Daily Call. Love thy Neighbor. January 18, 2016

Transcription

1 Iran compliance Market Strategy Love thy Neighbor (mn bpd) Source: Bloomberg, AHL Research Analyst OPEC Major Members Oil Exports* KSA Source: OPEC Annual Statistical Bulletin 2015 * For the year 2014 OPEC Major Members Proven Oil Reserves* (bn barrels) Source: OPEC Annual Statistical Bulletin 2015 * As of 2014 (USD/bbl) Jan-15 Feb Venezuela Mar-15 AHL Research research@arifhabibltd.com Iraq 267 UAE Nigeria Venezuela 98 Crude Oil Price Trend Apr-15 KSA May-15 Iran Jun-15 Iraq UAE WTI Arab Light Brent Jul-15 Aug-15 Sep-15 Oct-15 Nov Angola 37 Nigeria Dec Iran 8 Angola Jan-16 Iranian sanctions where it all began! Iran, over a period of multiple years, has encountered sanctions to its trade, travel, finance and economy. Major world powers including the P5+1 (US, UK, France, China, Russia plus Germany), EU and UN have made mutual efforts to curb Iranian nuclear program. These date back to 1979, when the USA first imposed economic and political sanctions against Iran (following an attack on its embassy in Tehran), succeeding with an embargo imposed in 1997 prohibiting any trade with Iran, while measures to curb development of ballistic missiles by the UN in 2006 and steps taken by the EU in 2007 to freeze Iranian assets, further isolated Iran from the global markets. Though resurfaced news regarding Iran s uranium enrichment operations called for more rigid sanctions from the US and its allies in EU, who stretched energy and trade sanctions during , targeting Iranian crude exports to bring its economy to a standstill until it agreed to limit its nuclear proliferation. Landmark Vienna Deal In an unprecedented turn of events, Iran reached a momentous deal (Joint Comprehensive Plan of Action-JCPOA) with the P5+1 and the EU on July 14th 2015 in Vienna, agreeing to abide by necessary steps to restrict its nuclear program, enabling lifting of some of the sanctions on its economy in a phased manner. Under this arrangement, Iran agreed to keep its uranium stockpile below 300kg and sell-off additional quantities to an international buyer while the 15-year plan allowed uranium enrichment (up to 3.67%) and R&D to be carried out exclusively at the Natanz facility, with the Fardow facility only being used for research purposes. Whereas the core of its heavy water research reactor in Arak shall be destroyed or removed from the country. Easing of sanctions will this lift the Iranian economy? Verification by the IAEA (International Atomic Energy Agency) of successful drawback in Iranian nuclear program has finally enabled the Islamic republic to rid itself of some of the sanctions curbing its economic growth. While Iran has come clean on its commitment to the Western world, we are yet to see the extent of complete lift-off of sanctions. Even though this paves the way for other parties to the agreement for simultaneous easing of sanctions such as those imposed by the UN and EU, the US maintained its stance to revert back in a slower fashion, initially only lifting sanctions on food, carpets and airline parts. This however, opens a wide gateway for Iran, which plans to reinstate production and export crude to Turkey, South Africa, Greece, Spain, India and Syria (initial estimates suggest ~ mn barrels initially) once its overseas frozen assets (~USD bn) are released and re-establishes its economic standing at pre-sanction levels. Iranian impact on the Pakistani economy In the wake of this recent development, a further decline in crude oil prices is anticipated that could very well support Pakistan s economic growth in terms of lower subsidy burden and lessening pressure on external accounts. With over 55% drop in international oil prices witnessed in 1H, Pakistan has enjoyed a contraction in its Current Account Deficit by 59% to USD 1.0bn in 5M, compared to USD 2.5bn in SPLY, predominantly driven by cheaper oil imports (USD 2.9bn in 4M compared to USD 5.1bn in 4MFY15). Based on our estimates, Pakistan saves ~ USD mn in oil imports for every one USD decline in annual average crude price (average crude price for 6M stands at USD 45.39). Therefore, considering our revised base case of USD 35/bbl average crude price for, Pakistan will be saving an estimated USD bn in, providing a hefty cushion to 1

