Transportadora de Gas del Sur SA TGS

Welcome to the TGS 2020 Q3 earnings release call. Throughout the call, all participants will be in listen-only mode, and afterwards, there will be a question and answer session. And just to remind you, this conference call is being recorded. Today, I'm pleased to present Christian Johansen, the Chief Executive Officer. Please go ahead with your meeting.

Good morning, everyone, and welcome to TGS Q3 2020 earnings call. My name is Christian Johansen. I'm the CEO of TGS. I'm calling in from Houston this morning, and with me from Oslo, I have our CFO, Frederick Amundsen. This morning was, to me personally, a good illustration of the unprecedented times we're going through. I woke up at 5 a.m., checked the market reactions to our Q3 report, and noticed that the share price was down 1.5% despite severe cost-cutting and positive cash flow. The oil price continued to slide to a level below 37 for Brent, and most oil service companies' share prices are quoted in cents rather than dollars. Getting out of bed, I get a text from my daughter's school saying that school is closed due to two new COVID cases. When I finally get to the office, there is a gift on my desk from the marketing department. The gift is a nice gray face mask with a TGS logo that our clients can look forward to receive for Christmas this year. COVID-19, global demand for oil and gas, and a consistently low oil price are factors completely outside our control. What we can control, however, is the following. Number one, cost. Well, we are reporting 64% lower cash operating costs than Q3 of last year. Cash collections. where we collected $109 million in the quarter, which is only 16% less than last year. As a result, we had positive free cash flow in Q3, which again provides support to a dividend of $0.125 per share, corresponding to a dividend yield higher than 5%. Last but not least, our revenues are to a certain degree within the control of management, and I'm happy to notice that our late sales versus peers continue to be superior. In the presentation that we posted on our website this morning, we're focusing a lot on cost and cash flow. The market has developed as we expected, and our cost-cutting measures are exceeding our plan. We have a good strategy for how to continue being cash flow positive, distribute cash to our shareholders, and at the same time take advantage of the down cycle, as you've seen TGS do many times before. Our 2021 investments will be lower in dollar value, but probably quite similar in terms of data volumes, the reason being lower vessel rates, more use of risk sharing, and a more selective investment strategy centered around a few geographic areas where we continue to see healthy demand. We continue to be focused on supporting a sustainable future by providing quality data and insights in the most resource-efficient manner possible, were contributing to minimizing the industry's environmental footprint. This year, we have introduced several initiatives for reducing emissions and further enhancing contribution to social development, as well as improving the ESG reporting to stakeholders. The efforts have been recognized in the government group's annual ESG ranking, which recently gave TPS an A- ranking. The energy transition offers interesting opportunities for TGS, and we see growing interest for alternative uses of TGS products. The world's largest library of subsurface data combined with strong competencies in areas such as geoscience, data management, data processing, and analytics position TGS well to contribute with insights related to carbon capture, utilization, and storage, and offshore mineral exploration, as well as to the renewables energy industries. We've already had several projects directed towards CCS, renewables, and DSM, and the fact is that some of these have already generated revenues for TGS in 2020. In the future, our ambition is to capture a greater part of this rapidly growing market that is very complementary to our asset-light data model. Once again, I would highlight that we have a plan, we're delivering on this plan, and we continue to believe that we will come out of this cycle with an even stronger position. With that, I would like to hand it over to the operator who will open up for questions. Thanks.

To ask a question, please press 01 on your telephone keypad. If you wish to withdraw your question, you may do so by pressing 02 to cancel. Our first question comes from the line of John O'Learson of ABG. Please go ahead. Your line is now open. I stand corrected. We are actually going to a question from the line of Christopher Muller-Lurken of Carnegie. Please go ahead. Your line is open.

Good morning, Christian, and good afternoon, Frederick. With regards to the... I know it's early in fourth quarter, but could you give any level of comment regarding client interest for data purchases as we approach the year-round?

Yeah, thanks for your question, Christopher. We usually don't say a whole lot about that. I think all I'm prepared to say in that regard is that it has developed as we expected. And that means that we expect to see a normal kind of – end-of-year spending, so we expect Q4 to be better than the previous two quarters in terms of late sales, but obviously weak compared to previous years where Q4 tends to be very strong. But we still expect to see more interest in late sales than we've seen in the previous two quarters as we normally see that kind of facing for Q4.

Do you get any impression that due to COVID-19, which was unprecedented for your clients, that they have cash left over as they hit the brakes immediately starting March, April? Or do you sense that your clients are still very cautious in terms of spending also when you talk about 2021?

