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PKN Orlen – 3Q19E results preview

The equities of PKN Orlen remain one of our strong conviction calls (Buy + Overweight, 12M EFV of PLN 131.0 per share). In our previous research reports we had recommended to overweight the equities of PKN Orlen, 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 both US$ and EUR is a vital profitability driver for the Company. Furthermore, the performance of the retail segment is far stronger than we had been expecting at the beginning of the year. On top of that, the Company’s energy assets have proved to be a far greater positive surprise this year than we had signaled previously. Given all the mentioned arguments we are increasingly bullish towards the equities. We believe that it is really incredible that the combined EBITDA of the retail and energy assets could to add up to roughly PLN 5 billion in 2019 – a half of the expected consolidated EBITDA LIFO of PKN Orlen. Moreover, it comes as a huge surprise to us that in 2019, the Company’s adjusted EBITDA LIFO in 2019 may grow by almost a quarter, even despite the probable drop in average refining and petchem margins in 2019. We are shocked that despite such a success, the current equity price of PKN is roughly at the same level as a year ago.
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 2019-2026 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).
The retail segment continues to outperform expectations. The Company’s management made clear signals last year that the 4Q18 results of the retail segment were too big a positive one-off (tied to the introduction of the emission tax in Poland and the positive low Rhine effects) so as to expect further retail EBITDA improvement in 2019 vs 2018. Ultimately, investors rationally treated the PLN 2.8 billion of EBITDA generated by the retail segment in 2018 as unsustainable and in turn lowered the expectations for 2019. Against all odds, however, this year the retail business is delivering positive dynamics in terms of fuel volumes, fuel margins and non-fuel sales. Moreover, the Company has embarked on an ambitious process of expanding its retail network in both Slovakia and the Czech Republic. All in all, we expect the EBITDA of the segment to grow to as much as PLN 3.3 billion in 2019 – a figure which is already far beyond most LT estimates of equity analysts.
Energy assets to constitute a considerable part of LT EBITDA? The performance of the Company’s energy assets has proved to be a remarkable success this year – currently we expect the combined energy assets in 2019 to improve EBITDA from a yoy perspective by as much as PLN 0.8 billion to PLN 1.6 billion. A considerable part of the EBITDA improvement can be associated with relatively low natural gas prices but investors need to bear in mind that positive dynamics can also be traced to sustainably higher energy volumes (CCGT PÅ‚ock started operations only in 3Q18, while CCGT WÅ‚ocÅ‚awek was closed for failure maintenance in 4Q18 and 1Q19) and higher electric energy and power prices (which we think will remain at high levels in the visible future). All in all, in our LT forecasts we expect the EBITDA of the energy assets to normalize at PLN 1.2 billion, even despite expected LT natural gas prices of US$ 20.6 per MWh.