2 the external sector. Another key consideration triggered by further decline in crude oil prices could be a possible interest rate cut in 2H. Based on our preliminary calculations, a decline in oil pricing can further dampen the MoM inflationary pressure in the coming months (2H CPI est. at 4.2% to 5.2% with est. 3.0% to 3.6%) to open up a small window of opportunity for the State Bank of Pakistan to cut its Policy Rate one last time. However, we believe, even if it happens to be the case, Central Bank may still need to observe a contractionary policy with expected hikes in the 2HCY16, in order to keep the real interest rates in check. Furthermore, in consideration of the local currency, we believe the /USD parity may witness only a meager depreciation in case of another 50bps interest rate cut. Hence, we maintain our estimate of 4.25% to 4.50% depreciation in for CY16. Given the improved Iranian outlook, we anticipate timely completion of the Iran-Pakistan gas pipeline, with the expected flow of 750-1,000mmcfd gas (maximum capacity at 4,670mmcfd) which may eventually help the energy starved country, with Power, Textiles, Fertilizer and Cement sectors as major beneficiaries. Impact on Crude Oil Prices As per US Energy Information Administration (EIA) world economy is confronted with an oil surplus of ~2mn bpd. With recent lifting of sanctions, supply glut condition may get worse since Iran is gearing up to escalate its production by mn bpd (an increase of 20% - 30% to current surplus). In our opinion though, Iran will be cautious of increasing its production keeping in view the already depressed oil prices, its need for investment in obsolete oil infrastructure and impact on other OPEC members. The crude oil prices have plunged massively since Jul 15 primarily on the back of return of Iranian oil to global markets, slowing Chinese & Emerging economies and major oil producer pumping oil at high levels (WTI, Brent and Arab Light down by 45%, 52% and 57%, respectively). In our view, while global markets have been pricing-in the impact of Iranian return, oil prices can still face pressure in short to medium term. Sector wise: Exploration and Production Sector (Negative) With increase in global oil production, the reference crude oil (Arab light) can further depreciate. However, it is pertinent to note that prices for gas (which constitute 58%,59% and 25% of the revenues of OGDC, PPL and POL in FY15 respectively) will be largely unaffected in since gas from most fields will be priced based on actual crude oil prices in 2HFY15 and 1H. In light of recent political, global and economic developments we have revised our base case oil price assumptions from USD 35/bbl & USD 45/bbl to USD 25/bbl & USD 30/bbl in 2H and, respectively. Please refer to the table below for further lucidity on the earnings of AHL E&P universe. Exhibit: Sensitivity of Oil Prices to the Earnings (Base Case*) EPS DPS PE (x) DY EPS DPS PE (x) DY OGDC % % PPL % % POL % % * With USD 25/bbl in 2H and USD 30/bbl in 2

3 Exhibit: Sensitivity of Oil Prices to the Earnings (Case # 1*) EPS DPS PE (x) DY EPS DPS PE (x) DY OGDC % % PPL % % POL % % *With USD 20/bbl in 2H and USD 25/bbl in Exhibit: Sensitivity of Oil Prices to the Earnings (Case # 2*) EPS DPS PE (x) DY EPS DPS PE (x) DY OGDC % % PPL % % POL % % *With USD 15/bbl in 2H and USD 20/bbl in Exhibit: Sensitivity of Oil Prices to the Earnings (Case # 3*) EPS DPS PE(x) DY EPS DPS PE(x) DY OGDC % % PPL % % POL % % *With USD 30/bbl in 2H and USD 35/bbl in Oil Marketing Companies (Neutral) We reiterate our stance on OMCs as unlikely to witness the same momentum of inventory losses in, which they witnessed in FY15. However in light of the said discussion on global development, OMCs can register inventory losses. Though with decline in crude oil prices, the seemingly easing situation of circular debt can further turn positive for cash strapped OMCs (especially PSO). Furthermore, if government decides to pass on the impact of possible decline in oil prices, the volumes for regulated products can witness upsurge thereby uplifting the bottom lines. Refineries Sector (Neutral to Positive) Drop in oil could be a mixed bag for refineries, as it may lead to inventory losses; however refinery margins may improve after a lag given crude oil prices decline more than the final product prices. Banking Sector (Neutral) The banking sector is currently subdued due to slow growth in advances and low interest rate environment. The general consensus for policy rate which currently stands at 6% was that it is at its bottom and was expected to rise by the last quarter of the current fiscal year (). The declining oil prices have again augmented our original stance and we believe that a room has been created for the SBP to go for another cut whilst the opportunity presents itself. The deduction stems from the news about Iran s nuclear compliance which means that a few sanctions will be lifted. Initial impressions suggest that export of oil from Iran will add to the glut and drive down oil prices further. What this means for inflation in Pakistan is that it is expected to come down which in turn will create the room for another cut. From what we have seen so far is that the government has taken the opportunities to 3

