Entering a new league; Buy

Transcription

1 Reinstatement of Coverage Equity Turkey Oil Refining & Marketing 19 March 2015 BUY Entering a new league; Buy Unauthorized redistribution of this report is prohibited. This report is intended for osman.memisoglu@baml.com. Reinstating at Buy with TRY71 PO, 33% upside potential We reinstate coverage of Tüpraş with a Buy rating and TRY71 PO, suggesting 33% upside potential. Tüpraş is the only pure refiner in our coverage cluster and we see it as a direct beneficiary of the weak oil price. The stock s performance should be driven by high earnings growth, FCF improvement and attractive prospective dividend yield from 2015E. Entering a new league via RUP launch Tüpraş is launching its flagship residuum upgrade project (RUP) in 2Q15, marking a new chapter in the company s history. The RUP should allow complexity of refining to match that of most European peers, and raise Tüpraş s yield of high-value added light oil product to an impressive 84%, underpinning further earnings growth. Supportive macro environment The drop in crude prices has positively impacted refiners via higher margins and lower energy costs. Tüpraş s net margin should exceed US$5/bbl by 2016E from US$3.2/bbl in 2014, while lower energy costs will add over c.us$100mn of savings. Monopoly with flexible access to feedstock Tüpraş has the advantage of being the only refiner in Turkey s high-growth oil product market. It also enjoys the benefits of diversified crude oil supply as it sources the feedstock from around 10 different countries. As RUP operations ramp up, Tüpraş can potentially save up to cus$100mn per year by diversifying away from costly crude from Kazakhstan and Russia to heavier and cheaper grades. Valuation undemanding; catalysts RUP and div/fcf yield Tüpraş is trading on 7.4x P/E and 5.5x EV/EBITDA in 2016E, at a 30% discount to average EEMEA refiners P/E. The stock should be driven by the RUP launch in the near term, while our longer-term thesis is based on an expected 12-15% dividend and FCF yields. Estimates (Dec) (TRY) 2013A 2014A 2015E 2016E 2017E EPS (Adjusted) EPS Change (YoY) -18.2% 21.9% -0.5% 24.8% 14.8% Dividend / Share Valuation (Dec) 2013A 2014A 2015E 2016E 2017E P/E 11.1x 9.11x 9.16x 7.34x 6.39x Dividend Yield 2.98% 0% 6.55% 12.3% 14.1% EV / EBITDA* 15.7x 22.2x 6.50x 5.48x 5.32x Free Cash Flow Yield* 2.21% 1.32% 8.09% 12.2% 15.4% * For full definitions of iqmethod SM measures, see page 45. >> Employed by a non-us affiliate of MLPF&S and is not registered/qualified as a research analyst under the FINRA rules. Anton Fedotov >> Research Analyst Merrill Lynch (Russia) anton.a.fedotov@baml.com Karen Kostanian, CFA >> Research Analyst Merrill Lynch (Russia) karen.kostanian@baml.com Denis Derushkin >> Research Analyst Merrill Lynch (Russia) denis.o.derushkin@baml.com Jake Greenberg Specialist Sales MLI (UK) jake.greenberg@baml.com Stock Data Price TRY53.10 Price Objective TRY71.00 Date Established 19-Mar-2015 Investment Opinion C-1-9 Volatility Risk HIGH 52-Week Range TRY41.75-TRY57.50 Mrkt Val / Shares Out (mn) TRY13,297 / Average Daily Volume 1,086,721 BofAML Ticker / Exchange TUPRF / IST Bloomberg / Reuters TUPRS TI / TUPRS.IS ROE (2015E) 21.2% Net Dbt to Eqty (Dec-2014A) 62.1% Est. 5-Yr EPS / DPS Growth 7.6% / NA Free Float 49.0% Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that take responsibility for this report in particular jurisdictions. BofA Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 46 to 48. Analyst Certification on Page 44. Price Objective Basis/Risk on page

2 19 March 2015 iqprofile SM Key Income Statement Data (Dec) 2013A 2014A 2015E 2016E 2017E (TRY Millions) Sales 41,078 39,723 26,626 33,004 42,915 EBITDA Adjusted 1, ,639 3,130 3,228 Depreciation & Amortization (240) (258) (431) (445) (457) EBIT Adjusted ,207 2,686 2,771 Net Interest & Other Income (841) (331) (379) (404) (151) Tax Expense / Benefit 1,186 1,286 (366) (456) (524) Net Income (Adjusted) 1,197 1,459 1,452 1,812 2,080 Average Fully Diluted Shares Outstanding Key Cash Flow Statement Data Net Income (Reported) 1,197 1,459 1,452 1,812 2,080 Depreciation & Amortization Change in Working Capital 1,525 1,603 (141) (416) (348) Deferred Taxation Charge (1,192) (1,292) Other CFO (116) Cash Flow from Operations 2,549 2,433 1,625 2,126 2,551 Capital Expenditure (2,255) (2,258) (550) (500) (500) (Acquisition) / Disposal of Investments Other CFI Cash Flow from Investing (2,159) (2,187) (550) (500) (500) Share Issue / (Repurchase) NA NA NA NA NA Cost of Dividends Paid (964) (396) 0 (871) (1,630) Increase (decrease) debt 2,278 1,233 (48.5) (545) (201) Other CFF (1,385) (961) (217) (172) (119) Cash Flow from Financing (71.2) (124) (266) (1,588) (1,951) Total Cash Flow (CFO + CFI + CFF) FX and other changes to cash (352) 0 0 Change in Cash Change in Net Debt 1, (506) (582) (302) Net Debt 2,859 3,857 3,351 2,768 2,467 Key Balance Sheet Data Property, Plant & Equipment 8,326 10,668 10,791 10,856 10,908 Goodwill Other Intangibles Other Non-Current Assets 2,820 4,024 4,080 4,144 4,230 Trade Receivables 1, Cash & Equivalents 3,663 3,898 4,356 4,394 4,494 Other Current Assets 4,145 2,923 1,846 2,282 3,019 Total Assets 21,139 21,933 21,427 22,048 23,056 Long-Term Debt 5,447 6,978 6,176 6,263 4,452 Other Non-Current Liabilities Short-Term Debt 1, , ,509 Other Current Liabilities 9,322 7,784 5,964 6,275 7,118 Total Liabilities 16,001 15,720 13,852 13,618 14,260 Total Equity 5,139 6,213 7,575 8,430 8,796 Total Equity & Liabilities 21,139 21,933 21,427 22,048 23,056 Business Performance* Return On Capital Employed 8.97% 4.52% 12.7% 14.6% 14.8% Return On Equity 24.1% 25.9% 21.2% 22.8% 24.4% Operating Margin 2.08% 1.30% 8.29% 8.14% 6.46% Free Cash Flow (MM) ,075 1,626 2,051 Quality of Earnings* Cash Realization Ratio 2.13x 1.67x 1.12x 1.17x 1.23x Asset Replacement Ratio 9.38x 8.75x 1.27x 1.12x 1.09x Tax Rate NM NM 20.0% 20.0% 20.0% Net Debt/Equity 55.6% 62.1% 44.2% 32.8% 28.0% Interest Cover 3.13x 1.74x 6.15x 8.04x 9.81x * For full definitions of iqmethod SM measures, see page 45. Company Description is Turkey's only oil refiner. The refining operations are conducted out of four sites around the country with a total capacity of 28.1mn tons per annum. Nelson Index Complexity of 7.3 should rise from the current 7.3 to 9.9 post the full launch of Residuum Upgrade Project in Izmit Refinery in 2Q The company also has a 40% stake in OPET, the third largest petroleum retailer in Turkey with approximately 1,300 fuel stations. Investment Thesis is likely to benefit from its dominant position in the Turkish refining sector assuming that Socar's Star refinery project will be operational by 2019YE. Moreover, earnings growth with the Residuum Upgrade Project coming into operation in 2015 is one of the major investment highlights for. Stock Data Price to Book Value 1.8x 2

3 Contents Investment summary 4 Reinstating at Buy; 33% upside potential 6 RUP as the main growth driver 11 Energy cost savings 14 Crude oil mix to drive margins 17 Efficiency improvement drives growth 20 Turkish market in growth phase 21 Monopoly in an attractive market 25 Strong financials 27 Turkey: the macro view 29 Commodity view 31 Refining outlook in Europe 34 Risks to the investment case 37 Company background 38 3

