It’s been almost two years since my last assessment. It was when a big acquisition with Pertagas was taking place. My view at that point was at best neutral, and more to pessimistic. That review is a good refresher to get a general idea if an acquisition makes economic sense, not just subjectively, but also in rough numbers.
PGAS came to my mind after I analyzed ICBP big acquisition which I am pretty sure it would be EVA negative. In my opinion, it would be better for investors to see big acquisition with a heavy dose of skepticism. That is because the company needs to deliver added value more than the premium it paid. The higher the premium, the less likely the acquisition would add value.
In case of PGAS, the big acquisition, as far as the big number tells us, does not change the negative condition of PGAS. If any, it brings additional burden when gas price is low.
Start with EVA. It is clear that PGAS is not economically profitable for many years.
Yes, we saw an improvement in 2018 when the acquisition was taking place. But the improvement is hardly an evidence that Pertagas acquisition adds value to PGAS shareholders.
What happened in 2018? Gas price exploded for a short time. It is no wonder that the biggest gas company Gazprom had similar ROIC profile with PGAS. Although gas price is regulated by local government, it is unreasonable to expect gas company gross margin to stay constant when traded gas price changes. Gross margin does change.
That ROIC chart above is telling me that there is nothing special with PGAS after the big acquisition.
In fact, now the downside of the acquisition is taking place. PGAS is now more capital intensive. It now has about IDR 80 T invested capital that needs to be compensated. The bad news is, PGAS has been earning returns below its cost of capital for years (see ROIC above – PGAS cost of capital is likely around 12%).
This low return condition is very likely to persist for a long time. Because of low gas price. In fact, the management points out that private investors seeking PGAS projects should only aim at IRR 11-12%. That is a break-even proposition. On the other side of continent, Gazprom is putting breaks to its gas production.
But, for reasons that is beyond rational, PGAS investors have been adamant to value PGAS as a value creator as seen by positive MVA for some years.
They were wrong. And then they make corrections. PGAS is now valued as a wealth destroyer, just as what EVA has been telling us for years. It is incredible how investors valued PGAS at 6.000/share in 2014. We are now standing at 1.030/share.
Does that make PGAS attractive? If PGAS is a wealth neutral company, like SRIL, its value would be its invested capital, which would be somewhere between 1.700 – 1900/share. But the fact is, it is not.
I believe the situation would get worse because it would have to invest more and more to produce and distribute more gas. That has been written for PGAS ever since it was obliged by the government to acquire Pertagas. The government has a goal of significant energy expansion by coal and gas. It would be done. And Indonesia is not alone in pursuing this coal and gas strategy. Meanwhile, gas price would still be low which should discourage more investment, and we need to decarbonize. While gas is different from coal, but gas production is producing a much more potent greenhouse gas, methane.
With that being said, as long as more money means more value, EVA will remain to be the main engine of stock market. Aside from a serious GHG issue, the possibility of gas price to stay low for a long time while investments would keep going up means EVA would suffer more in the future, and most likely in this year. With that wealth destroying condition, PGAS should be valued below its invested capital (book value), and I see no margin of safety at current price.
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