We upgrade PCHEM from a HOLD to BUY at a TP of RM6.50 based on 9x (unchanged) FY21 EV/EBTIDA (rolling forward from FY20) as we believe that the prospects for PCHEM is improving as general ASPs for most of its products are on an increasing trend. ASPs for polyethylene, urea and methanol have all improved significantly since the height of the Covid-19 pandemic in April due to the easing of lockdown measures and gradual recovery in economic activity. Deferments in global petrochemical plant additions as a result of Covid-19 have also mitigated the impending oversupply of petrochemical products and this would provide further sustenance for most petrochemical product prices in the near future. Hence, we upgrade our earnings assumption for FY21 -22F by 7/4% respectively while maintaining our FY20f forecast as we have already expected a stronger 2H20 due to higher ASPs for its products.

Demand in petrochemical products to be driven by China. Demand for petrochemical products have always had a strong correlation to macro-economic growth and while we can still expect a significant contraction in petrochemical growth YoY globally due to Covid-19, the contraction in growth is expected to be mitigated by China’s economic recovery as China’s has recovered significantly from its Covid-19 plight with industrial production and petrochemical demand improving significantly in 3Q20.

Deferments in capacity additions expected to mitigate petrochemical oversupply. Regional capacity additions are primarily concentrated in China, as China’s aims to be self-sufficient to meet the country’s petrochemical demand. According to IHS Markit, China’s self-sufficiency for propylene and ethylene would be at 93% and 73% respectively by 2025. Hence, even by 2025, China would still be a net importer of petrochemical products. The Covid-19 outbreak and lower crude prices have also caused major delays in capacity additions in China, India and Indonesia. Projects under its initial stages of construction are expected to get postponed and certain companies would be re-evaluating its investment projects on petrochemicals before it makes its final investment decision. Labour shortages and supply chain disruptions have also affected the construction/commissioning timeline of its projects.

Tighter polyethylene supply to sustain prices. The recent recovery in business activities in Asia from the re-opening of economies from lockdown restrictions are expected to sustain the strong trend in polymer prices. Average SEA Polyethylene prices is now c.20% higher than its price at the beginning of the year (vs SEA polypropylene price c.5%) due to its tight supply. While the demand from the construction and automotive industries are expected to be tepid going forward, the demand from packaging and the healthcare sector has been sustaining the growth of the industry. We also believe that the tight supply in polyethylene can be attributed to the flattening of production costs between ethane based (US, Saudi) and naphtha based (Europe, Asia) production centres due to the plunge in oil prices and naphtha cost as feedstock yields from ethane based crackers [c.75% ethylene yield] for ethylene is more than double that of naphtha [c.30% ethylene yield]. (less ethylene based production due to flattening of production costs between ethane and naphtha crackers would lead to tighter supply of ethylene and polyethylene).

Recovery in methanol prices. Methanol prices are currently on an upswing from a demand lift and tightening supply across major regions. Methanol prices are almost back to its pre-covid price as China demand for methanol has recovered to pre-covid levels due to its recovery in industrial production as China is the largest consumer of methanol in the world while methanol supply in Europe has seen a supply crunch from shutdowns of several plants at the height of the covid-19 pandemic. The Europe market has also seen an increase in formaldehyde demand with consumption of wood-based products and consumer goods improving as lockdown restrictions eased. The increase usage of methanol to olefin plants in China has also further supported methanol prices.

Stronger fertilizer prices. Urea prices have shown a strong trend since the beginning of the year due to heavy India buying. The urea industry is expected to benefit from a healthy progress of the monsoon season, which has driven fertilizer sales to an unprecedented level. Measures taken by the government of India to aid the rural economy has improved the purchasing power of farmers. With a healthy monsoon season, the autumn season should also see a healthy fertilizer offtake due to an expected increase in farmer’s income. This is expected to result in a sustenance of urea demand in 2021. India is still a net importer of urea despite accounting for 14% of global urea production and it is expected to remain the largest net importer of Urea in the next 2 years despite impending capacity additions domestically.

Outlook. We believe that the outlook for PCHEM is positive at this juncture as most product prices have recovered significantly from its YTD lows. Olefin prices are expected to be supported by stronger China demand, higher demand for healthcare related usage and economic recovery globally as nations adjusts to the new normal. Urea prices are expected to be supported by stronger demand from India while the oversupply in methanol is expected to be mitigated from a pick-up in industrial activity in China and plant shut-downs in Europe.

Forecast. We upgrade our FY21-22F earnings by 7/4% respectively while maintaining our FY20f forecast as we have already expected a stronger 2H20 due to higher ASPs for its products.

Upgrade to BUY with TP: RM6.50. We upgrade PCHEM from a HOLD (TP: RM5.90) to a BUY based on an unchanged FY21 EV/EBITDA multiple of 9x (rolling forward from FY20). We believe that the worst is over for PCHEM as most product prices are in recovery mode due to the aforementioned factors. We also expect stronger crude oil prices to support petrochemical product prices going forward. However we only expect its Pengerang Plant (PRefChem) to contribute to earnings materialy in FY22 as it would require some time to ramp up on its production in FY21.

Source: Hong Leong Investment Bank Research - 30 Sept 2020