The brokerage house after revisiting its investment case for Pakistan State Oil (PSO) has revised December 2023 share target price to PKR215, from PKR240, providing a total return of 66% from last close.
Its models incorporate risk-free rate of 17%, PKR/US$ of 240/270 and Arab Light of US$95/90 per barrel during FY23/FY24. More specifically, with the crop season likely to be impacted by the recent catastrophic floods (affecting HSD offtakes), reduced auto sales in the coming quarters and overall fallen retail sales due to lower affordability amidst higher prices.
Industry’s total POL demand is expected to cumulatively fall by 15% during FY23 (previous estimate 8%), due to an overall depressed economic outlook.
To note, PSO’s volumetric offtakes were down by 18%YoY as against industry’s overall decline of 20% during 5MFY23.
The much awaited revision in OMC margin provides significant impetus to the valuation. The brokerage house has incorporated uniform OMC margins of PKR6/liter for both MS and HSD from January 2023 onwards, up 61%/51% from current levels for MS/HSD, respectively.
The aforementioned increase is expected to result in gross margins for retail fuels to stand at 2.6%/2.5% (assuming current POL prices) from 1.6%/1.7% on MS/HSD, respectively.
Historically, OMC margin increases were done generally benchmarking with the core CPI (NFNE), increasing by 6% on an average, annually. Going forward, the brokerage house assumes an annualized growth in OMC margin by 8%, to be revised at the start of every fiscal year.
With regards to the company’s working capital issues, measures taken by the GoP in order to meet with conditions set out by the IMF may be a breath of fresh air for the company.
As the global lender pushes the GoP into fiscal consolidation by increasing power and natural gas tariffs, this is expected to reduce the financial burden on the cash-starved sector and consequently PSO.
The company may be the primary beneficiary of these hikes as repayments of its overdue receivables and LPS surcharges may begin flowing through from its two biggest defaulters SNGPL (overdue receivables: PKR305 billion) and power sector (overdue receivables: PKR92 billion) as per latest quarter, inducing increased collections from customers.
Ongoing winters may pose risk because in the near term, the national petroleum company is expected to suffer from increased circular debt build up during FY23 amidst volatile LNG prices due to current geo-political scenario, along with rapid depreciation of PKR/US$.
This subsequently results in increased working capital needs for the company and finance costs (82% short term in foreign currency, rising rates globally pose a risk).
Overall, the brokerage house expects belligerent build up of LNG receivables from Sui companies (as seen in the past) to gradually slowdown/ halt on the back of shrinking tariff differential between indigenous and imported gas assuming biannual gas price increase is incorporated in timely manner going forward.
The brokerage house liking for Pakistan State Oil (PSO) is due to: 1) gas and power tariff adjustments may prove to be cash-positive, 2) Modernization plans in refinery subsidiary (PRL) to enhance productivity, and 3) Phasing out of RFO coupled with increasing share of retail fuels, resulting in stable margins to drive unhampered future cash flow.
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