PTT Global Chemical. Lack of near-term positive catalysts. 21 October 2011 Asia Pacific/Thailand Equity Research Major Chemicals (PTTGC.

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1 Asia Pacific/Thailand Equity Research Major Chemicals Rating NEUTRAL Price (20 Oct 11, Bt) Target price (Bt) 63.00¹ Chg to TP (%) 18.9 Market cap. (Bt mn) 238,817 Enterprise value (Bt mn) 329,244 Number of shares (mn) 4, Free float (%) week price range - *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. Research Analysts Paworamon (Poom) Suvarnatemee, CFA paworamon.suvarnatemee@credit-suisse.com (PTTGC.BK) INITIATION Lack of near-term positive catalysts Initiate coverage with NEUTRAL. (PTTGC) is the merged company between PTT Chemical and PTT Aromatics. Although PTTGC s valuation is undemanding, its share price upside in the next six months may be capped by possible consensus downgrades and short-term risks to oil prices. We initiate on PTTGC with NEUTRAL and Bt63 target price. Offers exposure to oil price. Almost 70% of PTTGC s profit comes from PTTCH s integrated gas-based olefin plants, while the remaining comes from PTTAR s refinery and aromatics businesses. Oil price continues to be the biggest driver of PTTGC s performance. CS expects more downside than upside in the next six months for Brent crude oil. Margins are likely to recover in 2H12 at the earliest for ethylene, while strong PX margins are already factored into market consensus. Consensus downgrades possible. Our earnings forecasts are 4% and 14% below what we expect consensus combined PTTCH and PTTAR estimates to be for FY11 and FY12, respectively. We are more conservative than the market on the aromatics business. The announcement of 3Q11 results in mid-november may trigger consensus downgrade in the short term. Undemanding valuation, but We do not expect PTTGC s valuation to bounce much beyond its peers, which have recovered up to 15% during the period of trading suspension since 11 October. Although the current valuation is undemanding, we do not see a new or sustained share price catalyst over the next six months based on our views on oil, PE margins and PX margins. We initiate coverage on PTTGC with a NEUTRAL rating and target price of Bt63, based on 6x EV/EBITDA, implying 19% potential upside. Key risks are reinvestment of its free cash flow in lower-return projects, fluctuations in oil prices and PE and PX margins, and exchange rate volatility. Financial and valuation metrics Year 12/10A 12/11E 12/12E 12/13E Revenue (Bt mn) 375, , , ,310.2 EBITDA (Bt mn) 33, , , ,416.6 EBIT (Bt mn) 19, , , ,997.1 Net income (Bt mn) 15, , , ,455.0 EPS (CS adj.) (Bt) Change from previous EPS (%) n.a. Consensus EPS (Bt) n.a. EPS growth (%) n.a P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Focus charts and tables Figure 1: PTTGC's net profit breakdown into PTTCH and PTTAR about 70% to come from PTTCH (Bt bn) Figure 2: HDPE prices (US$/t) price volatility driven more by naphtha price fluctuation, which is linked to oil prices 40 1, , , E 12E 13E 1, YTD PTTAR PTTAR's stock gain PTTCH Naphtha HDPE-naphtha spread Source: IBIS Consensus Source: Company data, Credit Suisse estimates Figure 3: PTTGC's earnings sensitivities Variables Impact on EPS in 2012 (%) US$10/bbl rise in oil price +7.4 PX-naphtha spread up US$50/t to US$700/t +4.7 HDPE-naphtha spread down US$50/t to US$462/t -3.2 Bt1/US$ depreciation to Bt30.5/US$ +5.1 Source: Credit Suisse estimates Figure 4: Market cap (US$ bn)* PTTGC to rank 10 th in the SET; PTTCH and PTTAR were ranked 12 th and 19 th Figure 5: EV/EBITDA comparison, FY12E (x) Av erage = 6x 0 PTT PTTEP SCB AIS SCC KBANK BBL PTTGC CPALL CPF 0 Reliance IVL PCG PTTGC Shin-Etsu LG Chem Honam Hanwha Note: *Based on closing price as of 10 October 2011 Source: Company data Note: Price as of 19 October 2011 Source: Credit Suisse estimates (PTTGC.BK) 2

3 Lack of near-term positive catalysts (PTTGC) is the merged company between PTT Chemical and PTT Aromatics. Although PTTGC s valuation is undemanding, share price upside in the next six months may be capped by possible consensus downgrades and short-term risks to oil prices. We initiate on PTTGC with a NEUTRAL rating and target price of Bt63. Leverage to oil price PTTGC s businesses consist of PTTCH s integrated gas-based olefin plants and PTTAR s refinery and aromatics plants. We estimate that around 70% of PTTGC s profit should come from PTTCH and the remaining from PTTAR. Oil price continues to be the biggest earnings driver for PTTGC. We believe PTTGC provides a better exposure to oil prices than HDPE margins. In the past five years, the volatility of HDPE prices (hence, PTTCH s profits) has been influenced more by oil price fluctuation than changes in the HDPEnaphtha margins. CS expects tighter supply of oil over the medium to long term; we see downside risks in the next six months for Brent. We estimate that for every US$10/bbl increase in oil prices, PTTGC s profit in FY12 will likely rise by 7.4%. Largest petrochemical stock in Thailand PTTGC will be the biggest petrochemical stock in Thailand by market cap, based on its share price of Bt53. PTTGC should be among the ten largest Thai companies by market cap, but is estimated to be slightly more than half the size of Petronas Petrochemical Berhad (PCGB). Management expects synergy benefits to add Bt to annual EPS before tax, depending on the product price cycle. In our view, synergies should come from 2013 at the earliest. More synergies could be extracted with more detailed study to be done in the future. Cash investment to generate synergies during the first phase is estimated at US$92 mn. As such, we estimate PTTGC would generate a hefty free cash flow of US$1.3 bn a year if oil price stays at our forecast level of US$105/bbl in 2012 and US$115/bbl in 2013 for Brent. With huge free cash flow, we see rising risks of reinvestment in low-return projects, as PTTCH has a weak track record outside its core gas-based petrochemical plants. Undemanding valuation, but Despite its undemanding valuation, we see PTTGC s share price upside to be capped at our target price of Bt63. We do not expect PTTGC s valuation to bounce beyond its peers, which have recovered by 1 15% during the period of trading suspension since 10 October. There are no positive short-term catalysts. Our earnings forecasts are 4% and 14% below what we believe consensus combined PTTCH and PTTAR estimate would be for FY11 and FY12, respectively. We are more conservative than the market on the aromatics business. In the short term, 3Q11 results announcement in mid-november may trigger an earnings downgrade. Although the current valuation is undemanding, we do not see a new or sustained share price catalyst over the next six months, based on our views on oil, PE margins and PX margins. We initiate coverage on PTTGC with a NEUTRAL rating and target price of Bt63, based on 6x FY12E EV/EBITDA, at the average EV/EBITDA for regional peers (excluding Taiwan). Risks Key risks are reinvestment of its free cash flow in lower-return projects, fluctuations in oil prices and PE and PX margins, and exchange rate volatility. Oil price continues to be the biggest earnings driver for PTTGC In our view, synergy should come from 2013 at the earliest There are no positive shortterm catalysts (PTTGC.BK) 3

