hsbc what price is right
DESCRIPTION
HSBC outlook for chemical feedstocks in the Middle EastTRANSCRIPT
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.
Wh
at p
rice is
righ
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By Sriharsha Pappu and Tareq Alarifi
Feedstock pricing changes likely to be announced in 2011. We expect this decision to be
influenced by a combination of both economic and policy factors, and we forecast a phased
increase that does not fundamentally alter the competitive position of the industry
The impact on margins from these feedstock price increases is highest for companies with the
biggest cost advantages (eg SAFCO), while those with lower cost advantages and margins
(eg SABIC) are least affected. The increase in HSBC's energy price forecasts however, outweighs
the impact of higher feedstock costs
Yet despite generally raising our target prices, we are cautious on the sector for 2011 given
recent strong performance, elevated expectations and high valuations. Our top picks in the
sector are Tasnee (OW(V), TPSAR44), Yansab (OW(V), TP SAR65) and SABIC (OW(V), TP SAR130).
We downgrade Petrochem (TP SAR25) and Sahara (TP SAR25) to N(V) from OW(V) and
Industries Qatar (TP QAR135) to UW from N
Disclosures and Disclaimer This report must be read with the disclosures and analyst
certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Natu
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- Eq
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Sriharsha Pappu*
Analyst
HSBC Bank Middle East Limited, Dubai
+971 4423 6924
Sriharsha rejoined HSBC's chemical research team in 2009 after spending one and a half years covering the chemical sector on the
buyside at Dubai Group. Prior to that he was a part of HSBC's US chemicals research team from 2005 to 2008 and has been covering
chemicals on the sell side since 2004. Sriharsha holds a Bachelors degree in Electronics Engineering and an MBA from the Indian
Institute of Management. He was ranked No 3 in MENA in the 2010 Pan European Sell side Extel survey.
Jan
uary
2011
What price is right?Re-evaluating the feedstock price environment
Natural Resources & Energy/Middle East Chemicals - Equity
January 2011
Tareq Alarifi*
Analyst
HSBC Saudi Arabia Limited
+966 1299 2105
Tareq is a cross-sector equity analyst based in Riyadh. He joined the research team in 2008, prior to that he worked as a buy-side analyst
with HSBC. Tareq holds a bachelors degree in Biomedical Sciences from the State University of New York, and an MBA-Finance from
Rochester, New York.
110121_28253 DUB-Saudi Petchems - Sriharsha Pappu_F1:Layout 1 1/22/2011 12:50 AM Page 1
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The feedstock pricing question Pricing revision – topical in 2011
In the wake of constrained gas supply, multiple competing uses and a burgeoning cost advantage, there
are serious questions being raised about the feasibility of continuing with the current gas pricing regime
within Saudi Arabia. The view gaining traction among industry participants is that some form of
modification to the pricing framework is required both as an incentive for companies to provide new gas
supply and to ensure a more efficient distribution of limited gas resources. This discussion is particularly
relevant today as some of the feedstock formulae – particularly for liquids – run only until 2011, which
means a new pricing benchmark, at least for liquids, will need to be approved before the end of the year.
We believe that a new gas pricing framework will be approved at the same time, and therefore that a
change in the feedstock price environment is imminent.
A combination of economics and policy
In our opinion, any change to the feedstock pricing regime will be driven by a combination of economic
and policy factors. The economic argument based on incentives for supply growth, efficient allocation of
scarce resources and demand rationalisation would call for Saudi gas prices to reflect global levels of
USD4-5/mmbtu vs. the current price of USD0.75/mmbtu. However, an increase of this magnitude would
deliver a significant economic blow to the industry which would run counter to the key policy objective
of driving downstream chemical investment and generating employment.
We believe that policymakers will work to ensure that feedstock price increases take place in a manner so
as not to shock the industry or dramatically alter its competitive dynamic. We also believe that policy
makers will be just as conservative with their underlying energy price assumptions while assessing the
competitiveness of the petrochemical industry as they are while setting their annual budgets.
We are raising our estimates for Saudi gas and ethane equivalent prices from the current USD0.75/mmbtu to
USD2.0/mmbtu by 2015. We expect that this increase will take place in a phased manner, with prices rising
first to USD1.25/mmbtu by 2012 and in a staged manner thereafter (see table below). We also assume that the
liquids discount will decline by 1ppt each year from the current 28% before being fixed at 25% by 2014.
Summary
We expect to see a change in the feedstock pricing regime in 2011. We believe this will be influenced by a combination of both economic and policy factors and we are factoring in a phased increase in prices that does not fundamentally alter the competitive position of the industry. The increase in HSBC's energy price forecasts however, outweighs the impact of higher feedstock costs.
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In terms of margins, the rule of thumb is that companies with the biggest cost advantages and the highest
margins (eg SAFCO) are impacted more by an increase in feedstock prices than companies with lower
cost advantages and margins (eg SABIC). Our oil and gas team has increased its energy price forecasts
for 2011-15 by around 10% which has resulted in an increase in our product pricing estimates. In most
cases, the impact from higher product pricing outweighs the impact of higher feedstock costs.
Sector investment thesis Peak conditions to return by 2013/14, market likely to remain balanced in 2011
Rising emerging market demand and limited supply growth will create an environment of higher capacity
utilisation rates. Based on our supply assumptions and HSBC Economics global economic growth
forecasts, we expect to see a return to peak conditions (utilisation rates of over 90%) within the
commodity chemical sector by 2013/14.
However, while we are bullish on the sector in the medium term, we believe that in the near term supply growth in
2011 could potentially come in above expectations. We expect incremental supply from existing plants to match
demand growth for the year as improving macroeconomic conditions ease some of the bottlenecks (in terms of
feedstock supply) that resulted in a tight market in 2010. This should be particularly true for European cracker
operating rates, which are tied to operating rates at refineries in the region. An improving macro environment in
Europe should lead to higher ethylene supply on greater naphtha availability from refineries.
Furthermore, higher oil-product demand and higher oil prices could lead to an increase in OPEC
production quotas which would make more associated gas available, particularly in Saudi Arabia, and
result in an incremental increase in operating rates at newer crackers – which we estimate are currently
running on average at 80% – owing to feedstock supply constraints. In both these cases, incremental
supply would materialise from existing capacity only if demand growth continued to be strong and hence
should not result in a big dip in utilisation rates due to an oversupply situation. However, this incremental
supply would, in the short term, prevent a sharp rise in utilisation rates. We forecast ethylene utilisation
rates to improve by only 70bps in 2011 over 2010 levels.
Cautious on sector performance in 2011
We believe that after two years of exceptional stock market performance from the Middle East chemical
sector with stocks on average up 47% in 2009 and 24% in 2010, it is time to take a more cautious view on
the sector in 2011. Our cautious stance on performance is based on by high valuations and elevated
consensus expectations. Middle East chemical sector valuations are now above mid-cycle levels, with
stocks trading on average on a 15.6x forward PE versus the historical sector median forward multiple of
14x. While fundamentals are healthy, these appear to be already factored into share prices and we think it
it is unlikely that in 2011 the sector will generate the same level of returns seen in 2009/10.
HSBC Saudi feedstock pricing assumptions
2011e 2012e 2013e 2014e 2015e
Gas price (USD/mmbtu), New 0.75 1.25 1.50 2.00 2.00 Gas price (USD/mmbtu), Old 0.75 0.75 0.75 0.75 0.75 % Propane Discount, New 28% 27% 26% 25% 25% % Propane Discount, Old 28% 28% 28% 28% 28%
Source: HSBC estimates
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Consensus expectations for chemical company earnings in 2011 also fully reflect the recovery in
fundamentals in our opinion. Sector outperformance will require reported earnings to beat estimates
significantly, which we believe they will struggle to do given that current 2011 EPS consensus estimates
for the Middle East chemicals sector are on average 45% higher than they were a year ago.
