Star Petroleum Refining

Star Petroleum Refining Plc (SPRC)

 

Investment thesis

SPRC is our preferred pick within the Thai refining space promised on: 1) it is the most leveraged on its exceptionally high gasoline crack spread, 2) its incremental margin from using domestic crude, 3) its highest dividend yield among Asian refineries, and 4) its attractive valuation. SPRC currently trades at YE16 PER of only 5.7x, a deep discount to the regional average of 9.6x and to the Thai refining peer average of 8.0x. Also, its current share price implies a FY16 dividend yield of 8.7%, far above the 3.8% regional mean and the 4.2% Thai refining peer average. There is scope for the upside to the firm’s dividend payout policy of 50%, as SPRC will have no material CAPEX during the next few years.

Gasoline low season and high diesel inventory dampened 1Q16 GRM  

Continued decline in the Singapore benchmark GRM YTD from US$9.7 in Jan to US$6.6 in Mar has resulted from 1) low seasonal demand for gasoline, 2) high inventory of both gasoline and diesel as a result of weak demand, and ample supply availability, derived from high refining utilization rates and new capacity additions and 3) China’s diesel exports. Despite a recent retreat, the average gasoline crack spread in 1Q16 to date has sustained strong at US$18.9/bbl, much higher than its five-year average of US$15/bbl for the first quarter. In contrast, the average diesel crack spread has dropped to US$9.6/bbl over the same period, far below its five-year average of US$17.7/bbl for the first quarter.  

Resilient gasoline crack to negate weak diesel crack in 2Q16 

The upcoming US driving season and Ramadan, plus spring refinery maintenance activities (peaking in May), will buoy the gasoline margin in 2Q16 as it did last year. The sign of gasoline crack spread recovery has begun—that spread rose to US$17.7/bbl last week from US$15.2/bbl in Feb. In 2015, the average gasoline crack spread surged from US$15.4/bbl in 1Q15 to US$19.8/bbl in 2Q15 (peak at US$22.2/bbl in Jun). If history repeats itself this time around, we expect to see the gasoline crack spread rally to US$20 plus/bbl in 2Q16. 

In contrast, the diesel crack spread is expected to remain subdued on slowing GDPs and oversupply. Amid an expected gasoline crack rally during a diesel crack slippage, we thus think that the Singapore benchmark GRM in 2Q16 will sustain stable QoQ. However, there is scope for the upside if the gasoline crack spread is surprisingly higher than estimates.

Buoyant gasoline outlook to spur share price outperformance 

If the gasoline crack spread rebounds as we anticipate, SPRC is expected to have an at least US$1/bbl top up to its 2Q16 GRM compared to other diesel-based refineries. As SPRC is Thailand’s most gasoline-leveraged refinery, we therefore expect the firm’s 2Q16 GRM to outstrip other Thai refineries. Given the strong positive correlation between SPRC share price and gasoline crack spread, we expect the firm’s share price to rise accordingly and to outperform other refinery peers in 2Q16.