Equity Analysis /

Pakistan Oilfields: Q2 FY 20 preview – Much depends on drilling success; Neutral

    Intermarket Securities
    17 January 2020
    • We are Neutral on POL, even though it has an attractive dividend yield (c.11%) and may positively surprise on the drilling front. However, POL is trading at an implied oil price of US$62/bbl (very close to Brent), and thus stands exposed to downside in oil prices, in our view.
    • Rejuvenated drilling in both its own-operated fields and Tal block raise optimism about future production growth. POL is presently drilling another exploration well in Balkassar, and the Jhandial-2 well is critical for determining the company’s true reserves life, in our view.
    • POL is trading at a premium to its peers on most valuation metrics. This is partly justified by a very low exposure to circular debt, unlike peers, but we think that success in the aforementioned wells is key to sustaining the premium in the future.

    Remain Neutral until the results of present drilling 

    We maintain our Neutral stance on Pakistan Oilfields Ltd (POL) with a TP of PKR466/sh. POL’s low exposure to circular debt and high dividend yield warrant valuation premium over peers. However, it has less certainty about future earnings potential (without price catalysts), as Tal block’s overall production is depleting and Jhandial’s true reserves life remains uncertain, in our view. Also, since POL is trading at an implied oil price of US$62/bbl (very close to the present level of Brent), its cash flows are vulnerable to downside in oil prices, in our view. Nonetheless, we will become more positive on POL if it is successful in its present drilling program. 

    Drilling in both own fields and Tal are promising

    As stated in our earlier report, the second (appraisal) well in Jhandial field can ramp up production from the field, which has recently fallen to only 400bpd of oil, much below the potential of its estimated reserves. POL commenced drilling of the well in December 2019. A 1,500-2,000bpd oil flow can add incremental earnings of about PKR6-8/sh. Elsewhere, two exploration wells – Balkassar Deep (operated by POL) and Mamikhel South (Tal) – have been drilled to over half of their target depths. The well in Balkassar is in the vicinity of Joya Mair (another recent find) and Pindori (previously, a large asset for POL). Lastly, the company has also drilled a development well in Pindori. While Tal’s operator MOL is aiming for extending the production plateau, the onus is on POL’s own fields to generate future production growth. The increased drilling is thus an encouraging sign to us. 

    High FCF yield is a key attraction but with risks attached

    We estimate POL’s FCF yields to average 14% over FY20-22f (assuming flat oil prices of US$65/bbl), but this can be tested. Note that about 70% of POL’s revenues come from oil and LPG sales. This is a double-edged sword as it limits the exposure to circular debt (recent buildup is led mostly by gas), but it increases the sensitivity to oil prices, which are skewed on the downside, in our view (given global growth slowdown and barring geopolitical tensions). Another issue with POL has been high concentration in Tal block (over 65% of revenues), where some major fields are in sharp decline (albeit offset partly by newer finds). 

    Expect decent growth in Q2 earnings 

    We expect POL to post Q2 FY 20 NPAT of PKR4.4bn (EPS PKR15.44), which will be up 9% yoy and sequentially as well. This will take H1 FY 20 earnings to PKR29.56/sh, up 6% yoy. We also expect an interim dividend of PKR21.0/sh.