We prefer stocks with structural pricing drivers – Tasnee and Yansab
Our favoured plays within the Middle East petrochemical sector for 2011 are Tasnee, Yansab and
SABIC. Tasnee and Yansab have strong price momentum within important product chains (TiO2 for
Tasnee and MEG for Yansab) which is being driven by structural factors.
SABIC has significant operating leverage to improving fundamentals at its acquired GE Plastics business.
The business at its peak had EBITDA of USD1bn, and we expect a return to close to peak profitability by
the end of 2011from levels of cUSD200m in EBITDA in 2010e. SABIC also has volume leverage from
the expected commercial start up of Kayan towards H2 2011. Kayan is by far the single largest plant
SABIC has ever built and should drive revenue and profit growth y-o-y for SABIC in 2011.
For Tasnee, we believe that the TiO2 market will remain undersupplied well into 2012 given the lead
times for adding new capacity. We therefore predict 12-18 months of strong pricing power within the
TiO2 segment. This segment constitutes 35% of Tasnee’s earnings and will be a key contributor to the
company’s earnings in 2011. For more details, see our 1 November 2010 report on Tasnee, Painting a
stronger picture.
Yansab is a key beneficiary of the record levels of cotton prices – cotton and polyester are both used in
the textile industry and large price differences between the two often provide a catalyst for substitution.
The current price delta between cotton and polyester fibre stands at USD1,780/tonne – over 5.2x the
average of the differential between 2000 and 2009 which should spur greater polyester demand. This
substitution demand drives pricing for the raw materials used to make polyester such as paraxylene and
Mono Ethylene Glycol (MEG). Yansab has the strongest leverage to rising MEG prices among our
coverage and is our preferred play on this theme of strong cotton prices and interfibre substitution.
Downgrading Petrochem and Sahara to N(V) from OW(V); Industries Qatar to UW from N
We downgrade Petrochem to Neutral (V) from Overweight (V) on account of the stock’s strong
performance since the start of 2010 (up 50%) and limited upside from current levels to our target price
(7%), which we maintain at SAR25. The valuation disconnect between SIIG and Petrochem, flagged in
our April 2010 note Shifting into focus, which was the primary driver for our buy case on Petrochem has
also now closed making us less positive on the stock.
We are downgrading Sahara to Neutral (V) from Overweight (V) on disappointing execution of the Al Waha
project, which has resulted in our target price being cut to SAR25 from SAR30. We had initially factored in a
Q2 2010 start-up for the Al Waha polypropylene plant but the company has repeatedly pushed back the
commercial start-up date for the plant, with the most recent date given being the end of Q1 2011. Al Waha now
accounts for c40% of our valuation for Sahara as the repeated delays coupled with continued start up risks have
resulted in an assumption of lower operating rates and value for the asset.
We also downgrade Industries Qatar (IQ) from Neutral (V) to Underweight (V) on valuation grounds, despite
increasing our target price to QAR135 from QAR110. The stock has rallied sharply in the last six months and
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is up more than 40% since the start of H2 2010. This rally is partly explained by stronger fundamentals for IQ’s
products – fertilisers and petrochemicals – and partly by a stronger macro environment for Qatar, including the
award of the 2022 Fifa World Cup. We believe that all of these factors are more than adequately priced into the
stock and that the risks to the current share price are to the downside.
In addition to these three ratings changes, we have also made some adjustments to our target prices for
much of the rest of our coverage. These changes have been driven by: changes to our product pricing
estimates and crude price assumptions; changes to our feedstock pricing assumptions; rolling forward our
DCF’s to a 2011 start date; and changes to our cost of equity to reflect the new HSBC Strategy team
assumptions for the risk free rate and country risk premium. The changes to our ratings and target prices
are summarised in the table below.
MENA Petrochemicals valuation table
Company Ticker Rating Target Price (LC)
Current Price (LC)
Potential Return
Market Cap
(USD m)
EV (USD m)
6M avg. traded value
_______P/E _______ ___ EV/EBITDA ____ Dividend Yield
(USDm) 2011e 2012e 2011e 2012e 2011e
APC 2330.SE Neutral (V) 30.0 26.70 12% 1,008 1,313 11.4 10.3 10.3 7.4 6.9 5.6%IQ IQCD.QA Underweight 135.0 153.00 -12% 23,108 22,553 12.3 13.6 12.1 11.4 10.0 3.7%Chemanol 2001.SE Neutral (V) 17.0 15.15 12% 488 777 9.9 15.1 12.2 7.8 6.9 3.3%NIC (Tasnee) 2060.SE Overweight (V) 44.0 33.50 31% 4,532 7,709 16.5 9.1 9.3 5.7 5.9 5.5%Petrochem 2002.SE Neutral (V) 25.0 23.35 7% 2,992 5,829 12.5 18.3 9.6 0.0%Sahara 2260.SE Neutral (V) 25.0 22.30 12% 1,742 2,247 6.6 12.5 13.2 24.8 11.8 4.0%SAFCO 2020.SE Neutral (V) 190.0 180.50 5% 12,048 11,049 7.8 14.2 15.1 12.4 13.2 6.4%SABIC 2010.SE Overweight (V) 130.0 107.25 21% 85,898 85,898 126.0 12.0 10.1 5.9 5.2 4.1%SIIG 2250.SE Neutral (V) 25.0 22.20 13% 2,667 5,916 5.2 21.6 9.4 32.2 7.0 0.0%Sipchem 2310.SE Neutral (V) 29.0 25.80 12% 2,296 3,275 8.6 16.1 16.4 7.9 7.6 1.5%Kayan 2350.SE Neutral (V) 22.0 19.25 14% 7,709 15,674 44.9 36.3 14.0 20.7 9.2 0.8%Yansab 2290.SE Overweight (V) 65.0 46.30 40% 6,953 10,051 27.9 10.3 8.9 8.9 7.5 2.9%Average 15.6 12.4 13.2 8.4 3.1%Median 13.6 12.2 8.9 7.5 3.4%
Note: * IQ in QAR, all else in SAR, Data as of market close on 19 Jan 2011
Source: Thomson Reuters DataStream, HSBC estimates
HSBC Middle East Chemicals: changes to ratings and target prices
Company Ticker _____________ Rating _____________ ________Target Price _______ Old New Old New
Advanced Petrochemical Company 2330.SE Neutral (V) Neutral (V) 30 30 Industries Qatar* IQCD.QA Neutral Underweight 110 135 Methanol Chemicals (Chemanol) 2001.SE Neutral (V) Neutral (V) 14 17 National Industrialisation (Tasnee) 2060.SE Overweight (V) Overweight (V) 40 44 National Petrochemical (Petrochem) 2002.SE Overweight (V) Neutral (V) 25 25 Sahara Petrochemical 2260.SE Overweight (V) Neutral (V) 30 25 Saudi Arabian Fertiliser Co (SAFCO) 2020.SE Neutral (V) Neutral (V) 135 190 SABIC 2010.SE Overweight (V) Overweight (V) 110 130 SIIG 2250.SE Neutral (V) Neutral (V) 19 25 Sipchem 2310.SE Neutral (V) Neutral (V) 30 29 Saudi Kayan 2350.SE Neutral (V) Neutral (V) 18 22 Yansab 2290.SE Overweight (V) Overweight (V) 65 65
*IQ in QAR, all others in SAR Source: HSBC
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Sector view – 2011 6
Feedstock pricing today 10
Feedstock pricing tomorrow 18
Impact on product pricing and margins 26
SABIC 34
Yansab 37
Tasnee 40
Sahara Petrochemical Co. 43
National Petrochemical Company (Petrochem) 46
Advanced Petrochemical Company (APC) 49
Chemanol 52
Sipchem 55
Industries Qatar 58
Saudi Fertiliser Company (SAFCO) 61
SIIG 64
Saudi Kayan 67
Disclosure appendix 73
Disclaimer 76
Contents
We acknowledge the assistance of Mohit Kapoor in the preparation of this report.
