PTT Global Chemical

PTT Global Chemical Plc (PTTGC)
 
The sooner-than-expected announcement of the gas feedstock pricing revision and the only slightly-larger impact would remove the share price overhang. 2H12 and 2013 earnings growth visibility is improving on volume growth, capacity expansion, and potential asset injection. We trim our earnings forecasts for 2012-2014 to reflect the revision in the gas feedstock pricing formula. As the overhang from the risk of gas pricing change has now been removed, we upgrade our target price, which is now based on 7x CY13 EV/EBIYDA, on par with regional peers, from 6x CY13 EV/EBITDA previously. We upgrade from Neutral to Outperform. 
What Happened
PTTGC announced the long-awaited revision to the gas feedstock formula, which would increase its gas feedstock cost by 8% or US$40/tonne, from the current US$500/tonne. The new formula will be effective 1 August 2012.

What We Think
Overall, we are positive on this formula change, given that it came into effect four months earlier than we had expected. The US$40/tonne increase is however slightly higher than our previous assumption of US$30/tonne. We believe the change will significantly reduce the margin

risk for PTTGC for many years, given that the new formula reflects an oil price assumption range of between US$70/bbl and US$130/bbl, and a HDPE-naphtha spread range of US$450-600/tonne, sufficiently capturing future price volatility.

What You Should Do
Despite our cuts in earnings forecasts,we upgrade from Neutral to Outperform and raise our target price from THB65, based on 6x CY13 EV/EBITDA, to THB77, now based on 7x CY13 EV/EBITDA. Our higher valuation is based on the removal of the share price overhang from the downside risk of gas feedstock pricing revision. PTTGC’s share price should now reflect its strong earnings growth.
 

Key catalysts are 1) rising volume growth from higher utilisation and and the start up of its 95ktpa MEG capacity by 4Q12; 2) strong 2H12 earnings growth from improved margins of petrochemical and refinery products; and 3) inventory gain from higher oil price movement.

Net back pricing revision
PTTGC announced the change in its netback pricing formula for the gas
feedstock that PTTGC buys from PTT. The changes will result in the net cost
increase of US$40/tonne, or up 8% from its current net gas feedstock cost of
US$500/tonne based on the previous formula. The set of assumptions which
the formula is based on includes oil price at US$100/bbl, HDPE price of
US$1,300/tonne, and HDPE-naphtha spread of US$450/tonne.

What’s positive about the new formula?
Overall, we believe the positives from this new formula for PTTGC’s gas feedstock pricing will outweigh the negatives, leading to overhang removal.

We see the following positives from this new formula:

Faster-than-expected announcement

The announcement for this revision came in four months faster than both we and the market had
expected. The formula will be effective 1 August 2012. This will eliminate uncertainty for earnings downside and hence should remove any discount that investors will have put on PTTGC’s valuation.

Wider range US$70-130/bbl coverage of average oil price
assumptions.

The new formula will now reflect Dubai oil price assumption range between US$70/bbl to US$130/bbl, up from US$40-80/bbl range previously. We believe this should reasonably cover
future oil price volatility. Note that this oil price range is an average, not spot price; thereby as long as the oil price average remains within the range, there will be no need to revise the formula.

Wider range of US$450-600/tonne average spread of
HDPE-naphtha.

We believe this range reasonably covers the likely spread level of HDPE-naphtha over the next five years. On the low end of US$450/tonne, this level is close to industry cash cost level of
US$400-450/tonne and hence it is unlikely that the spread will move lower than this level. On the high end of US$600/tonne, this margin level was the peak level recorded during 2004-2008, and was never reached after the 2008 downcycle.

Incorporation of investment cost. The new formula also incorporates the investment costs that are not included into the formula calculation during the previous revision back in Aug 2008. This time the new formula includes US$1.48bn investment costs of PTTGC’s ethane cracker and polymers plants and US$1.34bn cost of PTT’s Gas Separation Plant #6 and ethane separation plant.

What’s negative about the new formula?
Under the new formula, we also see some negatives that could post downside on PTTGC’s future earnings.

Larger-than-expected change. The new formula resulted in US$40/tonne increase in net gas feedstock cost to PTTGC. This is US$10/tonne higher than our expectation but in line with market
expectation.

Not a full market-oriented formula. While the new formula covers a reasonably wide range of likely oil price assumptions of US$70-130/bbl, it still contains risk that if oil prices move out of the range for any period of time, there could be another revision to the formula.

Still competitive compared to naphtha
Despite the revision of the netback pricing formula for gas feedstock, PTTGC still enjoys a product margin advantage over naphtha-based producers. We estimate that PTTGC’s margins for both upstream and downstream products remain almost double those of naphtha-based producers, based on assumptions of average Dubai oil price of US$100/bbl.

Impact on earnings and margin
Given that 89% of the feedstock for its olefin units (its predecessor PTT
Chemical’s units) is gas-based, which we estimate to consume up to 3.8mtpa of
gas feedstock, the impact from the revision will be a reduction of THB3.7m in
PTTGC’s earnings before tax and THB3.3bn in its after-tax profit, translating to
an 11% cut in PTTGC’s EBIT and net profit for 2013.

Earnings revision
We revise down our earnings forecasts for 2012-2014 by 1.6% to 6.4% to reflect
the impact of the new gas feedstock pricing formula. For 2012 the larger cut is
due to the 4-month impact compared to our previous assumption of no impact
as we assume that the new formula will be used in 2013. For 2013-14 the small
revisions reflect the larger-than-expected increase in gas feedstock cost by
US$40/tonne vs. our previous assumption of US$30/tonne increase. Post
revision we estimate that the profit sharing to PTT will rise from 30% to 36%,
slightly higher than our previous assumption of 35%.

From feedstock price revision to capacity expansion and asset injection

We believe following the change in netback pricing for gas feedstock formula,
PTT is likely to implement two strategies that could add up to THB4.8bn
earnings, a 15% upside to PTTGC’s 2013 earnings forecast of THB31.8bn. This
is similar to 2006 when PTTCH raised capital of THB28bn to fund the purchase
of 50% stakes in 1mtpa PTTPE and 250ktpa BPE, and then in 2008 after PTT
and PTTGC agreed to revise the netback pricing formula; the capacity increase
was added in 4Q09 when PTTPE and BPE started up and operated.

While this time the event is in fact reversed with revision in gas feedstock
pricing formula having occurred already, we believe the next events will be the
announcement of capacity expansion and asset injection by PTT to PTTGC.
This, in our view, should be key catalysts to PTTGC’s share price by end-2012.

Valuation rerating after the risk for gas feedstock pricing revision overhang is removed

We upgrade PTTGC from Neutral to Outperform and raise our target price from
THB65, based on 6x CY13 EV/EBITDA, to THB77, now based on 7x CY13
EV/EBITDA. Our higher valuation for EV/EBITDA is based on our belief that
the discount previously applied to PTTGC on concerns of downside risk for gas
feedstock pricing revision is now completely removed. Our new valuation of 7x
EV/EBITDA is on par with regional peers of 7.2x, which we think is justified
given PTTGC’s 3-year 10% CAGR vs. regional peers average of 6.7%.