4 Investment summary We reinstate coverage of Tüpraş with a Buy rating and PO of TRY71/share, suggesting 33% upside potential. Tüpraş is the only oil refining company in Turkey that operates four refineries across the country. It also has stakes in retail fuel distribution and marine transportation businesses. Tüpraş is majority-owned and controlled by Koc Holding, one of the largest investment conglomerates in Turkey. Our investment view is based on the following: Entering a new league: Tüpraş is launching a flagship residuum upgrade project (RUP) that should take its operations to a new level on par with most of its European peers: the company s Nelson Complexity Index will be close to 10, while its light product yield should reach 84%, on our estimates. RUP should contribute c.us$600mn to annual EBITDA (around US$3 per bbl of oil processed). Chart 1: Nelson Complexity Index BPCL 7 Curr PKN Delek IOC Hellenic Thai Oil post-rup Marathon PBF Energy Tesoro Phillips 66 HollyFrontier Valero Reliance Chart 2: Light product yield 90% 85% 80% 75% 70% 65% 60% 55% 50% Calumet Reliance pre-rup Hellenic IOC Neste Northern Tier Thai Oil Marathon post-rup Phillips 66 Valero Tesoro Motor Oil Delek HollyFrontier End of investment cycle opens door to dividends: Tüpraş s capex should drop by about 80% in 2015 after the company completes RUP, its major investment project. Rising FCF (8-15% yield in E) should translate into dividend growth as the company does not have any other major investment needs and the main shareholder sees Tüpraş as a value asset. Chart 3: FCF and dividends (in TRYmn) 3,000 2,000 1, A 2015E 2016E 2017E FCF Dividends Chart 4: dividend yield 15% 14.0% 12.2% 10% 6.5% 5% 0.0% 0% 2014A 2015E 2016E 2017E Oil price decline leads to cost savings: Tüpraş s refining operations are an energy-intensive business. We expect cus$100mn annual cost savings on the back of the decline in the price of natural gas and oil products following the crude oil price trajectory. 4

5 Flexible access to crude oil supply: Tüpraş s access to a diversified supply of crude oil feedstock stems from its advantageous geographical position. Post the RUP launch, the company should be able to process heavier and cheaper crude oil, which may potentially lead to an additional cost savings of up to US$100mn per annum. Monopoly in a growing market: Turkey is a high-growth market for oil products with jet fuel and diesel demand up 11.2% and 4.2% in 2014, respectively. We forecast a significant middle-distillates deficit to persist over the coming years, which should support Tüpraş as the monopoly oil product producer in the country. Improving financials to drive up shares: The launch of RUP, combined with higher refinery utilisation and cost savings, underpins Tüpraş s impressive 22% EBITDA CAGR in E, gradual deleveraging to 1.1x net debt/ebitda in 2017E and rising dividend and FCF yields. Chart 5: EBITDA (CCS) and Net debt (TRYmn) 6,000 4,000 Chart 6: Net debt/ebitda , A 2015E 2016E 2017E EBITDA (CCS) Net debt A 2015E 2016E 2017E Rerating likely on the back of catalysts: Tüpraş is trading on 7.4x P/E and 5.5x EV/EBITDA in 2016E, including the full impact of RUP. The discount to the average 10x 2016E P/E of EEMEA peers is a high 29%. We believe the stock should be driven by the launch of RUP in the near term, while high EBITDA growth and improving FCF and dividends should pave the way for further rerating. Chart 7: P/E progression Chart 8: EV/EBITDA progression x x x 6.8x 6.3x 6.0x 5.8x x 5.4x 5.2x 5.0x 4.8x E 2016E 2017E 2018E 2019E 2020E E 2016E 2017E 2018E 2019E 2020E Source: BofA Merrill Lynch Global Research estimates Source: BofA Merrill Lynch Global Research estimates 5

6 Reinstating at Buy; 33% upside potential We reinstate coverage of Tüpraş with a Buy rating and PO of TRY71 per share, suggesting 33% upside potential. Valuation inexpensive, expect dividend growth Trading at a discount to peers On our estimates, Tüpraş is trading on 9.2x 2015E P/E and 6.6x 2015E EV/EBITDA and on 7.4x 2016E P/E and 5.5x 2016E EV/EBITDA. After the full launch of the residuum upgrade project, the stock looks inexpensive trading at 30% discount to EEMEA refiners (i.e. Neste, Motor Oil, Hellenic and PKN) on average 2016E multiples of 10.7x 2016E P/E and 5.8x 2016E EV/EBITDA. Chart 9: Global refining P/E Motor Oil Northern Tier PKN PBF Energy Med-Europe Valero Thai Oil Reliance S-Oil Phillips 66 Delek Med-US Hellenic Neste BPCL Med-Asia Tesoro HollyFrontier Marathon HPCL Formosa Pet IOC Calumet 2015E 2016E Source: Bloomberg, BofA Merrill Lynch Global Research estimates On 2016E estimates that include the full impact of RUP, Tüpraş trades at a significant 40% discount to the average 12.2x P/E and 20% discount to the average 6.8x EV/EBITDA of the global refining sector. Chart 10: Global refining EV/EBITDA Motor Oil Valero PBF Energy HollyFrontier Hellenic Delek Med-US Northern Tier Med-Europe PKN Marathon HPCL Tesoro Neste Thai Oil Reliance Med-Asia BPCL S-Oil Phillips 66 Calumet IOC Formosa 2015E 2016E Source: Bloomberg, BofA Merrill Lynch Global Research estimates 6

7 Turning into a dividend story Since its privatisation in 2006, Tüpraş has paid out its entire distributable profits as dividends in order to help its parent company Enerji Yatirimlari A.S. (EYAS), controlled by Koc Holding, repay its US$1.8bn acquisition loan. This dividend policy has been sustained despite the negative FCF since The current remaining outstanding debt of EYAS is US$230mn payable in We see the current shareholder structure with Koc Holding as the controlling shareholder as positive for further dividend growth. Tüpraş decided not to distribute dividends for 2014 due to a net loss posted in the statutory accounts on the back of a series of one-off losses and a negative inventory impact due to the massive decline in the oil price in 2H14. We expect Tüpraş to resume paying dividends next year as earnings should grow on the back of the launch of the RUP expected in early 2Q15. We forecast DPS of TRY3.5 for 2015, TRY6.5 for 2016 and TRY7.5 for Tüpraş s expected dividends would yield an attractive 6.5% for 2015 (payable in early 2Q16) and 12.2% for 2016 (payable in early 2Q17). Chart 11: Tüpraş DPS (in TRY) Chart 12: Tüpraş dividend yield 20% 14% 15% 15% 12% 14% 9% 8% 9% 10% 7% 7% 7% 4% 5% 0% 0% Tüpraş s expected dividend yield would be the highest among the EEMEA refiners, which offer, on average, 4.4% for 2015E and 5.6% for 2016E. It would also be significantly higher than the average yields of the global refining peer group 4.6% for 2015E and 4.6% for 2016E. Chart 13: Global refiners dividend yield 14% 12% 10% 8% 6% 4% 2% 0% Reliance IOC Tesoro Marathon S-Oil Med-Asia HPCL BPCL Valero Phillips 66 Formosa PKN Neste Delek Med-US PBF Energy Thai Oil Med-EEMEA Hellenic Motor Oil HollyFrontier Calumet Northern Tier 2015E 2016E Source: Bloomberg, BofA Merrill Lynch Global Research estimates 7

8 FCF yield becoming solid Our dividend estimates are supported by robust expected FCF generation from 2015E. Dividends should be matched fully by strong FCF yielding 8% in 2015E, 12.1% in 2016E and 15.3% in 2017E. Chart 14: Tüpraş FCF and dividends in TRYmn Chart 15: FCF yield 3,000 2,000 20% 15% 12.1% 15.3% 1,000 10% 8.0% A 2015E 2016E 2017E FCF Dividends 5% 0% 1.3% 2014A 2015E 2016E 2017E PO TRY71 implies attractive 33% upside potential Our PO is based on the average of a DCF and comparable multiple valuation approach. Table 1: Valuation summary US$m Weight US$m US$/share DCF 7,629 50% 3, Multiple 6,697 50% 3, m target mcap estimate 7, Number of shares (m units) m PO (US$/share) m forward (US$/TRY) m PO (TRY/share) Latest close (TRY/share) Upside potential to PO (%) 32.7% Source: BofA Merrill Lynch Global Research estimates Our DCF valuation results in a US$7.6bn equity value for Tüpraş. We use a 10.7% WACC for our DCF valuation based on 11.9% cost of equity, 5.2% aftertax cost of debt and 0% terminal growth. Table 2: Beta calculation Unlevered beta 0.88 Net debt (2015YE) 1,678 Mcap 6,870 Tax 0.20 Geared beta 1.05 Source: BofA Merrill Lynch Global Research estimates Table 3: WACC calculation RFR 6.0% ERP 5.5% Beta 1.05 CoE 11.8% CoD 6.5% CoD after tax 5.2% Net Debt / Capitalisation 21% Equity / Capitalisation 80% WACC 10.7% Terminal growth rate 0.0% Source: BofA Merrill Lynch Global Research estimates Our DCF-derived target equity value of US$7.6bn implies a TRY76.1/share price objective. 8