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Mid-cycle: trough behind, peak ahead The cyclical trough witnessed in late 2008 and
early 2009 is now well behind us with demand
having recovered during 2010, partly led by
restocking. The big question for 2011 and
thereafter is whether the recovery gains
momentum towards cyclical peak conditions or
whether it stalls, leading to a lower demand
growth, mid-cycle margin environment.
The view from chemical company management
teams, particularly after the Q3 2010 earnings
season, was that a robust recovery driven by
emerging market demand strength was in place
and would continue through 2011. This view was
reiterated by SABIC, Tasnee and Industries Qatar
on our recent investor trip in December.
The key takeaway from the trip for us was that
industry participants seemed to be the most
optimistic they have been for the best part of three
years. This bullish sentiment was based on robust
current demand, strong order books, expectations
of continued emerging market demand growth
outweighing weak developed market demand and
limited supply growth on the horizon.
Furthermore, the view was that chain inventories
are still well below pre-crisis levels which should
allow companies to push through any increases in
raw material prices. We expect to see this
environment of strong demand and limited supply
result in an increase in utilisation rates and a
return to a cyclical peak margin environment by
2013-14.
Long-term supply outlook favourable
After accounting for over 40% of global supply
additions over 2008-11, the Middle East has very
little to contribute in terms of new supply after
2011 (see chart at the top of the next page).
There are no new ethylene crackers planned in
Saudi Arabia between 2012 and 2015, and the
Dow-Aramco project is only tentatively set for
2016. Abu Dhabi, Qatar and Kuwait, which make
up the rest of the GCC petrochemical universe,
are contributing one additional cracker between
them in 2014. Iran, which has the potential to add
more supply, faces tremendous challenges from
economic sanctions and is unlikely to add
capacity in the medium term.
The lack of new Middle East supply is based on a
combination of factors: the limited availability of
cheap feedstock, the push towards downstream,
employment-generating industries and
diversification.
Sector view – 2011
Limited new capacity, robust emerging market demand to drive a
return to peak operating rates by 2013-14
However, market likely to remain balanced in the near term
We forecast a mid-cycle margin environment through 2011
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The only other region to add capacity apart from the
Middle East over the last decade has been Asia. We
do not see significant risks from current capacity
additions in Asia, particularly China. Based on the
latest directive from the National Development and
Reform Commission (NDRC) on domestic refining
and the chemicals sector for China’s 12th five-year
plan (2011-15), we believe the country will
continue to focus on increasing the average
production size of local refinery and chemical plants
while shutting outmoded capacity and thus
preventing overcapacity. For more details on
Chinese capacity addition plans please refer to our
Asian chemical team’s report from September 2010,
Asia Refining and Petrochemicals: Refining to hit
sweet spot in 2011-12.
Stronger demand, limited supply to drive next peak by 2013-14
Rising emerging market demand and limited
supply growth will create an environment of
higher capacity utilisation rates. As utilisation
rates increase pricing power starts to shift back to
producers; operating rates of over 90% are
considered peak conditions for the industry. Based
on our supply assumptions and HSBC Economics'
global economic growth forecasts, we expect to
see a return to peak conditions within the
commodity chemical sector by 2013-14 (see chart
at the top of the next page).
Talk of ‘supercycle’ premature, in our opinion
The limited visibility on any new supply in the
medium term has started to prompt talk in
investor circles of a potential “supercycle” in the
chemical sector. The idea being touted is that
feedstock availability concerns pose an
insurmountable obstacle to any meaningful supply
growth while rising emerging market demand
growth will continue to increase operating rates,
resulting in a multiyear period of high margins.
While we believe in a stronger fundamental
picture for the sector in the medium term, we are
not quite in the ‘super-cycle’ camp yet, for a
couple of reasons.
Firstly, we are barely 18 months removed from
one of the worst industry troughs in living
memory. Developed market demand for
commodity chemicals is still well below the levels
Middle East ethylene supply update Ethylene capacity adds (000 tons) Location Country 2008 2009 2010 2011 2012 2013 2014
Middle EastArya Sasol Bandar Assaluyeh Iran 940Gachsaran PC Gachsaran Iran 500 500Ilam PC Ilam Iran 458Jam PC Bandar Assaluyeh Iran 990 330Kavyan PC Bandar Assaluyeh Iran 1000Morvarid PC Bandar Assaluyeh Iran 500TKOC Shuaiba Kuwait 106 744QAPCO Umm Said Qatar 95QP/Exxon Mobil Ras Laffan Qatar 325RLOC Ras Laffan Qatar 975 325Jubail ChevPhill Al Jubail Saudi Arabia 150 150Kayan Al Jubail Saudi Arabia 325 1000Petro-Rabigh Rabigh Saudi Arabia 975 325Saudi Polymers Al Jubail Saudi Arabia 600 600SEPC Al Jubail Saudi Arabia 450 550SHARQ Al Jubail Saudi Arabia 100 1100Yansab Yanbu Saudi Arabia 867 433Borouge II Ruwais Abu Dhabi 700 700Borouge III Ruwais Abu Dhabi 750Total Middle Eastern Incremental Capacity adds 2731 3716 4358 3083 1100 500 2075
Completed and fully operationalCompleted and ramping upDoubtfulIncremental between now and 2014
Source: CMAI, HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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of 2007 with some major end markets, such as US
autos and US housing, still at a fraction of their
peak activity levels. While emerging market
demand remains robust, developed markets still
account for 60% of the commodity chemical
market by volume, and a sustained multiyear peak
is unlikely as long as developed markets continue
to drag, in our opinion.
Secondly, for a commodity sector with widely
diffused technology, multiyear peaks driven by
supply limitations often prove to be a mirage.
Once margins reach reinvestment levels, the
sector has a way of attracting new investment in
supply that leads to a balancing of operating rates.
A sustained period of higher margins would make
naphtha cracking attractive in the Middle East and
lead to a push for heavy feed crackers in the
region which would balance supply and demand.
To sum up our medium-term sector view in a
sentence: we are bullish on the chemical cycle,
but we are not super-cycle bulls.
Market to remain in balance in 2011 as incremental supply likely
While we are bullish on the sector in the medium
term, we believe that in the near term supply
growth could potentially come in above
expectations in 2011. We expect incremental
supply from existing plants to match demand
growth for the year as improving macroeconomic
conditions ease some of the feedstock supply
bottlenecks that resulted in a tight market in 2010.
This is particularly true of European cracker
operating rates which are tied to operating rates at
refineries in the region. As the chart at the top of
the next page illustrates, ethylene availability
from European naphtha-based crackers dropped
20% below 2007 peak levels as a result of reduced
naphtha supply. An improving macro
environment in Europe would lead to higher
ethylene supply due to greater naphtha availability
from refining.
Furthermore, higher oil-product demand and
higher oil prices could lead to an increase in
OPEC production quotas which would make more
associated gas available, particularly in Saudi
Arabia, and result in an incremental increase in
operating rates at newer crackers – which we
estimate are currently running on average at 80%
owing to feedstock supply constraints.
