Complete research is available only to clients of Biuro maklerskie mBanku To access our premium research, log in or open an account at www.mdm.pl Monday, February 03, 2020 | update PKN Orlen: reduce (downgraded) PKN PW; PKN.WA | Oil & Gas, Poland CAPEX Push Despite Bearish Oil Outlook Current Price PLN 75.66 Target Price PLN 68.03 In the last update on PKN Orlen last November, we flagged alarmingly-low crack spreads as potential signs of an impending Market Cap PLN 32.36bn cyclical downturn in the refining business cycle. Today, we are Free Float PLN 21.87bn forced to once again revise our already-muted oil outlook as we see ADTV (3M) PLN 171.8m most of the key benchmarks hit bottom. With the earnings prospects of PKN Orlen adjusted accordingly to assume 7% lower EBITDA and Ownership higher maintenance CAPEX (with additional spend of PLN 1bn announced in 2020), after factoring in reduced peer valuations, we State Treasury 27.52% lower our target price for PKN to PLN 68.03, and we downgrade the NN OFE 7.26% stock to back to reduce. Looking at the Company's worse-than- AVIVA OFE 6.28% expected 2019 Q4 results, with targets missed across all business PERN 4.90% segments, this would imply that the current 2020 LIFO EBITDA consensus for PKN is overestimated by at least 15%. Nevertheless, Others 54.04% against a backdrop of shrinking profits, PKN has just announced a multi-year CAPEX ramp-up of no less than PLN 2bn per year in a Business Profile move set to put additional downward strain on its valuation. On top PKN Orlen is the largest refinery in the CEE region of that, PKN is pressing on with potentially harmful acquisitions with 33mmt of annual crude processing capacity. It which include the overpriced local rival refiner Lotos, and the power operates over 2,700 service stations and through utility Energa with its inherent discount vis-à-vis the power sector produces fertilizers and petrochemicals through reflecting over-reliance on coal. Last but not least, PKN will have to subsidiary units and joint-ventures, including one take on much more debt to fund the planned investment. with LyondellBasell. In 2005, PKN Orlen acquired the Czech refiner Unipetrol, and in 2006 it took over Bearish conditions in oil... the former Mazeikiu Nafta refinery in Lithuania. In The negative trends in oil that we had signaled in November have continued the last few years, PKN has built a portfolio of upstream assets (mainly in Canada) with capacity uninterrupted, with increasing supply from new facilities coming up against for ca. 200mmboe. weaker global demand for middle distillates (affected by warm weather, the coronavirus outbreak, and low prices of natural gas), and lower gasoline PKN vs. WIG consumption in the US. At the same time, HSFO cracking margins have tightened to all-time lows under the IMO 2020 low-sulfur regulations, with 110 demand for bunker fuel met largely by blending. In the petrochemical PLN sector, the model margins for most products have dropped to levels not seen since 2012-2013, under pressure from increasing supply and a price 100 squeeze experienced by ethane-based EU producers as they try to compete with naphtha-based counterparts in the US and Asia. 90 ...will not dissuade PKN from boosting capital spend In the last five years, PKN spent PLN 4.2bn at most per year on capital investment, while generating average annual FCF of PLN 3bn on record 80 earnings. This year the Company seems to have radically changed its PKN approach by boosting CAPEX and equity investment amid weak market WIG condition. We have updated our model for PKN to assume average annual 70 capital spend of PLN 6bn in the 2020-2023 period based just on projects where the Company has given some sense of the potential returns (the Jul-19 Jan-19 Jan-20 Oct-19 overall ambitions reach much further), resulting in implied FCF of less than May-19 PLN 0.9bn (<2%). If we add to this the planned acquisitions of Lotos and Target Price Rating Energa, PKN's leverage ratio might come close to 2.0x by the end of this Company year. At this level, the usual premium to reward a flexible balance sheet may new old new old soon turn into a discount for a tight financial situation. PKN Orlen 68.03 94.17 reduce hold Current Company 9MTP Downside Price PKN Orlen 75.66 68.03 -10.1% (PLN m) 2017 2018 2019E 2020E 2021E Forecast Update 2019E 2020E 2021E Revenue 95,364.0 109,706.0 111,203.0 107,103.8 111,400.6 LIFO EBITDA -5.6% -6.0% -8.1% EBITDA 11,078.0 9,888.0 9,068.0 7,579.4 7,703.7 Net profit -6.6% -24.2% -8.6% EBITDA margin 11.6% 9.0% 8.2% 7.1% 6.9% EBIT 8,657.0 7,215.0 5,562.0 3,828.4 3,749.2 Refining margin* ($/Bbl) -4.1% -8.3% -8.3% Net income 6,655.0 5,556.0 4,489.0 2,905.7 2,822.7 Petchem margin ($/t) -2.8% -2.2% -2.5% P/E 4.9 5.8 7.2 11.1 11.5 USD/PLN +0.2% +0.1% +0.0% P/CE 3.6 3.9 4.0 4.9 4.8 *Incl. Urals/Brent pricing spread P/B 1.0 0.9 0.8 0.8 0.8 Analyst: EV/EBITDA 3.3 3.8 4.3 5.2 5.3 DPS 3.00 3.00 3.50 3.50 3.50 Kamil Kliszcz +48 22 438 24 02 DYield 4.0% 4.0% 4.6% 4.6% 4.6% [email protected] List of abbreviations and ratios contained in the report: EV – net debt + market value EBIT – Earnings Before Interest and Taxes EBITDA – EBIT + Depreciation and Amortisation P/CE – price to earnings with amortisation MC/S – market capitalisation to sales EBIT/EV – operating profit to economic value P/E – (Price/Earnings) – price divided by annual net profit per share ROE – (Return on Equity) – annual net profit divided by average equity P/BV – (Price/Book Value) – price divided by book value per share Net debt – credits + debt papers + interest bearing loans – cash and cash equivalents EBITDA margin – EBITDA/Sales OVERWEIGHT (OW) – a rating which indicates that we expect a stock to outperform the broad market NEUTRAL (N) – a rating which indicates that we expect the stock to perform in line with the broad market UNDERWEIGHT (UW) – a rating which indicates that we expect the stock to underperform the broad market Recommendations of Biuro maklerskie mBanku: A recommendation is valid for a period of 9 months, unless a subsequent recommendation is issued within this period. 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