Pakistan Energy: HUBCO and KAPCO Outlook

Pakistan’s leading brokerage house BMA Capital has revised its FY13E and FY14E earnings estimates by 7% and 5% to Rs8.65/share and Rs8.97/share respectively for Hub Power Company (HUBCO) after taking into consideration higher than expected 9MFY13 financial results, higher penal income on escalating Narowal’s receivables (Rs19 billion) and declining finance cost.

Non-availability of Narowal during March and April this year for generation has entitled it to Liquidated damages to the tune of Rs838 million (included in the receivables). The Company has filed a petition in the Supreme Court that has awarded a stay on any such damages through an interim order for now.

BMA has also increased its FY13E and FY14E earnings estimates for Kot Addu Power (KAPCO) by 11% and 10% to Rs8.7/share and Rs9.1/share respectively to account for lower finance cost on account of frequent cash injections.

The plans to resolve circular debt issue in one go seem good on paper. However the implementation of the same (tariff pass-on, change in energy mix etc) seems a tedious task given the limited fiscal space.

Therefore, BMA maintain its FY13E dividend assumption for HUBCO and KAPCO at Rs7.0/share and Rs7.5/share respectively.

Consequently, the target prices remain unchanged at Rs56/share and Rs58/share for HUBCO and KAPCO respectively.

Pakistan: PSO from Rags to Riches

In the recent past I have posted a few not really positive news items about Pakistan State Oil Company (PSO). The largest oil marketing company of Pakistan, operating in the public sector was also recently excluded from MSCI index.

Today I present highlights from a detailed report on PSO to be released by InvestCap one of Pakistan’s leading brokerage houses shortly. In this report the brokerage house has elaborated potential impact of the expected increase in POL product volumes stemming from increased usage in power generation.

For FY13, the brokerage house expects PSO to post earnings growth of 29% YoY (EPS: Rs47.18) due to various reasons that include: a) a 16% higher motor gasoline (Mogas) volumetric sales, b) 60% less exchange losses backed by lower depreciation of Pak rupee against US dollar (approximately 5% as compared to 10% during FY12) and c) higher margins on HSD (Rs0.10/liter to Rs1.86/liter) and Mogas (Rs0.25/liter to Rs2.23/liter) during last quarter of FY13. However, it anticipates earnings during 1HFY14 to remain flat YoY at Rs25.4/share in the absence of inventory gains.

PSO's sales volume for furnace oil (FO) having declined by 4% YoY during 9MFY13, Investcap expects the same to fall by 3% YoY during FY13. FO sales are anticipated to increase in FY14 after the benefits from the power sector reforms become evident. Thermal generation being the need of the hour implies increased usage of FO for electricity generation through FY14-16. PSO’s FO sales volume is likely to increase by 5% CAGR during FY14-16E or until successful completion of power generation projects using cheaper energy resources.

Positive correlation between economic growth and white oil sales has existed historically and the same relationship is expected to prevail in the future. During the last three years Pakistan’s economic growth has remained range bound between 3-4% and white oil sales leveled around 10-10.5 million tons. Going forward, the average economic growth rate is expected to 5% (FY14-16E) to be supported by ~7% higher volumetric sales of white oil annually by PSO.

Assuming cost of equity at 17% and terminal growth rate of 5%, InvestCap values PSO at DCF-based target price of Rs325/share for December 2013. The target price implies 18% upside from current levels. It maintains 'BUY’ stance on the scrip.

Pakistan: Fertilizer sector to invest US$100 million

In Pakistan fertilizer units getting gas from Sui Northern Gas Pipeline Limited (SNGPL) have expressed intentions to invest US$ 100 Million for the development of dedicated lower BTU gas fields. This is aimed at improving gas supply to fertilizer plants to improve capacity utilization of local plants instead of depending on costly imported urea costing hundreds of millions of dollars of foreign exchange every year. Fertilizer sector has been facing severe curtailment of gas since April 2010, one of the worst affected sectors, which has worsened rural economy over the last few years. 

Shahab Khawaja, Executive Director Fertilizer Manufacturers Pakistan Advisory Council (FMPAC) said that the new gas allocation through long-term arrangement is just continuation of existing policy. Now fertilizer plants getting gas from SNGPL network will get gas from different small fields as a replacement of gas which would be discontinued from existing sources. Getting required quantity of gas is the right as all the fertilizer companies have signed gas purchase agreements with the Government of Pakistan (GoP).

