Perusahaan Gas Negara (PGAS IJ)

Perusahaan Gas Negara (PGAS IJ) HOLD (Unchanged) 20 October 2017 Company update Equity Indonesia Infrastructure 130 120 110 100 90 80 70 60 50 StockData Target price (Rp) Prior TP (Rp) Shareprice (Rp) Rp1,840 Rp2,310 Rp1,680 Upside/downside (%) +9.5 Sharesoutstanding (m) 24,242 Marketcap. (US$ m) 3,013 Free float (%) 48.3 Avg. 6m dailyt/o (US$ m) 7.0 Price Performance 3M 6M 12M Absolute (%) -24.0-30.3-34.4 Relative to JCI (%) -26.5-34.6-43.8 52whigh/low (Rp) 3,010-1,405 Oct-16 Nov-16 Nov-16 Dec-16 Jan-17 Feb-17 Feb-17 PGAS-Rebase Major Shareholders Republic Indonesia 57.0% Capital Group 6.8% Estimate Change; Vs. Consensus 2017F 2018F Latest EPS (USD 1.1 1.2 Cents) Vs. Prior EPS (%) (2.6) (14.0) Vs. Consensus (%) - - Source: Bloomberg Mar-17 Chandra Pasaribu PT Indo Premier Sekuritas chandra.pasaribu@ipc.co.id +62 21 5793 1168 Apr-17 Apr-17 May-17 Jun-17 Jun-17 Jul-17 Aug-17 Aug-17 JCI Index-Rebase Sep-17 Oct-17 Challenging times Low demand from PLN Changing regulatory enviroment Potential write off from Muria block Hold maintained, new target price Rp1,840 PLN optimizes cost of generation. PLN, the state-owned electricity company, has reduced gas demand to optimize its cost blended of power generation. The cheapest power generation cost is based on Hydro but highly dependent on rainfall. Second cheapest with abundant of resource is coal-fired power generator. Third option then will be gas due to relative easiness of supply despite geothermal is slightly cheaper. By prioritizing coal and hydro, gas demand from PLN has followed minimum volume based on take-or-pay. In Java, PLN has a combined generating capacity of 33GW while peak load is 25GW in FY16. Therefore, PLN has sufficient room to cherry-pick the lowest generating cost among its several power generating sources. Coal and Hydro are the first priority to supply base load, while gas is used for peakers. Government aims to lower gas price. Currently, the Government is formulating new regulation to lower gas price. So far the proposal stated that transmission fee should be based on IRR of 11%, while margin of distribution is set at 7%. There are no further details on how the calculation will form gas price at the retail end. At this stage, impact on the distribution margin is not clear. However, we see further risk on PGN s distribution margins as the Government is keen to lower input prices to improve competitiveness of several manufacturing industries. Currently, distribution margin of PGN is US$3.2 per MMBTU in 1H17. PGN indicated that distribution margin could potential drop to US$2.0-3.0 per MMBTU. Aiming to boost distribution volume. In anticipating tighter distribution margin, PGN s management aims to increase distribution volume especially aimed towards industrial estate. Demand in industrial estate could come from power generation and direct usage from different industries. In order to be more focused, PGN s management has trimmed its capex to US$300mn for FY17 from US$500mn. The management s message is clear to concentrate on effective effort with immediate impact on volumes. Maintained Hold with new TP Rp1,840. PGN will face strong headwinds from regulatory changes and potential write Kalija pipeline. We have set zero revenue from Kalija starting FY19, but without any write-off of the pipeline. We also assumed that distribution margin will drop to an average of US$2.47/MMBTU. As a result we arrived at a new TP of Rp1,840 and maintain our Hold call on the counter. Year To 31 Dec 2015A 2016A 2017F 2018F 2019F Revenue (US$Mn) 3,069 2,935 2,829 2,952 3,083 EBITDA (US$Mn) 959 795 682 731 728 EBITDA Growth (%) (16.0) (17.1) (14.3) 7.3 (0.4) Net Profit (US$Mn) 401 309 257 302 301 EPS (US$Cents) 1.7 1.3 1.1 1.2 1.2 EPS Growth (%) (43.6) (23.1) (16.6) 17.3 (0.4) Net Gearing (%) 53.1 51.3 42.5 35.7 28.1 PER (x) 7.5 9.8 11.7 10.0 10.0 PBV (x) 1.0 1.0 0.9 0.8 0.8 Dividend Yield (%) 9.0 3.2 2.5 3.0 2.9 EV/EBITDA (x) 4.8 5.7 6.5 5.9 5.6 Source: PGAS, IndoPremier Share Price Closing as of : 20-October-2017

