Union Gas Holdings - DBS Research 2022-12-05: Ready, Gas Set, Go!

Union Gas Holdings - Ready, Gas Set, Go!

  • Union Gas (SGX:1F2) is one of the major distributors of bottled LPG in Singapore. Retail LPG contributed 83% of FY21A revenue, with natural gas (NG) at 2% and diesel at 15%.
  • The retail LPG segment sells bottled LPG cylinders to domestic households (40% of segment revenue), with the remaining 60% sold to commercial and industrial customers, e.g., hawker centres, factories, hotels. The NG and diesel segments are dependent on sales from Union Gas’s Cnergy fuel station at 50 Old Toh Tuck Road.

Market leader with an established brand name, backed by vertically integrated operations.

  • Union Gas has a strong operating track record of more than 40 years under the brand names “Union” and “Cnergy”, and one of the largest fleets amongst local players.
  • With the acquisition of related subsidiaries of Union Energy Corporation (UEC) in Aug 2021, Union Gas was able to vertically integrate its business model, from procurement to bottling, storage, retailing, and more, which differentiates Union Gas from its peers. With the acquisition, Union Gas is also able to substantially increase its commercial/industrial customer base, i.e., business-to-business (B2B) customers, which, in our view, is a strategic pivot away from its traditional business-to-consumer (B2C) business model that was reliant on household sales.

Pivot to commercial customers the next growth lever.

  • Between 2015 and 2020, LPG sales volume declined by a CAGR of 3% y-o-y, before growing by 9% in 2021. We believe the general downtrend in LPG sales volume in Singapore can be partly attributed to the rise of alternative heat sources, e.g., piped gas and electricity induction stoves, which are gaining adoption among new housing estates.
  • We expect sales to commercial/industrial customers to drive future growth, with a FY22F-24F revenue CAGR of 8%, driven by volume expansion and higher average selling prices (ASP) vis-à-vis higher fuel costs.
  • 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.

Inorganic growth supported by strong balance sheet.

  • Union Gas is also exploring other acquisitions and joint ventures (JVs), e.g., a potential JV with Surbana Jurong Infrastructure for its Cnergy fuel station, overseas market expansion into Cambodia, etc.
  • We believe Union Gas’s strong balance sheet (FY21A debt-to-equity ratio of 0.18x, FY22F at net cash) positions the company to tap into further M&A and JV opportunities, with an estimated M&A firepower of S$20m based on a debt-to-equity ratio of 0.30x.

In the near term, elevated propane prices and a strong US$ could pose headwinds.

  • In 1H22, Union Gas's gross margins declined to 26% (versus 1H21’s 41% and 2H21’s 31%), due to higher direct material and fuel costs amid higher crude oil prices.
  • We observe a negative correlation between higher oil/propane prices and gross margins, given that historically, we observe that Union Gas does not fully pass on costs to its customers. Furthermore, as cost of sales is denominated in US$ whilst sales revenue is denominated in S$, a stronger US$ could also impact gross margins. Both factors could pose challenges to gross margins in the near term, and act as a negative catalyst to Union Gas's Share Price.

We expect a moderated FY22F, though outlook should turn more positive in FY23F.

  • See Union Gas's Dividend History. 1H22 declared dividend was at 0.2 cents, a decline from 1H21’s dividend of 1.0 cents, hinting at a moderated FY22F outlook, which we believe has been priced in by the market. Although, we are currently witnessing some signs of crude oil/propane prices cooling in 2H22, which should bring some relief to Union Gas’s gross margins.

We believe most negatives have been priced in; now trading below average historical P/E.

  • Over the past year, Union Gas's Share Price has since corrected from its peak forward P/E (>50x) to a FY23F P/E ratio of ~22x, below its 4-year historical average P/E of ~24x.

Union Gas – Valuation & Peer Comparison

  • Initiate coverage on Union Gas with HOLD and target price of S$0.48.
  • Our target price is based on a FY23F EPS of 1.98 cents and a FY23F forward P/E ratio of 24.0x, which is aligned with Union Gas’s historical 4-year average.

2021 saw a rally in Union’s share price.

  • Positive catalysts in 2021, such as Union Gas’s upgrade into the Mainboard from Catalist Board and the acquisition of associated subsidiaries/companies of UEC, have led to Union Gas's Share Price trading at a record high of S$1.20 and a forward P/E ratio of >60x, at more than +2 standard deviation above its 4-year historical average ratio of 24.4x.

Now trading below average forward P/E.

  • Over the past year, Union Gas's Share Price has since corrected to a forward P/E ratio of ~22x, which is below its four-year average historical P/E ratio of 24x.
  • We believe investors’ general profit-taking following Union Gas’s upgrade to the Mainboard and M&A activities, as well as the moderating FY22F outlook, as hinted by the moderated 1H22 dividend payout (1H22 declared divdend of 0.2 cents, down from 1H21’s dividend of 1.00 cents), has contributed to the correction of Union Gas's Share Price.

Premium valuation relative to peers attributed to higher historical revenue growth, margins, and ROE.

  • Based on trailing P/E ratios, Union Gas is trading at a P/E ratio of 47.0x, at a premium relative to its peers’ average of 13.4x.
  • We believe Union Gas’s premium valuation, which is above that of its peers, can be attributed to its above-average historical 5-year revenue growth and 3-year EBITDA margins of 28.1% and 25.2% (versus its peers’ average of 11.0% and 22.9%), respectively.
  • Furthermore, upon conducting a DuPont analysis, we observed that Union Gas exhibited a higher 3-year return on equity (ROE) of 38.3%, above its peers’ ROC of 11.2%, which could justify its premium valuation relative its peers in the past few years.

Recovery in gross margins a positive catalyst.

  • Key financial metrics to look out for include Union Gas’s gross margins, which we believe are predominantly influenced by brent crude oil/propane prices. We are expecting moderated gross margins in FY22F (at 26.5%, down from FY21A’s 35.8%), following Union Gas’s 1H22 results.
  • Although, we assume a gradual recovery in gross margins entering FY23F (FY23F gross margins of 27.5%) as Union Gas gradually passes on costs to its customers. Furthermore, as at 2H22, we are already seeing some signs of cooling in the brent oil/propane prices, with Nov 22 propane prices at ~US$600 per metric tonne (down from >US$900 in March 22), which should bring some relief for Union Gas’s gross margins going forward.
  • Although, higher-than-expected oil/propane prices could lead to additional headwinds to Union Gas’s gross margins and act as a negative catalyst.

Key risks

  • Key risks, including (but not limited to):
    1. Lower-than-expected gross margins due to elevated crude oil prices and a stronger US$.
    2. Widespread adoption of alternative heat generation sources, e.g., piped gas, electricity.

Above is the excerpt from report by DBS Group Research.
Clients of DBS may access the full report in PDF @ https://www.dbs.com/insightsdirect/.

Singapore Research Team DBS Group Research | Pei Hwa HO DBS Research | https://www.dbs.com/insightsdirect/ 2022-12-05

Previous report by DBS:
2017-07-17 Union Gas Holdings Limited - IPO Factsheet.

Price targets by other brokers at Union Gas Target Prices.
Listing of research reports at Union Gas Analyst Reports.

Relevant links:
Union Gas Share Price History,
Union Gas Announcements,
Union Gas Dividends & Corporate Actions,
Union Gas News Articles

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