Equity Analysis /

Pakistan E&Ps: Unwarranted valuations despite cash-flow constraints

  • IMS E&P valuations stand unwarranted under higher oil price assumptions as earnings forecast jump 27-38%

  • More positives come from recent PKR devaluation while past liquidity issues can be resolved under energy reforms

  • Sporadic efforts by government to plug circular debt generation can unlock payouts and valuations

Intermarket Securities
11 November 2022

We raise our E&P estimates on higher assumed oil prices, which we now forecast at USD80/70LT per barrel for FY23/24f, as against USD60/60LT earlier. Our earnings estimates have increased by 27-38% on average for these years and we reiterate our Overweight stance on E&Ps.

We believe that government’s efforts to resolve the accumulation of circular debt has been underappreciated where stocks have underperformed oil price by 16% in the last 1 year.

More positives have risen from currency devaluation as USD denominated pricing policy gives a natural currency hedge. We are optimistic over key developments in the sector and a lot of past liquidity issues should be resolved as Pakistan undertakes energy reforms.

Estimates revised on higher oil prices and currency devaluation

The recent move by OPEC+ to reduce collective production target by 2mnbpd has put itself in the heart of the maelstrom, even though it comes as a pre-emptive output cut ahead of a possible global recession in an already tight oil market. The depleting petroleum inventories, that are alternative shock absorbers, are evidenced by i) US petroleum inventories including the strategic reserve have depleted in 86 of the last 118 weeks by a total of 480mnbbl and are at the lowest seasonal level since 2004, and ii) European distillate inventories have fallen by 122mnbbl over the last two years and are at the lowest seasonal level since 2002. Hence, oil is expected to see tighter supplies ahead, considering there is a soft-landing into recession as the buildup of fallen inventories will likely overlap the reduced petroleum consumption. We, therefore, lift our oil price assumption for FY23/24LT from USD 60/60 per barrel to USD 80/70 per barrel. Simultaneously, even though we remain optimistic about the government’s efforts to enable stopgap measures in overcoming circular debt generation, we believe the implementation of key changes may be sluggish in nature. Despite such adjustments, our revised estimates make E&P space a key value play.

As a result, we upgrade FY23-25f EPS by 27-38% and revise our target prices for our E&P Universe. We continue to prefer Pakistan Oilfields (POL, Buy, new TP PKR518/sh) and Oil & Gas Development (OGDC, Buy, new TP PKR143/sh). The key visible attribute is better certainty of dividends and lesser exposure to circular debt. 

Weary political climate but fundamentals remain intact

The E&P space has underperformed oil prices by 16% over last 1 year, even though it outperformed the KSE100 Index by 9%. Most of this underperformance is linked to escalation of circular debt, as the implementation of stopgap measures by the authorities has been sporadic, more specifically owing to upheaval in political climate during 2022. Despite the new supertax regime, E&Ps continue to post all-time high earnings on the back of high oil prices and currency devaluation. However, some of these earnings are strapped by circular debt owing to low tariff realization by consumers. The reference power tariff hike is already under implementation, however, a gas price hike is being considered at the moment with slow moves towards officiating the WACOG legislation.

We believe, potential positives from settlement of past circular debt and tariff hikes are being discounted by the market as such measures can materially improve the cash position as well as payouts of the Energy chain.

Tariff hikes stand warranted under IMF

Both OGDC and PPL face excessive receivable accumulation from GasCos, invariably hitting the cashflow generation and the payout capacity. The valuations have become depressed as the overdue receivable generation per annum owing to no gas price hike since 2016 stands at PKR10.4/share for OGDC and PKR19.0/share for PPL. The rise in gas tariff can potentially end the receivables conundrum; a vital move as we tread along the re-tracked IMF program.

PPL and OGDC face accumulation of receivables from GasCos, invariably hitting their cash flows and payout capacity. Resultantly, the valuations have become depressed owing to cash getting tied in gas circular debt. The overdue receivable generation per annum owing to absence of a gas price hike since 2016 stands at PKR19.0/share for PPL and PKR 10.4/share for OGDC. As this issue is resolved, we believe, this will potentially increase payouts and unlock valuations. In addition to this, owing to the weak fiscal performance during the year, such depressed valuations keep stake divestment of OGDC and PPL by the government on back-burner.