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PGNiG – 3Q19E results preview

We are getting increasingly bearish on natural gas prices and currently think a material rebound in gas prices in Europe is pretty improbable unless strong winter kicks in and the heating seasons proves demanding. But even in such circumstances, we think that any possible gas price rebound could unfortunately prove to be only a temporal one.
Based on the recent data from Gas Infrastructure Europe it can be estimated that the European gas inventories are at a higher level in a yoy comparison by an incredible 19% and that they are currently approaching historically unmatched levels of 97% of registered European storage capacity. All this is happening as a direct consequence of increasing LNG competition on global markets driven by a strong acceleration of LNG exports from the US. The LNG export terminals in the US should double their capacity this year and reach an annual export capacity of over 90 million cubic meters. While it can be expected that only part of the additional LNG exports from the US will reach Europe and a lot will depend on gas pricing but a few strong arguments point to Europe as becoming a potentially important importer. Firstly, Europe has over 200 billion cubic meters of installed LNG import capacity and has historically utilized only a third of its total import abilities. Secondly, we think the LNG exports prices from the US are at a competitive level in comparison to Gazprom’s contract prices. Thirdly, Europe, based purely on logistical costs, is a cheaper export target than Asia. Finally, the ongoing trade war between the US and China is perhaps a sign that Europe may be a preferred destination based purely on political reasons.
But even if we were to assume that in the future the majority of the LNG exports from the US were to avoid Europe, this should still have an indirect negative impact on European gas prices by creating a structural cap on prices on the continent. Please recall that the shale revolution in the US already brought irreversible LT structural changes in the crude oil value chain. We strongly believe that the introduction of additional LNG trade should lower global LNG prices by creating stronger market competition in a similar fashion as it occurred a few years ago on global crude oil markets (which could be devastating news for global natural gas upstream producers).
Based on our negative view on natural gas prices and based on our 12M EFV of PLN 4.25 per share, we reiterate our LT fundamental Sell recommendation and our ST Underweight-bias for the stock. Please note that we also see a couple of Company-specific arguments which are also worth considering.
Based on current PPE forward gas contracts we estimate that the weighted average gas prices on the PPE in 2020 could drop by 10% in comparison to the levels recorded this year. It should be remembered that a considerable portion of PGNiG’s industrial clients have gas prices which are tied to forward contracts on the PPE and a big portion of these had been signed in 2018 at a time of excessively high spot gas prices. It should also be borne in mind that the expected drop in the PPE gas prices are likely to have a negative effect on retail gas tariffs, which we think are unsustainable at current levels.
Based on management declarations, the bulk of the Company’s hedging gains this year is tied to strong US$. Assuming in 2019 the Company manages to record FX and hedging gains tied to natural gas purchases of a total of PLN 550 million, this will work as a demanding historical base for the year 2020. Please note that the hedging gains are unsustainable, unless the US$ appreciates beyond US$ 4.0 per PLN.
Based on our estimates the Company’s distribution segment has small chances of improving next year’s EBITDA due to the fact that the drop in distribution tariffs occurred this year in mid-February. The results in 1Q19 which were not necessarily impressive will unfortunately work as a demanding historical base.
We still assume PGNiG will win the Arbitrage case against Gazprom and obtain a 9% drop in the Jamal contract formula and simultaneously get a PLN 2.7 billion one-time retroactive payment in 2020. Our impression is that such an assumption is getting increasingly optimistic (also please note that this implies that our estimated forward multiples for the Company may not be credible).