Union Gas Holdings IPO: Investment Merits and Risks July 20, 2017

Netlink NBN trust IPO did not gain traction and closed at IPO price on the first day of listing. Recent IPO listing performances have been mixed. Notably, UnUsUal, Sanli Environmental and Kimly put up stellar performances.

The next upcoming IPO is Union gas holdings (UGH). UGH has a 40 years track record of providing fuel products in Singapore. Its businesses can be divided into 3 segments:

Excerpt from UGH IPO Prospectus

Estimated net proceeds from this IPO will be approximately S$5.72 mil. Bulk of the proceeds will be used to fund acquisition for the purpose of expanding its domestic network. Company also intends to enter the piped natural gas business and potentially venture into the foreign market.

Should Investors subscribe for the IPO? We list down the key investment merits and risks. Below are the key investment merits:

1) Earning Growth Catalysts

The potential acquisition of the local retail LPG dealers and venture into piped gas business offer earnings growth potential. Secondly, increase in Singapore population and households will also provide the company with the opportunity to grow their core business organically.

2) High Return on Equity

Net asset value (NAV) and unaudited pro forma earnings per share (EPS) will be 8.58 cents and 3.06 cents post IPO invitation. Return on equity (ROE) has been in excess of 20% since FY14. All things being equal, a high ROE generally implies that the company is effective in utilising Shareholders’ equity to generate returns for Shareholders.

3) Competitive Advantage

UGH’s financial highlights revealed a gross margin expansion since FY2014 due to lower purchase cost of Liquefied Petroleum Gas (LPG) cylinders. Company also claimed to have extensive distribution capabilities and quality products/ services offerings in the IPO prospectus. While these claims can be contentious, the gross margin expansion does suggest that the company holds certain competitive advantage and/or pricing power over its direct competitors.

Excerpt from UGH IPO Prospectus

Here are the key risks:

1) Changing Business Landscape and Declining Sales Volume

New generation of homeowners may not be familiar with Union gas. This is because piped natural gas facilities are easily accessible in new housing developments for Homeowners to tap onto. Citygas, a provider of piped natural gas and a Competitor of UGH, registered YOY increase in volume of piped natural gas sold in 1H17. UGH’s LPG cylinder sales volume paled in comparison. The company registered YOY decline in LPG cylinder sales volume for each of the last two financial years.

Increasingly, homeowners are also turning to electrical appliances and this alternative eliminate the need for natural gas products altogether. Company’s CNG and diesel business may also be affected by the proliferation of electric vehicles in the longer term.

2) Lease expiry

Company operates its CNG and diesel business through its fuel station which is on a 15 years lease term from JTC. This lease term expires in Dec 2023. The segments contributed 40% revenue for FY16. The lease expiry will cast uncertainty to the operations of these business segments.

Conclusion

Facing structural changes in business landscape, it will be challenging for company to grow its existing retail LPG and CNG businesses. It remains to be seen whether future acquisition in retail LPG sector can translate into long term earnings growth.

Low natural gas price gave UGH an earning boosts for FY16. Given the cyclical natural of commodity price, natural gas price may creep up in the future and affect company’s margin. In my opinion, using normalised earnings can give Investors a better sense of company’s long term profitability.

A simple calculation can be performed to estimate normalised earnings. This is done by averaging FY14 & FY15 Pro forma earnings (excluding write backs) which will give an EPS of around 2.1 cents. Adjusting for future acquisition and sales volume decline, I opined S$0.22 or lower as a good entry price.