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Strong Fundamentals at Rock-Bottom Valuations
August 30, 2008
Companies Featured Company OGDC PPL POL Rating BUY BUY BUY Target Price (PRs) 160 417 540
With 16% YTD decline in share values, Pakistan E&P sector provides some interesting buying opportunities. There is no fundamental reason to explain this decline in value and the simple explanation for this is the broader equity market sell-off. Valuations are at their most attractive and the sector is now discounting around US$45/bbl oil price. Despite strong operational and financial position, valuation gap of Pakistan E&Ps with Asian peers has widened to above 50%. It is something of a surprise that the E&Ps have not been considered more as a defensive play. The dollar denominated revenues and unleverged balance sheet provides a hedge against currency decline and interest rate hike. Besides, the monetization and regulatory risks are also low. Pakistan is still in the initial stage of exploration with one of the lowest drilling density of 1.99 wells/1000 km2 and higher success ratio of 30% while the significant potential is yet to be tapped. The strong upturn in exploration activity and the level of newsflows this will generate would lead to inevitable interest in the sector, we believe. Our key selling point for Pakistan E&P sector is its healthy operational and earnings momentum. We believe the sector is well positioned for a strong organic growth in coming years. Implying an oil price of US$40/bbl, PPL is our top pick in Pakistan E&P sector. Given its rising gas profitability profile, we believe markets justification of muted volume growth for low multiples of PPL is not logical. The company holds the most attractive exploration portfolio and its growth profile surpasses the domestic peers. We also recommend Buy on OGDC and POL. Both these stocks are available at an unwarranted valuation gap with the regional peers. OGDC has a large and well-diversified reserve base. It is regarded as the most aggressive E&P, which makes it a direct play on Pakistans relatively lower drilling density area. POL is all set to reap the benefit of upcoming production additions from the big discoveries of 2000s.
Valuation analysis EPS growth EV/DACF (x) EV/EBITDA (x) PE (x) P/CF (x) Div Yield ROE ROA ROACE
2008 12% 6.1 4.1 7.9 8.9 8% 44% 33% 58%
2009E 57% 3.1 2.4 4.8 5.1 11% 56% 44% 84%
E&P Sector vs KSE 100 & Arab Light 225 175 125 75 Oct-07 Aug-07 Nov-07 May-08 Aug-08 1% 13% -65% Apr-08 Jan-08 Mar-08 Jul-08 25
E&P Sector Absolute Rel. to KSE 100 Rel. to Arab Light
KSE100 Index 3M -16% 9% -4% 6M -20% 14% -33%
Arab Light 12M
Prices as of August 26, 2008
Table of Contents
I- Pakistan E&Ps: Grossly underpriced EV/DACF suggest a valuation gap of 66% Low EV/DACF multiple vs high ROACE Also cheapest on EV/EBITDA Lowest EV/Reserve in the region EV/ production is also lowest PE multiples suggest valuation discount of 53% Solidly attractive on valuation vs. growth matrix Top dividend yield in the region II- Operating & financial position Peer Comparison Competitive operating position in the region Profit margins compare favorably in Asia Industry leading returns III- Trading at an implied oil price of US$45/bbl IV- Declining oil price assumption Healthy jump witnessed in 1HFY09 wellhead prices HSFO-linked capped fields prices up by 10-11% Uncapped crude linked fields witnessed 17-30% increase Earnings sensitivity to oil prices V- Earnings stream leveraged against macro-economic turmoil Secured demand Rupee earnings hedged against devaluation Unleveraged balance sheets insulated from interest rate hike Investors should realize the defensive nature of E&Ps VI A- Pakistan: An under-explored country with rich prospects Significant potential yet to be tapped Governments strong focus on E&Ps Makor recipient of governments reform...