Equity Analysis /

Sidi Kerir Petrochemicals: Q1 19 – Polyethylene downturn begins; maintain Equalweight

    Myss Semeida

    Revenue falls on lower polyethylene prices and volumes

    SKPC released its full financials for Q1 19. Sales stood at just EGP1,227mn (-21%  qoq, -1% yoy). As we suspected, SKPC’s local polyethylene selling price fell to USD1,214/ton for the quarter (-5% qoq, -4% yoy) in tandem with the global market decline. Volumes also saw a sharp decline as the company was operating at a polyethylene utilisation rate of 83% in Q1 (-20% qoq, +5% yoy). We presume the first quarter of each year witnesses a maintenance shutdown, hence the slump in sequential volumes. Therefore, SKPC’s quarterly sales slump was both price and volume-driven, while the steady yoy top-line performance was the result of slightly higher volumes offsetting price losses.

    Q4 18 margins proved too high and unsustainable

    Naturally, with low prices and volumes in Q1 19, SKPC’s gross margin plummeted to 25% (-10ppts qoq, -5ppts yoy). On a sequential basis, we believe the margin contraction is overstated as we had previously noted Q4 18’s gross margin of 35% was too high and unsustainable. The indirect costs component of COGS was significantly lower than SKPC’s average and hence jumped back to a more normal level in Q1 19. It is also worth noting that in Q1 19, SKPC’s cost of raw materials per ton of polyethylene increased again by 9% qoq and 4% yoy. 

    EGP appreciation does not bode well for profitability

    On the bottom line, SKPC recorded EGP193mn in net profit, translating to a poor net margin of 16% for the quarter (-9ppts qoq, -7ppts yoy). With the EGP appreciation working against it, the company’s profitability was further pressured by an FX loss of EGP31mn in Q1 19, versus a gain in Q4 18 and a much smaller loss of EGP8mn in Q1 18. 

    Maintain Equalweight on FV of EGP19.22/share

    We do not expect any dramatic improvement in SKPC’s performance in the next quarter; even as the company usually ramps up volumes in Q2, global polyethylene prices are still hammered at an average of US$1,058/ton for Q1 19 (-10% qoq, -20% yoy). We estimate SKPC’s local polyethylene selling price at an average of USD1,218/ton for 2019 (-6% yoy). Our sales estimate for the year is EGP5,661mn, almost the same as 2018. However, it is worth noting that we assume an average exchange rate of EGP18.53/USD for 2019, while the current YTD average rate stands at EGP17.48/USD, which means SKPC is at risk of missing our estimates for the year. 

    We reiterate our sensitivity analysis on FX rate and its impact on FV, where SKPC’s FV at a fixed rate of EGP17.00/USD was EGP15.07/share, and at a fixed rate of EGP16.00/USD was EGP14.17/share. We believe the current market price of EGP12.93/share is pricing in today’s FX rate of cEGP17.10/USD, and the 25% gross margin in Q1 19 persisting into perpetuity. Our FV reflects margins at c27% into perpetuity. Hence, the 48.6% upside to our valuation is only temporarily warranted, because if the EGP maintains its strength, we will revise our FX rate assumptions to further revisit our SKPC recommendations.  

    On a more positive note, SKPC's board has approved NI Capital as the investment bank to advise on a capital increase to finance the 30% equity portion of the US$1.2bn polypropylene (PP) project. This is in line with our expectations, since we had previously noted that we were very sceptical about SKPC being able to finance the equity portion of the project with increased profit retention alone. We await further details on the capital increase and secured credit facilities to be able to gauge the impact of the PP project on our FV. Until then, we maintain our Equalweight recommendation on the stock at a FV of EGP19.22/share. SKPC is currently trading at 2019e 7.2x PE, and 4.1x EV/EBITDA, versus an average historical PE of 8.5x, and EV/EBITDA of 6.3x.