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Pakistan Gas Marketing: Fall in oil prices likely to provide liquidity space to Gas Utilities; WACC based return formula likely to increase by 2%

• The Pakistan Gas sector has been facing severe liquidity constraints on account of both natural gas and RLNG. During 9MFY20, SNGP recorded natural gas differential of Rs48.5bn. The annualized indigenous gas differential amount of Rs65bn (9M: Rs48.5bn), translates into Rs/mmbtu of ~Rs177 (or US$1.07) which is ~24-25% of the average consumer price in Pakistan.
• Our working suggests that at US$35/bbl, weighted average cost of gas will come down to US$2.68/mmbtu, resulting in improved cash flows of ~Rs50bn (net of 6% PKR depreciation) assuming government will not lower consumer gas prices in Jul-2020.
• RLNG sector issues also continue to aggravate due to lower offtake of RLNG by power consumers (take or pay agreements) amidst induction of relatively cheaper imported coal and indigenous Thar coal based power plants.
• However, the gravity of RLNG matter is likely to be appeased somewhat going forward as (1) the government through negotiations has already lowered number of cargoes imported to 3 per month (vs. 5 earlier) from Qatar in wake of COVID-19 outbreak, (2) the government has approved 150Mmcfd of RLNG supply to KEL’s new power plant from Jan-2021 and 3) substantially lower differential of ~US$0.5-0.6/mmbtu (May 2020E) between fixed rate RLNG to export industries and normal selling price.
• We believe resolution of above matters will be positive for SNGP, SSGC, OGDC, PPL, and PSO. OGDC and PPL receivables from Sui companies have increased by Rs62bn and Rs52bn, respectively during 9MFY20.
• In a positive development, Sui companies market based return formula WACC has triggered a change of over 2% due to increase in 70% weighted component i.e. KIBOR in 2H2019 to over 13%. This will likely result into return on asset of 19.64% for FY21 vs. earlier 17.43% earlier.

We maintain our earnings for SNGP for FY20E while for FY21F we revise it upward by 12% to Rs14.46/share after reducing its cost of gas purchased amidst lower oil prices which results in lower UFG disallowance in Rs terms along with some adjustments in volumes purchased for the year. We foresee earnings of Rs15.2/13.5/14.5 for FY19E/FY20F/FY21F. We currently have a ‘Buy’ stance on SNGP.