4 Key financial data Figure 6: PTTGC financial summary Year-end 31 Dec E 2012E 2013E Key assumptions Average Bt/US$ Dubai (US$/BBL) Ethylene capacity ('000 tonnes) 2,026 2,376 2,376 2,376 HDPE prices (US$/t) 1,203 1,353 1,384 1,600 HDPE naphtha spread (US$/t) MEG ethylene spread (US$/t) Market GRM (US$/BBL) Stock gain (US$/BBL) Accounting GRM PX naphtha spread (US$/t) Refining capacity (KBD) Utilisation % Profit and loss (Bt mn) Sales 375, , , ,310 Gross profit 27,794 53,384 51,155 57,021 EBITDA 33,539 60,197 58,321 64,417 EBIT 19,938 44,397 41,731 46,997 EBT 14,432 39,194 37,151 43,241 Core profit 10,776 33,099 32,064 38,455 Core EPS (Bt) Reported profit 15,521 33,099 32,064 38,455 Reported EPS (Bt) Balance sheet (Bt mn) Cash and short-term investment 21,035 29,400 37,231 45,605 Inventories 34,366 45,103 46,991 50,894 Property, plant and equipment-net 245, , , ,322 Total Assets 373, , , ,798 Short-term debt 14,264 18,315 23,315 23,315 Long-term debt 116, ,511 81,511 61,511 Total liabilities 178, , , ,634 Shareholders' equity 187, , , ,647 Cash flow (Bt mn) Net income n.a. 33,099 32,064 38,455 DDA n.a. 15,800 16,590 17,420 Other cash from operation n.a. (11,134) (286) (2,873) Cash from operations n.a. 37,764 48,367 53,002 Capex n.a. (12,246) (11,296) (9,112) Investments in sub., associates and others n.a Cash from investments n.a. (7,287) (9,245) (6,999) Inc (dec.) in debt n.a. (10,949) (15,000) (20,000) Other cash flow from financing n.a. (11,164) (16,291) Cash from financing n.a. (22,113) (31,291) (37,630) Free cash flow n.a. 30,478 39,122 46,003 Key ratios (%) EBITDA margin Net profit margin Net debt to equity ROE ROA Source: Company data, Credit Suisse estimates (PTTGC.BK) 4

5 Leverage to oil price (PTTGC) is the merged company between PTT Chemical (PTTCH) and PTT Aromatics (PTTAR). PTTGC s businesses consist of PTTCH s integrated gasbased olefin plants, and PTTAR s refinery and aromatics plants. We estimate that around 70% of PTTGC s profit should come from PTTCH and the remaining from PTTAR. Oil price continues to be the biggest earnings driver for PTTGC. We see that PTTGC provides a better exposure to oil prices than HDPE margins. In the past five years, the volatility of HDPE prices (and hence PTTCH s profits) has been influenced more by oil price fluctuations than changes in HDPE-naphtha margins. Although CS sees tighter supply of oil over the medium to long term, we foresee downside risks in the next six months for Brent. We estimate that for every US$10/bbl increase in oil prices, PTTGC s profit in FY12 would rise by 7.4%. The merger is the merged company between PTT Chemical (PTTCH) and PTT Aromatics (PTTAR). PTTGC is scheduled to start the first day of trading on 21 October Stock trading of PTTCH and PTTAR has been suspended since 11 October at the implied opening price for PTTGC of Bt53/share. Figure 7: PTTGC s capacity Product Capacity (tonne/year) Olefins 2,888,000 Ethylene 2,376,000 Propylene 512,000 Aromatics 2,259,000 Polymer 1,590,000 HDPE 800,000 LDPE 300,000 LLDPE 400,000 PS 90,000 Ethylene oxide and its derivative products 470,000 EO/EG 395,000 Ethanolamines 50,000 Fatty alcohol Ethoxylates 50,000 Oleochemical 812,000 Methyl Ester 200,000 Fatty alcohol 100,000 Glycerin 31,000 Base and specialty Oleochemicals 976,000 Phenol/Bisphenol A* 210,000 Petroleum products (bbl/day) 228,000 Note: *Capacity reflects PTTGC s 60% ownership in the business. Source: Company data Oil price continues to be the biggest earnings driver for PTTGC PTTGC s businesses include integrated gasbased olefin plants, a refinery (with 228 kbd capacity) and aromatics plants (PTTGC.BK) 5

