Sell PGAS, buy Energi Mega - JP Morgan

Stevanus Juanda (analyst) has downgraded his rating on PGAS from O/W to U/W. He cuts his FY11-12 EPS by 12% and 20%, placing it below consensus (4% lower on FY11). He cuts his DCF driven PxT by 30%, from Rp5400 to Rp3750, on the back of 11-13% lower distribution volume assumption over the forecast horizon, with 3-8% higher gas input cost (while maintaining selling price). On his new FY11 forecast the stock trades on 14.8x P/E. One important statement to highlight from the recent management call (1Q11 results) is that they are not expecting any hike in gas selling price in 2Q & 3Q of year 2011.
https://mm.jpmorgan.com/PubServlet?action=open&doc=GPS-590569-0.pdf

My take – I would agree with Steve’s call on PGAS, as I too listened-in to the fairly depressing 1Q11 results call. The company does not seem to have good handle on the security of its gas supply, as BPMigas can divert them away anytime when there is higher priority use for the gas. On this event alone, the investment community should have factored-in a higher risk profile and higher effective WACC.

I would also agree on the call that gas input price may rise faster than selling price, such that the market could have been overly aggressive with PGAS long term margin assumptions. Some Indonesian gas suppliers seem to have managed to renegotiate their contracted gas selling price (which is input cost for the likes of PLN and PGAS), with backing from BPMigas. See my recent write-up on Energi Mega Persada (ENRG), titled “Postcard from conference #3”. Its average gas selling price is clearly on the rise: from US$2.7/mcf in 2009, to US$2.9 in 2010, which is expected to go up to US$3.5 in 2011, and to US$5.0 in 2012.

[Sales note re-run] Postcard from JPM Indo conference #3 – Energi Mega Persada
Management presentation gave strong impression of a turnaround, supported by its financial figures in 4Q10. A few more quarters of financial recovery and coverage by Street analysts may drive substantial re-rating.

4Q10 turnaround; 1Q11 may set bullish tone for the year
ENRG managed to further increase its gas selling price to PLN in 4Q10, which resulted in higher quarterly profit run-rate. Higher oil price in 4Q10 also boosted quarterly profits, more than offseting the production decline. Given the higher gas price contract for its TSB gas, the company is forecasting average gas selling price to reach US$5.69/mcf in year 2012.

IDR bn Jan-Sep 2010 4Q10
Sales 830.6 419.2
EBITDA 135.6 237.2
Oil price US$78.0/bbl US$87.9/bbl
Gas price US$2.7/mcf US$3.7/mcf
Oil production 6,536 bopd 6,437 bopd
Gas production 41 mmscfd 38.5 mmscfd
Source: ENRG

Clarity over production growth targets; cross-checking possible
Average daily production came in at 13.1 thousand barrels of oil equivalent per day in year 2010 (1H10=13.3), with 49:51 split between oil and gas. This time around, the management communicates clearly what the company is looking to achieve (50.2 thousand boepd in year 2012), and how to get there (25k additional from Kangean TSB in March 2012). Keen investors can monitor the progress of the Floating Production Unit (FPU) being ordered from US-listed company BW Offshore Ltd (BGSWF US), which is 43% complete as of Feb-11. The management displays high confidence with regards to March 2012 target.

Capex needs to get to 50.2k boepd production are well funded
The TSB project is part of the bigger Kangean PSC, where its 50% partner Japex would support 100% of the capex needs (capex-carry-loan scheme), to be gradually re-paid using oil/gas output once the TSB production commence.

Major balance sheet issue resolved
One day before Lehman Brothers event, ENRG issued US$200mn junior loan with an all-in cost of 25% IRR, on top of the US$250mn senior loan at Libor+900. ENRG did a rights issue in Jan-2010, partly to accommodate the conversion of the US$200mn junior debt, plus the US$42mn adjustment to achieve 25% IRR, into equity. So as of Dec-10, total debt stood at US$407mn (US$200mn CS facility and the rest being capex-carry-loan scheme with Japex) or DER ratio of 0.6x, versus US$606mn debt as of Dec-09 or DER ratio of 3.3x.

EV-to-2P reserves of US$2/bbl, vs brent price of US$124/bbl
ENRG has 223 mmboe of net proved and probable reserves (2P) excluding Masela, or 531mmboe including its proportionate ownership in Masela.