National Refinery stops supplying fuel to Pakistan State Oil Company

According to media reports, National Refinery (NRL) has decided to halt supplies to Pakistan State Oil Company (PSO) after the state-owned oil marketing company stopped the payments to the refinery.

PSO has been suffering from a severe financial crisis due to lack of payments from various sectors on account of supply of petroleum products. Currently, the PSO owes National Refinery PKR 3.469 billion.

PSO stopped the payments of refineries a couple of days back. These refineries are the suppliers of diesel, petrol, aviation fuel, furnace oil etc. to the state-owned company, having the largest share in the sales of petroleum products in the country.

“NRL has decided to halt the supply to PSO after the stoppage of payment and intimated the OMC in written,” said sources familiar to the development. They added, NRL was the first and other refineries might follow suit.

PSO has been entangled in financial woes for the last many years, but in recent months the situation has aggravated immensely as its inter-corporate debt has increased to PKR1,024 billion with receivables at PKR762.653 billion and payables at PKR261.155 billion.

The breakup of the PSO payments to the local refineries showed that it has to pay PKR25 billion to Pak-Arab Refinery Company (PARCO), PKR10 billion to Pakistan Refinery (PRL), PKR3.469 billion to National Refinery, PKR9.049 billion to Attock Refinery (ARL), and PKR4.108 billion to Cnergyico.

Details of the company’s receivables show that the Sui Northern Gas Pipelines (SNGPL) has so far emerged as the biggest defaulter of Pakistan State Oil.

The SNGPL owes PSO PKR492.102 billion as of March 08, 2023.

The power sector continues to haunt the state-owned oil marketing company as it is required to PKR Rs178 billion followed by Pakistan International Airlines (PIA) and the government of Pakistan, which owe PSO PKR92.5 billion.

The most crucial payment of PKR124.666 billion in the head of LPS (late payment surcharge) is also part of the total receivables that have soared to PKR762.653 billion.

 

Pakistan: Power Generation decreases by 3.2%YoY in January 2023

Power generation has been reported at 8,515GWh for January, 2023, remaining flat MoM while decreasing by 3.2%YoY as compared to 8,797GWh generated last year.

This takes cumulative energy generated for the first 7 months of FY23 to 77,085GWh, a decrease of 7.3%YoY.

The demand supply shortfall remains a persistent issue in the country, where peak demand for the month was estimated between 16,000-17,000MW.

Circular debt for the power sector has been reported at PKR2.5 trillion as compared to PKR2.25 trillion in June 2022.

According to the revised Circular Debt Management Plan presented to the IMF, FY23 is targeted to close with a Circular Debt stock of PKR2.4 trillion after a PKR335 billion payout will be given in June to reduce the accumulation for the year.

Hydel generation for the month under review was reported at 800GWh, decreasing substantially on a monthly basis as January is the month of least hydrology in the country historically.

Hydel generation was up 56% on a yearly basis, partly due to dependable capacity on Hydel increasing to 10,592MW.

The significant increase in power generation have been seen from Coal fired power plants, with generation up 61%MoM aided by the new Thar Coal Block-1 and ThalNova plants which were added to the grid, along with increased generation from the plants running on imported coal to cover for the lack of hydel generation in the month.

Furthermore, Furnace oil (FO) based plants have finally seen an uptick in utilization, with 463MW generated in the month as compared to merely 39MW last month.

Despite this, owing to better availability of lower-cost alternatives, FO generation was down 63%YoY and remains at highly diminished levels.

Average cost of generation for the month under review rose by 59% to PK11.2/kWh owing to the decrease in generation from Hydel plants and the consequent increase in reliance on thermal sources.

In terms of the generation mix for January, the largest contributors are Coal (29%), followed by Nuclear (22%), RLNG (15%), Gas (13%) and Hydel (9%).

Coal based generation in generation mix has risen to 29% from the 18% recorded last month.

Generation from thermal based power plants was recorded at 63% of total generation in the month, considerably lower than the 3 year average of monthly generation in the month of January of 74%, mainly due to the emergence of new Nuclear based capacities.

HUBC has seen significant increases in power generation, with 58GWh more power generated in this month, while down by 72%YoY despite the new TEL plant coming online this year.

Utilization for the CPHGC remains meager at 6% for January, while the base plant generated 0.9GWh after three months of no utilization.