6 Figure 8: PTTAR's refining output Capacity Refinery unit Crude Refining Unit Condensate Splitter Unit 1 Condensate Splitter Unit 2 Total 280,000 petroleum products capacity Source: Company data (bbl/day) Description 145,000 A complex refinery with hydrocracker and visbreaker units, capable of converting fuel oil into middle distillates. This unit refines crude oil into products, which may include reformate for delivery to aromatics complex. 70,000 This unit produces reformate for delivery to the aromatics complex along with other petroleum products, including light naphtha, LPG and condensate residue. 65,000 This unit produces reformate for delivery to the aromatics complex along with other petroleum products, including light naphtha, LPG and condensate residue. 228,000 Figure 9: PTTAR s production capacity for aromatics plants Product (tonne/year) Aromatics Complex I Aromatic Complex II Total Paraxylene 540, ,000 1,195,000 Benzene 307, , ,000 Cyclohexane 200, ,000 Orthoxylene 66,000-66,000 Mixed Xylenes 76,000-76,000 Toluene - 60,000 60,000 Total 1,189,000 1,070,000 2,259,000 Source: Company data Earnings drivers: Oil price, HDPE and PX margins Given the bigger size and profitability of the integrated gas-based olefin plants, PTTGC s profit would be contributed largely by PTTCH s business (close to 70%) while the remaining should come from PTTAR (refinery and aromatics products) (Figure 10). Being a gas-based plant, PTTCH s profitability is high when product prices (mostly HDPE) are high, as the cost of ethane gas feedstock from PTT moves up at slower pace than its endproduct prices. As such, earnings drivers of PTTCH (i.e. oil price and PE margins) would continue to be the most sensitive factors to PTTGC s profit. In the past five years, the biggest swing factor of PTTCH s profit is oil price, not the spread between HDPE and naphtha (Figure 6). HDPE prices consist of naphtha price and the spread between HDPE and naphtha prices. The spread (influenced by the demand/supply dynamic of HDPE) is much less volatile that the naphtha price (influenced by oil price volatility). Naphtha prices swung from the low of US$539/t to the high of US$932/t, while HDPE-naphtha spread moved from the low of US$449/t to the high of US$627/t. PTTAR s refining output the second largest in Thailand PTTAR s PX output is sold to external clients through long-term contracts, while its benzene is partly used to produce cyclohexane 70% of PTTGC s profit to come from PTTCH, remaining to come from PTTAR Oil price: The biggest swing factor in PTTCH s profit in the past five years (PTTGC.BK) 6

7 Figure 10: PTTGC's net profit breakdown into PTTCH and PTTAR about 70% to come from PTTCH (Bt bn) Figure 11: HDPE prices (US$/t) price volatility driven more by naphtha price fluctuation, which is linked to oil price 40 1, , , E 12E 13E 1, YTD PTTAR PTTAR's stock gain PTTCH Naphtha HDPE-naphtha spread Source: IBES Consensus Source: Company data, Credit Suisse estimates In the latest note of CS 4Q11 Global Commodity Forecast Dangerous New Phase, dated 4 October 2011, we see more downside than upside in the next six months or so for Brent crude oil. An extreme lack of confidence adds downside pressure to what currently is at best only sluggish oil demand growth, at least at a global level. Combined with seasonal weakness in 4Q and 1Q, we expect Brent average prices to continue to deflate slowly this quarter, with no meaningful recovery in 1Q12. However, once the macro dust settles, strong underlying oil demand growth trends and any of a number of issues on the supply side should become more apparent. From 2Q12, we expect oil prices to again resume an upward trend, peaking at what we consider maximum sustainable levels around US$120 per barrel for Brent in early Although our base-case scenario is for the global economy to stabilise over the coming months, the full impact of the damage already done this summer is probably still playing out in oil markets. That said, aside from a severe crisis scenario, strong trend growth in emerging market oil consumption should continue to flow to the bottom line. Capacity utilisation across the oil supply chain, including its refining system, remains historically high. And if this year did anything in the world of oil, it underscored supply side risk among the entire range of MENA oil producers. In addition, an emerging trend of robust non- OPEC supply growth suddenly looks vulnerable too. CS sees short-term weakness in crude oil price for both Brent and Dubai But we stay positive on oil price for longer term with tight supply situation Figure 12: PTTGC's earnings sensitivities Variables Impact on EPS in 2012 (%) US$10/bbl rise in oil price +7.4 PX-naphtha spread up US$50/t to US$700/t +4.7 HDPE-naphtha spread down US$50/t to US$462/t -3.2 Bt1/US$ depreciation to Bt30.5/US$ +5.1 Source: Credit Suisse estimates Paraxylene (PX) cycle is expected to stay strong throughout 2012, as the market is tighter with limited capacity addition. In our forecast, we expect PX margins to stay high at US$650/t in and decrease to US$600/t in 2013 the level higher than the past five-year average of US$447/t. PX margins likely to stay above average in 2012 (PTTGC.BK) 7

8 Figure 13: World PX demand and supply growth (mn tonnes) (%) Utilisation rate of PX producers should continue to go up, raising margins to above the five-year average E 2012E 2013E 77 Capacity addition Production increase Consumption Utilization rate Source: PCI (PTTGC.BK) 8

