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Transcript of CFA Institute Research Challenge · We initiate analysis of Pakistan Petroleum Limited ... Porter's...
CFA Institute Research Challenge
Hosted by
CFA Society of Pakistan
Karachi School for Business and Leadership (KSBL)
CFA RESEARCH CHALLENGE JAN 31st 2014
Rating BUY
Current Price (29th Jan 15): PKR 220
Target Price (Jan 2015): PKR 248
Upside Potential: 18.25%
PAKISTAN PETROLEUM LIMITED
Ticker – PPL: KA Karachi Stock Exchange - Pakistan
OIL & GAS INDUSTRY – UPSTREAM SECTOR
Exchange Rate: USD/PKR 105.5 Date: 31st January 2013
HIGHLIGHTS
We initiate analysis of Pakistan Petroleum Limited (PPL) with an end of year target price of PKR 248/share, offering an upside potential of 18.25%. Pakistan Petroleum Limited, hereafter referred to as
PPL, is one of the pioneers of natural gas industry in Pakistan, and is currently responsible for
satisfying 20% of the natural gas demand of the country. PPL has posted strong profits over the last 5 years, and has paid substantial dividends to investors. PPL’s Compounded annual revenue growth rate for the past 5 years has been 17.5%. PPL has a diverse product portfolio because of which a decrease in production of one of the products do not affect the overall bottom line. Shift of reliance from gas to crude oil in recent years has improved the overall margins for the company as well.
Our estimates suggest that PPL is undervalued in the stock market, especially when compared
with its peers. Currently PPL is trading at a discount of even its 2P reserves 5.5%. Our valuation
shows that PPL has huge upside impending if the price starts incorporating the 3P reserves, exploration, and other tight-gas reserve potential.
PKR has depreciated 24% over the course of last 3 years. We estimate that the trend will continue in the same way because of the negative balance of payments that Pakistan has as well as the
huge IMF payments that Pakistan has to make, putting increasing pressure on the reserves. PKR depreciation against the dollar has a huge impact on PPL's profitability. Our valuation shows
that 1% depreciation results in 0.4% increase in the target price.
Within its industry, PPL is one of the most aggressive exploration and production company in
Pakistan. In FY13, PPL won the bid for 11 exploration blocks in Pakistan, and simultaneously has
been pursuing international expansion. PPL now has stake in fields in Iraq and Yemen putting it in an excellent position for upside potential in the longer run.
The most important risks to consider for our target price are security and political situation in Balochistan in particular and Pakistan in general. A strike in the province could stall all the operations and affect the performance of the company. Other risks include PKR/USD depreciation assumption, management performance, and valuation risks.
Market Summary
2011A 2012A 2013A 2014F 2015F 2016F 2017F 2018F
Net Revenue 78,252 96,222 102,357 111,128 118,548 118,884 119,486 120,349
EBIDTA 53,320 71,426 70,325 83,234 83,590 83,478 83,303 80,253
Net Income 31,446 40,899 41,951 49,900 52,003 52,730 53,469 52,212
Debt Financing 102 131 165 165 165 165 165 165
EPS 26.3 31.1 25.5 27.0 26.4 26.7 27.1 26.5
DPS 12.0 11.5 10.5 12.2 11.9 12.0 12.2 11.9
BV Per Share 79.0 96.1 90.9 88.3 102.2 116.7 131.4 146.3
Net Profit Margin 40% 43% 41% 45% 44% 44% 45% 43%
Return on Assets 25% 24% 20% 21% 20% 18% 17% 15%
Return on Equity 33% 32% 28% 29% 26% 23% 21% 18%
Dividend Yield 4.8% 5.1% 4.1% 5.5% 5.4% 5.5% 5.6% 5.4%
Valuation DCF NAV Multipliers
Estimated Price 264 255 218
Weights 25% 50% 25%
Target Price 248 PKR
Threat ofNew
Entrants
BargainingPower
Suppliers
BargainingPower ofBuyers
Competition in theIndustry
Threat ofSubsitutes
Porter's Five Forces
52-week price range (PPL) 172.8 - 260.1
Average Daily Volume 1,927,292
As % of shares outstanding 0.1%
Sharpe Ratio (2013A) 0.997x
Dividend Yield (2013A) 4.10%
Dividend Yield (FY14 Q2)
5.5%
Shares Outstanding 1,971,732,223
Market Capitalization 346,531,938
Government Holdings 71%
BV Per Share (PKR - 2013A)
90.9
ROE (2013A) 28%
ROE (2014E) 29%
Debt to Capital (2014E) 0.1%
P/BV 2.32
P/E 8.3
Original Gas Reserves (mn BOE) 2,898,993
Balance Gas Reserves (mn BOE) 775,205
Original Oil Reserves (mn Barrels) 72.3
Balance Oil Reserves (mn Barrels) 48.8
FY 13 Yearly BOE Production 58,719,189
Oil Revenues 27%
Gas Revenues 71%
CFA RESEARCH CHALLENGE JAN 31st 2014
BUSINESS DESCRIPTION Pakistan Petroleum Limited's history dates back to the establishment of a public limited
company in 1950 whose largest shareholder was Burmah Oil Company (BOC), UK. PPL is one of
the big 5 (other being OGDCL, MARI, POL and UEP) Exploration and Production (Refer Appendix
5) companies working in Pakistan in the oil and gas sector. It is not only a pioneer of natural gas
industry in the country, but has also been at the forefront of technological and exploration
developments such as 2D &3D Seismic Technologies, Stress Field Detection, Electromagnetic
Measurement while drilling, and other technologies for its exploration purposes. Company's
shareholding is a mix of government and private shareholders, with government holding 71
percent, private investors holding 22 percent, and the remaining 7 percent being held by PPL
Employees Empowerment Trust. PPL's gas customers include Sui Southern Gas Company Limited
& Sui Southern Gas Pipelines Limited and GENCO-II, and its crude oil customers are Attock
Refinery Limited, Pak-Arab Refinery Limited, BYCO, NRL, & PRL).
PPL satisfies more than 20% of the national natural gas demand, and also explores and produces
crude oil, condensate, and liquefied petroleum gas. The company has 100% stake in SUI, the
largest gas field, and also operates five other fields. Although PPL's gas production has been
decreasing recently due to depleting reserves at Sui, its crude oil production numbers have
increased which has resulted in an overall increase in profitability for the company. Oil
production increased by 15.13% (9,986 vs. 8,673 barrels/day) in FY13 YoY while gas production
declined by 10% (895 vs. 985 mmcfd) over the same period. Revenue contribution from oil, gas
and LPG stood at 27%, 71% and 2% respectively. Alongside that, company has also invested in
production of tight gas in Pakistan, and this year, company has commenced the first tight gas
production of Pakistan from Rehman-1 wells.
PPL has adopted an aggressive exploration policy to stay competitive in the longer run and to
further improve its reserve replenishment ratio. PPL operates 27 out of the 48 exploration
blocks currently under its name while the remaining 21 are operated by partners. The company
has recently gone global by acquiring an exploration block in Iraq, becoming Pakistan’s first State
Owned Enterprise with transnational operations. It has also acquired 100% shareholding in
“MND Exploration and Production Ltd.” which has provided PPL with working interests in three
exploration fields in Pakistan, and one in Yemen
Current Strategy (Exploration + HRM)
PPL’s recent strategy has been to aggressively explore and develop new hydrocarbon reserves
in the country. In FY13, PPL successfully won 11 exploration blocks in the country, and according
to reports, PPL's success rate on such exploration is 40%. Pakistan faces a huge shortfall in skilled
human resource in the field of geology and geophysics. Hence, PPL has invested heavily in its
employees and the community it works in. The aim is to develop talent internally and retain it
for the longer run. Concurrently, PPL has been revisiting its organizational structure and HR
practices to make the organization more proactive and responsive to changes in Pakistan’s
generally volatile business environment.