On the flipside, the more efficient Narowal plant witnessed significant utilization of 37% in the month with 56.5GWh generated, while the TEL plant remains well-utilized at 69% due to its high placement in the Merit Order.

KAPCO remains non-operational owing to the expiry of its PPA and is still out of the Merit Order, although it has sold 2.7GWh from its RLNG plant in the month.

NPL and NCPL have also seen a surge in utilization for the month as the plants are relatively less expensive compared to their peers in the FO group, with the plants recording 40% and 29% in utilization respectively.

As the hydrology in the country improves post January, the cost of generation should decrease going forward as reliance on thermal sources decreases in tandem.

 

 

Pakistan State Oil Co. warrants closer watch

Pakistan’s largest oil marketing company, Pakistan State Oil Company (PSO) is expected to suffer from increased circular debt build up during FY23 amidst volatile LNG prices due to current geopolitical scenario, alongside with rapid depreciation of Pak Rupee, in the near term. I am inclined to share with my readers the latest review by Pakistan’s largest brokerage house, AKD Securities.

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.

Energy Crisis in Pakistan: Fact or Fiction

If one looks at the history of power sector in Pakistan, a few points are clear. These include: 1) a myth that the country has been persistently suffering due to the shortage of energy products, 2) the successive power policies have been have been introduced to serve the interest of local and overseas investors, 3) blatant theft of electricity and gas has been going on with the connivance of employees of utility companies, 4) regulatory authorities have failed in protecting the interest of consumers and remained subservient to the incumbent governments.

Energy shortage

Pakistan is blessed with an enormous potential of hydel power generation. According to the experts Mighty River Indus along has the potential to generate more than 40,000MW electricity per annum. Another 10,000MW electricity per annum can be generated from smaller hydel plants (run of the river type facilities which does not require construction of dams/reservoirs. In addition to that 50,000MW electricity can be produced annually from Thar coal. However, at present total hydel generation is around 8,000MW, which goes down when water level drops in dams. Thermal power plants (mostly owned and operated by the private) have the lion’s share in the total generation. The share of coal and nuclear power plants in the total electricity generated has remained minuscule. Though, a lot is being talked about changing the energy mix and curtailing use of gas for power generation, a little success has been achieved.

Serving vested Interest

Major hydel power generation facilities, i.e. Warsak, Mangla, Tarbella and Ghazi Brotha are located in the northen parts of the country and cater to the needs to KPK and upper Punjab. Karachi is hub of trading and industrial hub and it is totally dependent on thermal power generation. The city has 10% of the total population of the country but gets nothing from low cost electricity generated from hydel power plants. To be precise, K-Electric supplies electricity to some parts of Sindh and Baluchistan. If transmission of hydel electricity to Karachi is difficult or uneconomical, quota allocation of gas to K-electric should be doubled. Karachi is surviving on self generated electricity, the city has a latent demand of 5,000MW, whereas K-Electric is capable of meeting only half of this demand. One can still recall that in the early nineties E-Electric used to export electricity to Punjab. HUBCO was constructed to primarily meet Karachi’s demand, but it was ‘hijacked’ by WAPDA for meeting Punjab’s demand.

Blatant Theft

Blatant theft of electricity and gas been been going on for ages with the connivance of utilities. On top of all some of the parts of Pakistan are provided free of cost electricity. One may recall that at one time the average T&D losses of electric utilities were as high as 40%. Lately, gas UFG, which mostly comprise of theft hover a little less than 10%. On top of this, utility companies carry the load of billions of rupees of receivables, the probability of recovery is very low. According to some analysts, if K-Elecric pays off its outstanding dues, SSGC will be able to pay off almost all the payable amount to E&P companies. Containing theft or recovering outstanding dues does not require any rocket science, but a firm commitment. However, utilities fail completely helpless because of the pressure of political and linguistic groups. It is also necessary to put on record that utilities don’t provide connections, taking refuge behind non-availability of electricity/gas, but are prompt in providing ‘temporary connections, which are often without meters. Analysts term this ‘offical kunda’.

Regulatory Authorities

The Government of Pakistan (GoP) initiated the process of liberalization, deregulation and privatization. Under this policy, the private sector was encouraged to establish industries, which remained the exclusive domain of the state for decades and it was also offered the stake in state owned enterprises along with management control. Prior to that the World Bank has refused to lend more money to WAPDA and the shift in policy gave birth to HUBCO and other IPPs. 

