Macquarie Equities Research (MQ Research) initiates coverage on Petronas Chemicals (PCHEM) with an Outperform rating and a target price (TP) of RM8.50 amid rising chemical prices led by supply cuts coupled with higher buying interests. MQ Research also sees that PCHEM’s Environmental, Social and Governance (ESG) moves should drive valuation and returns higher and believes that the impact from the Coronavirus outbreak would be momentary.

Conclusion

• MQ Research is encouraged to see early signs of recovery in earnings and share price.

Impact

• A meaningful rebound in ASP before the nCoV outbreak: Over the past two months, prices of ethylene (a proxy to the chemical industry) have risen by 22%, ending the multi-year downtrend. Nearly half of the Asian spot market supply has declined since mid-4Q19 as a price response, even before the nCoV outbreak. Such broad-based production cuts are rare. MQ Research considers this as a sign of recovery. Considering the low level of chemical inventory, any macroeconomic development could help return pent-up demand, supporting chemical prices particularly from 2Q/3Q 2020. Without possible nCoV negatives, Macquarie economics team sees global growth troughing in 4Q19 and that PCHEM’s earnings would have bottomed in 3Q19. Further, MQ Research sees any trade development as a plus alpha, expecting a reversal in the double whammy situation. Besides demand contraction, South East Asia has struggled with the supply increase because the US redirected its exports toward SEA from China.

• ESG conscious steps to drive valuations and returns higher. In 2020, MQ Research expects increased focus on ESG from investors as witnessed by Blackrock’s announcement making ESG integral part of portfolio construction. PCHEM’s latest steps run all the way to ESG concerns. While the street’s focus has been PIC-PCHEM’s higher cost for polyethylene (PE), the new oil cracker allows PCHEM to have various non-PE plastics for EV’s lightweight materials, safe drinking and medicines. These products are rarely produced in a gas cracker. In addition, Da Vinci like deals add technology to its venture into specialty and bio-based plastics. MQ Research believes China’s latest ban on single use plastics will further raise the ESG spotlight in the sector although the ban should impact only 1% of PCHEM’s sales (8.4m tpa of high-density PE sales).

Earnings and Target Price Revision

• MQ Research cuts FY19-21E OP by 8-18% reflecting maintenance shutdowns and sharp chemical price drop in 2H19. TP is unchanged mainly on valuation roll-forward.

Price Catalyst

• 12-month price target: RM8.50 based on a Residual Income Model.
• Catalyst: Chemical prices strength; higher DPS; increasing focus on ESG

Action and Recommendation

• Outperform. Macquarie’s economics team sees impact from the Coronavirus outbreak to be sharp but short-lived. MQ Research would advise investors to seek opportunities post correction.

12-month Target Price Methodology

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

Source: Macquarie Research - 10 Feb 2020