I think it's a mixed picture. I think overall, everyone is cautious in this market because there is so low visibility in what's going to happen. I think you're right. I mean, there are certainly companies who have a lot of their budgets left because they haven't spent them. But I think there is a great chance that we compete with corporate. And corporate would very much like to have these budgets back again, of course. But I think that's kind of the discussions we're going through right now. And as I said, we've October turned out to be pretty much as we planned for, so a decent start of the quarter. We expect to see a good December, as we always do. So we probably have three or four global deals that we are in negotiations with some of our largest clients, and obviously the outcome of that is highly uncertain, but we think we have – a really good database in the areas where companies are still spending. So that's obviously a great advantage that we haven't seen yet.

And lately, we have seen several of your clients merging, especially in U.S. onshore. Do you expect to realize any transfer fees from these transactions, or is it not so relevant for these ones?

No, there will be transfer fees in Q4. We actually had transfer fees in Q3 as well. They were rather small, though. But I think there will be at least two or possibly three in Q4. And then, obviously, we've seen a lot of M&As announced quite recently, which will close in early 2021, which is going to help us a little bit in terms of building some backlog for late sales for 2021. So... I mean, these transit fees are not as big as the one we had in Q3 last year. Obviously, Q3 was a tough comparison because we had a big transit fee in Q3 2019. But they're still reasonably sized, and they still help, obviously, with some visibility on revenues, which is good.

And as you now go into your budgeting season for 2021, you have already highlighted that. dollar investments likely to come down, but volume more flattish. Any geographical areas which you would highlight, which you would look at for next year?

I would probably be a bit careful by doing that because obviously this is a very competitive market too. So I think where you still see relatively healthy demand is... probably US Gulf of Mexico, Latin America, and to a certain degree, Norway, UK. So there will be investments in all these three basins for sure. And then in addition to that, I mean, we're looking at some interesting opportunities in Africa, Asia, Pacific, and even onshore where we see some opportunities of projects with really high pre-summing, of course. So I think... I think certainly our dollar investments will come down, which we highlighted today in the presentation. There's no question about that. But the data amounts are probably going to be quite similar to this year.

And final question from me, maybe more to Frederik. Is it possible to give any indications for multi-client amortization going forward?

Frederik, please go ahead.

I just saw from the presentation give some flavor to the straight line amortization coming down to 53 million for the quarter, which is down from the mid-60s that we reported early in the year. And that is an effect of the impairment taken that that's coming down. Then the remaining portion of amortization will be a direct link to the revenue recognized on ongoing projects, and that's harder to predict that mix, but at least you know then that it's about 50 million in straight line that is ticking underneath there.

And just to clarify that, in the amortization you reported for Q3, which was quite significantly down versus Q2, it also included that $8 million impairment.

That is correct. So it was about 78 million in normal amortization, of which 53 was trace line. And on top of that, it was 8 million in impairment related to the onshore library. Thank you.

Our next question comes from the line of John Olison of ABG. Please go ahead.

Good morning, good afternoon, gentlemen. A follow-up on Christopher's discussion about amortization or impairments. I just wonder in Q4, if you could elaborate a little bit on the potential risk of more impairments of the library, like year-end. I see that 6% of the book value as of Q3 is from the 2016 vintage. I presume that has to be zero at the end of Q4. And 15% is on 17%. I just wonder if you could elaborate a little bit on any risk of the significant impairment in Q4.

So for every quarter, we go through the sales prognosis forward. When we get to Q4, we do an elaborate process in conjunction with the budget process. And we go through that. We have a good headroom in the library, as such, in all regions. But, of course, when you go through this and you go through it on a project-by-project basis, there could be areas that we need to look at. So we can't guide anything on that, of course, but we are going through that. But on the portfolio as a whole, we have good and healthy headrooms. Okay.

It's a good point Frederick is bringing up. You know, if you look at the portfolio as a whole, you know, we have late sales this year that is probably going to be not too far off from $300 million and we have a data library of 763. I mean, that's a yield of 39%. So, I mean, we're still yielding it pretty good. If you just look at our late sales versus the size of the data library, it's yielding a good return. So, But as Frederick said, I mean, we have to go through every single project, and there will always be a project that sometimes failed the impairment test. But that's the way it is.