IMF Recipe

Many analysts have the consensus that the International Monetary Fund (IMF) is the lender of last resort, but its recipes are not aimed at enabling any country to ‘stand on its own feet.’ Often the country is trapped in a vicious cycle of borrowing. However, the advantage is that if the country succeeds in developing its own home grown plan and meeting the condition imposed by the IMF, it may overcome the balance of payment crisis. 

Pakistan has a long history of remaining under the IMF support program. In one of the latest country report, the Fund has once again highlighted the need to introduce structural reforms for the power sector. These weaknesses identified are: 1) the persistence of circular debt, 2) DISCOs still operating under the state control, 3) high T&D losses, 4) failure to follow corporate governance and 5) lack of the mechanism for passing on input cost adjustments to end consumers.

Emphasizing US$55 billion in planned investments as a part of CPEC, the Fund anticipates improved economic activity made up of 19 Chinese sponsored power sector investments (US$17.7 billion) and non-CPEC energy projects (US$25.4 billion). Mode of financing for energy projects has been bifurcated into: 1) direct borrowing and investment from Chinese financial institutions, and 2) financing of projects by private domestic sponsors as well as government backed borrowing from multilateral lenders.

A detailed analysis of the power sector shows: 1) the country has enormous resources to produce low cost electricity, 2) if pilferage is contained cash flow of DISCOs will improve and 3) circular debt issue will be resolved. Appropriately managed conventional sources of power generation can help in meeting the electricity demand and there may not be an urgent need to invest in alternative sources of power generation.

Pakistan Stock Market Fails in Breaching 50,000 mark

At Pakistan Stock Exchange, bullish sentiment resurfaced in the later part of the week ended 5^th May 2017. The rally was driven by upbeat about earning of listed companies and offtake announcements by Cements, Urea & POL products). This elevated the benchmark index by paltry 1.1%WoW to close at 49,851 points, a little shy of 50,000 mark. Bearish sentiments plunged average daily turnover by 26.4%WoW to nearly 264 million shares.

Key news flows during the week were: 1) CPI based inflation for April’17 declining to 4.78%YoY as compared to 4.92%YoY a month ago, 2) Ministry of Finance agreed to release Rs104 billion to settle pending power subsidy claims for the current financial year, 3) SECP announced the criteria for mutual funds’ investment in the listed companies, restricting investments in illiquid and unprofitable stocks and 4) Supreme Court of Pakistan formed the joint investigation team (JIT) comprising of six members from various agencies to investigate aspects of the Panama papers case against Prime Minister Nawaz Sharif and his family.

Stock leading the bourse included: NCL, BAFL, EPCL, LUCK, whereas the laggards were: AGTL, PIOC, SNGP and PTC. FIPI data points to foreign investors pulling out US$19.28 million during the week accelerating their exit over last week’s net outflow of US$10.71 million. The month of May remains a critical for markets as 15^th May approaches closer, for the MSCI revision. Additionally, CPEC summit around middle of this month in Beijing is expected to boost investors’ sentiment for Construction and Materials sector. Investors also await the federal and provincial budgetary incentives expected for the final budget before next election. 

OCAC recorded April'17 POL industry sales of 2.22 million tons rising 16%MoM/11%YoY beating the average seasonal uptick, based on strong retail fuels sales growth (MOGAS/HSD sales up 12/11%MoM and 14/5%YoY respectively) and increased generation on furnace oil (FO). From a cumulative perspective 10MFY17 industry sales now stand at their highest recorded mark of 21.04 million tons (up 12%YoY) where retail fuel growth led the charge (MOGAS/HSD sales growth of 17/12%YoY), supported by FO sales growth of 10%YoY. Growth in all three of these segments, which make up 96% of total industry volumes, bodes well for market penetrating OMCs focusing on these segments for growth.