4 reduce the rate in order to reduce the overall cost of borrowing which may again drive the decision. The local banking sector will be at a cross road again where NIMs will be under pressure however, a further cut may finally spur the advances which have yet to pick up. We have a neutral stance on the sector with a close eye on SBPs monetary policy due at the end of the week. Cement Sector (Negative) Iran is the fourth largest producer of cement in the world with total installed capacity of 80mn tons/year. However, about 35% of Iran's cement kilns are not working due to the gas shortage and technical problems, as per Secretary of Iran's Cement Industry Employers Association. The country's cement output decreased by 11% in 2015 to 61mn tons. Iran exported cement to 24 countries including Iraq, Azerbaijan, Turkmenistan, Afghanistan, Russia, Kazakhstan, Kuwait, Pakistan, Qatar, Turkey, the UAE, Georgia, Oman, India, and China. Post lifting of sanction in Iran, we view that local cement market will not be impacted as per our discussion with the cement manufacturers. Based on our calculation, currently 0.6mn tons/annum of smuggled Iranian cement is being dumped in Pakistani market which is around 2% of total market. The positive with the Iranian cement in south market is cheap price (8% lower to local price) while quality of the cement is viewed as negative. As far as exports are concerned, influx of Iranian cement in international market would be negative for Pakistani players who are already facing the brunt of anti-dumping duties in South African markets along with stiff competition in international cement pricing. We have run a sensitivity with respect to cement exports decline in the international market for (please check the table below). Exhibit: Exports Decline Analysis - LUCK DGKC FCCL KOHC ACPL MLCF FECTC Base EPS % export decline % export decline % export decline Fertilizer Sector (Neutral) Lower oil prices may create some pressure in international urea price which would eventually limit the pricing power of the local manufacturers. However, with the reduction in oil prices, the price of LNG would further drop below current levels (final price at USD 8.21/mmbtu). It is important to mention here though, that LNG prices are linked to crude (13.37% of prevailing Brent crude oil prices). Our calculation suggests that the final price of LNG would be USD 7.23/mmbtu assuming Brent s last closing price of USD 27.93/bbl. This would eventually allow all the fertilizer players on SNGPL network to operate on LNG. Power Sector (Neutral to Positive) The declining oil prices have a neutral impact on the profitability of the power sector; as the fuel component is a pass-on item in an IPP tariff. However, IPPs payable amount to their fuel supplier is expected to ease off on account of lower fuel prices which would lead towards softening in the intensity of circular debt going forward. Textile Sector (Positive) Availability of gas for captive power plants along with the reduction in electricity tariff could provide impetus to textile sector and export sales particularly in consideration of GSP+ status advantage. 4

5 Auto & Auxiliary Sector (Neutral to negative) Daily Call Auto assemblers margins could be in compression in case of appreciating JPY against USD (and depreciating against greenback). However, falling steel prices can be a positive sign for local automobiles assemblers margins and auto parts manufacturers as imported steel stems as a major raw material used in production. 5

6 Analyst Certification: The research analyst(s) is (are) principally responsible for preparation of this report. The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. In addition, we currently do not have any interest (financial or otherwise) in the subject security (ies). Furthermore, compensation of the Analyst(s) is not determined nor based on any other service(s) that AHL is offering. Analyst(s) are not subject to the supervision or control of any employee of AHL s non-research departments, and no personal engaged in providing non-research services have any influence or control over the compensatory evaluation of the Analyst(s). Equity Research Ratings Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as December 2016 for Target Price. In addition, return excludes all type of taxes. For more details kindly refer the following table; Rating BUY HOLD SELL Description Total return of subject security(ies) is more than +10% from last closing of market price(s) Total return of subject security(ies) is between -10% and +10% from last closing of market price(s) Total return of subject security(ies) is less than -10% from last closing of market price(s) Equity Valuation Methodology Following valuation technique(s) are used to arrive at the target price of subject security (ies); Reserve Based Discounted Cash Flow (RBDCF) Sum of Parts (SoTP) Free Cash Flow to Equity (FCFE) Free Cash Flow to Firm (FCFF) Dividend Discount Model (DDM) Risks The following risks may potentially impact our valuations of subject security (ies); Interest Rate Risk Exchange Rate (Currency) Risk Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for the purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time. However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own advisors to determine the merits and risks of such investment. AHL or any of its affiliates shall not be in any way responsible for any loss or damage that may be arise to any person from any inadvertent error in the information contained in this report. 6