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Pakistan Oil Fields (POL): 10 Year Low PE of 5.7x; Dividend Yield 15%; Upgrade to BUY

• Investment thesis: We upgrade our stance on Pakistan Oil Fields (POL) to ‘BUY’ from ‘HOLD’ as the stock has lost ~38% value from its peak since Apr-2018. Our investment thesis is based on 1) stable oil production in FY20 after decline of 2% in FY19, 2) Higher drilling target of 10 wells during FY20 to build its reserve base, 3) Cash rich balance sheet (cash to market cap. of 36%) to help in active participation in new block biddings coupled with support in non operating income and, 4) efficient cash flow cycle as the company is least affected from circular debt unlike its peer OGDC and PPL.
• Valuation: After sharp fall in share price, the company is trading at 10 year low PE of 5.7x on FY20 profits (last 5 years avg. PE of 10x) with an attractive dividend yield of 15%. Our blend of reserves and PE valuation suggests Target Price of Rs423, implying a total return of 28%.
• Higher exploration target for FY20: The company is planning to drill 10 wells during FY20 including 3 exploratory wells. During last three years, the company has drilled on average 7 wells per annum. We believe, this will help company to enhance and diversify its reserves and production portfolio.
• Stable oil production after decline of 2% in FY19: We estimate stable oil production where natural decline is estimated to be compensated by additional flows from Makori Deep and Mardankhel. Makori Deep 2 is expected to commence its operations by Dec-2019 with oil and gas flows of 1,844 bpd and 18.25 mmcfd. Similary, Mardankhel-3 has already commenced operations with oil flows of 275 bpd, while for drilling of Mardankhel-4 location is under review. Together these fields will contribute over 2k bpd which is ~3% production. Gas production is likely to witness growth of 3.0% with the help of flows from Makori Deep 2.
• Cash rich balance sheet: The company has cash balance of Rs37bn (including foreign currency balance of US$118mn). This is 36% of current market cap and is expected to support bottom-line through generating non operating profits amidst higher interest rates. We believe, higher  cash balance will also help company to actively participate in upcoming 35-40 blocks auction which is likely to materialize by the end of this year.
• Efficient cash flow cycle: POL has most efficient cash flow cycle in E&Ps industry. Cash flow from operating activities to net income ratio of the company is highest at 126% during FY19 compared to PPL and OGDC’s 53% and 74%, respectively. The company is least affected and immune from circular debt due to less reliance on cash starved Sui companies in terms of sales.
• Key risks: Key risks to our investment thesis include: 1) sharp decline in international oil prices, 2) delay in hydrocarbon flows from key fields, 3) significant exploration and development cost, and 4) any unfavorable decision related to Tal Block litigation.