In both these cases, incremental supply would
materialise from existing capacity only if demand
growth continued to be strong. Therefore it should
HSBC: Ethylene operating rate outlook
88 .9%
8 7 . 0%
8 3 .4 %
84 .1%
8 5 . 3%
8 8 .0 %
90 .0%
8 1 .0 %
8 3 .0 %
8 5 .0 %
8 7 .0 %
8 9 .0 %
9 1 .0 %
20 08 2 00 9 2 0 10 2 01 1E 2 01 2 E 2 0 13 E 2 01 4E
Ope
ratin
g ra
tes
(%
)
HS BC Eth y le ne o pe r a tin g r a tes
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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not result in a big dip in utilisation rates.
However, this incremental supply would prevent a
sharp rise in utilisation rates in the short term. We
forecast ethylene utilisation rates to improve by
only 70bps in 2011 over 2010 levels.
Cautious on chemical sector for 2011
We believe that after two years of exceptional
stock market performance from the Middle East
chemical sector, with stocks on average up 47% in
2009 and 24% in 2010, it is time to take a more
cautious view on the sector in 2011.
Our cautious stance is driven by two main
considerations: current market valuations and
consensus forecasts, and the outlook for supply in
2011.
Valuations and expectations
Middle East chemical sector valuations are now
above mid-cycle levels, with stocks trading on
average on a 15.6x forward PE vs. the historical
sector median forward multiple of 14x. While
fundamentals are healthy, these appear to be
already factored into share prices.
Consensus expectations for chemical company
earnings in 2011 also fully reflect the recovery in
fundamentals, in our opinion. Sector
outperformance will require reported earnings to
beat estimates significantly, which we believe
they will struggle to do given that current 2011
EPS consensus estimates for the Middle East
chemicals sector are on average 45% higher than
they were a year ago.
With supply also likely to surprise on the upside -
as production bottlenecks ease as discussed earlier
- we therefore think it unlikely that 2009-10 sector
stock performance will be repeated in 2011.
Western European cracker operating rates Saudi: new cracker operating rates in Q3 2010
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
WE ethylene supply from naphtha WE ethylene utilization rates
81% 81%
93%
75%
60%
65%
70%
75%
80%
85%
90%
95%
Yansab Sharq SEPC PetrorabighO
pera
ting
Rate
(%)
81% 81%
93%
75%
60%
65%
70%
75%
80%
85%
90%
95%
Yansab Sharq SEPC PetrorabighO
pera
ting
Rate
(%)
Source: CMAI, HSBC Source: HSBC estimates
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Current pricing regime Evolution of Saudi feedstock prices
The Saudi petrochemical industry was established in
an effort to diversify away from oil production by
taking advantage of associated gas production. The
associated gas was at that time being flared which
posed a challenge in terms of devising a pricing
mechanism for the gas. The basic framework used to
determine a gas price for the petrochemical industry
was to use an opportunity cost based pricing system
that accounted for the stranded nature of the gas. Gas
was stranded for two reasons: the absence of a
pipeline network to export the gas regionally and
unviable liquefaction economics at the time that
prevented LNG exports
A word about Saudi liquefaction economics
The major challenge presented by liquefaction at
the time was an unattractive return on capital
profile as the large capital investment required for
establishing an LNG industry would not have
been justified given the level of gas production
and its link to crude output. The historical capital
costs for LNG in the mid 1970s were around
USD1,500 per tonne of capacity, which on our
estimates would have translated into a USD18bn
investment to liquefy all of Saudi Arabia's
associated gas production.
Saudi Arabia’s annual gas output in 1975
(including flared gas) was 752 billion scfy which
would translate into c13 million tonnes of LNG
per annum on our estimates. Under the
assumption that gas production remained constant
and that all the gas was liquefied, LNG exports
would have generated USD1.9bn pa in revenues
at 1975 prices. Not only would this constitute a
low return on a capital investment of USD18bn,
but it would also have equated to only 6.7% of
Saudi oil revenue in 1975.
Feedstock pricing today
Low opportunity costs and industrialisation objectives shaped the
current pricing regime
Cost advantage spiralled as energy price environment underwent
a secular shift
Increased advantage, competing needs for gas placing upward
pressure on pricing
Current GCC feedstock pricing
Country Pricing regime (USD/mmbtu) Implied cost of ethane (USD/tonne)
Saudi 0.75 47 UAE 2.0 to 2.5 142 Kuwait 2.0 to 3.0 174 Qatar 1.5 to 2.5 126
Source: HSBC estimates
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In reality, gas revenues would have been even lower
than in our calculation, since in practice not all of the
gas could have been channelled to an LNG facility,
given the lack of a gas pipeline network at the time.
And contrary to the assumption in our estimate, oil
production in Saudi Arabia did not remain stable,
falling by more than 50% at one point in the mid
1980s (see chart below) which would have
constrained gas supply to any linked LNG facility.
The lack of a pipeline and unstable supply meant
that monetising the stranded gas through the
export route was unviable and that using the gas
for domestic purposes was considered instead –
principally to fuel electricity generation and to
develop the petrochemicals industry
Petrochemicals
Apart from being a use for stranded natural gas, the
development of the petrochemical industry was also
driven by the need to diversify the local economy
away from dependence on crude oil and to provide
an industrial base. The first set of petrochemical
products were methane based – ammonia, urea and
methanol – these being the simplest of all
commodity chemicals. The next step in utilising the
stranded gas was to exploit the ethane content of the
gas by setting up ethylene production facilities and
moving into basic plastics.
Electricity
The logic behind using gas for power generation
was straightforward. At the time, Saudi Arabia
generated much of its electricity by burning heavy
Saudi Arabia: oil revenues vs. potential LNG revenues
0
50 ,00 0
100 ,00 0
150 ,00 0
200 ,00 0
250 ,00 0
300 ,00 0
350 ,00 0
19 75 19 77 197 9 1 981 19 83 19 85 198 7 1 989 19 91 19 93 199 5 1 997 19 99 20 01 200 3 2 005 20 07 20 09
0 .0%
5 .0%
1 0.0 %
1 5.0 %
2 0.0 %
2 5.0 %
3 0.0 %
3 5.0 %
4 0.0 %
4 5.0 %
5 0.0 %
Saudi O il r eve nue (USDmn) Po tent ial Saud i LNG reve nu e as % of o il
Source: Saudi Aramco
Trends in Saudi gas and oil production Domestic use of natural gas
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
1975
1979
1983
1987
1991
1995
1999
2003
2007
Saudi Oil Production (Mboe pa) Saudi Gas Production (Mboe pa)
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
Gas consumption- public (Mboe) Power Generation Capacity (MW) Source: SAMA Source: SAMA
12
Natural Resources and Energy Middle East Chemicals January 2011
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oil, which detracted from the amount of oil
available for export. Substituting stranded natural
gas for some of that oil, which was then exported,
was the most appropriate use of both the gas and
the heavy oil.
Master Gas System (MGS)
Once the decision was made to utilise the stranded
associated natural gas for domestic consumption,
there still remained two open questions: how to
deliver the gas from the oil fields to the
consumption centres on the coast, and what price
to charge for the gas. The answer to both of these
questions lay in the development of the Saudi
Master Gas System (MGS), a network of
pipelines linking gas produced at the oil fields to
various end users across the Kingdom designed to
provide Saudi Arabia with natural gas as a
commercial resource.
The MGS was developed in the late 1970s in an
effort by Aramco to recover associated gas
produced at the oilfields, process it and supply the
country with dry and liquid gases. The idea was to
feed the gas to the two main industrial cities that
were being developed concurrently: Jubail on the
eastern coast and Yanbu on the western coast.