9 Largest petrochemical stock in Thailand PTTGC will be the biggest petrochemical stock in Thailand by market cap based on its share price of Bt53. PTTGC should be ranked among the ten largest Thai companies with biggest market cap, but is estimated to be slightly more than half of the size of Petronas Petrochemical Berhad (PCGB.KL, RM6.12, N [V], TP RM6.80). Management expects synergy benefits to add to annual EPS before tax by Bt /share, depending on the product price cycle. In our view, synergy should come from 2013 at the soonest. More synergies could be extracted with more detailed study to be done in the future. Cash investment to generate synergy during the first phase is estimated at US$92 mn. As such, we estimate that PTTGC would generate a hefty free cash flow of US$1.3 bn a year if oil price is to stay at our forecast of US$105/bbl in 2012 and US$115/bbl in 2013 for Brent. With huge free cash flow, we see rising risks of reinvestment in low-return projects, as PTTCH has weak track record outside its core gas-based petrochemical plants. Capital market impact Based on closing prices on 10 October 2011, PTTGC should have a market cap of US$7.8 bn, ranked as the 8 th largest stock in the SET. Prior to the merger, PTTCH and PTTAR were ranked as the 12 th and 19 th largest in the SET, respectively. In our view, synergy should come from 2013 at the earliest PTTGC: 8 th largest market cap in the SET Figure 14: Market cap (US$ bn)* PTTGC to be top ten in SET, while PTTCH and PTTAR were 12 th and 19 th Figure 15: Market cap (US$ bn)* still small, compared with NJA but second largest in SEA after PGCB PTT PTTEP SCB AIS SCC KBANK BBL PTTGC CPALL CPF Reliance FPCC Shin-Etsu LG Chem Nan Ya Formosa Plastic FCFC PCGB Honam PTTGC IVL Far Eastern Hanwha Note: *Based on closing price as of 10 October 2011 Source: Company data Note: *Based on closing price as of 10 October 2011 Source: Company data Compared with Petronas Chemical Berhad (PCGB), PTTGC is less leveraged to oil prices but more sensitive to the PX cycle, given the higher exposure of PTTGC s PX output. PCGB is more leveraged to oil price than PTTGC because PCGB s ethane cost is fixed at the lower level, compared with PTTGC s ethane cost, which is higher and linked to endproduct prices. In addition, PTTGC has an exposure to the refinery business, with 228 kbd output of refined products, while PCGB does not have refinery exposure. but smaller than Petronas Chemical (PTTGC.BK) 9

10 Figure 16: PTTGC's sales revenue breakdown, 2010 EO/EG based Poly mers Olefins 4% 7% 9% Oleochem Int'l business 3% 4% Light Naphtha 8% BZ 4% Refinery PX 42% 11% Figure 17: PCGB's sales revenue breakdown, FY11 Urea N-butane Others 10% 2% 16% Methanol PP 9% 3% Ammonia Benzene 3% 3% Ethy lene PE 9% 9% Others 1% Other aromatics products 7% EG 6% MTBE 6% Paraxy lene 9% Propolene 8% PVC & VCM 7% Source: Company data Source: Company data, Credit Suisse estimates (PTTGC.BK) 10

11 Figure 18: Capacity comparison, 2011 ('000 tonnes) PTTGC PGCB Refinery products (kbd) 210 BZ Toluene 60 PX 1, Ortoxylenes 66 MX 76 Cyclohexanes 200 LPG 438 Light Naphtha 1,040 Heavy-Aromatics 79 Condensate Residue 1,571 Heavy Naphtha 445 Reformate 184 Total aromatics 5, Ethylene 2,376 1,000 Propylene HDPE 775 MEG Polystyrene 90 EO derivatives 75 Methyl Ester 200 Fatty Alcohol 100 Glycerine 30 LDPE LLDPE VCM/PVC 680 PP 80 Total olefins 5,253 2,213 MTBE 300 Urea 1,433 Methanol 2,398 Ammonia 1,300 Carbon Monoxide 247 Oxogas 436 Total 5,813 Source: Company data, Credit Suisse estimates Synergy: Not till 2013 After the merger process of PTTCH and PTTAR is completed, PTTGC plans to co-invest together to achieve synergy. According to data provided by PTTGC, total investment would cost US$92 mn during with total benefits of US$ mn (or Bt0.5 1/share on EPS) depending on price cycles. In the table below, we see that a total benefit of US$ mn should start in 2013 and US$ mn in For the immediate benefits of LPG exchanges between PTTAR and PTTCH (listed in 1.2 in the Figure 19) of US$38 78 mn, we have already factored in our forecast, and we believe that market consensus has already done so since January 2011 when the government allowed refiners to sell LPG at higher price. Management estimates synergy value to increase pre-tax EPS by Bt0.5 1, depending on the product price cycle Most of the benefits should start in 2013 (PTTGC.BK) 11

