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%|
|Net income||18 907||20 114||-6.0%||23 984||40 437||(40.7%)|
|Net income margin, %||37%||44%||-3ppt||25%||44%||(43.2%)|
|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|
|Terminal growth rate||2.0%||2281||1841||1547||1337||1180||1057||958|
|Source: HF Research estimates|
|Figure 3. Equity value sensitivity to tariff and opex growth|
|Tariff CAGR over 2014-2022|
|Operating costs CAGR over 2014-2022||7.5%||1240||1414||1597||1789||1991||2204||2427|
|Source: HF Research estimates|
|Figure 4. Equity value sensitivity to dividend payout ratio|
|DPR in 2014-2022|
|DPR in the terminal year||41%||981||1045||1107||1168||1227||1284||1340|
|Source: HF Research estimates|