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Grupa LOTOS

We think 2019 should be a transformational year for Grupa LOTOS, as the two drivers of its investment thesis culminate. First is the completion of the EFRA upgrade, which will result in a 31% LfL improvement in LOTOS’s refining margin, we estimate. Second is the potential takeover by PKN ORLEN, which is on track to acquire the Polish government’s 53% stake in LOTOS next year, potentially leading to a full takeover. Should LOTOS remain a publicly listed entity into 2020, we see further support from IMO2020 regulations. We maintain our BUY rating with an 11% higher TP of PLN102.

A takeover target

PKN ORLEN and the Polish government agreed on 27 February 2018 to start the process of allowing PKN to buy at least a 53% stake in LOTOS. On 30 November 2018, PKN submitted the required documents for the approval by the European Commission. We believe the purchase of the government stake may be completed in 1Q19, which we think could be followed by a tender offer to LOTOS minorities.

Attractive fundamentals

LOTOS benefits from having one of the more advanced and flexible refineries in emerging Europe, with above-average middle distillate yields, which positions the company well both for growing diesel consumption in the region and new marine fuel regulations in effect from January 2020. The completion of the EFRA project in 1H19 should increase its NCI to 11.0 (from 10.0) and improve its already high refining margin by a further $2/bl, resulting in an 8% increase in EBITDA in 2019, we estimate.

We see significant dividend upside from 2019 even if the PKN ORLEN deal derails

LOTOS’s FCF in 2018 was negatively affected by the completion of EFRA investments. We expect the FCF outlook will reverse in 2019, with higher margins and lower capex driving a significant expansion in FCF yields. LOTOS’s traditionally low dividend payout ratio (we estimate 6% for 2018) results in what we view as a less-than-impressive current dividend yield of 1.3%, but it has substantial potential to improve (we note best-in-class Tupras’s dividend policy calls for a 90% payout ratio). We believe LOTOS minority shareholders will expect PKN ORLEN’s likely offer to reflect the company’s improving fundamentals or otherwise benefit from a significant dividend upside on a standalone basis.

Company update

BUY (maintained)

TP: PLN102.0 (previously PLN92.0)

Oil & Gas Poland

Report date:	14 December 2018
Current price, PLN		84.0
Upside/downside, %		21.4
MktCap, PLNmn		15,529.4
Average daily volume, PLNmn		24.7
Free float, PLNmn		7,269.3
Bloomberg		LTS PW

Summary valuation and financials, PLNmn (unless otherwise stated)

	2017		2018E	2019E	2020E
Revenue	24,186		29,954	29,484	28,775
EBITDA	2,902		3,025	3,947	4,255
Net income	1,672		1,900	2,256	2,507
Net debt	2,505		2,521	1,296	(305)
EPS, PLN	9.04		10.28	12.20	13.56
DPS, PLN	1.05		1.10	1.16	1.22
EV/sales, x	0.7		0.6	0.6	0.6
EV/EBITDA, x	6.2		6.0	4.6	4.2
P/E, x	9.3		8.2	6.9	6.2
Net debt/EBITDA, x	0.9		0.8	0.3	(0.1)
Dividend yield	1.3		1.3	1.4	1.4
FCF yield, %	9.6		1.6	9.0	11.3
RoIC, %	9.4		10.3	11.4	12.1
Source: Company data, Renaissance Capital estimates
Figure 125: Price performance – 52 weeks
PLN			LTS PW

90

80

70

60

50

40

Jan-18

Feb-18

Mar-18

Apr-18

May-18

Jun-18

Jul-18

Oct-18

Dec-17

Aug-18

Sep-18

Nov-18

Dec-18

Source: Bloomberg

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Renaissance Capital

14 December 2018

Grupa LOTOS

Figure 126: LOTOS current shareholding structure

Figure 127: LOTOS – model refining margin, $/bl

5Y range

Margin

14

12

Other

10

36%

State Treasury

8

53%

6

4

PZU OFE

2

Nationale

5%

Nederlanden

0

February

March

May

June

July

August

September

October

January

April

November

December

OFE

6%

Source: Company data

Source: Thomson Reuters Datastream, Bloomberg

Figure 128: LOTOS – share price performance ($) vs model refining margin ($/bl) Figure 129: LOTOS – sources and uses of funds, $mn

	Refining Margin (30-day moving average)									LTS PW Equity RHS		CFFO					Divestments
12											24	Capex and investments					Dividends
												Interest					FCF to equity
10											22	1,000
											20
8											18	500
6											16
											14
												-
4											12
2											10
											8	(500)
0			Jun-17	Aug-17					Jun-18	Aug-18	6
Dec-16	Feb-17	Apr-17			Oct-17	Dec-17	Feb-18	Apr-18			Oct-18	(1,000)
												2013	2014	2015	2016	2017	2018E 2019E	2020E	2021E

