KMG EP: April update on the first month of domestic supply pricing

Increasing our 12M TP to $7/GDR, "Hold" recommendation

Gulmariya ZhapakovaJune 01, 2016

As per the Company`s update on May 26, net sales price of crude oil in April, the first month of the new domestic supplies model, was higher by 106% than expected by the Company and by 99% than our estimates. Based on higher net sales prices to the domestic market we increase our 12M TP from $5.3/GDR to $7.0/GDR. However given the Company`s unprofitable operating model of domestic supplies and constant stream of negative free cash flows, and lower consensus for Brent oil in 2019 we maintain our Hold recommendation.

Supplies to the domestic market.The share of the domestic supplies as per the Company`s budget and government requirement is 28%-45% in 2016-2020. Terms of relationship agreement for domestic supplies (sales prices to the domestic market at cost plus margin of 3%) are no longer valid in 2016. Therefore, since April the Company moved to the new scheme according to which, KMG Processing and Marketing (KMG RM) will charge the Company for processing of crude oil and sales of refined products to the domestic market.

Net sales price of crude oil to the domestic market in April 2016 was above expectations. Net sales price of crude oil in April (including costs of marketing and processing, but excluding production and transportation costs) amounted to T31300/ton, higher than our estimate at T16700/ton, and Company`s guidance at T15200/ton. Higher net sales price in April is largely due to the greater yield of light refined oil products and an increase in Brent oil prices.

Domestic supplies model still remains unprofitable.  We expect a similar price dynamics for refined oil products (except of regulated prices for gasoline AI-80 and diesel fuel) with respect to changes in the price of Brent oil. Thus, we expect an average annual growth rate (CAGR) of domestic net sales price of crude oil (including costs of processing and marketing, but excluding production and transportation cost) at 8,2% from $11/barrel in 2016 to $18/barrel by 2022. However estimated production cost/barrel for domestic supplies in the 2016-2022 is higher, at $17-$22/barrel (excluding depreciation and head office cost). Given the share of domestic supplies at 40-45% in 2016-2022, a significant portion of the Company's sales is still at loss, in our estimates.

Increase of 12M Target price to $7.0/GDR, maintaining "Hold" recommendation. Higher than expected net sales price of crude oil to the domestic market, coupled with a slight decrease in consensus for oil Brent price allow us to increase our 12M target price to $7.0/GDR. However we still maintain our conservative view regarding the Company`s shares based on negative free cash flows ("free cash flow/price per share" yield at minus 5%), uncertainty regarding the redemption of minority shares by KMG NC, and the absence of the Company's strategy for the intended use of cash funds of $3.1 billion (at the end of 1Q2016).


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