PTT Global Chemical

PTT Global Chemical Plc (PTTGC)
Investment thesis: Last week, we accompanied PTTGC’s CFO on a non-deal roadshow to the UK. In all, we sensed that most of the investors we met weren’t very concerned about a possible increase in the cost of gas. But they seemed to have adopted wait-and-see stances over the stock. The underwhelming global macro-economic outlook and pending negotiations over the price of gas are likely to weigh down on sentiment in the near-term. In our view, two key factors to watch are oil price stability and incipient signs of a Chinese economic recovery. If these factors become more evident, the stock price should regain momentum. Within Thai Energy space, PTT remains our preferred pick at this moment.
Potential gas price adjustment under negotiation: While the gas pricing regime has not yet been discussed officially, management admitted that the firm's gas costs will certainly rise. But negotiations will cover the whole package, including the gas supply for the firm’s de-bottlenecking project and further asset injections from PTT. Management doesn’t anticipate that the gas price increase will be significant.
Profit-sharing scheme: At this stage, PTTGC doesn’t expect any change to its profit-sharing scheme with PTT. Under the worst-case scenario, PTT's share would rise only slightly. Management guided that the 2008 adjustment was caused by major related new investments by both PTT (GSP#6) and PTTCH (now PTTGC) (PTTPE). That isn’t the case this time.
Slower-than-anticipated demand recovery, but soon to rebound: Management admitted that the chemical demand recovery, particularly in China, has been slower than anticipated. But chemical demand in China is expected to rebound in late June, driven by restocking season. In addition, further economic stimulus measures by Beijing should support demand. Moreover, high-cost Naphtha crackers have cut operating rates, given the exceptionally thin HDPE-Naphtha spread.
Preparing other growth drivers: Apart from synergistic and debottlenecking projects, which should generate substantial benefits in FY13-14, PTTGC is preparing for further post-2015 growth. The firm is keen to start making selected market-backed (as against commodity) products that offer high and stable margins.   
Key takeaways from NDR in the UK
Last week, we accompanied Mr Patiparn Sukorndhaman, CFO of PTTGC, on a non-deal roadshow to the UK, where we met 17 asset management firms. In all, we sensed that most of the investors we met weren’t very concerned about a possible increase in gas costs, as they expect negotiations to cover the whole package, including gas supply for the firm’s de-bottlenecking project and further asset injections from PTT. But they seemed to have adopted wait-and-see stances over the stock. The scale of expected gas cost increases and possible changes to the profit-sharing scheme between PTT and PTTGC remain unknown, while slow demand in China and oil price volatility remain issues of concern.
The most frequently asked questions focused on: 1) a potential gas price adjustment, 2) the possibility of the profit-sharing scheme being changed, 3) the impact of the global economic slowdown on chemical demand and 4) the firm’s future growth prospects and CAPEX plan. We have summarized the key discussion points below:
1) Potential gas price adjustment under negotiation: While a change to the gas pricing regime has not yet been discussed officially, management admitted that the firm's gas cost will certainly rise. However, negotiations will cover the whole package, including gas supply for PTTGC’s de-bottlenecking project and further asset injections from PTT. The YTD spike in oil and gas prices has been out-of-range of the key parameters set in the existing gas price formula with PTT. The contract includes a provision enabling the renegotiation of price if the benefit has clearly shifted to one party over the other, skewing the “16% equal IRR” concept. However, management doesn’t expect the gas price increase to be significant. Expensive imported LNG and Myanmar gas won't be included in the revised formula, as those gas specifications can't be used as chemical feedstocks. PTTGC guided that the impact of the coming gas price adjustment won’t exceed 10% of its net profit. Management also said that the addition of an explicit a price renegotiation period (such as every 3-5 years) might be a subject of discussion with PTT.
In contrast to the 2008 gas price review, which took almost two years to conclude, the CFO said that negotiations will probably be finished by YE12, as PTTGC needs to secure new gas supply as feedstock for its facilities when debottlenecking is completed. The firm aims to debottleneck its new Ethylene and Polyethylene facilities, increasing Ethylene and Polyethylene capacity by 300KTA each—the projects are now undergoing a basic engineering redesign process.
Asset injections by PTT should be come under discussion. PTTGC is looking to consolidate PTT's other chemical units (Phenol and HMC), enabling it to enhance its earnings and integrate further downstream. Note that it currently holds 60% of PTT Phenol Co Ltd (PTT holds the remaining stake). The consolidation of Phenol would allow the firm to move further into the polycarbonate business. HMC Polymers Co Ltd is an associate of PTT (41% stake); it produces Polypropylene with a capacity of 750KTA. The consolidation of HMC would help PTTGC integrate further into the Polypropylene business, which would add value to its existing Propylene product.
