Equity Analysis /
Saudi Arabia

Petrochem: End of feedstock grace period to reduce margins; Neutral, PT: 26.3

    Iyad Khalid Ghulam
    Iyad Khalid Ghulam

    Vice President, Senior Equity Research Analyst

    SNB Capital
    13 May 2019
    Published by

    We remain Neutral on Petrochem with a revised PT of SAR26.3 (vs SAR30.8 earlier). We expect Petrochem’s 2019 net income to decline 25.6% yoy due to lower prices and the end of feedstock grace period which is offsetting the improvement in operating rates. The stock is trading at 2019f P/E of 14.8x, broadly in-line with the peer group average of 14.0x.

    Net income to decline 25.6% yoy in 2019f: We expect Petrochem net income to decline 25.6% yoy to reach SAR867mn in 2019f mainly due to 1) 10.7% decline in revenues on lower prices and 2) lower margins due to the end of the feedstock grace period. This will offset the ongoing improvement in operating rates which are estimated to reach 122% vs 115% in 2018.

    End of feedstock grace period: Petrochem is the last listed petrochemical company to change its feedstock prices, which were originally agreed with the Ministry of Energy upon its establishment in 2008. Ethane prices will increase from US$0.75 to US$1.75 starting from August 2019. Propane will be offered at 20% discount to Aramco’s propane prices, compared to a 28% discount to Japan naphtha price used earlier, starting from September 2019. This, along with lower prices, is expected to reduce gross margins to 26.6% in 2019f from 30.1% in 2018. 

    Gradual change in feedstock discounts, starting 2020f: According to the Fiscal Balance Program (FBP), the feedstock discount offered to petrochemical producers is planned to be removed during 2020 and 2021. However, the updated FBP extended the period to 2023 for fuel used in several industries without specifically changing the dates for propane and ethane. We expect the current discount of 20% on propane prices to be reduced gradually by 5% annually until 2023. We expect the current price of ethane of US$1.75/mmbtu to be adjusted to US$2.5 by 2022f. The assumption is based on 1) giving Saudi producers sufficient time to improve efficiency and 2) maintaining the competitiveness of Saudi producers. This is expected to increase the production cost for Petrochem, reducing its margins from 26.6% in 2019f to 18.6% in 2023. 

    Remain Neutral on Petrochem: We maintain our Neutral rating on Petrochem with a revised PT of SAR26.3. Petrochem’s key strength is the sustainable improvement in operating rates. The stock is trading at 2019f P/E of 14.8x, broadly in line with the peer group average of 14.0x.