Pakistan Oil & Gas Sector FY14E to better OMCs fortunes; APL preferred:
· We believe FY14E is likely to herald liquidity and profitability improvement for the downstream oil sector (OMCs), moving on from a tough past few years.
· Key areas of focus are likely to be (1) Pickup in sales volumes, (2) marketing margin uplift, (3) progress on circular debt reforms and (4) M&A in the sector.
· We project Pakistan oil consumption to grow by 5% YoY in FY14E vis-à-vis an average decline of 1% p.a. in the last 3 years, while progress on circular debt reforms will be critical in determining the sector’s fortunes.
· We maintain our preference for Attock Petroleum Limited (APL) over Pakistan State Oil (PSO), given the formers attractive FY14E dividend yield of 9% vs. the latter’s 2%.
FY14E to better FY13’s liquidity and profitability:
We believe FY14E is likely to herald profitability and liquidity improvement for the oil marketing (OMC) sector; moving on from a tough past few years. Key areas of focus for the sector appear to be (1) Pick up in industry sales volumes, (2) uplift in marketing margin, (3) progress on circular debt reforms by the government and (4) mergers & acquisitions (M&A) within the Pak OMC space.
Key areas of focus in FY14E:
(1) Pick up in industry volumes: We expect industry sales volumes to improve by 5% YoY in FY14E vis-à-vis an average 1% decline p.a. in the last 3 years. The recent measures taken by the govt. to reduce power load-shedding in the country are likely to deliver 6% YoY growth in Furnace Oil (FO) sales. Gas shortages and shrinking CNG/Petrol price differential are likely to drive up Motor Gasoline (MOGAS) sales by 5% YoY, while we expect High Speed Diesel (HSD) to witness an uptick of 3% YoY. At the same time, we flag that complete resumption of NATO supplies could boost Jet Fuel volumes. In 2MFY14 petroleum product sales volumes are up 5% YoY on the back of 11% YoY growth in FO volumes, where August 2013 sales have increased by 14% YoY though are down by 12% MoM.
(2) Margin uplift: In its recent analyst briefing, PSO had indicated possible increase in marketing margins on white oil products. This will, if materialized, somewhat compensate the industry for exchange losses, where PKR has already slipped by 5% vs. the USD YTD FY14. Note that APL remains relatively immune to exchange losses owing to its local sourcing of products. We estimate 2-3% earnings sensitivity for every 5% hike in marketing margins for APL and PSO.
(3) Progress on circular debt reforms: We believe progress on circular debt reforms will be pivotal in determining the sector’s fortunes. The government has raised power tariffs to reduce tariff shortfall with further hikes still on the cards, however overall improvement in the efficiency of the power sector (line losses, bill collection) will be critical.
(4) Mergers and Acquisitions: Industry consolidation remains one of the key themes in the sector, where recently we have seen Chevron Pakistan selling its operations to PARCO. We understand that Shell is also reviewing its portfolio in Pakistan due to prevailing low margins, and possible announcement of its exit may spark speculation on possible sale price and buyer.
APL our preferred play over PSO:
We maintain our preference for Attock Petroleum Limited (APL) (TP: Rs570 - Hold; FY14E EPS & P/E: Rs66.61 and 8.9x) over Pakistan State Oil (PSO) (TP: Rs275 - Sell; FY14E EPS & P/E: Rs63.06 and 4.9x) given (1) APL’s attractive FY14E dividend yield of 9% vs. PSO’s 2% FY14E dividend yield and (2) APL’s relative immunity to exchange losses and circular debt.