INDUSTRY OVERVIEW & COMPETITIVE POSITIONING Exploration and Production (E&P), the largest listed sub sector, constitutes about 30% of the total
market capitalization in KSE. It has evolved in to a concentrated industry where few heavyweights
(State-Owned Enterprises) stay in the limelight (appendix 24). Share of the leading companies
(OGDC, PPL, MPCL and POL) account for more than 60% of the total Oil & Gas production in the
country. Pakistan is rich in natural gas, and has become one of the highest gas dependent
economies of the world. Despite depleting resources, the national gas production in FY2013 was
about 92% of the total locally-produced hydrocarbons (in mmboe terms). However, oil
production has picked up over the last year (growth of about 14% in FY2013) and future prospects
are encouraging. Currently, Pakistan produces 17% of the total crude oil demand from
indigenous resources, which is expected to increase to 20% by FY2017. During the same period,
Gas71%
Oil27%
Others2%
REVENUE BREAKDOWN FY13
GoP71%
PPL Employees Empowerment
Trust7%
Private Investors22%
SHAREHOLDING STRUCTURE
140,000
150,000
160,000
170,000
180,000
190,000
FY12 FY13
DAILY BOE PRODUCTION
Gas Crude Oil
Source: Company Data
Source: Company Data
Source: Company Data
Source: Company Data
CFA RESEARCH CHALLENGE JAN 31st 2014
gas production is not expected to show much growth, especially when Sui, the biggest gas field
in Pakistan, is fast approaching its useful life.
Industry outlook determined by global economy
The depletion of natural gas reserves is not the only reason for the country’s changing energy
mix. The industry has achieved windfalls over the past few years due to the increase in
international oil prices. Around 8% of hydrocarbons (mmboe terms) yielded 49% of the
revenue for E&P Sector in FY2013. Hence, any future outlook for the industry is heavily
dependent upon the future global economy, its energy requirements and social and political
conditions affecting the oil producing countries. Recently, the discovery of Shale Gas and its ever
broadening potential is being closely watched by industry experts.
Impact of a volatile exchange rate
It is one of those rare industries which benefits from PKR depreciation. The Industry’s revenues
are determined in US dollars and the industry has benefitted from PKR depreciation over the
past couple of years. Although the PLM (N) government entered into yet another IMF program
to stabilize foreign exchange reserves, the prevailing inflation rates and persistent pressure on
the ever decreasing foreign exchange reserves will further dent PKR strength in the future.
Future prospects/Government Regulations
Gas pricing, being regulated by the government, significantly impacts the bottom-line of the
industry. As wellhead prices in Pakistan vary according to the specific Petroleum Policy
applicable to respective wells, these regulations mean that gas revenues are 5.4 times less than
oil revenues (mmboe terms). Also, with effective tax rates increasing in FY2013, major E&P
companies paid higher taxes, thereby, further reducing their profits. The government recently
awarded 50 exploration blocks, for the first time after 4 years. The delay caused by federal-
provincial problems, in the light of the 18th Amendment, looks likely to have been solved. This
will certainly help bring sustainability to the E&P sector, resultantly encouraging new players,
both local and foreign, to bring in much needed investments for the future.
Key indicators of O&G sector
With the E&P space dominated by state-owned enterprises, major players often enter into joint
ventures in order to hedge their risks associated with exploration and development. However,
each player has a competitive advantage that enables them to create shareholder value (E&P
sector ROE was about 30% in FY2013). Table 1 highlights the revenue breakup and production
numbers of each of the major player in the industry. As for the in-depth operational analysis,
following ratios help understand the significant advantages of each player among the peer
group:
Reserve Life (Years) OGDCL (22 years) boasts the longest reserve life among the peers, closely
followed by MPCL (17 years). PPL is not far behind the peers with a reserve life of 14 years
which has shown an impressive growth over the past few years as a result of the company’s
exploration-led growth strategy.
Reserve Replenishment Ratio (3yr Average) Despite its eroding reserves in Sui Gas Field, PPL
has been able to replenish about 90% of their reserves over the last 3 years. At the same time,
OGDCL, on the back of the Qadirpur gas feld has a reserve replenishment ratio of about 121%
over the same period.
Exploration & Development Cost/Barrels of Oil Equivalent (BOE) PPL incurs one of the highest
exploration and development costs among its peers (mmboe terms). POL spends the most per
BOE; however, their production numbers are nowhere near to that of PPL. OGDCL is also quite
close in terms of spending which means that all players are investing in making the industry
sustainable.
EV/EBITDA (Times) PPL has the lowest enterprise multiple of 4.4x among the peer, thereby,
showing that it is the most undervalued stock. Other players like POL and OGDC has a much
higher multiple of 6.4 times.
TABLE 1 (Company Data/Team Estimates)
26%
22%14%
2%
36%
YEARLY GAS PRODUCTION FY13
OGDC PPL Mari POL Others
Source: Company Data
46%
12%6%
36%
YEARLY OIL PRODUCTION FY13
OGDC PPL POL Others
Source: Company Data
TABLE 2 (Company Data/Team Estimates)
Source: Company Data
CFA RESEARCH CHALLENGE JAN 31st 2014
EV/Barrels of Oil Equivalent (BOE) Just as above, PPL has the lowest EV/BOE (PKR 5197),
effectively showing that PPL offers the cheapest price of one barrel of oil (mmboe terms). This
shows that PPL is trading at a discount as compared to its peers who get much higher prices per
BOE. (OGDC PKR 11,992, POL PKR 17,296).
INVESTMENT SUMMARY
Aggressive domestic exploration
PPL currently trades at discount of its 2P reserves value, which shows the melighupside potential
of the stock if exploration and tight gas potential is incorporated. PPL has been aggressive in
exploring new Oil and Gas wells/fields to replenish their reserves to ensure long term
competitiveness. For instance, higher production at Tal, Adhi and Nashpa are results of PPL’s
aggressive exploration over the last 7 years. Overall, PPL's reserve replenishment ratio was 90%
in 2013. New discoveries at Wafiq -1, Shahdad -1, and Lundali -1 in 2012 will start producing
gas in 2015 and create tremendous upside potential for the share price (appendix 13 for details).
A significant milestone achieved in 2013 was the commencement of pioneering tight gas
production from Rahman-1 block. We estimate that the production from Rahman-1 has added
Rs. 3/share in our target price. The share price is sure to be bolstered by PPL’s securing the grant
of 11 strategically-fit exploration blocks last year.
International exploration
PPL is credited with the major national milestone of acquiring block in Iraq and becoming the
first state owned enterprise with transnational operations where it has planned to invest
$100mn in Iraq and Yemen over the next 5 years. PPL also acquired 100% share in MND E&P
Ltd. which has working interest in one producing field and 3 exploration blocks in Iraq and
Yemen.
Strong Earnings growth - Stronger Fundamentals
PPL will continue to maintain liquid while continuing to pay high dividends as well. EPS for PPL
for the year 2012 and 2013 were 31.1/sh and 25.5/sh respectively, and we estimate it to grow
to PKR 27/sh in FY 14. Importantly, Current Ratio of PPL in FY13 was 2.29, because of strong
earnings and sales we estimate it to keep growing in the foreseeable future, assuming no
material investments are made, and reach 7.05 by Fy18. It has low debt to equity ratio, offers
ROE of 28%, and we expect its solvency ratio to stay between 0.74 in FY13 to 0.89 in FY22. With
changing demographics and stronger exploration intentions we predict that this strong earnings
will continue for PPL in the foreseeable future.
Government Regulations - Petroleum Policy and PIB's Government’s decision of paying off circular debt improved the balance sheet position of PPL.
From having non-earning trade receivables, PPL now has investments paying 11.5%. This is a
continuous source of earning for PPL and will continue to improve their bottom line. Moreover,
Petroleum Policy 2012 has improved the gas pricing mechanism, which couples with PPL’s
aggressive exploration to improve the profit positioning (appendix 15 for details).
Rupee depreciation, higher profits Depreciation of Rupee against the dollar is another important reason why the short term and
long term profitability of PPL is eminent. Although the volumes produced by Pakistan Petroleum
Limited is to fall by 2.5% in FY13 but the profits are still likely to increase by 18.9% due to PKR
depreciation, and our estimates suggest that there will be 1% increase in USD will contribute
almost PKR 1.95 to the target price.