Source: Thomson Reuters Datastream, Bloomberg Source: Company data, Renaissance Capital estimates

Figure 130: LOTOS – 2018E FCF bridge, $mn

Figure 131: LOTOS – 2019E FCF bridge, $mn

1,000

1,000

800

800

600

600

400

400

200

200

-

-

CFFO 2017

WC

Other

CFFO 2018

Capex

FCF 2018

Interest

Dividends

CFFO 2018

WC

Other

CFFO 2019

Capex

FCF 2019

Interest

Dividends

Source: Company data, Renaissance Capital estimates

Source: Company data, Renaissance Capital estimates

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Renaissance Capital

14 December 2018

Grupa LOTOS

Figure 132: Grupa LOTOS – operating and financial summary, PLNmn (unless otherwise stated)

Operating statistics	2015	2016	2017	2018E	2019E	2020E
Crude oil production, mnt	12	27	23	21	19	18
Gas production, bcm	-	-	-	-	-	-
Total hydrocarbon production, mn boe	12	27	23	21	19	18
Refining throughput, mnt	10.2	10.4	9.6	10.7	10.4	10.4
Income statement	2015	2016	2017	2018E	2019E	2020E
Gross revenue	22,710	20,931	24,186	29,954	29,484	28,775
Operating expenses	(22,286)	(19,076)	(21,957)	(27,149)	(26,257)	(25,226)
EBITDA	1,417	3,000	2,902	3,025	3,947	4,255
EBITDA margin	6%	14%	12%	10%	13%	15%
EBIT	423	1,855	2,229	2,805	3,227	3,549
EBIT margin	2%	9%	9%	9%	11%	12%
Financial items	(588)	(278)	216	(144)	(137)	(115)
Profit before tax	(195)	1,579	2,448	2,662	3,090	3,434
Net income	(263)	1,015	1,672	1,900	2,256	2,507
Average number of shares outstanding, mn	185	185	185	185	185	185
EPS, PLN per share	(1.42)	5.49	9.04	10.28	12.20	13.56
DPS, PLN per share	-	1.00	1.05	1.10	1.16	1.22
Payout ratio, %	-	18	12	11	9	9
Growth rates, %
Total hydrocarbon production	13	124	(13)	(11)	(6)	(6)
Revenue	275	112	(3)	4	30	8
EPS	(82)	(486)	65	14	19	11
DPS	n/a	n/a	5	5	5	5
Balance sheet	2015	2016	2017	2018E	2019E	2020E
Current assets	6,732	6,996	8,709	9,146	10,409	11,942
Non-current assets	12,438	12,331	12,462	13,751	14,431	15,126
Total assets	19,169	19,326	21,171	22,898	24,840	27,068
Current liabilities	5,426	5,272	6,194	6,051	5,941	5,876
Long-term liabilities	6,031	5,444	4,264	4,487	4,487	4,487
Minorities	0	0	0	0	0	0
Equity	7,712	8,611	10,712	12,360	14,412	16,705
Total equity and liabilities	19,169	19,326	21,171	22,898	24,840	27,068
Cash-flow statement	2015	2016	2017	2018E	2019E	2020E
Net income	(263)	1,015	1,672	1,900	2,256	2,507
DD&A	715	1,068	844	726	720	706
Other	922	912	783	811	137	115
Changes in working capital	114	(341)	(173)	(1,185)	(146)	2
Cash flow from operations	1,488	2,654	3,127	2,253	2,967	3,330
Cash flow used for investments	(1,162)	(1,003)	(1,449)	(1,736)	(1,369)	(1,348)
Cash flow used for/from financing	115	(1,201)	(483)	(975)	(371)	(382)
Effect of exchange rate changes	4	3	(5)	7	-	-
Cash flow for the year	445	453	1,190	(450)	1,226	1,601
Key data	2015	2016	2017	2018E	2019E	2020E
Net debt/(cash)	6,140	4,813	2,505	2,521	1,296	(305)
Net debt/equity, %	4.3	1.6	0.9	0.8	0.3	(0.1)
RoE, %	(3.4)	11.8	15.6	15.4	15.7	15.0
RoIC, %	1.9	8.0	9.4	10.3	11.4	12.1
RoACE, %	0.8	8.1	12.4	12.9	13.7	13.4

Source: Company data, Renaissance Capital estimates

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Petrom

OMV Petrom

OMV Petrom benefits from material exposure to conventional upstream production in Romania, with further upside potential from the Neptun discovery, where an FID was recently delayed into 2019. The company’s refining exposure is via the Petrobrazi refinery, which has above-average profitability due to its high complexity and inland premium pricing. Attractively valued, in our view, at a 2019E EV/EBITDA multiple of 2.1x and a current dividend yield of 5.8%, OMV Petrom’s investment case combines the benefits of EE’s downstream exposure with upstream upside and low relative valuations. Maintain BUY with a 9% higher TP of RON0.50.