The system was initially designed to process up to
3.5 billion scfd of gas, of which 2 billion scfd was
methane, primarily used as fuel for utilities and as
a feedstock for methanol and fertilisers. The
system was also designed to process 370 million
scfd of ethane as well as natural gas liquids
(NGL) which were to be used as petrochemical
feedstock.
The MGS (see chart below) is one of the largest
of its kind in the world and includes more than 65
gas/oil separation plants located at various oil
fields. Five gas processing plants separate out
methane gas which is then supplied by a 2,400km
pipe network that includes an east-west pipeline
running across the breadth of Saudi Arabia to
power plants, refineries, fertiliser plants, methanol
plants, and steel plants in the two industrial cities.
The system also includes two gas fractionation
plants that separate ethane, propane, butane and
natural gas liquids (NGLs) from the raw gas.
Ethane is then supplied to petrochemical plants in
Jubail and Yanbu. LPGs and NGLs are currently
used internally by the petrochemicals industry,
however at the time that the MGS was built, these
feedstocks were mostly exported.
In its early stages of implementation, the MGS
was used to power the entire energy requirements
of the east coast as well as a few desalination
plants along with multiple industrial projects. The
establishment of the MGS also resulted in several
international oil & gas companies setting up joint
venture projects in Saudi, mainly in the
petrochemical arena, to take advantage of the
availability, and relative inexpensiveness, of
feedstock at the newly inaugurated industrial
cities of Jubail and Yanbu.
Gas pricing and the MGS
Gas volume processed initially 3,500 mmscfd Heat content of delivered gas 35,00,000 mmbtu Gas price 0.5 USD/mmbtu Annual gas revenues 639 USD mn Initial investment in the MGS 12,000 USD mn Gas prices raised to fund expansion Expanded capacity 2,500 mmscfd Heat content of delivered gas 25,00,000 mmbtu Gas price increase 0.25 USD/mmbtu Incremental revenue from price increase 548 USD mn Cost of expansion 7,500 USD mn
Source: Saudi Aramco, HSBC
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Natural Resources and Energy Middle East Chemicals January 2011
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The first MGS phase began operations in 1982
and was entirely dependent on associated gas
supply from the oil fields. This coincided with a
peak in Saudi oil production at the time and when
Saudi Arabia’s oil production dropped by over
50% to a low of 2.5mbpd in 1985 this resulted in
lower gas availability within the new system.
Power outages and shortages in feedstock supply
to the petrochemical sector followed, with
Aramco then deciding on supplementing the
system with the little non-associated gas supply it
had at the time.
The logic behind existing gas pricing
The cost associated with setting up the MGS
provided the first data points for establishing a gas
price given the lack of economically viable
alternate markets for the gas. Aramco needed to
charge end users a rate for the gas that would at
least provide some return on capital given the large
investment cost associated with the project. Based
on the capital invested and the amount of gas
processed, a price of USD0.5/mmbtu was deemed
appropriate at the time. The link between the MGS
and gas prices is further highlighted when one
considers the fact that the only time that gas prices
have been raised in the Kingdom (in 1998 from
USD0.5 to USD0.75/mmbtu) was when Aramco
decided to spend USD7.5bn on upgrading the MGS
and increasing its processing capacity.
Surge in petrochemical investment
The availability of feedstock, not so much its pricing
at the time, spurred investment in the basic
petrochemical industry in the region. The largest
investments came in Saudi Arabia which, given its
oil production, obviously had the most amount of
associated gas available. Saudi took the first step in
jumpstarting the regional sector by establishing the
Saudi Basic Industries Corp. (SABIC).
Saudi Master Gas System in 2011
RED SEA
JEDDAH
SAUDI ARABIAYanbu Indus trial City
Jubail Industrial City
YANBU
JU’AYMAH
BE RRI SHEDGUM
UTHMANIYAH
HAWIY AH
HARADH
NA Gas
NA Ga s
Gas WellNA Gas
RIYADH
Gas We ll
Natural gas pipeline
NGL pipe line
RED SEA
JEDDAH
SAUDI ARABIAYanbu Indus trial City
Jubail Industrial City
YANBU
JU’AYMAH
BE RRI SHEDGUM
UTHMANIYAH
HAWIY AH
HARADH
NA Gas
NA Ga s
Gas WellNA Gas
RIYADH
Gas We ll
Natural gas pipeline
NGL pipe line
Source: Saudi Aramco
14
Natural Resources and Energy Middle East Chemicals January 2011
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SABIC’s growth was driven by the successful
deployment of the Master Gas System and further
supported by subsidised electricity costs and soft
government loans. These incentives, coupled with
the creation of the industrial cities of Jubail and
Yanbu along with supporting industrial
infrastructure at the two cities. laid the foundation
for SABIC’s success.
Feedstock advantage rising
It was not generally expected in the 1990s that the
Middle East would hold the cost advantage that it
currently does as global energy prices remained
low through the 1990s which meant that
petrochemical investment was made in regions
with the largest markets – the US, developed
Europe – rather than feedstock-rich regions such
as the Gulf.
However, the boom in oil and gas prices over the
past decade increased the cost advantage enjoyed
by the fixed-cost ethane based petrochemical
producers in the Middle East and also drove a
wave of investment in new capacity (see charts at
the top of the page). The new capacity placed
constraints on gas availability at a time when
competing uses for gas started to emerge while
the significant increase in the cost advantage
enjoyed by the petrochemical companies started
to raise questions about a revision to the gas
pricing framework.
Gas pricing – the new normal Competing uses for gas, limited supply growth
The single biggest driver for a change to the
existing gas price regime is the number of
competing uses for what is now a scarce resource.
A return on infrastructure investment model,
which is what the existing USD0.75/mmbtu price
was based on, was acceptable when the MGS was
being built and there were limited uses for the
stranded gas. However, with a massive increase in
gas demand within the region and production
failing to keep pace, a new pricing mechanism is
necessary in order to balance both policy and
economic interests.
This is particularly relevant in light of limited
production growth. While Saudi proven gas
reserves have continued to grow, from 263trn scf
in 2008 to 275trn scf (or 286,200 trn btu) at the
end of 2009, the amount of gas being delivered
has not kept pace with reserve growth. According
to Aramco data sales gas (methane) deliveries
declined by 0.281 trn btu in 2009 and delivered
ethane only increased by 0.092 trn btu in 2009
(see chart at the top of the next page).
One of the key reasons for limited growth in
delivered gas is that, as argued in our note of 26
November 2009, Saudi Infrastructure: Spending for
this generation, Aramco’s highest priority has until
Growth of ethylene capacity in the Middle East (000 tonnes) Saudi capacity vs. ethane cost advantage
----
5,000
10,000
15,000
20,000
25,000
30,000
2004 2005 2006 2007 2008 2009 2010 2011 2012
IranIraqKuwaitQatarKSAUAEMiddle East
----
5,000
10,000
15,000
20,000
25,000
30,000
2004 2005 2006 2007 2008 2009 2010 2011 2012
IranIraqKuwaitQatarKSAUAEMiddle East
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Jan-1990
Jan-1992
Jan-1994
Jan-1996
Jan-1998
Jan-2000
Jan-2002
Jan-2004
Jan-2006
Jan-2008
Jan-2010
0
200
400
600
800
1,000
1,200
LHS: Saudi Ethylene capacity ('000 ton)US Ethane (USD/Ton)Saudi Ethane (USD/Ton)
Source: CMAI, HSBC Source: CMAI, HSBC
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Natural Resources and Energy Middle East Chemicals January 2011
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recently been oil-related exploration projects. Given
the lead time between exploration and production
within the oil and gas sector, the lack of focus on gas
in the last decade or so is constraining current
supply. However, this has now changed, with
Aramco increasingly aware of the requirement to
increase gas supply. Aramco has set itself a goal of
discovering 3 to 7 trillion scf of additional non-
associated gas reserves annually.
