PCHEM’s 1Q19 core net profit of RM802m came below expectations on weaker than expected olefins and derivatives segment. Core net profit demonstrated both QoQ and YoY weakness in 1Q19 dragged by weaker average petrochemical prices. Meanwhile, we also have better understanding on the recent acquisition of 100% stake in Da Vinci for the expansion in speciality chemical business. All in, slashed our FY19-20 earnings estimates by 7%-4% respectively and maintain HOLD rating with lower TP of RM8.86.

Results below expectations. 1Q19 core net profit of RM802m (-36% YoY) came below expectations at 18%/18% of our/consensus full year estimates. The negative deviation largely stemmed from weaker than expected contribution from olefins and derivatives (O&D) segment.

Dividends. No dividend was declared, as expected.

QoQ: Despite plant utilisation was marginally higher at 95% (vs 94% in 4Q18), 1Q19 revenue fell -18% to RM4.13bn dragged by lower average product prices which resulted from lower crude oil prices. Core earnings plunged further by -38% due to weaker JV & associates which turned RM24m losses (from RM42m profit) due to statutory turnaround activities. This was cushioned by lower tax expenses (-55%).

YoY: 1Q19 EBITDA decreased by 31% YoY in tandem with weaker ASP on higher opex incurred on maintenance activities amidst lower plant utilisation (vs 100% in 1Q18). Core earnings further declined by 36% YoY from RM1.26bn on weaker JV & associates contribution (vs RM17m profit in 1Q18).

Outlook. Management is confident that the overall existing plant utilisation could hit at least 90% even with several turnarounds in 2Q-3Q19. However, petrochemical prices are likely to stay unexciting in the near term as a consequence of escalation of trade war between China and US. Meanwhile, PIC petrochemical plants are at 98% completion and are at commissioning stage. Management expects minimal contribution from PIC this year and to achieve plant utilisation of 70% in FY20.

Update on Da Vinci. Recall that PCHEM recently entered SPA to acquire 100% stake in Da Vinci Group, which operates globally in own-brand reselling, formulating and manufacturing of silicones, lube oil additives and chemicals for EUR163m. Da Vinci currently owns four plants and one R&D lab in Netherlands, Germany, Singapore and Canada. This venture allows PCHEM to grow its specialty chemicals business which typically fetches higher margins and less susceptible to oil prices volatility. The transaction is expected to be completed by end-FY19. Such investment is capable of generating net income of c.RM114m (3% of FY19 net earnings) assuming 15% ROI. In the longer run, PCHEM would continue to expand this business via greenfield projects leveraging on the technology available coupled with inorganic growth.

Forecast. We slashed our FY19-20 earnings estimates by 7%-4% respectively on lower contribution from O&D segment in view of weaker ASPs and lower margins. Meanwhile, FY21 earnings of RM4.9bn (+1% YoY) is introduced assuming overall plant utilisation of 92%, RM4.10/USD and oil price of USD71/bbl.

Maintain HOLD with lower TP: RM8.86. Post earnings adjustment, we maintain HOLD rating with lower TP of RM8.86 (from RM9.30) based on 9.5x FY19 EV/EBITDA. While we still like PCHEM for being Petronas’ petrochemical arm to benefit from downstream long term growth, the re-rating catalysts would rest on better petrochemical prices and favourable transfer pricing guidance on PIC’s feedstock.

Source: Hong Leong Investment Bank Research - 3 Jun 2019