JS Securities Limited - JS Research (October 18, 2022)

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JS Securities Limited – JS Research (October 18, 2022)

October 18, 2022

Karachi, October 18, 2022 (PPI-OT): EPCL: Management pins hopes on demand revival; Maintain Sell

The company has shifted its plant turnaround to Dec-2022 (normally carried out in July) in an attempt to mitigate impact of gas supply shortage which will be at its peak during the said month. Management is hopeful of improvement in PVC volumes as construction activity increases amid rehabilitation efforts post floods and upcoming election year.

We maintain a ‘Sell’ call on the stock with a TP of Rs55. We expect earnings to bottom-out in CY24 (P/E: 6x vs JS Universe CY24 PE of sub 4.0x).

Sequential EPS decline continues

Engro Polymer and Chemicals Limited (EPCL) held its 9MCY22 Analyst Briefing yesterday discussing financial performance and outlook. To recall, the company posted an EPS of Rs2.48 for 3QCY22, down 27% YoY and 3% QoQ taking 9MCY22 EPS to Rs10.24 down 10% YoY. The decline in profitability can be attributed to decline in volume amid lower construction activity, lower PVC prices, higher FX losses and finance costs.

As PVC segment suffers on both fronts

Volumes for PVC dipped to 50KT during 3QCY22 as against 58KT during previous quarter impacted by declining construction activity amid monsoon season. Downward trend in international PVC prices continued due to slowdown in demand as the global economy heads towards a recession, further compounded by the zero COVID policy in China.

As a result, the company saw its net sales decline 24% QoQ to Rs16.9bn for 3QCY22. 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%. Realized average PVC-Ethylene core delta for quarter stood at US$550/ton which has been on a declining trend since then, where the latest reading stands at US$416/ton.

The Chlor Alkali segment on the other hand witnessed largely stable volumes QoQ clocking in at 15KT as against 16KT, as demand remained elevated with current prices for Caustic Soda in liquid form hovering around 120KT.

Strategically timing plant turnarounds and other projects

In response to questions about the company’s plans to manage gas supply shortage, management of the EPCL shared that the company has shifted its plant turnaround to Dec-2022 (normally carried out in July), as gas supply shortage will be at its peak during the said month. The plant is expected to go offline for a month starting from the first or second week of Dec-2022.

With the country wide devastation caused by the floods, management of EPCL foresees a rebound in volumes as construction activity picks up with rehabilitation efforts and the upcoming election year. Similarly, a rebound in PVC prices is also expected as demand from India picks up post monsoon and demand from China normalizes post decline in COVID cases. Ethylene prices have been bearish over lower demand and excess supply in Asia and are to be driven by OPEC decisions and the resulting movement in crude oil prices.

Timelines for new projects remains intact with the HTDC and H2O2 projects expected to achieve COD during CY23 whereas process for anti-dumping duty is currently under way.

Valuation

We maintain a ‘Sell’ call on the stock with a TP of Rs55. We expect earnings to bottom-out in CY24 (P/E: 6x vs JS Universe CY24 PE of sub 4.0x), taking our 3-year CAGR over CY21-CY24F to negative 18%. 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 CY22E.