Key takeaways from Petronas Chemicals Group (PChem)’s 3Q19 results briefing include: (1) 3Q19 associate earnings were mainly dragged by 60%-owned aroma plant due to low utilization and start of debt servicing, (2) FY20-21 will be relatively subdued in terms of plant turnaround activities, (3) Pet Chem may potentially switch to sweet crude feedstock to derive naphtha for its new cracker at Pengerang, and (4) PIC-Pet Chem plants are targeted to deliver positive EBITDA in FY20 – underpinned by 80%-90% plant utilization. Maintain Sell due to earnings headwinds from margin squeeze arising from product price weakness. Our target price (TP) of RM7.50 is based on 9x CY20 EV/EBITDA.

Recap of 3Q19 Earnings Drag. Management provided enhanced granularity on key earnings drag in 3Q19, which include: (1) inventory write-down of RM63mn (YTD: RM106mn) for performance chemicals under the ethane chain, (2) associate losses mainly emanated from the 40%-owned BASF-Pet Chem aroma plant, and (3) sales volume decline (-1% YTD) despite production uptick (+2% YTD) was due to lower trading volume. For the aroma plant, we understand that average YTD plant utilization (PU) remains low due to turnaround activities (TA). On the bright side, current PU has reached a high of 80% - which management hopes to sustain on the back of improved plant reliability. Nevertheless, this plant reported positive EBITDA - albeit not sufficient to offset interest costs from project financing loans. On the latter, the plant had commenced recently debt servicing.

Breather for Plant Maintenance Activities in FY20-21. Plant TA in 3Q19 include: (1) PC Fertilizer Sabah (43 days), (2) PC Olefins, Glycols and Derivative plants (43 days), (3) PC LDPE (41 days), and (4) PC Ammonia (circa 37 days). The heavy TA were completed ahead of schedule and below budgeted capex. Moving forward, there are no planned plant TA in 4Q19. Meanwhile in 1Q20, there would be one TA at PC Methanol for approximately 30 days. Management provided guidance that FY20-21 would be relatively subdued in terms of plant TA. This is in contrast with busy years experienced in 2017-19.

Pengerang Firing Up. PIC-Pet Chem’s plants at Pengerang Integrated Complex (PIC) have achieved 99.4% completion as at Sept-19. The plants are currently undergoing commissioning in stages – where performance test runs will be executed in 4Q19-2Q20. Management targets positive EBITDA contribution from these plants in FY20 – underpinned by 70%-80% PU. On a surprise note, management is mulling the possibility of switching to alternative sweet crude feedstock to derive naphtha for its cracker at PIC. Recall that Pet Chem had initially planned to secure naphtha from sour crude at Petronas-Aramco’s refinery at PIC. However, this plan is derailed following a fire incident at the refinery back in Apr-19. Nevertheless, management has ruled out the possibility of sourcing for imported naphtha, ethylene or propylene feedstock. Additionally, Pet Chem quelled concerns that product margins may be squeezed from usage of more expensive sweet crude. According to management, this was on the back of “many choices” available.

Impact

No change to earnings estimates.

Valuation

Maintain Sell due to earnings headwinds from margin squeeze arising from product price weakness. Our target price (TP) of RM7.50 is based on 9x CY20 EV/EBITDA

Source: TA Research - 15 Nov 2019