-
10,000
20,000
30,000
40,000
Gambhat Hala Kirthar
RECENT DISCOVERIES 2P RESERVES (MMBOE)
Oil Gas
62%
64%
66%
68%
70%
72%
74%
76%
FY1
1A
FY1
2A
FY1
3A
FY1
4F
FY1
5F
FY1
6F
FY1
7F
FY1
8F
EBIDTA MARGIN %
Source: Company Data
Source: Team Estimates
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
FY11A FY13A FY15F FY17F
EV/PRODUCTION (BOE)
Source: Team Estimates
Source: Company Data
CFA RESEARCH CHALLENGE JAN 31st 2014
Demographics - Increase in Energy Demand Energy consumption was 3.1 percent higher in FY12 as compared in FY11, and we believe that
the trend will continue in the future as well. Industrial and residential need of energy as well as
the sheer number of vehicles has risen exponentially. Recent immigration from rural areas to
urban centers also ensures that whatever PPL produces is bound to get sold every year (appendix
8 & 10)
Change of oil-gas mix leading to better margins PPL’s oil production registered a staggering growth of 15.13%, rising to almost 12kbopd from
9kbopd in FY13. On the contrary, gas production witnessed a decline of 10% to 895mmcfd in
2013. Driven by Tal Block and Naspha, the company’s oil production grew substantially during
the period, and the Net realized prices on oil are 5.4x higher than on gas. Therefore, the
revenue growth from oil production has outweighed decline in gas production. If this change of
mix continues then PPL would not be effected by the decline in gas production (appendix 14 for
details).
Re-alignment of Strategy Under the current leadership with the international mission in mind, the company undertook a
massive re-alignment of strategic organizational goals. The re-structuring included changes in
reporting patterns, reviews of joint ventures and strategic collaborations, exploration and
production strategies and unconventional gas management. Moreover, numerous schemes for
employee and community development have been launched with a vision to stay competitive in
the longer run.
FINANCIAL ANALYSIS
Stable Earnings PPL has enjoyed stable EPS growth in last decade or so and we expect EPS to grow further
reaching a maximum of PKR27.1 by FY17; we expect EPS to decline slowly on YoY basis from
thereon because no replacement of reserves is assumed. Despite not assuming additional
reserves, EPS still remains above PKR20 till FY26 which implies a strong financial position for
PPL. Impressive upcoming earnings is primarily derived by depreciation of PKR and stable oil
prices. We expect government to further increase wellhead gas prices as an incentives to O&G
firms to explore more hydrocarbons to meet the energy needs. We expect oil mix % to increase
in upcoming years implying more profits per BOE. We also expect PPL to maintain EBIDTA margin
due to stable depreciation and amortization charges.
Strong Cash Balances/Solvency
PPL has remained a cash rich company over the last many years and we expect a robust growth
in cash balances in future as well. We expect 31% YoY increase in cash dividend coverage ratio
over next 5 years reaching PKR8.7 in FY18. We also expect current ratio to increase from 2.29
in FY13 to 7.1 in FY18. The trend from thereon remains upward implying a strong fundamentals
of the company. PPL has virtually no long term debt that leaves company with huge cash
reserves to increase exploration and drilling. We also expect PPL to post PKR29.1 operating cash
flow per share by FY18; up from PKR20.7 in FY12. We expect PPL to post 0.89 solvency ratio
(ability to pay off entire debt from operating cash flows) in FY18 up from 0.78 in FY13. The ability
to pay off almost all debt in one year makes PPL one of the most solvent company in Pakistan
(appendix 16).
Payout Ratio
PPL in well known for striking payout ratios ranging from 37% to 59% since FY06 and we expect
the company to maintain 45% payout ratio in upcoming years. Currently, dividend yield is 4.1%
and we expect it to reach 5.4% by FY18.
0%
10%
20%
30%
40%
50%
60%
70%
80%
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
20
12
20
13
20
14
E
20
15
E
20
16
E
20
17
E
EARNINGS
Net Sales
EBIT
EBITDA
Profit to Common Equity
0.0
10.0
20.0
30.0
40.0
FY1
1A
FY1
2A
FY1
3A
FY1
4F
FY1
5F
FY1
6F
FY1
7F
FY1
8F
EPS v.s DPS
EPS DPS
0%5%
10%15%20%25%30%35%40%
FY1
1A
FY1
2A
FY1
3A
FY1
4F
FY1
5F
FY1
6F
FY1
7F
FY1
8F
NET PROFIT / BOE (%)
-
10.0
20.0
30.0
40.0
50.0
FY07
FY08
FY09
FY10
FY11
FY12
FY13
NUMBER OF CONSUMERS(in millions)
Domestic Total
Source: Pak Economic Survey
Source: Team Estimates
Source: Team Estimates
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
DuPont Analysis
Our analysis indicate impaired ROE from 28% in FY13 to 19% in FY18 primarily due to assumption
of no growth in reserves. Similarly ROA declines from 22% in FY13 to 16% in FY18 whereas
Assets/Equity declines from 143% in FY13 to 123% in FY18 due to similar reason. We also expect
Sales/NI to decline from 48% in FY13 to 36% in FY18 primarily due to huge cash reserves
generating interest income only as we have assumed no addition of hydrocarbon reserves.
However, we expect net profit margin to increase from 41% in FY13 to 43% in FY18 reaching a
maximum of 45% in FY14. Higher profit margin is backed by higher oil mix %. From thereon, we
expect net profit margin to decrease slowly due to lower oil mix % and reduced crude oil prices.
VALUATION We have considered three standard approaches to value PPL – Discounted Cash Flow (DCF)
model, Net Asset Value (NAV) and comparable company multiple pricing.
DCF (Gordon Growth Model) Valuation
Free Cash Flow to the Firm (FCFE) is suitable for PPL since the company has no debt in its capital
structure except financial leases for computers and vehicles which do not affect the capital
structure significantly. According to our detailed DCF analysis, we derived a target price of PKR
264. DCFs generally do not work well for oil and gas companies because a) they have high
CAPEX requirement, which reduces Free Cash Flow and may create declining or negative Free
Cash Flow b) consequently, they are even more dependent on the Terminal Value than non-oil
and gas companies. Since energy reserves are scarce and non-renewable; it is not possible to
forecast reserve replenishment accurately. Hence, the analysis does not reveal much.
NAV Valuation
NAV is used as an alternative to traditional DCF for oil and gas valuation since reserves are
assumed to have a finite life. The major differences are a) the company never increases its
existing reserves and there are no additional future CapEx requirements beyond what is
required to develop existing reserves, and b) DCF is calculated at the corporate level, while NAV
model is applied at the asset level. The company’s assets are valued separately and aggregated
at the end. Using NAV model, we derived a target price of PKR 255. The company was valued
on a non-going concern basis. All variables were forecast for the next 25 years after which the
company’s reserves are assumed to be fully depleted. NAV is based on the following factors:
Sales: Sales are estimated using PPL’s production capabilities, and all output is assumed to be
sold. PPL sells its output to refineries at pre-determined rates which are defined under the
petroleum policy. The applicable rates are defined in terms of fields, zones and international oil
prices.
Production: Production has been estimated using a bell curve approach. If a particular field’s
resources have been utilized by less than 50%, the depletion factor (how quickly resources are
extracted) would be high for initial years in the pro-forma statements and then lower for
subsequent years. More emphasis has been placed on Nashpa, Tal Block, and Adhi Fields since
these are the current drivers of PPL’s growth.
Pricing: Well head gas prices vary according to field. A general observation suggests that fields
discovered recently have higher prices as compared to decade old fields like Sui and Kandhkot.
Prices for each field were forecasted for next 25 years through formula provided in relevant
petroleum policies.
Exploration Value: The exploration value is an estimate of the 3P reserves. We have taken this
as 12.5% of existing 2P reserves.
Cash Flows: The cash flows have been estimated using net sales and then deducting royalties,
development & drilling charges & exploration costs. This is in accordance with the NAV
framework.
CAPEX: Under NAV, no CapEx is assumed with the exception Maintenance CapEx & what is
required to develop existing reserves.
