Al Rajhi Capital: SABIC Q1 Earnings - 1 May

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1. Saudi Basic Industries Corp Petrochemicals – Industrial SABIC AB: Saudi Arabia 01 May 2018 US$94.95bn Market cap Target price Current price 21% US$153.7mn Free float Avg. daily volume 114.00 114.54 -0.4% downside as at 30/4/2018 SABIC (SABIC AB Equity) Existing rating Underweight Neutral Overweight Neutral Performance Price Close MAV10 MAV50 Relative to TADAWUL FF (RHS) Vol mn RSI10 122.0 109.4 112.0 104.3 102.0 99.1 92.0 94.0 70 30 -10 20 15 10 5 04/17 07/17 10/17 01/18 Source: Bloomberg Earnings estimates (SARbn) 2017 2018e Rev 152.2 172.6 165.7 Rev growth 6.4% 13.4% -4.0% Gross Profit Gross margin EBITDA EBITDA margin Net Profit Net margin Research Department Pritish Devassy, CFA Tel +966 11 2119370, devassyp@alrajhi-capital.com 2019e 51.2 57.8 55.8 33.7% 33.5% 33.7% 43.8 48.8 47.5 28.8% 28.3% 28.7% 18.4 21.3 20.6 12.1% 12.3% 12.4% EPS 6.1 7.1 6.9 DPS 4.2 5.0 5.0 73% Q1 earnings in-line SABIC continued to report a see-saw pattern of net profits with Q1 2018 net income at SAR5.5bn (Figure 2), which was ~6% below our expectation of SAR5.9bn. While there were a few surprises in previously announced results of its listed subsidiaries such as Yansab reporting a shutdown (not announced previously), SAFCO reporting a surge in costs due to restructuring and Kayan delivering its best ever set of quarterly profits, overall SABIC’s results were broadly in-line with consensus expectations. The stock has already rallied c13%, since end of February, mainly due to optimism around inclusion in FTSE and (probable) MSCI indices. Rising oil and polymer prices as well as additional details on previously announced large project have supported the rally. On a short term basis, we expect the stock to remain steady as long as product prices continue to remain at these levels. However the key concerns are –1) The historical 20% discount to MSCI chemical peers on EV/EBITDA basis has diminished to 10%, which could reverse 2) Product prices have already mimicked oil prices and may not move up from here unless oil rallies further 3) Margins of marginal cost producers, likely the Asian producers are healthy and thus product spreads may not expand further 4) Supply side risks in the US. As for our valuation, we use an equal mix of relative (EV/EBITDA 7.5x, ~20% discount to MSCI World Chem, SAR114.5/sh.) and DCF valuation (SAR113/sh.) methods and arrive at a TP of SAR114/share. Figure 1 Q1 2018 results summary (In SARmn) 1Q17 Revenue 36,954 Gross Profit 13,530 margin 37% Op. profit Payout ratio 68% 71% EV/EBITDA 7.8x 7.0x 7.2x margin P/E 16.2x 14.0x 14.5x Net profit 8,350 23% 5,235 Source: Company data, Al Rajhi Capital margin 14% 4Q17 1Q18 y-o-y q-o-q ARCe Comments Despite a high single digit increase in prices uniformly across the board, the revenue came higher 40,557 41860 13% 3% 43,365 by low single digits on a q-o-q basis indicative of slightly lower operating rates As costs declined moderately (2% q-o-q), margins 12,430 14210 5% 14% 15,328 improved 31% 34% 35% Despite GP miss, Op. profit came exactly inline with 6,570 8940 7% 36% 8,954 our expectations 16% 21% 21% Net profit came slightly below our exp. The company 3,670 5510 5% 50% 5,879 reported a strategic restructuring initiative which cost the company SAR1.1bn 9% 13% 14% Source: Company data, Al Rajhi Capital Figure 2 See-saw performance of EBITDA and profits continued in Q1 2018 14.0 12.9 12.3 12.0 11.8 11.5 10.2 10.6 10.6 10.1 11.1 10.0 9.0 10.2 10.8 10.9 11.2 8.0 6.0 5.8 5.5 5.2 5.2 4.5 3.7 4.0 3.7 2.0 Net Profit 0.0 Q3 FY16 Q4 FY16 Q1 FY17 EBITDA Q2 FY17 12m average EBITDA Q3 FY17 Q4 FY17 Q1 FY18 Source: Company data, Al Rajhi Capital Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.
