. 01/09 01/10 01/11 01/12 01/13 01/14 01/15 01/16 01/17 Equity Research COMPANY UPDATE (Transfer of Coverage) TURKEY / Oil & Gas 25 September 2017 Tupras Robust operational footing to be sustained Total return target increased to TRY147/sh.; Reiterate Buy We are reiterating our Buy rating for Tupras while increasing our 12M total return target (incl. DPS) by 46% to TRY147/sh. on the back of higher sustainable CUR and L/T Med Basin refinery margin, implying a 25% total return potential. Our conviction in Tupras is based on; 1) Favorable refining margins being sustained in the Med Basin in the medium term (FY18E-FY20E Med Ural net ref. margin avg.: USD4.1/bbl. vs. 10Y hist. avg.: USD3.4/bbl.) thanks to buoyant demand, favorable feedstock access, and tight refined product supply, 2) Tupras promising near to medium term operational outlook (2H17E net refining margin: USD7.5/bbl., FY18E: USD7.0/bbl. vs. 10Y average of USD4.0/bbl.), with a robust 3Q17 earnings profile, 3) Our view of Tupras admirable CUR being mostly sustained in 2018 (FY17E CUR: 107%, FY18E: 104% vs. 10Y avg.: 84%), given the management s execution success post RUP, 4) Strength of Tupras FCF (FY18E-FY20E avg.: 12%) and dividend yield (FY18E-FY20E: 9%), 5) Continuation of depressed tax overlay (FY18E-FY20E eff. tax rate of 11%), allowing higher pass-through of operational momentum to its bottom-line, 6) Further room for upwards revision to consensus estimates for Tupras, and 7) Defensive business structure coupled with hard FX denominated revenues in a relatively inelastic market. Robust YTD share performance yet still lagging regional peers Tupras shares have outperformed the BIST-100 by 35% YTD; having returned 81% in USD terms. The performance was principally driven by the improvement in Tupras operating KPI; thanks to; 1) higher than expected CUR post the RUP, 2) sustained improvement in product cracks in the Med Basin, 3) weaker TRY benefitting profitability. Yet, beyond the local benchmarks, shares have lagged regional peers by 23% since 2016 and is trading at a lower 1Y FWD EV/EBITDA premium at 28% (vs. 2-yr hist. avg. of 43%), which is unwarranted, in our view. YKY FY17E-FY19E EBITDA/NI/DPS are 12%/16%/10% above Cons. Our respective revised FY17E-FY19E EBITDA, net income, and DPS estimates are, on average, 12%, 16%, and 10% higher than consensus (Bloomberg) estimates, respectively. We expect the consensus to revise up their FY17E & FY18E forecasts following Tupras upcoming 3Q results, which we anticipate to be possibly the best quarterly operating performance observed over the past decade. On our estimates, Tupras is trading at 2018E P/E and EV/EBITDA multiples of 8.5x and 6.5x, respectively; vs. EM peer multiples and 10.5x and 5.5x, implying a 19% discount on a P/E basis. We believe the EV/EBITDA premium vs. peers is justified, which is currently lower than historical average, due to Tupras company-specific competitive advantages coupled with its healthier FCF and dividend yields. Buy. Figure 1: Tupras financial summary TRYm 2013 2014 2015 2016 2017E 2018E 2019E Sales 41,078 39,723 36,893 34,960 51,096 53,213 58,218 EBITDA 1,014 789 3,735 3,300 6,071 5,349 5,190 Net income 1,197 1,459 2,550 1,938 4,344 3,488 3,267 EPS reported (TRY) 4.8 5.8 10.2 7.7 17.3 13.9 13.0 DPS (TRY) 1.6 0.0 6.5 6.2 11.3 9.7 9.1 P/E (x) 9.8 8.1 6.5 8.7 6.8 8.5 9.0 Adj. EV/EBITDA (x) 13.6 19.1 6.1 6.7 5.7 6.5 6.7 Div. yield (%) 3.4% 0.0% 9.8% 9.2% 9.6% 8.3% 7.7% ROE (%) 24.1 25.9 35.3 23.6 45.5 29.8 24.9 Source: YKY Research 140 120 100 80 60 40 20 Stock Data Current price Target price DPS Total return 25% Current Mcap Bloomberg Ticker Price (TRY) Source: YKY Research Tupras share performance vs. regional peers Source: YKY Research TRY29,549mn/ 22 September 2017 TRY118.0 TRY136.2 TRY11.3 US$8476mn TUPRS TI Number of outstanding shares (mn) 250 High / Low Price Range (12M) 124.90/52.47 3-m Average Daily Turnover ($ mn) 34.0 Price Performance (%) 1M 3M 6M YtD Return 3.0 20.7 43.9 79.3 Relative to BIST100 7.6 15.6 25.1 34.5 0 Relative Price (TRY) BUY (prev. Buy) Koray Pamir koray.pamir@ykyatirim.com.tr +90 212 319 83 65
