Elixir Securities Limited – Elixir Insight

Karachi, November 09, 2018 (PPI-OT): Pakistan E and P Sector – Earnings Forecast Revised up on Higher Oil Prices and Weaker Currency Outlook

We review our investment case for E and P companies incorporating changes in company specific and macro outlook including higher oil prices (USD70/bbl vs USD60/bbl previously), relatively much weaker exchange rate (PKR/USD averaging 135 vs 130 earlier in FY19) and higher interest rates (200bps further increase in interest rate during the remainder of FY19).

As such, sector’s FY19/FY20 earnings are revised up by 7%/14%. However, valuations are expected to stay pat due to higher risk free rate assumption of 11% vs. 10% earlier.

Our top picks in the sector are MARI (PT: PKR1,772/share) owing to unwinding of entitlement factor on Mari field production and OGDC (PT: PKR193/share) on cheaper valuations (PE of 6.5x compared with average PE of 7.6x for other companies).

Revised Macro Assumptions to Bode Well: The macros have taken a sharp turn in recent times with rallying oil prices (averaging relatively higher than last year in spite of 16% slide from its high in Oct-18), depreciating PKR against USD by 9%/20% during FYTD/2018TD, and rising interest rates by 275bps during 2018TD. Oil prices and weaker currency are the major factors which are expected to push E and Ps’ FY19/FY20 earnings up by 7%/14% (compared to our earlier forecasts). However, valuations are expected to stay pat due to higher risk free rate assumption of 11% vs. 10% earlier.

We anticipate oil prices to persist at current levels of USD70/bbl owing to tighter oil supply outlook due to 1) US imposing sanctions on Iran (where temporary oil import relaxations to handful of countries have caused oil prices to slip over the last two weeks), 2) plummeting Venezuelan oil production due to its economic crisis, and 3) indication by OPEC to continue production freeze (however, possible suspension of OPEC’s production freeze in its next meeting in Dec-18 remains a credible threat to oil prices).

In the wake of Pakistan’s external account imbalances and alarmingly low FX reserves, US interest rate liftoff is expected to create further pressure on PKR which is expected to reach 142 by end of Jun-19 and averaging 135 in FY19.

Interest rates are expected to increase by further 200bps during the remainder of FY19 as imported inflation is expected to mount up with sliding PKR, and increase in energy tariffs.

In view of valuations, our top picks from the sector are MARI (PT: PKR1,772/share) and OGDC (PT: PKR193/share) – former due to unwinding of entitlement factor on Mari field production and latter on cheaper valuation (PE of 6.5x compared with average PE of 7.6x for other companies).

OGDC – Cheapest on Relative Valuation: Oil and Gas Development Company’s (OGDC) production is expected to continue to decline to 58mmboe/55mmboe in FY19/FY20 due to inadequate replenishment of reserves amidst natural decline in its fields (including Kal, Palli Deep, Qadirpur and Nashpa). Earnings are expected to post growth on account of higher international oil prices and weaker PKR. As such, we have revised up our FY19/FY20 EPS forecast by 4%/11% to PKR23.5/24.2. However, our Jun-19 PT is revised down by 2% to PKR193/share (26% capital upside) owing to revised up risk free rate assumption. The stock remains one of our top picks owing to 1) cheaper valuations indicated by FY19/FY20 PE of 6.5x/6.4x (compared with average of 7.6x/6.9x for others) and significantly discounted implied oil price of USD36/bbl and 2) attractive dividend yield of 7.7% in FY19.

PPL – GPF III to Add 60mmcfd Gas: Pakistan Petroleum Limited (PPL) is also been seeing declines in production levels due to Sui field’s depletion. PPL‘s Gas Processing Facility (GPF) III at Gambat South which is expected to add 60mmcfd of gas production has already been delayed (where it was expected to come online in mid of 2018). The company is pursuing contractors to expedite the completion of the facility, where we have assumed it to come online by the end of FY19 now. As such, our revised FY19/FY20 EPS estimates have gone up by 5%/19% to PKR22.7/PKR25.8. Our revised Jun-19 PT stands at PKR209 offering 17% upside. The stock trades at implied oil price of USD45/bbl.

POL – Additional Flows to Boost Earnings: Pakistan Oilfield Limited’s (POL) production is expected to post increase in FY19 led by additional flows from Mardankhel, improvement in flows from Jhandial (producing 842bpd of oil) and discovery in Khaur North (testing flows at 502bpd of oil). POL’s earnings for FY19 are revised down by 2% to PKR65.6 due to lower wellhead gas price from TAL block due to pending issue of windfall levy on oil. However, FY20 EPS has been revised up by 9% to PKR69.5. Our Jun-19 PT stands at PKR504/share posing capital downside of 5% but offers attractive dividend yield of 10.2%.