On the basis of the aproved 2016-2020 business plan and the budget by the BOD, KMG EP will reduce the selling price to the domestic refineries, and we believe that NC is tightening a pricing regulation to the refineries through KMG EP at the cost of minority shareholders. We also assume that at current structure of NC, price regulation would continue and KMG EP would keep low selling prices to the refineries.
We applied this assumption in our valuation model for a long term period (announced prices to the refineries are for further approval by the independent directors of KMG EP, and in case of changes, we will revise our target price/recommendation respectively).
Taking into account the futures quotes for crude oil of $40,8-62/barrel in 2017-2022, the selling price of $8,77-$11/barrel to the refineries and operating cost of $50-$45/barrel in 2016-2017, the enterprise value of OMG, EMG is negative, however, currently is offset by positive value of the associates ($900 mln) and cash of $3 bln (as of September, 30). As per the company data, cash is expected to decline from T938 to T600 ($2 bln), or by 2,4/GDR. By that time, oil reserves of the associates are expected to decline (resources of PKI are expected to be depleted by 2022), and as per the company data, a share of KMG in production of the associates is expected to decline by 17% to 2020 vs the production of 2015.
Based on our fundamental valuation, we lowered our recommendation from Hold to Sell for common shares with 12M target price of $5.0/GDR, Т9,229/common share, and Т3,692/preferred share.
We assume that after shares buyback of KMG EP, privatization of the refineries, the selling price of crude oil to the refineries will be adjusted to market requirements. Valuation of NC shares at IPO process will be determined on market prices of crude oil both for exports and for refineries.
To remind, the offer of NC as of November, 9 with regard to the shares buyback of KMG EP at the average price for the period of October,10-November,9 ($6,75-$7,25/GDR) is not final, and repurchase price of share might be adjusted based on market and company conditions at EGM as of January, 2016.