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May 24, 2016 11:28:40
Perusahaan Gas Negara: More Upside than Downside
 
Minimum earnings downside risk and valuation at cheapest; BUY
We upgrade PGAS to BUY (from NEUTRAL) and maintain our DCF/terminal EV/IC based TP of IDR2,650. Our BUY call is premised on 1.) cheap P/E valuation (cheapest since 3Q11 issue on major gas purchase price hike), 2.) Earnings downside risk has bottomed, 3.) Earnings upside risk on oil price increase. Post-earnings revision, PGAS is trading at 9.6x/9.0x 2016-17 P/E, –65% discount to 5-years historical forward P/E.
PGAS share price has been treated as an oil price play since 2013. Then why correlation has been reversing since Apr’ 16?

Ever since PGAS injected upstream O&G assets to its business since early 2013, its elevated business profile risk has made its share price becoming more attached to volatile spot movements in Brent oil price (figure 4). Yet, since 4 Apr’ 16 share price showed a reversible trend vs oil price (oil price up while PGAS price down). Arguing the reversible downward-trend in share price is caused by 1.) Negative potential outcome on Pertamina-PGAS synergy, 2.) Governance issues (eg; CEO accused of corruption case), seems to be more of sentiment driven rather than fundamental driven as usually historical share price re-tracts to slowly to normalized level as news flow sentiments fades out. In fact, there is slight earnings upside on higher oil price which would make PGAS’ upstream O&G spot business (8-9% of revenue) more profitable. 

Pepres no. 40 implies ~35% of PGAS distribution is affected
Perpres no. 40/2016 has not given full clarity yet on how will it impact PGAS earnings going forward. We are now waiting for the Ministerial decree on gas price cut in the next 1-2 weeks which will give further details. Our conclusion from Perpres No. 40 regarding gas price cut is that gas price cuts may only affect roughly ~35% of PGAS’ distribution volumes (apply to specific industry users and excludes power plants) which exceeds USD6/mmbtu. Yet, the govt must still consider gas supply adjacent to the surrounding industry users and price level deemed economical for the respective gas users. Hence we think further bureaucracy considerations are all in the loop before finalizing gas price cuts.

Higher upside risk than downside risk on gas price cut
Upside risk - Should negative sentiment fade away and overhanging risk on gas price cut is over, PGAS 2016-17 P/Es may re-tract by +53%/+63% to its 5-years historical forward P/E.  
Downside risk - Our sensitivity analysis suggests a USD1/mmbtu gas spread cut in 2016-17 gas price would cut 2016-17 earnings by –48%/-46% respectively, translating to 18.1x/16.5x 2016-17 P/E. This implies -19%/-11% downside risk to 5-years historical forward P/E.

 
Bull
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