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: Three months ended March 31, 2012
Business Overview: TGS operates a natural gas transportation pipeline system in Argentina and produces/commercializes natural gas liquids (ethane, propane, butane, natural gasoline) at the Cerri Complex. The company also provides midstream services and telecommunications. The financial statements are prepared in Argentine pesos under Argentine GAAP and were subject to a limited review by Price Waterhouse & Co. S.R.L.
Key Financial Metrics
| Metric (in millions of ARS) | Q1 2012 | Q1 2011 |
|---|---|---|
| Net Revenues | 645.0 | 531.5 |
| Gross Profit | 305.6 | 292.2 |
| Operating Income | 175.6 | 186.2 |
| Net Income | 79.4 | 81.3 |
| Cash Flow from Operating Activities | 198.8 | 120.3 |
| Total Assets | 5,157.9 | 5,709.3 |
| Total Liabilities | 3,125.0 | 2,921.5 |
| Shareholders' Equity | 2,032.9 | 2,787.7 |
Key Ratios (as of March 31, 2012):
- Liquidity (Current Assets/Current Liabilities): 1.66
- Shareholders' Equity to Total Liabilities: 0.65
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased by Ps. 113.5 million (21.4%) year-over-year. This was driven primarily by the Liquids segment (+Ps. 73.3 million) and Other Services (+Ps. 31.2 million). Gas transportation revenue grew modestly by Ps. 9.0 million.
- Profitability Decline: Despite higher revenues, Net Income decreased by Ps. 1.9 million (2.3%) to Ps. 79.4 million. Operating income fell by Ps. 10.6 million.
- Cost Pressures: Costs of sales increased by Ps. 100.1 million. The primary driver was a Ps. 67.7 million increase in variable production costs for Liquids due to a government tariff charge increase (from Ps. 0.049 to Ps. 0.405 per cubic meter) effective December 1, 2011.
- Financial Expenses: Net financial expense increased by Ps. 5.5 million, largely due to lower foreign exchange gains on assets denominated in US dollars compared to the prior year.
- Liquidity: Cash flow from operating activities improved significantly by Ps. 78.5 million, resulting in a net increase in cash and cash equivalents of Ps. 144.4 million.
Outlook, Risks, and Management Commentary
Outlook and Strategy
- Regulatory Renegotiation: Management plans to conclude the renegotiation of the gas transportation license with the National Government in 2012 to re-compose profitability. A 20% transitional tariff increase agreed in 2008 remains pending implementation due to regulatory delays.
- Liquids Segment: The company is focusing on mitigating incremental costs from new market regulations and securing natural gas supply at convenient prices to maintain sustainability.
- Expansion: TGS will continue managing expansion works under the Gas Trust Fund Program, which will generate revenues for operation and maintenance of new assets.
Risks and Contingencies
- Regulatory Uncertainty: The Public Emergency Law (expiring Dec 31, 2013) has suspended original tariff adjustment mechanisms. The outcome of the license renegotiation is critical for future profitability.
- Legal Proceedings:
- Turnover Tax: Ongoing disputes regarding tax exemptions on liquid sales and fuel usage. Provisions of Ps. 35.3 million and Ps. 79.3 million have been recorded for specific contingencies.
- ICSID Arbitration: Shareholders (Enron/Ponderosa) have filed claims against the Argentine Republic. Pampa Energía acquired rights to control these actions in 2011.
- MetroGAS Reorganization: TGS has an unsecured credit claim of Ps. 27.2 million in MetroGAS's reorganization process, with a full allowance for doubtful accounts recorded.
- Accounting Standards: Mandatory adoption of IFRS was postponed to January 1, 2013, to evaluate the impact of IFRIC 12 on service concession arrangements.
Investor Verification Checklist
- Tariff Renegotiation Status: Verify the progress of the license renegotiation with UNIREN and the timeline for implementing the 20% transitional tariff increase.
- Liquids Cost Pass-Through: Assess the ability to pass through the increased government tariff charge (Ps. 0.405/m3) to customers to protect margins.
- Regulatory Delays: Monitor the status of the acción de amparo and court rulings regarding the implementation of the 2008 transitional tariff agreement.
- Legal Provisions: Review the adequacy of provisions for turnover tax disputes and the potential impact of the MetroGAS reorganization on receivables.
- Debt Covenants: Confirm compliance with debt covenants (EBITDA coverage ratio > 2.0:1; Debt/EBITDA < 3.75:1) given the pressure on operating income.