INVESTMENT HIGHLIGHTS

• Petronas Chemicals Group Bhd’s (PChem) 2QFY19 to improve q-o-q due to lower Turnaround (TA) activities

• 3QFY19 PUR to mimic that of 3QFY18 at ~80%

• Average product prices to remain fragile due to ongoing geopolitical tensions however; offset by softer Ringgit

• Pockets of opportunity remain despite the ongoing USChina trade war as demand remains largely intact

• FY19-20F earnings trimmed by -8.0% and -3.3% respectively

• Maintain BUY with a revised TP of RM8.77 per share

Anticipating q-o-q improvement in 2QFY19 earnings. We are anticipating the upcoming PChems’ 2QFY19 earnings to be better on a quarterly sequential basis. We are expecting PChem’s 2QFY19 earnings to come in between RM900-RM1,100m due to lower turn around activities that took place during the quarter. Recall that, during 2QFY19 PChem has completed the maintenance on PC Aromatics back in April that took place for 26 days (in addition to 14 days in 1QFY19) and it has also shut down its PC Methyl Tertiary Butyl Ether (MTBE) plant in Gebeng in mid-April 2019 for 22 days. We opine that due to this, the PUR for 2QFY19 will remain above 90%.

Another round of heavy TA in 3QFY19. As previously guided by the Management, 3QFY19 will see several heavy TA taking place. There will be four plants that are expected to be under TA (Refer to Figure 1) and this is expected to bring down PChem’s plant utilisation rate (PUR) to below 90% and we opine that its PUR will be similar to that of 3QFY18 – at 79%, where heavy TA took place during the quarter as well which limits the production volume for some of its products.

Average selling prices (ASP) to remain fragile, however… We opine that in the near future ASP will remain fragile and under pressure from the ongoing geopolitical tensions that affects the crude oil price movements which we opine will drive consumers into a cautious purchasing mode. This is further exacerbated by the recent revision of global economic growth target by IMF to 3.1% from 3.3% previously.

That said, we observed that the spread for some of the chemicals such as: polypropylene, benzene, and urea have gradually recovered and stabilised from the recent bottom seen back in Mar-May 2019. (Refer to Figure 2-4). Hence, we opine that the gradual recovery in ASP for the chemical products as well as; the expected continued soft movement of Ringgit for the rest of the year will cushion PChem’s earnings. According to our in-house projection, Ringgit is expected to average at RM4.15 per USD in FY19 whilst our year-end Ringgit target currently stands at RM4.15 per USD.

Furthermore, demand for chemical products is expected to be cushioned by numerous TA activities that will take place across the globe. According to Bloomberg, it is estimated that about 26 oil refineries are scheduled for shutdown throughout the year for expansion and/or maintenance works. This, we reckon will balance out the new supply coming into the market from earlier this year.

Pockets of opportunity remain despite the ongoing US-China trade war. While we note that the ongoing trade war between US-China in general will have a negative impact globally especially on demand in the longer term should the trade war prolongs, however; we opine that pockets of opportunity remain in the midst of the trade war for regional chemical producers such as PChem. In terms of demand, we have observed that chemicals export from Malaysia to the rest of the world in monetary value remains relatively strong and similar to that of 2017 and 2018 – in some months, exports were also higher than that of 2017 which was pre-trade war. This is despite the softer yearover-year growth in the chemicals export compared to 2018 which signals that the demand for chemicals remains largely intact despite the geopolitical tensions. To date, chemicals remain the third largest Malaysian export at 6% of total exports. Refer to figure 5.

Furthermore, we opine that the recently imposed 10% tariff on Chinese goods could potentially lead to the following impact on petrochemical products: (i) increased in product pricing for a broad range of chemical products and; (ii) provides opportunities for PChem to produce new chemical products for the Chinese market due to PChem’s wide range of petrochemical products. Refer to Figure 6 for the list of some of the chemical products that are expected to be slapped with the additional tariff.

Impact on earnings. Due to the heavy turnaround activity in 3QFY19 to result in PChem’s utilisation rate to potentially drop to the level similar to that of 3QFY18 which was at 79% coupled with the soft albeit gradually improving product prices, we have trimmed our FY19-20F earnings by -8.0% and -3.3% respectively.

Recommendation. Despite the earnings revision, we are maintaining our BUY recommendation with a revised target price of RM8.77 per share (from RM10.43 per share previously) as we opine that all the negatives have been priced in and there’s a potential upside from the various reasons stated above. Our target price is derived from a PER20 of 16x pegged to EPS20 of 54.8sen.

Current share price presents a strong buying opportunity. Despite the heavy TA and lower PUR albeit >90% we reiterate our view that PChem’s current share price presents a strong buying opportunity given PChem’s clear growth strategy, venture into specialty chemicals with the ongoing acquisition of Da Vinci Group B.V and stable outlook for its chemical products. We also continue to like PChem due to its: (i) robust balance sheet; (ii) clear growth strategy; (iii) wide range of chemical offerings; (iv) favourable feedstock price from its parent company Petroliam Nasional Berhad (PETRONAS) and; (v) attractive FY20F dividend yield of 5.0%. Furthermore, PChem is also currently trading at 13.6x FY20F PER which is below its 5-year average PER of 16x which makes it an attractive stock to accumulate. Historically, it has traded up to 19.3x PER.

Source: MIDF Research - 9 Aug 2019