FLASHNEWS:

JS Securities Limited – JS Research (January 06, 2023)

Karachi, January 06, 2023 (PPI-OT): Efforts to curtail gas circular debt gather speed

In another effort to successfully complete the lingering ninth review of the ongoing IMF program, Pakistan government has reportedly increased its pace on resolution of gas circular debt plan with formation of a committee.

IMF in its recent Staff Report placed much emphasis on burgeoning gas circular debt and the need to address the same. In the same report, Pakistan government had ensured it has begun work on the Gas Circular Debt Management Plan (CDMP).

From the listed space, any liquidity injection in the gas chain bodes well to unlock valuations of OGDC, PPL, PSO and SNGP. Since announcement of the committee being formed, these stocks have reported returns of 14% – 38%, vs KSE100 performance of 4% during the same time. Despite recent run up, the said stocks trade at earning multiples of ~2.5x.

As a part of the CDMP, any measures taken regarding gas price increase across the board, would have negative implications on costs of the fertilizer, cement (LUCK and CHCC), textiles sectors and companies that run captive plants on gas.

Attempt to chalk out gas circular debt plan

In another effort to successfully complete the lingering ninth review of the ongoing IMF program, the government has reportedly increased its pace on resolution of gas circular debt. The government formed a committee comprising public and private sector representatives that would devise a detailed road map to address the issue. The road map would reportedly provide a strategy to reduce current outstanding gas circular debt of Rs1.6trn to Rs500bn, contracting it by almost 70%. The gas circular debt was estimated at Rs720bn as at Mar-2022 and at Rs620bn as at Jun-2021.

Further exaggerating the impact of the usual culprits – UFG losses, lower bill recovery and subsidized gas rates – has been by the sharp rise in international RLNG prices post Russia-Ukraine war and steep PKR depreciation. This has led to a situation of a higher bill to foot and lower funds available with the government to pay to Sui companies (SSGC and SNGP), followed by ballooning receivables on OGDC, PPL and PSO’s books. A strategic issue has also been higher reliance on RLNG amid lower indigenous gas exploration.

To comply with IMF recommendations

IMF in its recent Staff Report has given much attention to the burgeoning gas circular debt and the need to address the same by establishing reliable circular debt data, a gas Circular Debt Management Plan (CDMP), and circular debt projection capacity. In the same report, Pakistan government had ensured it has begun work on the CDMP, compile gas circular debt related data and structure regular data systems.

To reduce outstanding overdues in the gas sector the government briefed steps such as (1) regular adjustments to end-user gas prices as per established formulas, (2) measures to reduce unaccounted for gas losses and (3) improving liquidity of Sui companies. The government also quantified these measures estimated to generate Rs666bn. To recall, the last gas price increase was announced in Sep-2020, that too for limited segments and within the range of 1% – 6%. Prior to that, 31% gas price increase for all segments (62% for Fertilizer feed gas) was announced in Aug-2019.

Measures to benefit energy companies

From the listed space, any liquidity injection in the gas chain would bode well to unlock valuations of OGDC, PPL, PSO and SNGP. Where OGDC’s outstanding dues from the Sui companies stand at Rs78/share (OGDC market price: Rs80/share), PPL’s outstanding dues from the same are at Rs138/share, against its market cap of Rs72/share.

Since the announcement of the committee being formed, the aforementioned stocks have reported returns of 14% – 38%, vis-a-vis KSE100 performance of 4% during the same time. Despite recent run up, the said stocks trade at earning multiples of ~2.5x.

Gas price increase cannot be ruled out

As a part of the CDMP, any measures taken regarding gas price increase across the board, however, would have negative implications on costs of the fertilizer and cement sectors (LUCK and CHCC), in addition to companies that run respective captive plants on gas. Regarding fertilizers, impact of gas price increase could likely be passed on to farmers. With every 10% increase in gas prices, an assumption of all costs borne by corporates (worst case scenario) would impact profitability of the fertilizer sector by 4% – 6%, of LUCK and CHCC by ~1% and of EPCL by 7%. In addition, as the Staff Report itself highlighted uncovered subsidies (especially for export and zero-rated industries) among key reasons of piling gas circular debt, possibility of gas price increase for textiles sector also rises.

Moreover, higher gas prices are a risk to our base case CPI average of 24% for FY23. Given its weight of 1% in the basket, a significant increase in the said prices would impact our base case, in addition to impact from second round.