2) Profit-sharing scheme: At this stage, management doesn't expect any change to the current profit-sharing scheme (70% for PTTGC and 30% for PTT), but declined to rule out the possibility entirely. Under the worst-case scenario, PTT's profit share would rise only slightly. Management guided that the 2008 adjustment was caused by major related new investments by both PTT (Gas Separation Plant #6) and PTTCH (now PTTGC) (PTTPE). That isn’t the case this time. The potential investments are that PTT may revamp GSP#6 unit or PTTGC might build an Ethane Separation Unit to extract existing PTT by-pass gas for PTTGC's facilities once debottlenecking is completed. The investment cost is expected at about US$400/t, or only 50% of replacement cost.
3) Slower-than-anticipated demand recovery, but soon to rebound: Management admitted that the chemical demand recovery, particularly in China, has been slower than anticipated, due to: 1) weak demand among Western markets, which are the final destinations of Chinese exports, and 2) continued destocking in China, due to oil price volatility. But management expressed optimism about the outlook for chemical spreads, given that inventory levels in China are currently less than two weeks against a normal level of three weeks. Chemical demand in China is expected to rebound soon, driven by restocking season in late June ahead of that country’s peak production season in July-August. Further economic stimulus measures on the part of Beijing should also support demand.
In the absence of restocking flows, high-cost Naphtha crackers have cut operating rates in the face of an exceptionally thin HDPE-Naphtha spread of US$420/t, close to the mean Naphtha cracker cash cost of $400/t, which has tightened supply availability. According to ICIS news, Naphtha crackers in Asia have announced operating rate cuts, as olefins margins are under pressure from the recent sharp price correction. For example, in mid May, Formosa Petrochemical Corp (Taiwan) cut run rates at its three Naphtha crackers (totaling 2.9mt) in Mailiao to 80% from 90% earlier. Yeochun NCC (South Korea) has reduced the operating rates of its three Naphtha crackers (totaling 1.9mt) to 90% since late May from full rates earlier. Moreover, Chandra Asri (Indonesia) has cut production at its 600kta Naphtha cracker to a 90% operating rate in May from 95% in April.
In contrast, PTTGC has been running its plants at full capacity, as it operates gas-based facilities, which have a lower cash cost (about $350/t) than Naphtha-based crackers. Management targets a run rate of 90% for this year versus 79% in FY11, implying 14-15% YoY volume growth.
4)Preparing for new growth drivers: Ongoing synergistic projects will yield substantial benefits, starting FY13, while the start of the chemical spread up-cycle and the consolidation of Phenol and HMC should also boost earnings growth. Moreover, the commercial commencement of debottlenecked capacity should also boost the bottom-line in FY14-15. Note that the firm is revising some synergistic projects to evaluate the potential incremental benefits (originally expected at US$80-154m/year) and the potential incremental investment cost (originally expected at $92m).
Looking further ahead (post-2015), PTTGC is keen to start expanding into selected market-backed, high-volume specialty products, given their high and stable margins. It will focus on products such as polycarbonate and polyurethane, which are used heavily in the automotive, construction and electrical appliance industries (all of which are growing strongly in ASEAN). As such, acquisitions and greenfield projects will be necessary. The firm has set an investment budget of US$2-2.5bn for the next five years. It expects to gain knowledge relevant to the polyurethane industry from its recent purchase of Perstorp (France).
Moreover, PTTGC is interested in jointly investing in some downstream projects of the national Malaysian oil company, Petronas (RAPID projects). One project is now the subject of a feasibility study, which should be completed by mid 2013. If it is deemed commercially viable, the project could possibly start operating in 2016. The investment cost would be in the US$500-600m range. The shareholding structure of the proposed joint venture and other commercial arrangements have not been concluded yet.
Management said the five-year (FY12-16) CAPEX plan is US$4.5bn of which $2.5bn will come from operational cash flows from and $2bn from debt. However, the major CAPEX will mostly be back-loaded, as investments planned for FY12-13 are fairly modest.
Recommendation and valuation
Maintain BUY with a YE12 target price of Bt82: While we fundamentally like PTTGC, based on a buoyant 2H12 chemical outlook and its growth path during FY12-15, we think an underwhelming global macro-economic outlook (particularly mounting concerns about Greece's possible exit from EU) and pending negotiations on the gas price formula/profit-sharing scheme will weigh down stock sentiment in the near future. In our view, two key factors to watch are the stability of oil prices and incipient signs of a Chinese economic recovery. If these factors become more evident, the stock price should regain momentum. Within Thai Energy space, PTT remains our preferred pick at this moment.
Valuation-wise, PTTGC currently trades close to its bearish valuation level—an FY12 PER of 7.3x (0.8SD below its long-term average), a 31% discount to the Asian mean of 10.6x—and a YE12 PBV of 1.0x, a 44% discount to the regional average of 1.8x. We, therefore, maintain our BUY rating with a YE12 DCF-derived target price of Bt82.