Equity Analysis /
Pakistan

Pakistan OMCs: Inventory gains should mitigate Fx losses; IFRS 9 impact is a risk

    Ahmed Raza
    Ahmed Raza

    Investment Analyst

    Intermarket Securities
    8 August 2019

    OMCs are expected to post mixed results during Apr-Jun’19 quarter. Rising fuel prices should result in bumper inventory gains (similar to APL, which has already announced its 4QFY19 result). However, exchange losses will overweigh the above gains for players with more imported volumes, in our view.

    Emerging concern for the sector, especially for PSO, is the impact of IFRS 9, where companies have to assess financial assets for impairment and will be routed through P&L. In case it leads to more expenses, turnover taxes may kick in due to a thinner PBT line. Our quarterly estimates do not incorporate any IFRS-9 related impact. 

    We also highlight that margins on regulated products have not been increased in Jul’19 prices while further clarity is awaited on circular debt settlement. These concerns make a weak investment case for OMCs, but we are selectively bullish on APL (Jun’20 TP: PKR432) due to its improved market share (backed by increased sites and storages), unleveraged balance sheet and presence in specialty products.

    Inventory gains expected…

    OMCs are expected to record cumulative profits of PKR5.4bn, up 30%yoy/87%qoq during Apr-Jun’19 (including APL which has announced its 4QFY19 result) backed by inventory gains. However, there will be sharp differences between the results among OMCs which mainly import (PSO, SHELL, HASCOL) given PSO is partly protected by foreign currency borrowing, in our view. We are factoring in bumper inventory gains as MS/HSD prices went up by 26%/18% (on an ex-GST basis) during the quarter under review. This will result in a sequential jump of 48% in the sector’s gross profits during Apr-Jun’19, in our view. During the quarter, petroleum volumes also picked up by 5%qoq (albeit down 25%yoy) due to seasonally higher demand of furnace oil (FO) in summer months. 

    …but PKR depreciation will hurt some players more

    However, PKR depreciated by 12%qoq against US$ in 4QFY19, which should impact players with more international procurement (HASCOL and SHEL; up to 80% of total sales), a repeat of 2QFY19, during which PKR depreciated by 11% against US$. We are assuming after-tax exchange losses of PKR16.84/sh and PKR5.67/sh for SHEL and HASCOL, respectively, during Apr-Jun’19. These companies will also incur higher finance cost (due to the rise in interest rates) and turnover tax (due to thinner profitability), in our view. On the other hand, PSO (though also a major importer) is expected to record its highest quarterly profits in the last 6 years, at PKR5,717mn (EPS: PKR14.61), up 2.6x yoy. Its FE-25 borrowing (shielded against Fx losses) makes it distinct in the sector. We forecast a final dividend of PKR3.0/sh only, due to uncertainty on Energy Sukuk II. 

    Application of IFRS-9 may add to OMC woes

    IFRS standards will require companies to assess all financial assets for impairment. However, the issue of circular debt will compound its effects on the energy chain. While principal payments carry a sovereign guarantee (hence no impairment), IFRS-9 requires to account for the time value of money. Moreover, there has been uncertainty over Energy Sukuk II, which could have been an important trigger for PSO. We understand that the process has been stalled as GoP guarantees are required for this transaction and the IMF has placed a ceiling on such guarantees. However, GoP is required to announce a comprehensive plan to deal with circular debt by Sep’19, as per IMF staff report. Lastly, OMC margins on regulated products were not raised in Jul’19 prices (according to FY19 CPI) which account for 80% of petroleum products. This will impact HASCOL the most, in our view, due to the highest share of retail fuels in its mix. An additional concern is a higher turnover tax in FY20 budget (0.75% of revenues vs 0.50% previously). Despite the above problems, we prefer APL (Jun’20 TP: PKR432/sh), among OMC space due to its improved market share, debt-free balance sheet and presence in deregulated-product markets, which will keep the margin profile elevated enough to avoid turnover tax). 

    Risks: i) Exchange/inventory losses, ii) delay in the increase in OMC margins, and iii) the impact of IFRS-9.