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: Nine months ended September 30, 2016

Business Overview: TGS operates in Argentina, primarily engaged in natural gas transportation and the production and commercialization of natural gas liquids (ethane, propane, butane, and natural gasoline). The company operates under a 35-year license with a potential 10-year extension. The reporting period was significantly influenced by regulatory changes, including a transitional tariff increase and the initiation of an Integral Tariff Revision (RTI) process following a 15-year period of frozen tariffs.

Key Financial Metrics

Profitability (Nine Months Ended Sept 30, 2016 vs. 2015):

• Total Comprehensive Income: Ps. 468.6 million (2016) vs. Ps. (11.2) million loss (2015).
• Operating Profit: Ps. 1,381.2 million (2016), an increase of Ps. 1,088.1 million year-over-year.
• Net Financial Results: Negative results increased by Ps. 327.3 million, driven by exchange losses on net US dollar liabilities.
• Income Tax Expense: Ps. 254.0 million loss (2016) vs. Ps. (28.3) million loss (2015).

Revenue by Segment (Nine Months Ended Sept 30, 2016):

• Liquids Production and Commercialization: Ps. 3,153.7 million (64.8% of total revenue), up Ps. 1,288.7 million (69.1%) due to foreign exchange rate increases.
• Natural Gas Transportation: Increased by Ps. 585.7 million (27.5% of total revenue) due to partial application of Resolution 3724 tariff increases.
• Other Services: Increased by Ps. 154.7 million.

Liquidity and Cash Flow:

• Cash and Cash Equivalents: Increased by Ps. 643.9 million.
• Operating Cash Flow: Increased by Ps. 978.2 million, aided by improved operating income and derivative liquidations.
• Debt: The company maintains a net liability position in US dollars. On October 14, 2016, the Board approved the prepayment of US$ 30.8 million in 2007 Notes.

Material Changes vs. Prior Period

• Turnaround to Profitability: The company shifted from a comprehensive loss in the prior year to a significant profit, primarily driven by a Ps. 1,088.1 million increase in operating profit.
• Exchange Rate Impact: The devaluation of the Argentine peso (15.31% increase in the selling rate vs. year-end 2015) boosted revenue in peso terms for export-oriented segments but increased financial costs due to US dollar-denominated debt.
• Regulatory Tariff Adjustments: The partial application of Resolution 3724 (200.1% tariff increase) boosted transportation revenue, though implementation was delayed by Supreme Court rulings regarding residential users.
• Cost Increases: Operating costs rose by Ps. 1,208.9 million (54.5%), driven by higher natural gas costs for replacement thermal plants and labor costs.

Outlook, Risks, and Management Commentary

Outlook and Strategy:

• Tariff Normalization: Management views the start of the Integral Tariff Revision (RTI) in April 2016 as a critical step toward sustainable profitability. The goal is to secure a fair tariff scheme to recover investments and costs after 15 years of stagnation.
• Investment Plan: TGS is executing a mandatory Investment Plan of Ps. 794.3 million, though delays persist due to billing restrictions on residential tariffs.
• Debt Reduction: The company plans to reduce its net US dollar liability position through partial debt amortization.

Risks and Contingencies:

• Regulatory and Legal Risks: A Supreme Court ruling in August 2016 nullified tariff increases for residential users, causing a Ps. 423 million financial impact. TGS has requested financial assistance from the government to compensate for this loss.
• Domestic Market Obligations: Participation in the "New Stabilization Program" requires selling LPG at prices below market cost, creating negative operating margins. Government compensation for these programs is subject to significant delays.
• Arbitration: TGS is defending against an arbitration claim by PAE and Pan American Sur SA alleging a shortfall in product allocation valued at US$ 163 million. Management believes the claim is unsupported.
• Commodity Prices: Global oversupply of liquids has led to a drop in international reference prices, challenging margins in the Liquids segment.

Investor Verification Checklist

• Tariff Implementation Status: Verify the full implementation of Resolution 4054 (200.1% increase) and the timeline for the completion of the Integral Tariff Revision (RTI).
• Government Compensation: Confirm the status of payments owed by the Argentine Government for the "New Stabilization Program" and the Propane Networks Agreement (Ps. 280.5 million outstanding as of Sept 30, 2016).
• Debt Prepayment: Monitor the execution of the US$ 30.8 million prepayment of the 2007 Notes scheduled for November 14, 2016.
• Arbitration Outcome: Track the progress of the US$ 163 million arbitration claim filed by PAE and Pan American Sur SA.
• Exchange Rate Exposure: Assess the impact of continued Argentine peso volatility on the company's net US dollar liability position and financial results.