Perusahaan Gas Negara a Cushion Play

Despite short-term supply concern for PGAS, long-term outlook remains bright as PGAS as the largest gas distributor (85% market share) should be well positioned for ventures to any diversified gas related forms and upstream takeovers. PGAS is recommended as a defensive rotational play given its strong domestic exposure and less impacted from inflation impact. We have a BUY with a TP of IDR6,500 based on SOP method.

Positive short and long-term outlook
Despite PGAS efforts in the LNG supply to increase distribution, we see that existing and potential gas supply blocks remain the key earnings growth. However, on a long-term view, PGAS as the leader of gas distribution (83% market share) and transmission (51.7% market share) in Indonesia should be well positioned from ventures to any gas related forms and streams.

Amid shaky macro containing inflation concerns, we like PGAS defensive nature given: 1.) Rich cash with solid balance sheet followed suit with attractive dividends, 2.) Captive market with long-term contracts, 3.) A domestic play with b to b customer relationships thus not exposed to international gas price volatility.

Targets and risks We target 2013 and 2014 distribution volume of 848mmscfd (+5% y-o-y) and 949mmscfd (+12% y-o-y). We factored in a moderate margin spread of ~USD4/mmbtu in the long-run. There are no strong for 2013-14 earnings growth drivers besides arising from gas supply from existing and potential blocks. PGAS interest in acquiring 3 additional gas blocks amounting to USD1bn, short-term pipeline projects valued at USD250-500m and FSRU Lampung project at USD300m are upside risk earnings growth in 2015.

Defensive shield
PGAS is a good rotational play amid the shaky Indo-macro factors from budget deficit, inflation and weakening IDR concerns. PGAS 2014 PER at 15x is hovering at the same level as its 5 years historical forward PER which is deemed attractive amidst rotational transition. Our BUY call with TP IDR6,500 is derived by our SOP (sum of parts) valuation. We factor in PGAS’ upstream oil and gas blocks and LNG asset to the company’s business portfolio although it is still considered to be relatively small at this current stage.

Rich Cash to Flow to Variety Forms of Ventures

Stability is a diamond now
PGAS has once again proven its ability to adjust its selling price back in April ‘13, a testament to our confidence for stable distribution margin spread of around USD3.8/mmbtu for our long-term forecast. Margin spread would not be as high like in 2012 (USD4.3/mmbtu) as there are no more high gas charges to customers that exceed quota as distribution channel and gas supplies has increased along with the gas price evaluation.

Furthermore, our distribution volume forecast of 5% y-o-y and 12% y-o-y growth for 2013-14 is deemed conservative mainly spurred from its new supply from Conoco Phillips. We believe that the 5-10% supply ramp up from the Conoco’s existing contract of 400 mmscfd is visible.

Rich balance sheet
Due to recent IDR depreciation that could deteriorate Indonesia’s macroeconomic stability ahead, Bank Indonesia (BI) raised deposit facility (Fasbi) rate by 25 bp to 4.25% and notched BI benchmark rate by 25bps to 6% from 5.75% previously. This should partially benefit PGAS as it would park their consistently increasing excessive cash reserves (net cash) on much more favorable rates. This excess of cash reserves has not included the potential upstream block acquisitions.

Furthermore, weakening USD/JPY currency is a beneficiary to PGAS given that JPY currency has weaken against USD and PGAS’ long-term debt component is 70% JPY debt and the remaining 30% is USD debt. Amid the shaky macro in Indonesia containing inflation concerns should be less of burden to PGAS given captive demand from its b to b customers and its ability to pass on higher costs to its customers.

Valuation hovers at the 5 years historical forward PER
PGAS is currently trading at 15x 2014 PER which is a hovering level at its 5 years historical forward PER. The bullish JCI market on a ytd basis amid liquidity in the market coupled with PGAS realization to be able to pass on the higher gas costs to its selling price starting back in April 2013, rotational play to defensive stocks has led to a multiple positive reaction towards its share price seen by PGAS share price 20% outperformance against the JCI.

UPSTREAM VENTURE
PGAS acquired participating interests in 2 gas blocks back in March – May 2013 which are:
1.) Ketapang (East Java) with 20% participating interest worth USD71m. The operator will be Petronas Carigali which holds 80% of the project. The block has 84 million barrels of oil equivalent (MMBOE) of 2P reserves with valuation of USD4.5/boe. The current status is at near production stage and full production could reach 25k barrels/day and 50 mmscfd.

2.) Bangkanai (Central Kalimantan) with 30% participating interest worth USD27m in Bangkanai block with additional hurdle to invest up to USD30m to develop the block. PGAS acquired the 30% participating interest from Salamander Energy Limited. The block possesses 2P reserves amounting to 24 MMBOE and the valuation is USD4.6/boe.

3.) The 2 aforementioned acquired blocks amounting to USD98m are still a small investment portion of PGAS investment plan in acquiring oil and gas (O&G) blocks. PGAS plans to top up to a total of USD1bn of upstream blocks acquisition. As the remaining arrears are not fully disclosed yet, we tend to leave the arrears out of our calculation but is considered as an upside risk.

Upstream acquisition is a wise move
With PGAS rich cash stood at USD1.67bn in 1Q13 coupled with strong net cash position makes PGAS strategy to allocate such cash for upstream acquisitions very visible. We see that the USD1bn O&G asset acquisition for this year is a wise move to gain further earnings upside in the long-term.

But we believe the true value of upstream acquisition is the company’s access to secure future gas supplies and which could also logically improve bargaining power with gas suppliers. PGAS is known as a defensive stock at this current stage. However with potential large upstream acquisition, intrinsic risk is imminent but is considered a relatively healthy portion to PGAS business in order to gain an alpha exposure.

LNG TERMINAL CONSTRUCTION UPDATE
PGAS’ 2nd floating storage regasification unit (FSRU) was at keel laying stage at Hyundai Heavy Industries shipyard in South Korea back in end of February 2013. The FSRU is to be located in lampung and the construction schedule remains intact with completion in mid-2014. The new 100% owned FSRU, which costs USD300m, will able to receive 2m tonnes of LNG per year.

As part of the expansion, PGAS plans to open up a ~80 km pipeline in Lampung with investment of USD250-500m. This FSRU and pipe construction would assist in assuring that supply would be secured for customers in West Java – Southern Sumatra areas.

As an attempt to protect the LNG investment, the government has set allocation of domestic LNG for FSRU terminals across Indonesia. The new 100% owned FSRU has the right to receive 10 cargo allocations per year (equivalent to around 0.6m tonnes/year). The 10 cargo allocation roughly takes up 30% of the FSRU full capacity.

We took note from the company that the LNG business is still low in demand at the short-term as LNG demand is still unattractive given LNG high-pricing condition. However, long-term should be bright as this would prepare the learning curve experience for Indonesia’s LNG knowledge as it is expected by experts that Indonesia will import gas in the Asian market by 2018 to meet the increasing domestic demand.

VALUATION: SOP method
We derive our TP of IDR6,500 based on a SOP method breaking down into DCF, and asset value for its upstream assets and LNG business. Although its distribution and transmission business takes into account 97% of equity value from the SOP method, we believe its other ventures could have potential upside for further expansion and may have a higher proportion to the SOP valuation. For our DCF part, we use LT growth rate of 6% and 10.5% WACC assumption. For our upstream assets and LNG business we use the equity value with a conservative assumption.