May 30, 2016 13:56:26
Perusahaan Gas Negara ($PGAS): Low On Gas

Refuelling urgency
We initiate coverage of PGAS with a SELL and DCF TP of IDR1,900 (WACC 8.58%, LTG 3%), implying 8.1x FY17E P/E. This is a 46% discount to its 5- year P/E mean of 15.1x. We see de-rating catalysts from: 1) a weak volume recovery expected in 2016; 2) upstream diversification and supply risks; and 3) regulatory uncertainties.

Market sees volume recovery, not us
PGAS’ gas volume was down 7.3% YoY in 2015. This was in part caused by slower industrial demand as the economy slowed from 5.0% growth in 2014 to 4.79% in 2015 and in part, by lower gas usage by PGAS’ main customer. We believe gas is slowly losing its price advantage after oil prices declined and that PLN may be tilted towards building more coalfired than gas-fired power plants. Still-sluggish industrial demand and the development of more coal power plants are behind our paltry forecasts of 1-3% YoY growth for PGAS’ sales volume for 2016-18.

Supply risks; untimely diversification
PGAS’ contracts with Santos, Pertamina and Conoco-Philips - its main gas suppliers - will end in 2017, 2019, and 2023 respectively, at a time when these operators’ concessions for their oil and gas blocks expire. It remains unclear whether these concessions would be extended. To secure higher future supply, PGAS ventured into the upstream gas sector in 2013-14 and LNG business in 2010. As exploration to exploitation takes years, revenue accretion has been limited so far. We also think that PGAS paid undeserved premiums for its oil & gas blocks, as oil prices soon collapsed and Indonesia’s economy slowed down.

Regulatory overhang
Pressure from industrial users prompted the government to cut gas selling prices in North Sumatera by USD1.64/Mmbtu at end-2015. This may be followed by more price cuts in Java – a risk we do not rule out.