May 24, 2016 12:33:50
Perusahaan Gas Negara : Margins Intact Despite Industrial Gas Price Cut
After the Indonesian Government decided to cut industrial gas prices we spoke to PGN's management. We believe the company’s margins would remain intact, as costs would be borne by the Government. Premised on the several positive facts mentioned below, we reiterate our BUY call, with a DCF-derived TP of IDR3,500 (57% upside).
1.  A lower ASP for PGN may stimulate demand and improve its gas distribution volume;
2.  The stock is now trading at close to -2SD from its 5-year P/E band;  
3.  Its fundamentals are improving due to the recovery in oil prices.

¨        The Government will cap the cost of upstream gas that is sold by oil and gas contractors, at USD6/million British thermal unit (mmbtu). For existing gas fields that incur higher gas costs than USD6/mmbtu, the Government will lower end-user industrial gas prices for the supply from these fields – or any field that is incurring costs that are deemed as uneconomical.

¨        No impact to Perusahaan Gas Negara’s (PGN) margins as the Government will bear the cost. The Government’s way to cut the prices of industrial gas for end-users would be to limit the cost of supplying gas (of upstream producers) to distributors. As such, these distributors would be required to lower their selling prices by the same amount that is cut. The interests of oil and gas contractors would not be affected, since the Government would give them a higher share of production to offset the lower supply cost. As many as 31 production-sharing contracts will be revised in the near term.

¨        Price cut to benefit select players only. Potential beneficiaries of lower industrial gas prices would be companies operating in the fertiliser, petrochemicals, oleochemicals, steel, ceramic, glass and rubber glove industries. This, however, is subject to recommendations from the Ministry of Industry and the price points of gas supplied.

¨        Concerns on distribution margins still loom. The Ministry of Energy and Mineral Resources is expected to issue new policies to determine the gas transmission tariff and gas distribution margin of distributors.

¨        Fear of uncertainty now affecting the stock. PGN’s share price has declined by approximately 20% after news reports suggested that it may be directed by the Government to acquire Pertagas and, ultimately, become a subsidiary of Pertamina. Some market participants are expecting a rights issue, and PGN’s distribution margin might be diluted after such a merger, if it happens.

¨        Merger might be positive and fundamentals are improving, reiterate BUY. We think that a merger with Pertamina may be a positive. We also lift our FY16F earnings to reflect the impact of higher Brent prices – although this has not been priced in by the market yet, in our opinion. A downside risk would be the announcement of an unfavourable policy in the coming months. (Norman Choong, CFA)