Equity Analysis /
Egypt

Sidi Kerir Petrochemicals: The storm rages on; downgrade FV to EGP7.50, maintain Equalweight

  • Downgrade FV to EGP7.50 from EGP10.95, amid increasing pressure on the polyethylene market due to Covid-19

  • Covid-19 and oil price war weigh on an already struggling PE market

  • Cuts in feedstock cost will not prevent short-term losses; maintain Equalweight on hopes of long-term recovery

Downgrade FV to EGP7.50; maintain Equalweight

We downgrade our FV of SKPC to EGP7.50/share (down from EGP10.95/share) amid increasing pressure on the global polyethylene (PE) market due to the covid-19 outbreak. Our updated model of SKPC now reflects 1) lower PE prices, particularly for 2020, 2) a cut in oil price forecasts, 3) lower volume assumptions, and finally 4) the latest downwards revisions of SKPC’s feedstock cost. Given the dramatic crash in oil prices, and the weak demand environment for PE, we expect SKPC to continue to record losses despite its feedstock cost cuts.

Covid-19 weighs on an already struggling PE market

The global PE market had already been suffering from lengthy supply since mid-2019 due to a massive build-up of US capacity. Now, the market faces additional pressure as covid-19 hits plastics demand, specifically for the industrial sector. The implications of the pandemic along with the oil price war drove down PE prices from USD880/ton in February, to current levels close to USD700/ton. In an attempt to prop up prices and balance out demand, US companies have started to delay expansions and idle plants to take out about 10% of global capacity. Therefore, we estimate SKPC’s blended selling price for PE will average USD775/ton in 2020, assuming global pricing remains close to USD700/ton for the remainder of the year, and Brent averages USD35/bbl. We then assume gradual recovery in PE prices post-2020, to eventually settle at USD1,146/ton in the terminal year.

Cuts in feedstock cost will not prevent short-term losses

SKPC reported bottom line losses in 4Q19 as its blended selling price fell to an average of USD883/ton, even though its feedstock cost was revised down to USD6.86/mmBtu, from an initial USD7.33/mmBtu. From our talks with management, SKPC is due to receive a second USD0.5/mmBtu cut in its feedstock cost. Hence we assume the company will continue to receive gas at USD6.86/mmBtu in 2020, and that the second cut will be applied in 2021 bringing down SKPC’s feedstock cost to USD6.36/mmBtu. However, according to our calculations, SKPC will report losses at the gross profit level this year as the extremely low pricing trumps cheaper feedstock. To showcase the severity of the price decline, we believe that even Ethydco, with its feedstock cost at USD5/mmBtu, will not be able to avert losses at the EBIT level in 2020.

Maintain EW on hopes of long-term recovery

The valuation gap of 26.9% to our FV is mainly based on our long-term assumptions of price recovery for both polyethylene and Brent, that drive our perpetual gross margin assumption of 23%. However, seeing as we expect the company’s performance to remain distressed in the short-term, we choose to maintain our Equalweight recommendation on SKPC. We also remind you that while SKPC has shelved its polypropylene project for the meantime, the company has not completely scrapped its plans and will inevitably be faced with a massive capital increase and mounting debt.