Thai Oil Plc (TOP)

Investment thesis: Last week, we accompanied Mr Veerasak Kositpaisal, CEO of TOP, and other executives, on an NDR to Singapore and Hong Kong. Despite prevailing concerns about industry capacity additions, we felt that the investors we met were less bearish about refining fundamentals than they were earlier. With many current unplanned/planned shutdowns, they agreed that the spike in GRM would be short-lived, but the question is “when?” Also, a firm GRM trend and a rising YTD market GRM for TOP surprised them. A tight US ethanol supply situation is another major factor to be watched. If the situation worsens, we can expect a spike in GRM and a bounce in aromatics margins (similar to the situation in 2006).
The fund managers we met still lack confidence in China’s economic recovery and chemical demand. As such, we think a fundamental commodity re-rating theme may not play out this time around, so selective exposure—particularly among refining stocks—looks preferable at this moment.
Higher GRM but flat aromatics margin for 2H12: Greater unplanned/planned shutdowns and tight ethanol supply in US have boosted gasoline crack spread and GRM. The firm expects a retreat once Ramadan ends and those plants restart. Also TOP was optimistic about its 3Q12 GRM, due to the current margin strength, the normalization of the crude premium and increased domestic sales (due to the BCP shutdown). The current Singapore benchmark implies a market GRM of US$7-8 versus $4.6 for 2Q12. The firm also expects an aromatics margin bounce by late 3Q12—new PTA plants are projected to start up in 3Q-4Q12.
Prospects for refining and aromatics in 2013-14: TOP anticipates that Asia-Pacific and Middle East new supply will be much less in 2013 than in 2012—about 5mbpd versus 1.4m bpd. Demand-supply fundamentals will be more balanced. The firm expects its market GRM to be $5-6 (our estimate is $4.5). While much greater new supply is anticipated to go on-stream in 2014 (~1.8mbpd), TOP remains cautiously optimistic about the GRM outlook. Most of the new projects are in the Middle East, where start-up dates typically slip at least a year. On the aromatics front, 2013 should be good, due to fewer PX capacity additions.
Pursuit of expansion opportunities: Frequently asked questions included TOP’s growth strategy and the organic and inorganic means of achieving it amid an upcoming GRM down-cycle. Executives stated that the firm has set a concrete framework for strategic direction. It prefers upgrading to greenfield expansion. On the M&A front, TOP is keen to acquire assets in and outside Thailand. The firm said there are a lot of growth opportunities within ASEAN. Myanmar is a key mid- to long-term target. TOP will coordinate with PTT group. In the early phase, the group will propose building new power plants in Myanmar.
Recommendation and valuation
Maintain our HOLD rating with revised DCF target price of Bt65:  While we remain bearish on refining fundamentals amid a raft of new capacity additions and we think the QTD spike in GRM may be followed by a contraction (once planned and unplanned plant shutdowns end), our HOLD rating stands on TOP. In our view, the tight US ethanol market, which has pushed up American gasoline prices this year, is worth monitoring. If the situation were to worsen, due to a shortage of corn (forcing US ethanol plants to cut run rates), then more gasoline would be used to make up the ethanol supply shortfall.
The situation is likely to play out in a manner similar to 2006—more gasoline use would not only push up GRM again, but boost the price of PX, as there would be less feedstock available for aromatics production. That would boost short-term sentiment toward the stock.
Because of a much stronger-than-anticipated QTD GRM and also to fine-tune for the firm’s Revenue Department-approved and in-the-pipeline tax credit totaling Bt11bn, we have raised our TOP market GRM assumption for FY12 to US$5/bbl from $4.5/bbl, so have revised up our profit forecast by 14%. We have also rolled over our investment horizon to YE13. Our DCF-derived target price is Bt65, up from Bt61 previously.