Petronas Chemicals posted 9M14  core earnings of MYR1.96bn, missingexpectations  at  53%/59%  of  our/consensus  full-year  estimates.  Given the  recent  selldown,  we  upgrade  our  recommendation  to  NEUTRAL (from Sell), with a lower MYR6.08  TP  (0.5% downside, 14.3x FY15F P/E)from  MYR6.11.  We  cut  our  FY14/FY15F  earnings  by  27%/11%  after updating our utilisation rate and product price assumptions. 

9M14  earnings  reach  MYR1.96bn.  Major  maintenance  turnarounds carried  out  in  the  earlier  part  of  the  year  dragged  down  Petronas Chemicals’  9M14  revenue  by  9.8%  YoY.  Around  73%  of  the  revenue was  contributed  by the olefins and derivatives (O&D) segment,  and  the remainder  by  the  fertiliser  and  methanol  (F&M)  segment.  9M14  core earnings  declined  26.3%  YoY  due  to  the  aforementioned  turnarounds,which lowered the plants’  utilisation rates. The O&D segment accounted for  69%  of  total  earnings  while  the  F&M  segment  contributed  the remaining 31%. 

Mixed outlook for  product prices.  Management guided that the last of its  major turnaround programme  ended in October with the shutdown of a methanol plant in Labuan. We expect plant utilisation rate to  return  to the  85-90% level for the rest of the year.  Overall product outlook for the rest of the year  is  mixed as Petronas Chemicals expects  ethane-based and  aromatics product prices to soften  on the back of better supply  –  as several  regional  producers  come  back  online  from  their  own  m ajor turnaround programmes  –  coupled with softer  demand from China.  The company expects ammonia and methanol prices to trend upwards due to supply tightness while urea prices to soften due to a supply glut in China.   Upgrade to NEUTRAL with a lower TP of MYR6.08.  While  we expect Petronas Chemicals’  plants  to have  better utilisation rates  in FY15,  key product prices might come under pressure due to  an  oversupply in the market. We lower our FY14/FY15  earnings  forecasts  by 27%/11%  afterupdating  our utilisation rate and product price assumptions. We  upgrade Petronas  Chemicals  to  NEUTRAL  (from  Sell)  with  a  lower  TP  of MYR6.08 (from MYR6.11), based on a 14.3x FY15F P/E, which is on par with its regional peers. The counter is trading at  -1SD below its historical trading mean, given the recent selldown on oil and gas counters.

Key Highlights

Petronas  Chemicals  has  completed  the  scheduled  major  turnaroundssuccessfully. The last plant to undergo  a  turnaround was the Labuan methanol plant. The next round of major turnarounds will be in 2018-2019.

A floating production, storage and offloading (FPSO) vessel   supplying methanol to the Labuan plant  experienced a transformer  malfunction since mid-July and was only fixed in mid-September. This dragged the fertiliser and methanol (F&M) plant utilisation rate down to 64%.

The group plant utilisation rate stands at 75%. If the methanol supply problem did not occur, it would have been 88%.

Polyethylene prices may see downward pressure in the near term due to weaker demand from China as well as new supplies from  the  Middle East. Management expect prices to be on an uptrend 2016 as demand picks up again.

We  believe  the  weakness  in  crude  oil  prices  only  marginally  affects  Petronas Chemicals.  Naphtha makes up 7% of total feedstock amount. We estimate  that an 11% decrease in crude oil price may translate into a 4% EPS increase.

Global  urea  prices  are  under  threat  due  to  China’s  low  tax  export  window. However, additional demand  from India could provide a short-term price uptick. Management expects  prices  to  recover by  the  end of  the year as  the  northern hemisphere prepares for the planting season. 

Ammonia  should  remain  on  an  uptrend  due  to  tight  supplies  and  increased demand arising from  the northern hemisphere’s  planting season. We believe the ongoing  geopolitical  tensions  in  Ukraine,  which  handles  20%  of  the  world’s ammonia trade, may continue to keep prices on an uptrend.

South-East Asian (SEA) and Iranian methanol producers ramped up production earlier  in  the  year,  which  had  suppressed  prices.  Management  believes methanol prices are expected to be stable amid balanced supply and demand. 

Management  expects  the  Sabah  Ammonia  Urea  (SAMUR)  project  to  come online in 2016. The plant is expected to produce 1.2m tonnes per annum (tpa) of urea and 0.7m tpa of ammonia, making Petronas Chemicals the second-biggest urea producer in the region.

BASF’s  (BAS GR, NR)  aroma chemicals plant in Pahang  is  expected to come online  in  2016.  Aroma  chemicals  are  high-value  products  and  will  provide  an earnings buffer against commodity fluctuations.

The  Refinery and Petrochemical Integrated Development (RAPID) project  is  still on  track  with  11  infrastructure  packages  awarded  out.  Petronas  Chemicals  is expected to make a final investment decision by 1H15. 

Forecasts. We cut our FY14/FY15 earnings forecasts by 27%/11% as we update our utilisation rate and product price assumptions.  We now expect Petronas Chemicals to record  earnings  of  MYR2,709m  and  MYR3,397m for  FY14  and  FY15  respectively. The  FY15  earnings  growth  is  due  to  a  higher  plant  utilisation  rate  as  Petronas Chemicals has completed its scheduled major turnarounds for all its plants.

Risks.  The  downside  risk  to  Petronas  Chemicals’  earnings  is  lower  prices  for  its products,  which  are subject  to supply and demand dynamics.  A global oversupply of polyethylene products, its main earnings driver, could pose a risk to earnings.

Valuation. Our lower MYR6.08 TP is pegged to a 14.3x P/E on FY15F EPS, which is the average of other regional petrochemical players. In light of the recent selldown, we  upgrade our recommendation to  NEUTRAL  –  we believe Petronas Chemicals isfairly valued as it is trading at -1SD below its historical trading mean.

Source: RHB