PKN Orlen – Facing Growing Headwinds
PKN Orlen delivered strong results for the third quarter of 2019, but the future outlook has taken a turn for the worse with a downward shift in refining margins. The downturn is not priced into the current earnings consensus for now, with analysts expecting PKN to continue delivering future EBITDA as high as this year with the help of IMO 2020 benefits and a new polyethylene unit. Our own forecasts for FY2020-21 sit 15-20% below the market forecasts because they use more conservative assumptions as to refining margin benchmarks and take into consideration the unsustainable mix of positive factors, including low prices of natural gas, record-high margins on retail fuel sales, and unusually high land premiums, that drive PKN's earnings this year. This mix also includes record-high refinery throughput which the Company might not be able to maintain given demand forecasts. Also adding to the cloudy future outlook are PKN's capital investment plans and their impact on medium-term free cash flow. Finally, there is the matter of the merger deal with local rival Lotos, which we do not see as creating much value even with synergy factored in looking at the merged EV/EBITDA LIFO multiple. With all this in mind, we downgrade PKN from hold to reduce with the target price raised to PLN 94.17 after adjustments to reflect lower refining margins offset by higher retail profits, and after updating peer multiples.
Polski Koncern Naftowy Orlen's activities are divided into three main business segments: the Refining Segment that comprises crude oil processing as well as wholesale and retail trade in refinery products. The Petrochemical Segment that encompasses production and sale of petrochemicals and chemicals. The Retail Segment that comprises of sales at petrol stations. Co.'s basic products include gasolines, diesel oils, light heating oil, Jet fuel, liquid gas, polyetylene, polypropylene, benzene, butadiene, acetone, phenol, glycols, toluen, ortoxylene.
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