Thai Oil

Thai Oil Plc (TOP)
TOP’s earnings visibility is now deteriorating and its quarterly earnings volatility will increase sharply given higher inventory and the choppy oil price trend. Its core earnings of refinery and aromatics are stagnant as demand outlook remains bleak.
We downgrade TOP from Outperform to Neutral and lower our EV/EBITDA target price by 9% after cutting our FY12-14 earnings forecasts on the back of lower gross refining margins. We see TOP as a trading stock now as its earnings volatility is set to rise substantially with its higher inventory from 4Q12. 
What Happened
Our visit to the company confirmed our worst fears about an unfavourable 2Q12. We project TOP to swing from a net profit of THB7.2bn in 1Q12 to a net loss of THB6bn in 2Q12 mainly
due to a large inventory loss of THB7.8bn on a US$30/bbl lower oil price qoq. However, the company expects earnings to bounce back in 2H12 as inventory losses turn into gains. It also expects better GRM then on stronger seasonal demand and benefits in the additional 165kt
capacity from its PX max project to be completed in Aug 2012. TOP remains sanguine on its potential acquisition of ESSO (Thailand) given its nextdoor location and similarities in
business and facilities that will be most synergistic in a merger.
What We Think
While we believe that TOP’s earnings prospects will improve in 2H12 and 2013, volatility will also increase as choppy oil prices cause large swings in inventory gains and losses. The
higher inventory levels mandated by the government will worsen TOP’s earnings visibility by 4Q12. This could lead to a more discounted valuation.
What You Should Do
We cut our 2012-14 forecasts by 5-18% on lower GRM assumptions.
Earnings visibility is clouded by the rising risk of inventory loss and weakening global demand for oil. Our new target price of THB69, based on 6x CY13 EV/EBITDA, puts TOP at a slight discount to regional peers. Trading at 7.2x CY12 and 6.9x CY13 P/E, TOP is attractive against peers.
But we prefer petrochemical plays to refineries as the former has limited downside due to its depressed margins, while refineries are facing increasing earnings volatility.
A blood bath on 2Q12
We project TOP to report a net loss of THB6bn in 2Q12, swinging from a net profit of THB7.2bn in 1Q12. The second quarter is projected to see:
 A large inventory loss of THB7.8bn on US$30/bbl lower oil price qoq. We
estimate the company to incur US$9/bbl from stock loss (on 25m bbls of
intake) and US$1/bbl from inventory loss (on 8m bbls of inventory).
 Flat GRM at US$4.2/bbl on flat margins of middle distillates but softening
gasoline spreads in June on the back of lower demand from the US.
 Lower PX-ULG spread to US$400/tonne on weaker demand as PTA
downstream producers suffer from loss-making margins at US$130/tonne,
below the US$150/tonne breakeven cash cost level for the industry.
 Slightly higher lube margin at US$530/tonne on strong demand and tight
supply for lube base group 1
 High utilisation across the board and units, with the refinery run rate above
100% while aromatics utilisation remaining at the maximum effective run
rate of 84%
Fortune reversal in 2Q12 Unlike in 1Q12 when TOP’s bottom line was boosted by three non-recurring items totaling THB5.7bn on a pre-tax basis,2Q12 will see all these three factors reverse into negative territory. As earningsbefore tax will be negative, TOP will not be able to utilise its THB3.1bn in environmental tax incentives granted by Thailand’s Board of Investment; in 1Q12, TOP had used THB1.2bn in tax benefits to lower its effective tax rate to only 8.1%. The other two factors are an expected FX loss of THB1bn on the weakening THB0.7/US$, and stock loss of THB7.8bn in 2Q12 vs. stock gain of THB3.3bn in 1Q12.
Expect a sharp rebound in 2H12
We expect sharply improved earnings in 2H12 on the back of:
 Potential reversal of inventory loss to gain as oil prices rebound from the
bottom at US$90/bbl in 2Q12.
 Better GRM on stronger seasonal demand and potential windfall from an
expected one-month shutdown of BCP’s 120kbpd plant due to a recent fire.
