Vol mn RSI10 Petrochemicals Industrial AB: Saudi Arabia US$7.20bn 40% US$2.257mn Market cap Free float Avg. daily volume Target price 59.00-7% over current Current price 63.10 as at 25/7/2017 Underweight Underweight Neutral Overweight Performance 86.0 76.0 66.0 56.0 70 30-10 2 1 1 Earnings estimates (SARmn) 2016 2017e 2018e Revenue 2855.9 2725.7 3140.7 y-o-y -19.5% -4.6% 15.2% Gross Profit 1346.5 1248.9 1601.6 margin 47.1% 45.8% 51.0% Net income 1034.4 1021.7 1357.7 y-o-y -51.4% -1.2% 32.9% net margin 36.2% 37.5% 43.2% (SAR) Price Close MAV50 Source: Bloomberg Existing rating MAV10 07/16 10/16 01/17 04/17 Relative to TADAWUL FF (RHS) EPS 2.5 2.5 3.3 DPS 2.5 2.5 3.3 Payout ratio 101% 102% % P/E (Curr) 25.7x 19.3x P/E (Target) 23.6x 18.1x Source: Company data, Al Rajhi Capital 129.0 115.7 102.3 89.0 Research Department Pritish K. Devassy, CFA Tel +966 11 2119370, devassyp@alrajhi-capital.com N: Weak Q2; Stock bottoming out Buy on further correction in H2 Weak Urea prices (-20% q-o-q), higher cost impact on account of shutdown of III plant and lower equity income from Ibn Al-Baytar pushed Q2 earnings lower by 52% q-o-q to SAR204.3mn. Average Urea prices are now at US$183/t, the lowest level in a decade. We expect no meaningful recovery for Urea price in the near term (average price is already down ~9% q-o-q so far in Q3). On the other hand we also believe there is unlikely to be much downside from the current price. As per our estimates, Q3 and Q4 earnings may remain flattish (relative to Q2) as there are planned shutdowns and urea prices may remain tepid. Our target price for ranged from SAR60-62/share since the start of the year when the stock was trading above SAR 75/share and the stock has gradually declined to SAR63/sh. Post Q2 results, we lower our TP to SAR59/sh (and revise rating from Underweight to Neutral), implying downside of 7% from the current level. We believe the stock may see further correction in 2H, which may present better buying opportunities to position for an improvement in urea prices and increase in dividends. For now, we expect DPS of SAR2.5 for 2017 (yield: 4%) and SAR3 for 2018 (yield: 5.2%). The company is currently trading at a P/E of ~22.5x based on our 12 month forward EPS (19.3x 2018EPS) vs global fertilizer peers of 15.1x (Figure 5). Q2 Key highlights: a) Q2 revenue declined ~20% y-o-y to SAR679.5mn, primarily due to weak urea price and lower sales volume on account of likely shutdown of III plant, b) The company s 2016 board report stated that the company would close down its III plant for 20 days during 1H 2017 for maintenance, which seems to have taken place in Q2. However sale from existing inventories could have limited decline in sales volume, c) Despite only 20% q-o-q decline in top-line, Q2 gross profit slipped 41% q-o-q, impacted by higher cost due to shutdown which could have resulted in higher cost of production per tonne, d) Contribution from Ibn Al-Baytar fell in Q2, likely due to lower urea prices. Overall, lower revenue, higher operating costs and lower equity income from Ibn Al-Baytar pushed net profit 52% q-o-q lower to SAR204mn in Q2, missing our estimate of SAR241mn (consensus: SAR285mn) Why Urea price and spread may be lower in 2H 2017: Given that more that 90% of revenue comes from urea, s share price has been closely tracking product spreads in the past (Figure 1). We expect product-feedstock spread (i.e, primarily Urea minus Methane, weighed by % of revenue), to likely weaken sequentially owing to lower Urea prices this year, while its key feedstock cost, Methane remains fixed. Urea prices (US$183/t) are currently the lowest in a decade, weighed down by unfavourable demand & supply balance on account of new capacity additions and lower plant utilization rates (Figure 2). As per industry sources, global urea capacity is likely to increase by 5% y-o-y and 2.3% in 2017 and 2018, respectively, while overall urea demand is expected to grow by 2.5% during the same period, indicating the current oversupply market condition may only marginally tighten in 2018. Consequently, we expect Urea prices may remain weak in 2017 but likely to recover in 2018, as higher demand growth could offset the incremental supply next year (Figure 3). Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.
