PGAS Where's the Gas? Derating in the Pipeline; Assume at UW Target Price: IDR 3,982 - Morgan Stanley

Gas volume constraints - likely until 2013 - and associated earnings risk will hamper the stock's performance over the next 12-18 months, in our view.Longer term,declining ROE from new gas supplies will likely drive a further derating in PGAS shares.

Gas constraints and 2012 earnings risk:Our 2012 EPS estimate is 4% lower than consensus and assumes gas volumes of 895mmscfd. However, we see up to 8% additional downside to our EPS forecast if the 100mmscfd of gas earlier diverted from ConocoPhillips does not return in 2012. We expect new gas supplies in Indonesia to ramp up only in 2013, and with current basins maturing, gas sourcing will remain issue for PGAS in the medium term.

Incremental gas at lower ROE: PGAS is looking to obtain additional gas through liquefied natural gas (LNG) supplies, coal bed methane (CBM), and acquiring stakes in E&P fields. We estimate the gas ROE from these sources would be a low 12-15%, versus PGAS's current average of 46%. We think this will drive a longer-term derating of the stock. Also, PGAS' current transmission business generates an estimated 7% ROE, lower than its 15.7% cost of equity.

Defensive but unattractive valuations/EBITDA growth: PGAS, for which we estimate EBITDA growth at a 7% CAGR, 2010-13, is trading in line with comparables (which have an estimated 15-18% growth) in P/E and EV/EBITDA terms. Hence, we expect the stock to underperform the broader Indonesian market and other Asian utilities.

What's in the price? The current stock price implies 2011/12 gas volumes of 780/890mmscfd, in line with our estimates, and no tariff increase in 2012.

Key upside risks: Higher gas volumes and tariffs, along with marketing rights for LNG, as in our bull case.