Financial Summary (TRYm) 2014 2015 2016 2017E 2018E 2019E Income Statement Total revenues 39,723 36,893 34,960 51,096 53,213 58,218 COGS -38,460-32,767-31,206-44,473-47,329-52,493 Gross profit 1,263 4,126 3,755 6,623 5,884 5,725 Opex -732-877 -995-1,123-1,123-1,145 EBITDA 789 3,735 3,300 6,071 5,349 5,190 Depreciation 258 486 541 572 588 610 Operating income 531 3,249 2,759 5,499 4,761 4,580 Financial income/expense -235-599 -572-713 -678-605 Net other income/expense -112-425 -138-167 -360-442 Pre-tax income 184 2,225 2,050 4,619 3,724 3,534 Tax 1,286 339-92 -252-212 -243 Minority interest/other -11-14 -20-23 -24-25 Net income 1,459 2,550 1,938 4,344 3,488 3,267 Balance Sheet Cash and liquid assets 3,898 3,028 6,051 6,062 6,764 7,597 Inventories 2,371 2,102 3,608 3,891 4,094 4,571 Accounts receivable 170 2,540 3,180 3,806 3,918 4,315 Other current assets 553 1,073 828 1,468 1,532 1,647 Total current assets 6,991 8,742 13,667 15,227 16,308 18,130 Fixed assets 10,663 11,480 11,741 13,933 14,189 14,503 Financial and equity investments 4 4 4 8 8 9 Other non-current assets 4,274 5,244 5,806 5,685 5,674 5,686 Total non-current assets 14,941 16,728 17,551 19,626 19,872 20,198 Total assets 21,933 25,470 31,218 34,853 36,180 38,329 Short-term debt 788 1,903 1,986 4,308 4,401 4,564 Accounts payable 5,610 3,861 6,988 6,846 7,202 8,041 Other current liabilities 2,163 3,065 3,687 3,873 3,955 4,099 Total current liabilities 8,561 8,828 12,660 15,026 15,558 16,704 Long-term debt 6,978 8,048 10,176 8,479 7,906 7,415 Other non-current liabilities 181 225 215 237 242 251 Total non-current liabilities 7,159 8,273 10,391 8,716 8,148 7,666 Minority interest 56 63 79 97 100 103 Total shareholders' equity 6,157 8,305 8,088 11,014 12,374 13,855 Total liabilities and equity 21,933 25,470 31,218 34,853 36,180 38,329 Investment Case Tupras differentiates itself over regional refineries through its dominant position in a diesel deficit domestic market, high & sustained FCF and dividend yields, strong corporate governance, and capability to process a more diversified crude oil slate. Following a sharp correction in product cracks in 2016, a visible recovery has been observed in 2017, thanks to strong demand and limited supply increase. For 2018, while we are not anticipating another leg up in crack spread expansion; we expect a moderate normalization to above historical levels. Despite its outperformance vs. the BIST100, Tupras shares still trade at a discount to its peers on a P/E basis; and at a lower EV/EBITDA premium with room for upward revisions to sell-side s estimates. Stock Triggers & Risks Improving operational strength in 3Q17 and robust margin environment (partially related to the supply outages in the U.S. and Europe) are short-term triggers. Favorable dividend yield outlook continues to provide a safety net for the shares. Regulatory headwinds, slower than expected demand growth, and deterioration in regional product cracks are the primary risks. Chart 1: Shareholder Structure* Opet, 2% Shell, 1% Cash Flow Statement Profit before tax 184 2,225 2,050 4,619 3,724 3,534 Depreciation 258 486 541 572 588 610 Changes in working capital 1,689-3,851 981-1,051 41-35 Other 305 845 1,134 1,157 1,180 1,204 Operating cash flow 2,435-294 4,705 5,298 5,533 5,313 Capex -2,257-959 -884-1,358-842 -918 Asset sales & other 70 70 42 43 44 45 Investing cash flow -2,187-889 -842-1,315-798 -874 Change in debt 1,234 2,186 2,211 625-480 -328 Dividends -396 0-1,628-1,557-2,824-2,441 Other -962-2,435-2,333-1,601-1,649-1,698 Financing cash flow -124-249 -1,750-2,533-4,952-4,468 Total cash flow 124-1,432 2,114 1,449-217 -29 Net debt 3,867 6,924 6,111 6,725 5,544 4,382 Publicly floated, 49% Aygaz, 10% Source: The company, *51% owned by SPV Enerji Investments Koc Holding, 38% Chart 2: Tupras crude slate API breakdown * Key Ratios Gross margin 3% 11% 11% 13% 11% 10% EBITDA margin 2% 10% 9% 12% 10% 9% ROE 26% 35% 24% 45% 30% 25% EBITDA growth -22% 373% -12% 84% -12% -3% Earnings growth 22% 75% -24% 124% -20% -6% Net debt-to-equity (x) 0.6 0.8 0.8 0.6 0.4 0.3 Net debt-to-ebitda (x) 4.9 1.9 1.9 1.1 1.0 0.8 Source: The Company, YKY Research Source: YKY Research, Company financials, *2016 2
