We resume coverage on EPCL with a Neutral rating and a TP of PKR66/sh for December 2022. Our EPS estimates for CY22/23f are PKR11.66/10.75, based on PVC-Ethylene spreads of US$650/600 per ton. For the long term, we have assumed spreads at US$450/ton, 7% higher than the prior 13yr average spreads.
Our Neutral stance on EPCL stems from the expectation of a sharp decline in PVC-Ethylene spreads towards its long-term average of US$400-450/ton (still healthy levels). The expected correction in spreads is based on the normalization of global supply shocks.
But the above is mitigated by EPCL’s positives such as: (i) strong demand stemming from construction space, (ii) recent capacity expansion of c.50% allowing EPCL to substitute imports (over 90% share in 9MCY21), and (iii) innate hedge against PKR/USD devaluation given dollarized primary margins.
Resume coverage with Neutral and a TP of PKR66/sh
We resume coverage on Engro Polymer and Chemicals Ltd. (EPCL) with a Neutral rating and a TP of PKR66/sh for December 2022; our EPS estimates for CY21/22/ 23f are PKR15.95/11.66/10.75. In light of the recent strength in PVC-Ethylene spreads amid ongoing – but transitory – supply constraints, we have assumed spreads of US$650/600 per ton for CY22/23 (c.US$950/ton in 9MCY21); but beyond CY24f, we have assumed spreads of US$450/ton. The recent capacity expansion of 100,000 tons pa of PVC and 50,000 tons pa of VCM (online since Mar and Jun 2021) enabled EPCL to capture c.94% share of the PVC market in 9MCY21 compared with c.64% in CY20, as it enjoys strong competitive advantage in pricing against imports, in our view. Having said that, our Neutral rating stems from our expectation that PVC margins will ultimately normalize from presently elevated levels, when global supply issues subside.
PVC spreads are likely to moderate toward the long-term mean
Global PVC spreads have reached all-time-high of over US$1,000/ton several times during CY21, led by supply shortages created by: (i) the decrease in PVC production in China owing to its government’s Power Control Policy (ongoing), (ii) lower PVC production volumes from the US as certain plants went offline because of Hurricane Ida (lasted about two months), and (iii) rebounding of PVC demand from India post relaxation in Covid restrictions. We expect PVC prices to moderate beyond CY21 as Chinese PVC producers would likely shift their energy sources; or, alternatively, China will relax its power control policy and US based plants would also resume operations post turnaround, in our view. Inflationary factors and China’s zero-Covid policy will however subdue demand in China.
Capacity increase to drive market share capture
EPCL is likely to strengthen its presence in the domestic market against imports – with the help of recent expansion while recent PKR devaluation and global supply constraints are lifting the company’s competitive advantage. Demand for PVC from the private construction activity in Pakistan remains robust, and EPCL has also found new export avenues – promising greater capacity utilization in the future, in our view. However, the margins on exports are lower in comparison with domestic markets. Nonetheless, it can act as a cushion, should domestic construction demand slows down considerably, amid monetary and fiscal tightening in the near future and rising cost of construction (prices of other materials have risen 35-40% on average in the past 15mths).