CPPA reported generation numbers for February/March of 2017 where 6.38/7.62TwH were generated. The weighted average cost of generation during the months stood at Rs5.18/6.22/KwH up 31/12%YoY marking a general rise in the cost of generation in the public sector. Cumulative 9MFY17 generation amounts to 76.54TwH rising 5.8%YoY, aided in large part by 5.2%/65.2%YoY increases in FO/Nuclear generation, at a total net dependable capacity of 11,812MW (50% load factor on nameplate generation capacity of 23,623MW). Thermal sources for generation supplied 67% of total units produced where FO/HSD based generation persisted (30.1/1.2%). In a power policy backdrop riddled by long standing, systemic impediments, a one-off payment before summer, is a stop-gap measure at best, kicking the can down the road. Investors agree, as evidenced by the 9.2%CYTD (ex-KEL) decline in the sector's performance, where an investment case for KAPCO on yield remains compelling, while a 'chink' in NEPRA's tariff setting authority may give long term space to push through lucrative tariff for an extension.

Power mix remain steady as generation from renewable, ex-hydel showed a marked rise with Solar/Wind/Bagasse based projects increasing units generated by 310/69/63%YoY, but maintain meager shares of 0.6/1.0/0.8% in the national power mix during 9MFY17. Thermal sources for generation supplied 67% of total units produced as compared to 65% in 9MFY16, where FO/HSD based generation persisted (30.1/1.2% vs. 30.2/1.7% during 9MFY16). RLNG's share in the power mix continued to climb (4.9% as of 9MFY17) leading to decline in the share of units produced from gas, and is expected to continue tracking upwards as public sector RLNG projects near completion. Moreover, RLNG's cost of generation for 9MFY17 averages at Rs7.0/KwH, while March'17 cost of generation stood at Rs7.93/KwH, making RLNG based generation 23.2/49.0% cheaper than FO/HSD sourced units during the month.

Over the period, combined weighted cost of units generated by state-owned power plants inched up by 3%YoY, despite a 12%YoY increase in cost of generated units on FO (Rs8.8/KwH for 9MFY17). Additional allowances for debt repayment, higher repatriation of funds to provinces has also pulled up the cost of generation on Hydel by 21%YoY to Rs0.12/KwH, still the cheapest source of energy in the country. Feb/March'17 weighted average cost of generation stood at Rs5.18/6.22/KwH up 31/12%YoY marking a general rise in the cost of generation by public sector GENCOS.

Prominent power sector developments include: 1) Ministry of finance giving a nod to pay Rs104 billion as part of FY17's provisioned power sector, consumer subsidy, 2) Prime Minister M expressing dissatisfaction over persistent power blackouts, burdened by soaring shortfalls (5000-6500MW) and 3) CCI in its latest meeting approving amendments to NEPRA Act 1997 curtailing powers of the regulator when setting consumer/power tariffs. In a power policy backdrop riddled by long standing, systemic impediments, a one-off payment before summer, is a stop-gap measure at best, kicking the can down the road. Investors agree, as evidenced by the 9.2%CYTD (ex-KEL) decline in the sector's performance, where an investment case for KAPCO on yield (FY17/18F D/Y of 11.9/12.2%) remains compelling, while a 'chink' in NEPRA's tariff setting authority may give long term space to push through lucrative tariffs for an extension.

Pakistan Stock Market Remains Lackluster

Trading at Pakistan Stock Exchange remained lackluster evident from benchmark index sliding by 1.7%WoW and closing the week at 48,156 points. The average daily trading volume also declined by 3.5%WoW to 248.7 million shares.The lack of investors’ interest can be attributed to political volatility and absence of market triggers. News flows for the week included: 1) SECP in its press release dated 29th March apprised that its constituted committee (for reviewing in‐house financing) had submitted a report which focused on introducing reforms in Margin Financing (MFS) to improve banks' funding to investors through brokers, 2) GoP released total Rs505 billion (63% of total Rs800 billion allocated) inclusive of Rs122 billion from foreign aid, 3) GoP allowed PTA to auction a next generation mobile services (NGMS) license with a base price of US$295 million from the frequency spectrums left unsold in the previous two auctions, 4) NML announced selling of 40% stake of its auto assembling business to the Japanese giant Sojitz Corporation and 5) OGRA proposed an increase of POL products for April. Stocks leading the bourse include: SHEL, MTL, ASTL and MEBL, whereas laggards were: HASCOL, AKBL, KEL, NML. Volume leaders were: BOP, ANL, KEL and ASL. Headline inflation is expected to guide expectations for monetary policy and may trigger a rally in banks. Additionally, the much awaited outcome of Panama case hearings could alleviate political pressures.