US$/t Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Spread ($/MT) Share Price (SAR) Figure 1 share price and weighted average product spread 450 140 400 350 300 120 250 80 200 60 150 50 40 20 0 0 Spread Share Price Source: Company data, Al Rajhi Capital, Bloomberg Figure 2 Urea market to remain oversupplied Figure 3 Urea demand growth to improve from 2018 300 88.0% 8.0% 500 250 200 86.0% 84.0% 82.0% 6.0% 4.0% 450 400 350 150 50 80.0% 78.0% 76.0% 74.0% 72.0% 2.0% 0.0% -2.0% -4.0% 300 250 200 150 50 0 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E 70.0% -6.0% 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E - Urea capacity (name plate) Urea demand Avg. Utilization Source:Greenmarkets, Bloomberg, Al Rajhi Capital Urea capacity growth (%) Urea demand growth (%) Avg. Urea prices (RHS)* Source: Greenmarkets,Bloomberg, Al Rajhi Capital. * Our estimates for Urea prices. Expect no recovery in Q3 as well: We believe s earnings could remain under pressure sequentially in Q3 on account of weak Urea prices coupled with lower sales volume, following planned shutdown of IV (84 days) and V (25 days) plants in H2 2017. While dates of shutdown are not announced, we have assumed V plant to halt operation in Q3. IV s shutdown could take place across Q3 and Q4. Figure 4 : Summary of Q2 2017 results (SAR mn) Q2 2016 Q1 2017 Q2 2017 % chg y-o-y % chg q-o-q ARC est Revenue 709.9 846.6 679.5-4.3% -19.7% 553.0 Gross profit 329.5 493.4 288.7-12.4% -41.5% 304.0 Gross profit margin 46.4% 58.3% 42.5% 55.0% Operating profit 261.3 394.6 187.4-28.3% -52.5% 219.0 Net profit 302.3 423.4 204.3-32.4% -51.7% 241.0 Source: Company data, Al Rajhi Capital Disclosures Please refer to the important disclosures at the back of this report. 2
Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Valuation: We revise our TP to SAR59/share based on equal mix of DCF and relative valuation (PE of 18x is above historical average as earnings growth is expected to pick up from a low base and urea prices are around its trough levels). However, we have revised our earlier Underweight rating to Neutral for after the stock declined ~8% since Q1 (~- 14% YTD). The stock is currently trading at a 12 month forward P/E of 22.5x. vs 15.1x ( global fertilizer peer average). We use only global fertilizer peers as it is not right to compare with Saudi petchem companies valuation multiples. Risks: Key upside risks to our price may arise from major shutdowns of Urea plants globally, delay or suspension of construction of newer Urea plants worldwide, sharp pick-up in demand which may be because of change in regulations across Asian countries (import tax in China, fertilizer import quota in India etc.) all of which could tilt the supply-demand balance in favour of suppliers. Other upside risks relate to increase in dividends, increase in stake of associates/subsidiaries which could help bring in some efficiencies. Downside risks may arise from further decline in Urea price and acquisition of associates/subsidiaries at expensive valuations. Figure 5 1Y Forward P/E trend 30.0x 25.0x 20.0x 15.0x 10.0x 5.0x Source: Bloomberg, Al Rajhi Capital 1Y Fwd P/E Average Max Min Disclosures Please refer to the important disclosures at the back of this report. 3
