Petronas Chemicals Group Berhad TP: RM9.00 (+8.6%)

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1 COMPANY UPDATE Wednesday, April 04, 2018 FBMKLCI: 1, Sector: Oil & Gas THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* Petronas Chemicals Group Berhad TP: RM9.00 (+8.6%) Fertilizing Profits Last Traded: RM8.29 HOLD Kylie Chan Sze Zan Tel: We visited Petronas Chemicals Group (PChem) s new urea plant Petronas Chemicals Fertilizer Sabah (PCFSSB: formerly known as SAMUR). Key takeaways include: 1) current land utilization is circa 20%, implying substantial room for future expansion, 2) PCFSSB s output is mainly exported to Australia and New Zealand, 3) the bulk of production (70%- 80%) are sold via long term contracts, 4) PCFSSB s anniversary warranty shutdown will likely take place in 3Q19 for days, and 5) at current urea prices, we estimate robust profits of USD200/mt. We roll forward our valuation base year to CY19, and raise our TP to RM9.00 based on lower 9.5x CY19 EV/EBITDA (previous: 11.5x). Maintain Hold as we believe the stock is fairly valued at this juncture. Spanking New Urea Plant. We visited Petronas Chemicals Group (PChem) s new USD1.5bn urea plant (Figure 1), Petronas Chemicals Fertilizer Sabah (PCFSSB: formerly known as SAMUR). It is located on 211 acres of leasehold land (lease expiry: 2040) in Sipitang Oil & Gas Industrial Park, Sabah. PCFSSB is a world class plant, with nameplate capacity of 1.2mn tpa for urea, and 740k tpa for ammonia. PCFSSB is the largest single train ammonia and urea plant in South East Asia, and 3 rd largest urea plant in Asia Pacific. There are dedicated power cogeneration units, as well as a port facility (Figure 2) at PCFSSB that is operated internally. Current land utilization is circa 20%, thus implying substantial room for future expansion. Figure 1: PCFSSB Plant Share Information Bloomberg Code PCHEM MK Stock Code 5183 Listing Main Market Share Cap (mn) 8,000 Market Cap (RMmn) 66,000 Par Value (RM) wk Hi/Lo (RM) 6.80/ mth Avg Daily Vol ('000 shrs) 7,786.0 Estimated Free Float (%) 25.0 Beta 0.8 Major Shareholders (%) Petronas EPF Forecast Revision (%) FY18 FY19 Forecast Revision (%) Core Net Profit (RM mn) 4, ,321.9 Consensus 4, ,193.7 TA/Consensus (%) Previous Rating Hold (Maintained) Financial Indicators FY18 FY19 Net Debt/Equity (x) Net Cash Net Cash ROA (%) ROE (%) NTA/Share (RM) P/NTA (x) Share Performance Price Change (%) PCHEM FBMKLCI 1 mth 1.9 (0.3) 3 mth mth mth (12-Mth) Share Price relative to the FBMKLCI Source: Various Source: Bloomberg Page 1 of 7

2 Figure 2: PCFSSB Port Facility Specifications Jetty Depth: 13m Berth Capacity: Two 45k dwt urea vessels & one 21k dwt ammonia vessel simultaneously 2 tug boats Max loading rate: 1,000 mt/hour/system (2 systems) Source: PCFSSB, TA Research Shiploader 2 units Max Capacity: 1,000mt/hour each Travelling distance: 211m Freeboard: 14m Mainly Exported to Australia & New Zealand. The main output from PCFSSB is granulated urea, which is mainly used as fertilizer for the agriculture sector. Alternatively, urea may also be used as industrial feedstock for resins (plywood), adhesives and melamine etc. Whereas ammonia produced by PCFSSB s plant (circa 95%) is largely used as feedstock for its downstream urea plant. Meanwhile, the balance (5%) of ammonia output is stored at the warehouse, and any excess is exported via PCFSSB s port facility. PCFSSB s output is mainly exported to Australia (40%-50% of total volumes) and New Zealand. The bulk of the plant s production (70%-80%) is contracted to customers via long term contracts of at least a year (with optional extensions), thus ensuring earnings visibility. Anniversary Maintenance Shutdown Later in PCFSSB commenced operations in May-2017 and is currently running at full capacity. Its anniversary warranty shutdown will likely take place in 3Q19 for days. We believe the delayed timing of this shutdown is beneficial for PChem, given that the Group will undergo heavy statutory plant turnaround (TA) in 2018 for its main upstream cracker. To recap, plants that will undergo TA in 2H18, include: 1) Ethylene Cracker 1, 2) Asean Bintulu Fertilizer, and 3) Methanol plant. Urea Price is Expected to be Subdued in According to ICIS, the urea outlook from 2Q18 onwards is expected to remain muted, given the oversupply situation. Furthermore, according to the International Fertilizer Association (IFA), there would be a potential global urea surplus of 20m tonnes in This is underpinned by estimated supply of 194m tonnes, versus demand of 174m tonnes. Lower import demand is seen in the US, India, Mexico, Bolivia as domestic production increases. Meanwhile, Nigeria, Russia and Indonesia are seeing capacity expansion. Nevertheless, we estimate that at current urea prices (Figure 3), PCFSSB s profits are robust at USD200/mt. Furthermore, there is upside to margins given PChem s favourable gas feedstock purchase agreement with parent, Petronas. Page 2 of 7

