Pampa Energía (NYSE:PAM) is an Argentinian diversified player in the country's energy market. Pampa participates in oil and gas production, gas transportation, electricity generation (hydro, thermal and renewable), electricity transportation, and petrochemicals.
All of the segments the company operates in are under heavy government regulation. Because the government kept prices low in 2020 to fight COVID, PAM's earnings suffered considerably.
We believe the government is already allowing some of PAM's segments to recover profitability in order to attract investments. However, PAM's stock price has not yet reflected these changes.
Pampa is interesting for investors looking for a diversified play in the Argentinian energy sector. However, pure plays in each segment also trade in the US and may be more desirable.
Note: Unless otherwise stated, all information below has been obtained from PAM's filings with the SEC.
Most of the Argentina energy sector companies were born in the 1990s as a result of the privatization process of the whole industry. After the 2001 financial crisis, the government increased regulation of the sector, particularly in price of sales and inputs.
Until 2013, the government prioritized cheap energy over the sustainability of the system. Most segments were relatively unprofitable, some more than others. Particularly harsh was the situation of the distributors, those whose prices directly affected consumers and industries.
After 2013 the strains of the energy system became apparent, with generalized and recurrent power cuts in most big cities and oil and gas import deficits. From 2011 onwards, the confirmation of the feasibility of exploiting the Vaca Muerta basin also attracted interest in the oil & gas sector.
These resulted in the government changing strategy, and allowing a higher degree of profitability in hydrocarbon production and electricity generation.
The government that took office in 2016 marked a further change in policy. Profitability was recovered across all segments and several public-private participation projects were commenced. This resulted in increased profitability but also in a change in market psychology that then valued most Argentinian energy companies at lofty multiples.
The market situation began to revert in 2018 with the Argentinian financial crisis. It further deepened when the new government of 2020 returned to more heavy control policies.
Particularly, the government elected in 2019 (now in office) made use of price freezes, combined with heavy inflation (36% in 2020, 52% in 2021), to reduce profitability across all segments. These measures generated fears across market participants that the same policies applied between 2002 and 2013 were back for good.
Finally, in 2021, with the COVID crisis relatively surpassed, and economic indicators showing some recovery, the government started showing signs of better policies towards energy. Particularly, it allowed increases in gas & oil production, and in energy generation. Although these increases do not cover what was lost, they do show that the government is willing to sustain profitability in certain segments it considers strategic. In other segments, profitability is still lagging, mainly because they more directly affect consumers without improving the trade balance of the country (electricity transportation and distribution).
Pampa is different from other Argentinian companies in the fact that it presents its financial information directly in dollars. This is a very debatable issue given that Pampa's functional currency is the Argentinian peso and that Argentinian pesos are not freely convertible to dollars.
The government only allows the purchase of dollars at the official exchange rate (the one used by Pampa to convert its accounts) for authorized imports and payments of debt. That means Pampa's costs are indeed tied to the official rate.
However, the government does not allow companies or individuals to convert free proceeds into dollars at the official rate or at any rate actually. They may access the financial rate, 100% above the official one, and with important restrictions as well.
Another problem is the possibility of sudden depreciation of the Argentinian peso, given that some of Pampa's revenues are peso denominated. Currently, the premium of the free exchange market (not exactly free but freer than the regulated one) is above 100%. Additionally, while the 2020 depreciation of the official exchange of 42% was somewhat in line with the year's inflation of 36%, 2021's devaluation was only 22% against 52% inflation.
Therefore, it can be confusing to apply the same exchange rate to both expenses and free cash flows or free use assets (like cash balances).
Not only this, PAM's interim statements are presented in pesos, converted from dollar interim statements, from operations originally in pesos. They make no mention of the inflation adjustment that makes comparisons with previous periods easier, usually applied by other companies (IAS 29, financial reporting in hyperinflationary economies).
We think this form of presentation is incorrect and although comparisons in an inflationary context are always complicated, automatically converting all accounts to dollars does not reduce but increases complexity.