9 Table 4: Summary of DCF (US$mn) 2015E EV estimate 9,009 Less: Net debt (2015YE) 1,678 Less: minorities 28 Plus: subsidiaries 326 Target mcap (2015YE) 7,629 Number of shares (mn) Valuation (US$/share) 30.5 Valuation (TRY/share) 76.1 Latest close (TRY/share) 53.5 Total return (%) 42% Source: BofA Merrill Lynch Global Research estimates Table 5: DCF PO Sensitivity to WACC & Terminal Growth rate Termianl Growth rate WACC % 10.7% 11% 12.00% 13% 0% % % % Source: BofA Merrill Lynch Global Research estimates Our comparable multiple valuation is based on the average of 8x 2016E EV/EBITDA and 10x 2016E P/E target multiples Our target multiples are close to Tüpraş s five-year historical average one-year forward multiples. Our 2016YE equity value estimates are then discounted using our 11.8% cost of equity. Our comparable multiple approach provides us with a US$6.7bn target equity value or TRY66.6 per share. Table 6: Comparable multiple valuation (US$bn) Target multiple 8.0 Target multiple E EBITDA 1,234 15E Net income YE EV estimate 9,869 16YE Net Debt 1,378 16YE Minorities 32 16YE Subsidiaries YE equity value estimate 8,798 16YE equity value estimate 7,541 12m target equity value 7,212 12m target equity value 6,182 Weight 50% Weight 50% 2016E 12-m target equity value 6,697 # shares (mn) Valuation (US$/share) 26.7 Valuation (TRY/share) 66.9 Latest close (TRY/share) 53.5 Total return (%) 25% Source: BofA Merrill Lynch Global Research estimates 9

10 Chart 16: P/E progression Chart 17: EV/EBITDA progression x x x 6.8x 6.3x 6.0x 5.8x x 5.4x 5.2x 5.0x 4.8x E 2016E 2017E 2018E 2019E 2020E E 2016E 2017E 2018E 2019E 2020E Source: BofA Merrill Lynch Global Research estimates Source: BofA Merrill Lynch Global Research estimates Chart 18: Tüpraş historical 1-year forward P/E Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Chart 19: Tüpraş historical 1-year forward EV/EBITDA Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Source: Bloomberg, BofA Merrill Lynch Global Research estimates Source: Bloomberg, BofA Merrill Lynch Global Research estimates 10

11 RUP as the main growth driver RUP explained Since 2011, Tüpraş has focused on implementing a residuum upgrading project, a US$3bn investment to improve its competitiveness and profitability. The project consists of upgrading the Izmit refinery by improving its complexity to 14.5 from 7.8 currently. There will be no capacity additions, but the company will produce a higher share of white products: 4.5mn tons of raw materials will be transformed into 4.3mn tons of output. Of this, 3.5mn tons will be white products, comprising 2.88MMt of diesel, 0.52MMt of gasoline and 0.69MMt of LPG. Chart 20: RUP feedstock and output 4,000 3,000 2,000 1,000 0 (1,000) (2,000) (3,000) (4,000) (3,036) (1,214) (246) ,883 Management expects Tüpraş s total refining capacity utilisation to increase to reach 95% post completion, compared with 74.9% in 2014 as the company will be able to process heavy product (i.e. atmospheric dip) in RUP units. Chart 21: capacity utilisation 100% 94.9% 95% As of the end of January 2015, the company had spent a total of US$3bn on procurement and construction and the project was 99.8% complete. While the construction of the project was finished in December 2014, a test study of the units is currently under way and the full launch is planned in 2Q15. 90% 85% 80% 75% 70% 82.3% 82.6% 77.9% 78.7% 74.9% RUP leads to a significant improvement in product slate As a result of the RUP launch, we expect Tüpraş s light product yield to rise from the current 71% to 84% in The product slate will be much more geared towards diesel (+81%), while fuel oil production should drop by 85%, on our estimates. 11

12 Chart 22: Tüpraş product slate in % 1% 1% 18% 4% 22% 1% Chart 23: Tüpraş product slate in % 4% 4% 1% 2% 1% 24% 27% 18% 38% 19% LPG Naphtha Gasolines Jet fuel Diesel Fuel Oil Lube oil Asphalt Coke/sulphur LPG Naphtha Gasolines Jet fuel Diesel Fuel Oil Lube oil Asphalt Coke/sulphur Source: BofA Merrill Lynch Global Research estimates Post the launch of RUP, Tüpraş will be on par with most of its global peers in terms of complexity of refining operations. Chart 24: Nelson Complexity Index BPCL 7 Curr PKN Delek IOC Hellenic Thai Oil post-rup Marathon PBF Energy Tesoro Phillips 66 HollyFrontier Valero Reliance Chart 25: Light product yield 90% 85% 80% 75% 70% 65% 60% 55% 50% Calumet Reliance pre-rup Hellenic IOC Neste Northern Tier Thai Oil Marathon post-rup Phillips 66 Valero Tesoro Motor Oil Delek HollyFrontier and in margins Tüpraş recently guided that the positive impact from the RUP launch should add about US$650mn to annualised EBITDA. This translates into US$3.3/bbl in 2016, assuming a throughput increase to 26.7MMt to reach 95% capacity utilisation. On our estimates, RUP should contribute US$419mn or US$2.5/bbl to 2015E EBITDA (assuming RUP launch from April 2015 and 82% total refining capacity utilisation) and US$599mn or US$3.1/bbl to EBITDA in 2016 and onwards (assuming ongoing 95% total refining capacity utilisation). RUP profitability should be driven mainly by the diesel-fuel oil spread as the company will effectively replace fuel oil production with an increase in middle distillates. The spread has varied within a US$ /t range for the past two years with a decline recently on the back of the drop in the price of crude oil and related products. 12

13 19 March 2015 Our calculations of the RUP impact are based on a US$250/t spread. On our estimates, each US$10/t move in the spread leads to a 7% change in the EBITDA of the RUP. Chart 26: Diesel-fuel oil spread (US$/t) Source: Bloomberg, BofA Merrill Lynch Global Research estimates On our estimates, Tüpraş s net refining margins should exceed US$5/bbl starting from 2016, which is a sizeable increase from the US$3.2/bbl posted in FY2014. Chart 27: Tüpraş net refining margin (US$mn) FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 The margin increase will be a result not only of the RUP launch, but also significant cost savings on the back of lower energy costs, which we discuss in the following section. 13

14 Energy cost savings Tüpraş spent close to US$363mn or 63% of its clean CCS EBITDA on energy in As the energy price has almost halved since last year, we see further related cost savings as an important driver of Tüpraş s profitability. We expect energy costs to go down due to the following reasons. A 5-17% gas price decline in US$ in 2015E and 2016E In our base case, we expect the gas price for Tüpraş to go down by 5% in TRY from TRY798/mcm in 2014 to TRY758/mcm in 2015, or by 17% in US$ from US$364/mcm to US$303/mcm, respectively. A further 5% decline in both TRY and US$ in 2016 is also likely, in our view, if our oil price forecast materialises. The cut in the gas price in Turkey should be driven by: 1. A low import gas price % discount from Gazprom to Botas recently announced 3. Parliament elections in June 2015 Chart 28: Gas price (US$/mcm) Chart 29: Botas gas price to (TRY/mcm) Turkey input gas price Botas' gas price to Source: BofA Merrill Lynch Global Research estimates Source: Botas data, BofA Merrill Lynch Global Research estimates Russian gas accounts for c.60% of total gas consumed in Turkey, while the remaining import volumes are split between Iran (18%), Azerbaijan (7%) and others. Chart 30: Turkey gas balance 17% 58% 7% 18% Russia Iran Azerbaijan Other Source: Oxford Institute for Energy Studies Gazprom s export gas prices are linked to a basket of oil products with a 6-9 month time lag. Oil product prices usually follow the crude oil price with a short time lag. This implies that Gazprom s export price to Turkey will start reflecting January s weakness in the crude oil price only in 3Q15. 14

15 19 March 2015 Moreover, Gazprom and the Turkish state company Botas recently started negotiations on a gas price discount as part of the agreement on the construction of the Turk Stream gas pipeline. The discount is planned at 10.25% and may be applied retroactively since the beginning of the year so that the gas price for Botas in the first quarter will fall to around US$332/mcm. We would expect Gazprom s price to drop further, reaching a trough of US$165/mcm in 4Q15 on the back oil price decline. Chart 31: Gazprom s gas price to Turkey (US$/mcm) Chart 32: Brent crude oil price (US$/bbl) Source: BofA Merrill Lynch Global Research estimates We see long-term positive trends for Turkish gas consumers including Tüpraş. Gazprom recently scrapped its plans to export gas to Europe via the South Stream pipeline and now plans to build the Turk Stream pipeline to Turkey instead. The construction of TANAP pipeline project was officially launched recently that will direct natural gas from Azerbaijan s Shah Deniz field via Turkey to Europe. All this should help turn Turkey into a regional gas transportation hub, which would have a positive effect on the gas price for local consumers in the long term. Gazprom s 10.25% discount to Botas would be the first step in that direction. Liquids cost to drop by 48% in 2015 We expect the liquid energy cost (mainly fuel oil) to decline 48% in 2015 on the back of the global oil price drop. We forecast the average Brent oil price to go down by 52.6% to US$52/bbl in 2015 from US$98.9/bbl in 2014, driving down oil product prices accordingly. Chart 33: liquids consumption (kt) Chart 34: Liquids cost for (US$/t) Source: BofA Merrill Lynch Global Research estimates Source: BofA Merrill Lynch Global Research estimates Total energy cost savings to exceed US$100mn per annum On our estimates, in 2014, Tüpraş consumed 0.75MMtoe of energy, composed of 0.15MMtoe of natural gas feedstock and 0.6MMtoe of other energy feedstock, mainly fuel oil. 15

