EUR 20.00 For Business Accounts Only

Lotos – 3Q19E results preview

The equities of Lotos remain one of our strong conviction calls (Buy + Overweight, 12M EFV of PLN 107.0 per share). In our previous research reports we had recommended to overweight the equities of Lotos, seeing 2H19 as an especially good time for purchase. We clearly support such positive view. We believe that most of the positive arguments we had presented previously are still in action. Moreover, the current refining macro environment is visibly stronger than we had been expecting just a quarter ago, as refining margins are almost impervious to economic slowdown signals. Moreover, the unexpected vast appreciation of US$ is a vital profitability driver for the Company. Given the good macro environment, knowing that the coker unit is approaching the final testing stage and remembering that the Utgard upstream field is already operational, we are increasingly bullish towards the equities. It seems that the Company will be ready in time to participate in the potentially positive effects of IMO 2020. It is also fortunate that the Company should have time to publish at least 2 or 3 quarterly results in 2020, before the European Commission reaches any decision on the merger with PKN. Clearly, the positive effects from EFRA and IMO 2020 should not go unnoticed before the merger is executed it and should have impact on the possible transaction price (in this context, any delay in the merger processd could actually be good news for minority shareholders of Lotos).
Refining margins to remain supportive for the equities in 2020? Even despite obvious negative signals from the global economy, fuel product cracks have been surprisingly strong this year. We attribute this to several factors. Firstly, the fuel demand and fuel inventory levels in the US were generally supportive for refining margins. Secondly, even despite OPEC production cuts, the availability of competitive crude oil supplies was enough to fill the gap (we continue to believe that thanks to the shale revolution there is clearly much more competition on the crude oil market which has become the buyer’s market). Thirdly, good cracks are perhaps in part tied to the expected introduction of IMO 2020 which is already driving a buildup of operational diesel inventories destined for marine consumption. Finally, it should certainly be acknowledged that the refining margins were also positively affected by shock events such as the closing of the PES refinery in Philadelphia or the recent attack on Saudi Aramco’s refining units. It is hard to have a strong view on future refining margins these days, nevertheless we remain relatively bullish on the macro environment based on three arguments. Firstly, current model refining margins at roughly US$ 8.0 per barrel are visibly ahead of our average projections for the years 2019-2028 of US$ 6.0 per barrel. Secondly, we think it is probable refining margins should be on a general basis enhanced by the IMO 2020 changes next year, even though this is not included in our forecasts. Thirdly, investors should bear in mind that we have entered the relatively undemanding historical base period for refining margins (in 4Q18 refining margins were negatively affected by very poor gasoline cracks, while in 1H19, the margins were negatively affected by the narrowing of Ural-Brent differential).
Strong US$ is a very strong positive driver for Lotos. The appreciation of US$ may prove a vital factor to the Company’s EBITDA generating abilities in the coming quarters. We estimate that a US$ 0.10 per PLN change may increase the Company’s EBITDA by roughly PLN 100 million per annum (with the additional EBITDA evenly split between the refining and upstream segments). Trying to be conservative, we continue to assume the US$ to settle at 3.8 per PLN in the years 2020-2026, which could potentially indicate that the Company could deliver an EBITDA of PLN 200 million higher than our forecasts in 2020, based purely on FX rates, if the US$ were to remain at current levels.
Upstream EBITDA dynamics likely to improve starting from 4Q19. The negative EBITDA dynamics observed in previous quarters in the Company’s upstream business could have been one of the main concerns for minority shareholders of Lotos. Fortunately, we expect this negative trend to be halted already from 4Q19 due to three reasons. Firstly, the launch of the Utgard project should allow the Company to stabilize total upstream production volumes. Secondly, starting from 4Q19, the macro environment will cease to have a demanding historical base (please note that natural gas prices reached its highest point in September last year and started to plunge in 4Q19; crude oil prices are currently at comparable levels from a yoy perspective). Thirdly, the mentioned appreciation of US$ could support EBITDA.