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Pakistan State Oil Company Limited (PSO): Earnings revised up, Buy Maintained

• We maintain ’Buy’ rating on Pakistan State Oil Limited (PSO) with a revised Target Price of Rs258. The stock offers an upside of 27%. The company trades at a FY21E P/E of 6.8x and P/B of 0.8x.
• We are also revising up our earnings estimates for the company by 13% for FY21E.
• Our earnings revision primarily stems from (1) decrease in short term borrowings and (2) demand pick up as economy comes out from shocks of COVID-19.

Deleveraging – Balance sheet

• Payment proceeds from the issue of Pakistan Energy Sukuk 2 has enabled the company to significantly reduce its liabilities/improve liquidity.
• Hence, short-term borrowings over the past fiscal year have declined by Rs41bn, which was also aided by lower Furnace Oil (FO) sales. Going forward, we expect lower borrowings to reduce finance cost significantly.
• We project finance cost to reduce by 64% YoY, which is a result of both decline in borrowings and lower interest rates, of which the impact will be more visible in the coming year as re-pricing kicks in. 
• Reduction in other receivables has also helped improve the footing as the head showed a decline of Rs34bn primarily driven by decline in FE-25.
• To recall, FE-25 borrowing (foreign currency borrowing) were allowed by GoP as payments for imports.
• The mechanism addressed the issue of exchange losses (to be borne by GoP) and exchange gains (to be paid to GoP). There was a break through on exchange loss on the FE-25 borrowing with the GoP retiring Rs28.6bn of the total amount with a balance of Rs1.7bn left.

Government’s agreements with IPPs to help improve liquidity position further

• The government and IPPs are in discussions to revise future returns of the IPPs. The key demand for the IPPs has been resolution of the accumulated stock of circular debt. PSO’s highest proportion of Jun-2020 trade debts (past due) of Rs196bn emanates from GENCO Holding Company (Rs75bn in FY20 vs. Rs82.3bn in FY19), SNGP (Rs68.2bn in FY20 vs. Rs53.4bn in FY19) and HUBC (Rs23.3bn in FY20 vs. Rs25.6bn in FY19).
• The release of outstanding circular debt by the government will help IPPs/Gencos to retire their payables against PSO, which will further improve the liquidity position of the company.

Demand Pick Up

• FY21 has started on a promising note with industry volumes depicting an increase of 11% YoY in the first two months. The volumes have been primarily driven by a 19% YoY increase in HSD volumes and a 14% YoY increase in Furnace Oil sales, followed by a 9% YoY increase in MS volumes.
• PSO volumes shows a similar trend on a YoY basis during 2MFY21 with HSD, FO and MS improving by 29% YoY, 13% YoY and 14% YoY, respectively.
• Projected growth of car sales in the coming year is expected to be around 35% YoY, which is expected to bode well for MS demand, which in turn is projected to grow by 10% YoY for FY21E.

Margin revision – Due

• For FY20 the margin revision came in at around Nov-Dec 2019 period. OMC margins are fixed in PKR terms and linked to the Consumer Price Index (CPI). The last revision was of Rs0.17/ltr to Rs2.81/ltr from Rs2.64/ltr for MS and Rs0.40/ltr to Rs2.81/ltr for HSD which was in line with CPI.

We expect the revision to come at a similar timeline this year and have incorporated this in our model on a pro-rated basis.