Equity Analysis /

Pakistan OMCs - Volume growth awaited after margin increase

    Intermarket Securities
    18 December 2019
    • We have a Market-weight stance on Pakistan OMCs after multiple positives have played out including OMC margin revision and IMF nod for Energy Sukuk II. Going forward, OMCs which are better placed to capture higher market share should be preferred as we expect volumetric growth to commence from FY21.
    • APL is our top pick in the space with Jun’20 TP of PKR440/sh (16% upside) due to its long-term growth plans and presence in high-margin speciality products. We are Neutral on PSO with Jun’20 TP of PKR215/sh as we think positives from the expected Energy Sukuk II have been priced in.
    • We also resume coverage on SHEL with a Neutral stance and Dec’19 TP of PKR215/sh. Despite stable market share and healthy margins on lubricants, we are concerned with their high operating expenses, which may keep earnings in check.

    Marketweight stance as multiple positives have played out

    We have a Market-weight stance on Pakistan OMCs after multiple positives have played out. These include (i) the delayed increase in CPI linked OMC margins (for MS/HSD) in Dec’19 retail prices by PKR0.17/sh and (ii) IMF allowing to issue a fresh sovereign guarantee of PKR250bn, which is likely to pave way for another energy sector sukuk of PKR200bn. On the other hand, volumes have continued to decline with petroleum sales down by 8%yoy to 7.3mn tons during 5MFY20, due to double-digit decline in High-Speed Diesel (HSD) and Furnace Oil (FO). However, with growth expected in retail fuels from FY21f, we see value in OMCs who are positioned well to capture the rebound in volumes. In this context, we highlight Attock Petroleum (APL) as our top pick in the OMC space with a strong balance sheet to support growth plans.

    APL: Ingredients in place for sustainable growth

    We revise our Jun’20 TP for Attock Petroleum (APL) to PKR440/sh (from PKR424 previously) and maintain our Buy stance. Our liking for APL is based on (i) continued expansion in storage and retail sites, and (ii) presence in deregulated products like bitumen and jet fuel (20% of gross profits). By FY20, APL is expected to add 65k tons of storage capacity (85k tons as of Jun’19) while future plans will take it to 170k tons. This will go along with APL’s plan to add 50-60 pumps per annum. APL also benefits from the presence of non-petroleum products. To highlight, we estimate a gross margin of PKR4.9/litre on Jet Petroleum (JP) compared to PKR2.81/litre on MS/HSD. Similarly, margins are also high on bitumen, where volume recovery is expected as construction activity is picking up (local cement sales up 3%yoy in 5MFY20). APL currently trades at FY21 P/E of 7.9x along with 3yr fwd EPS CAGR of 18%. 

    PSO: PRL’s investment may consume circular debt cashflows

    We revise our Jun’20 TP for Pakistan State Oil (PSO) to PKR215/sh (vs PKR187/sh previously). Near-term benefit for PSO will be another energy Sukuk, which should help in reducing borrowing levels (PSO received PKR60bn from Energy Sukuk I). Additionally, the proposed increase in gas prices will likely address gas sector receivables of PSO (PKR60 as of Sep’19). PSO has also made decent gains in market share with 5MFY20 share at 51% (up 8ppts yoy) as other OMCs scaled back on their growth plans amid the economic slowdown. However, PSO may need to invest a large amount in its subsidiary, Pakistan Refinery Limited (PRL), which will stall growth in payout, in our view. For its refinery upgrade project, PRL may need an investment of US$1.0bn, where government support is critical for project feasibility. Triggers for PSO could include an increased focus on retail expansion (more pumps and MS storage expansion) and an increase in LNG margins.