AKD Quotidian about — Global risk-off and its impact on AKD Securities’ petchem plays

Karachi, June 07, 2012 (PPI-OT): The petrochemical sector has been under pressure following the recent sell-off in commodities, which has seen oil (Brent) fall from its CY12TD high of US$126.7/bbl to the current level of US$101/bbl.

According to AKD Securities, however, with the chorus for monetary stimulus growing, AKD Securities has discussed the price correlation of major petrochemicals (PVC and Ethylene for EPCL, PTA and Px for LOTPTA) with oil, and their subsequent primary margins performance.

Oil correlations: The historic correlation of all AKD Securities’ sample petrochemicals is high to oil with PVC having the highest while PTA having the lowest correlation. Therefore, incase oil stages a comeback, AKD Securities is likely to see margin expansion for EPCL but LOTPTA margins are likely to be pruned. A factor playing in favor of EPCL is that the correlation of ethylene (main raw material for PVC) with oil has been weakening in recent years as more of ethylene is now being produced on lighter feedstock (ethane) as opposed to naphtha, where naphtha has a very high correlation with oil.

EPCL PMs improved in May’12: Depsite the commodity sell-off, the regional PVC-Ethylene PMs actually improved by US$71/ton MoM to US$448/ton, as ethylene prices (-15% MoM) fell more than PVC (-3% MoM). While the margins in 2QCY12 are likely to improve on a QoQ basis, recurring earnings are likely to remain below last quarter owing to i) lower sales as plant turnaround during Apr’12 coupled with low demand due to product price uncertainty, ii) fx losses given the sharp volatility in PkR/US$ and iii) timing losses owing to downtrend in product prices. However, AKD Securities is likely to see an improvement in operating environment during 2HCY12 as product prices stabilize and demand recovers (helped by spending on infrastructure projects in the run-up to elections). Furthermore, EPCL also benefits from a diversified product line, which includes caustic soda in addition to PVC. In this regard, regional caustic soda prices have been on the rise despite the correction in other commodities due to shortage of the product as Chinese chlor-alkali plants have been operating at below 70% owing to poor margins in chlorine-derivative products. While AKD Securities has a Reduce’ stance on EPCL currently (Dec-end TP of PkR10.1), upside risks to AKD Securities’ call include better than expected PVC-Ethylene primary margins and higher than assumed capacity utilization at VCM plant.

LOTPTA margins under pressure: Similar to EPCL, LOTPTA’s PTA-Px PMs improved in May’12 (+US$49/ton to US$165/ton), however, margins have undergone a significant correction during the first week of Jun’12 (down to US$102/ton) following a sharp fall in PTA prices. Like EPCL, LOTPTA’s profitability is also likely to remain under pressure in 2QCY12 as lower sales in conjunction with inventory and foreign exchange losses will hurt 2QCY12 profitability. AKD Securities expects LOIPTA’s margins to remain under pressure over the next two years where AKD Securities has already incorporated the impact of weak margins into AKD Securities’ forecast (assumed PTA-Px PMs of US$150/ton over the next two years compared with CY11 average of US$320/ton). At current levels AKD Securities has a ‘Neutral’ stance on LOTPTA which is trading near Dec-end TP of PkR8.40.

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