Robust operational footing to be sustained We are reiterating our Buy rating for Tupras while increasing our 12M total return target (incl. DPS) by 46% to TRY147/sh. on the back of higher sustainable CUR and L/T Med Basin refinery margin, implying a 25% total return potential. Our conviction in Tupras is based on; 1) Favorable refining margins being sustained in the Med Basin in the medium term (FY18E-FY20E Med Ural net ref. margin avg.: USD4.1/bbl. vs. 10Y hist. avg.: USD3.4/bbl.) thanks to buoyant demand, favorable feedstock access, and tight refined product supply, 2) Tupras promising near to medium term operational outlook (2H17E net refining margin: USD7.5/bbl., FY18E: USD7.0/bbl. vs. 10Y average of USD4.0/bbl.), with a robust 3Q17 earnings profile, 3) Our view of Tupras admirable CUR being mostly sustained in 2018 (FY17E CUR: 107%, FY18E: 104% vs. 10Y avg.: 84%), given the management s execution success post RUP, 4) Strength of Tupras FCF (FY18E-FY20E avg.: 12%) and dividend yield (FY18E-FY20E: 9%), 5) Continuation of depressed tax overlay (FY18E-FY20E eff. tax rate of 11%), allowing higher pass-through of operational momentum to its bottom-line, 6) Further room for upwards revision to consensus estimates for Tupras, and 7) Defensive business structure coupled with hard FX denominated revenues in a relatively inelastic market. Figure 2: Tupras relative share perf. vs. BIST benchmarks Figure 3: Tupras share performance in TRY & USD terms 2.5 2 1.5 1 0.5 TUPRS XU100 XBANK XUSIN 0 2015 2016 2017 Tupras shares have outperformed the BIST-100 by 35% YTD; having returned 81% in USD terms. The performance was principally driven by the improvement in Tupras operating KPI; thanks to; 1) higher than expected CUR post the RUP, 2) sustained improvement in product cracks in the Med Basin, 3) weaker TRY benefitting profitability. Figure 4: Tupras share performance vs. regional peers Figure 5: Tupras share performance vs. regional peers 3
Yet, beyond the local benchmarks, Tupras shares have lagged its regional peers by 23% since the beginning of 2016, despite its differentiated attributes (proximity to multiple crude oil streams, strong domestic demand, etc., healthier FCF and dividend yields). Accordingly, Tupras 1Y FW EV/EBITDA indicates a 28% premium vs. regional peers compared to the 2-yr historic average premium of 43%, which is excessive, in our view. Figure 6: BIEPRNMK Index* and Tupras 1Y FWD EV/EBITDA Source: The Company, YKY Research estimates, BI Europe Refining & Marketing Valuation Peers (LTS PW, PKN PW, MOH GA, NESTE FH, SRS IM, ELPE GA) On our numbers, Tupras is trading at 2018E P/E and EV/EBITDA multiples of 8.5x and 6.5x; vs. its 3 year historical adjusted average multiples of 7.8x and 7.1x. We believe there is room for upward revisions by the market that would lower the implied 12M forward multiples (consensus), progression of which can be seen below: Figure 7: Tupras 12M forward cons. P/E multiple * Figure 8: Tupras 12M forward cons. EV/EBITDA multiple *, as of September 22, as of September 22 Accordingly, our respective FY17E-FY19E EBITDA, net income, and DPS estimates are, on average, 12%, 16% and 10% higher than the consensus (Bloomberg) estimates, mainly due to our higher CUR and refining margin forecasts. Figure 9: YKY estimates vs. consensus for Tupras (TRYm) 2017E 2018E 2019E YKYe Cons. Diff, % YKYe Cons. Diff, % YKYe Cons. Diff, % Revenues 51,096 51,799-1% 53,213 56,714-6% 62,475 61,972 1% EBITDA 6,071 5,023 21% 5,349 4,804 11% 5,108 4,881 5% Net Income 4,344 3,382 28% 3,488 3,038 15% 3,366 3,188 6% DPS (TRY/sh.) 11.3 9.6 18% 9.7 9.6 2% 9.1 9.5-4% Source: YKY Research estimates, Bloomberg Finance L.P. 4
