AKD Quotidian about — PSO: Earnings growth amid continuing liquidity problems

Karachi, October 31, 2013 (PPI-OT): Led by irregular interest income of PkR8.2bn from the power sector, PSO posted robust earnings growth of 83%YoY in 1QFY14 (NPAT: PkR7.8bn; EPS: PkR31.6), where AKD Securities upward revise AKD Securities Limited EPS estimate for FY14F by 33% to PkR77/share.

According to AKD Securities Limited however, highlight pending interest payable/receivable post circular debt retirement in Jun’13 as key risks to earnings going forward. Moreover, circular debt build-up during FY14TD has been less than encouraging, where AKD Securities expects liquidity constraints to lead to continued low payouts by PSO going forward.

However, PSO currently trades at a sizable 55% discount to the broader market P/E as compared to an average discount of 32% during FY10-FY12, presenting substantial upside from current levels. That said, AKD Securities highlight sustained energy reforms in the long-term as the only panacea for PSO, resulting in a potential re-rating for the stock. PSO currently provides upside of 23% to AKD Securities Limited revised Jun’14 TP of PkR335/share.

1QFY14 Review: PSO posted robust earnings growth of 83%YoY to PkR7.8bn in 1QFY14 driven primarily by an irregular PkR8.2bn in ‘other income’ booked as penal interest income from the power sector. However, penal interest paid to refineries during the quarter was PkR2.6bn against total penal interest payable of ~PkR14bn. Other highlights of the result include: 1) revenue growth of 11%YoY to PkR307bn on the back of increased MS and FO volumes, 2) 2.6xYoY increase in operating costs to PkR7.3bn due to higher currency devaluation during the quarter resulting in higher foreign exchange losses (PkR3.7bn), and 3) inventory gains of ~PkR2bn due to a sharp spike in crude prices during the quarter.

Circular debt update: As per company management, PSO’s receivables have spiked to PkR134bn at present from PkR77bn at FY13 end – an average monthly increase of PkR15bn post circular debt retirement in Jun’13. This
in recoveries by PSO during FY14F, which should result in continued financing requirements and a tough cash cycle.

Investment Perspective: While AKD Securities expects liquidity constraints to continue to result in low payouts from PSO, AKD Securities stills await potential benefits from the hike in power tariffs among other energy sector reforms going forward, which could warrant a re-rating for the stock, alongside a revision in margins. In this regard, PSO, currently trades at a FY14F P/E of 3.5x, a discount of 55% to the broader market P/E, significantly higher than is despite KAPCO turning to an advance payment mechanism to PSO, where anticipated higher collection post power tariff hikes have fallen short of expectations. In this regard, under-recoveries from the power sector during FY14TD stand at PkR63bn as compared to under-recoveries of PkR27bn in the same period last year.

OMC margin revision expected: PSO has been lobbying aggressively for an upward revision in regulated margins in order to cover rising direct costs and inflationary pressures. While AKD Securities stills await an update in this regard, PSO expects an increase of PkR0.25/litre to PkR0.4/litre (10%- 20%) across the product range shortly. As per AKD Securities Limited estimates, every 10% increase in margins for HSD and MS results in a +5% annualized EPS impact for PSO. Recall, earlier revisions in margins on favourable cash cycle products improves overall cash flows for PSO.

Estimates revision: AKD Securities revises EPS estimates for FY14F and FY15F to by 33% and 6% to PkR77 and PkR81, respectively, after the higher than expected interest income received in 1QFY14. That said, AKD Securities highlights additional irregular income/payments viz ~PkR40bn pending from the power sector as penal interest and PkR11.5bn interest charges payable to refineries as key risks to earnings going forward. Moreover, while AKD Securities continues to monitor circular debt build-up, AKD Securities remains unconvinced of any substantial improvement the average discount of 32% during FY10-FY12 when circular debt was at its peak. While this presents a case for further upside from current levels, clarity on the GoPs conviction to reign in circular debt could stands out as the key long-term trigger.