united capital flash note oil and gas - downstream

United Capital

Curr. Price Target Price Return Ratings P/E (x) P/BV (x) ROE (%) Div. Yield (%) Mkt. Cap (N'Mn) Total Assets (N'Mn) SHF (N'Mn) Net Margin Revenue (N'Mn)

CONOIL 36.21 28.40 -21.6% Sell 8.2 1.4 18.2 11.1 25,128 94,483 16,689 1.92 25,716

FO 187.00 103.19 -44.8% Sell 131.2 23.0 16.9 1.1 243,564 139,238 139,238 1.41 47,547

MOBIL 150.03 165.29 10.2% Hold 8.5 4.0 55.4 4.2 54,100 49,227 13,550 8.03 18,866

OANDO 17.96 30.05 67.3% Buy na 0.8 3.9 5.6 163,161 995,457 215,277 0.31 143,548

TOTAL 155.50 182.15 17.1% Buy 11.9 3.8 32.6 6.3 52,796 95,512 13,930 1.84 62,811

0.3

1.0

1.7

Apr-14 Aug-14 Dec-14 Apr-15

NSE ASI Oil & Gas

United Capital

05 May 2015

United Capital

Securities Trading

+234-1-280-8919

[email protected]

Asset Management

+234-1-280-7822

[email protected]

Trusteeship

+234-1-280-7853

[email protected]

Drivers and Drags…. Where is the balance of risk?

• The drumbeats of full deregulation are getting louder

• PMS demand is forecast to hit 41mn liter/day in 2015

• Crude Oil Price Slump; negligible impact on downstream players

• Foggy Climate of Uncertainty will stiffen Q2’2015 earnings

• Diversification and retail expansion will support profitability in 2015

• Cost efficient players will be better off

United Capital Research I Nigeria I Oil & Gas I Equities

Flash Note

Nigeria (Downstream) Oil and Gas

Analyst: Kayode Omosebi

+234-1-2808425

[email protected]

Team lead: Kayode Tinuoye

+234-1-2807334

[email protected]

The drumbeats of full deregulation are getting louder…

Although the fall in crude oil prices and the resultant effect on landing cost of

Premium Motor Spirit (petrol) has seen subsidy bill per liter drop significantly,

the strain on government revenue has brought the complete deregulation of

the downstream sector to the front burner. Judging from the body-language

of the incoming administration regarding the oil and gas sector and the

approval of the recommendation for the complete removal of subsidy by the

FAAC committee in April 2014, we think subsidy reforms are now imminent in

the near term. What’s more, the 2015 budget makes zero allocation for

subsidy payments.

…but it may take a longer time than the market anticipates

We think the full deregulation of the sector via total subsidy removal holds the

maximum benefits to players in the downstream. However, we note that this is

practically a daunting task given current political dynamics. Moreover,

complete subsidy removal remains unpopular among major oil producing

countries globally. The current scenario however makes market players worse

off given mounting pressure from FX weakness. More importantly, it is

unsustainable for the government in light of current fiscal pressures. We

therefore envisage a phased deregulation of the sector, where subsidy

removal is staggered alongside domestic refining capacity build-up.

Ultimately, a full deregulation of the sector will lead to market-determined

petroleum prices. This will support top-line growth for players even as market

determined pricing of petroleum products will attract significant level of

private investment in the sector which will lead to increased competition,

higher level of productivity and lower prices.

Source: Company Filings, Bloomberg, United Capital Research

In spite of the direct impacts o from macro headwinds,

the Oil and Gas sector has outperformed the market in

the last one year…

NSE, United Capital research

(%)

United Capital Research

www.Unitedcapitalplcgroup.com

Current Price 24.3

2015 Year High 25.2

2015 Year Low 17.0

YTD Return -3.6%

Average Volume (mn units) 21.7

Average Value traded ( N'mn) 533.3


Furthermore, a deregulated downstream sector will attract interest in local

refineries and pipelines. We expect the privatization of the four (4) state-

owned refineries – 2 in Port-Harcourt (PHRC) and 1 each in Kaduna (KPRC)

and Warri (WRPLC) to commence this year while greenfield refineries are

expected to begin production in the near term. We also foresee some

downstream players embarking on investment in refineries as the sector

opens up.

