AKD Securities Limited Equity Research – Daily Report

Karachi, December 18, 2017 (PPI-OT): OMCs: Devaluation to erode profits

For the OMC sector at large, abrupt closure of RFO fired power plants being for the greater part of November (due to environmental concerns) meant reduced sales. Additionally, since ~63% of FO is imported, OMCs with large market shares (PSO/APL/HASCOL have 11MCY17 FO market shares of 74/7/7%) were exposed to charges resulting from delaying import of RFO (demurrage). These developments have cast uncertainty over the OMC chain and future of the RFO POL segment (~35% of overall industry volumes are made up by FO, still the largest segment by volumes), leading the sector down 5.5% during November.

For the PSO and HASCOL winter has come early, where earnings are expected to face strong headwinds from reduced FO sales as well as sizeable devaluation of the PkR against US$. For the wider industry, questions marks over propensity to consume following expected hiking of POL product prices from Jan’18, headwinds to margins from loss booked on import shipments and reliance on foreign borrowing could keep investor interest subdued.

Import reliance to hurt HASCOL: HASCOL benefits from limited market share in the RFO segment so it was cushioned to reduced sales where the dip in earnings for CY17E are forecasted at PkR0.4/sh (-2.5% against base case). Moreover, currently the translation loss from devaluation due to difference in PkR/US$ payment at the time of receiving import cargoes, has a potential earnings impact on HASCOL that amounts to PkR1.18/sh lowering earnings by 9.1% from our base case. It is more likely that minor inventory losses may be borne by them which are expected to be mitigated by hedging arrangements for refined fuel imports.

Foreign borrowing to amplify losses for PSO: PSO is faced with a greater quantum of earnings declines because of longer lead times for shipments and resultingly higher inventory levels held at the time of devaluation. Additionally, the state OMCs foreign borrowing exposure (PkR74.16bn as of June’17 making up 55.3% of total short-term borrowing) is expected to lead to a translation loss of PkR~3.82bn (PkR11.7/sh) while raising the interest expense in PkR terms on these facilities going forward. Increased reliance on local sourcing has shielded the OMC from exchange losses on imported shipments where we peg the possible exchange loss for the quarter to rest at PkR452.8mn (PkR1.38/sh). Lastly our channel checks confirm the inability of public sector institutions to seek forward arrangements for their FX payments leaving PSO liable to book the entire loss absent possible mitigation strategies availed by private OMCs.

Outlook: Lastly, the pump prices of MOGAS and HSD have additional GoP levies built into the price (Petroleum Development Levy, GST) that can be reduced while keeping pump prices the same, where this tact has been applied by the GoP in months of increasing political pressure. PKR weakness will be reflected in the retail price of POL products beginning Jan’18 where we don’t see any major headwinds for transportation led MOGAS and HSD demand. That said, margins decline will be witnessed with the impact of these losses being directed by operational factors, namely the frequency of import shipments (shorter lead times and higher throughput between shipments could mitigate losses), availability of borrowing arrangements on concessionary FE-25 terms where exchange losses are mitigated and reliance on imported fuels vs. local upliftment.

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