 He said that the decision to supply gas to fertilizer industry through dedicated small fields is in line with the strategy to reduce burden from the SNGPL network, and to ensure continuous supply to general and industrial consumers in the country. This decision has been taken after detailed deliberations from all the concerned stakeholders in the larger interest of the country which is an agriculture economy. Agriculture contributes around 24% to the GDP of Pakistan and it also provides raw materials to all the major industries of Pakistan including textiles and clothing and sugar.

He said that successful implementation of the long term plan will ensure self sufficiency of country in fertilizer production and would also bring substantial savings of half a billion dollars of foreign exchange annually and subsidy of approximately Rs20 billion that the GoP has to pay on one million tons imported urea.

He informed that the post ECC approval, GSAs between gas fields and fertilizer plants were inked carrying the reservoir risks and gas transportation agreements with both sui companies were signed under OGRA's TPA Rules, these agreements strictly comply the TPA rules. The arrangement is beneficial for Sui companies with additional stream of tolling income and saving on 240 mmscfd of gas allocated to 4 fertilizer plants under existing GSAs with SNGPL.

While dispelling the impression that fertilizer sector would get dedicated gas from different small fields without any additional investment, he informed that to facilitate this transaction fertilizer plants are investing more than US$100 million in increasing the pipeline capacities of Sui companies where bottleneck exists. The SNGPL based plants being large scale units are now at verge of closure with over Rs100 billions payable bank loans. Current arrangement is a win-win for all stakeholders as fertilizer plants upon receiving the regular gas from different small fields would provide farmers with cheaper local urea and gas companies would be selling this gas to new customers with better rates.

He informed that Fertilizer plants will also pay a higher gas price than the gas price available to them under the existing GSAs, and will also have to incur significant additional investment for the smooth transportation of gas from respective gas fields to their plants. In the past despite guaranteed contracts with the fertilizer industry gas was diverted from fertilizer companies to other sectors, however, with the implementation of this arrangement, certainty of gas supplies to the fertilizer sector would be ensured to get continuous urea production for Pakistani agriculture sector.

 Pakistan: PSO deletion from MSCI Index

In this post presented is an update on MSCI's recent Semi-Annual Index Review, regarding PSO's deletion from the MSCI Frontier Market 100 Index. InvestCap, a leading brokerage house of Pakistan has highlighted the impact on price of shares of Pakistan State Oil (PSO), the largest oil marketing company though operating in the public sector but listed at all the stock exchanges of the country.

MSCI announced the results of Semi-Annual Index Review for MSCI Frontier Markets on 15May'13, the effective date for implementation is however 1st June 2013. Including PSO, twelve Pakistani stocks were participating in the constituents of MSCI Frontier-100 index.  According to the constituent revision, only PSO will be eliminated from MSCI Frontier-100 stock universe from 1st June 2013.

According to the brokerage house report, the immediate impact of this development is expected to be witnessed in the shape of selling pressure in this particular scrip by the international funds. InvestCap back such expectations by the rationale that due to the exclusion of PSO from the index, the index tracking funds currently following MSCI Frontier 100 index, will in turn seek to off-load their positions by selling in order to minimize tracking error.

However, with 1) an index weight of 0.17 percent, 2) Foreign Inclusion Factor (FIF) adjusted shares of 74.1 million (30 per cent of total shares outstanding) and 2) foreign investor holding of less than 4 per cent, selling from international investor is unlikely to affect price of the scrip in any significant manner in Pakistan market.  Moreover, with the reasoning for such exclusion still being unavailable, brokerage house still remain hopeful that PSO will gain back its position in the MSCI 100 index.

From the perspective of the local investor, this development is likely to stir investor confidence following the international investors' sentiments. However, brokerage house expects this to be a short lived phenomenon. Going forward, on a fundamental basis, PSO looks attractive as the new political setup has been firm in its commitment to minimize circular debt gradually. PSO being a major stakeholder in outstanding circular debt, with an amount of Rs100 billion (till 13th March 2013) tied up in the debacle as compared to total circular debt of Rs537 billion (till April this year).

PSO is currently trading at an FY13 PE of 5.09x and PBV of 0.97x seems more attractive as compared to the OMC sector and its peers. PSO's deletion from the MSCI Frontier-100 index appears to have only a sentimental impact on the price of the scrip and is therefore expected to pose a short term drag on the price performance and investor confidence. However, strong fundamentals justify a healthy return in the longer term.

Pakistan: Energy Sector Improving Outlook

During first nine months of current financial year (FY13) exploration and production (E&P) companies operating in Pakistan have posted decent growth in earnings as the sector profitability surged by 6 per cent due to better production, steady prices and robust other income. Analysts forecast E&P companies to conclude FY13 on higher earnings during fourth quarter due to improvement in oil production plus expected 2.5 per cent depreciation in value of Pak rupee against US dollar.