Figure 6 Margins and Valuation Metrics - vs. global peers Saudi Arabia Market Cap (US$ 'mn) TTM OPM (%) TTM NPM (%) 2017E PE 2018E PE 2017E EV/EBITDA 2018E EV/EBITDA 7,155 38.2 39.5 25.7x 19.3x 16.2x 14.4x MENA (ex-saudi Arabia) Israel Chemicals 6,054 0.1-2.2 15.0x 12.6x 8.5x 7.6x Jordan Phosphate Mines 330-9.1-15.4 NA NA NA NA Abou Kir Ferti. & Chim Ind. 1,105 26.9 38.1 NA NA NA NA Arab Potash/The 2,200 3.6 17.5 NA NA NA NA Europe K+S 5,023 4.1 2.2 25.2x 14.4x 9.6x 7.0x Yara International 10,700 4.9 3.1 18.2x 13.5x 8.1x 6.6x North America CF Industries 7,261 2.5-8.8 NA NA 14.1x 11.1x Mosaic 8,554 2.6 0.6 27.1x 19.0x 10.5x 8.4x Potash Corp 15,105 15.2 9.4 29.1x 25.8x 13.3x 11.9x Agrium 13,812 8.4 4.2 20.0x 16.8x 10.3x 9.2x Latin America Sociedad Quimica y Minera de 9,908 24.3 15.5 26.7x 25.5x 12.2x 11.6x Fertilizantes Heringer SA 58 4.2 1.0 NA NA 4.7x 4.5x Asia China XLX Fertilizer 279 5.6 0.5 6.1x 5.0x 6.4x 5.7x Coromandel International 1,965 8.8 4.8 21.5x 18.0x 13.4x 11.9x Engro Fertilizers 707 9.9 13.1 7.3x 6.6x 4.7x 4.5x National Fertilizers 602 6.1 2.7 NA NA NA NA Phosagro 5,498 27.5 28.1 9.5x 9.4x 6.7x 6.3x Taiwan Fertilizer Co Ltd 1,332 6.4 2.4 NA NA NA NA Fauji Fertilizer Bin Qasim Ltd 321-12.7 0.9 12.0x 9.3x 36.3x 17.4x Hubei Yihua Chemical Ind. 896-3.6-8.6 NA NA NA NA Acron PJSC 2,228 21.1 16.0 7.1x 7.2x 6.7x 6.5x Luxi Chemical Group Co Ltd 1,598 8.5 3.9 14.2x 11.7x 8.9x 8.1x PhosAgro PJSC 5,221 27.5 28.1 9.0x 8.9x 6.5x 6.1x Dorogobuzh PJSC 615 12.7 28.4 NA NA NA NA Median 6.4 3.9 16.6x 13.1x 9.3x 7.9x Average 9.7 9.0 16.5x 13.6x 10.9x 8.8x Source: Blooomberg, Al Rajhi Capital Disclosures Please refer to the important disclosures at the back of this report. 4
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Disclaimer and additional disclosures for Equity Research Disclaimer This research document has been prepared by Al Rajhi Capital Company ( Al Rajhi Capital ) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. 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This research document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or which would subject Al Rajhi Capital or any of its affiliates to any registration or licensing requirement within such jurisdiction. Explanation of Al Rajhi Capital s rating system Al Rajhi Capital uses a three-tier rating system based on absolute upside or downside potential for all stocks under its coverage except financial stocks and those few other companies not compliant with Islamic Shariah law: "Overweight": Our target price is more than 10% above the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Neutral": We expect the share price to settle at a level between 10% below the current share price and 10% above the current share price on a 12 month time horizon. "Underweight": Our target price is more than 10% below the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Target price": We estimate target value per share for every stock we cover. This is normally based on widely accepted methods appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis. Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company s profits or operating performance exceed or fall short of our expectations. Contact us Mazen AlSudairi Head of Research Tel : +966 1 211 9449 Email: alsudairim@alrajhi-capital.com Al Rajhi Capital Research Department Head Office, King Fahad Road P.O. Box 5561, Riyadh 11432 Kingdom of Saudi Arabia Email: research@alrajhi-capital.com Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No. 07068/37. Disclosures Please refer to the important disclosures at the back of this report. 6