PCHEM – Fundamental Analysis (10 Aug 2015)

At the time of writing, my family member owned shares of PCHEM.
Changes:
  1. 10 Aug 2015 – First write up of PCHEM using new style, and covers FY15 Q2 results.

Business Profile

PETRONAS Chemicals Group Berhad (PCHEM) is an integrated chemicals producer in Malaysia and one of the largest in South East Asia. PCHEM operates a number of production sites, which are fully integrated from feedstock to downstream end-products. PCHEM is involved primarily in manufacturing, marketing and selling a diversified range of chemical products, including olefins, polymers, fertilisers, methanol and other basic chemicals and derivative products.

The strategic business units offer different products and services, and are managed separately because they require different technology and marketing strategies. The following summary describes the operations in each of the Group’s reportable segments:

  1. Olefins and Derivatives – activities include manufacturing and marketing of a wide range of olefin and polymer products, which are used as basic feedstock for other products, to intermediate products including basic and high performance chemicals.
  2. Fertilisers and Methanol – activities include manufacturing and marketing methanol and a range of nitrogen, phosphate and compound fertilisers.
  3. Others – other businesses that supports the petrochemicals’ business operations.

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Operational Diversity

  • Comprises 26 companies producing and marketing a wide range of chemical products.
  • Operates two integrated petrochemical complexes, one in Kertih, Terengganu and the other in Gebeng, Pahang.
  • Four manufacturing complexes in Gurun, Kedah; Bintulu, Sarawak; and Federal Territory of Labuan that produce fertilisers and methanol including a new fertilisers manufacturing complex in Sipitang, Sabah (SAMUR Project) which will commence production in 2016.

Product Diversity

  • Olefins, Glycols & Derivatives
  • Polymers
  • Aromatics and MTBE
  • Methanol
  • Ammonia and Fertilisers

Geographic Diversity

  • Joint-venture partners include BASF, BP, Idemitsu Kosan, Mitsubishi Corporation, Sasol Limited, Vopak, Dialog, NAFAS and Japan Energy Corporation.
  • Kertih Integrated Petrochemical Complex, Terengganu
    • Ammonia
    • Benzene
    • Butanol
    • Butyl Acetate
    • Carbon Monoxide
    • Ethanolamines
    • Ethoxylates
    • Ethylene
    • Ethylene Glycols
    • Glycol Ethers
    • Oxogas
    • Paraxylene
    • Polyethylene
    • Propylene
    • Acetic Acid
  • Gebeng Integrated Petrochemical Complex, Pahang
    • Methyl Tertiary Butyl Ether (MTBE)
    • N-Butane
    • Propylene
    • Acrylics
    • Butanediol
    • Oxo-alcohols
  • Gurun, Kedah
    • Ammonia
    • Methanol
    • Urea
    • NPK Fertilisers
  • Federal Territory of Labuan
    • Methanol
  • Bintulu, Sarawak
    • Ammonia
    • Urea
  • Pasir Gudang, Johor
    • Styrene Monomer

 

Ownership

PCHEM is mainly owned by Petronas Nasional Berhad, and the few wide known local institutional funds. This counter is actively traded, and its volatility and liquidity are quite high.

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Economic Moats

Cost Advantage (Moat: Narrow)

EBITDA Margin has been declining since 2012 due to:

  1. High cost of material
  2. High operating expenses, especially maintenance on plantation.

Using Moody’s benchmark, PCHEM’s EBITDA margin is rated as A (below Aaa and Aa). Good, but not great.

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Switching Costs (Moat: Wide)

  • Petronas Chemicals is the leading integrated chemicals producer in Malaysia and one of the largest in Southeast Asia. It operates a number of world-class production sites, which are fully vertically integrated from feedstock to downstream end-products.
  • With a total combined production capacity of over 10 million mtpa, it is involved primarily in manufacturing, marketing and selling a diversified range of chemical products, including olefins, polymers, fertilisers, methanol and other basic chemicals and derivative products.

Network Effect (Moat: Wide)

  • Petronas Chemicals is the leading integrated chemicals producer in Malaysia and one of the largest in Southeast Asia. It operates a number of world-class production sites, which are fully vertically integrated from feedstock to downstream end-products.

Intangible Assets (Moat: Wide)

  • Strong political linked

Efficient Scale (Moat: Wide)

  • Petronas Chemicals is the leading integrated chemicals producer in Malaysia and one of the largest in Southeast Asia. It operates a number of world-class production sites, which are fully vertically integrated from feedstock to downstream end-products.

image

Refer to the above chart, ROIC of PCHEM declined drastically from 21.8% (FY12) to 14.8% (FY14). This is due to couple of reasons:

  1. Invested capital in new assets (plants) increased 2.5% (CAGR) yearly from 14,907 mln (FY11) to 16,171 mln (FY14), and 9.25% from 14,742 mln (FY13) to 16,171 mln (FY14).
  2. Slow down in revenue due to maintenance of plants and unfavorable selling price of products.
  3. High cost of material and high operating costs.

