Equity Analysis /
Pakistan

Oil & Gas Development: 2QFY20 preview – fundamentals are strong but remains undervalued

    Intermarket Securities
    21 January 2020
    • OGDC is our top pick in the E&P space, where its high FCF yield, relatively moderate buildup of circular debt and deep undervaluation are key reasons for our liking. We have a Buy stance on the scrip with a June 2020 TP of PKR187/sh. 
    • The company will undertake two new projects, in Qadirpur and Uch, which are aimed at arresting depletion rate and extending the life of the fields. We have incorporated the Qadirpur project in our estimates.
    • We expect OGDC to post a 2QFY20 EPS of PKR7.08, up 11% qoq but flat yoy. Key expectations are (i) no exchange losses (booked in 1Q), (ii) one-off impact of Uch-II’s new gas prices, and (iii) hefty exploration expenses.

    Top pick in the E&P space

    We have a Buy stance on Oil & Gas Development Co. (OGDC) with a June 2020 TP of PKR187/sh, and the stock is our top pick in the E&P space. Key reasons for liking OGDC are (i) deep undervaluation relative to the market and E&P sector, and (ii) high expected FCF yields of 12-13% over FY21-23f – a key metric to like in light of stagnating production and earnings growth across the sector, and rising circular debt. Unlike peers, OGDC’s high FCF yields are more sustainable, in our view, because of the relatively moderate buildup of circular debt, and new projects should contain depletion rate at some large assets. OGDC is trading at a FY20f EV/EBITDA of 2.6x and P/E of 5.4x (market P/E of 7.2x). The SPO by GoP, however, is a risk for the stock price. 

    New projects to arrest depletion at Qadirpur and Uch

    OGDC will undertake new projects at its two largest gas fields – Qadirpur and Uch – which produce about 55% of its total gas. Both projects will involve upgrading the gas compressors at the fields to improve pressure levels and in turn pump more pipeline-quality gas in the initial years (moderating their depletion rates), while also extending the life of the fields. As per management guidance, the project in Qadirpur will entail capex of US$20-25mn and is slated for completion by December 2020. The Uch project, however, will be completed in two phases in FY22-23 and will have an outlay of US$60-70mn. A similar project was undertaken by OGDC in Qadirpur during FY10-12, which was successful in containing the depletion for a few years and also extended the life of the field beyond the management’s target (more details inside). 

    Circular debt buildup is moderate compared to PPL

    Both OGDC and Pakistan Petroleum (PPL) have been gas heavy and have similar realized gas prices, but the buildup of circular debt has been more acute for PPL. We think the major reason for this is the revision of Sui’s gas price formula in FY17 (over 60%) in case of PPL amid delayed tariff hikes for the Sui utilities. There were no such revisions for OGDC’s fields. Gas contribution to overall revenues has declined from 60% in FY16 to 45% in FY19. Lastly, OGDC’s low sensitivity to oil prices is positive in the context of circular debt.

    2Q profits expected flat yoy

    We expect OGDC to post a 2QFY20 NPAT of PKR30.4bn (EPS PKR7.08), which will be flat yoy but up 11% qoq. This will take 1HFY20 EPS to PKR13.43, up 2% yoy. We also expect OGDC to announce an interim dividend of PKR2.5/sh (1HFY20 PKR5.0/sh).

    Risks: (i) sharp decline in mature assets, (ii) lower oil prices will dampen sentiment for the sector, and (iv) rising circular debt which puts pressure on payouts.