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: Six months ended June 30, 2016
Business Overview: TGS operates a natural gas transportation pipeline system in Argentina and processes natural gas liquids at the Cerri Complex. The company is subject to regulation by the National Gas Regulatory Body (ENARGAS) and the Ministry of Energy and Mining (MINEM). The financial statements were prepared in accordance with IAS 34 and subjected to a limited review by Price Waterhouse & Co. S.R.L.

Key Financial Metrics

Revenue and Profitability (Six Months Ended June 30, 2016):

• Total Comprehensive Income: Ps. 317.4 million (vs. Ps. 160.0 million in 2015).
• Operating Profit: Ps. 1,037.3 million (vs. Ps. 414.7 million in 2015), an increase of Ps. 622.6 million.
• Net Revenues:
  • Natural Gas Transportation: Increased by Ps. 534.2 million, representing 30.6% of total revenue.
  • Liquids Production & Commercialization: Ps. 2,058.5 million (up 55.3% or Ps. 733.0 million), representing 62.0% of total revenue.
  • Other Services: Increased by Ps. 105.6 million.
• Operating Costs: Increased by Ps. 724.7 million (47.4%) due to higher natural gas costs (RTP), labor, and other operating expenses.
• Net Financial Results: Negative Ps. 359.2 million increase in losses, primarily driven by exchange losses (Ps. 337.7 million) due to Argentine peso devaluation.
• Income Tax Expense: Ps. 170.0 million loss.

Liquidity and Cash Flow:

• Cash and Cash Equivalents: Positive variation of Ps. 502.6 million.
• Cash Flow from Operations: Increased by Ps. 906.4 million, driven by improved operating income and collection from derivative financial instruments.
• Investing and Financing Activities: Cash outflows increased by Ps. 144.0 million and Ps. 259.8 million, respectively, due to debt cancellation (impacted by exchange rates) and dividend payments.

Material Changes vs. Prior Period

• Tariff Increases: A transitional tariff increase of 200.1% (Resolution 3724) effective April 1, 2016, contributed Ps. 460.3 million to net revenue. This was the first significant adjustment in 15 years.
• Exchange Rate Impact: The Argentine peso devalued 15.3% against the US dollar (closing at Ps. 15.04/USD). This boosted revenue recognition for dollar-denominated contracts but significantly increased financial costs due to the company's net liability position in USD.
• Liquids Segment Performance: Revenue grew 55.3% despite a 9.4% decrease in total volumes dispatched from the Cerri Complex. The revenue increase was primarily due to the higher exchange rate, partially offset by falling international reference prices for natural gas liquids.
• Cost Structure: Operating costs rose significantly due to increased prices for natural gas used as fuel (RTP) and higher labor costs.

Guidance, Outlook, Risks, and Contingencies

Regulatory and Legal Risks:

• Tariff Suspension: In July 2016, the Federal Court of La Plata suspended the implementation of tariff resolutions (No. 28/2016 and No. 31/2016), reverting rates to March 2016 levels. If this judgment becomes final, the company's financial position and its mandatory investment plan (Ps. 794.3 million) would be seriously affected.
• Integral Tariff Revision (RTI): The company is pursuing an RTI to establish a sustainable, fair tariff scheme. This process is conditioned on signing an Integral Renegotiation Agreement.
• Arbitration Claim: PAE and Pan American Sur SA initiated arbitration claiming US$ 163 million (plus interest) for alleged breach of contracts regarding product allocation. TGS disputes the claim and believes it has meritorious defenses.
• Domestic Market Obligations: Participation in the "New Stabilization Program" requires selling LPG at prices below market cost, creating a negative operating margin. The government has delayed compensation payments, though TGS agreed to accept BONAR 2020 bonds for amounts due through 2015.

Outlook:

• Management aims to recover profitability through the RTI and the Integral Renegotiation Agreement.
• The company plans to reduce its net USD liability position through partial debt amortization.
• Efforts will focus on securing natural gas supply (RTP) at profitable prices amidst falling international reference prices.

Investor Verification Checklist

• Tariff Resolution Status: Verify the final outcome of the Federal Court of La Plata ruling suspending the April 2016 tariff increases and the status of the government's appeal.
• Investment Plan Funding: Confirm whether the Ps. 794.3 million investment plan can be executed given the potential loss of tariff revenue.
• Arbitration Exposure: Monitor the progress of the US$ 163 million arbitration claim and any potential settlement or judgment.
• Government Compensation: Track the receipt of BONAR 2020 bonds and the resolution of outstanding compensation for domestic LPG supply programs.
• Exchange Rate Sensitivity: Assess the ongoing impact of Argentine peso volatility on the company's USD-denominated debt and financial results.