Petrol Demand to hit 41mn liter/day in 2015, with plenty room for upside

Petrol demand is expected to be about 41mn liter/day in 2015 from 39mn

liter/day in 2014. Demand for petrol may grow to 51mn liter/day in 2020 and

could hit 60mn liter/day by 2025. The projected increase in petrol

consumption in 2015 stems from increasing industrial, transportation,

technology and infrastructure needs as well as residential needs mostly for

cars and generators. We do not expect a quick fix in the power reform by the

incoming administration, therefore PMS demand from generators will remain

high in the near term. We believe Nigeria is going through a process of energy

transition which will drive demand for energy going forward. On average, fuel

contributes c.90% of revenue for the quoted downstream players while PMS

contributes c.78% of revenue. The projected increase in petrol demand will

support revenue growth; a drop in cost of sales (post-deregulation) while

efficient local refineries will improve revenue margin of downstream players.

Crude Oil Price Slump; negligible impact on downstream players

In a deregulated market, drop in oil price will bode well for downstream

players as crude oil prices correlate positively with the all-in cost of refined

products. For subsidy-paying countries, this also means lesser occurrence of

under-recoveries on account of selling fuels below cost. Although oil

marketers mostly get fully compensated for the under-recoveries, payments

from the government come with long delays which usually forces players into

heavy borrowing and stretched balance sheets. This said, it is important to

note that since the drop in crude oil price is supply driven, rather than

demand, there is nothing to worry about for downstream players. However,

despite the decline in input costs for deregulated products such as AGO and

lubricants, the existing regulated environment continues to restrict expansion

in the operating margins of players in the downstream.

15.3

0

5

10

15

20

25

2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024

Billions

Source: CITAC, United Capital Research

PMS Consumption per liter in Nigeria (Historical & Forecast)



$/MT Naira/Litre

1 C + F 697.41 102.45

2 Trader’s Margin 10 1.47

3 Lightering Expenses (SVH) 28.44 4.18

4 NPA 5.25 0.77

5 Financing (SVH) 10.88 1.6

6 Jetty Depot Thru’ Put Charge 5.45 0.8

7 Storage Charge 20.42 3

8 Landing Cost 777.84 114.27

Distribution Margins:

9 Retailers 31.31 4.6

10 Transporters 20.35 2.99

11 Dealers 11.91 1.75

12 Bridging Fund 39.82 5.85

13 Marine Transport Av erage (MTA) 1.02 0.15

14 Admin Charge 1.02 0.15

15 Subtotal Margins 105.44 15.49

16 Highw ay Maintenance

17 Gov ernment Tax

18 I mport Tax

19 Fuel Tax

20 Subtotal Taxes

21 Total Cost 883.28 129.76

22 ** Ex-Depot (for collection) 528.64 77.66

23 ** Under/Ov er Recov ery 291.07 42.76

24 Retail Price 592.22 87

Expected Open Market Price (OMP) (Naira/litre) is Landing cost +Margins 129.76

* C+F price is Offshore Nigeria

Conversion Rate (MT to Litres): 1341

Exchange Rate (N to $): 197

* Official Ex Depot is exclusiv e of Bridging Fund, Marine Transport Av erage (MTA) & Admin. Charge

* *Ex Depot includes Bridging Fund, Marine Transport Av erage (MTA) & Admin. Charge

*** Effectiv e Date of New Approv ed Pricing Template is 19th January, 2015

Data is as at 27/04/15

PMSCost Element

PPPRA PRODUCT PRICING TEMPLATE PMS

Based on Average Platts’ Prices for 27th April, 2015

Average Exchange Rate of the NGN =N= to US$ for 27th April, 2015



Oando40%

Total

19%

Conoil

12%

Eterna7%

FO

10%

Mobil

6%

MRS6%

Source: Company Fillings, United Capital Research

Market Share by turnover based on recent fillings

Foggy Climate of Uncertainty will stiffen Q2’2015 earnings…

It is no news that the 2015 budget of N4.5trn which has been passed by both

the upper and lower chamber has shown total exclusion of fuel subsidy

payment. Though we expect the budget to be reviewed by the incoming

administration, we think the lack of clarity and foggy climate of uncertainty

will affect operations of players in the short term and stiffen Q2’2015 numbers.

