YPF Sociedad Anonima YPF
July 26, 2011 - 2:12pm EST by
otto695
2011 2012
Price: 42.50 EPS $4.10 $4.55
Shares Out. (in M): 394 P/E 10.4x 9.3x
Market Cap (in $M): 16,774 P/FCF 0.0x 0.0x
Net Debt (in $M): 1,200 EBIT 11,880 15,100
TEV ($): 17,977 TEV/EBIT 1.5x 1.2x

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Description

YPF Sociedad Anonima a cheap, energy company with several catalysts with a safe 8% dividend yield.  Shares in YPF provide a solid value in terms of liquidity in the Argentine stock market and the energy sector in particular.  The company is worth at least $55 to $60 if broken up and $50 when local prices are freed from government control.  This sources of upside potential comes from 1) an upward path of oil, gas, and refined product prices received in the Argentine market, and 2), the positive evolution of international prices for exported products, which mostly follow WTI prices.  Indeed, the high dividend yield makes YPF an attractive income play during the transition years of domestic price convergence to international levels and while wait for other value-creating initiatives.  Downside is $41 or -3.5%.
The Business
YPF is the largest integrated company in Argentina, and almost all its crude oil production is used as feedstock for the refining segment, which represents approximately 82% of the total crude oil processed by its three wholly-owned refineries. Among YPF's strengths are: strategic asset base, strong balance sheet (securing a fat dividend yield), growth potential, management structure, and liquidity. In addition, many believe that the combination of visible investment opportunities, particularly in terms of non-conventional resources in the natural gas segment, and the company's robust financial capacity provides the stock with significant upside risk should the current regulatory environment become more market friendly.
 
In Argentina, YPF's market share is 39% of domestic crude oil production and 36% of natural gas output. Its fully integrated model has proven to be the most adequate in a volatile market where there could be significant distortion in prices between refined products and crude oil while providing an effective entry barrier to potential competitors. The most relevant prices for the company are those obtained in the downstream segment. Indeed, as of 2010, sales revenue amounted to 87.1% from sales of products in the local market, while the remaining 12.9% of sales revenue came from exports (compared with 14.3% and 20.7% in 2009 and 2008, respectively).
 
Over the last several years, hydrocarbon production and reserves in Argentina have declined due to the sustained path of demand (boosted by cheap prices and strong economic activity), which was not accompanied by the supply due to the lack of incentives to promote investments in the sector. Argentina has become a net importer of natural gas since 2004 and a net importer of gasoline since 2010.  Although the government introduced adhoc mechanisms (i.e., Petroleo Plus), this was not enough to boost the necessary investments and mitigate the high fiscal burden that this long-standing policy of cheap energy prices represents for the government.  If you look in 2010, the total energy and transport subsidies increased 43% YoY, reaching US$9.4 billion or 3.6% of GDP. In addition, over the last two to three years, there have been significant local price increases in natural gas, crude oil, and especially refined products. Indeed, in valuing of YPF, it makes sense to assume that this upward trend will continue in the future, with local prices moving toward international levels, but still not achieving import parity. A stronger-than-expected price-increase scenario would not be viable from a political point of view, unless the government decides to decrease taxes charged on liquid fuels that currently hover around 44%, on average, which we do not expect to happen in the short-to medium-term.
 
Regarding crude oil prices, although there is no explicit cap on local prices for oil, the current price is significantly below international references. After the release of Resolution 394/2007, the local price of crude oil hovered around US$42/bbl, as it is the cap price for exports. However, since 2010, local crude oil prices have started to increase to the current level of around US$52-55/bbl, depending on the quality of oil. A few industry guys expect this trend to continue and local prices to rise, but still below our estimate for the WTI price, which stands at US$85/bbl for the long term.
 
Natural gas local prices are regulated depending on the segment.  Currently, YPF sells around 36% of the natural gas it produces to residential customers at US$0.60-0.70/mmbtu, and 52% to industrial customers and power plants at around US$3.00-3.50/mmbtu and US$2.70/mmbtu, respectively; implying an average price of US$2/mmbtu as of 2010. Although the average local price has increased 53% over the 2005-2010 period in U.S. dollar terms, it is still far below international references (currently above US$4.50/mmbtu).  Thus, many expect local prices to gradually increase to US$3.20/mmbtu, on average but still below international references. 
 
