Morning Shout released by KASB Securities Limited and Economics Research

Karachi, July 09, 2012 (PPI-OT): NRL: Likely 4Q losses may dominate sentiments

According to KASB Securities Limited,

• KASB Securities Limited revisits NRL’s key earnings drivers for FY13 and conclude overall core earnings momentum should shift the gear however it is unlikely to support earnings recovery beyond KASB Securities Limited’s base-case forecast (PRs45.3/sh).

• With a steep drop in oil prices (22% QoQ) and relative stickiness of domestic prices, base oil has re-emerged as a key earnings driver following a soft patch in FY12. Meanwhile, near-term backdrop for fuel oil margin remains weak.

• KASB Securities Limited’s immediate concern remains likely weak 4Q reading, with heavy timing and FX losses (estimated at PRs2.0 billion or PRs25.0/sh) overshadowing core-earnings. KASB Securities Limited estimates 4Q losses of PRs15.1/sh and FY12 EPS of PRs11.9/sh.

• Furthermore, KASB Securities Limited highlights likely settlement of receivables via PRs82 billion TFC issue will prove to be earnings/cash neutral for NRL.

• With a weak 4Q and a not-so-exciting start to FY13, KASB Securities Limited believes the stock price should trade in a range with likely downside from current levels. KASB Securities Limited maintains KASB Securities Limited’s Neutral rating with PO of PRs247.7/sh.

Earnings drivers shifting to base-oil
KASB Securities Limited revisits NRL’s key earnings drivers for FY13 and conclude overall core earnings momentum should shift the gear relative to 2HFY12 however it is unlikely to support earnings recovery beyond KASB Securities Limited’s base-case forecasts. Unlike 9MFY12 when strong recovery in fuel oil margin compensated for a soft patch in base-oil margin, earnings in FY13 is likely to be driven by base oil given steep drop in oil prices and relative stickiness of domestic base-oil prices. Based on current prices, KASB Securities Limited estimates base-oil margin to have recovered to US$55/bbl in 1QFY13 from a low of US$33/bbl in 3QFY12.

As near-term backdrop for fuel oil margin remains weak
Fuel oil margin is likely to emerge as a drag on NRL’s core earnings as regional demand/supply dynamics are not encouraging. Already, few signs are visible with simple GRMs, a key indicator for local refineries, hovering below US$2/bbl, down from US$5.63/bbl high seen in 3QFY12. BofAML Global Energy team sees significant downside risk to GRMs in 1H13 (particularly on gasoline cracks), given returning capacity in the EU/US and new capacity addition, which is likely to coincide with the seasonally weak ‘shoulder months’ in 3Q post driving season. This will set the stage for continued weakness in fuel oil spread for at least 1H.

No respite from settlement of receivables
Likely settlement of NRL’s overdue receivables of PRs9.8 billion will prove to be earnings/cash neutral in KASB Securities Limited’s view, as NRL does not receive interest income on overdue receivables nor does it pays interest cost on overdue payables. Furthermore, the cash settlement will only cater to principal portion. Just to highlight, under the proposed plans, NRL will receive PRs9.8 billion (60% of receivables) from PSO which it will pay to OGDC for fuel supplies.

4QFY12 earnings: Has market priced in the bad news?
Notwithstanding likely base-oil led margin recovery in FY13, KASB Securities Limited’s immediate concern remains likely weak 4Q reading with heavy timing and FX losses (estimated at PRs2.0 billion) overshadowing core earnings. With 22% drop in crude prices and heavy start-of the quarter stock, KASB Securities Limited estimates 4Q inventory losses of PRs18.7/sh, which may drag FY12 EPS to PRs11.9. Just to recall, a 22% drop in oil prices comes close to collapse in oil prices in 2Q09, when NRL posted PRs9/sh losses. A strong come-back in crude prices at 4Q close is unlikely to have any implication for inventory losses, in KASB Securities Limited’s view. In light of expected heavy losses in 4Q, KASB Securities Limited has scaled back KASB Securities Limited’s final DPS estimate to PRs17.5/sh from PRs25/sh.