- We maintain our Buy rating on PPL with a new TP of PKR165/sh (11% lower), as the 10% stock price correction CYTD has dragged the stock to its bottom-of-the-cycle valuations (FY20f EV/EBITDA of 2.0x). We think valuations have more than priced in the recent negatives (dividend cuts and an unsuccessful offshore well).
- PPL’s receivables have crossed PKR200bn; however, recent gas tariff hikes and other Energy sector reforms under the IMF program will substantially improve recoveries from gas utilities and, in turn, enable PPL to increase payouts and capex (both negatively affected by rising circular debt), in our view.
- PPL is presently trading at a 50% discount to its historical EV/EBITDA possibly due to dividend cuts since 4QFY18 and an unsuccessful offshore well, Kekra. We would be more positive if PPL: (i) resumes payouts (as a sign of improved cash-flows), (ii) drills more aggressively, and (iii) is able to slow down the depletion at Sui.
Steep CYTD correction has overplayed risks; Buy
We continue to like Pakistan Petroleum Ltd (PPL), even as it has corrected 9% CYTD. PPL is trading at the bottom-of-the-cycle valuations with forward EV/EBITDA of 2.0x, at a 50% discount to its historical average of 4.3x. It is also the lowest level in the past five years (last seen in FY16 when PPL had a large write-off related to foreign investments). We attribute burgeoning circular debt and ensuing dividend cuts for the recent pessimism, where investors have disregarded the benefits of 13.5% PKR depreciation, and 20% higher oil prices CY19td. In our view, a climbdown of PPL’s receivables buildup becomes more likely with recent gas tariff hikes and other Energy sector reforms under the IMF program. This can enable PPL to ramp up both dividends and drilling activity (albeit gradually), in our view.
Energy sector reforms should help stall the buildup of circular debt
PPL’s receivables have overshot to PKR206bn in 3QFY19 from PKR60bn in 3QFY17 (prior to Sui’s new regime being implemented). Delays in tariff determination of the gas utilities and the ensuing temporary mismatch in their revenues/cost was a major reason for the buildup. This has not only affected payouts but evidently also capex. PPL drilled only 11 wells during FY19 compared to an average of 22 wells in the prior three years. Another key reason for the moderate drilling during FY19 could be the substantial capex devoted to the off-shore Kekra well (about PKR35bn). Meaningful energy sector reforms will be needed to arrest the buildup. Importantly, reforms during FY13-16 (similar to the present IMF program) completely stalled the buildup during the program.
Intensive development of Sui to plateau production
Sui’s average production during FY19 was 385mmcfd compared to 400-430mmcfd in the previous five years. We highlight that between FY16-18, PPL has invested a cumulative PKR39bn in the development of Sui – eight new wells, overhaul of plants and compressors, and several well interventions. Each new well has added about 5-7mmcfd of output, compared with a 5-7% annual depletion rate (about 20mmcfd). PPL drilled four new wells at Sui in FY19 and plans to drill more during FY20f, mostly likely complemented with production enhancement techniques.
It is worth highlighting that PPL’s FY20f ROE of 21% is largely due to price catalysts from recent years (PKR devaluation and Sui price regime change). As Sui takes up about 30% of PPL’s annual capex outlay, lack of production gains from it can subdue the company’s ROEs in future (we estimate 5yr average ROE of 15%). Another germinating risk is PPL’s fast depleting reserves life (R/P ratio is only about 8 years as of Dec’18). Sui’s depletion and aggressive drilling at Adhi are key factors.
Catalysts and risks
Upside triggers: (i) strong recovery in Sui’s production, (ii) cash-flow improvement by resuming payouts and ramping up exploration, and (iii) a major discovery (>50mmcfd gas). Downside: (i) Sui’s plateau breaking down, (ii) Adhi’s reserve life continues to deteriorate, and (iii) the envisioned improvement in circular debt does not transpire.