We will analyze this subject segment by segment. In the meantime, an approximation was given by Pampa on its last annual report. According to Pampa, a 10% depreciation of the peso should reduce net profits by $7 million.
This is Pampa's biggest segment according to revenue and profits. It includes participation in hydro, thermal and renewable projects. In total, Pampa has an installed capacity near 5000 MW, or 12% of the country's generation capacity. Thermal generation accounts for 75% of the capacity.
Generators sell most of their production to CAMMESA, a state owned company that stands in the middle of the market buying from generators and selling to distributors and big users. Generators can also sell part of their production directly to big consumers.
CAMMESA and the Secretary of Energy have the ability to set prices in the market, either spot sales or installed capacity compensation. In general across all regulatory environments, CAMMESA has set differentiated prices depending on the particular technology utilized, therefore not benefiting the more efficient producers.
In 2020, CAMMESA converted most contracts, signed between 2016 and 2019, from dollar based to peso based. In doing so, CAMMESA also reduced the prices paid for electricity by four times. To further reduce profitability, CAMMESA did not increase the price paid for electricity during 2020.
This can be easily appreciated from the table below. Something similar happened to generated electricity compensation, falling from the $2 to $7 per MWh payable in dollars towards the $1.5 to $3 range, payable in pesos.
This dynamic generated an operating income of $240 million for the segment in 2020 against $322 million in 2019.
Only in May 2021 has CAMMESA offered to increase prices by 30%, conditional to companies signing a waiver against future claims of automatic inflation adjustments.
However, one of Pampa's generation segments has not been so affected. That is, supply contracts. These are contracts signed with CAMMESA for specific generations projects that were not modified. Many of these contracts are payable in dollars. Additionally, this segment also contains private agreements with big users that are also payable in dollars.
This strategy has allowed Pampa to sustain prices and profitability. 3Q21 nine-month accumulated operating profit is already $275 million, against $240 million in the whole 2020.
However, CAMMESA has also mandated that contracts should not be renovated, and that once they are finished, the generators should sell the capacity at the spot rate.
Regarding exchange rate risks, this segment is compromised, because most of its revenues are peso denominated and not automatically adjustable. Costs on the other hand are tied to the dollar because gas is paid in dollars.
If and when after the depreciation the government will allow for price recovery in pesos is an uncertain scenario.
However, prices are better than in the period from 2002 to 2015. For example, while Pampa's reported average gross margin per MW/h in the segment was $10 in 2013 or 2015, it was $33 in 2019 and $35 in 2021 (with the official rate).
Also related, according to several investments disclosed by Pampa we can estimate that each MW of capacity requires an investment of $1 million. With a gross margin of $20 (considering devaluation), to repay the investment requires 50 thousand MW/h which in turn amounts to 2000 days or 5.7 years.
If the investor was interested particularly in the Argentinian electricity generation sector, a more pure play is available, Central Puerto (CEPU).
CEPU's operations are not that different from Pampa's in the generation sector. Both companies have a thermal matrix (70%) with a smaller component of hydro and even smaller of wind. Both companies operate under the same regulatory environment.
However, what is concerning is that CEPU's financials (in adjusted pesos) actually show a completely different picture from that of Pampa's financials.
According to their latest interim report, CEPU's operating profits have actually fallen in real terms. That is, if we adjust the operating profit of last year in pesos by inflation, it is higher than today's operating profit.
In the same industry, same period and under similar conditions, Pampa's revenues (dollar denominated) have grown more than 40% and operating profit above 30%.
It seems that Pampa benefiting from the accounting of the situation prevalent in 2021, when the dollar has not depreciated that much (22%) but inflation has been high (52%).
Pampa participates indirectly in the electricity transmission segment, because it holds a 27% stake in Transener, the only operator of the Argentinian transmission network. Transener's financial statements can be found in Argentina's CNV website, in spanish.
Transmission is one of the most damaged sectors, because it is nearer to final consumers that the government is trying to shield from price increases. Transener rates have not been adjusted since August 2019. In the meantime cumulative inflation can be as high as 160%.
The result has been that this year, up to the third quarter, Transener has presented a net loss for the first time in several years. Operating income has fallen 75% from that of 2020 in real terms.