Significant upstream exposure

With 2P reserves of 839mn boe, the legacy assets of OMV Petrom represent the largest and the most conventional upstream portfolio among its emerging European peers. Further upside potential is associated with the potential development of the Neptun Deep block, where a discovery was announced in February 2012 and an FID could be taken in 2019. While OMV Petrom’s share of exploration costs in Neptun is a substantial $750mn (15% of its current market cap), we currently assign no value to this asset in our model due to the uncertain economics of the project; should an FID be taken, this could represent material upside potential for OMV Petrom, in our view.

Above-average refining margin

OMV Petrom’s Petrobrazi refinery in Romania has above-average profitability due to its high complexity and inland premium pricing in the fast-growing domestic market.

In addition, the company’s product slate is dominated by diesel (42%), which positions the company well for the strong growth we expect in Europe’s middle distillate consumption, as well as new marine bunker fuel specifications, in effect from 2020.

Attractive relative valuations

OMV Petrom trades at some of the lowest multiples in the sector, with 2019E EV/EBITDA and P/E consensus multiples of 2.0x and 5.8x, respectively (vs 2.1x and 6.8x based on our estimates). We estimate its 2019 FCF and dividend yields at 6.7% and 6.1%, respectively.

Company update

BUY (maintained)

TP: RON0.50 (previously RON0.46)

Oil & Gas

Romania

Report date:	14 December 2018
Current price, RON		0.36
Upside/downside, %		38.9
MktCap, RONmn		20,335.2
Average daily volume, RONmn		6.4
Free float, RONmn		3,207.8
Bloomberg		SNP RE

Summary valuation and financials, RONmn (unless otherwise stated)

	2017			2018E	2019E	2020E
Revenue	19,435			21,828	21,233	21,166
EBITDA	6,725			7,384	7,166	6,810
Net income	2,491			3,216	3,012	2,721
Net debt	(3,336)			(5,475)	(5,657)	(5,315)
EPS, RON	0.04			0.06	0.05	0.05
DPS, RON	0.02			0.02	0.02	0.02
EV/sales, x	0.8			0.7	0.7	0.7
EV/EBITDA, x	2.2			2.0	2.1	2.2
P/E, x	8.2			6.3	6.8	7.5
Net debt/EBITDA, x	(0.5)			(0.7)	(0.8)	(0.8)
Dividend yield, %	5.6			5.8	6.1	6.4
FCF yield, %	13.7			14.6	6.7	4.4
RoIC, %	8.6			11.2	9.7	8.4
Source: Company data, Renaissance Capital estimates
Figure 133: Price performance – 52 weeks
RON			SNP RE

0.5

0.4

0.4

0.3

0.3

Jan-18

Feb-18

Mar-18

Apr-18

May-18

Jun-18

Jul-18

Aug-18

Sep-18

Oct-18

Dec-17

Nov-18

Dec-18

Source: Bloomberg

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Renaissance Capital

14 December 2018

OMV Petrom

Figure 134: OMV Petrom current shareholding structure

Figure 135: OMV Petrom – model refining margin, $/bl

																5Y range				Margin
			Free Float									16
Fondul			16%									14
Proprietatea												12
12%
										OMV		10
				Romanian						51%		8
				State
												6
				21%
												4
												2
												0	February	March	April	May	June	July	August	September	October
												January										November	December
											Source: Company data								Source: Thomson Reuters Datastream, Bloomberg
Figure 136: OMV Petrom – share price performance ($) vs model refining margin ($/bl)												Figure 137: OMV Petrom – sources and uses of funds, $mn
	Refining Margin (30-day moving average)									SNP RE Equity RHS				CFFO						Divestments
13											0.10			Capex and investments						Dividends
														Interest						FCF to equity
												3,000
11											0.09
												2,000
9											0.08	1,000
7											0.07	-
5											0.06	(1,000)
3											0.05	(2,000)
			Jun-17						Jun-18
Dec-16	Feb-17	Apr-17		Aug-17	Oct-17	Dec-17	Feb-18	Apr-18		Aug-18	Oct-18	(3,000)
													2013		2014	2015	2016		2017E	2018E	2019E 2020E			2021E

