GCC Petrochemicals - Yansab and Petrochem Initiation

GCC PETROCHEMICALS SECTOR
Product spreads likely peaked but expected to remain elevated
Prefer proven operational excellence, like Yansab over Petrochem
16th August 2016
Companies Covered
YANSAB
Recommendation
BUY
Target Price (LC)
49.20
P/E 16
12.4
9.1
EV/EBITDA 16
6.9%
Div Yield 16
1.5
P/B 16
Petrochem
Recommendation
HOLD
Target Price (LC)
16.40
P/E 16
14.8
EV/EBITDA 16
10.3
Div Yield 16
na
P/B 16
1.2
1year
QTD
YTD
SASEIDX
-28%
-3%
-9%
YANSAB
-13%
4%
34%
PETROCHEM
-32%
-9%
-7%
SASEPETR
-23%
3%
6%
Source: Bloomberg Note: All financial
ratios and prices reflects the market
closing as of 11 August 2016
For the detailed report, please contact
the Sector Coverage Team:
Sector Coverage
Ankit Gupta, CFA
+9714 3199 767
agupta@shuaa.com
Asjad Yahya, CFA
+9714 3199 768
ayahya@shuaa.com
PRODUCT SPREADS: PAST THE PEAK, BUT WILL REMAIN ELEVATED
Our global supply-demand analysis suggests that petrochemical spreads have already peaked, but we
expect end-product spreads to remain elevated during 2016-19 compared to the previous cycle. Our
view is driven by: 1) Higher capital intensity; 2) Relatively better supply-demand balance during the
current cycle compared with the previous cycle. We expect HDPE and naphtha spread to average
$630/mt between 2017 and 2019, compared with 2016E of c.$740/mt, and 2014-15 average of c.$720/mt.
For PP, we expect propylene spread (over propane) to weaken on increasing propylene supplies, offset by
continual tightening in PP market. We expect spread over propane (KSA) to average c. $600/mt between
2017 and 2019 compared with 2016E level of $620/mt and 2014-15 average of $700/mt. Our product
spread outlook translates into muted earnings growth outlook for the KSA olefin/polyolefin companies,
unless complemented by improved operational scale.
YANSAB: STRONG FREE CASH FLOW GENERATION NOT WELL REFLECTED IN THE STOCK PRICE;
INITIATE WITH BUY RECOMMENDATION
Yansab, 51%-owned by SABIC, is among the most efficient petrochemical projects which commenced
operations in KSA since 2010. The company operated at an average utilization of 97% between 2011 and
2015, and we expect LT operating rates at 99%. Such high level of operating rates coupled with favorable
feedstock arrangements and product portfolio would translate into LT EBITDA margin of over 45% on our
estimates. High margin coupled with limited capex needs (LT: 5-6% of sales) implies that the company will
generate significant cash flows, with 2016-18E average FCF/share of SAR 4.9, or an average FCF yield of
11%. Such high FCF yield with strong balance sheet (2016E net-debt to equity being negative) augurs
well for potential dividends.
Strong FCF yield (2016E: 11.7%), potential upward revision to consensus (we are c. 35%/15% ahead of
consensus on 2016E/17E EPS; expect 2016/17 DPS to be 42%/27% higher than the consensus),
undemanding valuation (2016/17E PER: 12.4x/13.1x) and highest dividend yield (2016E: 6.9%) among KSA
petrochemicals makes us a buyer of the stock. The stock has outperformed broader petrochemical index
(SASEPETR) by 28% YTD, and we expect outperformance to continue. BUY.
PETROCHEM: ST OUTLOOK MUTED ON PLANNED SHUTDOWN AND OPERATIONAL UNCERTAINTY
– INITIATE WITH HOLD RECOMMENDATION
Petrochem has only one operating asset, a 65% ownership in Saudi Polymer Company, which
commenced commercial operations in Q4 2010. The project’s operating rates have improved significantly
since commercial start-up, however, we estimate that the plant is still not operating at optimal capacity
(H1 2016E: c.85%). Barring operational uncertainty, we are positive on the inherent project’s potential
profitability, with LT EBITDA margin of over 29% on our estimates. Such high margins with limited capex
needs (LT: 4-5% of sales) will translate into high free flow generation, which however will be mostly
utilized in debt repayment in the short-to-medium term (2016-18E cumulative FCF: SAR 4.8bn versus debt
repayment obligation: SAR 3.8bn).
High leverage (2016E debt to equity: 1.2x), potential downward revision to consensus (we are c. 35%/15%
below consensus on 2016/17E EPS; 2016E DPS: SAR 0.0 vs. cons: SAR 0.4), and operational uncertainty will
likely put a cap on the stock price, although the valuation appears cheap (2016/17E PER: 14.8x/9.8x), in our
view. HOLD.
Company
YANSAB
Petrochem
ADTV
Price (LC) Recommendation Target Price (LC) % upside/(downside) 6-month
(US$ mn)
43.49
BUY
49.20
13%
5.2
15.50
HOLD
16.40
6%
1.7