1. 1
Pak E&P Sector- Heads I win, tails I do not lose much!
E&P stocks and crude decoupling- Since our initiation on Pakistan’s E&P sector a month ago, the price of Brent
Crude has fallen by almost 25%. Curiously, however, E&P stocks have bucked the trend, and have hardly declined
over the period. This has taken many investors by surprise, as the key pushback from our initiation report was that
the key risk for E&P stocks was oil price decline.
Figure 1 –Pak E&P’s have resisted the recent decline in global
crude Prices in the last month
…as re-rating has taken place- What explains the de-coupling? Although this has taken many investors by surprise,
we attribute this to the expected re-rating of E&P stocks. Simply put, if oil is US$45/bbl, we expect investors to
become comfortable with near double-digit P/E’s for the overall market in general, and oil stocks as well. This is
because such a steep decline in oil price significantly changes the macro outlook, and specifically, the interest rate
outlook. We expect the discount rate to fall to 8% by March 2015.
E&P vals versus KSE- PPL The KSE-100 (ex-consumer ex-oil) is already trading at 11.5x on the basis of trailing
earnings, and if assume an ambitious 15% earnings growth, the forward multiple is 10.0x. Looking at the valuation
of oil stocks, we find that in the case of PPL and OGDC, valuations remain more attractive than the market, even at
a conservative US$45/bbl oil price.
Figure 2 –Even at low crude oil prices, OGDC & PPL PER’s are at discount to the
market
Where from here- Significant out-performance from E&P stocks would require a crude price rebound, in our
opinion. This can be seen through the valuation sensitivity below, where there is not much TP upside if oil price
remain at current levels. We expect the correlation between crude prices and E&P stocks to resume, going forward.
Figure 3 –Crude price & DR Sensitivity – E&P outperformance highly dependent on crude rebound
13th January, 2015Sector Update
PKR 183 8% 8.5% 9.0% 9.5% 10.0%
$75 250 248 245 242 240
$65 236 233 231 228 226
$55 221 219 216 214 212
$45 205 204 202 200 198
$35 189 188 186 185 183
OGDC
PKR 165 8.0% 8.5% 9.0% 9.5% 10.0%
$75 247 243 239 235 232
$65 228 225 222 218 215
$55 210 207 204 201 199
$45 192 190 187 184 182
$35 174 172 169 167 165
PPL
443 8% 8.5% 9.0% 9.5% 10.0%
$75 443 436 428 422 415
$65 409 403 396 390 384
$55 376 370 364 358 353
$45 342 337 331 326 322
$35 308 304 299 295 291
POL
Next Research
+92-21-111-639-825 Ext 113
research@nextcapital.com.pk
Oil & Gas Exploration & Production Sector
Source: Bloomberg
Source: Internal Estimates

2. 2
Although it would take a brave analyst to call the direction of oil prices, we continue to like the E&P sector (and PPL
in particular), for the margin of safety it offers. Very much a case of “heads I win, tails, I do not lose much.” That
cannot be said of very many stocks and sectors at the KSE right now. Mutual funds, which remain significantly
Under-Weight on the Oil and Gas sector (avg. weight of 12% for top ten funds, versus benchmark weight of 20%),
and other institutional investors, will need to take a closer look at the sector. Any rebound in oil prices can lead to a
sharp run-up in E&P stocks.
APPENDIX 1
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