3 Figure 3: Urea China Granular and Ammonia Middle East Prices Price (USD/mt) 650 Urea Ammonia Aug-2013 Feb-2014 Aug-2014 Feb-2015 Aug-2015 Feb-2016 Aug-2016 Feb-2017 Aug-2017 Feb-2018 Source: Green Market Fertilizer Multi Step Process for Production. PCFSSB s feedstock methane gas is derived from offshore fields at Sabah via the Sabah-Sarawak Gas Pipeline (SSGP) and Sabah O&G Terminal (SOGT). Circa 60% of this gas feedstock is reformed to produce ammonia gas and carbon dioxide. Meanwhile, the balance 40% is used as fuel gas to fire-up the integrated cogen power plant within PCFSSB. Output from the upstream plant (both ammonia and carbon dioxide) are then combined with UF80 at the downstream plant for urea synthesis (Figure 4). Urea produced is then formed into prills at the granulation plant, and thereafter, will be ready to market. PCFSSB s bulk urea storage warehouse may store up to 120k mt of granular urea, whilst the ammonia storage tank can keep up to 16k mt of liquid ammonia. The bulk of PCFSSB s granulated urea is exported via PCFSSB s port facility, whilst the balance is distributed to the local market via road tankers. Figure 4: PCFSSB Manufacturing Process Flow Raw Water Source: Sabah Water Dept JETTY NH 3 H 2 0 AMMONIA AMMONIA Process Steam (130mt/hr) PLANT TANKS ROAD CH 4 TANKERS Natural Gas (90 mmscfd) N 2 (CO(NH 2 ) 2 GRANULATION BULK UREA Process Air (82k NM 3 /hr) PLANT STORAGE UREA PLANT UF80 33mt per day Source: TA Research, PCFSSB Page 3 of 7

4 Deserves Premium to Peers. We roll forward our valuation base year for PChem to CY19, and apply a lower multiple of 9.5x forward EV/EBITDA (Previous: 11.5x). This implies a 0.8x premium over historical mean valuation of 8.7x (Figure 5), and 18% premium versus Asian peers (Figure 7). We believe this is justified, given: 1) superior EBITDA margin on the back of favourable gas feedstock agreement with Petronas, 2) strong product spreads in , underpinned by rising olefin prices and resilient demand, and 3) robust pipeline capacity expansion in , with new Aroma Chemicals Complex and RAPID. Our TP is hence raised to RM9.00 (previous: RM8.84) based on 9.5x CY19 EV/EBITDA. Maintain Hold as Stock is Fair Valued. However, we maintain Hold on PChem as we believe the above has been aptly priced-in to valuations. Furthermore, We believe that PChem is unable to fully leverage on stronger product prices in 2018, due to heavy statutory TA at the group s main ethylene cracker. Furthermore, the latter will also cause associated downstream plants to be shut down in tandem. Therefore, we believe that margins will be squeezed given that spreads are higher for ethane-based products. On top of that, we believe sentiment on PChem is largely influenced by operational performance, particularly plant utilization levels, which we expect to trend lower in FY18 (Figure 6). Forward EV/EBITDA Figure 5 : Forward EV/EBITDA Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Source: Bloomberg, TA Research +1 STD: 10.3x Mean: 8.7x -1 STD: 7.1x Figure 6 : Group Plant Utilization 100% 96% 95% 93% 90% 85% 80% 75% 70% 65% 60% 55% 50% 79% 82% 78% 80% 85% Source: Company, TA Research 88% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E Page 4 of 7

5 Figure 7 : Peers Comparison Ticker Company LCY Price Mkt Cap P/E (x) EPS Growth (%) P/B ROE (%) EV/EBITDA Divd Yield (LCY) (USD m) Malaysia TTNP MK Lotte Chemicals Titan MYR , Average Malaysia 3, Thailand SCC TB Siam Cement THB , (4.3) PTTGC TB PTT Global Chemical THB 96 13, IVL TB Indorama Ventures THB 57 9, IRPC TB IRPC THB 8 4, Average Thailand 11, Average SEA 7, South Korea KS LG Chemical KRW 387,500 25, KS Lotte Chemical KRW 429,500 13, KS Hanwha Chemical KRW 29,300 4, KS Kumho Petrochemical KRW 95,800 2, Average South Korea 11, Taiwan 6505 TT Formosa Petrochemical TWD , (15.6) (1.5) TT Formosa Plastics TWD , (2.4) TT Nan Ya Plastics TWD 82 22, (3.5) TT Formosa Chemicals & Fibre TWD , (9.4) Average Taiwan 26, (4.6) India RIL IN Reliance Industries INR , Average India 87, Average Asia (ex-sea) 41, Average Asia 28, Page 5 of 7

