This article first appeared in The Edge Financial Daily on April 14, 2020

Petronas Chemicals Group Bhd
(April 13, RM4.82)
Maintain sell with an unchanged fair value (FV) of RM3.25: We maintain “sell” on Petronas Chemicals Group Bhd (PetChem) with unchanged forecasts and an FV of RM3.25 per share, pegged at a 10% discount to forecasted financial year 2020 (FY20F) book value. This implies an FY20F enterprise value/earnings before interest, taxes, depreciation and amortisation (EV/Ebitda) of 5.4 times, which represents three standard deviations below the two-year average of 7.6 times and dividend yield of 3%.

As we highlighted in our update last month, petrochemical prices have decreased in tandem with the crude oil price downturn stemming from the unprecedented global demand plunge dampened by the Covid-19 pandemic amid the expiry of the Opec+ quota agreement following the Saudi-Russia quota discord. Demand for olefin products had already softened earlier due to the unresolved US-China trade war which began last year.

Since the beginning of the year, the Brent oil price has fallen by 59%, while naphtha’s decreased by 67%, benzene 70%, ethylene 37%, paraxylene 30%, methanol 22% and polyethylene 12%. Only urea registered a 23% increase in prices due to production outages in China.

We believe polyethylene prices are likely to decrease further due to a two–to-three-month lag differential between naphtha spreads and contracting oleochemical margins dampened by weak demand. Oleochemicals and derivatives accounted for 41% of PetChem’s FY19 profit after tax, with the rest coming from fertilisers and methanol. Given the sharp drop in demand from China, which accounted for 18% of PetChem’s FY19 production volume, we do not expect the group to readily redeploy its output to other regions experiencing the same outbreak.

The management had earlier guided for plant utilisation (PU) rates to be above the 92% achieved in FY19 due to lower turnaround days, with only units of its Gebeng and Labuan plants scheduled to undergo 30- to 40-day refinery turnarounds in the first quarter of FY20 (1QFY20) and 3QFY20 respectively.

We view this as unlikely as limited storage facilities, together with reduced offtake from customers, could mean that production volume would need to be scaled back. Hence, we maintain our FY20F–FY21F PU assumptions at 85%–88% for now.

We note that our FY20F–22F earnings forecasts are half of consensus estimates due to lower product prices, while lower PU rates translate into higher fixed overhead leverage. The Opec+ production cuts, which stem from necessity due to limited storage capacity, provide some relief but are likely insufficient to offset the drastic fall in oil consumption.

Hence, we expect PetChem’s share price to drop further as it currently trades at a price-to-book value (P/BV) ratio of 1.3 times, above its all-time low P/BV ratio of 1.1 times last month. PetChem currently trades at a high FY20F EV/Ebitda of 12 times versus the two-year average of 7.6 times with unexciting dividend yields of 2%. — AmInvestment Bank, April 13