Karachi, February 14, 2023 (PPI-OT): The much-awaited gas prices increase announced

The Economic Coordination Committee (ECC) has reportedly approved increase in gas prices from 10% – 69% for various segments other than residential, another effort by the government to successfully complete the lingering ninth review of the ongoing IMF program.

From the listed space, any reduction in pace of gas circular debt expansion would bode well to unlock valuations of OGDC, PPL, SNGP and PSO. On the other hand, a number of manufacturing sectors would bear negative impact on earnings, assuming power of passing on the impact to end consumers would be limited.

Fertilizer sector maintains the largest quantum of gas cost in its manufacturing process (~30% of cost of sales), the same sector witnessing the highest increase in prices as well. However, the sector holds higher pricing power and is expected to pass on the impact to farmers, which may be around Rs400/bag. In the ongoing macro adjustments, we highlight E and Ps, fertilizers and banking sectors that may be better positioned amid its respective business models to weather the impacts.

Non-residential gas prices increased by 10% – 69%

The Economic Coordination Committee (ECC) has reportedly approved increase in gas prices from 10% – 69% for various segments, another effort by the government to successfully complete the lingering ninth review of the ongoing IMF program. The price increase, which is said to be applicable from 1 January, 2023 to 30 June, 2023, will assist in curtailing pace of gas circular debt pile up, which is among the key recommendations discussed by IMF. While we await official publication for confirmation, this was a much-awaited measure as gas circular debt pile up has been magnifying with time. Current outstanding gas circular debt is at Rs1.6trn, which was estimated at Rs720bn as at Mar-2022 and at Rs620bn as at Jun-2021. The last gas price increase was announced in Sep-2020, that too for limited segments and within the range of 1% – 6%. Prior to that, 31% gas price increase for all segments (62% for Fertilizer feed gas) was announced in Aug-2019.

To comply with IMF recommendations

IMF in its recent Staff Report has given much attention to the burgeoning gas circular debt and the need to address the same by establishing reliable circular debt data, a gas Circular Debt Management Plan (CDMP), and circular debt projection capacity. In the same report, Pakistan government had ensured it has begun work on the CDMP, compile gas circular debt related data and structure regular data systems. To reduce outstanding overdue in the gas sector the government briefed steps such as (1) regular adjustments to end-user gas prices as per established formulas, (2) measures to reduce unaccounted for gas losses and (3) improving liquidity of Sui companies.

The listed space has winners and losers

Energy chain: From the listed space, any reduction in pace of gas circular debt expansion would bode well to unlock valuations of Oil and Gas Development (OGDC), Pakistan Petroleum (PPL), Sui Northern Gas Pipeline (SNGP) and Pakistan State Oil (PSO). On the other hand, a number of manufacturing sectors would bear negative impact on earnings, assuming power of passing on the impact to end consumers would be limited.

Fertilizer sector maintains the largest quantum of gas cost in its manufacturing process (~30% of cost of sales), the same sector witnessing the highest increase in prices as well. However, the sector holds higher pricing power and is expected to pass on the impact to farmers.

Accumulated impact of increase in feed and fuel for FFC computes up to ~Rs400/bag, whereas EFERT would need price increment of Rs295/bag. FFBL would require an increase of Rs262/bag of Urea and Rs109/bag for DAP against current Urea prices of Rs2,440/bag (Rs2,585 granular). FFBL would have a higher price increment requirement for Urea as cost on DAP production cannot be easily passed on to end consumer since DAP prices are determined as per international prices. FFBL would not have any impact because of the fuel rate increase as it uses its own captive power plant for fuel purposes. We highlight ~73% of the Feed gas used by EFERT’s Base plant is charged at Petroleum Policy 2012 rates, hence the lower per bag price increase required in the table below.

Export-oriented sectors: In addition, as the Staff Report itself highlighted uncovered subsidies (especially for export and zero-rated industries) among key reasons of piling gas circular debt, gas prices for Export-oriented sectors have also been increased. The ~30% jump in gas prices for Export-oriented sectors has resulted the segment, that previously received gas at ~22% discount to general industries, to now receive gas at only ~8% discount to the same. The increase raises concerns for textile sector margins in coming quarters, limiting the benefit of recent sharp PKR/US$ devaluation.

Others: Moreover, Engro Polymer (EPCL), is another energy intensive company, which is expected to take a hit of 7% (annualized), under the assumption that they run their plant on natural gas throughout the year, owing to 10% increase in gas prices. Moreover, the rate is still lower at Rs1,200/mmbtu, when compared to RLNG rates that are currently at ~Rs3,700/mmbtu.

Among other manufacturing companies under JS Universe, Lucky Cement (LUCK) and Cherat Cement (CHCC) consume gas at regular rates but the impact would be negligible on the two companies as the increase for captive power is lower compared to other increments and these companies also do not solely rely on gas for power generation.

Impact on inflation

Given weight of gas prices at 1% in the basket, an average increase of ~25% in the said prices may not have a grave impact on inflation through direct increase. Implications from second-round impact may be more serious. While in our base case we have incorporated a 40% jump in gas prices from the ongoing month, we present a sensitivity of gas price hikes. Please note, these numbers only reflect the first-round impact, that is the direct impact. A second-round impact also usually follows, broadly reflected in prices of other food and household related items.

Also, as fertilizer prices are expected to increase post gas price hike, the already higher rural inflation can continue to witness more pressure in the coming months. We highlight, Rural inflation in the headline, food and core inflation has been higher than urban segment during 7MFY23.

Prefer stocks resilient to macro adjustments

In the midst of the ongoing and prospective macro adjustments, we prefer stocks better placed to weather adjustments, broadly from the banking, energy and fertilizer sectors, which also offer attractive dividend yields in the range of 15-23%. From the E and P space, we prefer OGDC and PPL over steps towards improvement in piling of gas circular debt and immediate adjustment in PKR/US$. We also like MARI over growth and PKR devaluation play. From the fertilizer sector, we like FFC and EFERT given companies’ respective stable high D/Y at ~19%. In addition, we also highlight banking sector among prospective sectors to outperform amid current attractive multiples of 0.6x against Tier I recurring ROE at 23% on long term interest rates at 12%.