Risk free rate 10%
Adjusted Beta 1
Risk Premium 7%
Source: Team’s estimates
Source: Market Data, Team’s estimates
DUPONT ANALYSIS
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
FY1
1A
FY1
4F
FY1
7F
FY2
0F
FY2
3F
FY2
6F
FY2
9F
FY3
2F
DAILY BOE PRODUCTION
Sui
Depleted
Source: Team’s estimates
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
20
11
20
15
20
19
20
23
20
27
20
31
20
35
SALES (In Millions)
Source: Team’s estimates
-
10,000
20,000
30,000
40,000
50,000
2014 2015 2016 2017 2018
DFCF
Source: Team’s estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
WACC: PPL operates under a 100% equity structure with the exception of certain financial leases
which do not form a material part of the capital structure. The risk free rate is taken to be 10%
using the 10 year Pakistan Investment Bonds (PIBs). The company’s historical beta is 0.82 while
the adjusted beta comes out to be 1.03. The market risk premium is taken as 7% which is industry
norm. Thus the WACC comes out to be 17%.
Multiples Valuation
We used both Regional & Local PER, EV/EBITDA, EV/BOE Multiples based on a one-year forward
median. The weightage applied to both has been 12.5% & 12.5% respectively. We observed that
PPL’s market price is trading at a long-term discount relative to its peer group in the past. There
were number of factors supporting this discount in previous years, such as a) Influence of major
shareholder being the Government of Pakistan b) Lower multipliers on average for the KSE-100
than for exchanges where peers are listed (country risk).
Historical analysis suggests that PPL is trading at a 20% discount for P/E, 40% for EV/EBITDA,
and 69% for EV/BOE on a local basis. On a regional basis, PPL is trading at a 60% discount for
P/E, and 17% for EV/EDITDA. We highlight the fact that the business environment of the
Company has changed significantly since 2012 when PPL started operating globally. Currently,
PPL together with its subsidiaries (PPL Asia E&P B.V & PPL Europe E&P Limited) has a portfolio of
48 exploration assets of which the company operates 27, including one concession in Iraq, while
21 blocks, comprising three offshore leases in Pakistan and two onshore concessions in Yemen,
are operated by joint venture partners. Hence, diversification should reduce the risk in long-term
perspective (see appendix 17 for more details).
However, since the operation in Iraq & Yemen is still in initial stages and therefore it is difficult to
estimate the future revenues. Hence, we have taken a conservative approach and valued the
subsidiaries on a cost basis to be reflective of a conservative approach.
Based on P/E & EV/EBITDA ratio by using both local & regional peers as base, we have estimated
a target price of PKR 218.
INVESTMENT RISKS MARKET RISK: Commodity price assumptions
Revenues are contingent on an external factor that is normally driven by international demand
and supply. The company’s revenues are linked to a basket of Middle East crude oils which are
used to derive the base prices for gas & crude oil sales. Although Crude oil prices are outside
the company’s controls, however, the prices of PPL’s major revenue driver i.e. Natural Gas are
less sensitive since these are subject to zonal discounts/sliding scale which reduce the
vulnerability to price risk. Furthermore, gas prices of certain fields such as Adhi, Block-22 &
Nashpa etc. are capped and are only subject to change once the international crude oil prices
fall below a certain level.
The future prices of oil were obtained from World Bank forecasted Brent oil prices and median
discount of 2.39% was deducted to reach Dubai Light Prices which can also fluctuate over the
period of time. We conducted a sensitivity analysis to analyze the impact of these fluctuations
in the oil prices on PPL’s share price. Figure on the right shows that the share price of PPL will
increase by 2.21 PKR for each percentage point fluctuation in the oil prices.
MARKET RISK: USD currency assumptions
The company’s revenue are pre-defined in terms of fixed bands which are applicable according
to international Oil prices. These bands also vary on a field & zonal basis. Appreciation of the
domestic currency, i.e. PKR will have adverse impacts on the company’s profitability. However,
keeping in mind the current & historical macro situation of Pakistan, the risk stemming from this
factor is quite low.
A sensitivity analysis was conducted to evaluate the impact of this devaluation on the share
price of the company which is summarized in the adjacent figure and shown in detail in
appendix 21.
P/E EV/EBITDA
Current 8.3 4.44
Peers 9.3 4.36
Forecasted EPS 27 27
Implied Price 251.1 184
Average 218
0.0
5.0
10.0
15.0
2013A
Forward Multiples
Peers MedianEV/EBITDA
Peers MedianP/E
PPLEV/EBITDA
PPL P/E
PPL P/E
Peers MedianP/E
PPLEV/EBITDA
Peers MedianEV/EBITDA
2014F
210.0
220.0
230.0
240.0
250.0
260.0
270.0
280.0
OIL PRICE SENSITIVITY
Source: Team’s estimates
Source: Team’s estimates
160.0
180.0
200.0
220.0
240.0
260.0
280.0
300.0
EX C H A N G E R A T E F L U C T U A T I O N
Source: Team’s estimates
Source: Team’s estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Political Risk: Management Team assumptions
PPL, with 71% shareholding controlled by the government of Pakistan, is subject to the risk of
government intrusion and politically influenced appointments. Although increased media
scrutiny lowers the risk of a non-commercial interest prevailing over the company interest,
appointment of the board/managing director still remains subject to the government’s
discretion.
Political Risk: Petroleum Policy assumptions
The company’s revenues are contingent to petroleum policy which is subject to revision on an
ad-hoc basis. This presents significant uncertainty regarding valuation statistics which has been
done using the old applicable petroleum policies. The Company is a part of the oil and gas sector,
which is one of the most heavily regulated sectors of the economy. Changes in applicable laws
and regulations can adversely affect the Company’s revenues and profitability.
Economic Risk: Circular Debt
The Energy sector has previously been significantly affected by the spiraling circular debt back
in 2007-2008. In FY 2013, the debtor days of the company increased by 5.31 days to 161.35 days.
The situation appears to have repeated itself as the cash-strapped government looks to defer its
obligations until the cash flow situation improves. PPL received PIB’s worth PKR 21,825 Million
carrying a coupon of 11.5% against full settlement of overdue receivables. Although being a
partial resolution of the circular debt crisis, going forward there is material uncertainty regarding
the timely payment of outstanding receivables.
Economic Risk: Competition – Oversupply
The company’s major revenue driver is the Sui Gas Field which is expected to deplete till 2027.
The company’s reserve replenishment ratio is still quite low compared to its local and regional
peers. The Company follows a multi-pronged strategy which consists of seizing the
opportunities for joint bidding and swap arrangements with other E&P companies in order to
reduce its exposure to increased competition and to maintain a balanced exploration portfolio.
Operational Risk: Production & Reserve assumptions
The company is going through a significant change as far as its product mix is concerned. During
HFY2014 the company’s oil production is estimated to go up by 28% mainly due to Nashpa
field while gas production is estimated to decline by 5% due to declining reserves of Sui Field.
Multiple risks stem from the possibility of inaccurate proved reserves data as far as 2P & 3P
reserves are concerned. Numerous uncertainties exist in estimating quantities of proved
reserves. Actual future production may not be in line with the estimated proven reserves.
Operational Risk: Security situation in Balochistan
In the past Sui Gas field has come under militant attacks which resulted in suspension of
production. However, we believe that the Emergency response procedures in place by the
company’s management will avoid disruptions in supply. The company with the help of law
enforcement agencies is expected to safeguard its fields against possible attacks.
Valuation Risk
Valuation has been done using multiple methods e.g. DCF, NAV & Multiples to estimate
accurately the target price. According to Bloomberg, PPL is expected to outperform the KSE-
100 index. This is in line with our expectations based on forecasted financials. However, the
discount factor which has been kept constant at all stages at 17% maybe subject change if the
risk free rate increases. In addition, the terminal growth rate of 5% in is in accordance to long
term growth rate of the economy.
A sensitivity analysis was conducted to capture the impact of this risk on the share price (see
appendix 21).
