Petronas Chemicals Group (PCHEM) released its financial results for the second quarter (2Q19), posting a lower net profit (NP) of RM1.12b, 22.3% lower year-on-year. MQ Research cuts its target price (TP) to RM8.50, 17.4% above the current share price of RM7.24, though it maintains Outperform on PCHEM.

Event

• PCHEM posted 2Q19 operating profit (OP) of RM1,258m, below MQ Research’s estimates.

Impact

• Key product margins near lows. MQ Research attributes the drag mainly to restrained demand amid the ongoing US-China trade war and the Indian govt’s funding constraints ahead of the general elections. But, MQ Research sees PCHEM’s incomparably high operating margin (OPM) of 29% under the current conditions of high uncertainty as being encouraging. As well, MQ Research believes its key product margins are at or close to the bottom. Thanks to supply cuts from competitors bearing higher costs, MQ Research expects polyethylene and monoethylene glycol (MEG) margins to rise by 11% into 2020 without any major demand-side development vs. Macquarie’s economic team seeing a rebound of global growth over 2020 from the 2H19 low.
• Protected by volume growth: In 4Q19, PCHEM will start a new petrochemical facility, expanding its production capacity by 15% (1.8mn tpa). MQ Research sees PCHEM’s PIC-PETCHEM (known as RAPID) – which takes downstream only margin – is better positioned in the current supply glut of upstream ethylene. Once it fully ramps up, MQ Research estimates the new project could add an OP of RM850mn (19% of 2019E OP) pa. This attribute protects it more from potential fluctuations in product prices compared to peers.
• The transformation into a better company is on track. The acquisition of Da Vinci cements PCHEM’s mid- to long-term strategy to transform into a better company, reducing cyclicality and securing greater visibility in earnings. Specialty silicones and additives have been an attractive business, suiting of a low-risk growth profile: it is a capex-light business, while giving crucial benefit to the end product with low cost share. Multiple Western companies have pursued this as being witnessed by Lanxess and Berkshire Hathaway’s acquisition of Chemtura and Lubrizol, respectively. PCHEM aspires to increase its specialty portfolio to 25% in the next 20 years from the current 5%.

Earnings and Target Price Revision

• MQ Research cuts its FY19-20E NP by 19-20% to reflect weaker-than-expected petrochemical and fertilizer prices; and lower its TP to RM8.50 (from RM10.50).

Price Catalyst

• 12-month price target: RM8.50 based on a Residual Income Model.
• Catalyst: Chemical price recovery followed by the latest rebound in margins

Action and Recommendation

• Outperform. PCHEM’s share price has fallen 22% YTD. MQ Research thinks the current record low level of forward price to book (P/B) ratio of 1.7x should be pricing in the known negatives.

12-month Target Price Methodology

• PCHEM MK: RM8.50 based on a Residual Income Model methodology

Source: Macquarie Research - 14 Aug 2019