12 Figure 19: Synergy benefits Commencement Investment costs Synergy benefits Synergy description Date (US$ mn) (US$ mn) 1. Synergy from existing product lines 1.1 Enhance value of off gas into olefin products 3Q Utilise C3/C4 (LPG) from PTTAR as feedstock for PTTCH's olefin products* Immediately Substituting of heavy aromatics for wash oil at PTTCH Immediately Upgrade heavy gasoline, light cracker bottoms and cracker bottoms from PTTCH to petroleum products at PTTAR 1.5 Install PSA at PTTCH to produce hydrogen to substitute production at the HMU Cost savings from sharing storage tank and jetty Utilities costs reduction from stream offtake from PTTCH Total synergy benefits Note: *We believe that the benefits of LPG usage has already been included in most analysts forecast and perhaps cancel out the benefits of government s regulation released in January 2011 to allow refiners to sell LPG at weighted prices between international and fixed price. Source: Company data, Credit Suisse estimates The next step for PTTGC is to buy 40% stake in PTT Phenol, and perhaps PTT Utility (PTTUT) from PTT. (Currently, PTT owns 40% of both PTT Phenol and PTT Utility). If PTTGC is to buy PTT s stakes, PTTGC would have full 100% control in both ventures. However, we do not believe that the acquisition price would be attractive or provide abnormally high return to PTTGC, given that the acquisition would be a related company transaction with PTTGC as an affiliate company under PTT s control. According to the management, the merger will enhance new business opportunities in the future, as PTTGC will be able to continue expanding its business to cover higher value petrochemical products, increasing its profit margins and strengthening its financial position and competitiveness in the global market. However, a more detailed study is required on potential benefits, market condition and investment costs for the modification of the production process and the required infrastructure. One example of the opportunity is the construction of a Petrochemical Complex, comprising a New Cracker and a Catalytic Pyrolysis Process (CPP). This can be done by using Hydrowax, CRS Bottom, C3/C4 stream, Light Naphtha and Natural Gas Liquid to recover higher value petrochemical streams such as ethylene, propylene, mixed C4s and aromatics for further use as feedstock for intermediate streams and downstream products, which can only be obtained from the full integration of refinery, upstream and downstream units of both Aromatics and Olefins chains. Reinvestment risks PTTGC s major capex spending has ended with the full start-up of its second olefin cracker and completion of Euro IV upgrade in Cash flow requirement for synergy projects would be estimated at US$92 mn over As such, we estimate PTTGC to generate free cash flow a year of US$1.3 bn. We see risks that PTTGC would reinvest its cash in lower-return projects. PTTCH s acquisition track record is not impressive. The most recent acquisition of 50% stake in NatureWorks (NOT LISTED) does not look promising, given that the company has had poor profitability in the past. Purchase of PTT Phenol and, perhaps, PTT utility from PTT Future synergy remains unclear and subject to further study Weak track record of reinvestment outside gasbased olefin businesses (PTTGC.BK) 12

13 Figure 20: PTTCH s ROE by businesses non-olefin businesses achieved return below the cost of capital (%) PTTCH achieved lower returns on investment outside its core gas business Olefins and deriv ativ es Oleochemicals Serv ices & Others International Business Source: Credit Suisse estimates (PTTGC.BK) 13

14 Undemanding valuation, but Despite its undemanding valuation, we see share price upside of PTTGC to be capped at our target price of Bt63. We do not expect PTTGC s valuation to bounce beyond its peers, which have recovered by 1 15% during the period of trading suspension since 10 October. There are no positive short-term catalysts. Our earnings forecast is 4% and 14% below what we expect consensus s combined PTTCH and PTTAR estimate would be for FY11 and FY12, respectively. We believe that we are more conservative than the market on the aromatics business. The announcement of 3Q11 in mid-november may trigger earnings downgrade in the short term. Although current valuation is undemanding, we do not see a new or sustained share price catalyst over the next six months based on our views on oil, PE margins and PX margins. We initiate coverage on PTTGC with a NEUTRAL rating and target price of Bt63 based on EV/EBITDA of 6x in FY12, at the average EV/EBITDA for regional peers (excluding Taiwan). Prefer SCC for petrochemical exposure Our earnings forecast for PTTGC is lower than the consensus forecast of combined profit of PTTAR and PTTCH by 4% in FY11 and 14% in FY12 after adjusting for higher annual amortisation expenses incurred from the merger of Bt1 bn. We believe that our difference with consensus earnings forecast is due to our conservative forecast of PTTAR s profitability. PTTAR has missed earnings estimates in the latest reported quarterly profit in 2Q11. However, consensus earnings have been revised upwards with focus only on rising PX-naphtha spread (Figure 21) while PTTAR s byproducts report bigger losses (Figure 22). We expect that the announcement of its 3Q11 results in mid-november would trigger earnings downgrades. There are no positive shortterm catalysts Our earnings forecast is lower than consensus by 14% in FY12 We believe consensus estimate may be too high for the aromatics business Figure 21: PTTAR and PTTCH consensus earnings revisions (Bt bn) upgrade was focusing on PX-naphtha margins Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Mar 11 May 11 Jul 11 Figure 22: Disappointing earnings at PTTAR in 2Q11 driven by higher loss from by-products and higher fuel loss in the production process due to high oil price (US$/tonne) Q09 3Q09 1Q10 3Q10 1Q11 3Q11 PTTCH PTTAR Naphtha-condensate LPG-condensate Source: IBES, Credit Suisse estimates Source: Thompson Reuters, Credit Suisse estimates CS sees more downside than upside in the next six months or so for Brent crude oil. We expect Dubai crude to move in the same direction. Also, petrochemical demand and supply balance is not expected to improve significantly till 2H12. As such, we see a period of stable profits with risks on the downside if demand weakens due to economic slowdown. Though PTTGC s valuation is undemanding under our view of sustained high oil price in the medium to long term, we see limited short term catalyst that will drive its performance. At CS, we expect Brent crude oil price to be capped during 4Q11 1Q12 Limited short-term catalysts despite our view of longterm high oil price (PTTGC.BK) 14

15 Compared with regional peers, PTTGC is trading at EV/EBITDA of 5.2x, compared with the regional average of 6x. With possible consensus downgrades and subdued outlook of oil price over the next six months and limited upside on oil price in the short term, we believe that PTTGC s valuation is capped at our target price of Bt63, equating to P/B of 1.3x. Short-term risks are weaker oil prices and HDPE margins if global economy is too slow. Limited downside but upside is also capped: Initiate with NEUTRAL with 19% upside Figure 23: EV/EBITDA comparison, FY12E (x) 9 Figure 24: P/E comparison, FY12E (x) Av erage = 6x Av erage = Reliance IVL PCG PTTGC Shin-Etsu LG Chem Honam Hanwha PCG Reliance IVL LG Chem Honam PTTGC Hanwha *Prices as of 19 October 2011 Source: Credit Suisse estimates Figure 25: P/B valuation comparison, FY12E (x) *Prices as of 19 October 2011 Source: Credit Suisse estimates Figure 26: P/B versus ROE, FY12E (x) Av erage = Shin-Etsu Far Eastern IVL PCG Formosa Plastic Nan Ya FCFC LG Chem Reliance Honam PTTGC 0.0 IVL PCG LG Chem Reliance Honam Shin-Etsu PTTGC Hanwha Hanwha (%) *Prices as of 19 October 2011 Source: Credit Suisse estimates *Prices as of 19 October 2011 Source: Credit Suisse estimates (PTTGC.BK) 15

