Apr 25, 2017 11:16:29

We reiterate our BUY recommendation on PGN ($PGAS) with unchanged DCF-based TP of IDR3,450 (43% upside). We believe its low annualised ROE of 11.8% – and free cash flow generation that is merely sufficient for capex and dividend payment – should deter any intervention with its ASP. PGN recorded 1Q17 earnings of USD96.8m, 24-28% of our and consensus estimates respectively, driven by lower QoQ opex and higher profitability on oil and gas production.

  • Distribution segment sees a new norm. Perusahaan Gas Negara’s (PGN) blended distribution spread has stabilised at USD2.60/mmbtu since 3Q16. Its distributed volume of 816mmcfd reflects its new supply agreement to state power producer Perusahaan Listrik Negara’s (PLN) Muara Tawar power plant at a lower price, but higher volume. 1Q17 distribution volume was flat YoY, which shows weak industrial usage, specifically in the textile, ceramic, glass, and cement sector. Transmission volume saw a 14.2% YoY decline, but overall, the impact is small.
  • Potential intervention on price remains a drag on valuation. We continue to observe pressure from industrial users asking for a lower natural gas price. Recall that in late March, the Ministry of Energy and Mineral Resources was in a discussion to regulate the distribution margin at 7% of upstream gas cost, which poses further downside to ASP. However, PGN has maintained its blended margin guidance of USD2.60-3.00/mmbtu, which we believe is reasonable, as its FY16 free cash flow of USD650m was merely sufficient to maintain its USD500m capex target and usual dividend payout of 40-50%.
  • Oil and gas lifting to increase by 30% YoY. PGN had earlier guided that its oil and gas lifting target of 30% YoY increased after Muara Bakau started production in 2H17. This segment only broke even in 2016, but recorded a gross profit of USD15m in 1Q17. Due to its low base, PGN earnings have become more sensitive towards the contribution from this segment, while a higher YoY average crude oil price should bode well.
  • 1Q17 results were above consensus, on the back of 61% QoQ decline in quarterly opex while the oil and gas production segment recorded QoQ gross profit, also compared to gross losses of USD5.5m in 1Q16. Net gearing decreased to 0.43x (4Q16: 0.50x).
  • Reiterate BUY on undemanding valuation and decent results. PGN now trades at 10.7x FY17F earnings compared to its 5-year historical mean of 13x. Meanwhile, FY17F earnings are set for high double-digit growth, due to the low base effect of FY16. Potential catalysts are a higher crude oil price and improvement in distribution volume to the industrial users. Our DCF TP (WACC: 8.5%, TG: 3%) implies 15x FY17F P/E.
  • Downside risks would mainly be on the negative news from the potential merger with Pertamina, news flow on this has been quiet since mid-2016. (Norman Choong, CFA)