Pakistan Refinery Ltd: Profitability to persist in 3Q; uncertain beyond

Inventory gains + tax reversals; 2QFY11 EPS rises to PKR26: PRL posted profit after tax of PKR905mn (EPS: PKR25.86) during 2QFY11, against a loss after tax of PKR1.03bn (LPS: PKR29.36) during the same period last year. 1HFY11 now shows PKR881mn in earnings (EPS: PKR25.18) against losses of PKR1.7bn (LPS: 48.57) during 1HFY10. Return to profitability during 2Q is a temporary phenomenon for PRL, driven by inventory gains and tax reversals.

2QFY11 core EPS was a mere PKR2.0/share: 2QFY11 EPS included PKR19/share in inventory gains, and PKR4.5/share of tax reversals as per our estimates. Excluding these one offs, core earnings would likely have been a mere PKR2.0/share.

GRMs continue to weaken; though inventory gains shall persist in 3Q: GRMs for PRL averaged a mere USD0.32/bbl during 3QFY11 (to-date), USD1.24/bbl lower than last quarter. In addition, full period impact of removal of incidentals would lead to a combined reduction of USD1.9/bbl in primary margins for PRL in 3QFY11 on QoQ basis. However, inventory gains may continue during 3QFY11, with an even higher quantum, as oil prices continued their uptrend. Our initial estimates suggest 3QFY11 EPS at PKR18.0.

We refrain from assigning a Price Target; advise sell: Without inventory gains and post removal of incidentals, PRL would be a loss making entity. Removal of 7.5% deemed duty on HSD would trim earnings of the already loss making entity by another PKR48/share. Upgradation project’s viability and magnitude of incremental cash flows are uncertain, whereas inventory gains remain difficult to forecast. While PKR83/share in net unrealized interest income is a comforting factor, it is more than offset by weak quality assets worth PKR130/share.

2QFY11 core EPS was a mere PKR2.0/share

2QFY11 GRM for PRL was a mere USD1.56/bbl, which would likely have yielded an EPS of

PKR2.0/share for the quarter, assuming 0.5% turnover tax. Having expensed turnover tax at 1% during 1QFY11, PRL booked negative taxes at PKR36mn during 2QFY11, as 1Q tax adjustments would likely have more than offset an estimated PKR123mn in current taxation for 2Q, yielding an EPS impact of PKR4.5/share for tax reversals. Major impetus behind 2QFY11 earnings was PKR19/share in inventory gains as oil prices rallied by USD9/bbl during Aug-10 to Nov-10 (2QFY11 selling prices would track oil prices during Sep-10 to Nov-10 due to one month lagged pricing).

GRMs continue to weaken; though inventory gains shall persist in 3Q

GRM for PRL averaged a mere USD0.32/bbl during 3QFY11, USD1.24/bbl lower than last quarter, where GRM averaged USD1.56/bbl. Refineries have been disallowed the benefit of incidentals for calculating import parity price for refined products from Dec-10 onwards, which would trim refining primary margins by USD0.92/bbl as per current prices, with full impact visible from 3QFY11 onwards. Refineries would continue to pay incidentals on import of crude. Reduction in GRMs and removal of incidentals, combined, would trim PRL’s primary refining margins by USD1.9/bbl on QoQ basis during 3Q, which shall alone have a negative EPS impact of PKR15/share. However, oil prices have continued to rise in 3QFY11. Oil prices, on monthly average basis, posted gains of USD15/bbl during Nov-10 to Feb-11, as compared to an increase of USD9/bbl during Aug-10 to Nov-10. This would likely result in persistence of inventory gains, with likelihood of even higher quantum during 3QFY11. Assuming Feb-11 average oil price at USD98/bbl, 3QFY11 inventory gains would likely reach PKR31/share, which would yield 3QFY11 EPS of PKR18 for PRL, as per our initial estimates.

We refrain from assigning a target; advise sell

Post removal of incidentals, and ignoring inventory gains, PRL shall be a loss making entity, as negative margin HSFO comprises 38% of its product slate. Inventory gains remain highly volatile and being dependent on oil price movement and inventory holding, are very difficult forecast. PRL remains highly sensitive to any change in deemed duties, as removal of 7.5% deemed duty on HSD could trim earnings of the already loss making entity by another PKR48/share, likely resulting in shut down of the refinery. Upgradation project’s viability remains a question mark as existing balance sheet size remains insufficient to fund the USD345mn project. PRL booked a surplus on revaluation of property plant and equipment in Jun-10, worth PKR90/share, an attempt to keep equity in the positive zone. PRL also has PKR40/share in capital work in progress for feasibility studies on refinery upgradation project, realization of which remains dependent upon progress on upgradation project, which is unlikely in our view. This takes the total for weak quality assets to PKR130/share as opposed to Dec-10 estimated book value of PKR93/share. While PKR83/share in net unrealized interest income, as per Sep-10 accounts, is a comforting factor, it is more than offset by weak quality assets worth PKR130/share. With future cash flows clouded with uncertainties, we have refrained from assigning a Price Target to the stock. The share is up 69% since September 30, 2010 and we believe any strength should be taken as an opportunity to SELL.

Economic & Political News

PC plans to issue USD1.384bn bonds of OGDCL, PPL by march end

The Privatisation Commission has plans to launch USD1.384 bn convertible bonds of OGDCL and PPL during FY11. PC has proposed end March 2011 as deadline for launch of convertible bonds of OGDCL and PPL worth USD1.08bn and USD304mn respectively at the London Stock Exchange. However, a sub-committee of the Cabinet Committee on Privatisation, headed by Naveed Qamar, have instead recommended floating exchangeable bonds backed by sovereign guarantees on Friday.
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