2. Saudi Basic Industries Corp Petrochemicals –Industrial 01 May 2018 Figure 3 Indicative average prices of revenue drivers (polymers, urea, steel) USD/tonne HDPE 1Q17 1,155 2Q17 1,106 3Q17 1,130 4Q17 1,247 1Q18 1,331 y-o-y 15% q-o-q 7% LLDPE 1,155 1,101 1,118 1,170 PP 1,048 998 1,077 1,144 1,196 4% 2% 1,222 17% MEG 1,103 956 999 7% 1,054 1,148 4% Urea 253 202 9% 211 261 255 1% -2% Long steel 433 436 510 522 570 31% 9% Source: Al Rajhi Capital, Bloomberg Figure 4 Indicative prices of cost drivers (naphtha, propane, butane) USD/t 1Q17 2Q17 3Q17 4Q17 1Q18 y-o-y Naphtha 498 446 468 572 583 17% q-o-q 2% Propane 468 399 410 580 532 14% -8% Butane 554 421 436 576 513 -7% -11% Source: Al Rajhi Capital, Bloomberg What to expect in near term? The high-single digit improvement in EBITDA has been mainly driven by improvement in product-feedstock spreads as seen in Figure 3 and Figure 4. Apart from the improvement in spreads, the commercialization of couple of small projects and acquisitions has also helped the company improve its operating performance moderately. We expect the stock price rally to sustain in the near term given the improved oil price. There could also be some support from shutdowns globally which generally tend to lower operating rates in the second quarter. Also given the momentum related to FTSE and probable MSCI inclusion, the stock could remain at these elevated levels in the near term. Concerns: On the other hand, there are some concerns which investors should take a note of: a) The historical 20% discount to MSCI chemical peers on EV/EBITDA basis has diminished to ~10%. Some investors expect the discount to reduce to nil once SABIC gets included in benchmark indices. While this could be very subjective , we have kept historical discounts as it is because we believe liquidity (the main benefit of inclusion in indices) has never been an issue for SABIC. However we have shown scenarios with various estimates of multiples. As long as there are risks of reversal of favourable feedstock pricing and limited disclosures, we believe the discount could continue. The surge in multiples comes at a time when US chemical EV/EBITDA multiples have been dropping. Figure 5 Diminished discount to MSCI World Chemical Index 12 0% 10 -5% -10% 8 -15% 6 -20% 4 -25% SABIC MSCI World chem Mar-18 Jan-18 Feb-18 Dec-17 Oct-17 Nov-17 Sep-17 Jul-17 Aug-17 Jun-17 Apr-17 May-17 Mar-17 Jan-17 Feb-17 Dec-16 Oct-16 Nov-16 Sep-16 Jul-16 Aug-16 Jun-16 Apr-16 May-16 Mar-16 Jan-16 Feb-16 Dec-15 Oct-15 Nov-15 Sep-15 Jul-15 Aug-15 -35% Jun-15 0 Apr-15 -30% May-15 2 Discount Source: Al Rajhi Capital, Bloomberg Disclosures Please refer to the important disclosures at the back of this report. 2
3. Saudi Basic Industries Corp Petrochemicals –Industrial 01 May 2018 b) As shown in Figure 6, historically, product and feedstock prices have mostly mimicked oil prices. In 2018, despite future possible supply side risks, product prices have surged significantly to levels seen during 2011-13. Hence further upside movement in prices may be limited. The product prices are only just below the two sustained peaks seen ever in the history of product prices. Figure 6 Surge in oil prices have been already mimicked by both Product* and feedstock* prices Source: Al Rajhi Capital, Bloomberg. * For Product, we have used HDPE indicative price and Naphtha for feedstock indicative price c) Margins of marginal cost producers, which are likely the Asian producers, are still healthy and above historical averages which could mean that the cost pressures have been passed on to the customers, implying limited upside in spreads. Figure 7 Median EBITDA margin of top 50 Asian chemical producers is still healthy which could indicate no further surge in product-feedstock spreads 20% 20% 19% 18.6% 19% 18.1% 18.0% 18.0% 17.8% 18% 18% 16.8% 17% 17% 16.4% 16.4% 16% 15.2% 16% 15% Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Source: Company data, Al Rajhi Capital, Bloomberg d) The obvious other key downside risk remains the often cited oversupply risks due to increase in US capacity. It is important to remember that though polymer product prices trend in the same direction as of oil prices, the product prices do not increase proportionally. For example, even though oil price declined over 50% from 2014 to 201516, product price of HDPE saw only a 22-25% price reduction. This is because the prices are set by the marginal cost producer. So an increase in oil prices will increase product price only by as much costs increase because of oil for the marginal cost producer. With surge in cheaper gas based supply, increase in oil prices will have a lesser impact on polymer prices. At the moment already product prices have increased by high single digit % as compared to similar increase in oil prices. Long term drivers: Success of large-scale projects (such as USD20bn Oil-to-Chemical project, new petchem complex in Texas, CTO & Polycarbonate plants in China) will remain vital to determine the share price trend of SABIC over the long-term. The company aims to spend US$3-10bn on acquisitions, particularly in the specialties and agri-nutrients sectors. As a part of its long-term investment strategy, the company is putting to use the cash available and has recently acquired 24.99% stake in Clariant. We believe that the company’s robust cash surplus (~19% of market cap) and healthy leverage position (debt to total asset Disclosures Please refer to the important disclosures at the back of this report. 3
