Argentina's Errant Energy Policy

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many of my friends working in the US are asking me about Transportadora de Gas del Sur (NYSE: TGS). The Buenos Aires based company which transports and processes natural gas is the only US quoted Argentinean utility that has been profitable during Kirchner's administration. But, is it a good equity idea at current market prices? I will try to answer that question in this post. I hope this serves as a valid answer to my US based friends.

Argentina's energy policy is simply unsustainable. It works essentially like this: most end users pay a very low tariff for their gas and electricity usage while the government pays utility companies such as Pampa Energia (NYSE: PAM) or Edenor (NYSE: EDN) (which is an electricity distribution network controlled by Pampa), the difference between their operating losses and break even through subsidies. At best, utility companies do not make money at all. Actually, most of them have operating losses and the situation is getting worse every year. Corporate costs are soaring thanks to Argentina's unsustainable inflation rate (which is running up at a 25% yearly rate) and the government refuses to grant the tariff increases utilities need to survive. Of course the real depreciation rate of the assets these companies own and Argentina's infrastructure is deteriorating at an unsustainable rate. As Returns on Invested Capital are below zero for almost all utilities, companies do not spend as much in Capex as they should in order to sustain their current capital base.

The natural result of the facts stated above is that, as I mentioned in the beginning, Argentina's energy policy is completely unsustainable. Now it seems that the time has come for a policy change. The reason is that the Argentinean government is, for the very first time in many years, running a primary budget deficit (I expect it to be around 1% of GDP in 2013) and subsidies are the main problem. If you look at the national budget carefully, subsidies already account for over 3% of national GDP. Cutting subsidies and increasing tariffs doesn’t mean that utilities will start making actual money, but it could be the beginning of a new era.

In 2012, according to my 4Q estimates, the utility conglomerate Pampa should be showing a -7.3% net income margin despite its 30% Year over Year (YoY) revenue growth. Numbers for the electricity distribution network Edenor should be even worse. Edenor grew revenues by 31% YoY, but it should be posting a -15.4% net income margin for the year that ended in December 2012. Free Cash Flow yields were also tough for most companies in the sector so losses are not just an accounting problem.

Transportadora de Gas del Sur is a very different story. The company grew revenues by 46% YoY and it should be posting a 10% net income margin and positive operating cash flow. Being the only company that looks very far from a near term default and a potential nationalization process, it’s the best way to wait for a normalization of Argentina's energy policy. At some point it must happen. Maybe not during Mrs. Krirchner's mandate (which is going to be her last one unless she reforms the constitution), but it has to happen because Argentina's energy policy is just inconsistent. Trading at 1x Price to Book Value and at 2013 6x P/E, Transportadora de Gas del Sur is a bet that makes sense; if you can bear the risks.

martinzaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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