GAS TRANSPORTER OF THE SOUTH INC annual report, Q4 FY2018

Business context and reporting period

Transportadora de Gas del Sur S.A. (TGS), translated in the filing as Gas Transporter of the South Inc., filed its annual Form 20-F for the fiscal year ended December 31, 2018. The filing is not a quarterly report; it presents full-year 2018 results with comparative fiscal years 2017 and 2016.

TGS operates Argentina’s largest natural gas transportation system, a regulated liquids production and commercialization business, midstream services and telecommunications. The audited consolidated financial statements include TGS, Telcosur S.A. and CTG Energía S.A. They are prepared under IFRS and presented in Argentine pesos restated to constant currency at December 31, 2018 under IAS 29. Argentina was treated as hyperinflationary effective July 1, 2018; reported comparatives were restated accordingly.

Key financial metrics

Metric	2018	2017	Change
Revenue	Ps. 34,062.7 million	Ps. 19,953.3 million	+70.7%
Gross profit	Ps. 17,874.4 million	Ps. 8,017.6 million	+122.9%
Operating profit	Ps. 14,257.1 million	Ps. 6,204.8 million	+129.8%
Net income	Ps. 11,415.8 million	Ps. 5,751.2 million	+98.5%
Cash flow from operations	Ps. 12,796.6 million	Ps. 5,556.8 million	+130.3%
Capital expenditures	Ps. 8,123.7 million	Ps. 1,941.3 million	+318.5%
Cash and cash equivalents	Ps. 16,644.8 million	Ps. 3,916.7 million	+324.9%
Total debt	Ps. 20,597.1 million	Ps. 6,642.6 million	+210.1%

Calculated margins were approximately 52.5% gross, 41.8% operating and 33.5% net in 2018, compared with approximately 40.2%, 31.1% and 28.8%, respectively, in 2017. The filing does not present EBITDA as a primary consolidated performance measure in the supplied text.

Natural gas transportation: revenue of Ps. 15,462.1 million, up 107.4%; operating profit of Ps. 8,951.1 million, up 310.9%. Firm transportation revenue was Ps. 12,243.7 million and represented 79.2% of segment revenue.
Liquids: revenue of Ps. 16,627.4 million, up 48.8%; operating profit of Ps. 4,690.5 million, up 30.0%. Liquids sales volume increased 14.7% to 1,165,286 short tons, while export revenue was Ps. 6,025.4 million.
Other services: revenue of Ps. 1,810.1 million and operating profit of Ps. 571.0 million, increases of 50.9% and 46.1%, respectively.
Telecommunications: revenue of Ps. 163.1 million and operating profit of Ps. 44.6 million.
Liquidity: operating cash flow covered capital expenditures by approximately 1.6 times. Financing cash flow was positive Ps. 2,049.1 million, primarily because of the 2018 Notes issuance, partly offset by debt redemptions, dividends and share repurchases.
Debt: all financial indebtedness was denominated in U.S. dollars. TGS issued U.S.$500 million of 6.75% senior notes due 2025 and used the proceeds to redeem the 2014 Notes and fund investments. The reported debt-to-capital gearing ratio increased to 0.40 from 0.21.

Material changes versus the prior comparable period

Transportation results benefited from the full-year effect of tariff increases under the 2017 tariff review and additional increases effective April and October 2018. Nominal transportation tariffs increased 79.5% during 2018, and segment operating profit rose sharply.
The tariff renegotiation process, which had lasted approximately 17 years, was concluded when Decree 250/2018 ratified the Integral Renegotiation Agreement. TGS received the final tariff increase but withdrew related claims against the Government, including the ICSID claim.
Liquids revenue increased due to peso depreciation, higher international reference prices and greater sales volumes. However, natural gas input costs, export taxes and regulated domestic LPG sales continued to pressure margins.
Operating cash generation improved substantially, but capital spending accelerated to support the Five-Year Plan and midstream projects.
TGS issued the 2018 Notes, redeemed the 2014 Notes and increased its cash balance. It also paid Ps. 4,329.2 million in dividends and repurchased 13,600,780 shares, representing 1.71% of total share capital at year-end.
Adoption of IFRS 15 and IFRS 9 in 2018 did not materially affect retained earnings or revenue recognition; comparative information was not modified for those standards.

Guidance, outlook, management commentary, risks and unusual items

Management stated that it expected operating cash flows, capital-market access and available financing to be sufficient for working capital, debt service and planned capital expenditures for the foreseeable future, while acknowledging substantial exposure to Argentine macroeconomic conditions.

Planned capital expenditures for 2019–2021 total approximately U.S.$553.6 million, including U.S.$285.9 million for transportation reliability, U.S.$69.7 million for liquids, U.S.$187.1 million for the Vaca Muerta project and U.S.$10.9 million for other services.
The Vaca Muerta gathering and conditioning project has an estimated initial investment of U.S.$260 million and was expected to be completed in the fourth quarter of 2019.
ENARGAS approved a further 26% transportation tariff increase effective April 1, 2019. The tariff mechanism remains non-automatic and subject to regulatory approval.
Argentina’s CPI increased 47.6% in 2018, the WPI increased 73.5%, and the peso depreciated approximately 102.2% against the U.S. dollar. These factors materially affect costs, reported financial results, debt service and comparability.
TGS had a net U.S. dollar liability position of approximately U.S.$194.2 million at year-end. Management estimated that a 10% unfavorable peso/U.S. dollar movement would reduce pre-tax income by approximately Ps. 739.8 million, all else equal.
Government regulation remains significant. Risks include tariff freezes or delays, mandatory investment requirements, restrictions on gas allocation, changes to LPG pricing and export taxes, exchange controls, and possible changes to or revocation of the transportation license.
The Government owed TGS Ps. 292.9 million in LPG-related subsidies at December 31, 2018. Domestic LPG programs may require sales below market prices and can create negative operating margins.
An ICC arbitration award required TGS to pay U.S.$19 million plus interest in connection with gas processing contracts; TGS paid U.S.$21.3 million on June 14, 2018.
A first-instance judgment declared certain natural gas processing charges unconstitutional, but the National Secretariat of Energy appealed. The matter remained pending before the appellate court as of the filing date. TGS had not recorded a liability for the disputed charges covered by its injunction.
Subsequent to year-end, shareholders approved Ps. 6,942.0 million of cash dividends and a Ps. 6,354.1 million voluntary reserve for capital expenditures, share repurchases and/or dividends. A further Ps. 240.5 million dividend was approved by the Board.

Investor verification priorities

Reconcile all 2018 and 2017 figures using the IAS 29 constant-peso presentation and distinguish inflation-restatement effects from underlying operating growth.
Verify the sustainability and timing of ENARGAS tariff adjustments, including the April 2019 26% increase and future non-automatic adjustments.
Assess cash coverage of the U.S.$500 million 2018 Notes, lease obligations, mandatory Five-Year Plan spending and the Vaca Muerta project.
Monitor peso depreciation, inflation, exchange-control risk and the mismatch between peso transportation revenue and U.S. dollar debt and input costs.
Review LPG subsidy receivables, domestic-market pricing requirements, export taxes and international LPG and natural gasoline prices.
Review the status and potential exposure of the disputed natural gas processing charge, turnover-tax claims and other legal contingencies.
Evaluate related-party arrangements, particularly the Ps. 1,317.2 million technical assistance expense paid to Pampa Energía and the related U.S. dollar financial lease.
Confirm the effect of dividends and treasury-share repurchases on covenant compliance, distributable retained earnings and future liquidity.