Circular debt and overdue receivables remain a usual element in cash strapped liquidity dynamics for the power sector. Taking a comprehensive approach, AKD Securities map the timeline of developments and quantum of circular debt build up since the one‐time clearance of Rs480 billion in June 2013. Its analysis show that in a large number of cases the GoP has been asked by independent arbitrators (foreign and domestic) and high courts to clear the pile‐up. This perception gains further strength based on increasing reliance on IPPs in power generation mix particularly in the backdrop of 10,663MW of gross capacity additions coming online by CY20. Also, with its political agenda hinging on resolving the prevailing power deficit of over 5,000MW, it is believed that a limited clearance of overdue payables to them is more likely. The Rs48 billion being claimed by 13 IPPs currently is a minor hiccup whereas IPPs with planned CAPEX outlays have increased pressure to free up liquidity tied in GoP receivables (case in point being HUBC where the room for leverage falls from Rs71.7 billion in FY16 to Rs27.8 billion in 1QFY17 and Rs1.8bn in 2QFY17).

Inconsistent with previous month's improved performance, Pakistan’s exports remained lackluster in February 2017, declining by 8.0%MoM/8.6%YoY to US$1.64 billion. Total exports registered a decline across all segments, with highest impact coming from the heavyweight Food and Textile sectors amounting to US$318.9 million and US$995.3 million, sliding 12.7% MoM/24.6%YoY and 6.5%MoM/2.7%YoY respectively. On a cumulative basis, 8MFY17 textile exports were 1.6%YoY lower at US$8.23 billion, largely contributed by 9.2%YoY decline in the low value segment diluting the impact of 1.6%YoY growth in the value added segment. Contrary to expectations, inclusion in zero rated regime and recently announced export incentive package worth Rs180 billion (textile sector's share estimated at close to 90%) has so far failed in generating positive momentum in export trend, giving way to fresh concerns regarding the export‐oriented industry's competitiveness over regional players. Going forward, analysts expect textile exports to remain under pressure due to: 1) weak Chinese demand outlook and concerns of economic slowdown in the European Union following Brexit and 2) lack of currency competitiveness. Moreover, continuous rise in international and local cotton prices has also aggravated concerns about textile industry.

ASTL has recently raised its re‐bars prices per ton by Rs2,000 (up 2.5%) to Rs79,000 likely due to: 1) increase in scrap steel prices and 2) rise in Chinese re‐bar prices due to higher domestic demand as a result of improvement in Chinese property sector and continuous decline in steel production. The recent price increase is likely to improve the bottom line. That said, current re‐bar prices still remain below FY16 average of Rs83,000/ton resulting in reduced gross margin/earnings for FY17F. While the upcoming expansion is to aid earnings growth, analysts believe the current price level is already reflects that.

OGDC discovers hydrocarbon in District Hyderababd

Pakistan’s largest exploration and production (E&P) enterprise, Oil and Gas Development Company (OGDC) has discovered a new oil and gas reserve in Hyderabad District. The OGDC is the operator of joint venture of Nim Block having 95% share along with 5% shareholding of the Federal Government through Government Holdings.

The discovery at exploratory well Chhutto-1 is the first hydrocarbon reserve in Bulri Shah Karim, Tando Muhammad Khan in District Hyderabad. Initial results encouraged the company to drill two more wells in this licensed areas, of which one well has already been marked for immediate drilling.

The structure of Chhutto-1 was delineated, drilled and tested using OGDCL’s in-house expertise. The well was drilled down to the depth of 3,820 meters. The well has tested 8.66 million standard cubic feet per day (mmscfd) of gas and 285 barrels per day (bpd) of condensate through 32/64-inch choke at wellhead flowing pressure of 2,100 per square inch.

As declared by the Company, the discovery is the result of aggressive exploration strategy adopted by the OGDC. It has opened a new avenue and would add to the hydrocarbon reserves base of the country in general and OGDC in particular.

The OGDC has the largest acreage, production and hydrocarbon reserves in the country. It is listed at Pakistan and London Stock Exchanges with a debt-free robust balance sheet and cash reserves, although its huge financials are stuck up in the country’s chronic energy sector circular debt.

