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PGAS: Super Bluechip at Bargain Price!

Warren Buffett once said in one of his annual letter, ‘We like to invest in companies that are already established and operated for more than 100 years. We do not want to take the risk by invest in startup companies that do not have a long track-record of performance.’ In short, Buffett prefers to invest in mature and well-established companies rather than ‘brand new’ ones. However, when this principle is applied in Indonesia, investors may find it difficult. Because, from about 500 companies that listed on the Indonesia Stock Exchange, how much of them that have been established for more than 100 years? The fact is, our beloved country (Republic of Indonesia) was proclaimed in 1945 or seventy years ago, and the Jakarta Composite Index (JCI) itself was launched in 1983.

But fortunately, Indonesia actually has several companies that have been operating for more than a century. One of these companies is Perusahaan Gas Negara (PGAS). Formally, PGAS is established as a limited liability company in 1965, and listed on the Stock Exchange in 2003. However, as a gas company, PGAS has been operating long before that, ie since 1859 under the name LJN Eindhoven & Co. (belonged to private investor from the Netherlands. Not long after the Republic of Indonesia was proclaimed in 1945, the company was taken over by the new government, to become a SOE). PGAS is the first company in Indonesia, or probably one of the first in the world, who introduced the use of gas fuel for the public and general industry, where the company's main business is to distributing gas (made from coal) from coal mines to urban areas.

Today the company's main business is still the same, namely the distribution of gas, although no longer coal gas but natural gas, because it is more economical. Possibly because of its status as the first company in its field, and because the gas distribution is a high entry barrier business, PGAS is practically the sole ‘ruler’ in the gas distribution business in Indonesia, with a market share of 81% by the end of 2014. The combination of market monopoly, management integrity as a public company, plus experience for more than one hundred and fifty years (because, if monopoly is the only reason, then why other SOE’s like Pertamina, PLN, and PT Kereta Api, they still suffering losses?), causing PGAS almost always scored big profits each year, with an average ROE of nearly 30% over the last nine years (2006 – 2014). As a result, the company's net asset value increased from only US$ 569 million by the end of 2006, to US$ 2.8 billion by the end of 2014. This means that if someone buys shares of PGAS in 2006 and still hold it until today, regardless of fluctuations in the price of shares in market, his real capital gains are about 21.9% per annum, not including dividends (after the dividend, the total gain may be as high as 25% per annum). As a well-established state-owned company, PGAS pay dividends on average 30 – 50% of its annual net profit to shareholders.

In short, if you look at the excellent track record above, then PGAS is very interesting for long-term investment. It is also a big cap stock, so you can buy it for millions of US$ if you like. Moreover, the company also began to successfully make significant revenue from its investment in upstream sector of oil and gas, which started in 2011 by establishing PT Saka Energi Indonesia as a vehicle to acquire oil and gas blocks in the country, either as a whole or in part, and the acquisitions are still continue until today. Most recently, on April 15 yesterday PGAS added another gas block in its portfolio by acquiring a 11.7% participating interest in the Muara Bakau PSC in East Kalimantan Province, which is scheduled to start the gas production in 2017.

Logo of PT Saka Energi Indonesia

And the result, from the company's gross profit of US$ 1.04 billion in 2014, US$ 115 million or 11% of which comes from the oil and gas production (not distribution) business. It should be noted here is that profit is obtained when oil and gas prices were down in recent months. Because oil and gas prices are recently go up, then the profit should be greater in the future. PGAS’ venture in upstream business is apparently more successful in generating alternative income for the company. While the gas transmission business, though it was pioneered since 1998, but it only able to produce a gross profit of US$ 5 million for the company in 2014, or not significant. A description of the gas transmission can be read here.

Probably because of the company’s success in obtaining new revenue sources from oil and gas blocks, then management is more eager to acquire more blocks. That's why in 2014, PGAS issued US$ 1.3 billion of bonds in Singapore, where the funds will be used for working capital, including the acquisition of oil and gas blocks. The bonds will mature in 2024, with coupon of only 5.1% per annum (so we could say that PGAS has just received free money, because even if the proceeds are placed in local bank deposits or government securities, the profits will be more than enough to pay the coupon). The low interest rate and the ten years term of the bonds showed a high confidence of investors in Singapore that PGAS is a very good company and will continue to grow in the long run. Vecause if the company failed in its oil and gas blocks venture, the overall corporate income will not be disrupted because to the company's core business, namely the distribution of gas, has been very settled. Due to large value of the bond value (US$ 1.3 billion is about a half of PGAS net assets), then of course PGAS apply some hedge where the value of the bond will not be affected by the fluctuations in the Rupiah’s exchange rate against the US Dollar.

And what about the company’s shares?

For those of you who are already familiar with my investment style, then you'd know why I suddenly discuss this PGAS. Yup, that's because the stock suddenly dropped significantly in the past few weeks. When this article was written, PGAS is in a position of Rp4,340 per share, which is the lowest position in the last two years, and about 30% below its peak position of 6,250. Based on the company's financial statements for the full year 2014, and by using the exchange rate of Rupiah on December 31, 2014 which is Rp12,501 per US Dollar, the price reflects PBV of 3.0 times and PER 11.6 times. The question of course, is the price low enough? In this case, there are several things to note.