Risk Mitigating factor
Oil Price Select fields are eligible for zonal discounts,
capped Price on Certain Gas fields
Currency Assumptions
Low probability of USD/PKR appreciation
Management Team
Scrutiny by Media, external stakeholders
Petroleum Policy
Rates revision only for new discoveries
Delay or Default in
settlement
Strong credit policy, Strong ties with
government to recover overdue bills
Disruption in Supply
Crisis management & business continuity
plans in place, collaboration with law enforcement agencies
Economic & political
Instability
Proactive strategy, Regular scrutiny of prevalent situation
Increased Competition
Joint Ventures, swap arrangements
Production & Reserves estimates
Extensive technical studies, third party
verification
150.0
200.0
250.0
300.0
350.0
400.0
DISCOUNT RATE
Source: Team’s estimates
Source: Team’s estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Macro Risks
These risks include interest rate fluctuations and economic volatility. However, such
uncertainties will affect every player in the market. We are confident in PPL’s ability to weather
the interest rate risk as the company does not have debt expect lease financing for computers
and equipment which forms a very small part of the capital structure. The economic volatility is
not expected to affect the company as Pakistan is already facing an energy crisis, a net importer
of oil and currently under talks with nearby neighbors for import of natural gas.
Capturing all the risks
The impact of all the quantifiable risk which can affect our model and in extension our proposed
price for PPL of 256 PKR after a year was captured in a Monte Carlo simulation. Rather than
noting the impact of CPI, exchange rate, oil prices and risk premium in isolation as was done
under sensitivity analysis, this simulation analyzed the combined impact of all these variables on
the stock price. With the result of this simulation, we can say with 95% confidence that the stock
price will not fall below 224 PKR while there is a 25% probability of it being higher than 270 PKR
(see appendix 20 for more details).
SHARE PRICE MOMENTS PPL's 52-week share price range has been between PKR 170/sh to PKR 260/sh. PPL's share price
has been gradually increasing with an upward trend based on the positive exploration news that
investors received throughout the period as well as on exceeding EPS targets for the periods.
Above graph contains daily price data for PPL from January 2012 to January 2014 and we can
see that the share price reaches its highest level after July due to announcement of good results
and high dividend payout ratio. The fall in the share price is due to the rights issue and closing
of book share that took place on September 2012. Because we have classified it as a defensive
stock we can see that there is relatively no effect of external factors on the share price, and all
the changes are due to the internal news or factors. In the year 2013, we can see that increase
in share price was due to internal factors as well. Share price increased due to the discovery at
Sukhpur and successful production testing at Adam-1, and decrease is once again due issuance
of bonus shares and rights. Since September 2013, share price has been steadily increasing
backed by strong financials and earnings growth.
Source: Team’s estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
EXPLORATION Accelerating exploration activity
On the back of the recent exploration licenses awarded to PPL (10 Exploration licenses), it is
evident that PPL is moving on to high prospect areas of Baluchistan and offshore areas. This
would further consolidate their recent success at Gambat, Hala and Tight gas reserves potential
at Kirthar (Gambat with gas reserves of 290 bcf and Hala with gas reserves of 90 bcf). Looking at
PPL’s impressive record, we see high chances of PPL adding to its hydrocarbons reserve in the
medium-term as the company seeks to accelerate exploration. As per our estimates, the
forecasted expenditure is shown on the chart on the left.
Diversified Exploration Portfolio:
In FY13, PPL has 48 exploration blocks (27 operated by the company, 21 by partners) as opposed
to 33 blocks in FY10. Overtime, PPL has diversified its portfolio not only in terms of ownership
but geographically as well. PPL has most of it exploration blocks in Sindh, where geology is well
understood, and is a low risk and low cost area, following decades of exploration. After much
turbulence in Baluchistan, PPL has again entered the area after getting bulk of the blocks there
at the recent license bidding. PPL also has acquired 3 offshore exploration blocks and 3
international blocks (2 in Yemen & 1 in Iraq). The company has applied for extension on
exploration licenses at the offshore blocks as it is optimistic for the future and the offshore
region is relatively unexplored as of now. Offshore Indus is regarded as the world’s second-
largest delta and bears many similarities with many producing deltas in the world. Almost all the
areas in Offshore Indus have been leased out and major multi-national operators (including
Shell, Eni, and UEP) have developed significant interest in this area.
Geographically Spread Gas Reserves:
PPL’s hydrocarbon reserves (Gas specifically) are spread geographically with in Pakistan. As Sui
was one of the first to start commercial production, it helped PPL serve its customers for a major
part of the second half of the last century. Sui still holds about 55% of the total PPL gas reserves,
followed by Kandkhot and Adhi as net in line. As soon as security and political conditions became
severe in Baluchistan, PPL due to its ability to explore other parts of the country was able to find
alternates to fast depleting resources in SUI. Over the years, PPL has shifted its hub of activities
towards Sindh where it currently has about 24 exploration blocks. Other parts of the country e.g.
Kyber Pakhtunkhwa and Punjab, also has PPL’s presence in the region.
CORPORATE GOVERNANCE & SOCIAL RESPONSIBILITY
PPL’s business integrity and its relationship with investors require a wide-ranging and a
comprehensive governance structure. The Board of Directors is at the forefront, through
spending quality time at board meetings and discussions, in order to ensure a strong and an
effective governance system is in place. Resultantly, PPL publishes high quality of Annual
Reports, creates a stringent Audit and Internal Control and emphasizes upon Business Ethics and
Anti-Corruption measures like Whistle Blowing Policy.
PPL recognizes and respects the rights of each and every stakeholder, especially the local
communities, by conducting multiple programs like Rural Development Programs, Emergency
Relief, Business Community Plan, Occupational Health Surveillance Program and Corporate
Philanthropy (appendix 23). This endeavor to fulfill their Social Responsibility has led PPL to
numerous Awards and Recognition.
Being a member of the United Nations Global Compact (UNGC), it stands committed to UNGC’s
principles of sustaining good governance practices; include sustainable socio-economic
development of disadvantaged communities, environmental conservation and high standards of
health and safety as well as human resource development.
50%
19%
13%
6%6%
6%
WELL-DIVERSIFIED PORTFOLIO
Sindh Balochistan KP
Punjab Off-Shore International
3%
55%15%
3%
5%
4%1%
14%
PPL'S GAS RESERVESAdhiSuiKandhkotMazaraniQadirpurGambat Block
Source: Team’s estimates
Source: Company Data
Source: Company Data
0
2
4
6
8
10
12
14
20
08
20
09
20
10
20
11
20
12
20
13
20
14
E
20
15
E
THO
USA
ND
S
Forecasted E&D Expenses
Exploration (Rs. Mn)
Development (Rs. Mn)
Appendix 1: Income Statement
Income Statement
