Lotos confirmed at BUY, TP PLN 108.0 - EFRA effects not fully acknowledged by the market

We remain positive on Lotos and reiterate our BUY call despite a lowering of our new 12m target price to PLN 108 (PLN 112). We reckon that the market does not fully acknowledge the impact of the refinery upgrade (EFRA) on the companys realised refining margins, as well as the potential benefits of IMO-2020 regulation for Lotos. Refinery output in 4Q 19 clearly showed the positive impact of EFRA with the yield of middle distillates being almost 4%p above the 2018 level. Also, the yield of gasoline and naphtha was 2%p higher, which resulted in an overall improvement of the white product yields by 6% in 4Q 19 vs. FY 2018. According to our calculation, the refinery upgrade would increase Lotoss refining margins by some USD 1.9/bbl in 2020e. Moreover, with both gasoil and heavy fuel crack spreads reacting to the new regulation for marine fuel, we calculate an additional positive impact on Lotoss refining margin of ca. USD 0.8/bbl (excluding any benefits of a wider Brent-Ural spread). Thus, as a result of both EFRA and IMO-2020, we project the clean LIFO refining EBITDA of Lotos to rise by ca. PLN 450 mn in 2020e and remain at a comparable level in 2021e. Also, we project a higher yoy contribution of the upstream segment in 2020e (+PLN 180 mn) and 2021e (+PLN 300 mn) mainly on the back of the production launch at Utgard field (in 4Q 19) and Yme field (in 2021e) in Norway. All in all, we project a 20% higher clean LIFO EBITDA yoy in 2020e (broadly in line with consensus) and an 8% yoy increase in 2021e (5% above consensus). Any progress on the clearance of the acquisition by PKN should also support the share price of Lotos, provided that the European Commission does not come up with harsh demands with respect to asset divestments.