Another supply constraint is that much of the gas
extracted is a by-product of oil production, despite
the fact that non-associated gas accounts for 75%
of total gas reserves versus 48% in 1990; i.e.
while non-associated gas reserves have grown,
production from those fields has not. Aramco has
again refocused on developing its non-associated
gas production, which is evident from the fact that
currently 50% of all offshore rigs are deployed for
gas production, as opposed to between 20% and
40% in the past.
Moreover there are several sources of competing
demand for this gas, mainly from electricity
generation - which currently uses about 1 billion
to 1.5 billion scfd of gas and 0.9m bpd of oil in
Saudi Arabia - and water desalination which
currently uses 0.5 billion scfd of gas. Aramco
expects total domestic fuel demand to rise from
3.3 million bpd of oil equivalent in 2009 to
approximately 8.3 million bpd of oil equivalent in
2028. To put this in context, Saudi Arabia’s
current production capacity is 13.75 million bpd
of oil equivalent. To rephrase, if demand were to
increase as projected without a concurrent
increase in supply, within two decades over 60%
of Saudi Arabian energy production would go
towards meeting domestic consumption. This
would not only result in a significant revenue loss
for Saudi Arabia, but would also be very bullish
for global energy prices given Saudi Arabia’s
position as a swing producer of crude.
We outline the various calls on Saudi gas
production from the various sectors below.
Power demand
The Saudi Electricity and Cogeneration
Regulatory Authority has said about 0.9 million
barrels of oil are currently used to generate power
every year and, as the authority plans to raise
power capacity from 44.6GW at the end of 2009
to 121GW by 2032, the requirement will increase
to 2.4 million barrels of fuel oil per day – this
excludes the current amount of natural gas used.
Saudi Electricity (SEC) expects power
consumption to increase from 193GWh in 2009 to
251GWh in 2013, similar to our expectations
(please see our note of 9 June Saudi Electricity
Company – N: New tariff plan priced in, next
move key to unlock value) which is equivalent to a
Saudi gas deliveries (bn scf) Saudi Electricity Company: planned capex (SARm)
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
2005 2006 2007 2008 2009
Delivered sales gas Delivered ethane gas
30,000
0
5,000
10,000
15,000
20,000
25,000
2010e 2011e 2012e 2013e 2014e
Generation Transmission and Distribution Replacement Total
30,000
0
5,000
10,000
15,000
20,000
25,000
2010e 2011e 2012e 2013e 2014e0
5,000
10,000
15,000
20,000
25,000
2010e 2011e 2012e 2013e 2014e
GenerationGeneration Transmission and DistributionTransmission and Distribution ReplacementReplacement TotalTotal
Source: Saudi Aramco Source: Corporate reports, HSBC
16
Natural Resources and Energy Middle East Chemicals January 2011
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requirement of another 0.3 million boe per day.
To meet growing consumption, SEC plans to
increase generation capacity by 7GW between
2009 and 2013, with a further 4.5GW coming on
line over 2014 and 2015. We estimate that another
6GW will come on line via Independent Power
Producers (IPPs) and Integrated Independent
Water and Power Projects (IWPPs) by 2015.
At present half of electricity generation comes
from gas, with consumption of electricity set to
increase by c30% by 2013, according to SEC. It is
expected that this will lead to a significant
increase in gas requirement in the kingdom.
Water
Water is a critical issue for the Saudi government.
Domestic water consumption is equivalent to 230
litres per day per person, compared with Europe’s
100-200 litres per day, but is not covered fully by
desalinated water. Production of desalinated water
in 2008 was 1.1bn cubic metres, up 3.4% y-o-y.
The government estimates that demand for
drinking water will increase to about 10m cubic
metres per day over the next 20 years, if the
increase in the daily per capita consumption rate
continues at its current level. A significant
increase in desalination capacity is planned to
meet the higher demand. We estimate that
desalination capacity needs to double over the
next 20 years to cover drinking water needs alone,
and calculate that this would lead to a requirement
for an additional c0.5 billion scfd of gas.
Refining and petrochemicals
Integrated refining projects are a priority for the
government in order to both meet fuel demand and
introduce a more complex set of petrochemical
products that would help create a downstream
chemical industry and spur employment. Introducing
natural gas into the feedstock mix for integrated
refining projects will enhance margins thereby
improving the initial payback and encouraging more
complex petrochemical projects.
We estimate that the refineries due to come on
line will consume around 0.3 billion scfd of gas.
However, until the non-associated gas fields come
online, the majority of non-integrated
petrochemical projects will be delayed
indefinitely, in our view. The key integrated
refining and petrochemical projects that will
require gas supply over the next four to five years
are detailed below.
Saudi Aramco Total refining & petrochemical
company (SATORP): Aramco (62.5% share of
the JV) and Total are building a joint venture
400,0000 bpd refinery at Jubail which could
potentially add an world-scale integrated cracker
complex. Financing for the refinery part of the
project is complete and parts of the project are
under construction.
Yanbu refinery: The proposed Yanbu export
refinery, a 400,000 bpd full-conversion refinery on
the Red Sea coast, is designed to produce refined
products and petrochemicals. ConocoPhillips pulled
out of the venture in April 2010 and Aramco has
since said that it will go it alone if it cannot find a
partner. The refinery is a priority as it is needed to
process the additional heavy crude that is due to
come out of the Manifa oil field.
Aramco/Dow petrochemical project: Aramco and
Dow Chemical were originally planning to build an
integrated petrochemicals complex alongside a
400,000 bpd expansion to the existing 500,000 bpd
Ras Tanura refinery. This was modified in April
2010 when the two companies announced that they
would move the project to Jubail. The cost of the
complex has been reduced from USD20bn initially
to less than USD15bn. It is most likely that the
project will now be fed largely by ethane gas
provided by Aramco and, to a lesser extent, liquid
feedstocks provided by the Jubail refinery.
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Natural Resources and Energy Middle East Chemicals January 2011
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Gas exploration – the supply response
State oil companies such as Aramco have started
to respond to the rising demand for gas. For
Aramco, increased production of non-associated
gas is now a priority and new discoveries have
been principally made offshore as the exploration
in Rub al-Khali (the Empty Quarter, onshore) has
continued to disappoint. As a result, more
offshore exploration is under way with Aramco
increasing the number of active offshore rigs to
about 15 in 2009 from just one in 2000,
dedicating USD6bn (or 10% of its capital
investment) to the development of six offshore
facilities over the next five years.
The most significant non-associated gas field to
come online will be the Karan offshore field.
When completed in 2013, the field will be capable
of delivering 1.8 billion scfd of raw gas. Under
the USD1bn Shaybah scheme, Aramco wants to
build a plant to separate the equivalent of 228,000
bpd of natural gas liquids from crude oil produced
at the field.
In addition, under the Wasit scheme, estimated to
cost USD 6bn, Aramco aims to produce 2.5
billion scfd of sulphur-rich gas from the newly
discovered offshore Arabiyah and Hasbah fields
before transporting it to a central processing
facility at Wasit. The plan is to construct seven
offshore wellhead production platforms at the
Hasbah field, which can produce up to 1.3 billion
scfd of gas from the field, and six wellhead
platforms at the Arabiyah field, capable of
producing 1.2 billion scfd.
The scheme also includes six 12-inch flowlines, a
150km pipeline linking the facilities with Wasit, a
150km pipeline between Arabiyah and Wasit, and
a 91km submarine power cable. However, the
lead time required for completing such
developments, and the constraints on production
of oil due to OPEC quotas, will mean gas
production will be limited for the next three years.
