PTT Global Chemical Plc

PTT Global Chemical Plc (PTTGC)

Fears of a surge in costs for PTTGC after a change in its gas pricing formula have overhung share price for months.
Yesterday this was finally lifted by the announcement of the new formula, which raises gas cost 8%.
We thus cut this year’s profit by 9% and TP to Bt72. PTTGC is still sound and we still Buy.
News: PTTGC finally announced the long-rumored adjustment in the pricing formula for the gas feedstock supplied by PTT, made because of higher global crude oil prices that pushed up PTT’s gas price. This will raise PTTGC’s gas cost by US$40/t or 8%, based on an assumed crude oil price (Dubai) range from US$70 to US$130/bbl (up from US$40-80/bbl previously). The new pricing formula will be in effect from August 2012.
In the conference call, management added that this is not a contract renegotiation –the current contract allows the pricing formula to be reviewed from time to time if there is distortion of return on investment on the basis of equitable return. The adjusted pricing formula will be in effect until the end of each feedstock contract, the earliest of which is 2016. The US$40 increase reflects current Dubai oil price of ~US$100/bbl and current HDPE price of ~US$1,300/t.
Comment: This adjustment lines up with our expectation. Based on numbers provided by PTTGC, we estimate the new gas cost at ~US$540/t, up from US$500/t. This implies HDPE-gas spread of ~US$775/t, still competitive compared with US$565/t for naphtha-based producers. By our estimates, the new gas pricing formula implies PTT gas cost of ~US$285/t, up from ~US$230-240/t previously.
Management was unable to be specific about the trigger points for future adjustment of the pricing formula but said it will be generally on the basis of equitable return on investment for PTT’s GSP business and PTTGC. Note that the current adjustment also included the effect of the higher investment cost for PTT’s GSP#6 and PTTGC’s new olefins cracker and derivatives plants (LDPE and LLDPE) than earlier estimated. We believe the next adjustment could be when crude oil stays out of the range noted above for a certain period and forces one of the parties (PTT or PTTGC) to shoulder higher cost while the other enjoys a richer margin. Management said that even with the rise in gas feedstock cost for PTTGC, PTT still has to bear a higher gas cost. Hence, return on investment still skews more toward PTTGC.
Impact on 2012 forecast. The new gas price will lower our 2012F by 9% for the five months, leading us to lower our 2012 forecast by 9% to Bt29bn. The full year impact raises the impact to 16% in 2013 and 14% for 2014, based on PTTGC utilization of 85%.
PTT profit affected little. We expect only marginal impact on PTT’s profit, as the higher revenue from its GSP will offset the lower equity income from PTTGC (48% interest). We estimate the net impact to PTT for 2012-14F at 0.6%, 1.5% and 1.3%
Marginal adjustment of TP. With the earnings cut, our PBV-based TP comes down to Bt72/share from Bt75/share, based on 1.5x PBV. This new TP still offers attractive upside of 23% and yield of ~5-6% over the next three years. As the overhang on its share is now removed, we expect the market to reduce the valuation discount.