We believe the risk of a longer shutdown is high as this latest accident was
the second in the past 18 months and the plant’s location in a highly
populated area bring to the forefront concerns over public health and safety.
If TOP can successfully capture this benefit by diverting export sales to the
domestic market, we can expect additional income of THB200m-500m in
3Q12 depending on the volume diverted. Note that currently refining
margins for the domestic market are US$1-2/bbl higher than for exports.
 Benefit from additional 165kt capacity from its complete PX max project in
Aug 2012. This project is aimed to enhance returns on TOP’s existing
aromatics unit, which currently has 489ktpa PX and 177ktpa capacities of
benzene. After the completion of this “PX max” project, TOP will enhance
its overall margin by converting 144ktpa of toluene to an additional 65tpa of
PX and 100ktpa of benzene. Given that PX and benzene have higher
margins than toluene of US$500/tonne and US$100/tonne respectively,
this project could translate to higher earnings of US$40m-50m annually.
ESSO is still on the radar
TOP remains sanguine on its potential acquisition of ESSO (Thailand) given its
position next door and similarity of business and facility to gain maximum
benefits from a merger. At the current price of THB11/share, TOP will need up
to THB38bn to acquire a 100% stake in ESSO, which we think is not an issue
given that TOP’s balance sheet is strong with its current net debt to EBITDA at
0.7x, declining to 0.3x in 2013.
Our analysis indicates that the acquisition of ESSO, assuming the price paid is
THB11/share, will result in synergy benefits on five fronts almost immediately:
 Higher production volume in the refinery. ESSO has always run its 177kbpd
refinery at 75-85% utilisation on the constraint of sales volume, mainly due
to domestic demand and with very little of that volume exported. TOP’s
management has indicated that if the company is successful in acquiring
ESSO, it plans to boost utilisation to 100%, with the excess production
exported.
 Feedstock optimisation. TOP’s key strength is on hydrocracker to produce more middle distillate, while ESSO’s FCCC technology will produce more gasoline and platformate, which will be suitable for feedstock of aromatics.
Hence TOP could use additional feedstock from ESSO’s refinery at the 100% utilisation to produce more aromatics products.
Lube feedstock benefit. Currently, TOP has to buy fuel oil as feedstock for its 270ktpa lube production from an outside party. A merger with ESSO will allow TOP to use lube from ESSO as feedstock to replace purchased feedstock.
 Shared facilities of port, tank farm, and other infrastructure, given their locations right next to each other. Also TOP could reduce its logistics cost of crude by co-loading with ESSO at the same port.
 Retail empowerment. We believe ESSO’s strong gas station network nationwide could not only boost TOP’s margin by US$1-2/bbl but also help sustain its margin given that marketing margins are much more stable than GRM.
More inventory means higher volatility
We believe the recent government mandate to force all refiners in Thailand to raise their legal oil reserve from 5% to 6% will be negative for refiners, including TOP. While financially, the impact will be limited to only higher working capital requirements, the more negative implication will be increased earnings volatility with larger swings in inventory gains and losses. TOP has indicated
that it plans to implement this by 4Q12 and the company will boost its inventory from the current 8m bbls to 8.4m bbls, up 5%. This will increase the volatility of its inventory gains and losses and could eventually lead to higher discounts on its valuation.
Earnings revision
We cut our earnings by 5%-18% for 2012-14 on lower GRM assumptions. Earnings visibility is clouded by rising risk of inventory loss and weakening global demand for oil. We lower our GRM assumption by 18% in 2012 to reflect inventory loss and by 15% in 2013 to reflect weaker demand outlook.
Valuation
Following our cut in earnings forecasts we trim our target price to THB69, based on 6x CY13 EV/EBITDA, on par with regional peer average given that the downcycle for refinery should stretch for the next 2-3 years. Trading at 7.2x CY12 and 6.9x CY13 P/E, TOP is attractive against regional peers. However we prefer petrochemical plays IVL and SCC to refineries, as these petrochemical
companies have limited downside due to their depressed margins, while refineries face increasing earnings volatility.