2012A 2013A 2014F 2015F 2016F 2017F 2018F
PKR ('000)
Gross Sales 120 124 137,813 151,253 151,682 152,449 153,551
Net Sales 96,222 102,357 111,128 118,548 118,884 119,486 120,349
Field Expenditure (27,051) (30,603) (27,041) (30,968) (31,318) (31,869) (32,808)
Royalties (11,471) (12,292) (12,970) (14,142) (14,182) (14,254) (14,357)
Gross Profit 57,700 59,461 71,117 73,438 73,384 73,363 73,185
Share of profit from joint venture
68 - 93 99 99 99 100
Other operating income
11,594 6,893 8,649 9,911 9,911 9,911 7,237
Other operating expense
(4,655) (3,333) (3,967) (5,467) (5,482) (5,510) (5,550)
Finance Cost (179) (394) (424.14) (506) (507) (510) (514)
Profit Before Tax 64,529 62,628 75,468 77,476 77,405 77,354 74,459
Taxation (23,629) (20,677) (25,567) (25,473) (24,675) (23,886) (22,247)
Profit After Tax 40,899 41,951 49,900 52,003 52,730 53,469 52,212
Preferred Dividends
(0.041) (0.042) (0.044) (0.044) (0.044) (0.044) (0.044)
Profit to Common Equity
40,899 41,951 49,900 52,003 52,730 53,469 52,212
EBITDA 71,426 70,325 83,234 83,590 83,478 83,303 80,253
Shares outstanding
1,314,477 1,643,110 1,971,732 1,971,732 1,971,732 1,971,732 1,971,732
EPS 31.11 25.53 27.00 26.37 26.74 28.00 26.48
DPS 11.50 10.50 12.15 11.87 12.03 12.60 11.92
Payout Ratio 37% 41% 45% 45% 45% 45% 45%
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 2: Balance Sheet
Balance Sheets (Annual) 2012A 2013A 2014F 2015F 2016F 2017F 2018F
PKR ('000) Share Capital 13,145 16,431 19,717 19,717 19,717 19,717 19,717 Reserves 113,239 132,923 162,246 200,276 253,596 325,022 395,348
Total Equity 126,384 149,354 181,963 219,994 273,313 344,740 415,065
Provision for de-commissiong obligation 14,335 15,990 15,990 15,990 15,990 15,990 15,990 Long-term liability for gas development surcharge - - - - - - - Finance lease liability 131 165 165 165 165 165 165 Deferred liabilities 1,562 1,813 1,813 1,813 1,813 1,813 1,813 Deferred income - - - - - - - Deferred taxation 6,872 8,908 - - - - -
Non-Current Liabilities 22,899 26,875 17,967 17,967 17,967 17,967 17,967
Trade and other payables 18,096 33,398 18,210 19,453 18,096 33,398 24,876 Current maturity of long-term liability for GDS - - - - - - - Current maturity of finance lease liabilities 83 109 109 109 109 109 109 Current maturity of deferred income 1 - - - - - - Taxation 3,087 3,165 3,165 3,165 3,165 3,165 3,165
Current Liabilities 21,268 36,672 21,484 22,727 21,370 36,672 28,150
Total Liabilities & Equity 170,551 212,901 221,415 260,688 312,651 399,379 461,182
Fixed Assets 55,747 70,481 18,973 18,973 18,973 18,973 18,973 Property, Plants, & Equipment 55,313 70,079 18,962 18,962 18,962 18,962 18,962 Intangible Assets 434 402 10.55 10.55 10.55 10.55 10.55 Equity accounted investment in joint venture 413 - 0 0 0 0 0 Long term investments 20,346 55,707 55,707 55,707 55,707 55,707 33,418 Long term loans 21 1,519 1,519 1,519 1,519 1,519 1,519 Long term deposits 698 743 743 743 743 743 743 Deferred Tax Asset - - - - - - - Long term receivables 72 293 293 293 293 293 293
Non Current Assets 77,297 128,742 77,234 77,234 77,234 77,234 54,945
Stores and spares 3,468 2,835 30,811 32,096 50,159 40,337 40,631 Trade Debts 50,159 40,337 32,881 34,369 53,627 43,173 43,799 Loans and advances 692 1,003 1,003 1,003 1,003 1,003 1,003 Trade deposits and short term prepayments 161 283 283 283 283 283 283 Accrued financial income 553 1,496 1,496 1,496 1,496 1,496 1,496 Current maturity of long term investments 748 2,001 0 0 0 0 0 Current maturity of long term receivables 4 29 29 29 29 29 29 Other receivables 528 1,652 1,652 1,652 1,652 1,652 1,652 Short term investments 35,265 28,339 51,797 82,221 124,877 182,018 238,278 Taxation - - - 0 0 0 0 Cash and bank balances 1,675 6,184 24,229 30,304 2,291 52,154 79,066
Current Assets 93,254 84,159 144,180 183,454 235,417 322,144 406,237
Total Assets 170,551 212,901 221,415 260,688 312,651 399,379 461,182
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 3: Cash Flow Statement
Cash Flow Statement 2012A 2013A 2014F 2015F 2016F 2017F 2018F
PKR ('000)
Net Income 40,899 41,951 49,900 52,003 52,730 53,469 52,212
Non Cash Charges 6,898 7,698 7,767 6,115 6,073 5,948 5,795
Unwinding of Discount
Adjusted Net Income 47,797 49,649 57,667 58,118 58,803 59,417 58,006
Changes in WC (19,420) 25,124 (9,212) (5,538) (251) (449) (645)
Change in Trade Debts (18,063) 9,822 (10,571) (3,399) (154) (276) (396)
Change in Payables (1,357) 15,301 1,359 (2,139) (97) (173) (249)
Gains and Losses on sale of assets
Change in Stores and Spares
(1,195) 632 (933) (252) (11) (20) (29)
CF from Operating 27,183 75,405 47,522 52,328 58,540 58,948 57,333
CAPEX (2,085) (2,516) (2,750) (2,750) (1,925) (1,233) (734)
Current Maturity and LT Investments
(698) (1,252) 2,001 0 0 0 0
Changes in Short Term (14,414) 6,926 (30,918) (39,901) (41,584) (42,165) (42,755)
CF from Investing (17,197) 3,158 (31,667) (42,651) (43,508) (43,398) (43,489)
Dividends paid (15) (17) (24) (23) (24) (25) (23)
Preferred Dividends (0) (0) (0) (0) (0) (0) (0)
CF from Financing (15) (17) (24) (23) (24) (25) (24)
Net Change in Cash 9,970 78,546 15,831 9,653 15,008 15,525 13,820
Beg of year Bal 1,503 1,675 6,184 9,311 21,844 36,848 52,491
Ending of year Bal. 11,473 80,221 22,015 18,964 36,853 52,373 66,311
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 4: Ratio Analysis
Ratio Analysis FY12A FY13A FY14F FY15F FY16F FY17F FY18F
Profitability Ratios
Gross Profit Margin 60% 58% 64% 62% 62% 61% 61%
EBIDTA Margin 74% 69% 75% 71% 70% 70% 67%
Net Profit Margin 43% 41% 45% 44% 44% 45% 43%
Operating Margin 67% 61% 68% 65% 65% 65% 62%
Return on Assets 24% 20% 20% 17% 15% 13% 11%
ROE 32% 28% 26% 22% 18% 15% 13%
FCF (In millions) 26,292 72,257 89,648 92,542 92,704 93,022 93,423
Operating/Liquidity Ratios
Days Payable Outstanding
148 149 151 152 153 154 155
Total Assets Turnover 0.68 0.68 0.68 0.68 0.68 0.68 0.68
Current Ratio 4.38 2.29 3.62 4.91 6.41 7.92 10.01
Cash to Current Liabilities
1.74 0.94 1.94 3.23 4.73 6.24 8.33
Solvency Ratio 1.08 0.78 0.96 0.92 0.92 0.92 0.89
Assets/Equity 1.35 1.43 1.31 1.26 1.22 1.19 1.16
Solvency
Fixed Charge Coverage ratio
361 160 179 154 154 153 146
Debt/Equity 0.1% 0.1% 0.1% 0.1% 0.1% 0.0% 0.0%
Valuation
P/E 6.0 8.3 8.1 8.3 8.2 7.8 8.3
EPS Growth 18.2% -17.9% 5.8% -2.3% 1.4% 4.7% -5.4%
FCF Yield 10.7% 20.9% 21.0% 21.7% 21.8% 21.8% 21.9%
EV/EBIDTA 2.94 4.44 4.29 3.65 2.98 2.29 1.37
EV/Production (BOE) 3,218 5,197 6,175 5,293 4,372 3,403 1,989
EV / Reserves (BOE) 0.25 0.38 0.47 0.43 0.38 0.32 0.20
Price/Book Value 1.95 2.32 2.23 1.77 1.45 1.23 1.07
Market
EPS 31.1 25.5 27.0 26.4 26.7 28.0 26.5
DPS 11.50 10.50 12.15 11.87 12.03 12.60 11.92
Earnings Yield 16.6% 12.1% 12.3% 12.0% 12.2% 12.8% 12.1%
Payout Ratio 37.0% 41.1% 45.0% 45.0% 45.0% 45.0% 45.0%
Enterprise Value 209,657,4
83 312,173
,416 357,487
,484 305,052
,480 248,465
,630 190,657,
603 109,814
,003
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 5: Upstream Analysis
Raw oil or gas are initially explored, extracted and then produced by the E&P companies. They are then processed
by refineries and lastly, the OMCs make available these products to the consumer. However, analyzing the E&P
sector through the lens of international business, we bring to forefront the riskiness of current business scenario.
In a report published by Ernst & Young titled ‘Top 10 Oil and Gas Business Risks for 2010’, the two core factors in
strategic analysis i.e. ‘Access to reserves’ and ‘overlapping of service offerings’ have reduced in relativistic
measures. However, to comprehend the entire picture, we take into considerations all four quadrants of Financial,
Compliance, Strategic and Operations in view to better understand the trickledown effect to the local region where
PPL operates.