We believe that there are sufficient grounds warranting Tupras to sustain and improve its operational footing, details of which are as follows: Favorable demand & feedstock environment remain supportive of margins: Refining margins in Europe has remained constructive in 2017 thanks to 1) improvement in demand for distillates, 2) persistence of cheap and diverse crude oil accessibility, and 3) production outages related to unforeseen events and natural phenomena (particularly in the U.S). We believe Tupras can maintain an average USD2.50/bbl. (vs. the 5 year average of USD1.7/bbl.) spread over the Med Complex net refining margins post RUP; given 1) higher CUR (vs. historical levels & post-rup nameplate capacity) lowering unit costs, 2) higher share of lower API processed and other company specific attributes. Figure 10: Tupras net refining margin vs. Med. Ural Net Refining margin Source: The Company, YKY Research estimates Continued benefits of low crude oil prices: Supply led abundance of crude oil has led the crude oil prices (principally Brent) to settle at a below USD60/bbl. plateau since mid- 2015. We are not anticipating a radical change in the crude oil supply mechanics and expect the availability of ramped up or relatively high levels of crude oil to be available to the market. We expect Tupras to continue to benefit from the relatively depressed crude oil price environment; in addition to the higher availability of various heavier crude types. Figure 11: Brent Prices (USD/bbl.) & (TRY/bbl.) Source: The Company, YKY Research estimates 5
Domestic volumes remain strong; particularly at diesel: Turkey s diesel consumption grew by 8% YoY in 2016; with the 2017 YTD (Jan. to Jul.) demand growth trajectory of 8% YoY, with a much stronger print in July (mainly attributable to a one-off low base effect). The strength of diesel demand where we anticipate a CAGR of 6% for diesel demand between FY17E-FY20E, buoyed by increasing car ownership, continues to support Tupras key market, in our view. Figure 12: Turkey total domestic liquid fuel * consumption Figure 13: Turkey domestic diesel consumption * 2.5 2.0 1.5 1.0 0.5 5 Y Range 2016 2017 0.0 Jan. Feb. Mar. Apr. May. Jun. Jul. Aug. Sep. Oct. Nov. Dec. Source: YKY Research Estimates, Company Data, EMRA, * diesel, gasoline, jet fuel Source: YKY Research Estimates, EMRA,, *diesel, gasoline, jet fuel High capacity utilization rates likely to be sustained in 2018: One of the key drivers of Tupras operating performance and higher earnings revisions were above nameplate CUR (c.110%) observed in 2017. While we anticipate the longer term CUR run-rate to average at 102%; we anticipate to observe elevated level of CUR and production in 2018 as well thanks to 1) absence of a major maintenance activity at the RUP (likely to occur in 2019), 2) Tupras relatively short yet strong track record in sustaining high CURs and 3) continued favorable demand for mid-distillates. Figure 14: Tupras CUR progression (%) Figure 15: Tupras Opex/tonne progression (USD/tonne) Source: YKY Research, Company financials Source: YKY Research, Company financials The higher CUR, coupled with the TRY components of the OPEX has also led to a decline in Tupras OPEX (on a per USD per tonne basis); which we expect to be a sustainable benefit & differentiating factor for Tupras for the foreseeable future. 6
Strength in FCF and dividend yields providing a safety net against potential market downturns: Tupras continues to be one of the highest dividend yielders in our coverage universe; YKYe FY17E DPS of TRY11.3 (implying a div. yield of 9.6%). On top of a favorable operating performance, a low effective tax rate (c.11% between FY18E- FY20E) related to government incentives should continue to be supportive of the passthrough of the favorable operating performance to Tupras bottom-line. We believe that high dividend yield should continue to be one of the key appeals of Tupras; particularly if an asset rotation to the defensive companies comes into the spotlight, under a risk-off market scenario. In addition, we think that the sell-side is bound to increase its dividend yield estimates, which should be supportive of its appeal for dividend-seeking investors. Figure 16: Tupras FCF (USDm) & yield (%) progression Figure 17: Tupras DPS & yield progression One other factor worth highlighting is Tupras dividends being capped by its tax purpose earnings, which has been historically lower than its IFRS results, due to accounting differences between the standards. We believe that the residual cash flow in excess of the dividend payments should lead to a slow yet steady decline in Tupras net debt to EBITDA as well, which we expect to come down to 0.8x in 2019E, from as high as 4.9x in 2014, which was elevated due to continued CAPEX on RUP and a relatively poor operating performance in the year. Figure 18: Tupras FY17E* DPS & Yield estimates Figure 19: Tupras net debt progression, * to be paid in 2018 Source: YKY Research estimates 7
