JEDDAH – The Saudi petrochemical sector faces “cautious outlook” due to a slowdown in demand and weaker prices, the NCB Capital said in its report on “KSA Petrochemical Sector” for the month of June 2012.
However, the recent correction in stock prices leads to attractive entry-points in the sector, it added.
“We initiate coverage on SIIG with an Overweight rating and APPC with a Neutral rating. We upgrade Sahara and Saudi Kayan to Overweight from Neutral”, the report noted.
While some indicators of demand for petrochemicals (mainly industrial production data from the US and global auto sales figures) have improved in recent quarters, declining petrochemical imports in China is a point of concern. Additionally, the ongoing uncertainty over the strength of key European economies raises further doubts in terms of the strength of economic growth in the upcoming quarters. “Thus, we believe demand for petrochemical products will remain under pressure in the short-run with a strong rebound unlikely.” However, petrochemical companies based in the Kingdom are better placed to withstand this pressure than their global peers due to the low cost of production in Saudi Arabia and its proximity to Asia, which continues to increase its share in global demand.
Amid the uncertain global economic environment, we expect the pressure on demand for petrochemical products to lead to lower petrochemical prices YoY. Petrochemical prices are likely to remain firm in 1H12 mainly due to high oil prices during the major portion of the period, but drop in 2H12 as oil prices decline. We expect prices of all petrochemicals (except methanol, MTBE and benzene which are likely to benefit from tight demand-supply conditions) to fall 5-10 percent YoY in 2012. However, urea prices are expected to remain firm amid rising demand from Asia and limited sup after increasing 47 percent YoY in 2011.
However, “we believe ammonia prices would drop 9 percent in 2012, considering that they remained weak in 1Q12, after rising 43 percent YoY in 2011.”
Petrochem was initially scheduled to start commercial operations in 2Q12. However, the company is yet to release any update on this. Petrochem is expected to continue to report losses in 2Q12 arising from pre-operating expenses. “We assume the commercial operations at the company’s petrochemical complex will start in July 2012.”
In the April 2012 edition of its World Economic Outlook, the International Monetary Fund (IMF) said it expects the global GDP to grow 3.5 percent in 2012 and 4.1 percent in 2013E. The IMF raised its estimate for 2012 by 0.2 percent and 2013 by 0.1 percent (from the figures in its January 2012 edition of the report) based on improving economic conditions in the US and sustained support from emerging economies. However, economic growth is expected to remain weak in Europe due to the ongoing debt crisis. Slowdown in the world’s fastest growing economy, China, remains another important concern. The Chinese economy grew 8.1 percent in 1Q12, lower than 8.9 percent in 4Q11, due to weak internal consumption and demand for exports. The financial turmoil in Europe (China’s largest trade partner) is negatively impacting the demand for exports from the country.
The petrochemical sector is cyclical with long-term prospects tracking economic cycles. A business cycle lasts approximately 7-10 years, whereas peaks and troughs represent demand and supply imbalances in the sector.
The report tracked three key indicators - industrial production in the US; global auto sales; and Chinese petrochemical imports - to understand the demand outlook for petrochemicals. Industrial production in the US has improved constantly in the last year. However, the pace of recovery has been slow and would continue to be so in the remaining months of 2012. Similarly, auto sales (which increased in 1Q12 mainly driven by growing demand from emerging economies) are expected to remain weak in the near term as prevailing economic concerns could dent consumer confidence. Chinese petrochemical imports, too, are likely to stay weak in 2012, given the feeble domestic and export demand. However, NCB Capital report said the demand outlook for the long term is positive, considering the improvement in economic conditions.
Benzene is mainly used in producing intermediate petrochemicals (such as ethylbenzene, cumene, cyclohexane and nitrobenzene) which has a variety of applications in the automotive, textile and electronics industries.
Styrene is the largest derivative of benzene and is largely used in producing different homopolymers and copolymers such as polystyrene, expandable polystyrene, acrylonitrile butadiene styrene resins, styrene butadiene rubber and unsaturated polyester resins.
In 2011, the East Asian region was the largest producer of benzene, accounting for 22 percent of the total global production. It was followed by China (20 percent), Western Europe (18 percent) and North America (17 percent).
China climbed to the second position in 2011 from fourth with a market share of 13 percent in 2008, benefiting from aggressive capex. In terms of consumption, the East Asian region led with 22 percent of the total demand for benzene globally, followed by China, North America and Western Europe (20 percent each).
Worldwide demand, according to IHS news, for benzene is expected to increase at a CAGR of 3.5 percent to 50 million mtpa in 2016 from 42 million mtpa in 2011, faster than the CAGR of 0.6 percent witnessed during 2007-11. This would primarily be driven by rising demand for styrene in end markets. Although the demand outlook for benzene remains positive, increasing supply from China and the MENA region might pose a serious threat in the coming years.
Polyethylene is the most popular ethylene derivative and is used in a variety of applications such as films and sheets, injection and blow molding, pipes, and paints. Ethylene production facilities are distributed across the globe.
The key producing regions are Asia-Pacific (34 percent of global production in 2011), North America (23 percent), the Middle East and Africa (19 percent) and Western Europe (17 percent).
Asia and the Middle East are emerging as the global hub of ethylene and its derivatives given the capacity additions expected to come online by 2012. BMI expects that Middle East and Africa would represent 24 percent of the expected global ethylene capacity of 182 million mt by 2012 compared to about 12 percent of the 132 million mt in 2007. The Middle East alone currently accounts for 17 percent of the global ethylene production.
NCB Capital reiterated its Overweight rating on Sipchem with a revised price target of SR26.8. “We believe the company’s earnings for 2012E would benefit from strong product prices, an integrated product flow and low production cost.”
The start of the Phase 3 expansion remains a key growth catalyst for the stock.
2012w net income estimate revised downwards on lower 1Q12 earnings Sipchem’s gross margin dropped to 31.6 percent in 1Q12 against our expectation of 43.7 percent. It stood at 38.6 percent in 1Q11 and 45.1 percent in 4Q11.
Weak earnings during the quarter led to downward revision in our net income estimate for 2012. “We expect the company to record revenues of SR3.7 billion (up 11.8 percent YoY) and net income of SR747 million (up 5.8 percent YoY) in 2012E, benefiting from higher prices and production volumes.
“We estimate methanol prices to rise 4 percent YoY in 2012 as lower cargoes from Iran and shutdowns have tightened supply globally during most of 1H12. We also believe acetic acid (up 5 percent YoY) and vinyl acetate monomer (up 7 percent YoY) prices would track the movement in methanol prices in 2012.”
According to Chemical Markets Associates, Inc (CMAI), the global demand for methanol is expected to increase at a CAGR of 7.5 percent during 2011-16, higher than the 4.5 percent CAGR recorded during 1999-2010. This is mainly due to increasing demand, particularly from China, in fuel blending and other applications in the energy sector. China alone accounts for about 40 percent of the global demand for methanol. However, planned capacity additions are not likely to be sufficient to meet rising demand. CMAI projects annual demand for methanol globally to increase by over 18 million mt during 2012-15.
However, the report estimated that annual methanol supply would increase by close to 16 million mt during the same period. Tight demand and supply conditions would support methanol prices in the long run.
“We maintain our Overweight rating with a revised price target of SR26.8 The stock is currently trading at 2012E P/E of 9x and EV/EBITDA of 6x. (versus the sector averages of 9.5x and 7.2x, respectively). The stock price has underperformed TASI by 10.1 percent since our update released in March 2012. We believe the stock offers an interesting investment opportunity at current levels given Sipchem’s diversified product mix, low cost of production.” – SG