Any Risk-Tolerant Investor Has to Check out This Pipeline Operator From South America

Horizontal drilling and hydraulic fracturing have boosted oil and gas production in North America, resulting in the need for an expansion of the outdated North American pipeline network. As a result, pipeline operators in North America have attracted investors' attention, and their stocks have risen significantly since 2012. Oil and gas production is growing rapidly in South America too, so I'll move off the beaten path to dive deeper into the details surrounding Transportadora de Gas del Sur (NYSE: TGS  ) , a gem from the midstream sector of Argentina. 

What? 
Transportadora de Gas del Sur is the largest pipeline company in Argentina and operates in three segments: natural gas transportation, natural gas liquid production and commercialization, and midstream services and telecommunications. The largest segment converts natural gas to liquid petroleum, which is primarily sold to the world markets. The company's pipelines transport about 60% of all of Argentina's gas through a 5,671 mile pipeline system; TGS owns 4,744 miles of this. TGS manages the remaining 927 miles for a fee.

TGS is restricted from having its own retail gas business, so it actually transports and resells natural gas to retailers. This sector is run by an oligopoly in Argentina as there is only one other major pipeline operator currently, Transportadora de Gas del Norte (TGN), which operates Argentina's northern pipeline system. So TGN operates a separate pipeline system that is largely non-competing with that of TGS.

This all started back in 2012 when Argentina nationalized YPF (NYSE: YPF  )  without paying a single penny to Repsol. The Vaca Muerta "war" started. Cristina Kirchner, Argentina's President, accused Repsol of fleecing YPF by using too much of its profits for shareholder benefit rather than investing in exploration and turning Argentina into an importer of fuel. Repsol, the Spanish energy giant, owned 51% of YPF, and YPF's assets in the Vaca Muerta basin are believed to be one of the world's largest shale oil and gas fields. Since then, Repsol has initiated legal action against Argentina and YPF and has also threatened to do so against anyone doing business with them.

On top of that, TGS has low awareness, and an investor can hardly find a professional article in the online financial publications detailing its fundamental position, its products, and its services. 

So what? 
This conflict between Repsol and the Argentinean government has negatively affected the valuations of Argentinean stocks traded on the U.S. markets, including Transportadora's. Kirchner's interventionist policies coupled with the company's low awareness have created a buying opportunity for the risk-tolerant investor. It's possible to exploit the pricing disconnect between TGS and the small midstream companies of North America, as illustrated at the table below ($1 = 6.14 ARS): 

Company

PBV

EV/EBITDA* 

($million)

NET DEBT/EBITDA*

($million)

Annual

Yield

SemGroup

Corporation

2.61

 3,080 / 185 = 16.65

470 / 185 = 2.54

1.4%

Crosstex 

Energy  LP

1.96

3,440 / 210 = 16.38

1,040 / 210 = 4.95

5.1%

Holly Energy 

Partners LP

4.75

2,640 / 200 = 13.2

800 / 200 = 4

6.4%

Transportadora 

de Gas del Sur (**) 

1.21

650 / 130 = 5

250 / 130 = 1.92

3%

EV: Enterprise Value
EBITDA: Earnings Before Interest, Taxes, Depreciation, Amortization.
(*) Estimated EBITDA for 2013.
(**) TGS's American Depository Receipts (ADRs) represents five of the company's common shares.

Transportadora has been consistently profitable over the last seven years and enjoys a sound balance sheet. Furthermore, the company can serve its debt and has a solid track record as a high-yield dividend payer for the last five years. 

Now what? 
Big Oil appears ready to handle whatever happens on the legal front between Repsol and the Argentinean government. The exploitation of the Vaca Muerta Basin will demand capital and technology, and Argentina now lacks both. I wasn't surprised when Chevron (NYSE: CVX  ) and YPF signed a memorandum of understanding in late 2012 to explore both conventional and unconventional shale gas and oil.

Chevron moved forward in July 2013 when it signed a deal with YPF to invest $1.24 billion in the Vaca Muerta shale. In August 2013, the Chevron-YPF venture received final approval from Argentina's province of Neuquen. Based on this deal, the venture will drill 115 wells expecting an output of 11 million barrels of oil in the first year. After the first stage ends, Chevron will have an option to continue the accord (which encompasses as much as $16 billion in spending) until 2048. From the second to 35th year, the venture would drill 1,562 wells to produce 782 million barrels at a rate of 23.7 million of barrels a year. 

This is a relatively low-risk investment for Chevron, which knows that YPF has already found both a massive deposit of natural gas that is equivalent to a quarter of Argentina's proven reserves in Vaca Muerta, and an oil deposit of 927 million barrels that represents Argentina's oil consumption for two years. Both discoveries also bode well for Transportadora's business because they are in close proximity to the company's existing lines.

However, Chevron isn't alone. ExxonMobil, which is already exploring for unconventional oil and gas with YPF in Argentina, announced last summer that it plans to invest $250 million to explore the Vaca Muerta shale.

 

It is clear that the international energy players will ramp up their efforts in Argentina, and Transportadora is well positioned to exploit the upcoming tsunami of investment in this South American country, which is struggling to raise the cash it needs to develop its lucrative shale oil and gas resources. 

Foolish takeaway 
The rising tide lifted all the boats in 2013, and many companies reached new highs primarily due to the fact that the S&P hit record levels. However, I strongly believe that 2014 will be a stock picker's market. President Cristina Kirchner also enters her last term, and the current political uncertainties in Argentina will wane significantly over the next two years. As a result, the dominant position in Argentina, in conjunction with the gross undervaluation compared to its peers in North America, make Transportadora a compelling investment at current levels and could push the company's stock much higher in 2014.

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