6 Earnings Summary Income Statement Balance Sheet FYE 31 Dec (RMmn) E 2019F 2020F FYE 31 Dec (RMmn) E 2019F 2020F Revenue 13, , , , ,446.3 Fixed assets 18, , , , ,475.2 EBITDA 5, , , , ,535.0 Associates & JCEs 1, , , , ,032.4 Depreciation (1,337.0) (1,589.0) (1,732.9) (1,819.8) (1,964.1) Intangibles Net finance cost Others Share of Associates Non-Current Assets 20, , , , ,963.6 Exceptionals (177.0) (7.0) Pretax Profit 4, , , , ,833.6 Inventories 1, , , , ,712.0 Taxation (888.0) (822.0) (845.5) (869.9) (933.4) Trade and other rcvb 2, , , , ,522.7 MI (290.0) (237.0) (238.3) (245.2) (263.1) Cash and Deposits 7, , , , ,075.6 Net Profit 2, , , , ,637.1 Others Core Net Profit 3, , , , ,637.1 Current Assets 11, , , , ,365.3 Per Share Data Total Assets 31, , , , ,329.0 Core EPS (sen) DPS (sen) Borrowings Book Value (RM) Deferred Tax Net Tang Asset (RM) Others Non-current liabilities 1, , , , ,050.0 Ratios FYE 31 Dec E 2019F 2020F Borrowings Valuations Trade & other Payables 2, , , , ,136.7 Core PER (x) Others Dividend yield (%) Current Liabilities 2, , , , ,263.7 EV/EBITDA (x) P/BV (x) Total Liabilities 3, , , , ,313.7 P/NTA (x) FCF Yield (%) Share capital , , , ,871.0 Reserves 26, , , , ,394.6 Profitability ratios Minority Interests 1, , , , ,749.7 EBITDA margin (%) Equity 28, , , , ,015.2 EBIT margin (%) PBT margin (%) Total Equity + Liabilities 31, , , , ,329.0 Core Net margin (%) ROE (%) Cash Flow Statement ROA (%) FYE 31 Dec (RMmn) E 2019F 2020F Pretax profit 4, , , , ,833.6 Liquidity ratios Depreciation 1, , , , ,964.1 Current ratio (x) Net Interest (308.0) (191.0) (223.1) (209.9) (226.4) Quick ratio (x) Associates & JCEs (17.0) (16.0) (30.0) (33.0) (36.3) Working Cap Changes (1,620.0) (160.7) (275.8) Leverage ratios Interest Received Total Debt/ Assets (x) Income Tax Paid (888.0) (822.0) (845.5) (869.9) (933.4) Total Debt/Equity (x) Others 1,083.0 (1,634.0) Net Gearing (x) Net Cash Net Cash Net Cash Net Cash Net Cash CF from Operations 3, , , , ,042.6 Interest coverage (x) n.m. n.m. n.m. n.m. n.m. Capex (3,428.0) (4,600.0) (4,200.0) (3,500.0) (3,500.0) Growth ratios Dividends from Assoc Revenue (%) Others , EBITDA (%) CF from Investing (2,824.0) (3,370.0) (4,101.5) (3,420.0) (3,419.6) PBT (%) Core Net Profit (%) Dividends (1,520.0) (2,160.0) (2,100.3) (2,247.4) (2,411.3) Core EPS (%) Net Change in debt (7.0) (23.0) Interest Paid 47.0 (20.0) Key Assumptions Others (1,282.0) (342.0) Utilisation Rate - O&D 100% 94% 73% 73% 82% CF from Financing (2,762.0) (2,545.0) (2,100.3) (2,247.4) (2,411.3) Utilisation Rate - F&M 93% 90% 95% 95% 95% Net Cash Flow (1,628.0) (604.0) (220.7) ,211.7 Beginning Cash 8, , , , ,864.0 Ending Cash 7, , , , ,075.6 Page 6 of 7

7 (THIS PAGE IS INTENTIONALLY LEFT BLANK) Stock Recommendation Guideline BUY : Total return within the next 12 months exceeds required rate of return by 5%-point. HOLD : Total return within the next 12 months exceeds required rate of return by between 0-5%-point. SELL : Total return is lower than the required rate of return. Not Rated: The company is not under coverage. The report is for information only. Total Return is defined as expected share price appreciation plus gross dividend over the next 12 months. Gross dividend is excluded from total return if dividend discount model valuation is used to avoid double counting. Required Rate of Return of 7% is defined as the yield for one-year Malaysian government treasury plus assumed equity risk premium. Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy and/ or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. As of Wednesday, April 04, 2018, the analyst, Kylie Chan Sze Zan who prepared this report, has interest in the following securities covered in this report: (a) nil Kaladher Govindan Head of Research TA SECURITIES HOLDINGS BERHAD (14948-M) A Participating Organisation of Bursa Malaysia Securities Berhad Menara TA One 22 Jalan P. Ramlee Kuala Lumpur Malaysia Tel: Fax: Page 7 of 7