On the other side of the library equation is the inputs, so new investments. And looking at the project schedule, it looks like Q4 will be pretty low in terms of multi-client investments. No surprise as such, I guess. But I just wonder if... Should we expect more surveys to start now in Q4, or is it an excellent service for next year?

Yeah, I think I commented on that this morning, that we're looking at one or two other surveys that may start late this year, so that's probably going to be December. or it may be early 2021. And these projects are pretty much committed already, so it's more of a timing discussion whether we do it this year or next year. So obviously, based on that, it's a little bit of uncertainty on whether we're going to invest 320 or whether it's going to end up at 310, but we're still going to be pretty close to our guided figure with a little bit of risk on the downside, which again means that there is risk on the upside in terms of cash flow. So I mean, for us, that's... That's also a positive thing. But I think going into 2021, these projects will certainly happen. So you will see that Malvinas, the big 3D in Argentina, that will continue into next year. And then we've got a couple of other projects, of which two of them are highly pre-funded as well, that will probably be Q1 investments for 2021.

Okay. I know it's early, but is it possible to elaborate a little bit on investment opportunities for 2021? If everything stays like it's now, is it likely that your investments would come down sharply? It's basically my key question.

I think if the market stays as it is today, you will see a combination of three or four converted contracts that are heavily pre-funded. One onshore and probably a couple in Latin America. And in addition to that, you will see a few or quite a few risk share investments where we have discussions with our partners on that and obviously sharing the risk increases our appetite. So you will probably see quite a few surveys where we share the risk with one of our suppliers. So I think in general, if the market stays as it is today, you will see that the total dollar value go down. You will see the pre-funding be quite healthy. And you will see the total data amounts that we acquire will probably be in line with this year.

Okay. Well, thanks for that. And Christian, I hope your weekend mornings are better than your week mornings. Thank you. Thank you, John.

Our next question comes from the line of Amy Wong of UBS. Please go ahead.

Hi, guys. Thanks for taking my questions. I have a couple. The first one is actually you were starting to answer it a bit on the risk sharing. To what extent can you talk about how much risk sharing your suppliers are engaging with? you know, would what happened in the last cycle be a good indication of how the risk sharing is going to go this time around?

Yeah, I mean, typically, you know, the risk share is around 50% or sometimes slightly higher. It all depends on how much you give away on the other side. So I think, you know, in general, we're happy to do collaboration projects where we share the risk pretty much 50-50. So that's been a good model for both TGS and and spectrum in the past, and it's also been a very good model for our suppliers. And in this case, we're mainly talking to Chinese suppliers. So I think you're going to see that we're probably going to do that more next year than we did this year. And the reason for that is that this year started out with a very strong backlog where we already had a significant pre-funding committed. But for next year, I mean, that's probably going to be a bit more challenging, and you will see that we're probably quite happy to share that risk and both parties will benefit from that.

Okay, yeah, that makes a lot of sense. In terms of next year's projects that you guys have in the pipeline, can you talk a bit about the mix of the technologies you're going to use in there?

Yeah, I think there is no secret that we have an ambition to continue to do OBM surveys, particularly in the U.S. Gulf of Mexico and possibly Norway as well. So that is certainly high on the agenda for 2021. Then on the 3D side, we already have announced the 3D in Argentina, of course. Our ambition would be to keep that vessel in Latin America for the winter and spring season and possibly do some risk sharing on that. Norway, UK is probably going to be lower activity for next year. Hopefully, we can do some OBM surveys, but it will probably not be a whole lot of new 2D or 3D. That's the way it looks right now. Same with onshore. You will see onshore investments come down. And then Africa is still a bit uncertain because there are some big new projects in Africa that we are pursuing, and that could happen, but it's still very early days. So I think OBN is certainly going to be a quite significant part of the total investment, and then the main 3D activity is going to be Latin America.

Okay, that's very helpful. Thank you very much, Christian. I'll turn it over.

Thanks. Our next question comes from the line of Suha Islam of Goldman Sachs. Please go ahead. There we went. We have a slight technical issue. OK, we'll now go to the question from the line of from Goldman Sachs. Please go ahead. line is open.

Thank you. Two questions from my side, please. Firstly, on M&A, could you talk a bit about your appetite for further industry consolidation and whether you'd look for something on the multi-client side or perhaps something in something like carbon capture or non-oil and gas? And then secondly, on cost savings, can you talk about how much of what you've done is structural versus cyclical? As we think about when that market recovery hopefully happens, will some of those costs start to come back?

