyan@marc.com.my; Sharidan Salleh, +603-2082 2254/ sharidan@marc.com.my.

August 25, 2016