The recent devaluation of the Naira has affected operation of downstream

players in terms of forex differentials of under recovery of subsidy and a longer

period in dollar bidding to import petrol. This has led to a reduction in

importation of PMS over the past four months. Furthermore, downstream

players have been faced with heavy financial burden due to outstanding

subsidy payments; the resultant effect of this is an increase in impairment

charge on loans to downstream players by the bank. The lack of clarity and

foggy climate of uncertainty certainly means that the banks will be much

more cautious in extending credit to the downstream sector while players will

have to tread carefully in future imports.

However, we believe this issue is temporary as we expect the incoming

administration to provide clarity on the future of the industry which will guide

operators.

…but diversification and retail expansion will support profitability in 2015

Players in the industry have begun to push sales of non-regulated petroleum

products through enhanced distribution and retail network. Petrol sales

promotes sales of other petroleum products, therefore evenly distributed

service station will help drive sales of other products. Furthermore, growing

market share will play a major role. Petrol margin is slim at 10% of pump price,

therefore pushing volumes and growing market share is key to operating

profitably. Players with low market share will end up as fringe players with

heavy investment outlays yielding low returns. OANDO and TOTAL dominate

the market



Strong brand name, retail outlet distribution, good technical support and

strategic assets will help support retail expansion. We expect the big

downstream players to expand their operations into refining post

deregulation. Forte Oil and OANDO have diversified their business to non-

traditional petroleum marketing activities, with FO’s acquisition of Geregu

power plant and OANDO’s acquisition of ConocoPhillips’s assets; we expect

this to drive growth for both companies.

We expect to see greater efficiency in cost management

The recent drop in petrol pump price means an increase in subsidy

payments, which have often been delayed; hence players have had to

borrow more to offset cost due to lengthened subsidy reimbursement on the

back of government’s weak fiscal position. Given our outlook of a long

route to full deregulation, we believe cost management will be a major

driver of profitability in the medium term. We expect opex-to-sales ratio to

drop by 3bps to 7.2% for 2015 but the retail drive of most players will exert

pressure on OPEX. We think players like Mobil will continue to be pressured

by its higher operating leverage relative to the industry with opex-to-sales

ratio of 10% versus peer average of 7.5% despite its past stellar performances

in cost efficiency. Overall, we think downstream players will need to

manage cost efficiently especially for deregulated products. We expect to

see a decline in industry cost-to-sales to 88.3% and an average of 88.5% for

the next 5 years though reduction in petrol price and other cost factors will

pressure top line and stiffen margin in the short term.



Investment Rating Criteria

United Capital Research adopts a 3-tier recommendation system for assets under our coverage: Buy, Hold and Sell. These generic

ratings are defined below;

Buy: Based on our valuation and subjective view (if any), the total return upside on the stock’s current price is greater than our

estimated cost of equity.

Hold: Based on our valuation and subjective view (if any), the total return upside on the stock’s current price is less than the cost

of equity, however, the expected total return on the stock is greater than or equal to the Standing Deposit Facility rate of

the Central Bank of Nigeria (which is currently MPR – 200bps; i.e 10%). We consider this as the minimum return that may

deserve our holding of a risk asset, like equity.

Sell: Based on our valuation and subjective view (if any), the total return upside on the stock’s current price is less than the

Standing Deposit Facility rate of the Central Bank of Nigeria (which is currently MPR – 200bps; i.e. 10%). We consider this as

the minimum return that may deserve our holding of a risk asset, like equity, especially as we consider the average 4.5%

total transaction cost for an average retail investor.

NR*: Please note that in addition to our three rating heads, we indicate stocks that we do not rate with NR; meaning Not-Rated.

We may not rate a stock due to investment banking relationships, other sources of conflict of interests and other reasons

which may from time to time prevent us from issuing a rating on the shares (or other instruments) of a company.

Please note that we sometimes give concessional rating on stocks, which may be informed by technical factors and market

sentiments.

Current Stock Rating Dispersion and Relationship

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Company Disclosure

Dangote Cement Plc h

Dangote Flour Plc h

Dangote Sugar Plc h

Diamond Bank Plc h

FirstBank Holdings Nigeria Plc h

Guaranty Trust Bank Plc h

Guinness Nigeria Plc h

PZ Nigeria Plc h

Transnational Corporation of Nigeria Plc g, h

Disclosure keys

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united capital flash note oil and gas - downstream

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