According to Transener, a new regulatory agreement is being discussed with the new government (already almost two years in the process). However, given the government's reluctance to abide by its word, it is unclear whether a new agreement will be of any planning use.
Transener does not trade in the US and therefore foreign investors cannot concentrate on it if they desired to. Anyways, Transener is one of the least profitable sectors of Argentinian energy.
Pampa had a 50% stake in Edenor (EDN), the distributor responsible for half of the metropolitan area (9 million people). Pampa agreed to sell its position in Edenor to a private conglomerate in 2020 and the sale is still under approval from regulatory agencies.
Definitely the worst segment, historically, has been distribution, particularly in the metropolitan region. Because distribution prices directly affect consumers, the government has had a zero profitability policy with distribution companies.
We have analyzed EDN in detail for Seeking Alpha, but to summarize, the company has not been allowed to have real profits since the 2002 period. When the government allowed the company to increase prices it was only under the commitment to sustain significant capital investments.
The company today trades at a meager $300 million market cap because there are significant doubts that it will ever be profitable. EDN has also expressed on its financial statements since 2020 that there are doubts about its capability to continue as a going concern.
Pampa sold its majority stake in the company in 2020, however the transition period has not ended yet. Since 2020, the company has deconsolidated EDN operations.
In our opinion this has been a wise decision because the government and the public consider EDN to be the epitome of selfish pursuit of profits, and it is very improbable that they will allow the company to have even meager returns.
To summarize, TGS owns and operates the pipelines connecting three hydrocarbon basins (Vaca Muerta, San Julian and Austral) with the country's capital and to one of the country's main hydrocarbon export centers and deep-water ports (Bahia Blanca). TGS also operates an LNG plant in Bahia Blanca from which it can liquify natural gas for its export.
Both gas distribution and gas liquefaction are regulated. Particularly, the government asks TGS to sell part of its LNG at reduced prices in the interior market. The government has not actualized the prices paid for gas transportation, that remain at the levels of 2019.
Therefore, TGS's business has leaned more and more in the liquefaction segment, which now represents 60% of revenues. Because this segment can export, and therefore can increase prices, is the one sustaining TGS profitability.
Thanks to liquefaction, TGS was able to increase its net profit even although gas transportation is losing revenue in real terms. Up to 9Q21, TGS has produced AR$12 billion in net income, or some $60 million dollars at the free exchange rate (Pampa reports $120 million). Either figure, Pampa owns 27% of that profit.
We could consider that TGS is in the petrochemistry business, but apart from that participation, Pampa directly owns three plants dedicated to the production of several petroleum products. Pampa is the only national producer of styrene and polystyrene.
This segment is the least regulated of all although Pampa actually has a domestic monopoly on production of styrene and its derivatives.
The segment has enjoyed both price and volume recovery, and profits this year may quintuple those of 2020. Current profits up to 3Q21 amount to $24 million against $5 million in the same period of 2020.
The final segment we will be covering. We have inverted the name because 90% of production and revenue in this segment comes from gas rather than oil. In fact, Pampa sold a significant part of its oil fields in Vaca Muerta to Vista Oil & Gas (VIST).
The Argentinian government also intervenes heavily in oil & gas, but its objective is different from other segments. For example, during the 2020 oil sell-off the government set a minimum price of $45 per barrel.
In the gas segment, the government offers supply contracts under the plan GasAr. The plan sets a minimum daily dispatch according to season and a price to be paid for those dispatches. The price usually follows the international price of gas. Participants in GasAr also have export priorities once they have covered their contracted quota for the domestic market.
According to data from 3Q21 the company currently produces 7.6 million cubic meters of gas and 4.5 thousand barrel equivalents per day. This is close to Pampa's estimates for the following winter (June to August) when it has committed to deliver 9 million cubic meters of gas per day.
The price of gas has followed the international price. While the average price received in 2020 was $2.3 per MMBTU, the average for the first nine months of 2021 was already $3.8.
