Investment Highlights

• We maintain SELL on Petronas Chemicals Group (PChem) with unchanged forecasts and fair value of RM3.25/share, pegged to a 10% discount to FY20F book value. This implies an FY20F EV/EBITDA of 5.4x, which represents 3 standard deviations below its 2-year average of 7.6x and dividend yield of 3%.

• As we have 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 by the unresolved US-China trade war which began last year.

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

• We believe polyethylene prices are likely to decrease further due to the 2–3-month lag differential between naphtha spreads and contracting oleochemical margins dampened by weak demand. Oleochemicals and derivatives accounted for 41% of PChem’s FY19 profit after tax with the rest from fertilisers & methanol.

• Given the sharp drop in demand from China, which accounted for 18% of PChem’s FY19 production volume, we do not expect the group to readily redeploy its output to other regions which are also currently experiencing the same viral outbreak.

• Management had earlier guided for plant utilisation (PU) rates to be higher than the 92% achieved in FY19 due to lower turnaround days, with only units in Gebeng and Labuan plants scheduled to undergo 30–40 day TAs in 1Q2020 and 3QFY20 respectively.

• However, 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 are half of consensus estimates due to lower product prices while lower PU rates translate to higher fixed overhead leverage. The OPEC+ production cuts, which stems from necessity due to limited storage capacity, provide some relief but likely insufficient to offset the drastic fall in oil consumption (See our Sector Update on 10 April 2020).

• Hence, we expect PChem share price to drop further as it currently trades at a P/BV of 1.3x, above its all-time low P/BV of 1.1x last month. PChem currently trades at a high FY20F EV/EBITDA of 12x vs. its 2-year average of 7.6x with unexciting dividend yields of 2%.

Source: AmInvest Research - 13 Apr 2020