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: Second Quarter and Six Months ended June 30, 2014
Business Overview: TGS is Argentina's leading natural gas transporter with a firm contracted capacity of approximately 2.9 Bcf/d. It is also a leading processor of natural gas and a major marketer of natural gas liquids (Liquids). The company operates three primary segments: Natural Gas Transportation, Production and Commercialization of Liquids, and Other Services (midstream and telecommunications).

Key Financial Metrics

Second Quarter 2014 vs. Second Quarter 2013

• Net Income: Ps. 115.0 million (Q2 2014) vs. Net Loss of Ps. 20.8 million (Q2 2013).
• Earnings Per Share: Ps. 0.145 per share (Ps. 0.724 per ADS) vs. Ps. 0.026 loss per share.
• Total Net Revenues: Ps. 961.4 million (Q2 2014) vs. Ps. 475.2 million (Q2 2013).
• Operating Profit: Increased by Ps. 147.8 million year-over-year.
• Net Financial Expense: Ps. 76.2 million (Q2 2014) vs. Ps. 123.6 million (Q2 2013).
• Income Tax Expense: Ps. 55.5 million (Q2 2014) vs. Ps. 7.5 million gain (Q2 2013).

First Half 2014 vs. First Half 2013

• Net Income: Ps. 37.3 million (H1 2014) vs. Ps. 93.3 million (H1 2013).
• Earnings Per Share: Ps. 0.047 per share (Ps. 0.235 per ADS) vs. Ps. 0.117 per share.
• Total Net Revenues: Ps. 2,201.5 million (H1 2014) vs. Ps. 1,300.9 million (H1 2013).
• Net Financial Expense: Ps. 542.4 million (H1 2014) vs. Ps. 217.5 million (H1 2013).
• Cash Flow: Net decrease in Cash and Cash Equivalents of Ps. 261.0 million, primarily due to debt principal cancellation.

Material Changes and Segment Performance

Revenue Growth Drivers:

• Liquids Segment: Revenue increased Ps. 413.8 million in Q2 and Ps. 781.9 million in H1. Growth was driven by higher volumes sold, increased processing on TGS's own account, foreign exchange rate appreciation of the peso, and higher international reference prices.
• Natural Gas Transportation: Revenue increased Ps. 30.7 million in Q2 and Ps. 27.9 million in H1. Drivers included more export services, higher interruptible services, and new rate schedules (Resolution I-2852). However, the segment represented a smaller percentage of total revenue (20% in Q2 2014 vs. 34% in Q2 2013).
• Other Services: Revenue increased Ps. 41.7 million in Q2 and Ps. 90.8 million in H1, driven by management services for gas trusts, compression/treatment services, and telecommunications.

Cost and Expense Increases:

• Cost of Sales: Increased Ps. 351.1 million in Q2 and Ps. 663.5 million in H1. Primary drivers were higher variable production costs in the Liquids segment (due to increased natural gas prices for the Cerri Complex), higher export taxes, labor costs, and turnover taxes.
• Financial Results: H1 2014 net financial expenses surged to Ps. 542.4 million due to a Ps. 282.3 million increase in foreign exchange losses caused by local currency devaluation and Ps. 69.3 million in negative results from derivative instruments. Q2 2014 saw an improvement in financial results compared to Q2 2013 due to lower FX variation and debt principal cancellation in May 2014.

Outlook, Risks, and Management Commentary

Tariff and Regulatory Environment:

• Resolution No. I-2852 established new rate schedules with stepped increases (8% starting April 1, 14% starting June 1, 20% starting August 1, 2014). Management notes this is a partial application of the 2008 Transitional Agreement and does not fully compensate for sustained increases in operating costs.
• Delays in implementing tariff increases and rising fixed costs in the Transportation segment contributed to an operating deficit in that segment.

Liquidity and Capital Resources:

• TGS cancelled Ps. 762.5 million of financial debt principal in May 2014, which significantly reduced its U.S. dollar-denominated net liability position.
• Cash and cash equivalents decreased by Ps. 261.0 million in the period, primarily attributed to this debt repayment.

Risks and Contingencies:

• Foreign Exchange Risk: Significant exposure to Argentine peso devaluation against the U.S. dollar, impacting financial results on dollar-denominated liabilities.
• Regulatory Risk: Dependence on ENARGAS for tariff approvals; current rates may not cover cost increases.
• Forward-Looking Statements: Management warns that actual results may differ materially from projections due to known and unknown risks.

Investor Verification Checklist

• Debt Reduction Impact: Verify the extent to which the May 2014 debt cancellation (Ps. 762.5 million) has reduced future interest and FX exposure.
• Tariff Adequacy: Assess whether the new stepped tariff increases (Resolution I-2852) are sufficient to cover the sustained rise in fixed and variable operating costs in the Transportation segment.
• FX Sensitivity: Monitor the volatility of the Argentine peso against the U.S. dollar, as this remains a primary driver of net financial expenses and overall profitability.
• Liquids Margin Stability: Confirm the sustainability of the Liquids segment's revenue growth, which relies heavily on international reference prices and FX rates.
• Cash Position: Review the company's liquidity position following the significant cash outflow for debt repayment to ensure sufficient working capital for operations.