Karachi February 16, 2022: Topline Securities analyst Sunny Kumar in research note published today on Engro Polymer has assigned Rupee 73 fair value to the company. “We reiterate ‘Buy’ on Engro Polymer & Chemicals Limited (EPCL) with a Dec-2022 Target Price of Rs73, offering a potential total return of 36% (including dividend yield of 18%).”
Topline liking for EPCL primarily stems from its double-digit Dividend Yield (D/Y) of 18% for 2022 and 2023, which is amongst the highest in our coverage universe. Its D/Y also comfortably fares better than current 6M T-Bills yield of 10.6% and our universe dividend yield of 9% for 2022.
Topline analyst believes that, EPCL will likely continue to pay ~100% dividend just like 2021 after the removal of covenant imposed by International Finance Corporation (IFC) to pay dividends in 2021. We further believe that just like other group companies Engro Fertilizers (EFERT) & Engro Corporation (ENGRO), we would continue to see strong payout from EPCL. The average payout of EFERT and ENGRO for last 5-years stands at 100% and 94% respectively.
Topline has also revisited earnings estimates, and increased earnings forecasts by 17-21% over 2022-2025F primarily on the back of higher PVC Ethylene Core Delta.
The international PVC-Ethylene Core delta are currently hovering around US$753/ton, up 78% as against last 10-year’s (2012-2021) average of US$422/ton, however 31% down from its all-time high of US$1,088/ton in Mar-2021.
These margins are likely to remain healthy albeit lower than current levels as global PVC market is undergoing supply constraints, while ethylene’s market is going through capacity expansion globally. That said, we believe EPCL’s core delta to average in at US$650/ton and US$600/ton in 2022E and 2023F respectively, with a long-term assumption of US$450/ton.
Topline have arrived at DCF based target price of Rs73 per share, offering a potential total upside of 36% (including dividend yield of 18%). EPCL is currently trading at 2022E/2023F PE of 5.47x and 5.51x compared to historical 5- year (2017-2021) average PE of 6.22x.
Key risks to our investment thesis includes (1) sharp decline in PVC-Ethylene core delta, (2) discontinuation of gas supplies, (3) higher than expected increase in gas prices, and (4) dumping of PVC in domestic market.
EPCL is the only manufacturer of PVC in Pakistan. The local demand for PVC has reached 260k tons which is expected to grow by a 5-year CAGR of 5%, given macro economic recovery, incentives given to construction sector and new application of PVC.
Traditionally, PVC is used in construction for pipes, fittings, door frames, flooring solutions, roofing; in electronics for insulation purposes and in pharmaceuticals as tablet packaging. In past few years, the market has seen introduction of new applications of PVC, which includes Interlock Indoor Tiles, Spiro Pipe, Blister Packaging and Foam Board.
Topline believe EPCL’s capacity expansion came at an appropriate time given pickup in construction activity backed by construction package as 54% of EPCL’s PVC sales are directed towardsthe construction sector. We believe there is huge potential in the domestic market, given Pakistan’s per capita consumption of PVC remains one of the lowest in the world (see side graph). In case of low domestic demand, EPCL could route more production into export markets.
EPCL has expanded its PVC capacity by 100K tons (51% of existing capacity) to 295K tons and VCM capacity by 50k (25% of existing capacity) to 254K tons. Before expansion, EPCL’s PVC plant is running at over 95% capacity utilization except for 2020 where utilization levels declined to around 83% amid COVID-19 related lockdown and gas leakage incident.
With new PVC capacity of 100K tons and VCM debottlenecking exercise of 50K tons, EPCL may potentially be able to cater to 100% local PVC demand till 2024 at a full capacity utilization level. However, we expect utilization to remain at an average rate of 86% over 2022-2024. EPCL can support local PVC market up to 295k tons, however they may have to import VCM over 245k tons due to lower VCM plant capacity. The production from imported VCM would have lower margins.
EPCL has also been earning premium margins on PVC due to custom duty of 11% on importsfollowed by additional custom duty of 2%.Caustic Soda is an allied product for EPCL, which is expected to contribute around 14% to the overall revenues in 2022E.
Caustic soda is used in textiles, soap, detergents, petroleum products, food, pulp & paper, water treatment, alumina, metal processing, mining, glass making and other chemical production. In Pakistan, textile sector, soap and detergent manufacturers are the main users of caustic soda. Since Caustic Soda is an essential raw material of textile value chain, success of Caustic business is dependent on the growth of textile industry. Over the past years, Pakistan textile exports have benefitted from two key events (1) US China trade war (prior to COVID-19 outbreak) and (2) early recovery from COVID-19 outbreak.
Textile sector is the single largest export earner of Pakistan, which is expected to contribute 62% to the country’s total export in FY22 & 8.5% to the country’s overall GDP. Soap and Detergent segments also provide impetus for growth amid increase in usage due to changing life style amidst COVID-19 as people are more focus towards hygiene products.
EPCL is catering to the Pakistan’s South market, as other caustic soda players (Sitara Chemicals, SITC and Ittehad Chemicals, ICL) are based in the North. Thus EPCL holds a strong competitive advantage over other players in the South. Topline expect EPCL’s caustic soda sales have remained around the 90k tons mark, with a capacity of 106k tons per annum. The remaining is used in-house.
EPCL have also introduced Caustic Flakes with annual capacity of 20,000 tons, which is a premium product over the liquid it is currently producing. The new product is likely to be priced approximately Rs15,000/ton higher compared to caustic liquid price of around Rs65K-70K/ton
Discontinuation of gas supplies: Government is considering to place moratorium on gas supply to industrial units for generating their own electricity in the wake of depleting gas reserves and surplus electricity in the country. However, moratorium on gas supply will not be applied to those plants which falls under co-generation facility after detailed audit.
Management believes that their plant fall under co-generation facility; thus gas will not be discontinued. Meanwhile, being the major risk, EPCL is evaluating other options including usage of alternative energy and shifting towards RLNG.
To somewhat mitigate the risk, company is investing in new technology called high temperature direct chlorination (HTDC), which will be reducing gas consumption by 10% in PVC manufacturing. This will have a positive impact of Rs0.3/share (2.6% of bottom line in 2023). The project has a total cost of US$16mn and is expected to come online in 2023.
Higher than expected gas prices: EPCL is self-sufficient in term of electricity requirements as it has its own captive power generation facility of 66MW. The power is generated from gas, which makes the company vulnerable to potential increase in gas prices.
Currently company is securing gas at Rs1,023/mmbtu. We have assumed an average 6% increase in gas prices in our model. Higher than expected increase in gas prices would be risk to earnings. We estimate for every 5% increase in gas prices, company earnings are impacted by Rs0.3/share (3%).
PVC Dumping: National Tariff Commission (NTC) imposed anti-dumping duties on import of PVC in Pakistan to protect local industry is set to expire this year in Jun-22. These duties are applicable on import from China, South Korea, Thailand and Taiwan in a range of 3.44% to 20.47% (see table for more details). Higher than expected dumping can hut EPCL volumesif anti-dumping duty is not continued.