Elixir Securities Limited – Elixir Insight

Karachi, June 25, 2018 (PPI-OT): Pakistan Equity Market – Increase in Gas Tariffs to Burden End Consumers

OGRA has proposed to increase gas tariffs in line with revenue requirements of both Gas Distribution Companies (Discos).

It is moderately positive for Gas Discos (SNGP, SSGC) due to slight upward revision in UFG benchmarks, and relatively similar Return on Operational Assets. More importantly, we expect cash flows of Gas Discos to improve with reduction in consumer subsidies.

The surge in baseline tariffs for domestic consumer remains the highest jumping by ~3x which is likely a result in reduction in consumer subsidies and have a spillover impact on inflation (2% MoM and 1.5% YoY).

EFERT and FATIMA are expected to gain at the expense of other fertilizer manufacturers as they enjoy incentive pricing for feedstock. We expect FFC of increase urea prices by ~PKR65/bag to pass on the impact of higher gas prices.

Higher gas tariffs shall have negative implications cements, textiles, chemicals, and glass manufacturers while they are largely Neutral for E and P’s and IPP’s.

Gas Tariff Increased in line with Revenue Requirements: Oil and Gas Regulatory Authority (OGRA) has provisionally approved increase in gas tariffs for both Gas Distribution Companies (Discos), in line with revenue requirements. The latter is attributable to: 1) increase in wellhead gas prices (due to increase in international oil prices and PKR/USD depreciation), 2) reduction in inter-class subsidies, 3) increase in UFG benchmarks, and 4) adjustment in required return of Discos.

Based on our estimates, higher gas prices are likely to result in one-off incremental MoM CPI inflation of ~2% (likely in Jul-18 or when effective), escalating FY19F average CPI inflation forecast from 7.2% to 8.7%. This will however create a higher base effect for YoY inflation in the following year i.e. FY20.

Cash Flows to improve for Gas Discos: We believe that the said revision in tariffs would be moderately positive for Gas Discos as their 1) UFG benchmarks have increased slightly to 6.3% from 4.5% in preceding years, 2) Return on Operational Assets stands at similar level of 17.43% vs. 17.5%/17% for Sui North (SNGP) / Sui South (SSGC) previously. More importantly, cash flows should improve significantly due to lower funds stuck with the government.

Gas Tariff for Baseline Domestic Consumers to Jump Trifold: The increase in baseline tariffs (for gas consumption up to 300m3) is 186%/168% for SNGP/SSGC consumers, and 30%/11% for consumption greater than baseline levels. This increased burden is attributable to reduction in subsidies enjoyed by domestic consumers.

Fertilizer – Positive for EFERT: The base tariff (ex of GIDC) has been raised by PKR33-35/mmbtu (up to 28%) on feedstock gas utilized by fertilizer manufacturers while the tariff on fuel stock has been raised by PKR11-96/mmbtu (2-16%). Note that Engro Fertilizer’s (EFERT) Enven Plant and Fatima Fertilizer (FATIMA) continue to enjoy subsidized feedstock tariff of USD0.7/mmbtu – however the recent PKR depreciation has jacked up their fuel stock prices by PKR11/mmbtu (16%) as well. Nonetheless, we expect Fauji Fertilizer (FFC) to be price setter and increase the Urea prices by PKR65/bag to completely pass on the impact of higher gas prices – this increase is likely to be over and above the impact of budgetary announcements (reduction in GST and removal of subsidies). Incorporating the increase in gas prices, along with removal of subsidy, we expect Urea retail prices to cross PKR1,600/bag mark in July (compared to ~PKR1,500 as of now and 2017 low of ~PKR1,320).

While the increase in end prices for farmers appears to be exorbitant, we do not expect it to have material impact on demand for domestically produced fertilizer owing to 1) curtailment of production from LNG based players, 2) the already present shortage of Urea in the market and 3) higher landed price of imported Urea. EFERT stands to gain marginally, as its weighted average cost of production is likely to go up by PKR50/bag (due to utilization of subsidized gas at Enven) while end product prices may escalate by PKR65/bag, leading to a potential increase in core margins.

Other Manufacturing Sectors to Witness Increased Cost of Production: Increase in gas tariff for captive power plants by 30%/20% to PKR780/PKR718 per mmbtu for SNGP/SSGC shall raise cost of production for textiles, cements, chemicals and glass sectors. However, due to gas shortage in North region, a number of industries in the region switched to expensive LNG leaving them exposed to only the negative impact of recent PKR/USD depreciation.

With regards to cement sector, our understanding suggests that DG Khan Cement (DGKC) and Maple Leaf Cement (MLCF) are relying on LNG due to gas shortage in North region. As such, only Lucky Cement (LUCK) shall bear the major impact of sharp increase in gas tariff for captive power plant. Owing to capacity expansions and excess supply pressures, we do not anticipate LUCK, DGKC or MLCF to pass on this increase to end consumers.

