2023-03-20 03:31:33 ET
Summary
- Pampa Energía is an Argentinian conglomerate participating in energy generation, natural gas production, petrochemicals, and gas and electricity transportation.
- The gas business is particularly valuable because it has hedged most of its production until 2028 at an accretive price of $3.6/MMBTU.
- For the energy and petrochemicals segment, which suffers much higher price risks, my approach is to use ranges of operating profit.
- The company's financial costs should be adjusted upwards because they have been unsustainably lowered by carry trade profits from funds earning peso interest.
- After the adjustments, the company trades at a P/E of 6 for conservative earnings and a P/E of 4.5 for current adjusted earnings.
Pampa Energia ( PAM ) is an Argentinian integrated energy conglomerate.
The company operates in unconventional natural gas production, energy generation, and petrochemicals. Through subsidiaries, it also participates in gas transportation and electricity transportation.
In January 2022, I recommended the stock , which is up 45% since (despite the recent selloff). The company recently published FY22 results. Although the results should be adjusted to accommodate inflation-generated problems, the stock is clearly still undervalued.
Note: Unless otherwise stated, all information has been obtained from PAM's filings with the SEC .
Generation business
PAM has an installed capacity of 5GW (11.5% of Argentina's capacity). That capacity is divided between thermal (3.8GW), hydro (0.9GW), and wind (0.3GW).
Argentina's electricity market is divided into two fixed-price market/contract types: base energy and PPA agreements.
PPA agreements are normal for new capacity and generally have long terms of up to 20 years. Most of the payment is tied to capacity and not to actual generation because the generator is supposed to get repayment for the capital invested. These contracts are also hedged from political risk (as of 2023) because no government has ever challenged or modified the terms of a PPA contract.
Base energy markets pay a fixed price for capacity and a variable price depending on generation. The prices and formulas have been changed many times in the past 20 years. Further, sometimes the price adjustments have been in line with inflation while sometimes not. The current scheme puts more weight on capacity than on generation, which tends to penalize more efficient operators (whose capacity is more demanded) against less efficient ones (only asked to generate under supply-strained conditions).
In both types of agreements, the fuel prices are hedged for the thermal generator. Under the base energy markets, the national grid company (CAMMESA) purchases all electricity from generators and provides all the fuel to generators, while under PPA contracts, the generator might need to purchase the gas but is then compensated on the price received for the electricity.
The company's hydro production is tied to base energy prices, the wind portion is tied to PPA, and the thermal is divided (2.7GW base, 1.1GW PPA).
The PPA portion is relatively hedged in dollar terms because the costs are relatively fixed, as are prices (usually dollar-denominated).
The base energy operations are different. They carry a lot of price risk.
First, on an operational basis, their gross margins variate depending on how much the price adjustment follows inflation. Argentina's inflation currently runs at 6% a month, so a few months of under-adjustment are enough to eat all gross profits. The government has been relatively fair and adjusted prices every few months. Still, risks exist. For example, the government announced plans to increment prices by 60% for FY23, but inflation is already at a 102% annualized rate.
The second risk is that of dollar conversion. Argentinian peso prices of the base energy market sometimes rise faster and sometimes slower than the AR$/US$ rate, further increasing variability.
As of FY21 and FY22, PAM generated approximately $350 million in operating profits from this segment. In FY20, when prices remained frozen much longer, the company generated $240 million in operating profits , with substantially the same total capacity. In my opinion, these could work as ranges of price risk.
Finally, this segment risks losing the hydro concessions, which must be renovated between 2024 and 2029. The risk that the concessions will not be renewed is substantial, given that Argentinians are not very fond of public concessions, preferring direct public administration. YPF ( YPF ), the Argentinian public-private energy giant, has an electricity generation subsidiary that could step in and get the concession (making Argentina's capitalists and statists happy).
In my opinion, though, the loss will not be substantial. The hydro plants generate significantly below their stated capacity because the rivers feeding them have decreased for decades. For FY22, the sector represented only $8 million in gross margins for PAM. The combined expected loss (high probability of occurrence multiplied by low damage if the event occurs) is low.
Natural gas
PAM produced 127 billion cubic feet of natural gas in 2022, 22% above 2021. The company also produces oil, but at a much smaller scale (2 million barrels in 2022).
All of the production is obtained in Vaca Muerta, Argentina's unconventional play, and approximately 70% comes from PAM's operated properties (particularly 66% from El Mangrullo), while the rest comes from participations.
PAM's cost of sales per thousand cubic feet has remained relatively constant at around $2.8 (including all oil extraction costs). This is above the price of Henry Hub natural gas as of this moment.
