Dec 14, 2016 09:27:04

Perusahaan Gas Negara ($PGAS) - Set For a Reversal Of Fortune

The pressure on PGN’s distribution margins, stemming from competing feedstock, is set to reverse. This is because the overhang on its stock from worries over the gas price cut overhang has been removed, while coal prices have doubled since early 2016 and crude oil prices are on the rise. With no more asset impairments in hand, PGN’s E&P segment’s operating margins could be lifted by the rise in crude oil prices. Overall, we expect gross margins to improve. Maintain BUY and DCF-based IDR4,000 TP ( also implying 15x FY17F reported earnings.

¨ No impact from the gas price cut. On 5 Dec, the Government announced that the natural gas tariff for three priority sectors in the upstream segment – fertiliser, steel and petrochemicals – would be cut by USD0.50-1.50/mmbtu. Only five companies stand to benefit from the lower tariff, of which two would also receive lower transmission fees from Pertamina Gas. These companies are big volume gas users and buy the commodity directly from oil & gas blocks, bypassing distributors such as Perusahaan Gas Negara (PGN).

¨ No definite date for further price intervention. The tariff cut was lower than what was announced earlier. Also, the ceramic, glass, oleochemical and rubber glove industries would also not benefit from the lower tariffs. Energy and Mineral Resources Deputy Minister Mr Archandra Tahar stated that, in the event of a similar reduction in gas tariffs, these sectors – which use natural gas for power generation only – would have a lower multiplier impact on the economy. This is in comparison with the fertiliser, steel and petrochemical industries, which also use natural gas as a raw material. Thus, the decision to not lower tariffs on these sectors at this juncture, in view of the impact to the Government’s budget.

¨ Sentiment should shift towards fundamental/recovery potential. While talk of a Pertamina merger still linger, (see our 30 Aug A Study Of PGN, Pertamina And Pertagas report), we believe the most detrimental factors, ie distribution margins or potential margins compression from the gas price cut, is largely over. We believe fundamental variables, such as gas distribution volumes and distribution margins recovery, as well as the recovery potential of its troubled E&P and LNG segments, are likely to drive its share price. And these factors are turning towards PGN’s favour, in our opinion.

¨ Rising crude oil prices and higher coal price bodes well for PGN. As coal prices have doubled and crude oil prices are on the rise, PGN’s appeal (as natural gas is a competing feedstock) ought to increase. This, in turn, would reverse the pressure on its distribution margin. In our opinion, PGN should maintain its ex-LNG pipe gas distribution margin of USD3.00/mmbtu, this might even improve in FY17 should volumes recover and surcharges reappear. With 2017 crude assumption of USD44.50/bbl, Its E&P segment’s impairment is done, while operating margins would benefit from higher ASP.

¨ Downside risks. PGN is now trading at 11x of our FY17F reported net profit, vis-à-vis its 5-year historical mean of 13x. Downside risks to our call are still an intervention from the Government, which may put pressure on margins, as well as an unfavourable outcome from the merger with Pertamina. (Norman Choong, CFA)