AmCapital PGN (PGAS, Rp3,875): Supply hiccup sees no short-term resolution

· During the conference call on Wednesday 12 May 2010, PGN highlighted the recent issue of declining gas supply, mainly the sizable contracted gas from the Corridor Block, an onshore Sumatra-based gas field operated by ConocoPhillips (CoPhi), which has been dedicated for PGN’s West Java customers.

· The company disclosed its total gas distribution volume for Jan’10-Mar’10 had been gradually falling from as much as 906.8mmcfd on Jan’10 to as low as 773.3mmcfd on Mar’10. Note that PGN reported 1Q10 average gas distribution volume of 841mmcfd, 70.9% of which came from the company’s Strategic Business Unit or SBU Area 1 that covers the South Sumatra and West Java (including Banten and Jakarta) regions. ConocoPhillips and Pertamina are the largest gas suppliers for the SBU Area 1, accounting for some 89% of total gas sold in the SBU 1 Area in 2009.

· At the meantime, the contracted gas volume from CoPhi’s Corridor Block had continued to drop after peaking at 378.5mmcfd on Jan’10 to 275.0mmcfd on Mar’10 or an average 1Q10 volume of 325mmcfd. This reflected some 7.3% below its contracted FY10 volume.

· No recent update on recent flow rate from the CoPhi’s Corridor has been provided during the call. Still, the company maintains its FY10 distribution volume guidance at 800-900mmcfd as PGN confirmed another South Sumatra-based gas flowing to West Java from Medco Energi’s Lematang Block beginning on April 2010.

· We understand that 1) the allocation of gas from CoPhi’s Corridor has been altered in a bid to support the Enhanced Oil Recovery (EOR) program at Chevron’s Duri, Riau, which is the country’s largest oil field 2) there has also been short fall of gas at another CoPhi’s gas fields at the South Jambi block, which has been dedicated to Singapore-based customer.

· At this juncture, it seems that PGN has no short-term resolution for the declining supply from the CoPhi’s Corridor Block, though it said of the Government’s established task force team may address the gas supply issue while Indonesia’s Vice President Boediono will set up a monitoring team, including upstream regulator BP Migas, to seek solutions.

· Though in short-term the supply hiccup may deter the sentiment on the counter and PGN’s FY10 earnings profile (CoPhi’s gas accounted for 38.6% of 1Q10 gas distribution volume and it costs the least at US$1.85/mmbtu), the longer term positive is the make-up gas from both CoPhi’s Corridor Block and Pertamina South Sumatra may be sold at higher price, assuming both companies are able to fulfill its volume commitment.

· Our sensitivity calculates: 1) on our base assumption of 320mmcfd for the CoPhi’s Corridor gas, any 10% decline in Corridor’s volume will escalate our FY10 blended cost of gas by 1.2% and lower our FY10 core EPS by 5.2%, 2) assuming the CoPhi’s Corridor gas only flows at 270mmcfd this year, our blended FY10 cost of gas will increase by 1.9% and our FY10F EPS will decline by 8.1%.

· PGN has no update on the planned M&A though it admitted fail in one of its two targeted gas block targets, while on the LNG receiving terminal, it seeks operation by mid-2012 for the West Java-based terminal, in which it has joint venture with Pertamina.

· We are in the process of re-initiating our coverage in PGN. At our revised estimates prior to factoring the CoPhi’s Corridor and shortfall at Pertamina South Sumatra, we forecast FY10-11F core EPS of Rp245-Rp278, translating into core PE of 15.2x-13.7x, respectively. Higher or lower gas supply is the main risk in PGN.