According to a report by BMA Capital, during nine-month period companies in its universe posted a decent growth in earnings as the sector profitability surged by 6% YoY to PKR118 billion. The marked increase in earnings has been attributed to better production, steady oil/gas prices and robust other income. OGDC led the pack with earnings growth of 9% YoY owing to robust oil and gas production (up by 7% and 4% respectively) and considerable surge in other income (up by 58%). PPL followed with 4% surge in earnings on account of stellar oil production (up by 14% YoY). However, POL remained the laggard with 8% dip in earnings due to lackluster trend in both oil and gas production (down by 5% and 16% respectively).

During third quarter (Jan-March 2013) performance was marked by lackluster activity with both PPL and POL depicting notable decline of 8% YoY and 6% YoY respectively in earnings on account of sluggish gas production (declined by 13% and 18% for PPL and POL respectively) and lower oil prices (down 7% YoY). OGDC also depicted a decline of 4% in earnings primarily due to a phenomenal surge in exploration charges (owing to increased number of dry wells written off).

It is pertinent to note that higher 2D/3D seismic activity and increased number of dry wells propelled exploration charges of the sector to PKR14.8 billion during 9MFY13. Barring OGDC’s dry wells; the exploration charges were still higher by 107% YoY. That said, exploration costs remained a major dent on the profitability during this period. On the other hand, notable uptick in other income by 29% YoY (solely due to OGDC’s interest income of energy sector TFC) partially neutralized the impact of higher exploration expense.

BMA believes the E&P companies to conclude FY13 on a higher note with 4%‐16% QoQ appreciation in earnings in 4QFY13. The recovery in earnings is likely to come from improvement in oil production plus expected 2.5% depreciation of Pak rupee value against US dollar. Whereas, lower exploration costs (reduced/absence of dry well write‐offs) and improved other income will further support bottomline. However, higher than estimated decline in gas production (for PPL and POL), further dry well write‐offs (particularly OGDC) and more than anticipated decline in crude oil prices will remain key downside risks.

BMA has trimmed down its FY13 EPS estimates by 6%‐11% to PKR24.7, PKR27.5 and PKR50.5 for OGDC, PPL and POL respectively. Downward revision in earnings estimates is based on 1) higher than estimated explorations costs, 2) lower than expected gas production and 3) slightly lower than anticipated other income in 9MFY13.

Crude oil prices depicted a volatile trend since the start of CY13 as Nymex peaked to US$98/bbl in Jan13 while it bottomed to US$87/bbl in mid Apr13. The outgoing month of April13 was marked by a sharp retreat in oil prices as both Nymex and Arab light lost ground by 4% and 6% MoM respectively. The bearish trend in oil prices can be attributed to weakening global demand coupled with a hefty jump in US crude supplies. Refinery maintenance period and renewed fears over Euro‐zone economic turmoil kept the oil prices under serious pressure.

However, oil prices (both Nymex and Brent) closed the last week on a higher note with largest daily gains of 3% on 2^nd May in last 6 months owing to 1) below expected jobless claims in the US and 2) cut in interest rates by ECB. Based on these measures to stimulate economic growth, oil prices may rebound sharply in 1HFY14. Weak economic performance by the two largest oil consuming nations US and China will remain key downside risk to oil prices, going forward.

OGDC with highest volumetric growth stood out in the sector with a healthy 10% YoY uptick in topline during 3QFY13 compared to a nominal 1% and 3% improvement in sales of PPL and POL respectively. Going forward, the completion of phase 2 of both KPDTAY‐II and Sinjhoro‐II coupled with start‐up of Makori East GPF (ME GPF) in 2HFY14 will further strengthen the production. Moreover, development activity at Uch‐II and positive announcement at Nashpa‐4 will further spark activity in the stock. However delay in materialization of cash flows (interest income) on TFC (energy sector) investment will remain a key concern on dividend payouts.

PPL in the near term is likely to witness additional flows from Nashpa and TAL block will remain the key offsetting factors to persistent decline in gas production from mature fields. Also, any additions from Adhi and Latif will further strengthen the production profile. In the long term, materialization of tight gas flows and positive outcome of company’s ongoing exploration activity (9MFY13 exploration cost already up) will act as key triggers.

POL after posting a dismal 1HFY13 (oil production down by 11% YoY), has sharply bounced back with production of 5,000bbls/day in 3QFY13 depicting a marked increase of 16% QoQ and 9% YoY. This coupled with additional flows from Manzalai‐9, Maramzai‐2 and Mamikhel‐2 (expected to tie‐up in May‐June 2013) and ME GPF kickoff (expected in Jan14) will further propel the hydrocarbon production of the company.