• Upgrade to NEUTRAL from Sell with a new MYR5.49 TP from MYR5.65, 10% expected total return. The refining margins recovery – as evident by the Tapis Crude 211 crack spread – may provide some breathier for Petron amidst the continuous upgrade work to comply with Euro 5 specifications. Sales volume may still be on a healthy track, but distribution and marketing margins could erode under intense competition. We upgrade our call following a 24% share price retracement post our end-January downgrade.

• The global refining margin recovery seen in 3Q19 was largely due to the turnaround season, which took away a portion of supply. Some complex refineries, which have the capability to break the heaviest of crude into sweet variants, have been benefiting from increased demand from shipping companies, given the impending IMO 2020 regulations. The Tapis Crude 211 crack spread – with product prices that include a mix of gasoline and diesel – has recovered to average USD8.00/bbl in 3Q19 (2Q19: USD5.70/bbl). Despite a recovery in refining margins, Petron is still exposed to a potential inventory loss in 3Q19 from a decline in oil prices for its 18-20 days’ worth of inventory.

• 3Q19 turnaround. The company’s Port Dickson Refinery (PDR) has been shut down entirely for three weeks in September for maintenance work. It also took this opportunity to perform integration work for the Diesel Hydrotreater project, which enables PDR to comply with the Government’s requirement to implement Euro 5 specifications for diesel by Sep 2020. However, distribution of end products may not be affected, as Petron can still import such products to mitigate the difference.

• Healthy volume growth amidst fierce competition. Overall sales volume grew 3% YoY to 18.3m in 1H19 (1H18: 17.8m). We believe competition in the retail segment remains intense, especially when competitors are ramping up their advertising & promotions (A&P) initiatives. Therefore, marketing and distribution margins could be still under pressure. Meanwhile, the latest update on the proposed targeted subsidy is likely to be announced in the upcoming Budget 2020. We believe the impact of a proposed targeted subsidy will be minimal – assuming non-subsidised vehicles will have to pay based on the weekly automatic pricing mechanism scheme – especially when crude oil prices have retraced to the USD60.00/bbl level.

• Earnings revisions. We cut our FY19F-20F earnings 2.4-4.3% on higher operating costs – mostly A&P. Post earnings adjustment, our TP is lowered to MYR5.49 from MYR5.65. Following our downgrade since end January, the share price has retraced 24%, suggesting that most negatives have been priced in. Consequently, we upgrade our call amidst the recovery in crack spreads seen in 3Q19.

Source: RHB Securities Research - 7 Oct 2019