Macro Analysis /
Pakistan

Rise in gas tariffs – tough decision but a step in right direction

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Follow
    Intermarket Securities
    18 September 2018
    • The ECC has reportedly increased consumer gas prices by 10-143% to partially offset (c.60% of the required amount) mounting revenue requirements of the twin gas utilities (SSGC and SNGP). This should improve their liquidity position, but their price differential claims would continue to rise – albeit at a slower pace.
    • This is the first important decision by the newly elected PTI government. Price increases for the general public are soft, while the brunt has fallen on sectors enjoying healthy margins. Importantly, there has been no increase in tariff for the Textile sector, which may see continued government support through a separate package.
    • Assuming no pass-on, incidence of increase in gas prices is negative for multiple sectors including Fertilizer, Chemicals and Cements. On the flipside, likely impetus to inflation should bode well for Banks, Pharmaceuticals and OMCs. 

    PTI takes a difficult call: The newly elected PTI government has reportedly increased consumer gas prices by 10%-143%. Additional revenue of c.PKR90bn (0.3% of GDP) will be generated, which is short of the initial target of PKR152bn. This may mean further staggered tariff increases going forward. In keeping with its earlier rhetoric, the increase is softer on the general public and appears to be tilted towards sectors enjoying healthy margins (Fertilizers, Cements and Chemicals). These sectors, particularly Fertilizers, are likely to face earnings erosion unless price pass-on takes place. We believe this measure is largely positive for the twin Sui companies, but their price differential claims would continue to rise – albeit at a slower pace Importantly, there has been no increase in tariff for the Textile sector, which may see continued government support through a separate package. 

    Fertilizers: An increase of 50/30% in feed/fuel gas prices to PKR185/780 per mmbtu (ex-GIDC) would require a pass-on of PKR120 per bag for Urea (on FFC, but lower for EFERT and FATIMA). This translates into negative EPS impact of 31/24/6/3% for FFBL / FFC / EFERT / FATIMA respectively; FFBL is understandably the most impacted, as DAP contributes 55% in total fertilizer production. That said, our base case earnings already assume gas price hike of 27/20% for feed/fuel (PKR156/718 per mmbtu – ex. GIDC) for CY19F. Incorporating the recent gas price hikes in our estimates would lead to our CY19F base case EPS estimates being cut by 19/12/2/1% for FFBL / FFC / EFERT / FATIMA. We retain estimates for now as we await clarity on pass-on. However, given recent challenges to the sector’s pricing power, any pass-on may prove to be temporary and unlikely to last over the medium term, in our view. We are Marketweight on the Fertilizer sector where we would look to take profits on strength. 

    Cements: We anticipate the highest earnings impact would be on LUCK (6%), followed by DGKC (2%) while we flag that MLCF now mostly relies on coal for its power needs. Punjab-based manufacturers should be relatively shielded as they are already being charged c. 70% at RLNG tariffs (DGKC and MLCF). That said, indirect implication of increase in grid tariff would impact all cement players, except for LUCK. Due to different cost structures, we believe pass-on would be difficult in the current operating environment. Nevertheless, we would be buyers in Cements at dips as the worst appears to have been priced-in already. 

    Others: We believe the impact of 30% rise in gas tariffs would be most visible for Chemicals (4%-13% impact) and Steel (up to 5% impact). Due to import parity pricing structures in most cases, a complete pass-on would be difficult to achieve, in our view. Within our active coverage, MUGHAL appears most impacted with a 5% hit. IPPs should remain unaffected given their cost pass-through structure (FY18: 18% of total generation was on natural gas). For OMCs, 40% higher prices for CNG should be beneficial for Mogas sales. 

    Inflationary pressures to rise: In Aug’18, CPI and core inflation clocked in at 5.8% and 7.7% respectively. Higher gas prices will eventually feed into core inflation, which is on the rise since 1QCY18, and lead to higher interest rates (DR presently at 8.0%). Sectors that should benefit from these dynamics include Banks (rising margins), Pharmaceuticals and OMCs (CPI-linked price increase). Within these sectors, our preferred stocks are BAFL, AGP and SHEL.   

    Risks: (i) Further increase in gas tariff, (ii) inability of sectors to pass-on the cost impact, and (iii) rise in electricity tariff.