4. Saudi Basic Industries Corp Petrochemicals –Industrial 01 May 2018 ratio: ~18%, lower than peer average) should provide sufficient headroom to fund its aggressive investment plans in future. Valuation: Given unexpected improvement in product prices, we revise our forecasts for both feedstock and product prices higher (see base case expectations in next paragraph). Post revision in our estimates and updating our target EV/EBITDA multiple (7.5x, that is ~20% discount to MSCI chemical peers which trade at 9.3x), we revise our target price to SAR114/share based on equal mix of DCF and relative valuation. We remain Neutral on SABIC, given the upside of -0.4% ( ~4% after including 2018e dividends of SAR5/share). The stock is currently trading at an EV/EBITDA of 7.8x on our 12month forward EBITDA, which is c8% above historical average. We believe 7.5x is a fair estimate given that we are more likely at the upper end of the cycle than at the lower end and hence justifies a lower valuation multiple than historical levels. What can go wrong with our estimates? In our base case, we expect product prices to likely dip by mid-single digits given that we are operating in a cyclical industry having already witnessed a sharp rally in oil prices. Beyond 2019, we expect prices to increase by 2-3% on an average. In the below we have assessed a few scenarios whereby we have assumed various discount to MSCI World Chemical peers and movement in product prices and feedstock in 2019 over 2018. We have assumed YTD average price levels to be sustained in 2018. Based on these, there is significant potential if the discount to target multiple declines. Figure 8 Scenario analysis Price & feedstock movement in 2019 Discount to MSCI peers -10% -5% 0% 5% 20% 110 114 118 121 10% 118 122 126 130 5% 122 126 130 134 0% 126 130 134 138 Source: Company data, Al Rajhi Capital Risks: Key upside triggers are associated with faster than expected successful commercial launch of its above mentioned future expansion projects and increase in product spreads. SABIC is most likely to be included in MSCI EM Index, generating additional global interest in the stock once Saudi Arabia upgrades to Emerging market list, which could eliminate a bit of the discount compared to global peers provided disclosures improve. Downside risks include weak oil & thereby decline in petchem product prices, unplanned plant shutdowns and any further unexpected revision in the subsidized feedstock prices. The newer projects such as the OTC project are quite large and are unconventional, the success of which could be a key factor. Disclosures Please refer to the important disclosures at the back of this report. 4
5. Saudi Basic Industries Corp Petrochemicals –Industrial 01 May 2018 IMPORTANT DISCLOSURES FOR U.S. PERSONS This research report was prepared by Al Rajhi Capital (Al Rajhi), a company authorized to engage in securities activities in Saudi Arabia. Al Rajhi is not a registered broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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6. Saudi Basic Industries Corp Petrochemicals –Industrial 01 May 2018 Disclaimer and additional disclosures for Equity Research Disclaimer This research document has been prepared by Al Rajhi Capital Company (“Al Rajhi Capital”) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital’s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. 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"Neutral": We expect the share price to settle at a level between 10% below the current share price and 10% above the current share price on a 12 month time horizon. "Underweight": Our target price is more than 10% below the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Target price": We estimate target value per share for every stock we cover. This is normally based on widely accepted methods appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis. Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company’s profits or operating performance exceed or fall short of our expectations. Contact us Mazen AlSudairi Head of Research Tel : +966 1 211 9449 Email: alsudairim@alrajhi-capital.com Al Rajhi Capital Research Department Head Office, King Fahad Road P.O. Box 5561, Riyadh 11432 Kingdom of Saudi Arabia Email: research@alrajhi-capital.com Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No. 07068/37. Disclosures Please refer to the important disclosures at the back of this report. 6