JS Securities Limited - JS Research (February 15, 2023)

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JS Securities Limited – JS Research (February 15, 2023)

February 15, 2023

Karachi, February 15, 2023 (PPI-OT): EPCL: Improved demand from China not enough to rebound margins; Maintain Sell

Management remains optimistic in terms of a partial rebound in PVC prices from current levels as demand from China (post COVID lockdowns) and India picks up improving core delta, however, global slowdown in demand remains a key threat.

We maintain a ‘Sell’ call on the stock with a TP of Rs47. We expect earnings to bottom-out in CY23 (P/E: 7x vs JS Universe CY24 PE of sub 4.0x).

Partial super tax reversal lifts profits

Engro Polymer and Chemicals Limited (EPCL) held its CY22 Analyst Briefing yesterday discussing financial performance and outlook. To recall, the company posted an EPS of Rs2.59 for 4QCY22, down 50% YoY and stable QoQ. PBT for the quarter declined 44% QoQ owing to decline in core delta, however, partial reversal of super tax booked by the company kept profits stable sequentially. EPS for the full year clocked in at Rs12.86, down 22% YoY.

Rebound in volumes despite plant turnaround

Higher volumes remained the key driver for 17% growth in net sales sequentially clocking in at Rs20bn during 4QCY22 as volumes recovered partially from the impact of floods despite shutdown of PVC plant throughout Dec-23. The company managed to sell 67KT (including 7KT exports) during the quarter as compared to 51KT during the previous quarter. Pipes and fittings remained the leading area of use for PVC, accounting for 56% of total consumption followed by Film and Sheets accounting for 10%.

Struggled to translate into profits

Margins dragged down due to lower PVC-Ethylene core delta which averaged US$387/ton as compared to US$514/ton during previous quarter. PVC prices continued to slide amid weak demand globally and normalized supply. The company, however, recorded a partial reversal for super tax supporting profits temporarily in 4QCY22. Although the case regarding imposition of 10% super tax is ongoing, as advised by the company’s lawyers the case for reversal of 4% super tax remains weak hence the company has booked partial reversal of 6%.

Higher gas prices to take a toll

In a recent development, the ECC has approved hike in gas prices which is expected to put pressure on the company’s profits. Rate for captive power plants has been increased from Rs1,087/mmbtu to Rs1,200/mmbtu (up by 10%). Currently, EPCL is in contract with SSGC under which it will be receiving gas at RLNG rates until end of Feb-23, thereon, the company expects to revert back to indigenous gas at the new rate of Rs1,200/mmbtu. Though the increase is lower than our base case estimates of 40% increase, the recent revision applicable till Jun-2023 may revise gas prices after that.

Outlook: Sales mix to shift towards exports

Management remains optimistic in terms of a partial rebound in PVC prices from current levels as demand from China (post COVID lockdowns) and India picks up improving core delta. Global slowdown in demand remains a key threat. Ethylene prices on the other hand are expected to track crude oil prices and adjust to impact of decisions taken by the OPEC. In terms of volumes, management is targeting PVC sales of 230-240KT for CY23 although sales mix is expected to shift towards exports as local demand struggles amid low construction activity. Timelines for new projects (HTDC and H2O2) remains intact for now, however, with the issues related to opening of LCs, timeline maybe stretched towards end of CY23.

We maintain a ‘Sell’ call on the stock with a TP of Rs47. We expect earnings to bottom-out in CY23 (P/E: 7x vs JS Universe CY24 PE of sub 4.0x), taking our 3- year CAGR over CY21-CY24F to negative 19%. Upsides to our investment thesis stem from lower-than-expected decline in core delta, higher than expected PKR/US$ depreciation and higher pay-out ratio beyond CY23E.