Besides, CROIC of PCHEM also declined from 28.9% to 12.7% because of the following reasons:

  1. Invested capital in new assets (plants) increased 2.5% (CAGR) from 14,907 mln (FY11) to 16,171 mln (FY14), and 9.25% from 14,742 mln (FY13) to 16,171 mln (FY14).
  2. Net capital expenditure increased 192% (CAGR) from 964 mln (FY12) to 2,815 mln (FY14), and 64% from 1,716 mln (FY13) to 2,815 mln (FY14).

Although both ratios declined in the past 2 years, this doesn’t mean PCHEM lost its moats. PCHEM was mainly dragged down by maintenance CapEx (for existing plants) and operational CapEx (new plants). I believe that this is a short term issue, and PCHEM will recover its profitability soon.

Scale

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EBITDA Margin has been declining since 2012 due to:

  1. Slow down in revenue due to:
  1. The weak operating condition was exacerbated by mix product prices. The generally weaker prices have caused profit spreads to narrow. Polymer prices rose whereas ethylene glycols and aromatics prices fell. Moving forward, management expects softening olefins and derivatives prices on weakening crude and naphtha values as well as bearish downstream demand. Product prices for ethylene, polymers, MEG and aromatics are expected to be weak.image
    Source: http://www.bursamarketplace.com/index.php?ch=48&pg=186&ac=9332&bb=research_article_pdf
  2. Lower plants utilization because of maintenance
    image
    Source: http://www.bursamarketplace.com/index.php?ch=46&pg=170&ac=11776&bb=research_article_pdf
  3. High cost of material
  4. High operating expenses, especially maintenance on plantation.

Using Moody’s benchmark, PCHEM’s EBITDA margin is rated as A (below Aaa and Aa).

Net capital expenditure increased 192% (CAGR) from 964 mln (FY12) to 2,815 mln (FY14), and 64% from 1,716 mln (FY13) to 2,815 mln (FY14). This is mainly for new plants and maintenance of existing plants.

image

Leverage & Coverage

PCHEM is a debt-free company. They paid some finance costs for unwinding of discount factor for other long term liabilities and provisions. You can refer to Note 16.2 and 20 in 2014 Annual Report.

Liquidity

image

PCHEM’s “Days Payable Outstanding” was double of “Days In Receivables”, and its “Days In Inventory” was quite consistent at level 44 days. In layman’s term, PCHEM using other people’s money to do business.

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As for FCF, PCHEM’s FCF declined since FY12 because:

  • Net capital expenditure increased 192% (CAGR) from 964 mln (FY12) to 2,815 mln (FY14), and 64% from 1,716 mln (FY13) to 2,815 mln (FY14).
  • Profit before tax reduced from 4,550 mln (FY12) to 3,551 mln (FY14)

FY15 Q2 Results

PCHEM 2Q15’s revenue decreaed –1.1% YoY if compare to2Q14, and PCHEM’s quarterly profit dropped by -7.9%yoy compared to RM605 achieved in 1Q15. 1H15 earnings slumped by -10.9%yoy, and the drop in earnings is in tandem with the drop in 6M15 revenue of -9.8%yoy. The lacklustre numbers were largely due to lower ASPs despite achieving better volume sold, production and plant utilisation rates.

PCHEM’s group plant utilisation rate (PUR) in 2Q15 declined to 78% compared to 90% achieved in 1Q15. The dip in PUR was attributable to a statutory plant turnaround at its Gurun urea facility and planned maintenance at its glycols and derivatives facilities. Excluding these plant maintenance activities 2Q15 PUR would have still came in below what was achieved in the prior quarter at 89%. (MIDF, 10 Aug 2015)

The fertilisers and methanol (F&M) segment’s profit saw a marginal increase of 2%, due to an improvement in the segment’s plant utilisation from 76% to 80% and lower tax expense. However, this was offset by lower urea prices as a result of additional supply from China due to more competitive export tax structure and lower ammonia prices as regional producers resumed operations.

image

Source: http://www.midf.com.my/images/pdf/research-Report/Equity-Beat/2015/PetChem-Gloomy%20product%20prices%20persists-MIDF-100815.pdf

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Source: http://www.bursamarketplace.com/index.php?ch=48&pg=186&ac=17612&bb=research_article_pdf

