Due to revised margins, PSO and APL may see improvements in profitability.

We revise our OMC Universe estimates while maintaining a Buy rating. Our revised EPS estimates for PSO and APL in FY24f/FY25f are PKR106.14/98.91 and PKR109.52/95.61, Jun’24 revised TPs are PKR281 and PKR457, respectively. The government has recently notified an increase in white oil margins by c.30% to PKR7.82/litre. This, coupled with an expected rebound in demand, should lift profitability. Given its elevated short-term borrowings, the expected ease in policy rate should further support PSO’s earnings. The government has implemented a hike in gas prices by up to 193% in order to restrict gas circular debt at its current level. This step should improve PSO’s cash position, consequently increasing payout capability. PSO remains our top pick in the sector with a TP of PKR281/sh.

Estimates revised

We maintain a Buy stance on both PSO and APL with revised Jun’24 TPs of PKR281/sh and PKR457/sh, respectively (Previously PKR180/sh and PKR400/sh). Estimates revision is based on (1) higher-than-expected increase in white oil margins by c.30%, (2) expected rebound in white oil demand amid economic recovery, and (3) Government’s effort to keep circular debt restricted at current levels. Resultantly, PSO and APL revised EPS/DPS for FY24f are PKR106.14/15.00 and PKR109.52/36.00.  

OMC margins revised upward

The federal government recently approved upward revision in white oil margins by c.30% to PKR7.82/liter for FY24, higher than our expectations. We had assumed OMC margins at PKR6.54/litre. OMC margin revision is linked to inflation, however, we believe due to significant increase in OMC margins since last two years, the companies will receive 75% of CPI in FY25f and thereon, full impact of CPI will be received. The higher-than-expected increase in OMC margins should lift our universe GMs by 0.8ppts and 0.2ppts to 4.4% and 4.2% in FY24f and FY25f, respectively.

Rebound in white oil sales is expected

OMC volumes in FY23 remained under pressure due to deteriorating macro-economic situation coupled with a surge in average MS and HSD prices by 65% and 75%, respectively. We expect overall sector demand to remain flat at 16.8mn MT in FY24f due to decline in furnace oil sales, whereas MS and HSD demand is expected to rebound on the back of expected improvement in economic activity coupled with reduction in POL prices in the year. The government’s efforts to curb HSD smuggling from Iran should also result in improved HSD demand. Per our estimates, MS and HSD demand in FY24f/FY25f is expected to arrive at 7.6mn MT and 6.7mn MT, with a YoY change of 3% and 6%, respectively.

Gas price hike to reduce circular debt build-up

The government has recently increased gas prices by up to 193% and a further 10% hike in average gas price is expected in Jan’24 on the IMF’s push. Increase in gas prices is expected to stop further circular debt build-up, however, we have incorporated a 10% build-up in our estimates. The hike in gas prices should improve PSO’s cash earnings and consequently its payout capacity. We estimate PSO’s DPS at PKR15/PKR20 for FY24f/FY25f. To illustrate, PSO maintained a payout ratio of above 50% (Pre-circular debt), and if the same trend repeats, PSO’s payout can hover around PKR50/sh in FY24f and FY25f. The stock has gained 57% since the IMF SBA, 13.0ppt above the KSE-100’s performance and currently trades at a Jun’24 P/E of 1.6x compared to KSE-100 P/E of 3.9x. We believe the market is still highly underpricing the scrip due to circular debt concerns where the reduced build-up will be a major driver for PSO.

Courtesy – IMS Research

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