Investment with Income:
Transportadora de Gas Del Sur S.A. (TGS)
Per share values in USD 1-19-2012
Market value $ 3.00
Indicated Dividend rate 49%
Durig Capital seeks out quality high yielding global investments that offer both a high yield and a good probability of appreciation, while providing a unique hedge against inflation and/or a continued devaluation of the US dollar. As a result of our diversification research efforts, we have identified and selected Transportadora de Gas Del Sur S.A. (TGS), Argentina’s largest natural gas pipeline operator, for our Investment with Income Portfolio.
US Dollar Concerns
Most investors seeking income with growth for their investment portfolios are aware that the artificially very low US Treasury return rates still remain, even before taxes, significantly below current inflation rates. American savers are thus thrust into the tenuous position of continuous wealth erosion. Considering that last year was another year of declining equity and property prices, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the constant printing of more dollars (not only to backstop the US economy, but also that of Europe) leaves one with the stark realization that all of these components have precipitated a widespread erosion of wealth that will likely continue, and perhaps even accelerate, until the aforementioned conditions begin to change.
We would like point out something that been growing at a amazing rate. Unfortunately, it is not our economy. According to the Federal Reserve, the unfunded liabilities (known in Enron terms as off balance sheet debt) of the US Government now exceed $1million dollars per average tax payer.
The Natural Gas Market
Natural Gas is considered to be one of the more environmentally friendly sources of guaranteed energy while having one of the lowest costs to provide electrical power generation. It is therefore forecast to be one of the top providers of new guaranteed energy power plants in the near future. The newer technological ability of transforming Gas to Liquids (GTL), a refinery process that converts Natural Gas into such products as ethane, propane, butane and natural gasoline are recovered. The conversion to liquids should lessen the price spread between gasoline and Natural Gas. However, we are currently seeing the highest price spread since GTL technology has become a reality.
With that said, Natural Gas inventories are still growing more than expected during this unseasonably warm winter, raising concerns that the U.S. could run out of places to store the liquid. As more gas producers come online, the added supply plays a major role in the current bulging inventories. If inventories are increasing during the heaviest usage winter heating season, the problem is that added new sources could grow inventory much faster during the warmer lower heating time period. This excess inventory issue is a major factor why the spot price of natural gas is at the lowest price in 10 years.
With our energy usage/needs having only increased over time and with both gas and diesel prices on the rise during most of the recent past, we see the combination of a 10 year low in this carbon based fuel and a growing market for its use as a very intriguing investment opportunity.
Transportadora de Gas Del Sur S.A.
During our review of Transportadora de Gas Del Sur S.A. we found very few professional articles detailing their products and services. Other than rather simple articles featuring their high margins and very oversize dividend, very little (if any) of the many underling merits of the business were ever discussed. After diving deeper into the details surrounding Transpotadora De Gas Del Sur, we believe this is a largely misunderstood business that simply needs a better and more detailed explanation of a number of its hidden values.
The company has two main revenue streams:
1) Liquids, 61% of Revenues
TSA’s largest and faster growing business segment is an unregulated portion that converts natural gas to liquid gasoline and/or diesel. A majority of these sales go to world markets, where 90% of it is settled in US dollars. Liquid petroleum, as exports outside Argentina, provided 31% percent of total sales for the company. Thus, a major profit hub of Transportadora’s overall business is acquiring low cost natural gas at the wellhead, converting it into liquids, and then selling it at spot prices to the World markets. We think this is a good business, as judging by the current (and growing) price spread of the two carbon based fuels it should have very robust margins.
However, the stock of TGS appears to have a close correlation to the price of Natural Gas (see second graph below) and not the spread between gas and liquid fuel prices (see the first graph). Considering that the liquids business profits are likely to affected more by buying Natural Gas at the low levels and then selling at higher (gasoline) prices, the spread charts indicate that the current price difference should make this particular segment of their business extremely profitable.
The liquids segment also has revenues from a (not at risk) consulting division that provides cleaning and conversion to liquids services without taking ownership of the fuel.
Spread, with Gasoline Price in Blue and Natural Gas in Red
Natural Gas Price in Blue and TGS Transportadora de Gas Del Sur S.A. in Red
2) Gas Transportation, 33% of Revenues
TGS pipelines transport about 61% of all of Argentina’s Gas, and is Argentina is recognized as the largest gas producer in South America. Argentina also uses Natural Gas for over 50% of their energy needs. Since all non-interruptibility contracts with TGS are regulated and performed at a fixed rate, similar to a real estate rent, TGS revenues are not sensitive to the price the price of gas, volumes and other such factors. All guaranteed Gas (not-interruptible) clients pay connection fees that do not fluctuate with gas prices or actual usage. TGS provides a wholesale pipeline transportation business primarily to resale natural gas companies, as TGS is restricted from having their own retail gas business. They have one major pipeline competitor and don’t foresee any new direct competitors, putting them in the dominate and very desirable position of an oligopoly. Thus, the second major aspect of TGS’s business should not be directly correlated to natural gas prices, as its revenues are fairly immune to natural gas price swings.
Late last year, YPF S.A. (YPF) said they had found a huge deposit of unconventional natural gas that would be equivalent to a quarter of the country’s proven reserves in the region of Patagonian province of Neuquén. TGS has 2 gas lines into the Neuquén region and their competitor, TGN, has only one. Transportadora de Gas Del Sur S.A. has a total of 5598 miles of pipeline, 4754 miles of which is owned by the company and the remainder leased. The transportation portion of the business is a heavily regulated and licensed industry. Their current license is good until 2027, after which they have an additional ten year option.