Source: Petrostrategies.org
Appendix 6: Pakistan Proved Reserves
Source: US Energy Information Administration (EIS)
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 7: Pakistan Natural Gas Production
Appendix 8: Pakistan’s Oil Consumption
Source: US Energy Information Administration (EIS)
Source: US Energy Information Administration (EIS)
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 9: Pakistan Natural Gas Proved Reserves
Appendix 10: Pakistan Natural Gas Consumption
Source: US Energy Information Administration (EIS)
Source: US Energy Information Administration (EIS)
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 11: Pakistan Total Oil Production
Appendix 12: GDP vs Consumption
Source: US Energy Information Administration (EIS)
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 13: Activity Map
Source: Company Data
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 14: Production
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
FY0
6A
FY0
7A
FY0
8A
FY0
9A
FY1
0A
FY1
1A
FY1
2A
FY1
3A
FY1
4F
FY1
5F
FY1
6F
FY1
7F
FY1
8F
FY1
9F
FY2
0F
FY2
1F
FY2
2F
FY2
3F
FY2
4F
FY2
5F
FY2
6F
FY2
7F
FY2
8F
FY2
9F
FY3
0F
FY3
1F
FY3
2F
FY3
3F
Yearly Oil Production (Barrels)
Adhi Kandhkot (Con) Sui (Con) Mazarani
Adam Qadirpur (Cond.) Miano Manzalai
Mamekhel Maramzai Makori Makori-east
Gambat Block Hala Block Mela Naspha
0%
20%
40%
60%
80%
100%
Field Wise Revenue Share
Adhi Sui Kandhkot Mazarani Chachar Adam
Block-22 Qadirpur Miano Sawan Manzalai Mamikhel
Maramzai Makori Makori -east Mela Gambat Block Hala Block
Lundali Latif Tajjal Naspha Kirthar
Source: Team Estimates
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100% F
Y06
A
FY0
7A
FY0
8A
FY0
9A
FY1
0A
FY1
1A
FY1
2A
FY1
3A
FY1
4F
FY1
5F
FY1
6F
FY1
7F
FY1
8F
FY1
9F
FY2
0F
FY2
1F
FY2
2F
FY2
3F
FY2
4F
FY2
5F
FY2
6F
FY2
7F
FY2
8F
FY2
9F
FY3
0F
FY3
1F
FY3
2F
FY3
3F
FY3
4F
FY3
5F
FY3
6F
FY3
7F
FY3
8F
Yearly Field Wise Gas Production (mmcf)
Adhi Sui Kandhkot Mazarani Chachar Adam
Block-22 Qadirpur Miano Sawan Manzalai Mamikhel
Maramzai Makori Makori -east Mela Gambat Block Hala Block
Lundali Latif Tajjal Naspha Kirthar
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 15: Field Wise Gas Price
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
5.50
6.00
Field Wise Gas Price
Adhi Sui Kandhkot Mazarani
Chachar Adam Block-22 Qadirpur
Miano Sawan Manzalai Mamikhel
Maramzai Makori Makori -east Mela
Wafiq - Gambat South Adam - Hala Lundali Latif
Tajjal Naspha Kirthar
Source: Team Estimates via Petroleum Policies
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 16: Expected Cash Flows
Appendix 17: Multiples Comparison
Multiples Comparison P/E EV/EBITDA
Company 2013A 2014F 2013A 2014F
CNOOC (China) 8.2 8.1 2.92 2.45
PetroChina (China) 10 8.6 4.97 4.36
Sinopec (China) 7.5 6.8 4.03 4
Cairn India 4.8 5.1 3.31 3.32
ONGC (India) 9.4 8.8 3.46 3.38
PTT pcl (Thailand) 7.4 7.3 3.69 5.12
PTT exploration 9.5 9.3 6.41 5.77
AWE (Australia) 21.3 45.8 3.77 3.69
Beach Energy (Australia) 13.5 11.3 3.54 3.48
Oil Search (PNG) 67.9 17.9 16.86 15.11
Origin Energy (Australia) 17.5 17 8.6 8.54
Roc Oil Company (Australia) 4.4 3.5 1.34 1.37
Santos (Australia) 21.5 19.8 6.8 6.73
Tap Oil 114 43.7 0.48 0.44
Woodside Petro (Australia) 15.8 13.9 6.04 6.02
OGDC 12.52 9.3 4.7 4.48
POL 8.94 8 6.6 4.6
Median 10.0 9.3 4.03 4.36
43%
32%
25%
Forecasted 2014
CF fromFinancing
CF fromInvesting
Cash & cashequivalents atend of year
40%
40%
20%
Forecasted 2015
CF fromFinancing
CF fromInvesting
Cash & cashequivalents atend of year
Source: Team Estimates
Source: Company Data
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 18: Risk Matrix
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 19: Regression Analysis
Company Name Ticker R2 ᵨ T-stat for ᵨ
PPL PPL 27% 51.72% 11.91
CNOOC CNOOC 70% 83.86% 5.72
PETROCHINA PTR 62% 29.67% 8.969
ONGC ONGC 9% 29.67% 11.33
We ran a basic regression analysis for testing the correlation of PPL stock prices along with its regional
peers with Arab Light Oil prices. The dependent variable can be defined as stock prices of each company,
while the independent variable was the Arab light Oil prices. The period was for the regression was
defined as 2009-2013. To further supplement the analysis we conducted t-test for correlation
coefficient, and with 5% level of significance we conclude that all the correlation coefficients are
statistically different from 0.
Conclusions
The purpose of this analysis was simply to test the correlation of PPL’s stock performance and oil price
trends. The correlation coefficient (ρ) for PPL stock price, turned out to be 0.52. This showed significant,
positive relationship. Moreover, we sought to check whether PPL differs significantly, in the manner of
this relationship, from the regional competitors. The conclusion is that there are no significant
differences, with the exception of ONGC, which is an Indian based company.
30
55
80
105
130
50
100
150
200
250
300
1-J
an-0
9
1-A
pr-
09
1-J
ul-
09
1-O
ct-0
9
1-J
an-1
0
1-A
pr-
10
1-J
ul-
10
1-O
ct-1
0
1-J
an-1
1
1-A
pr-
11
1-J
ul-
11
1-O
ct-1
1
1-J
an-1
2
1-A
pr-
12
1-J
ul-
12
1-O
ct-1
2
1-J
an-1
3
1-A
pr-
13
1-J
ul-
13
1-O
ct-1
3
$/B
AR
REL
PK
R/S
HA
RE
DATE
PPL Share Price Arab Light Price
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 20: Monte Carlo Simulation Monte Carlo Simulation was conducted in addition to the sensitivity analysis to analyze the combined impact of variables that affect our target stock price.
Variable Distribution Parameters Explanation
Δ g (OIL P)
Normal X = 0 SD = 1%
The future prices of oil may fluctuate around a standard normal distribution which will be multiplied with production volume to get revenues in USD
Δ USD/PKR
X = 4% SD = 1.5%
Gives the devaluation rate of PKR in range of 1% to 7% with 95% probability. These rates are then used to convert the revenue of PPL to PKR
ΔCPI X = 8% SD = 2.5%
Changes in inflation will be 0% on average with a standard deviation of 2.5% on a normal curve which will be used to get the final CPI
Δ Risk Premium
X = 7% SD = 1.67%
Risk premium will vary from 2% to 12% with 99% probability. This premium and CPI will be used to calculate discount rate at each iteration which will also follow a normal distribution
The time period selected for this analysis was the same as in the valuation, which is 25 years from 2015 onwards.
10,000 iterations were performed to allow the variables to distribute along their curves and get an
accurate estimate
The result of the Simulation is presented in the following graph
Source: Team Estimates
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 21: Sensitivity Analysis
Oil Prices
As discussed in the report oil price is a major part of the Valuation model used to price this share.
Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor
should be able to judge the impact different values of this variable will have on the share price. These
values are analyzed in the sensitivity analysis above where each percentage point rise in the price of oil
causes the share price to rise by 2.21 PKR. The range of price vary from 235 PKR to 276 PKR with oil price
fluctuations of -10% to 10%. The relationship between oil price and share price is linear which means
sensitivity remains the same at each point in the graph.(Team Estimates)
Exchange Rate
Depreciation of rupee against dollar works in favor of PPL since it receives price for oil and gas in USD.