16 We expect gas consumption to increase by c.250ktoe/year once RUP becomes fully operational. Other energy costs (i.e. fuel oil) should rise in line with the higher refining capacity utilisation, planned to reach 95% post full RUP launch from the current 75%. On our estimates, weighted average energy costs should go down by 43% from US$470/toe in 2014 to US$268mn in 2015 and by 40% to US$283/toe in 2016 driven by: 1) a lower crude oil price, 2) lower natural gas prices, and 3) TRY devaluation (Botas s gas price for Tüpraş is denominated in TRY). This should lead the energy cost to decline from US$2.4/bbl of crude oil processed in 2014 to US$1.7/bbl in 2015 and (-28% vs. 2014) and US$1.8/bbl in 2016 (-25% vs. 2016). In absolute figures, Tüpraş should achieve US$113mn and US$109mn in energy cost savings in 2015E and 2016E, respectively, corresponding to about 11% and 9% of its EBITDA. Table 7: Tüpraş energy consumption, cost and savings E 2016E Total energy feedstock (ktoe) ,156 - gas liquids (i.e. fuel oil) Energy prices (US$/toe) - weighted average gas liquids (i.e. fuel oil) Total energy cost (US$mn) gas liquids (i.e. fuel oil) Energy cost in US$/bbl of throughput % YoY -28% -24% Energy savings vs (US$mn) Energy savings vs (TRYmn)

17 Crude oil mix to drive margins Up to US$100mn of annual cost savings possible Due to its advantageous location on the shores of the Mediterranean, Tüpraş enjoys more flexibility in crude oil supply than some other refiners in Europe. Tüpraş purchases about 20 different types of crude oil from around 10 countries, with gravities ranging from API. The weighted average API of the crude oil used is between 32 and 33 currently. Crude oil feedstock is the largest cost items for the company. In 2014, Tüpraş spent TRY34.6bn (US$15.8bn) on 21.1MMt of raw materials, of which crude oil purchases of 20MMt accounted for about US$14.2bn, on our estimates. We believe that further changes in the feedstock mix could be positive for earnings and will be driven by the company s ability to process heavier crude oil post the full launch of RUP. Table 8: Cost savings from feedstock mix changes Weighted average Average discount API to Brent (US$/bbl) US$/bbl saving vs US$mn savings On our estimates, a higher share of cheaper heavier crude in Tüpraş s feedstock mix should drive down the average discount of purchased crude oil from US$4.2/bbl in 2014 to US$4.7/bbl in 2015 and US$4.9/bbl in This should translate into US$58mn and US$92mn of cost savings or 5% and 7% of EBITDA, respectively. Our analysis is based on the assumption that the average API of the crude oil bought by decreases gradually from 32.3 in 2014 to 30.9 in 2015 and 30.4 in Chart 35: crude oil feedstock mix (in MMt) Iran Russia S. Arabia Turkey Iraq Kazakhstan Italy Libya Others In our view, there could be an increased supply of cheaper heavy crude oil from Iraq and Saudi Arabia, replacing more expensive lighter grades (i.e. CPC, Urals, etc). 17

18 Chart 36: Tüpraş s crude oil feedstock mix per country in % Chart 37: Tüpraş s crude oil feedstock mix per country in % 1% 20% 7% 12% 25% 7% 27% 12% 23% 5% 14% 19% Iran Russia S. Arabia Turkey Iraq Kazakhstan Italy Source: BofA Merrill Lynch Global Research estimates Iran Russia S. Arabia Turkey Iraq Kazakhstan Italy Source: BofA Merrill Lynch Global Research estimates Higher oil intake from Iraq possible Since 2012, in most cases, Tüpraş has offset declining Iran crude oil imports with higher shipments from Iraq. In 2013, it imported 6.1mn tons of crude oil from Iraq, up from 1.8mn tons in However, on our estimates, Tüpraş s purchase of Iraqi crude oil might have declined by about 2MMt to 4.1MMt in 2014 (undisclosed by ) on the back of geopolitical instability in Iraq owing to the advance of Islamic State on its territory. In the meantime, Iraq is still expected to make the largest contribution to OPEC capacity over the coming decade. Its 90 billion barrels of oil resources offer production longevity, making the country a key long-term supplier to the global oil market. Production has grown from 2.4 million b/d when the Technical Service Contracts came into force in 2010, to 3.3 million b/d in The majority of the production increase has come from the southern fields, but Kurdistan is becoming an important contributor. According to WoodMackenzie s estimates, Iraqi hydrocarbon liquids production could rise to around 4.5 mb/d in 2020, while Kurdistan's contribution is expected to increase from its current 8% to around 16%, with 725,000 b/d production forecast for Chart 38: Iraq s hydrocarbon liquids production (kboepd) Chart 39: crude oil purchases from Iraq (hist. and forecast) 5,700 4,700 3,700 2,700 1, Source: WoodMackenzie Due to the advance of Islamic State into Iraq output from the northern federal Iraqi fields is almost completely shut-in now. However, production from the 18

19 southern fields and Kurdistan remains unaffected, although the militants presence has increased security risks for oil operators in Iraq. Higher purchases from Iraq would be value-accretive for Tüpraş, as these may be priced at a significant discount of around US$4-5/bbl to the Brent oil price. We believe Tüpraş will aim to grow purchases from Iraq to cover rising refining needs post the RUP launch, should the geopolitical situation allow. We would expect about a 2MMt of annual increase in oil purchases from Iraq in 2015 and 2016 by Tüpraş. Iran remains potential catalyst Tüpraş used to buy 7-10MMt of Iranian crude oil per year before the latest sanctions against the Iranian energy sector came into effect in Tüpraş s purchase of Iranian crude oil has dropped to around 5MMt/year since then and is now set on an annual basis for the company. Chart 40: crude oil purchases from Iran (hist. and forecast) Table 9: Impact of higher crude from Iran Additional volume (MMt) Total volume (MMt) US$mn gain Source: BofA Merrill Lynch Global Research estimates Should Iran s negotiations with the West over its nuclear programme end in a comprehensive agreement, it would have long-term positive implications for the export of Iranian crude to Turkey. 30 June 2015 is the key deadline for negotiations to watch at the moment. See EEMEA Economic Weekly: Iran negotiations crunch time published on 13 March 2015 for more details on the Iran negotiations and potential outcomes. We currently model Tüpraş making purchases of 5.1MMt of Iranian crude oil per year based on recent historical volumes. Assuming Iranian crude oil is priced at around a US$5/bbl discount to Brent, a 1MMt incremental supply of crude from Iran could result in about a US$15mn gain for Tüpraş. Our calculation is based on the assumption that Tüpraş s crude oil purchase discount to Brent drops to around US$3.1/bbl in 2016, as highlighted above. 19

20 Efficiency improvement drives growth Apart from the flagship RUP, Tüpraş has undertaken other projects to streamline efficiency: Izmir refinery: Investment in efficiency improvement projects at the Izmir refinery resulted in savings of more than US$30mn/annum. The installation of a new gas turbine with 25MW electricity generation capacity yielded annual energy savings of 132,383 gcal and annual monetary savings of US$9.7mn. Through modifications of operational parameters, diesel productivity was increased, which yielded US$11.3mn in annual savings. By improving operational parameters at crude oil units, semi-finished products were transformed into kerosene instead of naphtha. As a result, productivity increased 2%, and annual savings of US$12mn were achieved. Kirikkale refinery: Investment to improve crude oil energy efficiency at Kirikkale will result in annual monetary savings of more than US$50mn Chart 41: Investing in Efficiency projects (US$ mn) OMP EVP Source: Company, Merrill Lynch Research 20

21 Turkish market in growth phase Turkish oil product market in growth stage Relatively healthy economic growth in Turkey in recent years (i.e. GDP growth of 3.8% in 2013 and 2.7% in 2014) underpinned strong trends in petroleum product consumption in 2014: jet fuel rose by 11.2% YoY diesel consumption was up 4.2% gasoline demand rose by 3.2%. In the meantime, the country s use of non-standard and informal petroleum products has dropped as a result of various measures being implemented. Chart 42: Turkey oil product demand growth 12% 10% 8% 6% 4% 2% 0% -2% Gasolines Jet fuel Total diesel Source: BofA Merrill Lynch Global Research estimates Going forward, our macro research team expects 3.2% GDP growth in 2015 and 4% in 2016 in Turkey which, on our estimates, should translate into steady 2% per annum growth in total oil product demand, among the strongest rates in Europe. By 2020, Turkish consumption of petroleum products should reach 40Mt, on our estimates. Most of this increase reflects incremental demand for gas/diesel oil, with the bulk of this representing road diesel, while a projected expansion in ethylene capacity should provide a substantial boost to naphtha sales. We expect the sales of most other oil products to increase during the forecast period. Chart 43: Turkey oil product market growth (kt) 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 LPG Naphtha Gasolines Jet fuel Total diesel Total fuel oil Lube oil Asphalt Others Source: BofA Merrill Lynch Global Research estimates Gasoline consumption decline reversed Gasoline demand in Turkey has been in decline since the late 1990s because of the improved efficiency of gasoline engines as well as one of the highest retail fuel prices in Europe. As Turkey seeks accession to the EU, it is likely that it will increasingly adopt EU policy standards and initiatives. Thus, in line with wider EU policy, we expect the government to start pushing for a reduction in carbon 21