16 Risks Price and margins volatility PTTGC s gas-based olefin plants profitability is higher due to high oil prices, as product prices will go up faster than the cost of its gas feedstock from PTT. For every US$10/bbl rise in oil price, we estimate PTTGC s profit to go up by 7.4%. Also, sharp and quick spike in oil prices would also result in stock gain at its refinery. The impact would be the opposite if oil prices are on the way down. PTTGC s profit is also influenced by the spread between paraxylene and condensate, the spread between benzene prices and condensate, and the refinery s gross refining margins (GRM). Paraxylene is the beginning product of polyester chain (polyester fibre and PET). Product spreads and GRM are affected by demand and supply dynamics of each product. Operation PTTGC does not purchase natural gas or processed gas feedstock from any other suppliers except PTT, while PTTGC is also the only company to which PTT supplies ethane for petrochemicals production. PTT supplies the requirement of PTTGC s ethane, propane and LPG feedstock. If there are material interruptions in supply from PTT, PTTGC s production rate would get affected. PTTGC s revenue and a major part of its costs is denominated in USD. Appreciation of the THB against the USD may materially and adversely affect its profitability. We estimate that for every Bt1/US$ depreciation in Thai Baht, PTTGC s profit would rise by 5.1% in FY12. Reinvestment of cash PTTCG s major capex spending has ended with the full start-up of its second olefin cracker and the completion of Euro IV upgrade in Cash flow requirement for synergy projects is estimated at US$92 mn over As such, we estimate PTTGC to generate free cash flow a year of US$1.3 bn. We see risks that PTTGC would reinvest its cash in lower-return projects. PTTCH s acquisition track record is not impressive. The most recent acquisition of 50% stake in NatureWorks (NOT LISTED) does not look promising, given that the company has had poor profit track record in the past. For every US$10/bbk rise in oil price, profit to go up by 7.4% Volatility of prices of aromatics products and refining margins Gas availability from PTT PTTGC s profit up 5.1% for every Bt1/US$ depreciation in Thai baht Weak track record of reinvestment outside gasbased olefin businesses (PTTGC.BK) 16

17 Appendix 1: Synergy benefits This part is an excerpt from PTTAR s Information Circular on the Amalgamation Between PTTAR and PTTCH. Synergy benefits Figure 27: Synergy benefits Investment Synergy Commencement costs benefits Synergy description Date (US$ mn) (US$ mn) 1. Synergy from existing product lines 1.1 Enhance value of off gas into olefin products 3Q Utilise C3/C4 (LPG) from PTTAR as feedstock for PTTCH's olefin products* Immediately Substituting of heavy aromatics for wash oil at PTTCH Immediately Upgrade heavy gasoline, light cracker bottoms and cracker bottoms from PTTCH to petroleum products at PTTAR 1.5 Install PSA at PTTCH to produce hydrogen to substitute production at the HMU Cost savings from sharing storage tank and jetty Utilities costs reduction from stream offtake from PTTCH Total synergy benefits Note: *We believe that the benefits of LPG usage has already been included in most analysts forecast and perhaps cancel out the benefits of government s regulation released in January 2011 to allow refiners to sell LPG at weighted prices between international and fixed price Source: Company data, Credit Suisse estimates PTTAR and PTTCH, together with KBC Advance Technology Pte. Ltd. (KBC), commissioned a study to project possible gains in synergy after the amalgamation process. The majority of these gains will come from the ability to internally transfer existing products between plants and/or by adding value through various product combinations. The following items are expected to create significant value as a result of the amalgamation. 1. Synergy creation from existing product lines 1.1. Enhancing value of off gas into olefin products at PTTCH s olefin plant Currently, off gas streams produced at PTTAR s plants are routed to plant fuel systems. From the study, these gases comprise significant quantities of C2 and C3+, which are suitable feedstock to be upgraded to a higher-value olefin product at PTTCH s plant Utilising C3/C4 stream from PTTAR as feedstock for PTTCH s olefin products Currently, C3/C4 stream produced from PTTAR s plant is sold to the domestic market to be used as fuel, to petrochemical plants as feedstock or routed to PTTAR s refinery as fuel and/or feedstock for its own use. After the amalgamation, the MergedCo will have access to C3/C4 stream from PTTAR, which can be used as ethylene feedstock at PTTCH s ethylene cracker. This will benefit the MergedCo more than selling it to other petrochemical plants Substituting of Heavy Aromatics for Wash Oil at PTTCH PTTCH currently purchases Wash Oil from external sources for use in the cleaning of equipment. From the study, Heavy Aromatics, which is a by-product at PTTAR s plants, is of similar quality and can serve as a lower cost substitute for Wash Oil. As Heavy Aromatics has been used as a fuel oil blending component, by using it as substitute for Wash Oil, PTTAR needs to use diesel as fuel oil blending component in replacement for Heavy Aromatics. However, the value recovered from using Heavy Aromatics as a substitute for Wash Oil is expected to be higher than the marginal costs associated with using diesel as replacement for Heavy Aromatics. (PTTGC.BK) 17