Gas power generators for peaker Pembangkitan Java-Bali (PJB), is a subsidiary of state-owned electricity company PLN, an important client of PGN due to significant gas supply to MuaraTawar gas unit. PJB is part of the Java-Bali system that has a total capacity of 36.06GW, with dependable capacity of 33.15GW in FY16. Peak load of Java-Bali system reached 25.05GW in FY16, still below the itsdependable capacity. Therefore, the Java-Bali system has the flexibility to fire up power generation using hydro and coal to fulfill base load, while using gas power generator as peaker. By doing so, Java-Bali system is expected to achieve the highest efficiency in power combination. Based on PLN s annual report, coal and hydro are among the cheapest energy to generate electricity. Hydro power generation cost PLN about Rp272/kWH, while coal cost around Rp532/ /kwh in FY16. Hydro and coal power generation is running best 247, providing base load electricity. Nevertheless, demand of electricity will increase during the night, of which gas power generator could easily switch on to meet peak demand. Gas power generation has the advantage of quick and efficient start up, but the cost itself is significantly higher than coal and hydro, at Rp1,085 per kwh. Fig. 1: Java-Bali system Capacity vs peak load (GW) Fig. 2: PLN power generation cost by energy (Rp/kWh) Source: PJB Source: PLN Since PLN has a healthy margin over its peak load, it increases the flexibility to fire up low cost power generation. Additionally, demand of electricity remained tepid with only 3.1% yoy growth in 9M17. In past decade, demand for electricity has been growing CAGR between 6.7-7.0%. Therefore, electricity demand for this year seems to relatively low, causing PLN to rely more on coal and hydro power generation. Fig. 3: Electricity demand Fig. 4: Dependable power generation by energy (MW) Source: PLN Source: PLN 2

PJB has a total generation capacity of 7.0 GW in FY16, of which 2.7GW is generated using gas. MuaraTawar gas fired power generator has a capacity of 1.8GW, while gas purchasing contract could amount to 400 mmscfd. However, with weak demand and option to used coal and hydro, gas became a least option for power generation. Unless we see strong demand of electricity, we do not expect any significant recovery of gas demand. 3

Government Regulation aimed to lower gas price The Government is keen to see lower gas price to support competitiveness of several industries such as power generation, fertilizer, and petrochemical, since these are basic materials that have long chain of value added. Back in Jun14, when oil price was above US$1000 per barrel, the difference between non-subsidized high speed diesel (HSD) and gas was US$17.9/MMBTU. When oil price dropped to an average of US$50 per barrel in Sep17, the difference dropped to US$9.8/MMBTU, making gas less appealing. Gas price in Indonesia has not adjusted despite lower oil price. We believe that the reason behind this is poor gas infrastructure resulted a highly segmented market. Gas in Indonesia is not easily transferable, unlike fuel which is supported by strong infrastructure. There are three components that formed gas price: 1) gas price at well head, 2) transmission fees and 3) distribution fee. Gas price at well head represents the cost of oil and gas lifting which is determined by production sharing contract (PSC), plus natural condition of the gas itself. For instance, high sulfur content will increase the production cost. According to PGN, cheap gas is not available anymore, with well price at least at US$5-6/MMBTU. Therefore, lowering gas price at well head is closely related with PSC scheme, which is unlikely to change. Transmission fee has been already regulated by the Government, based on a basic formula that reflects IRR = WACC plus margin of 1-3%. Currently, IRR should be running around 11-12% based on WACC in US$ of 8%. Therefore, transmission fee are already regulated with relativee no significant room to lower transmission fee. Despite being regulated, PGN s transmission fee could vary from US$0.5/MMBTU from TGI to US$2.3/MMBTU from Kalija. The value of investment cost plus lifetime of the pipeline will determine transmission fees. This only leaves room for the Government to regulate distribution fees, which has yet to be regulated. Based on our latest discussion with PGN, the Government has proposed a distribution margin of 7%. However, it has yet to be clarified what is the benchmark gas price. It still remains questionable whether this margin could cover business risk in distribution. If the returns do not reflect optimal returns, investors will be reluctant to develop new distribution networks. This will lead to a unsustainable business model. Fig. 5: Price of energy content HSD vs gas (US$/MMBTU) Fig. 6: PGN quarterly distribution volume Source: PGAS, IndoPremier Source: PGAS Currently, PGN s distribution margin runs about US$3..2/MMBTU in 1H17. It remains questionable how the proposed regulation will affect the distribution margin. Nevertheless, PGN indicated there will be further pressure on distribution margin in order to reduce gas price. Increase distribution volume to negate margin pressure PGN s management sees that distribution margin pressure is inevitable. To negate the negative impact on margins, PGN s business plan will be volume oriented. New investment plans will be directed to immediate increase in volume. For this reason, PGN has reduced its capex from US$500mn to US$300mn in FY17. Furthermore, PGN now explores the possibility to distribute gas to industrial estates, due to rapid development of such industrial enclave. PGN expects this business plan to have immediate impact to increase distribution volume. 4