3Q17 operational performance should be robust: We believe Tupras is bound to deliver a spectacular set of 3Q17 results; thanks to 1) continued strength in mid-distillates; particularly in diesel and jet fuel (with the CRKS321B Index standing at 13.9 vs. the 3Y average of 10.4 and 10 year average of 11.0), 2) temporary yet significant supply disruptions in Europe supporting the regional margins, 3) weak base year effect, and 4) continuation of a favorable tax overlay. Figure 20: Brent (NWE) 321 Crack Spread (USD/bbl.) & Tupras share performance Source: The Company, Bloomberg Finance L.P. Accordingly, we expect Tupras to achieve a net refining margin of USD8.25/bbl. in 3Q17 (vs. USD5.68/bbl. in 3Q16 & USD7.8/bbl. in 2Q17). Thus, under our assumptions, Tupras should post TRY12.89bn in net sales (up 36% YoY), TRY1.80bn in EBITDA (up 124% YoY) and TRY1.27bn in net profit (up 119% YoY) in its 3Q17 IFRS results. If realized, the quarter would mark Tupras best operating performance over the past decade, which we view as a meaningful catalyst for the share performance, triggering further upwards revisions. Deficit mid-distillate market appears sufficient to digest STAR output: We are not expecting the SOCAR Turkey Aegean Refinery ( STAR ) to have a significant impact on Tupras competitive positioning and margins due to 1) strong domestic middle distillate demand in Turkey still not to be fully met post the STAR, implying the STAR is likely to capture market share from imports rather than that of Tupras, 2) Benefits of Tupras four refineries across Turkey (vs. one that of the STAR).. Figure 21: Tupras market share in Turkey diesel market * Figure 22: Turkey domestic diesel consumption * Source: YKY Research, Company financials, EMRA, * m tonnes Source: YKY Research Estimates, EMRA, Company financials, *m tonnes 8
On our calculations, post the RUP being fully operational, Tupras trailing 12M domestic diesel sales stood at 11.0m tonnes as of 2Q17, which we view as a sustainable production plateau (vs. 4.8m tonnes p.a. diesel production plan of STAR). Accordingly, Tupras market share in the domestic diesel market stands at c.48% with the rest of the market primarily served by imports. Under the assumption of Tupras domestic volumes remaining constant and Turkey s diesel consumption growing at a CAGR of 3.5% p.a.; we expect Turkey to have a diesel deficit (to be served by imports) of 10.5m tonnes p.a. in 2019, which should negate concerns on a sustained pressure on Tupras refining margins related to increase in Turkey s refining capacity. To recap, the 10 million tonnes p.a. crude oil refining capacity STAR s completion rate stands at 92% (Engineering: 99%, Construction: 75%), as of July 2017. In our understanding, a conservative full kick off of production could commence in September 2018. The total project cost is expected to stand between USD5.6bn to USD5.8bn, with USD4.5bn (USD2.2bn in equity, USD2.3bn in debt) spent as of March 2017. The storage section of the investment has been ramped up significantly in order to allow higher trading and arbitrage opportunities. Potential political volatility with Northern Iraq does not pose a tangible risk to Tupras: Turkey s relations with the Iraqi Kurdish Regional Government ( KRG ) have worsened following the plans of a referendum in the region. The Turkish State has expressed that it could deploy a number of potential measures including the potential halting of KRG s crude oil exports through Turkey. KRG crude oil exports are mostly transit in nature, partially transported to Turkey over the Kirkuk-Ceyhan pipeline to the oil Terminal in Ceyhan (located in Southern Turkey) and shipped to global markets. Figure 23: API progression of crude oil processed by Tupras Figure 24: Geo. Layout of Tupras crude oil imports*,** Source: YKY Research, Company financials Source: The Company, EMRA, * disclosure discontinued by the State as of 2017, ** mn tonnes While Iraq is and expected to be one of the main source of crude oil imports for Tupras (with 9.3m tonnes imported in 2016 corresponding to 1/3 of Tupras crude oil imports) thanks to its proximity and relatively lower API, all of these purchases are made from Iraq central government, through the State controlled SOMO, with no exposure to KRG s exports. Accordingly, we are not anticipating a direct impact on Tupras operations (including its API progression) under the scenario of a possible disruption of KRG s crude oil exports; with the impact on crude oil prices being relatively limited as well, given KRG s growing yet relatively low contribution to the global crude oil supply. Favorable view by rating agencies should help sustain the beneficial cost of borrowing for Tupras: Moody s has revised Tupras rating outlook to positive and has affirmed its ratings at Ba1 (vs. Turkey s Ba1 negative) in early September. The principal reason behind the revisions appears to be driven by Moody s view of sustainable improvement in Tupras refining margins post the Resid Upgrade Project. Note that Fitch has also revised Tupras outlook to stable from negative; while maintaining its Long- 9
Term Local and Foreign Currency IDRs at BBB- in August. The drivers of the rating revision were 1) Improvement in its operating performance post RUP, 2) low CapEx intensity leading to a higher sustained FCF profile, 3) expectation of the continuation of a high dividend profile going forward and 4) strong 1H17 performance. Accordingly, Tupras rating remains a notch higher than Turkey s sovereign rating of BB+. While the drivers of the ratings revisions are well known by the market; the favorable stance of the rating agencies towards Tupras; should continue to help the Company to maintain its relatively low cost of borrowing for the foreseeable future, in our view. Weaker than expected demand growth for mid-distillates and unforeseen production disruptions & fines are the key risks for Tupras: They key risks to our positive positioning on Tupras are 1) supply disruptions and/or production cuts leading to an increase in crude oil prices, 2) reversal of the risk on attitude toward Turkish equities, 3) unforeseen production disruptions at Tupras which would dent its CUR, 4) lower than expected demand growth for mid-distillates, pressuring product cracks, 5) faster than anticipated consumer migration from diesel-powered vehicles to alternative (mainly EV) platforms and 6) unforeseen regulatory or tax related fines imposed on Tupras. 10
VALUATION 22 September 2017 Tupras We have increased our 12M total return target by 46% to TRY147/sh. (12M target price: TRY136/sh., DPS: TRY11), implying a 25% 12M total return potential. We value Tupras through a USD based DCF model, under the assumption of a 5.75% risk-free rate, 5.0% equity risk premium, 6.25% cost of debt, 9.75% cost of equity and a 0% terminal growth rate. The key drivers of the valuation change are 1) increase in our sustainable CUR assumption to 103% (previously: 95%), given our higher conviction of Tupras being able to consistently (and without significant disruptions) operate over the nameplate capacity post RUP (2Q17: 117%), 2) higher long-term (2020 and forward) sustainable Med Basin margin of USD3.6/bbl. (vs. USD2.9/bbl. previously); due to the higher growth trajectory of the mid-distillate products buoyed by a higher demand environment with limited supply increase expectation in the Med Basin, and 3) rolling of our 12M target price to 2018. Figure 25: Tupras DCF Summary (USDm) 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E Sales 14,107 14,217 15,098 15,112 15,256 15,256 15,256 15,256 15,256 15,256 15,256 Sales growth, % 22% 1% 6% 0% 1% 0% 0% 0% 0% 0% 0% EBITDA 1,676 1,429 1,346 1,235 1,247 1,247 1,247 1,247 1,247 1,247 1,247 