E&P Sector investment case intact despite PKR appreciation Share prices of Pakistan’s oil and gas exploration companies (OGDC: –14%, PPL: -10%, POL 4%) have come off significantly from their peaks in Mar14, on the back of an appreciating PKR and fears of a foreign fund winding up. It turns out that the fund winding up is only a USD 10.6mn fund incorporated in the United States, a smaller sub-fund of the larger Luxembourg based Asian Growth Fund (net assets of USD 11bn) managed by Franklyn Templeton. The only exposure of the US based sub-fund of Asian Growth Fund in Pakistan’s market was 173,278 shares of OGDC (0.03% of free float and 23% of average daily volume during Jan-Mar14) and 266,405 shares of MCB as on Dec31’13. Hence as the panic was unwarranted, the prices of the oil E&P companies are likely to recover sharply. PKR appreciation in 3Q FY14, how it impacts the earnings of E&P companies PKR appreciation of 2.7% on an average basis in 3Q FY14, is likely to impact the earnings of oil E&P companies negatively as the revenues of these companies are USD denominated. Moreover, these companies also have USD denominated deposits, and they are likely to book mark to market losses on the same during 3Q FY14 as PKR/ USD parity is likely to close at 98. We anticipate OGDC and PPL’s earnings to be pulled down by PKR 0.52/sh and PKR 0.29/sh respectively due to the exchange losses. However, in spite of the PKR appreciation and ensuing fx losses, earnings growth for the sector remains over 37% for FY14. This is due to the fact, that the growth is mainly led by volume accretion and not merely due to price inflation and PKR depreciation. Oil & gas production touches 92,904bbl/day and 4,029mmcf/day respectively FY14 has seen accretion in Pakistan’s oil production by 22%. Gas production however still depicts a decline. During Mar14, Pakistan’s oil production touched 92,904bbl/day, up from an average of 76,500bbl/day in FY13. Gas production is flat at 4,029mmcf/day in Mar14. The increase in oil production is mainly led by Nashpa-4 (addition of ~4,500bbl/day) and Tal Block’s Makori Gas Processing Facility (addition of ~6,000bbl/day to-date). We anticipate flows to rise further from the new Makori Gas processing Facility in the near term. Gas flows remain flattish, to date, however, a number of new discoveries, are likely to come on stream in the upcoming six months, as the new Petroleum policy offers better gas pricing compared to the 2009 Petroleum Policy. PPL announces another discovery Pakistan Petroleum Limited (PPL) announced a tight gas discovery earlier today, from an exploratory well Naushahro Firoz X-1. PPL has a post discovery stake of 90% in the block. The initial maximum flows are stated at 11.2mmcf/day at a flowing wellhead pressure of 2.635psia. Back of the envelope calculation reveals an annualized EPS impact of 0.48/share on PPL’s bottom-line assuming premium prices for tight gas. Change of currency base rate and impact on FY15 earnings Sensitivity analysis reveals that every 1% increase in value of PKR against the USD, decreases earnings of OGDC, PPL and POL by 0.5%, 0.5% and 1% respectively on an annualized basis for FY15. We have tweaked our FY15 earnings assumptions due to the change in PKR/USD parity. The new earnings for FY14 and FY15 are given in the table below. Pakistan’s E&P sector is still likely to post earnings growth of 37% in FY14, in spite of the PKR appreciation. Oil and Gas Development Company Limited (OGDC)’s price weakness provides an attractive entry point for investors we believe. Trading at a forward P/E of 8.2x, the stock has emerged as our top pick in the Pakistan’s oil E&P space. OGDC offers an earnings growth of over 40% in FY14, being the major beneficiary of production addition from Nashpa, KPD-Tay, Sinjhoro and Tal Block. The stock provides an upside of 19.5% and a dividend yield of 4%, taking the total stock return to 23.5% for CY14. Moreover, OGDC has always traded at premium P/E multiples, now trades at a discount of 3% to its peer PPL. PPL has been the most aggressive in announcement of exploration successes in FY14. The discoveries have been gas heavy, and hence will require drilling of additional wells before the production can be brought online. We maintain a BUY stance on PPL as it presents earnings growth of 24% in FY14, an upside of 12% and trades at a FY14 P/E multiple of 8.4x. Global Research
Posted on: Wed, 26 Mar 2014 14:01:00 +0000