Downgrade FV to EGP10.95; Recommend Equalweight
We downgrade our FV for Sidi Kerir Petrochemicals (SKPC) to EGP10.95/share (down from EGP17.03/share), as we incorporate 1) prolonged recovery in global polyethylene prices, 2) lower consensus forecasts of Brent, 3) lower EGP/USD exchange rate assumptions, and 4) a one-year rollover of our model. Although the longer-than-initially-anticipated recovery in polyethylene prices contributed towards our downgrade of SKPC, our long-term assumptions of subdued oil prices and EGP appreciation played a much larger role. We also remain wary of how SKPC’s gigantic polypropylene project and the associated capital increase will reshape the company, which gives us all the more reason to change our recommendation back to Equalweight.
Global polyethylene price lows drag down SKPC for the short-term
Global polyethylene prices have plummeted to decade-lows of c.USD900/ton. Supply has been long as US polyethylene capacity sees its largest ever build-up, and demand growth stalls on the back of the US-China trade war. Capacity growth for 2019 is forecasted at a total of 6.9 mn tons, a c.5.7% addition to global capacity, with another 8.5 mn tons due to come on-stream in 2020, a further 6.9% addition. Hence, we assume prices will remain pressured to average just USD1,029/ton for 2020, a polyethylene-naphtha spread of USD501/ton, then gradually correct to reflect the historical average spread of c.USD636/ton by 2023.
Oil prices and the EGP/USD Exchange rate: Key long-term value drivers
In our current FV, we incorporate up-to-date consensus forecasts for Brent within the range of USD60-64/bbl, downgraded from USD70-72/bbl last year. We believe the downgrade is warranted given the uncertainty over US-China trade talks and fears of a global recession. We also now forecast an EGP/USD exchange rate of EGP17.27/USD into perpetuity, given the sustained strength of the EGP. This is much lower than our previous forecast of EGP22.67/USD into perpetuity, which had assumed c.5% depreciation in the EGP each year. Those two changes alone significantly brought down SKPC’s perpetual cash flows, and hence its long-term value.
PP project will reshape SKPC; Full picture still unclear
At almost four times the equity value of the company, SKPC’s USD1.2 billion polypropylene project will change the shape and form of the company as we know it. We remind you that SKPC’s 70:30 debt-to-equity capital structure for the project means the zero-leverage company is about to take on c.USD840 million in debt. This will imply a loss of c.EGP80 million in annual interest income, and the booking of c.EGP700 million in interest expense. Also, let’s not forget the c.USD360 million capital increase, which should take place end of 2019. Management have recently noted that the project is expected to start commercial production by 1Q 2023. We now await the completion of the capital increase, and further details to be announced regarding the project’s financing and capex schedule to be able to gauge its impact on SKPC’s FV.