Equity Analysis /

Pakistan Petroleum: Growth potential intact; cash-flow improvement likely

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    21 October 2019
    • We maintain our Buy rating on PPL, with a new TP of PKR142/sh (bonus adjusted). We like PPL because of encouraging growth prospects in two of its largest fields, and cheap valuations. As OGDC is similarly undervalued, but has better DY, we prefer OGDC over PPL. 
    • Adhi and Gambat South will be the primary source of production growth for the company, where increased drilling and development capex have been very fruitful in the past three years. A recent reserves upgrade also increases optimism about extension of the same trend.
    • We expect PPL to post a Q1 FY 20 EPS of PKR5.21, down 8% qoq, but up 3% yoy. Key expectations are (i) 22% qoq lower oil revenues due to decline in both oil production and prices, and (ii) hefty exploration expenses due to three dry wells during Q1.

    Raise TP to PKR142/sh; reiterate Buy 

    We maintain our Buy rating on Pakistan Petroleum Ltd (PPL) with a revised target price of PKR142/sh (previously PKR138/sh bonus-adjusted). Our Buy rating stems from PPL’s superior potential for production growth – particularly in Adhi and Gambat South, the reserves of which have been recently upgraded as per PPIS data. This is complemented by undemanding valuations (EV/EBITDA of 2.3x). A key concern for PPL has been rising circular debt, which has depressed its payout policy in recent years; we do not see considerable improvement in FY 20f. However, swift power and gas tariff increases and other reforms in the energy chain will stall the buildup beyond FY 20f, in our view (similar to the period under previous IMF program). A second GoP Sukuk issue (not incorporated) will be a key trigger.

    Adhi and Gambat South are key growth drivers

    Besides Sui, the most important assets for PPL are Adhi and Gambat South, which will not only yield the bulk of revenue growth in future but also enhance EBITDA margins (courtesy oil revenue and PP-12 prices, respectively). A recent reserves upgrade for both blocks means that PPL will continue aggressive drilling there and add more production facilities. The company has already drilled three wells in Adhi at the start of FY 20, and we expect the field to maintain oil production around 10,000bpd during FY 20/21f. In Gambat South, PPL plans to expand the capacity of GPF-IV (a gas processing facility) by 45mmcfd; the block is presently producing about 80mmcfd of gas. Meanwhile, depletion at Sui has been manageable but entails significant capex for drilling and work-overs. 

    Expect big dry-well expenses in Q1 result

    We expect PPL to post 1QFY20 NPAT of PKR14.2bn (EPS PKR5.21), which will be down 8% qoq but up 3% yoy. The expected sequential decline in earnings is due to expected 13% qoq lower oil production amid lower refinery off-take from Adhi, Nashpa and Tal (which also led to 8% lower LPG production). Gas production was up 2% qoq, where decline in Sui was offset by higher output from Gambat South and Tal. Similar to previous quarter, PPL is expected to book large exploration expenses, owing to three dry wells in Nashpa (Shawa), Kotri and Sadiqabad blocks. We estimate PKR6.1bn of exploration expenses for the quarter, without which our 1Q earnings estimate would be higher by PKR1.2/sh. Lately, another drag on earnings has been high depreciation and amortization expenses. The former is due to development capex (processing plants) in Adhi and Gambat South. Amortization expenses, however, may moderate in coming quarters due to the recent reserves upgrade. Note, PPL has been charging windfall levy on oil produced from three Tal block fields, the terms of supplementary agreement of which are contested by the government.

    Risks: (i) Worsening circular debt, which keeps payout policy depressed, (ii) sharper-than-expected depletion at Sui, and ( iii) unfavourable decision on gas prices of Tal block fields.