Transportadora De Gas Del Sur: No Value Anymore (NYSE:TGS)

Transportadora de Gas del Sur (NYSE:TGS) is the operator of half of the Argentinian gas pipeline network, owner of a liquefaction plant in the country, and of a treatment plant at the doors of Vaca Muerta.

In November 2021, I recommended the company. The stock has returned 120% since. In this review, I provide a new review of the company’s segments, and what I expect from them. My opinion is that the current stock price already discounts most future positive developments, and therefore it is not an opportunity anymore.

Note: Unless otherwise stated, all information has been obtained from TGS’ filings with the SEC.

Business description

Transportation segment: TGS core business is the concession of half of Argentina’s high-transit gas pipelines. This business has regulated prices and has suffered from contract insecurity. During some periods it has been unsustainably unprofitable (like now) and during others extremely, but also unsustainably profitable (2016-2019). Today, despite its enormous assets (around $1 billion net book value), it is generating losses, because the government has only granted a 60% price increase in the last three years (more than 300% accumulated inflation). The segment cannot grow in volume terms because the pipelines are already utilized at full capacity.

Liquids segment: TGS owns a plant in Bahia Blanca to produce ethane, propane, and butane from natural gas. The segment has been recently very profitable and is the current profitability engine of the company. Its profits are affected by international gas prices but mostly by gas availability in Argentina, which was restricted up to 2016. The segment has shown very slow real (volumes) growth since it resumed normal operations in 2016.

Midstream segment: The fastest growing segment of the company, it has two business lines. The first one is the operation of unregulated pipelines connecting the Vaca Muerta production with the main pipelines and treatment plants of the region. Prices for these pipelines are unregulated and contracted between TGS and the upstream companies. The second segment is a treatment plant for natural gas in Vaca Muerta, one of the only two available. Transported and treated gas has more than tripled since 2020. Contracts in this segment are usually denominated in dollars.

Low leverage: The company has a single $500 million bonds program paying 6.75% fixed and maturing in May 2025. Against these, the company has steadily accumulated bonds and foreign currency, with liquid assets for about $440 million.

Complicated financial income reporting: Like many Argentinian companies, TGS’ financial income reporting is not easy. For TGS, with low peso-denominated liquid assets, the main problem is the conversion of pesos to dollars. The company purchases dollars through the purchase and sale of bonds. The purchase has to happen at the financial exchange rate (currently about AR$350) but the resulting dollars are recorded at the official rate (currently about AR$180). The result is an automatic loss on the fair value of assets. I prefer to ignore these issues, given that TGS has a small net liability exposure to foreign currency, and simply consider the interest cost in dollars.

Recent developments

Transportation is already unprofitable: For the first time since 2016 (when rates were adjusted), TGS’ transportation segment presents an operating loss in 3Q22. It is very probable that the government will provide a price increase to cover inflation soon, as the infrastructure managed by TGS is critical.

Liquids segment maintains record (and unsustainable?) profitability: The liquids segment is geared to post $230 million in operating profits (at the official rate) for FY22, a similar figure to the one published for FY21. The problem is that natural gas prices are already down to 2020 levels when the company generated about $120 million in operating profits. In my opinion, the $120 million figure seems more realistic considering gas prices for the past decade.

Midstream is growing fast and is sustainable: Transported gas reached 13 MMm3/day in 3Q22, up from 6.4 MMm3/day in 3Q21 and 3.4 MMm3/day in 3Q20. Gas treatment contracts in the Tratayen plant reached 9.4 MMm3/day from 3.3 MMm3/day in 3Q20. New pipelines were authorized in April for another 17 MMm3/day that should be online in June 2023. Additional capacity for the Tratayen plant for another 9 million MMm3/day is expected online in 2023 as well.

Profitability calculations

Transport segment: This is a low-risk, asset-heavy investment with regulated prices. Theory indicates that IF (a big if) the government wants to reach a long-term arrangement, it should provide a relatively low return on assets. In my opinion, with about $1 billion in net assets, the segment can be valued as if generating about $50 million in yearly operational profits, eventually.

Liquids segment: With volumes not growing significantly since 2016, and profitability mostly affected by natural gas price movements in 2021 and 2022, I prefer to return to a conservative scenario of $120 million in operating profits for this segment, as shown during the period 2016-2020. If eventually international natural gas prices remain elevated, then they could be revalued.

Midstream: Only considering the capacity that is already contracted and the announcements of new capacity incorporated in 2023, this segment is expected to eventually double its volumes.

Profitability should move with volumes. For example, transported gas grew 70% between 3Q22 and 3Q21, and treated gas grew 15% during the same period (contracts for treatment doubled though). During that period, revenues grew only 15% in real Argentinian peso terms (30% if FX effects are neutralized).

In my opinion, from the current $60 million (annualized from 3Q22 profits), this segment should be able to reach $100 million in operating profits in the next two years.

Financial expenses: The company’s bonds pay $37 million in annual interest, but the company is also generating about $16 million in interest income from its $400 million in liquid assets. This leaves an approximate net financial cost of $20 million yearly.

Income taxes: As usual, I consider a 35% tax rate, the statutory rate in Argentina.

Then, adding up $50 million from transportation in a regulated environment (currently generating losses), $120 million from liquids under MMBTU prices between $3 and $5, and midstream earning $100 million in the next two years, I arrive at $270 million in operating profits.

From those $270 million, I subtract $20 million of interest, and then 35% income taxes. The result is that I expect the company to generate $160 million of net income, in the long term.

Remember that the long term means a profitable, albeit low return, transportation segment (today making a loss), a liquids segment generating almost half of what it generates today in terms of profits, and a midstream segment almost twice as big as it is today.

Still, with TGS trading at $3.3 billion, I believe it is expensive, and it does not represent value anymore.