22 emissions from transport. Therefore, growth in the car stock should be skewed towards new diesel and LPG cars, while the number of gasoline cars remains relatively static. We conservatively expect gasoline consumption to increase at only a 1-1.3% E CAGR. Local diesel market in deficit Turkey has large deficit in diesel, with domestic production covering only onethird of total demand in Chart 44: Domestic production of diesel vs. imports in Turkey (MMt) Diesel production Diesel imports Source: Company data, WoodMackenzie, BofA Merrill Lynch Global Research estimates Tüpraş s full-scale launch of RUP should contribute about 2.9MMt/annum of diesel to domestic output and cover about 12% of demand in 2015E and 16% in 2016E. After the launch of RUP, Turkey will still have to import diesel to cover close to 50% of local demand. Diesel demand driven by auto & GDP Diesel demand growth (c.5.2% pa from ) was driven largely by the road transport sector. Car penetration in Turkey of 165 cars per 1,000 people is still well below the European average of 500. Increasing purchasing power combined with a strong dieselisation trend in the car fleet has contributed to rising diesel consumption. Chart 45: Turkey GDP YoY (%) vs. car sales (% yoy) Chart 46: Total vehicle numbers in Turkey (mn) 15 75% % 45% 30% 15% 0% -15% GDP YoY (%) Car sales LTM (% yoy) Cars Other Source: Bloomberg, BofA Merrill Lynch Global Research While the recent strong dieselisation trend in the car fleet has contributed to rising diesel consumption, it is commercial transport which is estimated to account for around two thirds of diesel demand. The other major sector of gas/diesel oil demand is Turkey's large agricultural sector. Agricultural fuel demand has grown steadily over the past decade and 22

23 19 March 2015 continued increases in agricultural production are expected to result in this volume continuing to rise over the remainder of the forecast period. Also, the increase in diesel consumption can be attributed to the implementation of the Special Consumption Tax (SCT) reimbursement in base oils to address problems such as the consumption of off-spec Number 10 diesel. These measures have been very effective in preventing this type of misconduct in the market. We would expect growth momentum to be maintained until 2020 and forecast above a 2% E CAGR of diesel demand in Turkey. Chart 47: Turkey consumer confidence vs. car sales Chart 48: Diesel consumption & GDP growth rate in Turkey Turkey Consumer Confidence ,000, , , , , , ,000 Car Sales LTM % 6% 4% 2% 0% -2% -4% -6% M-14 GDP Growth (LHS) Diesel Demand Growth (RHS) Source: Bloomberg, BofA Merrill Lynch Global Research Source:, BofA Merrill Lynch Global Research Rise in air traffic to boost jet fuel growth Jet fuel demand has grown strongly from 2011 at an average annual rate of 12% during this period. Growth in domestic air travel and the development of budget airlines (mainly inter-city flights) were among the key drivers. International travel has seen growth in this period as well, with a rise tourist numbers. Istanbul has become a hub for Turkish airlines and big investments in infrastructure will continue to bolster jet fuel consumption growth (above a 4% E CAGR). Chart 49: No of air passengers in Turkey (mn); 14% CAGR in past five years Domestic International Eurocontrol forecasts 7% CAGR growth for flight movements for Turkey (leading in Europe) thorough Turkish airports authority (DHMI) expects 9% CAGR growth in passenger numbers through 2023 (350mn pax in 2023 vs. 166mn achieved in 2014). 23

24 Chart 50: # of air flights in Europe CAGR in E Turkey Georgia Azerbhaijan Armenia Moldovia Bulgaria Romania Ukraine Belarus Malta Hungary Cyprus Slovakia Iceland Croatia Bosnia-Herz. Lithuania Poland Serbia & Mont. FYROM Albania Slovenia Estonia Morocco Czech Rep. Lativia Greece Santa Maria Austria Ireland Sweden Belgium Denmark Germany Italy Netherland UK Lisbon France Switzerland Finland Norway Spain Canary Isl. Source: Eurocontrol Statistical Reference Area Chart 51: Turkey s car park by vehicle type Turkey as 2 nd biggest auto-lpg market worldwide LPG demand grew rapidly to reach 1.3 Mt by the start of the last decade and, although the government has scaled back the subsidies since then, consumption continued its progress and overtook gasoline in The increase in gasoline price in recent years boosted conversions form gasoline to LPG, and the number of vehicles equipped to run on LPG is now estimated at 3 million. As a result, Turkey is the second largest auto-lpg market in the world amounting to 2.7 Mt in Source: WoodMackenzie Conventional Hybrids AEV/PHEV Other LPG Diesel Gasoline Fuel oil demand under pressure Fuel oil demand has been in terminal decline throughout the last decade as demand in the power and industrial sector has diminished, due to the steady displacement of fuel oil by natural gas in these sectors. Inland demand is expected to continue to fall in the period to 2025 although this is more than offset by rising marine bunker fuel demand, so that demand increases to 1.8 Mt by Overall, this represents an annual increase of 1.0% between now and the end of the forecast period. 24

25 Monopoly in an attractive market Tüpraş is by far the leading player in the Turkish wholesale market for oil products across all the segments of the value chain: Tüpraş controls all Turkey s 28.1MMt refining capacity. In terms of geographical location, its refineries are deployed adjacent to consumption areas and are best suited to meet the country s needs, which adds to the competitive strengths of the company. It owns 59% of the total petroleum products storage capacity in Turkey, comprising 1.7 million tons of crude oil, 1.3 million tons of white product and 0.9 million tons of black product. Tüpraş maintains a leading c.50% market share in wholesale of oil products in Turkey, which is mainly covered by own production, but also via imports (mainly diesel). The RUP should allow Tüpraş to raise its market share to 60% in 2016, on our estimates. Chart 52: Tüpraş s market share in 2014 Chart 53: Tüpraş s market share in 2015E Chart 54: Tüpraş s market share in 2016E Total Asphalt Gasolines Jet fuel Fuel oil Diesel LPG Lube oil Others Naphtha 48.3 % 98% 95% 94% 80% 39% 21% 18% 10% 8% Total Asphalt Gasolines Jet fuel Fuel oil Diesel Others LPG Lube oil Naphtha 56% 98% 96% 93% 79% 53% 45% 24% 20% 10% Total Asphalt Gasolines Jet fuel Fiesel Others Fuel oil LPG Lube oil Naphtha 60% 98% 96% 95% 60% 56% 54% 27% 19% 11% 0% 50% 100% 150% 0% 50% 100% 150% 0% 50% 100% 150% Higher net refining margin than Med peers In line with its peers, Tüpraş s refining margins compressed from 2011 to 1H14 driven by higher capacity utilisation across the industry, lower price differentials between crude grades and higher energy costs due to an increase in natural gas prices in Turkey. However, even in tough times, the company generates higher margins than its peers on average, mainly thanks to a Turkey inland price premium and a better crude oil sourcing mix. In 2014, Tüpraş s net refining margin was US$3.2/bbl, US$1.2 above the Mediterranean net complex benchmark. The RUP project should add up to US$3/bbl to Tüpraş s margin on our estimates. 25

26 Chart 55: Net refining margins: Tüpraş vs. Med complex (US$/bbl) FY11 FY12 FY13 FY14 FY15 FY16 net refining margin Med net refining margin Competition to challenge Tüpraş only from 2019 The state oil company of Azerbaijan, SOCAR, is building a new refinery in Turkey through the Star consortium (81.5% owned by SOCAR, 18.5% owned by TURCAS Rafineri Yatirimlari A.S), which could end Tüpraş s domestic monopoly when completed in Located on the Aegean coast, the refinery will have 10MMt capacity (vs. 28.1MMt for Tüpraş), according to the current plan. The new refinery will feed its sister petrochemical company, Petkim, 1.7mn tons of naphta. In addition, Star will produce 0.5mn tons of jet fuel and 6mn tons of ULSD diesel. Additional refining capacity coming on stream post 2018 should have only a limited impact on Tüpraş and the local market, given the considerable deficit of diesel. On our estimates, Turkey will still have to import close to 4MMt of diesel post the launch of Star in Chart 56: Turkey diesel balance post the launch of Star refinery Star production Imports production 26