EBITDA growth, % 59% -15% -6% -8% 1% 0% 0% 0% 0% 0% 0% Taxes -121-114 -125-131 -149-166 -183-199 -216-221 -221 Δ in working capital -287 16-1 6-3 0 0 0 0 0 0 CAPEX -375-225 -238-238 -241-241 -241-241 -241-241 -241 Free cash flow 893 1,106 982 872 855 841 824 807 791 785 785 FCF Yield, % 10.5% 13.0% 11.5% 10.2% 10.0% 9.9% 9.7% 9.5% 9.3% 9.2% 9.2% Risk-free rate 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% 5.75% Beta 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 Equity risk premium 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Cost of equity 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% Cost of debt 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% Debt/equity 36.7% 34.0% 31.3% 28.8% 26.9% 24.9% 22.9% 21.0% 19.0% 17.0% 15.0% WACC 8.3% 8.4% 8.5% 8.6% 8.6% 8.7% 8.7% 8.8% 8.9% 9.0% 9.1% Discount factor 1.00 1.08 1.18 1.28 1.39 1.51 1.64 1.79 1.95 2.13 PV of FCF 1,106 905 740 668 605 545 491 442 402 369 EV 2018E-2027E 6,273 EV terminal at 0.0% growth 4,060 EV total 10,334 + Participations (2017E) 688 - Net debt (2017E) 1,818 Target mcap (USDm) 9,976 Current mcap (USDm) 9,071 Current share price (TRY) 118.0 Target share price (TRY) (inc. divs.) 147.4 Total return potential, % 24.9% Source: YKY Research, Company financials Our conviction in Tupras is based on 1) Favorable refining margins being sustained in the Med Basin in the medium term (FY18E-FY20E Med Ural net ref. margin average: USD4.1/bbl. vs. 10Y historical average: USD3.4/bbl.) thanks to buoyant demand, favorable feedstock access, and tight refined product supply, 2) Tupras favorable near to medium term operational outlook (2H17E net refining margin: USD7.5/bbl., FY18E: USD7.0/bbl. vs. 10Y average of USD4.0/bbl.), 3) Our view of Tupras admirable CUR being mostly sustained in 2018, 4) Strength in Tupras FCF (FY18E-FY20E ave.: 12%) and dividend yields (FY18E FY20E: 9%), 5) Continuation of depressed tax overlay (FY18E FY20E eff. tax rate of 11%), allowing higher pass-through of operational strength to its bottom-line, 6) Further room for upgrade to sell-side estimates, and 7) Defensive business structure coupled with USD denominated revenue stream. 11
Figure 26: Tupras Peer Multiples * 22 September 2017 Tupras Company Country Mcap P/E(x) EV/EBITDA(x) (USD mn) 2018E 2019E 2018E 2019E Emerging peers MOL Hungary 9,619 9.6 8.6 5.2 5.1 PKN Poland 14,363 11.1 11.5 6.3 6.4 Unipetrol Czech 2,818 12.0 11.2 5.9 5.4 Lotos Poland 3,002 9.9 8.6 5.5 5.1 OMV Petrom Romania 4,160 6.4 5.9 2.3 2.2 OMV Austria 18,791 13.8 13.5 5.1 5.1 Median 10.5 9.9 5.5 5.1 Average 10.5 9.9 5.6 5.4 Russian peers Lukoil Russia 43,984 6.4 6.0 3.4 3.3 Rosneft Russia 57,866 0.1 0.1 4.3 3.9 Surgutneftegas Russia 17,835 4.1 4.3 n.m. -3.6 Gazprom Neft Russia 18,211 4.1 4.0 3.8 3.6 Tatneft Russia 16,171 6.7 6.6 5.2 5.0 Median 4.1 4.3 4.1 3.6 Average 4.3 4.2 4.2 2.4 European peers Erg Italy 2,438 20.6 18.7 8.3 8.1 Neste Oil Finland 11,260 14.1 13.8 8.5 8.3 Hellenic Greece 2,619 8.1 8.9 6.0 6.2 Motor Oil Greece 2,513 9.3 10.0 5.0 5.4 Saras Italy 2,349 12.0 16.2 4.2 4.7 Median 12.0 13.8 6.0 6.2 Average 12.8 13.5 6.4 6.5 All peers Median 8.1 8.6 5.2 5.1 Average 7.8 8.0 4.7 4.0 Tupras Turkey 8,526 8.5 9.1 6.5 6.7 Premium (discount) vs. Emerging -19% -8% 19% 31% Russia 107% 111% 61% 85% All 5% 6% 27% 33% Source: YKY Research estimates, Bloomberg Finance L.P., * As of September 22 Tupras shares are trading at a discount on a P/E basis vs. EM peers. Despite the discount, we believe Tupras P/E multiple expansion since mid-2016; should also be considered within the context of higher valuations attached to Turkish equities; driven by higher earnings profile, with the BIST-100 having returned 33% YTD in TRY terms, with similar trends in various EM markets as well. On an EV/EBITDA basis, while Tupras 1Y FW EV/EBITDA (consensus) indicates a 28% premium vs. regional peers; the premium is lower compared to the 2Y average premium of 43%, which is unwarranted, in our view. Figure 27: Tupras 12M forward P/E (cons.) multiple* Figure 28: Tupras 12M forward EV/EBITDA (cons.) multiple*, * As September 22, * As September 22 12
