Perusahaan Gas Negara Murky merge schemes

We think that PGAS-Pertagas potential M&A schemes, open-access & unbundling policies” issues is still a rough scheme, therefore needs further study and unlikely to proceed in the mean-term. We like PGAS given its given its rich cash position to cater diversified projects aligned with strengthening its vertical integrated chain. We see that the share price is overly punished against its fundamentals, hence leaves ample room for attractive upside.

What happened?
There have been plans regarding a merger of two prominent entities, PGAS & Pertagas, as well as plans by the government regarding open access & unbundling implementations to comply with Permen ESDM No.19 year 2009. Pertagas is supporting the unbundling policy as it would reduce the gas price charged to customers. In contrarian, PGAS agrees unbundling policy under a condition that higher gas price may be charged to its customers given that operational cost hike is imminent as unbundling policy would extend the value chain of the business.

Regarding open-access policy, it does create an efficient and effective gas distribution flow in a national interest perspective, however, full-implementation would be detrimental to PGAS dominance in the industry. Furthermore there is also an issue regarding potential merger of PGAS and Pertagas given that there is cross sections with PGAS pipe expansion and Pertagas existing pipes, which is the main reason that hampers PGAS’ business growth.

How we see this?
We see that proposals for various potential M&A schemes, full open-access and unbundling policy, remains unclear, thus needs further study and unlikely to proceed in the mean-term. We sense that these overhanging issues is driven more to political rather than national interest. We are of the view that PGAS should maintain its dominant presence in the gas distribution market as to have maximum optimization of gas distribution for domestic users as part of reducing Indonesia’s dependencies on oil import.

Trading at a bargain
PGAS is currently trading at xx 2014 PER, a xx% discount to its historical forward PER. We maintain our BUY call with TP of IDR6,000. Risks to our call: 1.) Unfavorable government policies, 2.) Limited gas supply from upstream O&G blocks.

Potential impact of open access policy
The government is currently pushing open-access policy for PGAS as to comply with Permen ESDM No.19 2009. PGAS has implemented its open-access post 2005 for its transmission business. However, it may be difficult for PGAS to implement open access for its existing distribution pipelines given technicality reasons in the field therefore dedicated pipelines is still necessary and it complies with Permen ESDM No.19 2009 article 10.

Unbundling policy should increase costs
PGAS current transmission business segment has already implemented unbundling policy by separating the gas trading segment by setting up a subsidiary, PT. Gagas Energy Indonesia. However, PGAS distribution business segment does not separate its distribution and trading business. We see that unbundling policy for its distribution business may lead to cost inefficiencies for PGAS and may enforce PGAS’ to increase its gas selling price as to maintain its margin spread of ~USD4/mmbtu.

PGAS and Pertagas JV issue?
One of the main issue why there has been a push from the government regarding PGAS and Pertagas merge scheme is that both of the companies could create potential synergies. Currently, PGAS is experiencing gas supply crisis to serve domestic industrial needs. PGAS gas distribution infrastructure facility is well equipped in North Sumatera, however Medan has been suffering gas supply crisis. Meanwhile, there has been gas oversupply as to cater the demands in East Java.

In order to cater the needs in West Java-Sumatra high gas consumption, the government is planning to make a gas distribution connection from East Java to West Java. However, there have been competition between PGAS and Pertagas as there are 11 intersections in the West and East Java area which has emerged a drawback to Pertagas and has hampered PGAS’ pipe expansion in connecting gas distribution from East Java to West Java. Despite this, several strategies from PGAS such as building LNG facilities to cater gas supply needs and acquiring upstream oil and gas (O&G) blocks to secure gas supply is deemed as a wise move in our view.