Growth Drivers

  • 7 Jan 2015 – Petronas Chemicals historically has benefited from a stronger dollar, and we estimate that every 1% appreciation of the dollar against the ringgit will enhance its earnings by 1.6% to 1.7% as the group exports 60% of its products, with the remaining 40% sold domestically tied to dollar-denominated benchmark prices. The risk of further margin pressure outweighs possible upside from a stronger dollar and better spreads.
  • 10 Aug 2015 – For every 10.0 sen of depreciation in MYR against the USD, group’s EBITDA could improve by 6% assuming other cost structure and PU remain unchanged.
  • 13 Apr 2015 – PCHEM has set aside RM3 billion for capital expenditure (capex) this year. The bulk of the capex will be channelled to its Sabah Ammonia Urea (SAMUR) project and aroma and specialty chemical complex in Gebeng, Pahang.
  • 10 Aug 2015 – The SAMUR plant, which will increase production capacity from 1.4mmtpa to 2.6mmtpa, is on track for completion by 1QFY16. Additionally, PChem will incur borrowings going forward to fund its future projects, including RAPID, with a maximum net debt/EBITDA level of 2x.
  • 19 Mar 2015 – PCHEM is expecting to start up its Sabah Ammonia and Urea (SAMUR) project early next year, about six months behind schedule, a senior company official said on Tuesday.
  • 22 Jul 2015 – PCHEM and Germany’s BASF will jointly build a new world-scale production plant in Kuantan for highly-reactive polyisobutene (HR-PIB).
  • The new plant, which will have an annual capacity of 50,000 tonnes of HR-PIB, will be at the site of their existing joint venture, BASF Petronas Chemicals Sdn Bhd.
  • HR-PIB is an important intermediate product for the manufacturing of high-performance fuel and lubricant additives, including additives for sludge prevention.

Issues/Risks/Challenges

The softening crude oil and feedstock prices impact PCHEM earnings severely. ASPs are weakening in tandem with the drop in global crude oil prices as demand remains volatile due to the uncertainties surrounding the broader economy.

image

Source: http://www.midf.com.my/images/pdf/research-Report/Equity-Beat/2015/PetChem-Gloomy%20product%20prices%20persists-MIDF-100815.pdf

image

Source: http://www.bursamarketplace.com/index.php?ch=48&pg=186&ac=17612&bb=research_article_pdf

Besides, PCHEM’s plants’ utilization rate has been fluctuating. In 2Q15, a statutory plant turnaround at its Gurun urea facility and planned maintenance at its glycols and derivatives facilities.

image

Source: http://www.bursamarketplace.com/index.php?ch=48&pg=186&ac=17612&bb=research_article_pdf

Seasonality

The prices of petrochemical products and their underlying feedstock are subject to significant fluctuations as they are influenced both by global supply and demand as well as movements in the prices of key commodities such as crude oil and natural gas. Consequently, margins have historically been cyclical and are sensitive to supply and demand imbalances both domestically and internationally. Supply is affected by significant capacity expansions by producers, and if such additions are not matched by corresponding growth in demand, which is generally linked to the level of economic activity, average industry operating margins will face downward pressures. As a result, the petrochemical cycle is characterised by years of tight supply, leading to high capacity utilisation rates and margins, followed by years of oversupply, primarily resulting from significant capacity additions, leading to reduced capacity utilisation rates and margins.

Returns to Shareholders

Based on FY14 dividend per share (0.31), dividend yield is 5.2% as of 10 Aug 2015.

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Valuation

EY% Valuation

  • Trailing:
  • FY14 (EPS: 0.341) – 6.55 (Uncertainty Risk: HIGH)
  • R4Q (EPS: 0.29) – 5.58 (Uncertainty Risk: HIGH)
  • Forward:
  • FY15 (EPS: 0.324 ± 5%) – From 5.92 to 6.54 (Uncertainty Risk: HIGH)
  • FY16 (EPS: 0.375 ± 5%) – From 6.85 to 7.57 (Uncertainty Risk: MEDIUM)
  • EPS applied to reach the current stock price (5.99): 0.311

10-Y DCF

  • Good Scenario (12.0% – 14.0%): From 5.45 to 5.89 (Uncertainty Risk: HIGH to VERY HIGH)
  • Base Scenario (10.0%): 5.05 (Uncertainty Risk: VERY HIGH)
  • Bad Scenario (6.0% – 8.0%): From 4.36 to 4.69 (Uncertainty Risk: VERY HIGH to EXTREME)
  • Ugly Scenario (2.0% – 4.0%): From 3.79 to 4.06 (Uncertainty Risk: EXTREME)
  • At current price (5.99), based on RDCF, assumption of FCFF growth rate in the next 10 years is 14.4%.

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I think the fair value of PCHEM range from 5.6 to 6.3.

Going Forward

In the next 1-2 years, I think PCHEM earnings may be inconsistent because ASPs are weakening in tandem with the drop in global crude oil prices as demand remains volatile due to the uncertainties surrounding the broader economy.

I will continue to accumulate this counter for my family member.

Resources

Excel – http://1drv.ms/1IYH0Jw

Notes – http://tinyurl.com/mtrh67a

2Q15 Quarterly Report – http://www.bursamalaysia.com/market/listed-companies/company-announcements/4822381

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