However, PAM's production is completely hedged at average prices of $3.6 per thousand cubic feet, thanks to long-term contracts with the Argentinian government until 2028 (the GasAr Plan contracts). The hedge even covers the expansion of production because the company was granted contracts for 413 million cubic feet daily going into 2028, 20% above the average production in 2022.
The remaining production can then be sold at spot rates or exported to Chile, contingent on Argentina's supply being covered (which is almost a certainty given that the country sits on top of one of the largest shale gas deposits on earth).
At the gross profit level, the contracts represent $120 million in gross profits yearly but leave all oil production to be sold at no cost (the oil production costs are already included in gas costs). Considering 6.4 thousand barrels produced per day (20% above 2022 production), it represents an additional $152 million with $65 per barrel prices.
Therefore, the company's O&G segment can easily generate $270 million in gross profits. From these, approximately 10% has to be discounted as sales expenses (paid ad valorem), and $72 million in administrative expenses, leaving approximately $170 million in operating profits for the segment.
These operating profits are very hedged because of the GasAr contracts and the low price we are assigning to oil.
Petrochemical and holdings
PAM also owns and operates Argentina's only plant of styrene and polystyrene. This plant suffers from the same problem as the gas segment: peso prices sometimes move faster and sometimes slower than the exchange rate, generating volatile profits in dollars, despite production not changing. What during the upside seems a windfall then eats profits on the downside.
For this segment, I also approach the problem using ranges of operating income, which I believe are between $20 and $50 million, based on prices in the past few years.
Finally, PAM participates in TGS ( TGS ), the Argentinian gas transporter, and Transener, the Argentinian electricity transporter. I have covered TGS in another article recently , expecting $160 million in net income for the long term, or approximately $58 million for PAM at its 36% participation rate. For Transener, I expect $10 million in net income, which translates to approximately $3 million for PAM.
Finally, PAM receives $22 million in management contracts from TGS and TRAN, which is used to offset its corporate expenses.
Financial
A big portion of the company's extreme net income shown in 2022 ($450 million), comes from non-sustainable movements in the financial portion of the income statement.
As of December 2022, the company owes $1.6 billion, mostly dollar-denominated, mostly fixed rate, paying an average of 8.4%. This translates to $135 million in interest costs. The maturities are $193 million in 2023, $210 million in 2024, $85 million in 2025 and 2026, $654 million in 2027, and $293 million in 2029.
The company also has $572 million in assets that are dollar-denominated. Unfortunately, these assets cannot offset the debt's interest cost because no low-risk investment yields 8.4%. These reserves substantially reduce the risk of maturity default and also work as a source of financing for CAPEX in the O&G and generation segments.
Up to this point, a conservative back-of-the-envelope calculation would subtract the $135 million in interest costs from the company's operating profits.
Still, the company only records $50 million in net interest costs. This happens because the company's peso-denominated funds yield a high dollar-denominated rate. The Argentinian interest rate is close to 6% monthly, above the depreciation rate of 5.2% monthly. The result is a massive profit from carry trade that offsets the debt costs. This profit is not sustainable and could very well reverse into enormous losses in dollars if the foreign exchange rate moves faster than the interest rate on peso funds. These movements represent $166 million in PAM's latest earnings report.
Therefore, my take is to eliminate $135 million from operating as interest expenses, given that the company's debts are mostly dollar-denominated and carry a fixed rate.
Conclusions
From the O&G segment, we calculated operating profits of $170 million.
For the generation segment, a low range of $240 million and an upper range of $350 million (or more if the Argentinian economy keeps appreciating).
We assigned a range of between $20 and $50 million for the petrochemical segment.
This adds up to $430 million in the lower range and $570 million in the upper range. We discount $135 million in interest costs from these, reaching $295 to $435 million in after-interest income.
Finally, we apply the Argentinian income tax rate of 35% to reach $191 to $282 million in net income from consolidated operations. The $60 million from the holding are already after taxes. Therefore the final figure for PAM ranges between $250 and $340 million in net income.
The company has 55 million ADR equivalents (converting all shares to ADRs) and trades at $27.6, yielding a market cap of $1.5 billion. Different sites offer different market caps for PAM, which is common for Argentinian companies (probably because they translate the Argentinian peso market cap into dollars using the official exchange rate, which is incorrect).
Therefore, PAM trades at a market cap of $1.5 billion and, according to my calculations, could generate net income ranging from $250 to $340 million. A big portion of that income is almost completely hedged (the O&G portion), and the rest has a sufficiently wide range to accommodate FX price variations (Argentina generally getting more or less expensive in dollar terms).
In my opinion, this represents a very attractive yield, with the possibility of continued expansion, and most importantly, of a multiple to earnings increase.
For further details see:
Pampa Energía Trades Significantly Below Conservative Earnings Estimates