Pressure on gas pricing
In the wake of constrained gas supply, multiple
competing uses and a burgeoning cost advantage,
there are now serious questions being raised
regarding the feasibility of continuing with the
current gas pricing regime within Saudi Arabia.
The view gaining traction among industry
participants is that some form of modification to
the pricing framework is required both to provide
an incentive for new gas supply and to ensure a
more efficient distribution of limited gas
resources.
This discussion is particularly relevant at the
current time given that some of the feedstock
contract pricing formulae – particularly for liquids
– run only until 2011, implying that a new pricing
benchmark, at least for liquids will need to be
approved before the end of the year. We believe
that a new gas pricing framework will also be
approved at the same time and so a change in the
overall feedstock price environment is imminent.
However, any such change is unlikely to be driven
by economic factors alone, with policy factors
likely to play just as big a role in the decision. We
outline our thoughts on the potential framework
for a change to the feedstock pricing mechanism
in the next section.
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Natural Resources and Energy Middle East Chemicals January 2011
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The economic argument Rising energy prices have increased the cost advantage
When the Saudi petrochemical sector was first
established in the early 1980s, foreign technology
partners for SABIC were attracted to Saudi Arabia
by low cost gas feedstock at a price of
USD0.50/mmbtu. With US natural gas prices in
the USD1-2/mmbtu range at the time the Saudi
gas price, while attractive, was not dramatically
lower than prevailing international prices.
The Saudi gas price was raised once to
USD0.75/mmbtu in 1998 and has since remained
at that level despite there having been a secular
shift in the global energy price environment in
recent years. The chart at the bottom of the page
illustrates this shift. The Saudi cost advantage for
the production of ethylene using pure ethane as
feed has tripled on average over the 2003-10
period compared to its 1990-2003 average, driven
exclusively by changes in global energy prices.
The dramatic increase in the cost advantage enjoyed
by Saudi petrochemical producers is at odds with the
lack of changes to the domestic feedstock pricing
regime over the last twelve years. The economic
argument for an increase in domestic feedstock
prices is therefore twofold: that the current cost
advantage is well in excess of what was implicitly
guaranteed when the industry was established; and
that with rising energy prices having allowed the
Feedstock pricing tomorrow
Economics would suggest a sharp increase to USD4-5/mmbtu
However, policy more than economics will set future feedstock prices
We expect to see a gradual rise in feedstock prices, with fundamental
industry competitiveness unaltered
Saudi ethylene cost advantage vs. Naphtha based producers (1990-2010)
0
200
400
600
800
1000
1200
1400
1600
1800
2000
1990 1993 1996 1999 2002 2005 2008 2011
USD
/ton
Saudi ethane cost advantage
1990 to 2003 average USD240/ton
2003 to 2010 average USD760/ton
0
200
400
600
800
1000
1200
1400
1600
1800
2000
1990 1993 1996 1999 2002 2005 2008 2011
USD
/ton
Saudi ethane cost advantage
1990 to 2003 average USD240/ton
2003 to 2010 average USD760/ton
Source: HSBC estimates
19
Natural Resources and Energy Middle East Chemicals January 2011
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Saudi petrochemical industry to generate exceptional
profits over the last seven years, some of those
profits now need to be shared with the government
through an increase in feedstock costs.
Higher prices needed to incentivise production growth and limit demand
New sources of gas, higher production costs
With the exception of Qatar, which has large
resources of non-associated gas, the Gulf
Cooperation Council (GCC) countries have
traditionally been reliant on associated gas (a by-
product of crude production) for their gas needs.
The amount of associated gas available, though, is
limited by the amount of crude production, which
in turn is limited by OPEC quotas.
In recent years, as demand for gas from the power,
infrastructure and petrochemical sectors has grown,
oil companies in the region have started to focus
heavily on exploring for non-associated gas. Their
efforts have borne fruit to a certain extent as the
chart at the bottom of the page shows. Gas
production has increased by 50% since the start of
the last decade while crude production has grown by
only 2% over the same period, highlighting that the
bulk of the gas production growth has come from
non-associated gas fields.
As non-associated gas production grows, the
question of gas pricing starts to gain greater
attention. It is one thing to price associated gas at
very low levels because the costs of production –
since it is a by-product – are minimal and this gas
would have been flared if it were not used by the
petrochemical industry. However, when gas is
produced from non-associated fields, the costs of
production and extraction are dramatically higher
than those for associated gas. In addition, there
are now competing uses for gas from the power,
fertiliser, metal and petrochemicals sectors which
render the traditional argument of a lack of
alternative uses void.
Furthermore, there is a strong case to be made that
if this growth in non-associated gas production is
to be maintained, then exploration companies,
particularly the international ones, need sufficient
incentives to invest in exploring for offshore gas
fields. These companies need to see the potential
to generate an adequate return on capital that
compensates them for both discovery, as well as
production, costs. As almost all of this new gas
production will be consumed domestically,
capping domestic gas prices at the current low
levels limits the attractiveness of gas exploration
in the region and therefore constrains potential
supply. The economic argument for raising
GCC ex Qatar: Oil vs. gas production
12,000
13,000
14,000
15,000
16,000
17,000
18,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
(000
bbl
/d)
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
(bcf
/d)
GCC ex Qatar (oil production) GCC ex Qatar (gas production)
12,000
13,000
14,000
15,000
16,000
17,000
18,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
(000
bbl
/d)
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
(bcf
/d)
GCC ex Qatar (oil production) GCC ex Qatar (gas production)
Source: BP World Energy Statistical Review 2010
20
Natural Resources and Energy Middle East Chemicals January 2011
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domestic gas prices therefore is that higher prices
would incentivise new production and allow
supply to keep pace with growing demand.
Lower prices result in uneconomic resource allocation
The other economic argument for higher domestic
gas pricing comes from the demand side. Low gas
prices and consequently low retail electricity
prices mean that there is little incentive for users
to ration their consumption, driving rapid demand
growth as shown in the charts at the top of the
page. Power demand in both Saudi Arabia and
Qatar is expected by MEED to double from
current levels over the next decade.
In the absence of supply growth from non-
associated gas, the incremental increase in power
generation will have to come from burning
heavy/fuel oil to generate electricity. On our
estimates, this would imply an increase in fuel oil
consumption to 2.4m bpd from the current levels
of 0.9m bpd, an incremental loss of 1.5m bpd that
could potentially have been exported and a
potential revenue loss of USD110m per day at
current international market prices.
The low gas prices also create the potential for using
ethane for fuel rather than converting it into higher
value added petrochemicals. Ethane can be burnt for
fuel use and at the current delta between Saudi
ethane prices and global fuel oil prices (see table at
the bottom of the page), ethane is being sold at
roughly one tenth of its heating value equivalent.
Ethane has so far not been used for fuel, given its
value as a petrochemical feedstock. However, if
power generation demand continues to grow at the
projected rate and results in a large fall in revenue
due to lost fuel oil sales, the argument for
replacing some of the heating oil that is consumed
with ethane at a tenth of its price will likely start
to take hold. Raising domestic prices would not
only incentivise new gas supply, freeing up
heating oil for export, it would also make ethane
less attractive as a heating oil substitute resulting
in a more economic resource allocation.
To sum up, the economic rationale would be to
raise feedstock prices to levels in line with global
natural gas prices (USD4-5/mmbtu). This would,
in theory, still provide a degree of cost advantage
to the petrochemical producers relative to crude-
based producers while incentivising new supply
and curtailing runaway demand growth.