27 Strong financials FCF to grow on capex drop as RUP launches In 2014, Tüpraş deployed about US$1bn in capex, split between US$500mn for the RUP, US$484mn for RUP-related projects and US$50mn for energyefficiency projects (which we believe are fairly discretionary in nature). Beyond 2015, Tüpraş expects capex to be around US$200mn per annum, mostly on maintenance and efficiency. Chart 57: Tüpraş s capex breakdown (US$mn) Chart 58: FCF and dividends (TRYmn) ,500 2,000 1,500 1, A 2015E 2016E 2017E Maintenance Others Residium upgrade FCF Dividends Chart 59: Tüpraş s debt FX exposure EUR, 3% TL, 14% We estimate that an 80% drop in capex in 2015E should release about US$300mn of FCF. On our numbers, Tüpraş could generate up to US$800mn FCF/annum in the long term post the launch of RUP. We expect the company to focus on paying dividends in the first few years after the RUP completion. Leverage: gross debt of TRY7.8bn; 10% short term As of 2014 Tüpraş had gross debt of TRY7.8bn (c.us$3.3bn), of which short-term debt represented TRY737mn (10% of the total). Net debt was US$1.7bn (US$1.9bn when adjusted for a US$290mn EMBRA fee liability), up 4% YoY. In terms of FX exposure 83% of total debt is US$ denominated, 3% is in euros and the remaining 14% is in Turkish lira. US$, 83% Source: Company data 27

28 Chart 60: Tüpraş Debt Maturity profile (TRY mn) 2,500 2,343 2,000 1,827 1,500 1,489 1, Source: Company, BofA Merrill Lynch Global Research We expect Tüpraş s net debt/ebitda to go down from 5.9x in 2014 to 1.1x in 2017E on the back of high earnings growth and gradual deleveraging post the RUP launch. Chart 61: Net debt/ebitda A 2015E 2016E 2017E Source: Company, BofA Merrill Lynch Global Research Impact of FX on Tüpraş: positive in the long term Besides export revenues, which are US$-denominated, Tüpraş generates around 81% of its revenue domestically. These revenues are in Turkish lira but also US$linked. The company may also incur gains and losses from inventory due to FX. That said, excluding raw materials, capex and finance costs, most of Tüpraş s operating costs are in Turkish lira. On the debt side, Tüpraş is exposed to FX risk as 83% of gross debt is US$denominated, 3% is in euros and the remaining 14% is in Turkish lira. Weaker lira implies an FX loss owing to the US$-denominated debt revaluation. All in all, on our estimates, a 10% weakening in TRY has 17% positive impact on EBITDA and mostly negligible below 2% negative impact of on the net income in In longer term, the company wins from weaker TRY once FX losses stemming from the debt revaluation are left behind and the products are priced based on a stronger USD. 28

29 Turkey: the macro view Trimming GDP growth forecasts In its recent report Trimming GDP growth forecast, our macroeconomics research team highlighted that Turkey has largely missed a great opportunity to ride a strong cyclical tailwind and to address its macro vulnerabilities smoothly at a time when the Fed s normalisation of rates is looming. As a result, first domestic politics hit the TRY and Turkish assets, and then soured EM risk sentiment on the back of increased concerns of an earlier-than-expected Fed hike took its toll. Further volatility in both domestic politics and global financial markets in 2Q15 is likely to take its toll on economic activity and macro indicators. The risks are to the downside on GDP growth and the CAD, and to the upside on inflation in 2015 due to TRY weakness. Leading indicators suggest that both private consumption and investments have been slow to recover in 1Q15. Our 2015E GDP growth forecast was cut by 0.5ppt to 3.2%. June elections key to the outlook Turkey is expected to hold parliamentary elections on 7 June. The elections have become the crossroads for the outlook for Turkish assets. President Erdogan has suggested that June elections could represent a break from the past in terms of both moving to a presidential system and introducing a new economic framework. The row between President Erdogan and the Central Bank of Turkey (CBT) on monetary policy caused the markets to question the CBT s independence going forward. One concern is interference with the CBT s policy, which could lead to more aggressive rate cuts than desired and result in the TRY weakening. Chart 62: Real GDP growth to bounce back, but recovery delayed 12 Real GDP growth (%yoy) e 2015F 2016F Source: Haver, BofA Merrill Lynch Global Research Chart 63: Domestic demand is likely to strengthen % Q14 14F 15F Private cons. Public cons. GFCF Inventories Net exports GDP growth Source: Haver, BofA Merrill Lynch Global Research 29

30 19 March 2015 Chart 64: External demand pulling down Turkish IP growth Chart 65: Weaker TRY is likely to dent domestic confidence PMI_TU Turkish IP growth (rhs, % yoy) Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan Jan-07 Jan-08 Jan-09 Jan-10 Consumer Confidence Index Real Sector Confidence Index (sa) Jan-11 Jan-12 Jan-13 Jan-14 Jan Source: Haver, BofA Merrill Lynch Global Research Exhibit 1: Gross National Savings (% of GDP) Source: Haver, BofA Merrill Lynch Global Research A Robin Hood recovery Lower oil prices act as a significant tax cut for a large number of consumers, funded by a few oil exporters. This income redistribution from rich, saving countries to poor, non-saving peers should be positive for growth as the latter have a higher marginal propensity to consume. This is also the case for the EEMEA region and Turkey is comfortably at the receiving end of this transfer. In a global backdrop with lower oil prices and global yields, Turkey stands out in EEMEA for four main reasons, in our view: 1) its economy is relatively more closed and depends more on domestic demand, with exports to GDP at 25%; 2) the average age of the population is a young 29.3 and this demographic has a higher tendency to spend; 3) it is one of the main energy importers, with energy imports to GDP at 7%; and 4) its growth model depends heavily on lower interest rates Source: Haver, Bank of America Global Research Side effects of low oil price The side effect of lower oil prices on Turkey s growth would be a rise in oil product exports because some 80% head to Europe and MENA. In addition, lower crude prices have a positive impact on inflation as fuel prices in TRY have come down by roughly 15% from July highs to end-2014 and by another 5% in January. 30

31 Commodity view The wide gap in crude stocks between Europe and US... Commercial crude oil inventories in the United States have continued to build at a rapid rate and are now sitting at 444 million barrels, the highest level on record (Chart 66). Meanwhile, crude oil inventories in Europe hit the highest seasonal level in six years in December but drew in January on the back of strong refinery run rates and now sit at 464 million barrels, slightly above the 5 year average (Chart 67). Chart 66: Crude inventories in the US have continued to build at an alarming rate and are now sitting at the highest level on record mn bbl US crude stocks 320 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: EIA, BofA Merrill Lynch Global Commodities Research Chart 67: Meanwhile, crude oil inventories in Europe hit the highest seasonal level in six years in December, but drew in January mn bbls Euroil crude oil stocks 420 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Euroil, Reuters, BofA Merrill Lynch Global Commodities Research We still see a 180mn barrel build and remain bears... We see commercial inventory levels across the OECD increasing from 2,700 million at the end of 4Q14 to 2,880 million by the end of 3Q15 (Chart 68). Crucially, while inventories in the OECD Americas are already at previously tested maximum storage capacity levels, we now see that surplus potentially expanding to OECD Asia and Europe (Chart 69) (see Heating oil holding crude ). 31

32 Chart 68: We see commercial stock levels in the OECD increasing from 2.70 bn at the end of 4Q14 to 2.88 bn by the end of 3Q15 2,900 2,800 2,700 2,600 OECD total oil stocks (crude, ngl, products, feedstock) mn bbl 2,500 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: IEA, BofA Merrill Lynch Global Commodities Research Chart 69: We now see the crude oil surplus potentially expanding to OECD Asia and Europe mn bbl OECD Europe & Asia crude oil stocks 440 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: IEA, BofA Merrill Lynch Global Commodities Research...but we mark our targets up given current price levels Since we still expect global oil supply to run above demand for at least six more months, we believe that downward pressure on petroleum prices will likely continue. Yet, the Brent market has been somewhat tighter than we projected on the back of unexpected disruptions. Meanwhile WTI weakness has become extremely pronounced even against domestic grades like Light Louisiana Sweet (Chart 70) that are only a pipeline move away. On the back of these reasons, we shift our WTI end of 1Q and 2Q target to $45 and $41, respectively, and move our Brent end of 1Q and 2Q target to $55 and $48 (Chart 71). So we remain bearish, but in a different shade of gray. Chart 70: WTI weakness has become extremely pronounced even against domestic grades like Light Louisiana Sweet - (1) (2) (3) (4) (5) (6) $/bbl WTI-LLS (7) Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 WTI-LLS (03-Mar-15) WTI-LLS (31-Dec-14) WTI-LLS (28-Nov-14) WTI-LLS (29-Oct-14) WTI-LLS (29-Sep-14) Source: Bloomberg, BofA Merrill Lynch Global Commodities Research Chart 71: We shift our WTI end of 1Q and 2Q target to $45 and $41 respectively, and our Brent end of 1Q and 2Q target to $55 and $ Brent & WTI crude oil: forecast versus forward 40 BofAML 30 $/bbl EoQ fcast Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 WTI Brent Source: Bloomberg, BofA Merrill Lynch Global Commodities Research forward The strong USD, high stocks, and weak EMs cap oil prices Very high inventory levels are perhaps the main reason to remain cautious on the global crude oil price outlook over the next few months. While the microeconomics of the oil industry are poor, the global macro framework is not helping. To begin with, the USD has continued to strengthen even as Brent crude oil prices bounced up in recent weeks (Chart 72). Should the USD rally further in 32

