PCHEM’s 1QFY23 results underwhelmed expectations, mainly due  to weak volumes and product spreads which we believe will  prevail in the near term given a weak demand outlook. Hence, we  cut our FY23-24F net profit forecasts by 62% and 17%, respectively, lower our TP by 21% to RM6.20 (from RM7.80) and downgrading our call to UNDERPERFORM (from MARKET  PERFORM).

Grossly below expectations. 1QFY23 core net profit of RM459m  disappointed, merely making up 9% of our full-year forecast and 12% of the full-year consensus estimate. The variance versus our forecast was mainly due to lower-than-expected sales volumes and product spreads at the fertilizers & methanol (F&M) segment.

Fertilizers faltered. Its weaker core net profit (-52% QoQ) were mainly due to: (i) contraction in sales volume, and (ii) weak product spreads on the back of lower average selling prices (ASP). Additionally, this was exacerbated by: (i) a weaker USD versus MYR, and (ii) chunky net pre-operating costs at Pengerang Integrated Complex (PIC) (circa  RM100m). In particular, bottomline contraction was mainly driven by the  F&M segment due to tepid sales for urea and ammonia products.  Meanwhile, 1QFY23 production volumes (-5% QoQ) were impacted by lower plant utilization (PU) of 96% (4QFY22: 100%). This was due to increased plant maintenance activities at PC Aromatics and PC LDPE. The above more than offset narrowed losses at the specialties segment as sales volumes improved (+16%).

Specialties turned loss making after Perstop acquisition. The dismal YoY performance (-77%) was mainly attributed to: (i) high earnings base given that record 1QFY22 profit was propped by strong product spreads, (ii) increased energy and utilities costs, and (iii) USD  strength versus MYR. Therefore, bottomline contracted in spite of a surge in topline. The latter was underpinned by a higher sales volumes as well as consolidation of PCHEM’s newly acquired specialty chemicals company, Perstop. Meanwhile, volumes were propped by higher PU of 96% (1Q22: 87%) given less turnaround activities at the olefins & derivatives plants.

Demand still languishing. We believe that the recovery in global demand for petrochemicals will likely be muted in the near term due to  tepid consumer spending, particularly in China. This is mainly underpinned by an inflationary environment that has hit consumer spending. Moreover, Chinese consumption has recently shifted from consumer goods during the pandemic to services currently. This change in behaviour is likely driven by the upliftment of Covid-19  lockdowns. Hence, Chinese consumers are now prioritizing travel and social activities. As such, this has dented demand for consumer goods that require petrochemical feedstock as raw material input.

Forecasts. We cut our FY23-24F net profit forecasts by 62% and 17%, respectively, to account for weaker ASPs and volumes at the F&M  segment.

We also lower our valuation on PCHEM to 14.3x CY24 PER (from 15x).  This is in-line and to correspond with its large Asian peers (e.g. PTT  Chem, LG Chem, Formosa, LCTITAN) which have recently been de-rated. As a result of this, and coupled with the cut in our forecasts, our  TP is lowered to RM6.20 (from RM7.80). There is no change to our TP  based on ESG given a 3-star rating as appraised by us (see Page 5).

We downgrade PCHEM to UNDERPERFORM from MARKET PERFORM due to the gloomy outlook for ASPs. This emanates from the weak demand outlook as highlighted above. In turn, this may result in sustained weakness in product spreads, and hence earnings.

Risks to our call include: (i) demand rebounds due to strong economic growth, (ii) dip in crude oil prices leading to cheap feedstock costs for PIC, and (iii) market supply tightens due to plant outages and delay of upcoming capacity.

Source: Kenanga Research - 30 May 2023