Target price cut on falling volumes

Mariyam Zhumadil, CFAAugust 19, 2014

This week KazTransOil published broadly neutral consolidated financial results for 1H2014. The rise in operating costs following the tenge devaluation in February was expectedly offset by a timely tariff increase, which helped to preserve pre-devaluation operating profit margins. However, oil transportation volumes at the company’s core pipelines fell by 4.4% YoY due to a decline of crude output in Kazakhstan. Additionally, the company’s bottom-line has been hit by a sizeable loss from associates whose foreign currency denominated liabilities increased, while transportation tariffs remained flat.

We have updated our model to reflect actual 1H2014 consolidated production and financial results (neutral); 2) lowered contribution of associates (negative); 3) revised downward oil transportation volumes (negative). As a result, we reduce our 12M target price by 6.3% to T1349 per share and maintain a Buy recommendation on the stock. Our valuation implies a 19.3% upside to the current market value, in addition to the 9.7% expected dividend yield.

1H2014 consolidated output fell by 5.5% YoY

The company's 1H2014 consolidated oil transportation volumes (includes KCP and Munaitas) fell by 5.5% YoY to 30.9 mn tons, while oil transportation volumes at its core pipelines declined by 4.4% YoY to 25.4 mn tons. The decline in oil transportation volumes was primarily attributable to lower oil output in Kazakhstan (-3.1% YoY) due to maturation of producing Kumkol fields. In order to reflect current production dynamics and the expectations of practically flat Kazakh output over 2015-2016, we have reduced our 2014 transportation volume growth rate projection to negative 2.2% and assumed that volume would remain flat afterwards.

Timely tariff hike helps to preserve margins after devaluation

KazTransOil's 2Q2014 consolidated revenue grew by 12.8% YoY thanks to a robust growth in oil transportation revenue (+13.9% YoY) and an increase in other revenues (+7.6% YoY). The company’s oil transportation revenue rose on the back of a healthy growth in tariffs (+23.6% on export and +50.9% on domestic routes), slightly offset by a 1.8% decline in oil turnover.

During the quarter cost of sales increased by 17.2% YoY to T19.4bn, largely in line with the expected cost increase after the tenge devaluation. Recall that in the revised tariff application following the tenge devaluation, the company’s compensated operating costs increased by 27.0% compared to the pre-devaluation tariff application. We have assumed that the company’s operating costs not included in tariffs will increase in line with the inflation rate and, therefore, we expect total operating costs in 2014 to grow by 15.7% YoY.

SG&A costs grew by just 2.6% YoY to T2.3bn, which is way below the rate of growth for compensated SG&A costs in the approved tariffs (+17.1% YoY) and the previous five year average growth rate of 5.8%. We expect SG&A costs to accelerate in the 2H2014 and on a full-year basis assume a 5.9% YoY growth.   

EBITDA margin improved by 4ppt in the 2Q2014 largely due to a one-off profit from the receipt of fines and penalties from the transportation companies, which rented KTO’s pipelines. Net income in the 2Q2014 grew by 6.2% YoY to $21.4bn, while for the 1H2014 it fell by 34.6% YoY largely due to a negative contribution of earnings from Kazakhstan-China pipeline (KCP) and Munaitas. KCP recorded a T30.1bn FX loss related to the tenge devaluation in 1Q2014 due to an increase of liability on the USD denominated loans. Additionally, both of the associates with Chinese participation did not apply for tariff revision following the tenge devaluation in order to preserve economic attractiveness of the pipeline for producers exporting oil to China. We expect KCP’s and Munaitas’ tariffs to be revised upward during the upcoming annual tariffs review.

KazTransOil's net cash at the end of 1H2014 stood at T124.9bn, which excluding the 2013 dividend payment, translates into a net cash position of T82.9bn (or T215 per share). The company’s net cash position increased by T47.3bn during the 1H2014 thanks to robust operating cash flow generation (T43.1bn), partially offset by capex spending (T26.8bn).