18 1.4. Upgrading Heavy Gasoline, Light Cracker Bottoms and Cracker Bottoms from PTTCH into Refined Petroleum Products at PTTAR Currently, PTTCH produces Heavy Gasoline, Light Cracker Bottoms and Cracker Bottoms. Heavy Gasoline is primarily used internally as plant furnace fuel, while Light Cracker Bottoms and Cracker Bottoms are sold to external customers at a price significantly lower than fuel oil. However PTTAR can refine all three heavy streams into refined petroleum products at higher premium than utilising them as fuel or selling them to external customers Installing a pressure swing absorption unit (PSA) to purify hydrogen at PTTCH as substitution for PTTAR s hydrogen manufacturing unit (HMU) Currently, PTTAR produces purified hydrogen for the production of cyclohexane and for quality improvement of refined petroleum products at its refinery. However, from 2012, PTTAR will require substantial amount of purified hydrogen for diesel quality improvement in order to comply with the Euro 4 standard. The additional required amount of purified hydrogen shall be from an increase in production capacity of HMU. Currently, PTTCH has a significant amount of fuel with high concentration of hydrogen, which can be extracted for purified hydrogen to replace with higher cost purified hydrogen from HMU, resulting in the decline of overall hydrogen costs. 2. Cost savings from sharing storage tank and jetty The amalgamation will allow PTTAR and PTTCH to continuously transfer products to each other without any legal limitations and without excise tax implications, which they could not have done as separate entities. In addition, PTTAR will have access to PTTCH s jetty for the export of aromatics products, which is currently being exported through other company s jetty. In order to get access to PTTCH s jetty, additional investment in new pipeline from PTTAR to the jetty will be required and the service of storage tank and jetty with other company would have to be discontinued. 3. Utilities costs reduction from steam offtake from PTTCH Currently, PTTCH has its own steam production unit with sufficient capacity to cover steam demand by PTTAR. PTTAR can therefore source from PTTCH the steam demand in excess of the minimum offtake obligation it currently is obligated with other steam suppliers and the entire steam demand after the contract with other steam supplier ends. (PTTGC.BK) 18

19 (PTTGC.BK) 19 Regional valuation comparisons Figure 28: Regional valuation comparison Mkt EPS P/E P/B Div. yield EV/EBITDA ROIC ROE Price TP Upside cap growth (%) (x) (x) (%) (x) (%) (%) Company Ticker Rating Forex (local) (local) (%) US$ mn 11E 12E 11E 12E 11E 12E 11E 11E 12E 11E 12E 11E 12E Taiwan Formosa Plastics 1301.TW N TWD , Nan Ya Plastics 1303.TW O TWD , Formosa Chemical & Fibre 1326.TW O TWD , Formosa Petrochemical 6505.TW U TWD , Far Eastern New Century 1402.TW O TWD , Korea Hanwha Chemical KS U KRW 26,450 33, , Honam Petrochemical KS O KRW 317, , , LG Chem Ltd KS O KRW 340, , , India Reliance Industries RELI.BO O INR 842 1, , Thailand PTTGC.BK N THB , Indorama Ventures IVL.BK O THB , Malaysia Petronas Chemicals Group PCGB.KL N MYR , Average Asia ex-japan Note: *Prices as of 19 October 2011, Implied share price of PTTGC is based on 10 th October 2011 closing price. Source: Company data, Credit Suisse estimates 21 October 2011

20 Financial summary Figure 29: PTTGC key assumptions Key assumptions E 2012E 2013E Avg exchange rate (Bt/US$) Dubai (US$/bbl) Ethylene capacity ('000 tonnes) Propylene capacity ('000 tonnes) Ethylene utilisation (%) Spot ethylene-naphtha spread (US$/t) Spot propylene-naphtha spread (US$/t) Spot HDPE-naphtha spread (US$/t) Market GRM (US$/BBL) Stock gain (US$/BBL) Accounting GRM PX - naphtha spread (US$/t) Refining capacity (KBD) Utilisation % Aromatics capacity (KBD) Utilisation % PX capacity ('000 tonnes) 1, , , ,156.0 Source: Company data, Credit Suisse estimates Figure 30: PTTGC P&L statement Year-end 31 Dec (Bt mn) E 2012E 2013E Sales 375, , , ,310 Cost of sales (347,510) (391,965) (408,376) (442,289) Gross profit 27,794 53,384 51,155 57,021 SG&A expenses (9,152) (10,249) (10,716) (11,345) Other income (exp) 1,297 1,262 1,291 1,321 Operating profit 19,938 44,397 41,731 46,997 Interest income (exp) (5,506) (5,203) (4,580) (3,756) EBT 14,432 39,194 37,151 43,241 Minority interest (1,652) (1,898) (1,895) (1,895) Equity income Tax (2,432) (4,703) (3,715) (3,459) Recurring EAT 10,776 33,099 32,064 38,455 Non recurring gain/loss 4, Net profit 15,521 33,099 32,064 38,455 EBITDA 33,539 60,197 58,321 64,417 Basic EPS (Bt) Source: Company data, Credit Suisse estimates (PTTGC.BK) 20