Downstream prices. The average price of refined products will likely increase from US$71/bbl as of 2010 to US$102.30/bbl at some point.  This 44% increase is the result of two dynamics: 38% is mainly explained by an upward trend in local prices and the remaining 6% by an improvement in the output-mix. Thus, many estimate the margin per barrel over the local oil price will increase from the current level of US$26/bbl (1Q11) to US$32/bbl by 2017. Theses assumptions imply that after-tax gasoline1 local prices will increase from the current level of US$1.12/liter to US$1.40/liter by 2015 and US$1.60/liter by 2017, in line with international references, but still below import parity.
 
Although there is no explicit regulation that limits prices in the downstream segment, the companies do not have complete discretion over them and the government has intervened in the market on some occasions. In spite of that, over the last three years, gasoline average price increased 42.8% in U.S. dollar terms (45% in the last seven years) and diesel prices increased 58% (71.6%) in the same period.  This upward should trend to continue and many believe YPF should benefit from that, as diesel and gasoline currently represent 60% of the total refining sales volumes.
 
Gasoline and diesel demand increased 73% and 35% over the 2002-2010 period, and many expect this strong pace to continue. YPF should be able to take advantage of this hike, as it is investing approximately US$1.5 billion in the downstream segment between 2010 and 2014 to change its refining product mix. As a result of this, YPF estimates that gasoline production capacity would increase 27% by 2014 (20% by 2013 and 7% by 2014) and diesel production capacity would increase 8% by 2014, both compensated for by a decrease in the fuel oil and virgin naphtha production, which are lower value-added products. For product prices that are linked to the WTI or international references (i.e., fuel oil, bunker, LPG, jet fuel, petrochemicals, among others), we are assuming that their prices will move in line with WTI reference prices.
 
Owner-operators
Repsol is YPF's controlling shareholder with ~58% of its equity, while Grupo Petersen has a 25% stake, and the balance is free float. In 2008, Repsol and Grupo Petersen signed a shareholders' agreement, which, among other things, allowed Grupo Petersen to actively participate in YPF's management and in strategic corporate decisions. Indeed, the combination of world-class industry know-how, provided by a global player such as Repsol, and the Petersen Group's in-depth knowledge of Argentina, ensures an adequate management structure for the company. The commitment of both shareholders to YPF has been reinforced recently, as Grupo Petersen decided to exercise its call option to acquire an additional 10% stake in the company, increasing its shareholding from 15% to 25%, while Repsol has publicly stated its intention to maintain at least 51% of the company. Grupo Petersen is a conglomerate of Argentine companies with interests in several industries, including construction, banking, energy, and agribusiness. The group is entirely owned by the Eskenazi family. Repsol is a global integrated oil and gas company, with its headquarters in Spain. 
 
Financials
As of 1Q11, YPF had a net debt of $1.2 billion, equivalent to ~30% of our 2011 estimated EBITDA. The company paid a cash dividend of $1,128 million in 2010, or $2.90 per ADR, which implies a 6.7% dividend yield at current prices. Many expect YPF to continue delivering cash flow generation that would allow the company to maintain its cap ex program of ~$2.4 billion per year and its cash dividend payout policy of 90% of net income while maintaining a solid financial structure. Nevertheless, debt should grow from the current level of $1.25 billion, equivalent to 31% of 2010 EBITDA, to a still very comfortable level of $2.9 billion, or 60% of 2013E EBITDA.   The dividend is secure:  The average annual dividend payment amounted to US$1.4 billion over 2006-2010, implying an average dividend yield of 8.3% per year. According to the agreement reached in 2008, YPF's two main shareholders, Repsol and Petersen, have agreed upon a dividend payout that would amount to 90%.  In addition, the high dividend payments are also guaranteed by the fact that the 15.5% stake in YPF acquired by the Petersen Group in 2008 is being paid out with dividend payments. Thus, the company should continue to post an attractive dividend yield, by paying dividends in the range of US$1.3-1.4 billion per year, which would mean a yield in the range of 7.7-8.7% for the coming years. 
Valuation
YPF is worth $55 to $60 on a break-up basis.  YPF is trading around 8x 2012 P/E vs. 11x for Petrobras, 21x for Ecopetrol and 10x for Pacific Rubiales.  On a FV/EBITDA basis, YPF looks cheap as well: 4x FV/EBITDA vs. 7x for Petrobras, 9x for Ecopetrol and 3.5x for Pacific Rubiales.  On a trading non-breakup valuation, the YE2012 target price of US$50.00 per ADR (Ar$232.00/share) suggests upside potential of 18% for the stock, not including a dividend yield.
 
 

Catalyst

 1. Increase in local prices to that of international market
 2. Break-up of refining biz, gas stgations, etc..
 3. Liquidity: YPF's free-float increased to 17% of its equity, or ~$3.0 billion, after Repsol's recent public offering.
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