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Elixir Securities Limited – Elixir Insight

Karachi, June 25, 2018 (PPI-OT): Pakistan Equity Market – Increase in Gas Tariffs to Burden End Consumers

OGRA has proposed to increase gas tariffs in line with revenue requirements of both Gas Distribution Companies (Discos).

It is moderately positive for Gas Discos (SNGP, SSGC) due to slight upward revision in UFG benchmarks, and relatively similar Return on Operational Assets. More importantly, we expect cash flows of Gas Discos to improve with reduction in consumer subsidies.

The surge in baseline tariffs for domestic consumer remains the highest jumping by ~3x which is likely a result in reduction in consumer subsidies and have a spillover impact on inflation (2% MoM and 1.5% YoY).

EFERT and FATIMA are expected to gain at the expense of other fertilizer manufacturers as they enjoy incentive pricing for feedstock. We expect FFC of increase urea prices by ~PKR65/bag to pass on the impact of higher gas prices.

Higher gas tariffs shall have negative implications cements, textiles, chemicals, and glass manufacturers while they are largely Neutral for E and P’s and IPP’s.

Gas Tariff Increased in line with Revenue Requirements: Oil and Gas Regulatory Authority (OGRA) has provisionally approved increase in gas tariffs for both Gas Distribution Companies (Discos), in line with revenue requirements. The latter is attributable to: 1) increase in wellhead gas prices (due to increase in international oil prices and PKR/USD depreciation), 2) reduction in inter-class subsidies, 3) increase in UFG benchmarks, and 4) adjustment in required return of Discos.

Based on our estimates, higher gas prices are likely to result in one-off incremental MoM CPI inflation of ~2% (likely in Jul-18 or when effective), escalating FY19F average CPI inflation forecast from 7.2% to 8.7%. This will however create a higher base effect for YoY inflation in the following year i.e. FY20.

Cash Flows to improve for Gas Discos: We believe that the said revision in tariffs would be moderately positive for Gas Discos as their 1) UFG benchmarks have increased slightly to 6.3% from 4.5% in preceding years, 2) Return on Operational Assets stands at similar level of 17.43% vs. 17.5%/17% for Sui North (SNGP) / Sui South (SSGC) previously. More importantly, cash flows should improve significantly due to lower funds stuck with the government.

Gas Tariff for Baseline Domestic Consumers to Jump Trifold: The increase in baseline tariffs (for gas consumption up to 300m3) is 186%/168% for SNGP/SSGC consumers, and 30%/11% for consumption greater than baseline levels. This increased burden is attributable to reduction in subsidies enjoyed by domestic consumers.

Fertilizer – Positive for EFERT: The base tariff (ex of GIDC) has been raised by PKR33-35/mmbtu (up to 28%) on feedstock gas utilized by fertilizer manufacturers while the tariff on fuel stock has been raised by PKR11-96/mmbtu (2-16%). Note that Engro Fertilizer’s (EFERT) Enven Plant and Fatima Fertilizer (FATIMA) continue to enjoy subsidized feedstock tariff of USD0.7/mmbtu – however the recent PKR depreciation has jacked up their fuel stock prices by PKR11/mmbtu (16%) as well. Nonetheless, we expect Fauji Fertilizer (FFC) to be price setter and increase the Urea prices by PKR65/bag to completely pass on the impact of higher gas prices – this increase is likely to be over and above the impact of budgetary announcements (reduction in GST and removal of subsidies). Incorporating the increase in gas prices, along with removal of subsidy, we expect Urea retail prices to cross PKR1,600/bag mark in July (compared to ~PKR1,500 as of now and 2017 low of ~PKR1,320).

While the increase in end prices for farmers appears to be exorbitant, we do not expect it to have material impact on demand for domestically produced fertilizer owing to 1) curtailment of production from LNG based players, 2) the already present shortage of Urea in the market and 3) higher landed price of imported Urea. EFERT stands to gain marginally, as its weighted average cost of production is likely to go up by PKR50/bag (due to utilization of subsidized gas at Enven) while end product prices may escalate by PKR65/bag, leading to a potential increase in core margins.

Other Manufacturing Sectors to Witness Increased Cost of Production: Increase in gas tariff for captive power plants by 30%/20% to PKR780/PKR718 per mmbtu for SNGP/SSGC shall raise cost of production for textiles, cements, chemicals and glass sectors. However, due to gas shortage in North region, a number of industries in the region switched to expensive LNG leaving them exposed to only the negative impact of recent PKR/USD depreciation.

With regards to cement sector, our understanding suggests that DG Khan Cement (DGKC) and Maple Leaf Cement (MLCF) are relying on LNG due to gas shortage in North region. As such, only Lucky Cement (LUCK) shall bear the major impact of sharp increase in gas tariff for captive power plant. Owing to capacity expansions and excess supply pressures, we do not anticipate LUCK, DGKC or MLCF to pass on this increase to end consumers.

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