This article first appeared in The Edge Financial Daily on July 23, 2019

Petronas Chemicals Group Bhd
(July 22, RM7.70)
Downgrade to hold with a lower target price of RM8.30: The continued uncertainty over trade talks between the US and China has taken a toll on petrochemical prices. We expect the second quarter ended June 30, 2019 (2QFY19) earnings to be soft, and likely further weaken in the third quarter with a heavy plant turnaround.

Polyethylene product prices declined 4% quarter-on-quarter (q-o-q) in 2QFY19, and for polypropylene relatively flat. In the fertiliser and methanol (F&M) segment, the urea price was up 1% q-o-q on better demand in Southeast Asia, but the methanol price declined 3% q-o-q, currently at the year-low of US$259 (RM1,067) per tonne.

We expect Brent oil price in the second half of 2019 (2H19) to trade between US$65 and US$70 per barrel (bbl), hence capping any drastic recovery in product average selling prices (ASPs). On the expectation of softer demand and ASPs generally not showing any recovery, we expect 2QFY19 profit to be soft versus 1QFY19 core profit of RM845 million, partly offset by a 2% appreciation q-o-q in the US dollar against the ringgit. In addition, with the US and China trade talks still looking uncertain and rather unfruitful, we believe product ASPs would likely remain low for the rest of 2019.

Meanwhile, the overall 3QFY19 plant utilisation is expected to be lower as Petronas Chemicals Group Bhd (PetChem) undergoes its heaviest plant turnaround in 2019 with a cracker plant to be shut down for more than a month and the polymer and fertiliser plants for 30 days. As such, we expect weaker earnings q-o-q, assuming there’s no recovery in ASPs. With consensus forecasts still looking on the high side, we see further downside risks.

We cut our FY19 and FY20 earnings per share (EPS) forecasts by 18% to account for weaker ASPs for methanol — -15% to US$280 per tonne, and polyethylene products (-5% to US$950 to US$1,000 per tonne). We also slashed our FY21 EPS forecast by 19% mainly to account for weaker polyethylene prices in the long term (lower by 25% to US$900 per tonne), as a result of rising capacity in China and softer global demand.

PetChem’s share price has fallen 7% over the past one week, and is now trading at a 12-month forward price-earnings ratio of 17 times, close to its five-year mean of 16.7 times. In our view, the current valuation is justified given the group’s long-term capacity expansion growth once the dust settles. However, the likely upcoming weak results may not be fully priced in.

Key upside risks to our “hold” call include a sustained recovery in product selling prices and higher-than-expected product price spreads. Downside risks include declines in product prices, a lower plant utilisation and weaker product demand. — Affin Hwang Capital, July 22