Pakistan meets around 12% of its oil requirement from indigenous resources. Historically, the OGDCL’s production has hovered between 35,000 and 45,000 bpd. The company has embarked upon an aggressive exploration and development program in the last few years to take advantage of a slowdown in drilling activities in the Middle East and around the world.

Only recently, the company launched four fresh seismic crews started operations in Kharan, Pasni, Gwadar, Zhob and Musakhel in Balochistan which remained inaccessible due to security situation for a long time. It was for the first time that its nine seismic crews were simultaneously working in various parts of the country. The number of such crews never went beyond five in the past, he claimed.

HUBCO More than just an Independent Power Producer

The Hub Power Company Limited (HUBCO) is Pakistan's largest multi-project power producer (1200MW RFO powered base plant, 214MW RFO powered Narowal, 84MW hydel based Laraib) and a stalwart of the IPP space in Pakistan.  Continuing with its pedigree of developing diverse capacity additions, expansion into coal fired power through its 46% stake in China Power Hub Generation Company Limited (CPHGCL) is now likely. Inclusion of the 2x660MW project in the priority list for CPEC projects confirms the market’s bullish expectations and allows us (AKD Securities) a firm basis to include dividend income from the project in our valuation set. We await the financial close of Thar Electric Power, to incorporate upside. Furthermore, the COD of SECMC (expected Dec'18) may also be achieved offering additional upsides. Moreover the company has also approached relevant authorities for developing a mine mouth power project of, 330MW in Thar. Having had a strong bull run (FY14-16 return of 102%), on the back heightened investor expectations of value addition post expansion plans, the stock trades at attractive price.

Going forward, earnings are expected to be driven by: 1) movement past the trough of the U-shaped tariff for the base plant, 2) improved efficiency in the base plant from continuing overhauls (boiler overhaul completed) and 3) termination of O&M contract with O&M services at the base plant (and planned coal expansion) to be managed internally, reducing consolidated O&M costs (halving of annual O&M expense). The separation of O&M services subsidiary Hub Power Services Limited as an in-house O&M provider in a technical agreement with GE and its stake in SECMC are value accretive. The absence of these companies in the consensus valuation method (DDM using income paid through tariffs post indexation), may be undervaluing the company and missing value additions from these segments of HUBC's business.

CPHGCL (2X660MW) coal fired plant with accompanying jetty adjacent to its base plant site, with an expected cost of US$2.4 billion (in an 80/20 debt to equity) through a JV with China Power International  Holdings, and HUBC holding minority stake in the project (recently notified at 46%). To recall, coal based power plants have a lucrative upfront 27.2% ROE (imported coal) during the four year construction period, with a guaranteed 17% US$ indexed IRR. Thus, the planned project, with expected COD by FY19-20 (staggered COD is planned, with each 660MW unit brought online in a span of 2-3 quarters of each other), is expected to be a major contributor to payouts from FY20 (Rs5.73/share in annual dividend income from CPHGCL).

HUBCO’s base plant with 1,200MW net generation capacity forms the foundation of the current valuations as it makes up for 80% of units generated by the company. These factors allow the base plant to add Rs63.2/share to DDM based valuation in the form of dividend income (at 100% ownership). Having a U-Shaped tariff (unique in the Power Sector) the plant's tariff peaks towards the end of its tariff period, expiring in FY27. Additionally, the recent completion of boiler overhauls and incorporation of a wholly owned subsidiary to carry out plant O&M significantly reduces O&M costs for the consolidated entity.

A number of catalysts continue to fuel investor expectations including: 1) demerger of Narowal into a separate IPP, with potential listing to raise additional funds for sizeable CPHGCL equity drawdown, 2) Pak Rupee depreciation and increase in US CPI provide upside to indexations built into the tariff and adjusted quarterly, and 3) additional income from the acquisition of 6% stake for US$20 million in Sindh Engro Coal Mining Company (SECMC) tasked with mining for coal in Thar Block II (COD expected Dec'18). Lastly, headway on additional projects, including 330MW Thar Electric (TEL) could be value accretive (26.5% ROE on local coal vs. 24.5% on imported coal).

Under the scheme of arrangement for asset desegregation approved in the EOGM on Feb'15, the newly formed Narowal Company Ltd will have 392.2 million shares. Post demerger, 100% ownership of Narowal Company Ltd will remain with HUBCO; the company may put up a minority stake for listing through Offer for Sale.

