PKN - 3Q12 trading statement – Superb cash earnings in 3Q12, earnings momentum into 4Q12 remains the key question mark

LIFO EBIT down 20% q/q, albeit still very strong (cash) earnings momentum - LIFO EBIT to come in at around PLN 1.0bn, some 9% above the consensus and our estimate - Beat explained by one-off gain (PLN 100m) on yellow certificates - Petchem and retail prevented PKN from posting record high LIFO EBIT - Reported earnings to be supported by massive LIFO impact (PLN 450m) and loan revaluation gain (PLN 200m) - Net income seen at PLN 1.3bn, broadly in line with consensus - Slightly positive market reaction expected

PKN reported its 3Q12 trading statement with huge non-cash gains on inventories (roughly PLN 450m) and loan revaluation (PLN 200m) pulling up the reported figures to near record highs. However, cash earnings (LIFO EBITDA) were down 15% q/q courtesy of the intense pressure on petchem and retail margins as well as the maintenance shutdown of the petchem units at Plock. Still, LIFO EBIT – the key operating metric – is seen at a robust PLN 1.0bn, 9% above the consensus and our estimate.

The beat, however, is mainly explained by the PLN 100m one-off gain related to yellow certificates. Thanks to the positive LIFO impact (PLN 450m) reported EBIT is expected at around PLN 1.4bn (up 85% y/y). Net income should be further boosted by a PLN 200m loan revaluation gain and is forecast to come in at PLN 1.3bn in 3Q12 (versus negatives in both 3Q11 and 2Q12).

In terms of segments, refining was extremely strong and should be the only segment to show y/y and q/q earnings improvement on a LIFO basis in 3Q12. Refining LIFO EBIT is forecast at PLN 0.8bn in 3Q12, driven primarily by the superb white product cracks and healthy sales volumes.

We expect the retail segment to generate EBIT of around PLN 170m (down 30% q/q) in 3Q12 on the back of narrowing margins and the lack of positive impacts of Euro 2012 (i.e. weak non-fuel sales). In petchem, we forecast LIFO EBIT at PLN 100m in 3Q12, down significantly both q/q and y/y, due to deteriorating margins along with lower sales volumes.

Although sales volumes in the R&M segments were in line with our estimate, they are still on an upward trend y/y, defying the downward dynamics of Polish fuel consumption. Petchem sales at 1,342kt in 3Q12 were down slightly y/y, reflecting the maintenance shutdown and weak PVC consumption.

All told, PKN posted yet another quarter of robust (cash) earnings.

However, the key question mark continues to hang over the company’s earnings momentum going into 4Q12. As the refinery maintenance period winds down in mid-October, the IEA estimates more than 3.0MMbbl/d of returning CDU capacity in the Atlantic Basin and Europe alone, with more additions expected in Asia into the year-end. As a result, margins are down roughly US$ 6-7/bbl over the last week, potentially signalling the beginning of the normalization process, which analysts and industry participants alike had been predicting since April 2012. Hence, a positive reaction on today’s release may be a good opportunity to turn bearish on

With this 3Q12 earnings power we acknowledge that PKN does not seem to be excessively valued on 2012F EV/EBITDA of 6.2x – either compared to peers or to its historical average. However, we believe, the company will not be able to replicate similar results next year as the YTD margin 19 October 2012

Please note that the information at the back forms are an integral part of the report 5 strength has been driven by one-off factors (Petroplus closures, the most active spring maintenance shutdown period in Europe over the last 10 years, the 1MMbbl of refining capacity shut-in in the Gulf of Mexico due to Hurricane Isaac, the shutdown of the Amuay refinery in Venezuela due to a fire accident) which may not repeat in 2013. On our estimates, this leaves PKN trading at a 25% premium to peers on 2013F EV/EBITDA.