The first, as one of the most established, most consistent, and most profitable companies in the Indonesia Stock Exchange, it is reasonable if the valuation of PGAS is (almost) always high, it can be seen from its PER that is always between 14 to 16 times in normal times, sometimes even higher than that. However, just like any other stocks, it does not mean that the valuation of PGAS is never low. In the last five years, there were three moments where PGAS fall down about 30% from its highest positions, ie in September 2011, December 2013, and today. Here’s the details:

Date
Lowest
Highest (before drop)
Change (%)
Sep-11
2,350
4,475
(47.5)
Dec-13
4,435
6,250
(29.0)
Apr-15
4,370
6,150
(28.9)

Now, if we look back at the experience in September 2011 and December 2013, it did not matter how deep the declines, yet in the end PGAS will rise again. But unlike the two previous declines (and perhaps also the declines before that) where the decreases were aligned with the corrections of JCI (in September 2011 and December 2013, JCI had drop 17 and 19% from its peak respectively), this time the price correction of PGAS happened when the JCI was still relatively stable. In addition, if you look at the case of September 2011, PGAS had drop to a price which reflects PER of only 8.5 times (using the EPS at the time). While at the current price, PGAS still have PER of 11.6 times. So maybe the price could down further?

That was a first. Secondly, whenever a large stock (including PGAS) down, then there will be a lot of bad news related to the company that 'explain' the cause of the decline, or in other words, the negative sentiments. Based on my record alone, in this time there are several 'bad news' associated with the company, namely:

1. The Minister of Industry, Saleh Husin, told the press that the Ministry of Industry proposes (proposes to who?) a decrease in gas price by 10 – 20%, which, if it the proposal is accepted, PGAS profit margin would be depressed (the minister probably didn’t know that the selling price of gas from PGAS is already the cheapest in the country due to large scale of the business, even cheaper than the subsidized ones),
2. PGAS Revenue in 2015 is predicted to fall about 6% because the gas consumption by State Electricity Company or Perusahaan Listrik Negara (PLN) has been reduced (this issue is not valid, because in 2014, PGAS revenue from PLN was US$ 624 million, up from the previous year of US$ 575 million. If the revenue from PLN is really reduced, then the effect would not be significant because PLN only contributed of less than 20% of PGAS total revenues),
3. PGAS must submit its oil and gas blocks to Pertamina (what the hell???), and
4. PGAS have difficulty in obtaining gas supply (although this issue is correct, but it's just an old story).

Frankly, I am quite know that those negative issues will eventually evaporate by themselves. In fact, most of these negative issues are coming out just after the stock was down (when PGAS was still high, there are no negative issues). And as an investor, that is the challenge: When you are targeting (or already bought) a blue chip stock whose prices are down, then you should be able to sort out, which news that for real and which news that only rumors. You may read about that here. Beyond that, you have to stay focus on the fundamentals of the company and its stock valuation.

And the third, related to the company's fundamentals. Although to this day PGAS still dominate the gas distribution business in Indonesia, but the company's market share continues to fall from 93% at the end of 2010, to only 81% by the end of 2014. The decline occurred because the amount of gas distributed by the company had been stagnant over the last four years, because, as already mentioned above, PGAS have it difficult to obtain gas supplies from the producers, and these conditions have been occurred since 2010. In 2014, PGAS had distributed 1,717 MMScfd of gas, or just grew a little from 1,661 MMScfd in 2010. As a result, although the value of PGAS net assets is still growing significantly eevery year (due to the high profitability ratios), but the net income had a stagnant growth. In 2014 PGAS recorded a net profit of US$ 748 million, or only grew slightly compared to US$ 696 million in 2010. The difficulties in obtaining gas supply also causing the management to be 'lazy' in building new gas pipelines and other infrastructures.

To deal with the problem of gas supply, since 2011 the company seeks to have its own supply of gas through the acquisition of oil and gas blocks. And here is the good news: As already mentioned above, these efforts have been successful so far, where today PGAS have a new source of revenue from the sale of oil and gas, this time in its position as a producer, not distributor. At the end of 2014, of the eight oil and gas blocks owned by the company either in whole or in part (not including the Muara Bakau Block which acquired in 2015), three of which were already in production. In fact, if not for this new source of revenues, PGAS net income in 2014 will not be decreased by 10.1% compared to 2013, but would be more than that.

However, the fact remains: Net income of PGAS in 2014 was down from the previous year. If in the upcoming first quarter of 2015, the company again record a decline in profits, the negative sentiments that have been mentioned above will back to the show, and PGAS shares will drop further.

In conclusion, despite PGAS, on its current price, is very interesting in terms of valuation, while the long-term outlook of the company is fairly good due to a successfull venture in the upstream business, but I prefer to wait and see, especially because the JCI looks like running out of fuel for rose further (if JCI down then PGAS would still down further), and we also better wait for the company’s next financial statements, just to be sure. I do not know PGAS decline will stop at what price, but as already mentioned above: No matter how deep the decline, but in the end the stock will rise again.

But Sir, I've already bought the shares, what should I do? Well, if you bought PGAS at the price of 4,750 or lower, I think the price was quite low so that, although it may take a long time, you will eventually earn a profit. Besides, PGAS could only down further from its current position if: 1. JCI is fall down, 2. There is serious negative sentiments (so far, the negative sentiments associated to PGAS are only 'jokes'), or 3. The company posted a profit decline in first quarter of 2015. So here is my advice: If none of three conditions above that happened, then you can still hold your shares. You may also buy more shares at the power prices. But if one of the three conditions occurs, you better sell your shares, at least half of them. So if you hold 1,000 lots of PGAS, you could sell 500 lots and hold the remaining. In this way, if PGAS really down further, you can use the proceeds from your sale earlier to later buy the stock at lower prices. But if PGAS was rebound, then your loss is only half of what it should be. Good luck!

PT Perusahaan Gas Negara (Persero), Tbk
Rating of Performance in 2014: A
Rating of share price on 4,340: AA

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