DBS Group Research’s Ho Pei Hwa has initiated coverage on Union Gas Holdings on Dec 5 with a “hold” call and target price of 48 cents. While the company is actively growing new markets, it faces near-term cost pressures. Year to date, Union Gas has dropped by nearly 41% to close at 48 cents on Dec 7, valuing the company at $151 million.
With more than 40 years of operating history, Union Gas is a leading distributor of bottled liquefied petroleum gas (LPG) in Singapore. Its sale of LPG constituted 83% of its FY2021 revenue, with customers ranging from individual households to commercial and industrial users such as coffee shops, hawkers, factories and hotels.
Union Gas runs a vertically integrated operating model, from procurement to bottling, storage, and retailing. With better operational control, the company is actively going after new growth among industrial and commercial customers, as a counter to dipping sales seen in the household market as more home users use alternatives such as piped gas and electricity induction stoves.
Ho expects Union Gas to generate 8% CAGR revenue growth from commercial and industrial customers between FY2022 and FY2024, with both higher volume and higher average selling prices. “We believe the commercial/industrial segment is more resilient than households, with bottled LPG remaining the preferred heat source for the former, as it is considered the more efficient form of fuel, with its higher calorific value, lower maintenance costs, and better control of the size/ intensity of the fire, which is key for food establishments,” writes Ho.
Ho believes that the current FY2022 is likely to end with moderated earnings relative to the previous year, and that at current levels, the market has priced in this view. Nonetheless, the company is poised for a more positive outlook for the coming FY2023, as there are signs of crude oil and propane prices easing in the current 2HFY2022, which will lend some “relief” to Union Gas’ gross margins.
Ho notes that over the past year, the company’s share price has corrected from its peak forward P/E of more than 50 times to a FY23F P/E ratio of around 22 times, which is below its four-year historical average earnings of 24 times.
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Ho’s price target of 48 cents is based on a forward earnings ratio of 24 times, in line with the 24 times four-year historical average earnings. “Positive surprises in margins from easing crude oil prices could act as a positive catalyst to Union’s share price. Further M&As and JVs could also support an upward re-rating of Union’s share price,” says Ho.
As the company aims for new growth in new markets, it faces some near-term headwinds in the form of elevated propane prices, which raises costs for the company. There is also the strong US dollar, which is used to price most commodities, which leads to unfavourable currency conversion as Union Gas sells and reports in the Singapore dollar. “Both factors could pose challenges to gross margins in the near term, and act as a negative catalyst to Union’s share price,” notes Ho.
In 1HFY2022, due to higher fuel costs, its gross margins declined to 26%, down versus the preceding 2HFY2021’s 31%, and 1HFY2021’s 41%. “We observe a negative correlation between higher oil/propane prices and gross margins, given that historically, we observe that Union does not fully pass on costs to its customers,” Ho adds.
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The DBS analyst notes that Union is also exploring other acquisitions and joint ventures to drive further growth. For example, it has formed a potential joint venture, Surbana Jurong Infrastructure, for its Cnergy fuel station and for overseas market expansion into Cambodia.
As at end-FY2021, Union Gas had a debt-to-equity ratio of just 0.18 times and it is likely to end this year at a net cash position. As such, Ho believes that the strong balance sheet puts the company in good stead to tap into further M&A and JV opportunities. If the company is to leverage up to a debt-to-equity ratio of 0.3 times, it can muster some $20 million to make acquisitions.