The aforementioned new discovery will increase the countries known reserves by about 25%. Considering the close proximity of 2 existing TGS pipelines and the corresponding right of ways, this large of an increase in should allow TGS to possibly negotiate additional contracts to move the gas (risk-less transport business) while also supply an even lower cost (at risk business) source to make highly profitable liquids (i.e., gasoline.)
Earnings and Book Value
TGS’s overall US GAAP earnings for the last 5 years averaged $1.50 per (ADR) share per year. Judging from this, they are trading at only about 2x historic profits. The first nine months of profit for 2011 are 81 cents per ADR share, making this year’s run rate $1.08. Considering that the industry average is a PE ratio of 16.1, a 2.78 PE ratio for TGS is astonishingly low for a dominate oligopoly business with a solid balance sheet.
Historical US GAAP earnings:
TGS currently trades at about 16% discount to its book value. However, we think the depreciated value of the 4754 miles of pipelines and property that is figured into the stated book value might be considerably lower than what its true market value really is. Therefore, we see buying shares of a very profitable “almost monopolistic” business at a (16%) discount to a “book value” that might very well be cloaking other significantly discounted assets, as a savvy investment opportunity.
Dividends and Taxes.
We believe that the last dividend was an abnormally large onetime distribution, and we expect it to be significantly cut to more historical levels this year. However, considering the company is trading near a 2.8 PE based on just 9 months reported earnings and that their 5 year US GAAP average yearly earnings is $1.5, we think that a very respectable level of dividends could easily be maintained alongside the retention of considerable funds for capital improvements and ongoing concerns. A review of the dividend history revealed no consistency in the dividends, and their annual reports contained no stated dividend policy or guidelines. Our contact the company’s representatives confirmed that no such policy or guidelines exist at this time. The payout last year was a onetime event, is clearly unsustainable, and is far above what it was in prior years. Our best estimate after talking to TGS company representatives is that the next dividend may be in the 7 cent range, and will most likely be paid in the spring of 2012. Short term, this would give about a 6% yield on new purchases of the stock, but only about 2.4% on a yearly basis. A 30% payout of earnings, which we see as being more reasonable, would probably bring the dividend yield to over 10%.
No taxes need to be paid on Argentina dividend stocks unless the dividend is found to exceed profits. If profits are exceeded, they would be taxed at a 35 % rate. This Argentine regulation inspires us to think that TGS, which in the last 9 months had tremendous cash flow and depreciated their assets about $1 per ADR share, could easily pay out about 30 cents per share per year and still retain over 70% of the US GAAP income.
While we now want to identify what we believed to be the three largest risks to our investors, please do not assume that this list is intended to be complete or comprehensive.
- Natural Gas Prices.
- Geo Political issues.
- The Argentina Peso.
1. Natural Gas Prices. Since Natural Gas prices ended 2011 near 10 year lows and been trading down since then, this is plainly one of a natural gas company investor’s greatest concerns. After reviewing the company, we think they might actually be the recipient of benefits from possibly increased profits due to a larger spread between low gas prices and high liquid prices.
2. Geo Political issues. The second largest risk we could identify was the Geo-political risk of the county of Argentina. With that said, in 2011 Argentina in had some of the highest GDP growth rates in the World that we could identify, surpassing both India and China, and has by far the fastest growing GDP in Latin America.
Even though the Argentine economy is seeing some of the most robust growth in the world, which certainly helps to minimize the Geo political risk, it should be kept in mind that this is a highly regulated industry and this is one of the most regulated companies that we have reviewed. Robust economic growth does not stop local regulators from implementing poor bureaucratic policies, which over time have severely hampered the Argentinean gas industry.
3. The Dollar vs. the Argentina Peso. Since all their debt is carried in US dollars, we were concerned about what effect this might have on the company’s earnings. However, much to our surprise, about 30 percent of their business is done in the World markets, is settled in US Dollars, and is their fast growing business. Deducting their USD assets from their USD debt (according to their 2010 annual report) leaves only 115.5 million US dollars of debt exposed to currency fluctuations.
Summary and Conclusion
TGS integrates well into our strategic plan of finding strong balance sheet companies that own highly desirable assets and/or are monopolistic businesses, and are significantly undervalued as a result of depressed markets and/or currencies, such as our recently selected Southern Cooper Corp (SCCO) or Administradora de Fondos de Pen (PVD), an oligopoly similar to TGS, when neither copper nor the Chilean peso were finding a bottom.
Even though the currently indicated dividend level from online financial sources is clearly not sustainable and not to be expected, it is extraordinary to find a monopolistic styled business in a most desirable clean energy resource sector that, considering a historical 5 year period, is trading at less than a mere 2.8x’s GAAP earnings. If TGS were to initiate a 25-30% payout level, based on current prices the dividend would likely be in the 8-10% range while retaining plenty of cash to continue growing the value of its brands and properties. Furthermore, Argentina’s recent major Natural Gas discovery, in close proximity to two existing TGS lines, should help significantly improve Argentine energy needs and help insure future revenue growth for TGS, who’s main business is transporting/buying/selling fuels.
Therefore, we think TGS allows our clients to attain the strategic goals of an income stream and long term capital growth, as well as some diversification away from the US economy and the US dollar, which is why we have added it to our Investment Growth & Income Portfolio.
Durig Capital and some clients currently have positions in TGS.
Durig Capital clients may currently own these bonds.
Contact our fixed Income analyst for questions at 971-327-8847.