We upgrade our recommendation to “Hold” (TP from $5.0 to $5.9/GDR) reflecting the more positive outlook for oil prices (growth to $67.5/barrel in 2019) and favorable FX rate of KZT/USD (weakening to 380 KZT/$ in 2020). In spite of the step to the less profitable business model of self-processing of oil, we believe that ramp up of production at Kashagan will reduce the domestic supply burden for the company, and the required share of oil supplies to the domestic market (Ozenmunaygas and Embamunaygas) will not exceed 40% from total production volume of the company in 2020.
Retrospective change of sales prices to the domestic market and transition to the new business model. To be compliant with the IPO prospectus, the company inFebruary 2016, corrected the 2015 sales price for Kazmunaygas Refining and Marketing (KMG RM) increasing it from T23 700/ton to T37 000/ton, and cancelling the 2016 price of T19 460/ton. However as of March 31, and effectively from the second quarter, the company will sell oil refined products directly to the domestic market while taking the larger price burden of regulated domestic market. KMG RM on that side will serve as an agent by providing the processing and selling services to the company at the cost of 25% of the diesel wholesale price.
2015 financial results. Revenue for 2015 went down by 37.4% yoy to T530 bln, and excluding the FX gain of T449 nlb, the company reported a net loss of T205 bln owing to the fall of Brent oil prices by 47.0% yoy to $52.4/barrel, an increase of supplies to the domestic market and to Russia at prices below the export price, and an increase of operating expenses by 9.1% yoy (not including other taxes). As per the 2015 financial results, the company will not pay dividends for common shares.
Outlook for 2016-2019. We expect an average annual revenue growth rate (CAGR) of 16.3% by 2019 and relatively low net profit margin at 3-7% largely due to the bullish expectation of oil prices (Bloomberg consensus forecast - $67.5/barrel in 2019), favorable Tenge weakening to 367.3 KZT/$ in 2019, that are offset by an increase of the domestic supplies up to 40% from company oil production.
Price risk remains high in case of the cancellation of minority shares buyback. In the event of the disagreement between the independent directors of KMG EP with the board of directors (BD), and a cancellation of the shares buyback offer by KMG NC, share prices may decline below $5,0/GDR.
We upgrade our recommendation to “Hold”. Acknowledging high investment risk that surpass the potential return, we upgrade our recommendation to “Hold” (TP from $5.0 to $5.9/GDR) assuming that the share of required volume supply to KMG RM will not exceed 40% by 2020, and the export revenue will mitigate the losses from unprofitable sales of oil product to the domestic market.