In the 3Q17, PGN was able to distribute 800 mmscfd a significant increase of +49.4% qoq due to higher demand from PLN. However, the spike in demand might not be sustainable as PLN had to fire up gas power due to deficit from hydro from the dry season. As the rainy season has started, the operation from hydro is expected to increase causing demand towards gas to decline. Demand from other sectors such as Petrochem and food manufacturing has increased, but not enough to compensate falling volume from PLN, ceramic and glass industry. Potential write-off from Kalija. PGN has wrote-off US$16.7m due to lower-than-expected reserve from the Muria block. Furthermore, PGN has invested US$275mn to develop the Kalija pipeline. Up to this stage it is still unclear whether PGN will implement any write down on Kalija pipeline. The Muria block is expected to produce 100-110mmscfd up to FY26, but currently productive lifetime is expected only to reach FY18. In Kalija pipeline, PGN holds 80% ownership while 20% is owned by Bakrie Group. Assuming time weighted average of the lifetime of the pipeline, PGN should potential write off US$146mn. Albeit, we have not implement any write offs for the Kalija pipeline. New Target price of Rp1,840 We have lowered our DCF target price to Rp1,840 from previously Rp2,310 due to 1) contribution from block Muria and Kalija transmission revenue only up to FY18. 2) lower distribution margin, assumed at an average of US$2.47/MMBTU, 3) lower capex for FY17. Fig. 7: DCF valuation of PGN 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F PGN Parent EBIT 358 348 394 392 402 369 360 324 Tax on EBIT (72) (70) (79) (78) (80) (74) (72) (65) Depreciation & amortization 351 356 362 370 379 387 395 403 Capital expenditure (320) (320) (370) (370) (370) (370) (370) (370) Working capital changes (6) (2) (8) (3) (6) 1 (2) (3) Free cash flow to firm 311 312 299 310 324 313 311 289 Terminal value 4,916 TGI Net income 58 58 58 58 59 59 59 59 Terminal value 496 EV PGN 4,053 EV TGI 281 Total EV 4,334 Net debt (1,334) Equity value 3,000 Equity value - per share (Rp) @Exr Rp13,000 1,670 Sum of parts DCF of PGN 1,670 Upstream asset 170 Equity per share 1,840 Source: IndoPremier 5