Source: Thomson Reuters Datastream, Bloomberg

Source: Company data, Renaissance Capital estimates

Figure 138: OMV Petrom – 2018E FCF bridge, $mn

Figure 139: OMV Petrom – 2019E FCF bridge, $mn

2,000

2,000

1,500

1,500

1,000

1,000

500

500

-

-

(500)

(500)

CFFO 2017

WC

Other

CFFO 2018

Capex

FCF 2018

Interest

Dividends

CFFO 2018

WC

Other

CFFO 2019

Capex

FCF 2019

Interest

Dividends

Source: Company data, Renaissance Capital estimates

Source: Company data, Renaissance Capital estimates

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Renaissance Capital

14 December 2018

OMV Petrom

Figure 140: OMV Petrom – operating and financial summary, RONmn (unless otherwise stated)

Operating statistics	2015	2016	2017	2018E	2019E	2020E
Crude oil production, mnt	83.4	79.6	74.9	72.5	70.2	68.0
Gas production, bcm	95.2	94.6	92.7	87.2	82.8	78.7
Total hydrocarbon production, mn boe	179	174	168	160	153	147
Refining throughput, mnt	4.2	4.1	4.5	4.1	4.4	4.4
Income statement	2015	2016	2017	2018E	2019E	2020E
Gross revenue	18,145	16,647	19,435	21,828	21,233	21,166
Operating expenses	(18,675)	(15,170)	(16,165)	(17,640)	(17,410)	(17,651)
EBITDA	6,493	5,100	6,725	7,384	7,166	6,810
EBITDA margin, %	36%	31%	35%	34%	34%	32%
EBIT	(530.0)	1,476.2	3,270.4	4,188	3,823	3,514
EBIT margin, %	-3%	9%	17%	19%	18%	17%
Financial items	(196.2)	(211.3)	(366.2)	(252)	(237)	(275)
Profit before tax	(726)	1,265	2,904	3,935	3,586	3,240
Net income	(676)	1,043	2,491	3,216	3,012	2,721
Average number of shares outstanding, mn	56,644	56,644	56,644	56,644	56,644	56,644
EPS, RON per share	(0.01)	0.02	0.04	0.06	0.05	0.05
DPS, RON per share	-	0.02	0.02	0.02	0.02	0.02
Payout ratio, %	-	81	45	37	41	48
Growth rates, %
Total hydrocarbon production	(1)	(2)	(4)	(5)	(4)	(4)
Revenue	(24)	(21)	32	10	(3)	(5)
EPS	(132)	(254)	139	29	(6)	(10)
DPS	(100)	n/a	33	5	5	5
Balance sheet	2015	2016	2017	2018E	2019E	2020E
Current assets	4,980	6,012	8,327	10,729	10,685	10,254
Non-current assets	36,138	35,402	33,732	33,231	34,920	36,737
Total assets	41,118	41,414	42,059	43,960	45,605	46,991
Current liabilities	5,038	4,485	5,129	5,768	5,590	5,504
Long-term liabilities	10,392	10,223	8,509	7,464	7,464	7,464
Minorities	(55)	(63)	(59)	0	0	0
Equity	25,743	26,769	28,480	30,728	32,551	34,023
Total equity and liabilities	41,118	41,414	42,059	43,960	45,605	46,991
Cash-flow statement	2015	2016	2017	2018E	2019E	2020E
Net income	(676)	1,043	2,491	3,216	3,012	2,721
DD&A	6,761	3,464	3,580	3,280	3,343	3,296
Other	(948)	(25)	82	672	237	275
Changes in working capital	146	(27)	(199)	62	48	2
Cash flow from operations	5,283	4,454	5,954	7,230	6,640	6,294
Cash flow used for investments	(4,953)	(2,896)	(2,446)	(3,845)	(5,032)	(5,113)
Cash flow used for/from financing	(794)	(376)	(1,524)	(1,495)	(1,426)	(1,524)
Effect of exchange rate changes	10	0	(1)	1	-	-
Cash flow for the year	(455)	1,183	1,983	1,891	182	(342)
Key data	2015	2016	2017	2018E	2019E	2020E
Net debt/(cash)	733	(657)	(3,336)	(5,475)	(5,657)	(5,315)
Net debt/equity, %	0.1	(0.1)	(0.5)	(0.7)	(0.8)	(0.8)
RoE, %	(2.6)	3.9	8.7	10.5	9.3	8.0
RoIC, %	(1.3)	3.7	8.6	11.2	9.7	8.4
RoACE, %	(0.9)	4.8	9.8	11.8	10.3	8.9

Source: Company data, Renaissance Capital estimates

66