As the share price has reached our previous MYR7.56 TP, we downgrade to NEUTRAL as we believe the market has taken into account Petronas Chemical’s 21% YoY FY16F earnings growth, driven by a higher utilisation rate, additional capacity coming online andfavourable exchange rates. Our new MYR7.19 TP (2% downside) is based on 17.1x FY16F P/E. Product prices may dampen earnings, though, due to the current global challenges.

Utilisation rate and start-up of a new plant. Petronas Chemicals is expecting its group utilisation rate to average 90% for FY16, as there could be no major statutory turnaround planned for the year. This wouldbe an improvement over its expected FY15 utilisation rate of 85%, and utilisation rates of 80% and 78% for FY14 and FY13 respectively. Another positive note in FY16 would be the start of commercial operations of the Sabah Ammonia and Urea (SAMUR) project in 2H16, which could add a further 1.94m tonnes er annum (tpa) of capacity to its products portfolio.

Product prices could be a dampener. Notwithstanding the high utilisation rate and additional capacity coming online in FY16, we point out that petrochemical product prices could trend lower on the current global economic challenges and lower crude oil prices. We lower our FY16 product price forecasts by 3%-30% YoY across the segment. We are bearish on aromatics while expecting polymers and fertilisers to be resilient.

Downgrade to NEUTRAL with a MYR7.19 TP. We believe the market has taken into account Petronas Chemicals’ 21% earnings growth in FY16F, which would be driven by the start-up of the SAMUR plant, its 90% target group utilisation rate and the favourable MYR/USD exchange rate. However, product prices continue to be a concern, due to the factors mentiond above. As the stock has reached our previous TP of MYR7.56, we downgrade it to NEUTRAL (from Buy) with a lower TP of MYR7.19, based on 17.1x FY16F P/E. This is at a 10 premium to other petrochemical products players. We believe the 10% premium is justified, considering Petronas Chemicals’ huge EBITDA margin of +30% from its cheap feedstock advantage, as well as its foray into the lucrative specialty chemicals segment.

Utilisation rate. Petronas Chemicals is targeting a group plant utilisation rate of 90% for FY16, excluding SAMUR. Having a total nameplate capacity of 10.8mtpa, at 90% utilisation rate, the company would be producing approximately 9.72mtpa of petrochemical products in FY16. Although its target utilisation rate is set at 90%, we are forecasting a full-year utilisation rate of 85% for the group. Recall that in FY13-14, Petronas Chemicals underwent a major statutory turnaround programme that dragged down its group utilisation rate to 78% in FY13 and 80% in FY14. We understand that the next round of major turnarounds may start in FY18 and gradually pick up pace moving into FY19.

Product prices. Product prices for both olefins and derivatives (O&D) and fertilisers and methanol (F&M) are on a downward trend. Having already started the year lower– vis-à-vis FY14 – following the crude oil price crash, product prices closed the year even lower, falling by 10-40% across both segments. For FY16, we expect the prices of more resilient ethane-based O&D products – high-density polyethylene (HDPE), linear low-density polyethylene (LLDPE) and low-density polyethylene (LDPE) – to remain durable. This is because we are expecting new supplies of ethylene to come online in FY17 and FY18. Meanwhile, we anticipate naphtha-based products or aromatics – benzene, methyl tertiary butyl ether (MTBE) and paraxylene (PX) – to trend lower, brought upon by the cheaper cost to crack naphtha. We expect fertilisers to remain stable while methanol prices are expected to trend lower. All in, we expect product prices to be lower by 3-30% for FY16.Worst case scenario. We considered a scenario in which product prices, across all segments, are lower by 7-15%, when compared to our FY16 forecasts. All other variables remained the same. The worst case scenario implies a crash in demand for petrochemicals and fertiliser products, which we believe is unlikely.

SAMUR. We believe the main growth engine for Petronas Chemicals’ earnings for FY16 would be the start-up of its SAMUR plant, which will add a further 1.2mtpa capacity of urea and 0.74mtpa of ammonia to its portfolio. We understand that SAMUR is expected to kick-start commercial operations in 2H16 and we have imputed this into our assumed utilisation capacity. An earlier-than-expected start-up of SAMUR could provide an earnings upside to our forecast. In the event that the project does not start commercial operations in FY16, we expect a 17% downside to our earnings forecast for the year.

Refinery and Petrochemicals Integrated Development (RAPID). The engineering, procurement, construction and commissioning (EPCC) awards for the petrochemicals portions for RAPID were handed out in late FY15 for the polymers and glycols plant. The EPCC contract for the elastom ers plant has yet to be announced. Petronas Chemicals has yet to announce its partners for the petrochemicals plant for RAPID and their respective stakes. W e expect this to be announced after all th EPCC packages for the petrochemicals portion have been awarded. Looking at Petronas Chemicals’ balance sheet, as of 3Q15, it was in a net cash position of MYR9.5bn. With RAPID expected to cost MYR16.7bn (USD3.9bn), the group has the financial capacity to undertake the project alone. However, it is partnering three other petrochemicals firms to leverage not just on their engineering capabilities, but also on their marketing arms to open up new markets. This is because these firms are already established players in their respective markets.

Earnings. We expect Petronas Chemicals to register 21% YoY net profit growth in FY16, mainly driven by the start-up of SAMUR, its 90% utilisation target as well as the favourable MYR/USD exchange rate. Recall that 100% of revenue is in USDterms while only 60% of the group’s costs are denominated in the US currency. However, we believe that the pressure of product prices being lower in FY16 would dampen Petronas Chemicals’ earnings. As such, we lower our earnings estimates for FY15, FY16 and FY17 by 1%, 5% and 4.5% respectively.

Valuation. We believe the market has already taken Petronas Chemicals’ earnings growth for FY16 into account, as its stock price has done very well over the past few months. We downgrade our recommendation to NEUTRAL (from Buy with a TP of MYR7.19 (from MYR7.56), based on FY16F 17.1x P/E. This is at a 10% premium tothat of its regional peers. We believe the premium is justified, considering Petronas Chemicals’ fat margins due to its cheap feedstock advantage as well as its foray into the lucrative specialty chemicals segment. We offer an alternative DCF valuation to our P/E valuation method, arriving at a TP of MYR7.16.

Risks. Key downside risks to our forecast are: i) lower-than-expected product prices, ii) disruptive unexpected shutdowns and iii) SAMUR delaying its commercial operations date. Upside risks include: i) a better-than-expected recovery in product prices, and ii) lower feedstock cost, resulting in better margins.