Year To 31 Dec (US$Mn) 2015A 2016A 2017F 2018F 2019F Income Statement Net Revenue 3,069 2,935 2,829 2,952 3,083 Cost of Sales (2,106) (2,048) (2,066) (2,131) (2,250) Gross Profit 963 887 763 822 833 SG&A Expenses (392) (454) (444) (463) (485) Operating Profit 571 433 319 358 348 Net Interest (103) (115) (86) (81) (74) Forex Gain (Loss) (21) (10) (9) 0 0 Others-Net (10) 77 77 80 82 Pre-Tax Income 437 385 301 357 356 Income Tax (35) (76) (44) (55) (56) Minorities (2) 0 0 0 0 Net Income 401 309 257 302 301 Balance Sheet Cash & Equivalent 1,200 1,373 1,195 1,090 1,076 Receivable 387 555 357 373 389 Inventory 43 65 62 59 56 Other Current Assets 92 131 131 131 131 Total Current Assets 1,723 2,125 1,745 1,652 1,652 Fixed Assets - Net 3,508 3,590 3,753 3,807 3,807 Goodwill 0 0 0 0 0 Non Current Assets 801 615 615 615 615 Total Assets 6,438 6,834 6,618 6,579 6,579 ST Loans 0 100 0 0 0 Payable 117 112 0 118 125 Other Payables 429 433 408 411 416 Current Portion of LT Loans 122 171 225 225 317 Total Current Liab. 667 815 748 754 858 Long Term Loans 2,619 2,658 2,327 2,070 1,752 Other LT Liab. 186 191 191 191 191 Total Liabilities 3,472 3,664 3,266 3,015 2,801 Equity 592 599 599 599 599 Retained Earnings 2,428 2,565 2,746 2,959 3,172 Minority Interest 2 7 7 7 7 Total SHE + Minority Int. 3,023 3,170 3,352 3,565 3,778 Total Liabilities & Equity 6,495 6,834 6,618 6,579 6,579 Source: PGAS, IndoPremier 6

Year to 31 Dec 2015A 2016A 2017F 2018F 2019F Cash Flow Net Income (Excl.Extraordinary&Min.Int) 403 309 257 302 301 Depr. & Amortization 485 320 343 351 356 Changes in Working Capital (447) (251) 180 (6) (2) Others (28) 160 85 81 74 Cash Flow From Operating 413 538 865 727 728 Capital Expenditure (855) (216) (505) (405) (355) Others 62 (83) 26 23 20 Cash Flow From Investing (792) (299) (479) (383) (335) Loans 887 189 (377) (258) (225) Equity 16 7 0 0 0 Dividends (271) (97) (76) (89) (88) Others (191) (130) (112) (103) (94) Cash Flow From Financing 441 (32) (565) (450) (407) Changes in Cash 62 207 (179) (106) (14) FinancialRatios Gross Margin (%) 31.4 30.2 27.0 27.8 27.0 Operating Margin (%) 18.6 14.7 11.3 12.1 11.3 Pre-Tax Margin (%) 14.3 13.1 10.6 12.1 11.6 Net Margin (%) 13.1 10.5 9.1 10.2 9.8 ROA (%) 6.4 4.7 3.8 4.6 4.6 ROE (%) 13.6 10.0 7.9 8.7 8.2 ROIC (%) 7.9 5.5 4.7 5.5 5.5 Acct. Receivables TO (days) 34.6 37.8 37.8 33.4 33.4 Acct. Receivables - Other TO (days) 11.4 20.8 21.1 11.7 11.7 Inventory TO (days) 38.7 37.7 32.5 35.2 39.2 Payable TO (days) 22.1 20.4 20.0 20.0 19.7 Acct. Payables - Other TO (days) 17.3 17.1 16.8 14.5 14.3 Debt to Equity (%) 90.7 92.4 76.1 64.4 54.8 Interest Coverage Ratio (x) 0.2 0.3 0.4 0.3 0.3 Net Gearing (%) 53.1 51.3 42.5 35.7 28.1 Source: PGAS, IndoPremier 7

Head Office PT INDO PREMIER SEKURITAS Wisma GKBI 7/F Suite 718 Jl. Jend. Sudirman No.28 Jakarta 10210 - Indonesia p +62.21.5793.1168 f +62.21.5793.1167 INVESTMENT RATINGS BUY : Expected total return of 10% or more within a 12-month period HOLD : Expected total return between -10% and 10% within a 12-month period SELL : Expected total return of -10% or worse within a 12-month period ANALYSTS CERTIFICATION. The views expressed in this research report accurately reflect the analysts personal views about any and all of the subject securities or issuers; and no part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in the report. DISCLAIMERS This research is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty nor accept any responsibility or liability as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendations contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is not and should not be construed as an offer or a solicitation of an offer to purchase or subscribe or sell any securities. PT. Indo Premier Sekuritas or its affiliates may seek or will seek investment banking or other business relationships with the companies in this report.