21 Figure 31: PTTGC balance sheet Year-end 31 Dec (Bt mn) E 2012E 2013E Cash and short-term investment 21,035 29,400 37,231 45,605 Account receivable 35,549 42,184 43,527 47,295 Inventory 34,366 45,103 46,991 50,894 Other current assets 3,399 4,033 4,161 4,522 Total current assets 94, , , ,315 Investment under equity method 4,176 4,469 4,738 5,045 Long-term investment Fixed assets 245, , , ,322 Other non-current assets 29,188 24,442 22,644 20,792 Total assets 373, , , ,798 Short-term loans from financial institutions 3,315 3,315 3,315 3,315 Account payable 32,957 37,173 38,730 41,946 Amount due to related companies Current portion of long-term borrowings 10,949 15,000 20,000 20,000 Other current liabilities 7,183 8,447 8,592 9,206 Total current liabilities 54,405 63,936 70,637 74,468 LT debt 116, ,511 81,511 61,511 Financial lease Other liabilities 7,654 7,654 7,654 7,654 Total liabilities 178, , , ,634 Minority interest 7,829 9,728 11,623 13,517 Shareholder's equity 187, , , ,647 Source: Company data, Credit Suisse estimates Figure 32: PTTGC statement of cash flow Year-end 31 Dec (Bt mn) E 2012E 2013E Net profit n.a. 33,099 32,064 38,455 Non cash adjustment n.a. 15,800 16,590 17,420 Equity income n.a. (506) (523) (568) Minority interest n.a. 1,898 1,895 1,895 Ch in w/c and others n.a. (12,526) (1,659) (4,200) Operating cash flow n.a. 37,764 48,367 53,002 Capex n.a. (12,246) (11,296) (9,112) Investments n.a Change in other assets n.a. 4,746 1,798 1,852 Free cash flow n.a. 30,478 39,122 46,003 Chg in debt n.a. (10,949) (15,000) (20,000) Dividend paid n.a. (8,275) (16,291) (17,630) Share capital n.a. (2,889) 0 0 Capital adjustment n.a Cash flow from financing n.a. (22,113) (31,291) (37,630) Change in cash n.a. 8,365 7,832 8,373 Source: Company data, Credit Suisse estimates (PTTGC.BK) 21

22 Figure 33: PTTGC key ratio Year-end 31 Dec (%) E 2012E 2013E Sales growth n.a EBITDA growth n.a Opertaing profit growth n.a Net profit growth n.a EPS growth n.a Gross margin Operating margin EBITDA margin Net margin ROE ROA Net debt/equity Interest coverage (x) Trade receivables (days) Trade payables (days) Inventory (days) Source: Company data, Credit Suisse estimates (PTTGC.BK) 22

23 Companies Mentioned (Price as of 20 Oct 11) Far Eastern New Century Corporation (1402.TW, NT$30.20, OUTPERFORM, TP NT$39.30) Formosa Chemical & Fibre (1326.TW, NT$83.90, OUTPERFORM, TP NT$113.90) Formosa Petrochemical (6505.TW, NT$87.70, UNDERPERFORM, TP NT$76.85) Formosa Plastics (1301.TW, NT$84.80, NEUTRAL, TP NT$100.20) Hanwha Chemical ( KS, W24,950, UNDERPERFORM [V], TP W33,000) Honam Petrochemical ( KS, W282,000, OUTPERFORM [V], TP W520,000) Indorama Ventures PCL (IVL.BK, Bt32.00, OUTPERFORM [V], TP Bt47.00) LG Chem Ltd. ( KS, W314,500, OUTPERFORM, TP W600,000) Nan Ya Plastics (1303.TW, NT$68.90, OUTPERFORM, TP NT$84.80) Petronas Chemicals Group BHD (PCGB.KL, RM6.04, NEUTRAL [V], TP RM6.80) (PTTGC.BK, Bt53.00, NEUTRAL, TP Bt63) Reliance Industries (RELI.BO, Rs838.40, OUTPERFORM, TP Rs1,022.00) Disclosure Appendix Important Global Disclosures I, Paworamon (Poom) Suvarnatemee, CFA, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for PCGB.KL PCGB.KL Closing Target 10 Price Price Initiation/ 10 Date (RM) (RM) Rating Assumption 9 16-Feb O X 9 5-Apr Aug N 8 RM Feb Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug-11 Closing Price Target Price Initiation/Assumption Rating O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered 9 O 7 N 3-Year Price, Target Price and Rating Change History Chart for PTTGC.BK PTTGC.BK Closing Target Price Price Initiation/ 50 Date (Bt) (Bt) Rating Assumption Bt 0 20-Oct-08 Closing Price Target Price Initiation/Assumption Rating Series5 O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts stock ratings are defined as follows: Outperform (O): The stock s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. (PTTGC.BK) 23

24 Neutral (N): The stock s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29 th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock s absolute total return potential to its current share price and (2) the relative attractiveness of a stock s total return potential within an analyst s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-japan Asia stocks, ratings are based on a stock s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the % and % levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts coverage universe weightings are distinct from analysts stock ratings and are based on the expected performance of an analyst s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. Credit Suisse s distribution of stock ratings (and banking clients) is: Global Ratings Distribution Outperform/Buy* 49% (61% banking clients) Neutral/Hold* 40% (56% banking clients) Underperform/Sell* 9% (53% banking clients) Restricted 2% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors. Credit Suisse s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. See the Companies Mentioned section for full company names. Price Target: (12 months) for (PCGB.KL) Method: We set our target price at RM6.80/sh based on P/B of 2.5x, reflecting the valuation premium of Bursa Malaysia against the Stock Exchange of Thailand (SET) of 11% on EV/EBITDA. The premium reflects higher liquidity in domestic market in Malaysia, which explained the valuation premium of Bursa Malaysia against other markets in ASEAN Risks: Risks to our target price of RM6.80/sh are 1) ethan price renegotiation with Petronas Group companies 2) Avaliability of gas supply with Petronas 3) Appreciation of Malaysian Ringgit as PCG's revenue and major part of its costs are denominated in US$, 4) Flucturation in oil price and petrochemical margins, and 5) Unscheduled shutdown of plants from unforseenable events Price Target: (12 months) for (PTTGC.BK) Method: Our Bt63/sh target price is derived from our targeted Price to Book for PTTGC at 1.3x based on our forecast of cost of equity of 13.5% and return on equity of 15%. Risks: The risk to our PTTGC target price of Bt63/sh include its exposure to the volatility of oil prices, petrochemical prices, and exchange rate. Also, PTTGC may reinvest its free cash flow in lower-return projects. Please refer to the firm's disclosure website at for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names. The subject company (PTTGC.BK) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. (PTTGC.BK) 24