33 the coming months, Brent crude oil prices could face severe headwinds. Moreover, leading economic indicators in EMs are worsening (Chart 21), and the sharp drop experienced by currencies like the BRL or the TRY in recent days suggests that investor confidence on a firm EM recovery in 2015 is running thin (Chart 73). Chart 72: The USD has strengthened even as Brent crude oil prices bounced up in recent weeks, but this divergence may not last long Brent crude oil price and spot dollar index (DXY) $/bbl index USD appreciation oil price depreciation Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 Brent crude oil price Source: Bloomberg, BofA Merrill Lynch Global Commodities Research USD (DXY) (rhs, reverse axis) Chart 73: Leading economic indicators in EMs are worsening, and investor confidence on a firm EM recovery in 2015 is running thin index EM manufacturing PMIs 46 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Emerging Markets China India Indonesia Brazil migem Mexico Source: Bloomberg, BofA Merrill Lynch Global Commodities Research expansion Potential Iran deal presents a key downside risk to prices On top of that, a deal with Iran to close the nuclear episode may occur over the next few months. Should a deal materialize that partly lifts sanctions, the IEA estimates that Iranian crude oil production could increase by thousand b/d over the course of three months (Chart 75). Given Iran s cash strapped conditions, the negotiations present a key downside risk to any oil price recovery in 2H15 and beyond. Chart 74: The recent sharp drop experienced by the BRL or the TRY is another indicator of falling confidence on a firm EM recovery Brazilian real and Turkish lira against USD price of 1 unit in USD Chart 75: Should a deal materialize, the IEA estimates that Iranian output could increase by k b/d over the course of 3 months mn b/d Iranian crude production and exports mn b/d Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 Brazilian real Turkish lira Source: Bloomberg, BofA Merrill Lynch Global Commodities Research 2.0 Jan-02 May-04 Sep-06 Jan-09 May-11 Sep-13 production exports (rhs) Source: IEA, Jodi, BofA Merrill Lynch Global Commodities Research 1.0 For more detail about our commodity views see Bears in another shade of gray note published on 6 March

34 Refining outlook in Europe Lower crude price boosts margins for some, at least for now Global crude oil prices have been in freefall in recent months, and we still see limited support for the market in the near term. The bulging surplus in crude oil is giving a mild boost to refiners via plunging feedstock costs. In Europe, crude processing has seen a strong recovery since June when it averaged below 9.5 million b/d, the lowest refinery run rate since 1985, and utilisation rates are now above seasonal averages. Retaining our US$5.5-6/bbl gross margin view The above may create the risk of refineries postponing closures, further aggravating a surplus in the product markets in Despite the recent strength in margins (US$7-8/bbl in 3-4Q14 and 1Q15), our long-term forecast for our benchmark margins in Europe remains about within US$5.5-6/bbl range. Chart 76: European refining margins (US$/bbl) Q13A 2Q13A 3Q13A 4Q13A 1Q14A 2Q14A 3Q14A 4Q14A 1Q15E 2Q15E 3Q15E 4Q15E Chart 77: For the first time since 2009, refinery capacity is likely to outgrow global oil demand 3 Global oil demand & CDU mn b/d BofAML fcast oil demand growth CDU capacity growth Source: BP, IEA, BofA Merrill Lynch Global Commodities Research North West Europe (cracking) Source: BofA Merrill Lynch Global Research estimates Mediterranean (complex) We prefer to remain conservative on the European refining margin outlook in long-term as: Diesel may suffer from too much supply. The impact of the new distillateoriented refinery capacity, adding 700k b/d of distillates to the market, may be felt in 1H15. Tax changes in Russia are a strong incentive to export premium products, especially diesel, that however may be mitigated by some refineries closures. Net, distillate inventories should continue to build, likely putting pressure on cracks and keeping the gasoil forward curve in contango. 34

35 New CDU capacity could outgrow demand. Our commodity team projects global crude distillation unit (CDU) capacity to grow by 1.8 and 1.0 million b/d in 2015 and 2016, respectively. With the strongest CDU growth since 1999 (Chart 67), global refinery capacity may easily outgrow demand (Chart 68). Most of the new capacity is set to come from China and the Middle East, including several upgrading units to produce distillates and gasoline (Chart 47). Chart 78: We project CDU capacity globally to grow 1.8 million b/d in 2015, the largest annual growth since 1999 Net CDU additions by region mn b/d BofAML fcast Africa Asia Pac. (ex. China) China Eastern Europe Europe Latin America Middle East North America Total Source: BP, IEA, BofA Merrill Lynch Global Commodities Research Chart 79: Most of the new capacity comes from China and the Middle East and includes a lot of upgrading components Net upgrading capacity growth by region 1.5 mn b/d Africa Asia Pacific Eastern Europe Europe Latin America Middle East North America Total Source: BofA Merrill Lynch Global Commodities Research Tüpraş remains a case apart Tüpraş should be the best positioned to sustain any potential weakness in refining margins should the current strength be only temporary and global product demand fall behind supply. Our 22% EBITDA CAGR in forecast is built solely on the improving economics of refining operations post the launch of RUP and does not incorporate further improvement in the external refining environment Tüpraş is a monopoly in its core refining market The deficit of middle distillates to support will not to be covered by domestic production within the next 5-7 years The nearest competing refinery will start operations only in 2018 The RUP project should provide significant support to Tüpraş s profitability. Our earnings forecast for is currently based on US$5/bbl net refining margin in 2015, US$5.3/bbl in 2016 and US$5.4/bbl in On our estimates, US$1/bbl change in the net margin should result in about 15% change in EBITDA and 20% change in the net income. 35

36 19 March 2015 Chart 80: net refining margin forecast (ius$/bbl) FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company data, BofA Merrill Lynch Global Commodities Research 36

37 Risks to the investment case Our investment thesis may be prone to the following risks: Changes in the refining outlook: Tüpraş is a pure play on refining margins and may be negatively affected should global supply of oil products outgrow demand. However, it is better positioned to withstand any macro shocks than its refining peers in EEMEA due to: (1) its dominant position in the Turkey market; and (2) flexible access to crude oil and ability to diversify its supply sources. In the meantime, our model is built based on our rather conservative long-term US$5.75/bbl in-house benchmark gross Med margin. Risks to dividends: expected resumption and increase in dividends may come under question, if 1) Koc Holding acquires other assets in the oil & gas (i.e. upstream) via, 2) new upgrade projects in other refineries are launched (i.e. Kirikkale, Izmir). Regulatory risk: 11% devaluation of TRY vs. USD year-to-date poses the risk of the regulators trying to put caps on the oil product prices in Turkey to curb down the inflation. In our view, such a risk is more relevant for the retail business rather than wholesale, as wholesale oil product prices in Turkey are linked to the CIF Mediterranean price quotes. Currency Risk: Tüpraş does business with high monetary value in foreign currency, especially in case of procurements as needed by its field of activity. Foreign currency positions in connection with these transactions are followed up by Finance Department on a regular basis. The required amount of foreign currency assets is available, considering the fact that existing stocks are priced in foreign currency. Thus, a natural hedge is maintained to keep the open foreign exchange position in acceptable level. Liquidity Risk: A significant portion of the receivables arising out of the sales to private sector customers is secured in order to get rid of the collection risk. Material part of the sales and receivables is attributable to public enterprises and free from the collection risk. Furthermore, average figures of receivables and stocks are kept shorter as far as practicable, due to Tüpraş s policies and economic conjuncture. Long-term cash valuation is not done because of lower number of days. So, liquidity risk should be limited. Commercial Risks: Tüpraş s prices are based on the CIF Mediterranean (Genova/ Lavera), price quotes and foreign exchange rates pursuant to the Oil Market Law and Energy Market Regulation Authority s applicable criteria. In order to mitigate the effects of quick changes in crude oil prices, the price averages of longer periods are used in the pricing of crude oil, rather than periods of a few days. Besides, the crude oil pricing days are determined closer to the potential selling days of products. Thus, time-related risks caused from the difference of purchasing and selling prices are eliminated as much as possible. Additionally, the crude oil and product stocks are kept in optimum level in order to eliminate the risks caused from price changes. Supply/Transportation: Continuity of the production is maintained by using domestically supplied and predominantly imported raw materials. Purchase operations of raw materials have been optimized; in order to diversify supply sources, distribute risk in supply chain, provide advantage in price and freight costs; and to increase operational capability of the company. 37