Valuation & Investment Perspective: Having had a strong run (FY14-16 return of 102%), on the back heightened investor expectations of value addition post expansion plans, the stock trades at a premium. The financial close of TEL also offers additional upside. Between now and the commencement of operations in the 1320MW coal fired extension project, the COD of SECMC (expected Dec'18) may also be achieved offering additional upsides. That said, both projects will be a drain on liquidity, which the company may balance by offloading Narowal post demerger. Despite this, management has recently stated its aim to implement quarterly payout regime.

Regulatory impediments with pending approvals on 1,320MW coal fired power plants having the potential to delay the project in a material manner. In the backdrop of additional burden of upcoming projects and investments, liquidity crunch may ensue if circular debt resurges. Any surge in debt build up may impede FO supply, particularly at the base plant, where PSO (with whom a Fuel Supply Agreement governs payments) is exposed to a liquidity crunch and may face problems opening LC's/ facilitating shipments.

HUBCO, Pakistan, energy crisis, circular debt

Impact of low oil prices on Pakistan

In its latest meeting OPEC decided to maintain its oil output. This has triggered another slide in global crude oil prices. There are growing expectations that prices may remain low for longer than expected period.

One of Pakistan’s leading brokerages houses has analyzed possible implications of lower oil prices on the local stock market under three oil price assumptions of Arabian Light crude (WTI and Brent are less related to Pakistan as the country buys crude mainly from the Middle eastern countries. The brokerage house has based its analysis on three assumptions: 1) US$35/bbl, 2) US$40/bbl and 3) US$45/bbl) against its base case of US$50/bbl.

Remaining a key positive on the macro front, significant improvements are expected on 1) the BoP position on lower oil imports and 2) controlled inflation opening up room for continued monetary easing.

However, from the market's perspective this scenario will be a drag on index heavyweight Oil & Gas sector. Additionally, lower interest rates will continue weighing on banking sector's performance, however boding well for leveraged plays and high dividend plays.

Pakistan continues to benefit from lower oil prices, where another slide in the commodity's price holds positive implications for the country. Sensitivity analysis undertaken by the brokerage house indicates that with US$5/bbl reduction in CY16 will result in additional import bill savings of US$8 million/annum where oil averaging below US$45/bbl could comfortably lead to current account surplus for FY16.

Besides helping to sustain recent improvements in the BoP position, lower oil prices also have trickle down benefits on inflation, which can sustain at current levels (2.5%YoY average in CY15) across the medium term. With lower fuel costs and indirect impact on food, the sensitivity analysis indicates CY16 CPI average can hover in the range of 2.8% to 4.2%YoY.

A downwards trend in oil prices can effectively counter the low-base effect on CPI numbers, unlocking room for further monetary easing. While room could exist for a rate cut at US$45/bbl average. It is expected that the central bank may remain cautious with potential and discount rate may hover around at 5.5% at the lower extreme.

Pulled lower by falling global oil prices, Oil & Gas companies have experienced broad based selling (down 33%CYTD). E&Ps suffer from hampered profitability with POL being the most affected on account of high oil price partiality (53% of revenues in FY15). That said, the gas heavy (80%+ of overall production, 1,173mmcfd in FY14) OGDC continues to persevere in the E&P sector as its profitability is the least hurt by tumbling oil prices. Volatility in oil prices and its consequent impact on the interest rate cycle is likely to have negative implications for banking sector's profitability.

For the Big-6 banks, this is most likely to reduce CY16 earnings by 5%-18% assuming the worst case scenario. However, factors such as potential increase in the capital gains backlog and any uptick in private sector credit growth are expected to provide support to bottom-line should the interest rates come down further. In this backdrop, banks with a higher CASA ratio, greater concentration towards high margin consumer/SME segments, and higher PIB/investment ratio are expected to fare better than the rest. 

While Oil & Gas and Banks are likely to bear the brunt in case of lower oil prices and continued monetary easing, brokerage house sees cost side benefits trickling down to sectors with 1) high leverage sectors like Fertilizers, Cements and Telecom 2) higher fuel and energy costs sectors like Cements, Foods ,Shipping and Aviation.

Apart from these, Power sector is likely to benefit from reduced liquidity constraints amid lower cost of generation while a lower interest rate environment should keep the sector in limelight on account of attractive dividend yields.