We upgrade PCHEM to OUTPERFORM following its conference call yesterday, which reaffirmed the fact that FY12 earnings would be stronger than our earlier expected. We are revising our FY12 estimates upwards by 11% on likely higher petrochemicals prices in tandem with our higher crude oil price assumption. The company revealed that its 1Q12 plant utilisation rate was at 89.8%, just slightly below the 90% target. Going forward, managing the value chain with high value products would be the key to drive profit margin higher while maintaining the targeted plant utilisation rate at 90%. Our new price target of RM7.46/share is based on a lower targeted PER of 14.5x, which is the recent high after normalising from the peak of  20x in March 2011, and our CY13 EPS of 51.4 sen.

Utilisation helped to push 1Q12 higher. Petronas Chemicals Group Bhd (PCHEM) had on Monday reported a strong set of 1Q12 result due mainly to a higher plant utilisation. The group achieved a 89.8% utilisation rate in 1Q12 as compared to 78.0% in the preceding quarter. This was partly attributable to improved demand for Olefins & Derivatives (O&D) products in the quarter as well as the fact that 4Q11 results were affected by a power interruption at its ethylene crackers. As such, the plant utilisation rate at O&D rose to 95.2% from 89.0%. In addition, improved methane gas supply for the methanol facility in Labuan helped pushed the plant utilisation rate at Fertilisers & Methanol (F&M) higher to 85.2% from 67.7%.

High value products to drive future earnings. The commendable 1Q12 plant utilisation rate of 89.8% is just 0.2% below  its 90% target. Going forward, with the targeted utilisation rate remaining at 90%, managing the value chain with higher value products is the way to improve the profit margin. This includes specialty chemicals products, like one of it latest ventured together with BASF in the Kuantan facility. Meanwhile, construction work of the USD1.5b Sabah Ammonia Urea (SAMUR) project in Sipitang, Sabah, which had its groundbreaking in Feb 2012, is progressing well to be completed by end 2014. This new facility will support new earnings growth for PCHEM from FY15 onwards.

Fine-tuning FY12-FY13 estimates, introducing FY14 forecast.  We have revised upward our crude oil price assumption  following our new house's view in Mar 2012. The new assumption for 2012 is an average price of USD101/bbl from USD97/bbl, and USD107/bbl in 2013 from USD106/ bbl previously. We have kept our USD/MYR assumption unchanged. In addition, we have tweaked volume growth estimates to 3% and 1% from 4% each in FY12-FY13 as our previous assumption was too optimistic. That said, our plant utilisation rate assumption is 86.3% in FY12  (87.1% previously) and 87.1% in FY13 (90.1% previously), which is lower than management's target of 90%. Given the above changes, we are upgrading our FY12 estimate by 11% but cutting FY13 EPS by 12%. We are introducing our FY14 estimates where we expect the EPS to grow 5% p.a. Our major assumption is for petrochemical prices to track crude oil price movements. 

Upgrade to OUTPERFORM.  For the YTD, the share price of PCHEM has outperformed the KLCI by 5%. However, the valuation has normalised from a peak of 20x in Mar 2011, and has been hovering around 14x in the past ten months. We have rolled over our valuation base to CY13 from CY12 and consequently, derived a new price target for PCHEM  of RM7.46/share at 14.5x PER, its recent PER high in Oct 2011 (previous TP was RM7.02/share on 16.5x PER CY12 earnings). With the change, we are upgrading PCHEM to an OUTPERFORM from a MARKET PERFORM previously.