38 Company background Brief history 10 July 1990 was a turning point in Tüpraş s history, which had served for many years as a state economic enterprise, when it was handed over to the privatisation administration. The IPO was carried out in Following the sale of some of its shares to the private sector in 1991 and 2000, the long-awaited government privatisation of a majority stake in the company took place in 2005 when a consortium comprising Koc Holding (98%) and Shell Overseas Investments B.V. (2%) acquired a 51% controlling interest in Tüpraş for US$4.14bn. The remaining 49% of the company's shares are now held privately and listed on the London and Istanbul stock exchanges. Almost entire trading share trading volumes are on Istanbul stock exchange. Key refining assets Turkiye Petrol Rafinerileri A.S. (Tüpraş), a Turkish industrial company with core activities around oil refining and marketing, is Turkey s only oil refiner. The refining operations are conducted at four sites around the country with a total capacity of 28.1mn tons per annum and a complexity of 7.3, which is higher than the Mediterranean refinery complexity (5.95). We expect NCI to reach 9.9 post the launch of full operation of RUP. Major refineries and their product storage infrastructure are located near the biggest demand centres of the country; which implies low transport costs for these areas. The company also has a 40% stake in Opet, the second-largest petroleum retailer in Turkey with more than 1,300 fuel stations. In addition, a majority stake (79.98%) in shipping company Ditaş creates synergies and adds value to the operations. We describe Tüpraş s four refineries below. Se the refining map in the end of this note for more detail: The Izmit refinery is located at the centre of a consumption hub that accounts for around 33% of Turkish petroleum product consumption. The refinery is capable of producing at Euro-V standards in compliance with EU norms. Its Nelson Complexity Index is 7.78 but it will raise its NCI to 14.5 with the completion of the ongoing RUP, a US$ 3bn initiative. Table 10: Refining asset portfolio of Tüpraş Refinery Capacity Nelson Year of Name mmt/year Complexity establishment Izmit Izmir Kirikkale Batman Source: Company data, BofA Merrill Lynch research estimates The Izmir refinery started production in It has a 7.66 Nelson Complexity. The refinery s capacity utilisation rate was 77.1% in 2013, including the processing of imported semi-finished products. Its production of main marketable petroleum products consisting of LPG, naphtha, gasoline, jet fuel, diesel, base oil, heating oil, fuel oil, bitumen, wax, extracts and other products reached 8.1 million tons per annum. The Kirikkale refinery was established in 1986 to meet the petroleum demands of the Ankara, Central Anatolia, Eastern Mediterranean and Eastern Black Sea regions. With a Nelson Complexity of 6.32, Kırıkkale has Turkey s largest road tanker filling capacity. The refinery s capacity utilisation rate was 65.6% for crude oil or 67.4% including imported products used in processing. Its main products are LPG, gasoline, jet fuel, kerosene, diesel, fuel oil and bitumen. Approximately 3.19 million tons of petroleum products have been produced. 38

39 The Batman refinery was commissioned in 1955 and was the first refinery founded in Turkey. Batman s crude oil processing capacity has reached 1.1 million tons a year. The refinery has the advantage of being located near domestic sources of crude oil; however, since it does not have upgrading units, its configuration is simple and its Nelson Complexity Index is Integration into retail and logistics Tüpraş is integrated into the downstream and logistics segments of the value chain via Opet (fuel distribution, 40% owned) and Ditaş (maritime oil transportation, 80% owned). It currently has no plans to move into upstream projects, including in Iraq, where it sources a significant share of its feedstock. Any such strategic decision would have to be made by the Board and the Koç family in particular. Opet second-largest fuel distributor Opet has the second-highest capacity in terms of terminal (major terminals in Marmara, Agean, Black Sea and Mediterranean) and high storage capacity (1.2mmcm). Thanks to Opet, Tüpraş has reached coverage of the entire country, including the market east of the Black Sea and Mediterranean regions, far from Tüpraş s own refineries. Opet has 19% and 13% market share in white and black products, respectively. It operates 1,361 stations under the Opet and Sunpet brands. In addition, Opet supplies jet fuel to domestic and international airlines through a JV with Turkish Airlines, THY-Opet, and produces lubricating oils through another JV with Fuchs (Germany). Tüpraş holds a 40% stake and accounts for Opet using the equity method. Ditaş marine transportation Ditaş transports crude oil for Tüpraş, and transports petroleum products for both Tüpraş and other suppliers. It uses its own tankers and charters tankers. Ditaş transported 6.4 million tons of crude oil and 3.1 million tons of petroleum products in Revenues amounted to US$103mn, or just 0.4% of Tüpraş consolidated revenues. Shareholder structure Tüpraş is a public company with shares listed on the Istanbul Stock Exchange and London Stock Exchange. The 51% stake is controlled by Koc Holding, Aygaz and Opet via joint entity Enerji Yatirimlari (see Exhibit 3). The remaining 49% is in the free float. Tüpraş was established in 1983 by the Turkish government. In 2006, the company was privatised by Enerji Yatirimlari, which is 77% owned by Koç Holding. The remaining 23% is held by the Koç s subsidiary Aygaz (20%) and Opet (3%). 39

40 Chart 81: Tüpraş shareholder structure Exhibit 2: Tüpraş shareholder scheme Free float, 49% Koc Holding, 39% Source: Company data Opet, 2% Aygaz, 10% Source: Company data Koc Holding s asset portfolio is diversified across several industries. The shareholder sees Tüpraş as part of the value asset group with a focus on high dividends. This should bode well for minorities, once RUP is fully launched and FCF rises. Chart 82: KOC s total asset & weightage of each sector 8% 14% 7% 5% 66% Energy Automotive Customer Durables Finance Other Source: : Company data State supervision is carried out by the Privatisation Administration through the Group C (preferential) share. Class C shares do not hold any other privileges concerning voting rights, apart from veto rights at general meetings on actions that might hinder the supply of petroleum to the Turkish armed forces, such as closure or sale of one of the refineries, a reduction corresponding to more than 10% of capacity, or spin-off or merger and/or liquidation of the company. Management team Tüpraş board of directors consists of 12 members, including four independent directors. The Turkish government has the right to nominate one of the independent members of the board. As discussed above, the government s veto 40

41 right can be used with regards to (1) Tüpraş actions concerning the needs of the Turkish armed forces, (2) articles of association and (3) the rights of the government s shareholding. Omer M. Koç has been the Chairman of the Board since 2008 after joining Tüpraş in He was previously on Koç Holding s Board of Directors. In January 2006, Yavuz Erkut became Tüpraş s CEO after serving more than six years as Opet s CEO. He has spent more than 28 years with the company. As shown in the chart below, Tüpraş s management executive compensation is performance-based and linked to a number of parameters including share price performance and economic profit. A similar incentive scheme is place for the management teams of other companies owned by Koc Holding. Exhibit 3: Maximising Shareholder Value Source: Company data 41

42 42 Table 11: Refiners valuation sheet Performance v/s MSCI Global Energy Index Nelson Complexity Mkt Cap Gearing % P/E EV/EBITDA FCF yield Div yield Performance 17-Mar-15 ($m) 2015e 2015e 2016e 2015e 2016e 2015e 2016e 2015e 2016e YTD 12m YTD 12m Europe Hellenic Pet 1,477 NA % 31.7% 5.1% 7.3% % Motor Oil 869 NA % 19.5% 6.9% 9.2% NA 87% Neste 6,521 NA % 5.9% 2.9% 3.0% NA 80% PKN 6,404 19% % -1.7% 2.9% 2.9% % 5,435 20% % 12% 6.5% 12.2% % Median (ex. ) % 12.7% 5.1% 7.3% % US Calumet 1,843 69% % 8.4% 10.4% 10.4% NA 53% Delek 1,895 10% % 6.6% 3.1% 3.1% % HollyFrontier 8,145 4% % 4.8% 8.0% 8.0% % Marathon Petrol 30,299 36% % 5.3% 1.9% 1.9% % Northern Tier 2,046 30% % 13.9% 12.9% 12.5% NA 80% PBF Energy 3,011 27% % 15.6% 3.9% 3.9% NA Phillips 66 45,171 19% % 1.4% 2.8% 3.1% % Tesoro 11,712 34% % 5.4% 1.9% 1.9% % Valero 31,635 12% % 10.5% 2.6% 2.6% % Median % 6.6% 3.1% 3.1% % Light product Yield 19 March 2015 Asia BPCL 8,622 45% % 12.3% 2.6% 3.4% % Formosa Pet 21,114 11% % 8.2% 2.8% 3.0% NA NA HPCL 3,278 70% % 39.3% 2.0% 4.2% NA 30% IOC 12,998 52% % 22.7% 1.2% 4.2% % Reliance Industries 45,360 21% % -3.0% 0.9% 0.9% % S-Oil 6,416 25% % 18.6% 2.0% 2.1% NA NA Thai Oil 3,259 50% % 15.0% 4.2% 4.2% % Median % 15.0% 2.0% 3.4% % Source: Bloomberg, BofA Merrill Lynch research estimates

43 Exhibit 4: Refining map of Turkey 19 March