AKD Securities Limited Equity Research - Daily Report (January 10, 2023)

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AKD Securities Limited Equity Research – Daily Report (January 10, 2023)

January 10, 2023

Karachi, January 10, 2023 (PPI-OT): Pakistan Oil and GAS: Circular debt resolution on the cards

Gas sector circular debt has ballooned to ~PkR1.5tr according to recent news flow, with OGDC, PPL and PSO amongst those affected by it. OGDC/PPL Trade debts have increased to PkR490bn/PkR401bn, respectively, at Sep’22 quarter end, compared to PkR164bn/PkR143bn at the end of FY18.

As a result, OGDC and PPL have faced liquidity issues, which has led to a fall in gas production in the country, requiring greater volumes to be diverted to natural gas consumers. To note, the average daily gas throughput has dropped from 3,934MMCFD in FY19 to 3,233MMCFD in the Sep’22 quarter.

Our understanding is that the commission would be looking to address the low-hanging fruits on the balance sheets of OGDC and PPL, at least as the first step, namely the TFCs and T-Bills, respectively.

The overdue balance of OGDC’s TFCs at the end of the Sep’22 quarter stood at PkR142.65bn (PkR33.2/sh). As for PPL, the company held PkR46.8bn worth of T-Bills, translating into PkR17.2/sh.

While the aforementioned transactions would alleviate the liquidity crunch for the companies, it would not arrest the build-up of receivables going forward. For that, the GOP needs to approve and implement the WACOG bill, which has been in a limbo since Feb’22.

Successful implementation of the aforementioned transaction would provide investors a yield of 22%/39% for PPL/OGDC, respectively, with the likelihood of the former higher due to the nature of its instrument.

Gas sector circular debt explained: The Gas sector circular debt has ballooned to ~PkR1.5tr according to recent news flow, with OGDC, PPL and PSO amongst those affected by it. The circular debt in the gas sector can be traced back to the diversion of costlier RLNG to natural gas consumers, along with high UFG losses at the distribution (SNGP/SSGC) end. To illustrate, OGDC/PPL Trade debts have increased to PkR490bn/PkR401bn, respectively, at Sep’22 quarter end, compared to PkR164bn/PkR143bn at the end of FY18.

The resulting liquidity crunch has led to the companies being unable to explore and replace the naturally depleting reserves, which has led to the overall indigenous production of gas to drop. This adds to the burden as more RLNG is diverted to Natural Gas consumers. To note, the average daily gas throughput has dropped from 3,934MMCFD in FY19 to 3,233MMCFD in the Sep’22 quarter.

The government’s plan-Short-term relief: In Dec’22, the government of Pakistan constituted a committee to address the ballooning circular debt issue that has perturbed the liquidity position of gas producers in the country. Our understanding is that the committee would be looking to address the low-hanging fruits on the balance sheets of OGDC and PPL, at least as the first step, namely the TFCs and T-Bills, respectively.

In lieu of the receivables, OGDC had received privately placed TFCs from Power Holding Limited (PHL) in FY13, which were to mature in 7 years, later enhanced to 10 years. The overdue balance at the end of the Sep’22 quarter stood at PkR142.65bn (PkR33.2/sh). As for PPL, the company held PkR46.8bn worth of T-Bills, translating into PkR17.2/sh.

As a part of the transaction, the government is likely to retire the instruments, and payout the cash to shareholders. The government would then stand to receive 79%/72% of the amount back from OGDC/PPL, collectively against its shareholding and withholding tax on dividends. Out of the two, we believe that the PPL transaction is an easier task to achieve, with the secondary market for t-bills relatively more liquid compared to TFCs.

Long-term policy overhaul is still the need of the sector: While the aforementioned transactions would be able to alleviate the liquidity crunch for the companies, it would not arrest the build-up of receivables going forward. For that, the GOP needs to approve and implement the WACOG bill, which has been in a limbo since February last year.

The WACOG bill in essence would bring with it a uniform rate of supply for gas consumers, based on the weights of imported RLNG and indigenous gas, whereby reducing the burden of diverting RLNG to natural gas consumers to meet increasing demand.

Investment Perspective: If the government is able to successfully carry out the transaction, it would release some much-needed liquidity for the companies. The stocks have also shown strength in the recent past in hopes of a transaction, with OGDC and PPL gaining 22% and 53%, respectively, since December 21, 2022.

We continue to believe that while the transaction would give investors a one-time benefit to investors, the need for the sector is to introduce policy measures that address the build-up of circular debt in the future. This would unlock value for the sector which once was the go-to for investors looking for an exchange rate hedge.