Kenanga Research & Investment

Petron Malaysia Refining - A Crack Spread Refinery Play

Publish date: Thu, 27 Oct 2022, 09:18 AM

We are initiating coverage on PETRONM with a MARKET PERFORM call and TP of RM4.65. The group primarily operates the Petron Port Dickson Refinery, with a rated capacity of 88k barrels per day, and is also involved in petroleum products marketing and retail kiosks. As a largely refinery play, the group’s earnings are susceptible to the fluctuations of crack spreads, which has fallen drastically since peaking in mid-2022 amidst deteriorated demand outlook. Although some mild reprieve is expected in the coming months, product prices are not likely to be anywhere near the peaks earlier in the year – resulting in possibly weaker earnings in the coming quarters.

A refinery play. PETRONM is part of the larger Petron Corporation (headquartered in the Philippines), which entered Malaysia back in 2012 after acquiring ExxonMobil’s downstream business. Petron Malaysia Refining & Marketing Bhd (PETRONM) primarily operates the Petron Port Dickson Refinery, which has a rated capacity of 88k barrels per day. The facility produces a wide range of petroleum products including gasoline, diesel, LPG, and aviation fuel. While PETRONM also markets and operates some petrol stations in Malaysia, the network of petrol kiosk is shared with a non-listed sister company, Petron Fuel International Sdn Bhd.

Earnings volatility. Being largely a refinery, PETRONM’s earnings is highly susceptible to the fluctuations of crack spreads which is essentially the price difference between the cost of a barrel of crude oil which a refiner buys as input raw material and the selling prices of its output, petroleum products. Whilst both crude oil and petroleum products are inter-related, they are each separate commodities, subjected to different day-to-day market forces. Therefore, losses can occur if cracking spread fails to cover the processing cost or when the cost of crude oil simply ends up higher than the selling prices of the end products.

Regional crack spreads currently down trending. The Singapore Mogas 92 (Platts) Brent crack spread futures have fallen off a cliff from its peak in May-June 2022, and hence, we are anticipating results for the upcoming quarters to be drastically weaker. Crack spreads have generally enjoyed a gradual increase since 2021, underpinned by the declined global refining capacity amidst refinery closures during the pandemic, low inventories, coupled with improved global demand for petroleum products as the world transitions out of the pandemic. The addition of the Russian-Ukrainian conflict has pushed crack spreads even further to peak in May-June 2022. Since then, crack spreads have declined steeply as regional supply has outstripped demand coupled with the inventory build-up, while recessionary fears continue to cast doubts over future demand.

Gasoline product prices to see mild rebound in coming months, but still nowhere near mid-2022 peaks. According to EIA’s projections, gasoline product prices are expected to see a mild uptick towards end-2022 / early-2023, although it will still be nowhere near the peak we saw in mid-2022. That said, the product markets will likely remain shaky until the mid-decade. The balance for fuel markets will continue to be fragile in both the short and long terms, with any global unexpected and prolonged outages leading to volatile prices – all while significant extra capacity will be slow to come online.

Initiate coverage with MARKET PERFORM, and TP of RM4.65 – pegged to 5x PER on FY23F EPS, in line with average valuations of its closest peer HENGYUAN. Our ascribed valuation is also broadly in line with some of its other listed refinery peers globally (e.g. TOA Oil, Phillips 66, HF Sinclair, Valero, Marathon Petroleum). Note that our TP has taken into account our in-house ESG rating of two stars, which warrants a 5% discount to our initial valuations.

Risks to our call include: (i) possible recession to dampen demand of petroleum products, (ii) sudden plunge in crude oil prices, and (iii) operational hazards (e.g. fire) that might disrupt utilisations.

Source: Kenanga Research - 27 Oct 2022

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