Elixir Securities Limited – Elixir Insight

Karachi, December 13, 2017 (PPI-OT): Pakistan OMC and Refinery Sectors – Potential Exchange Losses in the Offing

During the ongoing month, the PKR has depreciated by ~5% which will likely lead to exchange losses for the OMC and Refinery sectors. The magnitude of losses will however depend on the dependence on import for each company.

Amongst OMCs, HASCOL and PSO will see the most impact owing to their high dependence on imports to meet domestic demand. On the other hand, APL will face minimal impact as it sources its products locally.

Within Refineries, ATRL remains relatively unaffected by the decline in PKR as it sources its crude oil domestically while PRL may be the most impacted due to its higher crude oil imports.

Moving ahead, the depreciation episode will likely play out well for OMCs as higher PRK based POL prices increase absolute margins on FO and trickle down inflation may lead to high margin increase in MS in the next year. However higher FO prices may expose the sector to faster buildup of circular debt.

For refineries, profitability may improve despite stable USD based GRMs as they will translate into higher PKR value subsequent to the devaluation.

Product Sourcing to Define Exchange Losses: During the ongoing month, PKR has depreciated by ~5%, where the impact on the Oil Marketing Companies (OMCs) and Refineries will depend on the proportion of their imports. Exchange Loss impact is higher for companies that rely upon imports as the key source of products/raw material as compared to those who procure domestically.

Within the OMC space, Hascol Petroleum (HASCOL) and Pakistan State Oil (PSO) will face the highest impact as these companies rely heavily on imports to fulfil domestic demand. The impact on HASCOL is also magnified owing to its high sales volumes as compared to its bottom line while PSO’s depreciation impact is enhanced by GoP directed USD borrowing. The company had previously guided that any exchange losses arising from USD borrowing may be compensated by GoP while it also retains previously unrealized exchange gains of PKR2.4bn to cover for any losses.

Meanwhile Attock Petroleum Limited (APL) will be least effected amongst OMCs owing to higher domestic procurement mainly from its sister concern Attock Refinery (ATRL). However we highlight that the guided impact are specifically for exchange losses which may be diluted owing to higher inventory gains as PKR based POL prices increase post the decline in PKR/USD parity.

In line with the source of procurement theme, Pakistan Refinery (PRL) remains highly sensitive to the PKR depreciation as the company imports a sizable chunk of its crude oil requirement as compared to ATRL which relies on domestic crude oil to meet its requirements.

Depreciation to Have Positive Impact Moving Ahead: While the OMC and Refinery space will face an initial jolt in the form of exchange losses in the near term, PKR depreciation will play out positively for these segments moving ahead. For OMC’s, this will translate into higher absolute margins for Furnace Oil (FO) as PKR based POL prices increase. However this may lead to a faster buildup in circular debt as FO cost will also go up. In the longer term, PKR depreciation will likely lead to higher inflation which translates directly in Motor Spirit (MS) margins owing to the CPI linkage with them.

For refineries, profitability depends upon USD based Gross Refining Margins (GRM). PKR depreciation will lead to higher PKR based margins for refineries despite stable GRMs mainly due to conversion.

APL Remains the Best Bet from OMC’s: The OMC space in Pakistan continues to remain marred by i) concerns on FO offtakes as Coal and LNG based power plants come online, ii) continued buildup of circular debt in the election year and iii) possible exchange losses due to the recent PKR depreciation. FO sales decline and buildup of circular debt remains major concern for PSO owing to its 74%market share in the FO segment while Hascol remains highly vulnerable to exchange losses. Therefore we continue to highlight APL as our top pick in the segment where the company’s comparatively limited exposure to FO sales shields it from decline in demand and circular debt concerns while high local procurement makes it’s relatively immune to exchange losses.

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