Morning Shout released by KASB Securities Limited and Economics Research

Karachi: Refineries & OMCs to benefit from ECC decision

According to KASB Securities Limited,

•             In yesterday’s ECC meeting, the govt. has (1) raised marketing margins by 30‐ 32% and (2) has allowed incidental on refined product for refineries.

•             The margin upgrade is pretty much expected, however, recovery of incidentals is a complete surprise for the market which should significantly benefit refineries.

•             KASB Securities estimates EPS impact of 17‐18% for PSO and 7‐ 8% for APL (incorporated already). KASB Securities reiterates our Buy rating for PSO (top pick) and APL.

•             For refineries, KASB Securities estimates earnings impact of 6‐12% for NRL and 20‐40% for ATRL. KASB Securities has a Buy on NRL with PO of PRs404/sh. Given ATRL’s portfolio value (PRs160/sh) and expected improvement in ATRL’s core earnings, KASB Securities sees good trading opportunity in ATRL.

Margin upgrade finally materializes; top pick PSO

In yesterday’s Economic Coordination Committee meeting, the government has (1) raised marketing margins by 30‐32% and (2) has allowed incidental on refined product for refineries. Both the changes are likely to be effective from Sep11. Soft crude prices in August (down 6% MoM so far), a key pre‐condition for tweaking pricing formula in our view, have allowed the room to government for meeting the long standing demands of downstream industry. The margin upgrade is pretty much expected, however, recovery of incidentals is a complete surprise for the market which should significantly benefit refining companies.

Earnings impact on OMCs and refineries

KASB Securities estimates EPS impact of 17‐18% for Pakistan State Oil and 7‐8% for Attock Petroleum. While KASB Securities has already incorporated the impact in our EPS/PO estimates, KASB Securities sees upgrade in consensus estimates. KASB Securities reiterates Buy on PSO (top‐pick, PO: PRs320.98) and APL (PO: PRs434.43).

For refineries, KASB Securities estimates earnings impact of 6‐12% for NRL and 20‐40% for ATRL assuming 0.5‐1% incidental. KASB Securities has a Buy on NRL with PO of PRs404/sh. Given ATRL’s portfolio value (PRs160/sh) and expected improvement in ATRL’s core earnings, KASB Securities sees good trading opportunity in ATRL.

Nominal impact on retail prices

On our estimates, the current changes (dealer + marketing + incidentals) translate into only PRs1.35‐1.4/litre or ~1.3‐1.4% impact on end‐consumer prices and should not face any political opposition beyond near‐term media scrutiny. This completes the second phase of price reforms which has proved to be beneficial for both refineries and oil marketing companies. KASB Securities believes the deregulation of freight pool remains a politically difficult proposition under current coalition government and is unlikely to be taken up any time soon. To us, the margin upgrade and tweaking in ex‐refinery formula are well justified. Pak rupee has depreciated by over 12% and CPI is up 35% since the margin were fixed in rupee in Feb‐ 09.

The revised margin translates into 2.4‐3.2% of ex‐refinery prices (1.81‐2.4% previously) which is far below than the 3.5‐4% margin which prevailed over 2002‐2009. Similarly, refineries incur incidental on imports of crude oil however the same was not included in the ex‐refinery prices effective Dec‐10.

Confusion on incidentals recovery

The import incidentals which include Marine Insurance (.09%), LC Commission (0.15%), Bank Charges (0.10%), Ocean losses including Handling Charges (0.65%) are calculated on product price. Just to highlight, these incidentals were disallowed only on energy products sold locally and the Dec‐10 decision did not impact the pricing mechanism on naphtha, furnace oil and other non‐energy products (base oil, asphalt etc).

 

While the timing of implementation of decision and incidentals’ elements to be included are not known yet, KASB Securities understands local refineries demanded a complete withdrawal of Dec‐10 decision. Few news reports and our discussion with industry sources suggest ocean losses (0.5%) are not included in the revised incidentals. In case ocean losses are excluded, the net incidental would be 0.5% of product prices. It remains to be seen if the diesel deemed duty would be calculated on C&F prices+ incidentals or only C&F prices (excluding incidental).

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