Thanks. Yeah, I think in terms of consolidation, I mean, we've been quite open and everybody obviously have noticed that we submitted a public offer for the data library of PGS, which didn't go through. I think in general, I think everyone who's in this market should be in favor of further consolidation. I mean, if you look at exploration spending in general, it's probably down somewhere around 80% since the peak. And we pretty much have the same number of companies out there, except those spectrum, which was acquired by TGS. So there are still too many players. There's no question about that. We need more consolidation in seismic. We need more consolidation in in drilling and we probably need more consolidation in subsea as well. So I think we can be quite open about that, that we are very open to have discussions and we would entertain any initiative for further consolidation whether it's in multi-client seismic or whether it's in the processing business which is quite human capital and capital intensive as well. We would certainly entertain those ideas and we spend quite a bit of time internally looking at how we can make this industry more profitable for the future. So I think that answers your first question without being too specific, which I obviously cannot be. In terms of outside oil and gas, we have some really interesting initiatives now in terms of we've already seen interest from clients in some of the products that we already have, that we've mainly licensed these products to oil and gas, but you see a lot of them can actually be used outside oil and gas and for renewables. Carbon capture and storage is one example. Minerals is another one. We even see opportunities within probably more wind than solar, but certainly within wind. I think we continue to pursue some of these alternatives and see how we can build some kind of a data business around that. That may involve some smaller acquisitions, but I don't think you would see big consolidation thoughts or initiatives from TGS, partly because some of these companies are trading at very high multiples now, and we will probably do smaller acquisitions and organic growth rather than doing big, big steps into this market. In terms of cost cuts, a lot of these cost cuts are actually permanent because we certainly see a lot of potential after the acquisition of Spectrum. We've seen a lot of synergies that are way higher than we expected at the time. And we also see that we can operate our business more efficiently given the current market. And I think some of that will be sustainable for the future even when the market picks up again. You will see that our costs will certainly not come back to what it was pro forma 2019. So will it come up 10%? Possibly. But it will certainly not come up like 30% or 40%. That's the way we look at it right now.

Very clear. Thank you.

Our next question comes from the line of Mike Pickup of Barclays. Please go ahead.

Good afternoon, everyone. Mickey. Basically, a follow-up on that, obviously, on the geophysical side, the broader geophysical side. Have you any ambitions of scale for your non-oil and gas-related businesses as yet, or are we too early? Can you please repeat that, Mitch? Yeah, I'm just wondering on the non-oil and gas side, the broader geophysical offering, have you got any ambitions of the scale you can get that business up to as you build it out?

Yeah, I think we certainly do, and we're running quite a few scenarios internally. I think, you know, if you just look at what we've done in 2020 without any initiatives in that regard, I mean, we haven't really tried, but it's almost like client-driven rather than driven by our salespeople. We've We probably had sales of 50, 60 million Norwegian kroners, so like, you know, six, seven million dollars of products to renewables or renewable sectors. And then we're looking at how can we grow that and how can we also add other products that fit to our data business. I think in the big scheme, it's still relatively small because, I mean, oil and gas is big. I mean, oil and gas is a big industry where the willingness to pay has been quite significant over time. So, I mean, we're not talking about, you know, 50% exposure to renewables. But, you know, if we could build a renewable business that is similar to our well data business, which is, you know, between 6% and 10% or up to 12% of total revenues, I mean, that would be a nice kind of first step.

Okay, thank you. Cheers.

Thanks.

Next question comes from the line of Christopher Muller-Luckin of Carnegie. Please go ahead.

Yes, just a follow-up question regarding the Melvinas project you have announced. Is that a converted contract survey like the other projects you've done in Argentina earlier this year, or is it more a standard multi-client.

No, it's the same as the previous ones. So you would see a high preferring on that project. That's not a secret.

Thank you. Just to remind everyone, if you would like to ask a question, please press 01 on your telephone keypads. You can withdraw your question by pressing 02 to cancel. And there will now be a brief pause while any further questions are being registered. And we have no further questions. Please go ahead, speakers.

All right. Thank you, everyone. So I've mentioned in my introduction the market has developed as we expected in early April. And our cost-cutting measures are actually according to plan or just actually ahead of our plan. So we have a good strategy for how to continue to be cash flow positive, continue to distribute cash to our shareholders, and at the same time take advantage of the down cycle that you've seen TGS do many times before. With that, I would like to thank you for the attention, hope that you all stay healthy, and continue to look forward to see you in person as soon as the regulations allow us to. Thank you very much.