TGS

Business Context and Reporting Period

Company: Transportadora de Gas del Sur S.A. (TGS)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Fiscal Year and Fourth Quarter ended December 31, 2016
Business Overview: TGS is Argentina's leading natural gas transporter with a firm contracted capacity of approximately 2.8 Bcf/d and a major processor of natural gas liquids. The company operates three primary segments: Natural Gas Transportation, Liquids Production and Commercialization, and Other Services.

Key Financial Metrics

Fiscal Year 2016 Performance (vs. 2015):

• Net Revenues: Ps. 7,402.1 million (2016) vs. Ps. 4,226.6 million (2015); an increase of Ps. 3,175.5 million.
• Operating Profit: Ps. 2,231.8 million (2016) vs. Ps. 688.2 million (2015); an increase of Ps. 1,543.6 million.
• Net Comprehensive Income: Ps. 930.6 million (2016) vs. a net loss of Ps. 172.1 million (2015).
• Earnings Per Share: Ps. 1.171 per share (Ps. 5.857 per ADS) for 2016 vs. a loss of Ps. 0.217 per share in 2015.
• Cash Flow from Operations: Increased by Ps. 1,670.5 million year-over-year.
• Net Financial Results: Negative financial results decreased by Ps. 163.1 million, driven by lower net foreign exchange rate differences.

Fourth Quarter 2016 Performance (vs. Q4 2015):

• Net Revenues: Ps. 2,533.7 million (Q4 2016) vs. Ps. 1,387.3 million (Q4 2015).
• Net Comprehensive Income: Ps. 462.0 million (Q4 2016) vs. a net loss of Ps. 160.9 million (Q4 2015).
• Cost of Sales and Expenses: Increased by Ps. 693.0 million (42.2%) compared to Q4 2015.

Material Changes vs. Prior Period

Revenue Drivers:

• Liquids Segment: Revenues surged 64.0% to Ps. 4,768.3 million, primarily due to the Argentine peso devaluation against the US dollar and higher volumes sold on the company's own account. This segment accounted for 64% of total revenues in 2016.
• Transportation Segment: Revenues increased by Ps. 1,073.2 million, driven by a 200.1% transitional tariff increase approved by Resolutions 3724 and 4122. However, management notes that tariffs remain insufficient to cover long-term operational cost increases.
• Other Services: Revenues rose by Ps. 241.8 million, aided by exchange rate effects on USD-denominated sales.

Expense and Financial Variations:

• Operating Costs: Increased by Ps. 1,901.9 million year-over-year due to higher natural gas costs for Replacement Thermal Plants, labor costs, and operational expenses.
• Financial Results: The reduction in negative financial results was largely due to the liberalization of the foreign exchange regime in December 2015, which reduced exchange rate losses on financial debt.
• One-time Items: The 2015 results included a Ps. 324.4 million charge related to the acquisition of rights from arbitration proceedings, which did not recur in 2016.

Outlook, Risks, and Management Commentary

Regulatory and Tariff Outlook:

• Integral Tariff Review (RTI): Management emphasizes the critical need for the RTI process, initiated in April 2016, to establish a sustainable regulatory framework. Current tariffs are deemed insufficient to support the business or fund the 2017-2021 investment plan.
• Liquids Margin Pressure: While revenues increased due to exchange rates, management warns that depressed international reference prices for propane and butane, combined with domestic supply program obligations, could worsen operating margins in the Liquids segment.

Liquidity and Capital Resources:

• Cash Position: Cash and cash equivalents increased by Ps. 682.6 million in 2016.
• Government Receivables: In October 2016, TGS received Argentine BONAR 2020 bonds (Ps. 144.8 million) as payment for government arrears; over 90% of these remain restricted in treasury.
• Debt Management: Financing activities used Ps. 721.6 million more than the prior year, driven by bond prepayments and debt reduction efforts.

Risks:

• Regulatory uncertainty regarding tariff adjustments and the RTI process.
• Volatility in international commodity prices affecting the Liquids segment.
• Foreign exchange rate fluctuations impacting USD-denominated revenues and debt obligations.

Investor Verification Checklist

• Tariff Sustainability: Verify the status and expected timeline of the Integral Tariff Review (RTI) and the magnitude of approved tariff increases versus operational cost inflation.
• Liquidity Constraints: Confirm the liquidity status of the Ps. 144.8 million in BONAR 2020 bonds received from the government and the conditions restricting their use.
• Commodity Exposure: Assess the sensitivity of the Liquids segment margins to international propane and butane price fluctuations versus the Argentine peso exchange rate.
• Debt Structure: Review the remaining US dollar-denominated debt and the effectiveness of current hedging strategies given the liberalized exchange regime.
• Regulatory Framework: Monitor updates on the Public Emergency Law No. 25,561 and any new resolutions affecting the Natural Gas Transportation segment's revenue model.