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Pakistan State Oil: 2QFY20 results review: Penal income disguises weak result; Neutral

    Intermarket Securities
    18 February 2020

    Pakistan State Oil (PSO) has posted 2QFY20 NPAT of PKR2.9bn (EPS PKR6.19), which is down 18% qoq but has improved from last year EPS of PKR0.15. This takes 1HFY20 earnings to PKR6.4bn (EPS PKR13.71), up 51% yoy (weak spell in 1HFY19). Although the 2Q result is better than our estimate of PKR4.87/sh; without a large and nonrecurring penal income booked, the result has effectively come in lower than our expectation. PSO did not announce any dividends against our expectation of PKR4.0/sh (however, it is possible that PSO will announce a dividend in 3Q post second Energy Sukuk issue by GoP).

    Key deviation from our estimate came from much lower gross profit and higher-than-expected penal income.

    Key Highlights for 2QFY20: 

    • Against our Gross Profit estimate of PKR9.4bn, PSO has booked PKR6.9bn, which indicates inventory losses of about PKR2.0-3.0bn. Although retail prices were fairly stable during the quarter, ex-refinery prices of HSD and MS fell sharply in October 2019 and then stabilized. Inventory losses could have also emanated from negative import differentials on petrol amid rising international prices towards the end of the quarter. It is unlikely that Furnace oil has contributed to the losses given low inventory amid weak demand and abundant supply with local refineries.
    • Penal income of about PKR4.5-5.0bn is a surprise, given there was no major cash-flow event in the Power sector during the quarter (GoP Energy Sukuk-II issue delayed till March 2020). However, increased capacity payments to old IPPs and Gencos amid low utilization could have opened up room for them to settle outstanding penal charges, in our view. Major payments would have come from KAPCO, HUBC and WAPDA. Note, however, that PSO skipped dividends. The former two aspects of the result give a mixed picture of PSO’s cashflow health.
    • In Opex, Distribution expenses also came in slightly higher than expected, which could be attributed to increased marketing and promotions by PSO to secure its market share in a declining market, where some major competitors have been struggling. This has proved fruitful, given encouraging sales and market share performance until February 2020. PSO has also booked some exchange gains during the quarter.
    • Finance cost is up 48% qoq which can be attributed to penal charge paid to Parco (doubled yoy also due to interest rates). The latter is matched with any penal income received. Finance cost should thus normalize in future quarters, in our view.
    • Effective tax rate of 40% is now normal for PSO because of final tax regime on LNG sales.

    To reiterate, minus the penal income which is largely nonrecurring, this is a weaker-than-expected result. The stock has recently rallied partly in anticipation of the second Sukuk issue – which is due in March but seems largely priced in, in our view. Another major injection will not completely alleviate PSO’s cashflow problems, where the LNG sales is the major contributor in the buildup. Also, whatever cashflow improvement PSO makes will be mostly utilized in turning around its subsidiary Pakistan Refinery. For these reasons, we are Neutral on PSO with a June 2020 TP of PKR217/sh.