Nov 28, 2016 12:15:05

A month since taking office as Minister of Energy and Natural Resources (ESDM), Ignasius Jonan has been focusing on two key regulations: uniform standard price for fuel nationwide and lowering industry gas price.
ESDM Minister issued one price for fuel regulation
Agreeing with Arcandra (Deputy ESDM Minister), soon Jonan will issue industry gas price regulation.
The latter has been in discussion for quite some time which has negatively impacted investors’ sentiment on Perusahaan Gas Negara ($PGAS) as overhang remains.  PGAS share price has dropped 27% since Aug16 - at this level one could be tempted to argue that downside from uncertainties have mostly been priced in.

Furthermore, what the government has provided so far in terms of regulatory clarity on gas pricing, in theory has neutral impact on PGAS.  The new regulation will set the price for downstream at below US$6/mmbtu for three main sectors: petrochemical, steel, and fertilizer.  But this is only be applied to upstream suppliers which directly supplying to these downstream customers. Therefore, PGAS may be spared on pricing but of course it would lose out on volume here.
To be fair, business has been tough for PGAS regardless of regulatory risk.  For one, distribution ASP has been weak.  Recent re-pricing for PLN for gas supply to Muara Tawar also contributed to the drop.  At the same time, upstream gas prices have increased.
Additionally, the ability to pass through the higher gas prices may be limited. Industries would have found it difficult to pass through price increases as the economy slowed - spreads fell as a result.
As such, Abdul lowers his volume growth forecasts, considering near zero growth in volume this year.  He also assumes the spread to remain stable at the 3Q level.
Whilst much of the above dynamics/developments may have been priced into the stock, one big uncertain outcome is the potential M&A with Pertagas.
Abdul’s forecast assumes that Saka remains with PGAS but does price in Pertagas. Recall that the government plans to merge Pertamina, Pertagas and PGAS in a SOE holding structure.
Initially, the gov’t was aiming to complete the process of creating all SOE holdings by end of year but with just a few days left in Nov16, there have been no new updates on proposed merger.
Gov’t proposed structure on Pertamina-PGAS-Pertagas merger
Abdul has been insightful in analyzing possible scenarios of how the deal could go through. Please see below for his detailed analysis.
So what would it take for us to be bullish on PGAS?
Abdul highlights a possible trigger is pickup in volume. This can come from the distribution network that PGAS is building.  With an additional network, PGAS will be able to connect with more clients that could switch to gas.
However, the target for completion is 2019.  So in the near term, an increase in volume can only come from clients within the existing or newly built network.  We expect the network size to grow 7-9% each year.
From earnings sensitivity perspective PGAS is much more levered to price than volume.  For example if volume grows 15% next year, the impact to NPAT is only 14%.  Another reason why bottom line impact from the network build-up is unlikely near term.
As such, Abdul reiterates his SELL recommendation on PGAS with TP of Rp2,400.