Our revised estimates are c. 12% higher than the consensus estimates on average for FY17E-FY19E at the EBITDA level. The positive deviation at the EBITDA level appears to stem from 1) our slightly higher CUR assumption, 2) higher refining margin estimates over the consensus. Figure 29: YKY estimates vs. consensus for Tupras 2017E 2018E 2019E YKYe Cons. Diff, % YKYe Cons. Diff, % YKYe Cons. Diff, % Revenues 51,096 51,799-1% 53,213 56,714-6% 62,475 61,972 1% EBITDA 6,071 5,023 21% 5,349 4,804 11% 5,108 4,881 5% EBITDA M. % 11.9% 9.7% -2.2 pps 10.1% 8.5% -1.6 pps 8.2% 7.9% -0.3 pps Net Income 4,344 3,382 28% 3,488 3,038 15% 3,366 3,188 6% DPS (TRY/sh.) 11.3 9.6 18% 9.7 9.6 2% 9.1 9.5-4% Source: YKY Research estimates, Bloomberg Finance L.P. At the net income level, our estimates are 16% higher on average vs. the consensus mainly due to our higher EBITDA estimates; and our slightly lower effective tax rate assumptions. Thanks to Tupras strong operating performance in 2017, the consensus revisions have been on an upward trend, with further room for revision, in our view. Figure 30: Tupras FY17E cons. EBITDA progression Figure 31: Tupras FY18E cons. EBITDA progression Figure 32: Tupras FY17E cons. net income progression Figure 33: Tupras FY18E cons. net income progression 13
3Q17 Preview 22 September 2017 Tupras We anticipate Tupras to post a robust set of results in its 3Q17 IFRS financials (to be disclosed in late October/early November) and lead the consensus (Bloomberg) to revise their FY17 (and possibly FY18) estimates higher. We anticipate, 1) Tupras to maintain a high a CUR of 110% (vs. 117% in 2Q17) given the higher demand related to peak driving season and lack of significant maintenance activity, 2) continued strength in middistillates; particularly in diesel and jet fuel, thanks to favorable demand coupled with further yet temporary support arising from regional refinery outages in Europe and hurricanes impacting the refined product output from the U.S, 3) continued weak base year effect, and 4) continuation of a favorable tax overlay. Figure 34: Tupras CUR progression (%) Figure 35: Tupras net refining margin progression (%) Source: The Company, YKY Research estimates Source: The Company, YKY Research estimates Figure 36: Monthly Gasoline Crack (USD/bbl.) Figure 37: Monthly Diesel Crack Progression (USD/bbl.) Source: The Company, YKY Research Source: The Company, YKY Research Accordingly, we expect Tupras to achieve a net refining margin of USD8.25/bbl. in 3Q17 (vs. USD5.68/bbl. in 3Q16 & USD7.8/bbl. in 2Q17). Thus, under our assumptions, Tupras should post TRY12.89bn in net sales (up 36% YoY), TRY1.80bn in EBITDA (up 124% YoY) and TRY1.27bn in net profit (up 119% YoY) in its 3Q17 IFRS results, which are likely to be disclosed in late October/early November. If realized, 3Q17 would mark Tupras best quarterly operating performance over the past decade (even in USD terms), which we view as a meaningful catalyst for the share performance and also to trigger upward forecast revisions by the sell-side. 14
Appendix 1: Domestic demand progression Figure 38: Turkey Gasoline Consumption (Monthly) * Figure 39: Turkey Gasoline Consumption (Annual) * Source: YKY Research, EMRA, * mn. tonnes Source: YKY Research, EMRA, * mn. tonnes Figure 40: Turkey Diesel Consumption (Monthly) * Figure 41: Turkey Diesel Consumption (Annual) * Source: YKY Research, EMRA, * mn. tonnes Source: YKY Research, EMRA, * mn. tonnes Figure 42: Turkey Jet Fuel Consumption (Monthly) * Figure 43: Turkey Jet Fuel Consumption (Annual) * Source: YKY Research Estimates, Company Data, EMRA, * thousand tonnes Source: YKY Research Estimates, Company Data, EMRA, * mn. tonnes 15
Appendix 2: Product Crack Trends 22 September 2017 Tupras Figure 44: Monthly Gasoline Cracks (USD/bbl.) Figure 45: Monthly Diesel Cracks (USD/bbl.) Source: The Company, YKY Research Source: The Company, YKY Research Figure 46: Monthly Jet Fuel Cracks (USD/bbl.) Figure 47: Monthly Fuel Oil Cracks (USD/bbl.) Source: The Company, YKY Research estimates Source: The Company, YKY Research estimates 16
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