Downgrade FV to EGP1.25/share; Maintain Equalweight
We downgrade our FV of Qalaa Holdings from EGP2.70/share to EGP1.25/share, as we slash our estimates for ERC in light of the recent turmoil in the oil market. We revise down our valuation of the refinery from EGP2.21/share to EGP0.38/share, to reflect 1) a cut in oil price forecasts, 2) narrower diesel-high sulfur fuel oil (HSFO) spreads, and 3) yet another delay in Qalaa’s consolidation of ERC, which has been pushed to March, from January initially. After years of anticipation, the ill-fated ERC has come online amid a global pandemic and a raging oil price war, which have overshadowed the initially anticipated benefits of IMO 2020 for the refinery. We maintain our Equalweight recommendation on Qalaa, as we take a conservative stance on Brent prices and spreads given lack of visibility in the oil market at the present time.
ERC| Estimates slashed on oil market meltdown
The collapse in Brent prices and diesel-HSFO spreads has tragic consequences for ERC. Our initial assumptions for 2020 included Brent at USD61/bbl, and an expansion in spreads driven by IMO 2020 to reach an average of USD420/ton. Now, Brent is at USD25/bbl, and the diesel-HSFO spread is at USD202/ton; both less than half of our initial assumptions. This has compelled us to cut our assumptions for 2020 to an average of USD35/bbl for Brent and USD193/ton for spreads, as we account for minor recovery towards year-end. That being said, our initial EBITDA forecast has been cut to a third to reach just USD318 million; a margin of 28%. In the years to follow, we assume gradual recovery in oil prices as per consensus forecasts to settle at USD59/bbl, and a less aggressive recovery in spreads to settle at USD250/ton, in the terminal year. Our assumptions therefore drive a 4-year CAGR of 18% for revenue, but just 5% for EBITDA. Hence, it is justifiable that our model assumes gradual EBITDA margin contraction, settling at 18% in perpetuity.
Qalaa’s high dependency on ERC now a key concern
Given the dramatic downgrade in ERC’s profitability for 2020, Qalaa’s plan to return to bottom line profits on a consolidated basis this year is looking rather unachievable. ERC should be reporting 10 full months of operations this year, which we estimate will bring in net profit post minority of just EGP100 million for Qalaa, as we account for its 13.14% stake in the refinery. To put things in context, Qalaa reported losses of EGP774 million on the bottom line level for 9M19; a net loss close to EGP1 billion on an annualized basis, that ERC will do little to offset. Not only that, but we believe the limited amount of free cash flow will most likely put a dent in Qalaa’s plans to deleverage over the next 5 years, not to mention that ERC’s plans to distribute dividends will be scrapped.
Blurry outlook on ERC but TAQA’s prospects still strong
When it comes to Qalaa’s ERC, the outlook on the refinery’s volatile value drivers has become increasingly ambiguous due to the current state of crisis, which is why we hold a conservative view on the company. However, our respective valuations for each of Qalaa’s other subsidiaries remain unchanged. We particularly remind you that Qalaa’s backbone, TAQA Arabia (FV: EGP1.29/share), still exhibits huge growth potential, which keeps us on the fence with regards to Qalaa’s stock. We therefore remain Equalweight on the stock until the dust settles, providing us with further clarity on the outlook for ERC.