Hence fluctuations in the exchange rate will affect its revenues and in extension the share price. We
believe that the investor should be able to judge the impact different values of this variable will have on
the share price. These values are analyzed in the sensitivity analysis above where each percentage point
rise causes the share price to rise by 9.5 PKR. The range of price vary from 204 PKR to 278 PKR with
exchange rate fluctuations of -2% to 6%. The relationship between exchange rate and share price is non-
linear and share price becomes more sensitive at higher fluctuation rates. (Team Estimates)
210.0
220.0
230.0
240.0
250.0
260.0
270.0
280.0
-10% -9% -8% -7% -6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
160.0
180.0
200.0
220.0
240.0
260.0
280.0
300.0
-2% -1% 0% 1% 2% 3% 4% 5% 6%
CFA RESEARCH CHALLENGE JAN 31st 2014
CPI
Another major part of the projections is the Expected Consumer Price Index (ECPI), which has been
assumed to affect a lot of cost heads. Therefore, an incorrect estimation of this variable can impact the
price. For this purpose a sensitivity analysis was performed for the expected consumer price index. The
ECPI was varied from 0% to 20% (the value in the base model is 8%), with intervals of 1%, and the
recalculated share prices were recorded. The range of price vary from 181 PKR to 360 PKR while each
percentage point change in CPI causes the price to fall by 9 PKR on average. (Team Estimates)
Risk Premium
Another major part of the NAV Valuation model used to price this share is the Market Risk Premium.
Therefore, an incorrect estimation of this variable can impact the price. We believe that the investor
should be able to judge the impact different values of this variable will have on the share price
For this purpose a sensitivity analysis was performed for the market risk premium. The market risk
premium was varied from 0% to 16% (the value in the base model is 7%), with intervals of 1%, and the
recalculated share prices were recorded. The range of price vary from 193 PKR to 342 PKR while each
percentage point change in risk premium causes the price to fall by 10 PKR on average. (Team Estimates)
150
200
250
300
350
400
150
200
250
300
350
400
CFA RESEARCH CHALLENGE JAN 31st 2014
Discount Rate:
Another major part of the NAV Valuation model used to price this share is the Discount Rate. Therefore,
an incorrect estimation of this variable can impact the price. We believe that the investor should be able
to judge the impact different values of this variable will have on the share price
For this purpose a sensitivity analysis was performed for the market risk premium. The market risk
premium was varied from 4% to 30% (the value in the base model is 17%), and the recalculated share
prices were recorded. The range of price vary from 176 PKR to 476 PKR. (Team Estimates)
150.0
200.0
250.0
300.0
350.0
400.0
CFA RESEARCH CHALLENGE JAN 31st 2014
Appendix 22: Stock Price Simulation The risk associated with PPL stock was also measured through calculation of Value at Risk (VAR) using
Monte Carlo Simulation. Following parameters were used for this simulation
Simulation Parameters
Stock Price 221.22
Mean Returns 21%
Std Dev. 32%
Time Step (Year) 0.08
Number of Runs 10,000
Descriptive Statistics
Mean 273.9
Median 261.8
Standard Deviation 87.3
Skewness 0.9
Minimum 88.8
Maximum 751.0
Upside Potential 70%
Count 10,000
As per the result of this simulation, we can say with 95% confidence that the share price will not fall below 155 PKR in a year.
Source: Team Estimates
0
0.01
0.02
0.03
0.04
0.05
0.06
STOCK PRICE SIMULATION RESULT
SellHold
Buy
CFA RESEARCH CHALLENGE JAN 31st 2014
APPENDIX No 23: CORPORATE GOVERNANCE AND SOCIAL RESPONSIBILITY
FRAMEWORK & MECHANISM: THE GLOBAL COMPACT
PPL became a member of UNGC in April, 2006 and has remained
committed to its principles of sustaining good governance practices
ever since.
HUMAN RIGHTS Principle 1: PPL respects the rights of it human resource by
supporting their right to education, healthcare, and basic civic
amenities.
Principle 2: PPL conducts its business according to the highest
ethical standard.
LABOR STANDARDS Principle 3: PPL acknowledge the rights of collective bargaining and
freedom of association (Unionization) and fosters the relationship
between Management and Workers as a result.
Principle 4&5: PPL supports abolition of child labor and elimination
of forced and compulsory labor
Principle 6: PPL provides equal opportunities for employment and
does not discriminate on the basis of race, religion, sex, language,
and social origin
ENVIRONMENT Principle 7: PPL complies with National Environmental Quality
Standards.
Principle 8: PPL is committed to raise awareness about
environmental issues among the masses and other stakeholders,
and work towards minimizing its own impact on the environment.
Principle 9: PPL is committed to investing in the latest
environmental-friendly technology to reduce its own carbon
footprint.
ANTI-CORRUPTION
Principal 10: PPL is committed to eliminate corruption within its own
business operations as well as with its relationships with external
stakeholders. This is to be achieved through implementation of
stringent ethical codes and policies.
Corporate Governance Methodology: For assessing the overall strength of Corporate Governance policies
AND Social Responsibility at PPL, we have tried to rate their actions as
per the United Nations Global Compact framework & mechanism and
assigned ratings to each criteria. As a result we have given them a
score of 7.8 out of 10. We have given extra weightage to Environment
and Anti-corruption (30% weight) as opposed to Human Rights and
Labor (20% weight)
UNITED NATIONS GLOBAL
CHARTER
HUMAN
RIGHTS
LABOR STANDARDS
ENVIRONMENT
ANTI-CORRUPTION
CFA RESEARCH CHALLENGE JAN 31st 2014
According to our estimates, PPL receives a score of 7.8 (out of 10) on their
implementation of the United Nations Global Compact. Although, the score is
quite impressive, considering it is an E&P company, there is still vast room for
improvements. Some of such areas are discussed below:
As most of the exploration blocks are situated near extremely undeveloped
areas, comprising of deprived and underprivileged population, PPL can most
certainly do more in assisting for the betterment of the society in general and
community in particular.
PPL, being a state-owned enterprise, has deep and entrenched level of
bureaucratic layers, which has impeded the company from realizing its
potential. This has meant that a lot more can be done to promote ethics and
anti-corruption policies within the organization.
Source: Team Estimates
UNGC Criteria PPL’s Score for each Criteria
PPL’s Score after applying Weights
HUMAN RIGHTS 9 1.8
LABOR STANDARDS
9 1.8
ENVIRONMENT 7 2.1
ANTI-CORRUPTION 7 2.1
TOTAL SUM 7.8
20%
20%
30%
30%
Governance Methodology Weights
HUMANRIGHTS
LABORSTANDARDS
ENVIRONMENT
ANTI-CORRUPTION
CFA RESEARCH CHALLENGE JAN 31st 2014
APPENDIX No 24: PORTER’S FIVE FORCES
Threat of New Entrants: [Rating = 2]
High barriers to enter the market
Exploration licenses needed: About 8 local and 2 foreign firms were awarded licenses recently
High level of technical expertise required
High capital costs
Bargaining Power of Suppliers: [Rating = 3]
limited number of drilling machinery and equipment producers, detonation and seismic systems
Entrance of reputed international players like Schlumberger, Weatherford etc have increased options
available to existing players for latest technology.
Specialized labor force required
Bargaining Power of buyers: [Rating = 2]
Highly regulated industry where both upstream and downstream companies are state-owned, therefore
government regulations play an important role in the buyer-seller relationship.
Limited number of buyers
Competition in the Industry: [Rating = 1]
More than 60% of the total hydrocarbons being produced by the 3 leading companies. HHI index is greater
than 0.25 (High concentration)
Relatively large competitors
Higher Oil production gives higher revenues to the players. Long term focus towards increasing the share of
oil in the production mix
Joint Ventures are common in order to hedge their risks associated with exploration and development
Threat of Substitutes: [Rating = 1]
Highly inelastic demand and all that is produced is easily sold off as Pakistan is an energy starved country.
Globally, shale gas is touted to become a substitute for natural gas and similar fossil fuels.
Soure: Team Estimates
00.5
11.5
22.5
3Threat of New Entrants
Bargaining PowerSuppliers
Bargaining Power ofBuyers
Competition in theIndustry
Threat of Subsitutes
Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society of Pakistan, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.
CFA Institute Research Challenge