NCB Capital: efficiency and lower costs to drive 2013e earnings of KSA petrochemical sector

Updating its report on the Kingdom’s petrochemicals sector, NCB Capital, the GCC’s leading wealth manager and the Kingdom’s largest asset manager, has downgraded Sipchem and Sahara to Neutral while maintaining all other ratings, remaining Overweight on SABIC, SIIG, Yansab and APPC.

“The continued subsidy on feedstock costs, expansion in valuation multiples and lower risk premium has increased our price targets by an average of 6%,” said Iyad Ghulam, equity research analyst at NCB Capital. “However, the slow global economic recovery and subsequent impact on petrochemical demand remains the sector’s key concern."

The update downgrades Sipchem and Sahara to Neutral from Overweight off the back of the recent rally in stock prices. Sipchem is up 17.3%, while Sahara is up 10.7% since NCB Capital’s last update in March 2013 compared to a 7.7% increase in TASI. However, progress in the ongoing merger talks between Sahara and Sipchem is a key catalyst in the near term. Due to the lack of clarity, NCB Capital has not incorporated this into its model.

“We maintain our Overweight ratings on SABIC, SIIG, Yansab and APPC, and our Neutral ratings on SAFCO, Kayan, Tasnee and Petrochem,” continued Iyad   Ghulam. “Our top picks are SABIC and Yansab. Despite its strong growth outlook, SABIC has lagged the market rally while the strong dividend outlook is the key catalyst for Yansab.”

Mr. Ghulam went on to say: “We have postponed the expected price hike of feedstock to January 2014E from 2Q13E. Although initially planned for the beginning of 2012, we now believe the Ministry of Petroleum and Minerals will not announce a feedstock price hike in 2013E. This delay has positively impacted our valuations on SABIC, Sipchem and SAFCO by an average of 1-2% while operating income increased by an average of 7% for 2013E.”

NCB Capital expects the total net income of the ten stocks under coverage to increase 15.2% YoY to SR38.3bn in 2013E (against a decline of 18.5% YoY in 2012). The updated price targets are up by an average of 6% mainly driven by 1) lower feedstock cost (a delay in ethane price hike and continued decline in propane prices) 2) improved operational efficiencies 3) lower risk premium and multiples expansion. In 2014E, the expected improvement in demand and higher earnings from startups are expected to increase net income by 8.5% YoY to SR41.5bn despite the expected decrease in ethane subsidy.

SABIC:

New projects, attractive valuation and good entry point:

“We remain Overweight on SABIC with a revised PT of SR121.5. The stock has underperformed the TASI by 7.7% since our last update,” commented Iyad Ghulam. “It is currently trading at 2013E P/E of 10.6x, a 20% discount to its local and global peers. We believe this is unjustified given SABIC’s strong earnings outlook and expansion plans. In addition, the stock offers an attractive dividend yield of 5.4% in 2013E.”

Sipchem:

Valuations stretched – downgrade to Neutral:

NCB Capital downgrades Sipchem to Neutral from Overweight with a revised PT of SR25.2. The stock has outperformed the TASI by 10% since the last update in March 2013. It is currently trading at 2013E P/E of 14.2x, a 21% premium to peers. Although remaining positive on the company’s earnings outlook, NCB Capital downgrades Sipchem to Neutral as it believes all the positives have been priced in.

Saudi Kayan:

More shutdowns in 2Q13:

“We remain Neutral on Saudi Kayan with a PT of SR13.,” said Iyad Ghulam. “Despite lower feedstock costs, the company is expected to report a net loss in 2013E due to shutdowns and high interest expenses. However, we expect Kayan to start reporting profits by 2014E. Diversified product mix and the association with SABIC are key positives for the stock. However, weak operational efficiency is a key disadvantage.”

Yansab:

Dividend announcement major catalyst:

“We remain Overweight on Yansab with a revised PT of SR64.9,” commented Iyad Ghulam. “Lower feedstock costs, multiple expansion and lower risk premium increased our PT by 7.9%. Net income is expected to grow 24.1% YoY in 2013E driven by lower feedstock costs and higher prices. After announcing the first semiannual dividend, we believe the dividend growth outlook is a key driver.”