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, 2014
Business Overview: TGS operates in Argentina, primarily engaged in natural gas transportation and the production/commercialization of natural gas liquids (Liquids). The company also provides midstream services (gas conditioning, compression) and telecommunications. The financial statements were prepared in accordance with IAS 34 and subject to a limited review by Price Waterhouse & Co. S.R.L.

Key Financial Metrics

Revenue and Profit (Six Months Ended June 30, 2014):

• Net Income: Ps. 37.3 million (down from Ps. 93.3 million in H1 2013).
• Operating Profit: Increased by Ps. 226.6 million compared to H1 2013.
• Net Financial Expense: Increased by Ps. 324.9 million year-over-year, driven primarily by foreign exchange losses.
• Income Tax Expense: Ps. 14.7 million (down from Ps. 54.4 million in H1 2013).

Segment Performance (H1 2014 vs. H1 2013):

• Natural Gas Transportation: Revenues increased by Ps. 27.9 million. This segment represented 16% of total revenues (down from 26% in 2013).
• Liquids Production & Commercialization: Revenues increased by Ps. 781.9 million, accounting for 77% of total revenues (up from 70% in 2013). Growth was driven by foreign exchange rates, higher international reference prices, and increased volumes.
• Other Services: Revenues increased by Ps. 90.8 million.

Cash Flow and Liquidity:

• Operating Cash Flow: Net increase of Ps. 274.6 million, primarily generated by the Liquids segment.
• Financial Activities: Cash outflows were driven by the cancellation of financial debt principal in May 2014 and dividend payments.

Debt and Capital Structure:

• Debt Restructuring: In February 2014, TGS issued 2014 Notes (US$255.5 million) to exchange a portion of outstanding 2007 Notes. The exchange offer acceptance rate was 67%.
• Net Liability Position: The company holds a U.S. dollar-denominated net liability position, exposing it to significant foreign exchange risk.

Material Changes vs. Prior Period

Decline in Net Income: Despite a Ps. 226.6 million increase in operating profit, net income fell by Ps. 56.0 million. This was primarily due to a Ps. 282.3 million increase in foreign exchange losses resulting from the devaluation of the Argentine peso (approx. 25% higher devaluation in H1 2014) and Ps. 69.3 million in negative results from derivative financial instruments.

Cost Increases: Cost of sales and administrative expenses rose by approximately Ps. 663.5 million. Key drivers included:

• Higher variable production costs in the Liquids segment due to increased natural gas prices (Replenishment Thermal Plant).
• Increased export taxes and turnover taxes due to foreign exchange rate variations.
• Rising labor and fixed costs.

Tariff Adjustments: ENARGAS Resolution No. I-2852 established progressive tariff increases for natural gas transportation (8% in April, 14% in June, 20% in August 2014). However, management notes these increases do not fully compensate for sustained operating cost increases or comply with the retroactive provisions of the 2008 Transitional Agreement.

Outlook, Risks, and Management Commentary

Regulatory and Legal Risks:

• Tariff Dispute: TGS filed a motion for reconsideration with ENARGAS regarding the methodology to recover tariff increases effective retroactively from September 1, 2008, as per the 2008 Transitional Agreement. The company is also negotiating the Integral License Renegotiation Agreement.
• Legal Claims: Significant provisions exist for tax contingencies (Ps. 46.3 million for turnover tax on liquids; Ps. 93.7 million for fuel tax). A preliminary injunction regarding Presidential Decree No. 2067/08 was confirmed for six months but is under extraordinary appeal.
• ICSID Arbitration: The arbitration claim by Enron Corp. and Ponderosa Assets against the Argentine Republic was suspended until January 12, 2015.

Management Strategy:

• Focus on implementing the 2008 Transitional Agreement and negotiating the Charge for Access and Use (CAU) adjustment.
• Continued management of pipeline expansion works under the Gas Trust Fund Program.
• Efforts to restrain operation and maintenance costs while ensuring system reliability.
• Monitoring the economic-financial situation to manage resources efficiently.

Investor Verification Checklist

• Foreign Exchange Exposure: Verify the current Argentine peso to U.S. dollar exchange rate and its impact on the company's dollar-denominated debt and net liability position.
• Tariff Resolution Status: Monitor the outcome of the motion for reconsideration filed with ENARGAS regarding the 2008 Transitional Agreement and the potential for retroactive tariff recovery.
• Debt Maturity Profile: Review the specific terms and maturity dates of the 2014 Notes and remaining 2007 Notes to assess refinancing risks.
• Legal Provisions: Assess the likelihood of the tax contingencies (turnover tax on liquids and fuel) becoming actual liabilities and the potential for recovery through tariff adjustments.
• Liquids Segment Margins: Analyze the correlation between international natural gas liquid prices and the company's cost of natural gas inputs (RTP) to evaluate margin sustainability.