With eleven months of the fiscal year behind us, the prominence of oil marketing companies has diminished greatly since the calendar year began. The sector has lost 12.1% in market cap over the past five months, underperforming the broader market by 9.2%. Apart from the broader equity sell-off, the fallout is majorly due to the sharp depreciation of the local currency (prompting exchange losses and shortages), challenges related to working capital, the influx of smuggled products and an overall highly regulated margin regime, causing the sector participants to suffer greatly in the face of volatile retail finished product prices. That said, we believe the future volumetric recovery remains intact (by 5%) as recuperating economic activity and improved mobility underpins our positive outlook for the sector going forward. Within the sector, we consider APL to remain our most favoured pick. We recommend a Buy stance on the company with a Dec’23 target price of PkR400/sh

Economic turmoil weighing in: As we enter the final month of the fiscal year-the demand for petroleum products hasn’t looked this bad in years. We expect industry offtakes for the full year to end at 16.9mn tons, down 25%YoY, just narrowly shy of the levels witnessed back in FY20 when COVID-19 hit (16.4mn tons). Said fall is majorly due to the declining industrial activity (LSM: ↓25%YoY during 9MFY23), falling power generation (10MFY23: ↓10%YoY), shock in the auto-sector (↓50%YoY 10MFY23) and the unprecedented wave of inflation that has gripped the economy (May’23 CPI: 38.0%). Amidst OMC/Dealer’s consistently petitioning for upward revisions in their regulated profits throughout last year, ECC came through and approved margin revisions for both the retail products (MS/HSD) come Dec’22, which presently stand at PkR6-6.5/liter (vs. PkR3.5-4.0/liter during 1HFY23). That said, effective margins currently hover around ‾2.20%, still below the long-term averages of 2.70%. Going forward, we have assumed an annualized growth in OMC margin by 9%, to be revised at the start of every calendar year.

Overall, the broad-based economic slowdown continues to haunt the sector’s sustainability as risen prices and dampened industrial/commercial activity have kept offtakes under pressure.

Industry sales down 40%YoY: May’23 volumetric offtake clocked in at 1.3mn tons, changing by +11%/-40% on a MoM/YoY basis, with HSD and FO leading the decline (down 36%/80%YoY). There has been a recovery in volumes on a MoM basis, after reaching nearly three-year lows observed in Mar and April’23 amidst rampant influx of smuggled diesel during the annual Rabi harvesting season. Overall, total POL sales remained down by 26%YoY during the eleven months, clocking in at 15.27mn tons vs. 20.67mn tons SPLY. On a product wise basis, HSD (-36%YoY) and FO (-80%YoY) offtakes remained the most dampened, as muted industrial activity and power generation (FO generation down 61% YoY during 10MFY23) have begun taking toll. Furthermore, It is worth mentioning that the prices of both MS & HSD have risen by ‾PkR52/49 per liter compared to SPLY, to presently stand at PkR262/253 per liter, respectively. These prices represent an increase of 25%/24% vs. June’22, in line with the current government’s plan to pass on the full cost of supply and levies to consumers (PDL: PkR50 per liter for MS/HSD).

Outlook:

More recently, the Petroleum Division has put forward a proposal aimed at establishing a bonded storage facility for the OMC sector in cooperation with foreign suppliers, majorly for company’s import-heavy business models. It should be noted that the proposal has been rejected by the various OMC managements stating that the proposal is unrealistic, overall deregulation of retail prices is required and this may in turn hurt the refinery sector. Our opinion is that there needs to be precise details/clarity regarding the proposed mechanism that claims to alleviate exchange losses and clarification regarding expenses and the party(s) responsible for bearing these costs.  Finally, we consider APL to remain as our most favored pick. We recommend a Buy stance on the company with a Dec’23 target price of PkR400/sh

Courtesy – AKD Research