We downgrade SIIG to Neutral from Overweight with a revised PT of SAR26.1 (from SAR30.8 earlier) on projected lower profitability. We expect SIIG’s net income to decline 6.4% yoy in 2019 due to lower revenues and margins from Petrochem (50% owned by SIIG), which will be partially mitigated by higher income from the JVs. The stock is trading at 2019f PE of 14.0x, in line with the peer group average of 13.9x.
Net income to decline 6.4% yoy to SAR809mn in 2019f: We expect SIIG’s net income in 2019 to decline 6.4% yoy to reach SAR809mn mainly due to: 1) 10.7% decline in Petrochem’s revenues on lower prices, which offsets the higher operating rates of 122%, and 2) lower margins due to the end of feedstock grace period at Petrochem. We also expect margins to decline to 26.6% in 2019 from 30.0% in 2018. This will offset the increase in income from JVs, which we expect to reach SAR402mn in 2019 (from SAR329mn in 2018) driven by operational efficiency following the major 46-50 days shutdown at the JVs in Q1 18.
Better performance of JVs in 2019f: We expect income from JVs to grow by 22.1% to SAR402mn in 2019. Despite weak prices in 2019, we believe the higher income from associates has been driven by operational efficiency following 46 and 50 days shutdown at SCP and JCP, respectively in 2018. However, we believe the growth in income is already reflected in SIIG’s stock price. The JVs are trading at 2019f PE of 17x, compared with SIIG’s PE of 14.0x. We believe the improving operating efficiency and higher product prices of the JVs will be a key catalyst for SIIG.
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 to US$1.75 from US$0.75 starting August 2019. Propane will be offered at a 20% discount to Aramco’s propane prices, compared with 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 2019 from 30.0% in 2018.
Inclusion in FTSE and MSCI a key stock driver: SIIG is part of MSCI and FTSE indices with an estimated weight of 1.0% each. Passive inflow from MSCI and FTSE is expected to be US$174mn (SAR653mn). This represents around 41 days based on 3-month daily trading average. We believe the inclusion will support the stock price in 2019.