Figure 1. Summary of 1H2014 consolidated financial results   
in mn KZT, except per share 2Q2014A 2Q2013A YoY 1H2014A 1H2013A YoY
Revenue 51 642 45 795 12.8% 97 027 92 864 4.5%
Cost of sales (excl.depr'n) 19 433 16 576 17.2% 36 309 33 634 8.0%
EBITDA 30 948 28 014 10.5% 57 632 56 490 2.0%
EBITDA margin 60% 61% +4ppt 59% 61% (2.4%)
Net income 18 907 20 114 -6.0% 23 984 40 437 (40.7%)
Net income margin, % 37% 44% -3ppt 25% 44% (43.2%)
EPS 49 52 -6.0% 69 105 (34.3%)
Sources: HF Research estimates, company data     

Valuation update and sensitivity analysis

We have updated our model to reflect actual 1H2014 consolidated production and financial results (neutral); 2) lowered contribution of associates (negative); 3) revised downward oil transportation volume growth assumptions (negative). As a result, we cut our 12-month target price by 6.3% to T1,355 per share, which at the current share price translates into a 19.5% upside to the current market value, in addition to the 9.7% expected dividend yield.

In order to reflect current production dynamics and the expectations of practically flat Kazakh output over 2015-2016, we have reduced our 2014 transportation volume growth rate projection to negative 2.2% and assumed that volume would remain flat afterwards. Our revenue forecast for 2014 has been revised down by 14.0% to T203.2bn, which implies a 6.9% YoY growth. We have trimmed our revenue forecasts on average by 13.5% over the forecast horizon. We expect the company’s EBITDA margin in 2014 to decline by 0.6 ppt YoY to 47.9% and over the ten year forecast horizon expect EBITDA margin and ROE to average 37.2% and 12.6%, respectively.

Our valuation exhibits almost zero sensitivity to terminal growth rate assumption and is highly sensitive to cost of equity, tariffs and operating costs growth rate assumptions. A 10% change in the cost of equity, tariffs and operating costs annual growth rate translates into a 15.2%, a 9.9% and a 9.8%, respective changes in our fair value estimate.

Figure 2. Equity value sensitivity to COE and terminal growth rate
    Cost of equity
    9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0%
Terminal growth rate 2.0% 2281 1841 1547 1337 1180 1057 958
3.0% 2290 1847 1552 1341 1183 1059 960
4.0% 2299 1854 1557 1345 1186 1062 962
5.0% 2308 1861 1562 1349 1189 1064 965
6.0% 2317 1867 1567 1353 1192 1067 967
7.0% 2326 1874 1572 1357 1195 1070 969
8.0% 2335 1881 1577 1361 1199 1072 971
 
Source: HF Research estimates       
         
Figure 3. Equity value sensitivity to tariff and opex growth        
    Tariff CAGR over 2014-2022
    3.2% 4.2% 5.2% 6.2% 7.2% 8.2% 9.2%
Operating costs CAGR over 2014-2022 7.5% 1240 1414 1597 1789 1991 2204 2427
8.5% 1103 1276 1459 1651 1854 2066 2289
9.5% 956 1130 1313 1505 1707 1920 2143
10.5% 800 974 1157 1349 1551 1764 1987
11.5% 635 808 991 1183 1386 1598 1821
12.5% 459 632 815 1007 1209 1422 1645
13.5% 272 445 628 820 1022 1235 1458
 
Source: HF Research estimates   
         
Figure 4. Equity value sensitivity to dividend payout ratio        
    DPR in 2014-2022
    40% 50% 60% 70% 80% 90% 100%
DPR in the terminal year 41% 981 1045 1107 1168 1227 1284 1340
46% 1046 1109 1169 1228 1286 1341 1396
51% 1111 1172 1231 1289 1345 1399 1451
56% 1177 1236 1293 1349 1403 1456 1507
61% 1242 1299 1355 1409 1462 1513 1563
66% 1307 1363 1417 1470 1521 1571 1619
71% 1373 1427 1479 1530 1580 1628 1674
 
Source: HF Research estimates    

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