Pampa also reports a cost per barrel equivalent of $15. One barrel equivalent is 5.8MMBTU. Therefore if the company sells 5.8 MMBTU it can receive $20.3, against a cost of $15. That is an operating income of $0.9 per MMBTU.
With MMBTU being equivalent to 28 cubic meters of gas, and commitments for some 8 million cubic meters per day on average, or 285 thousand MMBTU, that amounts to an operating profit of $257 thousand per day or some $100 million per year.
However, Pampa currently reports operating profits well above this number, which is probably explained by peso to dollar conversion mechanisms.
Foreign exchange risk is much lower for the oil & gas segment given that revenues are payable in US dollars. We expect that a devaluation would not affect this segment that much.
The last report of available reserves filed by Pampa dates to April 2021, when it reported total proven reserves (developed and undeveloped) for 22 billion cubic meters. At a consumption of 9 million cubic meters a day, that amounts to some 6.5 years of operations with no new reserves added.
This is a topic to follow closely because Pampa has reduced investment in exploration and development between in 2020 and has only ramped it up in 2021, but with results not published yet.
As can be seen from the table below, in 2020 reserves did not fall because there were significant revisions and improved recoveries accounted for, but little new discoveries, compared to 2019.
Pampa's long term debt stands $1.4 billion at 3Q21, at an average rate of 7.5%. This debt is mostly dollar denominated, so there is no risk of over or under calculation.
The situation does not seem difficult to handle given that Pamps currently hold more than $500 million between cash and fair value securities (mostly government bonds to pay for receivables).
Additionally, Pampa has been buying back stock for the last three years, when the stock price fell from its heights of 2017. Specifically, the company bought $340 million in 2018, $140 million in 2019, $100 million in 2020 and $60 million in 2021.
Pampa operates in several segments, some of which are more profitable than others, depending basically on decisions from the government.
Therefore the fundamental risk of Pampa is government risk, that is, what will the government determine to be a desirable profitability and investment level for each of the sectors Pampa operates in.
Particularly important for their weight in Pampa's investments are generation and oil & gas.
In the case of oil & gas, we have established an operating profit forecast near $100 million yearly. We believe this to be a conservative approach given that it uses current proven reserves and an average MMBTU price of $3.5
In the case of generation, as we have seen there are concerns about the use of dollar denominated financial statements over appreciating earnings. Because there is a comparable company under the same regulations, with similar assets and generation capacity, CEPU, that reported lower earnings, against PAM's higher earnings in this segment, we call for caution.
Particularly, CEPU reported operating profits 50% lower in 2021 than those for 2020. We prefer to use a similar approach and discount 2020's operating profits by half. Therefore based on figures already presented, $240 million in operating profit in 2020, we consider it conservative to use a $150 million figure.
In the case of petrochemistry, prices and volume recovery call for a good year, with $40 million in operative income.
Finally there are the unconsolidated subsidiaries. In the case of Transener, the company has recorded losses this year. In the case of TGS, the company managed to produce profits based on its liquefaction segment. Particularly, from these two companies Pampa accounted for $35 million in earnings.
Therefore we come to a conservative estimate of $325 million in operative earnings plus subsidiaries net income. From these we have to subtract $110 million in interest payments yearly ($1.4 billion by 7.5%). We arrive at income before taxes of $215. Finally, applying the income tax rate of Argentina (30%) we arrive at a net income of $150 million.
The company currently reports a market cap of $1 billion. Therefore according to current income the company is in value price area. The investor should then consider if events will probe similar, better or worse.
For the better, we could see recovery in the generation and transportation segments, if the government decides to increase prices. This of course is difficult to predict and very uncertain.
For the worse, gas prices could fall, given that they are in the upper range of the last 10 years price history. According to data from the company, the break-even price of gas is above $2.7 per MMBTU but we believe it should at least be $3 for the company to be profitable.
Also, if generation and transportation do not receive price adjustments, their operating profits will continue to fall in dollars.
We believe Pampa is an interesting speculative option with some downside protection for someone betting on Argentinian energy. However we also believe there are pure play options (like CEPU, VIST, TGS) on each segment that could provide the investor with more refined strategies.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.