Elixir Securities Limited – Elixir Insight

Karachi, December 19, 2017 (PPI-OT): Pakistan OMC Sector – Incorporating Lower FO Sales Forecasts

Following up on our detailed report on Power Sector, we revise our OMC sector investment case accounting for sharp decline in FO offtakes with industry volumes forecasted to decline by 24/44/11% over FY18/19/20. Subsequently, we estimate volumes to drop 10% annually to reach sustainable levels of 2.5mn tons.

Resultantly our earnings projections decline by 2 -12% and 5 – 17% in FY18 and FY19 respectively from our previous estimates. Within this space, PSO takes the biggest hit owing to its high ~74% market share in the FO segment.

We revise down our stance on the sector to Market weight owing to the ongoing themes of i) exchange losses arising out of recent 5% PKR depreciation, ii) continued buildup of circular debt in the ongoing election year and iii) reduction in FO sales which will negatively impact sales and also hinder domestic procurement owing to possible disruption in refinery operations.

Amongst the OMC players, we maintain a liking for APL due to its relatively limited exposure to circular debt concerns while high local procurement also makes its relatively immune to exchange losses.

Furnace Oil Decline to Hurt OMC Sales: We revise our OMC investment case accounting for sharp decline in FO offtakes owing to shifting power mix as discussed in our previously released detailed report titled “What Lies Ahead for IPP’s, OMC’s and Refineries”.

We highlight that with more LNG and Coal based power plants coming online, the power mix will continue to move away from FO based generation thus reducing its demand and consequently OMC sales. We forecast the FO sales to decline 24/44/11% in FY18/19/20 and subsequently fall 10% pa to reach sustainable levels of 2.5mn tons, roughly in line with local refinery production.

We believe that the GoP will maintain baseline FO based power production to support local refineries, barring which the country will have to import refined products which will be a drag on precious FOREX reserves and further burden the already burgeoning trade deficit.

Strongest Impact on PSO: Decline in FO sales will impact Pakistan State Oil (PSO) the most owing to its commanding ~74% market share in the black oil market while Hascol Petroleum (HASCOL) will be the least impacted owing to its limited exposure in the segment. Revising our volume assumption leads to APL/PSO EPS attrition of 2/12% and 5/17% in FY18 and FY19 respectively from our previous case. Our Hascol earnings estimates for 2018/19 fall by 5/3% as the company relies primarily on retail fuels as an earnings driver.

However, the same also leads to improvement in cash flow cycle for OMCs, especially PSO, as its exposure towards circular debt also falls owing to dwindling FO sales.

Downgrade to Market weight on OMCs: We revise our stance on the sector to Market weight owing to i) continued buildup of circular debt in the election year and ii) possible exchange losses due to the recent PKR depreciation and iii) supply side concerns that may arise due to limited refinery operations emanating from cyclicality in FO sales.

Within the sector, we highlight APL as our top pick as the company’s comparatively limited exposure to FO sales shields it from more than expected decline in demand and circular debt concerns while high local procurement makes its relatively immune to exchange losses.

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