Saudi petrochemical sector to remain volatile due to lack of catalysts: Al Rajhi

Saudi Al Rajhi
JEDDAH – The Saudi petrochemical sector is currently trading at a discount due to near-term headwinds, Al Rajhi Capital said in its recent report on “Saudi Petrochemical Sector.” It expects the performance of the petrochemical sector to remain volatile over the next couple of months due to lack of catalysts. However, the report remains positive over the medium-term as “we expect industrial activities in the key markets to improve. At the stock levels, we remain Overweight on SABIC, SAFCO and NIC. We have raised our target price for SABIC to SR137.5 as we expect earnings to improve with many of its plants coming online over the medium-term.”

With the adjournment of the merger, the report expects Sipchem and SPC to remain under pressure, and continue with our Neutral rating on these stocks. Most of the Saudi petrochemical companies have large projects under development and we believe these will provide earnings accretion over the next couple of years. These projects, which include NIC’s titanium & SAPCO projects, SABIC’s elastomer plant, SAFCO’s fifth unit SAFCO-V among others, will commence production over the next few quarters. These projects will add to the volumes, thus boosting the earnings performance of these companies over the coming quarters.

Petrochemical prices generally witness a roller-coaster ride with prices climbing up in Q1 on account of shutdowns in various parts of the world and moving down in Q2, when most plants restart post turnaround. Prices of basic olefins – ethylene and propylene – were up 13.8 percent q-o-q and 10.7 percent in Q1 2013. However, the Q1 2014 was different as prices either declined or rose lower-than-expected affecting revenues (e.g. ethylene prices declined 0.3 percent while propylene prices were up 6.8 percent). Price pressure remained on polyolefins – polyethylene and polypropylene – as well. In addition to these, prices of many intermediaries and derivatives declined or did not rise as much as it did in the first quarter of 2013 on account of lower shutdowns globally and this hurt Saudi producers’ performance.

Traditionally, Saudi petrochemical producers have witnessed a weak quarter in Q2 and we do not expect this trend to change this year, especially with manufacturing in China remaining bleak. However, Al Rajhi expects product prices to gather momentum in the second half of 2014 as industrial activities improve and developed countries show more consistent growth in consumption. Moreover, with naphtha prices remaining at higher levels due to higher crude prices, Saudi petrochemical players will continue to reap healthy margins as compared to the global peers. The severe weather in the US and downcast industrial condition hurt the Saudi-based producers, and this was reflected in their stock performance as well. The export-oriented petrochemical sector remained a laggard on the Tadawul and returned just over 4 percent YTD underperforming the TASI, which has yielded over 15 percent over the same period. This situation is comparable to that of the one in 2013 (over similar period), when the sector index’s performance (5.8 percent) was sub-par as compared to the TASI (11.9 percent) as economic uncertainties engulfed the global markets.

However, as positive changes unfolded in the second half of 2013, the sector index posted a robust rally returning 28.8 percent and beating TASI’s 25.5 percent yield for the entire year.

“We expect this to continue as improvement in developed markets will bolster demand improving Saudi producers’ bottom-line performances. We anticipate H2 to be a sentiment-booster for the petrochemical sector, with the broader market sentiment remaining positive,” the report noted.

Moreover, with naphtha prices remaining at elevated levels due to higher crude prices, Saudi petrochemical players will continue to reap healthy margins as compared to the global peers.

Petrochemical producers continue to face near-term headwinds. Weaker product prices coupled with planned & unplanned shutdowns and lower ramp-up after resumption hit Saudi producers’ Q1 earnings performance. The companies under our coverage reported a 4 percent decline in y-o-y earnings. This was also reflected in their stock price performances as the sector index gained a meager 4 percent YTD compared to TASI’s 15 percent gain. As product prices continue to remain under pressure in Q2, the report expects flat earnings growth for the quarter. The developed markets, especially the US, are showing decent signs of economic revival. Although the US GDP declined 1 percent (seasonally adjusted annual rate) in Q1 2014, the decline on a q-o-q basis was primarily due to severe weather conditions. Another key reason was a sharp decline in exports as sluggish economic recovery in many parts of Europe and Asian markets led to poor demand growth. However, the industrial growth remained positive as the Purchasing Managers’ Index (PMI) rose consistently m-o-m in the last four months.

Moreover, consumer confidence remained at relatively higher levels as people continue to remain optimistic about the business and labor market conditions.

The US economic growth seems to be gathering pace, and hence the US Fed has decided to continue tapering its bond-buying program. We believe a rise in industrial growth and positive consumer sentiment are an indicator of an upbeat economic scenario in the country. Bloomberg consensus estimates 3.5 percent growth in Q2 and 3 percent in the H2-2014. On the other hand, growth in many parts of the Eurozone remains fragile. The GDP of the 18- nation bloc grew at a low 0.2 percent (q-o-q, source: Eurostat) in Q1 2014, lower than 0.4 percent growth forecast, indicating muted business growth. Given this scenario, the ECB is mulling monetary stimulus at its June meeting.

Nevertheless, the economic indicators in some major economies remain positive and the economists anticipate GDP growth to steadily accelerate in the coming quarters.

China’s economic expansion slowed to its weakest in the last six quarters as the Q1 2014 GDP grew at a milder pace of 7.4 percent (y-o-y) much slower than the Q4 2013 number of 7.8 percent. It surpassed the consensus estimates by a slight margin, although the industrial output lagged behind the forecast. Manufacturing remains under pressure as the PMI readings (HSBC-Markit) for the last four months have stood below the 50 mark (the level that separates expansion from contraction), despite showing a recovery in the month of May. The government has been offering sops to small scale businesses and boosting investments in infrastructure, although it is yet to help the industrial sector.

Similarly, India’s economic growth continues to languish at the decade-low levels as manufacturing remains a laggard. The PMI has been above the 50-mark since January; however, “we are yet to see a steady and healthy growth in the industrial scenario. With a new government assuming charge, the existing policy paralysis is expected to come to an end,” Al Rajhi report noted.





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