GCC ex Qatar: Gas consumption Projected growth in power demand (Saudi and Kuwait)
8.0
10.0
12.0
14.0
16.0
18.0
20.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Gas consumption (bcf/d)
8.0
10.0
12.0
14.0
16.0
18.0
20.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Gas consumption (bcf/d)
40
10.8
85
21
0102030405060708090
Saudi Arabia Kuwait
GW
2010 2020e
40
10.8
85
21
0102030405060708090
Saudi Arabia Kuwait
GW
2010 2020e
Source: BP World Energy Statistical Review 2010 Source: MEED, HSBC
Heating value comparison
Btu/lb Price Units USD/lb price on heating value
Methane 23811 0.75 USD/mmbtu 0.02 Ethane 22198 0.75 USD/mmbtu 0.02 Bunker fuel oil 18000 80.0 USD/bbl 0.24
Source: EIA, HSBC
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Natural Resources and Energy Middle East Chemicals January 2011
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The policy response There appears to be widespread agreement
between companies that we cover – SABIC,
Tasnee, Sahara – and Saudi Aramco that
feedstock prices for the chemical sector need to
rise from the current levels. The areas of
disagreement pertain to the quantum and timing of
any potential price increases.
The energy producers such as Aramco argue for
an early increase to levels in line with US gas
prices based on the economic rationale stated
earlier. Chemical industry participants on the
other hand argue in favour of a phased approach
to any pricing increase which would allow the
industry to focus on cost management and raise its
competitiveness over time.
In general, we believe that regional policy makers
are sympathetic to calls for a phased approach to
feedstock price increases for the reasons outlined
below.
Shock treatment not the answer
The table below illustrates the impact on methanol
cash margins of a sudden increase in gas prices
from the current levels of USD0.75/mmbtu to US
gas price levels of USD4.5/mmbtu. As can be
seen, the financial impact is substantial, with cash
margins for methanol being cut almost in half
from over 75% to under 40%. While from a
global chemical industry standpoint cash margins
of roughly 40% are very attractive, the impact of a
halving of margins on the domestic petrochemical
sector would be severe.
Methanol, admittedly, is an extreme example as
the cost curve is not linked to crude and the
margin impact on other crude based
petrochemicals such as ethylene would be much
lower. However, the basic principle still holds – a
sudden increase in gas prices to international
levels would severely impact the profitability of
the industry without giving it time to adjust to the
realities of a new feedstock price regime.
The financial stresses that such a change would
place on industry balance sheets would not be
welcomed by banks and project finance institutions,
which as capital providers and enablers of industry
development had factored a certain degree of
profitability into their forecasts. Furthermore, such a
move would run against the precedent of policy
changes in the region which generally occur in a
gradual manner following a consultative process and
keeping a long-term outlook in mind.
Diversification still essential for job creation
Policy makers in the region have employment
generation as their key long-term objective and
have not lost sight of the fact that industrial
growth is essential to meet that objective.
The challenge of job creation is most acute in Saudi
Arabia. Home of the largest population base in the
GCC, over half of Saudi Arabia’s population of 18.5
million is under 20 years old and only 3 million, or
16% of the population, are in the workforce. Around
2 million Saudis are between the ages of 20 and 24,
and in this age range only 0.5 million are employed,
including expats. Of the 1.8 million Saudis between
the ages of 15 and 19, few have jobs. All this
Cash margin impact of a change in gas prices
Gas prices (USD/mmbtu) 0.75 4.50
Methanol production cash costs incl freight (USD/tonne) 91 230 Methanol prices (USD/tonne) 380 380 Cash margins (USD/tonne) 289 150 Cash margins (%) 76% 39% Change in cash margins -37ppt
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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suggests that around 1.7 million jobs must be found
in the next 10 years – more if women are to play a
greater role in the workforce (see charts at the
bottom of the page).
As the region’s primary non-oil industry, the
petrochemical sector is the logical first stop for
employment generation. Commodity chemicals
are primarily export orientated and do not create
enough jobs to make a dent in the region’s
employment statistics. Job intensity rises the
further one moves down the petrochemical chain
and, in order to meet the policy objective, the
regional petrochemical industry needs to make the
move towards downstream chemical businesses.
It would be hard to incentivise chemical
companies to make the move downstream while
simultaneously hurting their competitiveness with
a shock increase in feedstock prices. Saudi
chemical companies have strong balance sheets
and have capital available to invest in emerging
markets such as China and India.
The investment decision for new chemical
capacity invariably boils down to whether to
invest where feedstock competitiveness is secure
(such as the Middle East) or where the market is
secure (China/India). If regional feedstock
competitiveness were greatly reduced by policy
action, chemical companies would likely see no
reason to invest in downstream sectors within the
Middle East, dealing a blow to the key policy
objective of job creation.
Supply incentives need not revolve around price alone
The question of whether to provide incentives for
non-associated gas exploration in order to boost
supply is the most challenging one facing policy
makers. With extraction costs likely to be
substantially higher than current sale prices of
USD0.75/mmbtu, there is no incentive for
companies to explore for gas. As discussed above,
it is unlikely that prices will be raised to levels
that would make gas exploration lucrative,
particularly if one were to factor in exploration
costs as well as development and extraction costs.
However, in our opinion policy makers do have
some tools that allow them to provide supply
incentives without needing to resort to a fully
market-based gas pricing model.
Gas sale terms to National Oil companies
(NOCs) could be on a minimum guaranteed
return on capital basis which would allow
foreign joint venture partners to meet their
hurdle rates while transferring the subsidy
burden to the state.
There could be differential pricing terms and
rights for gas and condensate. The gas could
be sold to the NOC on a fixed price basis
while the foreign JV partner could be given
rights to any condensate that is produced
alongside the gas which could be sold in the
international market. This would effectively
Population growth – CAGR (2002-09) Labour force growth pa (%)
9.0%
4.4%
7.2%8.0%
2.7%3.7%
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
UAE Kuwait Qatar Saudi Arabia Average
9.0%
4.4%
7.2%8.0%
2.7%3.7%
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
UAE Kuwait Qatar Saudi Arabia Average
9.0%
4.4%
7.2%8.0%
2.7%3.7%
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
UAE Kuwait Qatar Saudi Arabia Average
4.4%
7.2%8.0%
2.7%3.7%
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
UAE Kuwait Qatar Saudi Arabia Average
0123456789
GCC Bahrain Kuwait Oman Qatar Saudi Arabia
UAE1980-1990 1990-2000 2000-2010
0123456789
GCC Bahrain Kuwait Oman Qatar Saudi Arabia
UAE1980-1990 1990-2000 2000-20101980-1990 1990-2000 2000-2010
Source: Arab Labour Force, HSBC Source: World Bank, HSBC
23
Natural Resources and Energy Middle East Chemicals January 2011
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give the JV partner the lion’s share of market-
priced condensate while the NOC gets the
rights to fixed-priced gas.
Another incentive could be potential
collaboration on downstream petrochemical
projects which allows the E&P partner to benefit
directly from domestic use of the gas found.
Consideration for future exploration acreage,
if other upstream oil opportunities were to
open up, is another potential incentive for
foreign JV partners.
A combination of one or more of these incentives
was offered to the four exploration JVs that
Aramco approved in 2004, with the aim of
increasing domestic natural gas output by
exploring in the Rub al-Khali. While the success
of this exploration effort has been mixed, it does
illustrate that supply incentives do not need to
come from price increases alone.
The compromise solution Phased increase in feedstock prices over several years
We believe that the template for feedstock pricing
increases in the Middle East will be based on the
precedent set with liquid feedstock pricing starting in
2002. The table at the bottom of the page shows the
discount factors applied to liquid feedstocks, such as
propane, butane and light naphtha, and how that
discount has evolved over the last decade.
While liquid feedstock prices have increased by
an average of 700bps between 2002 and 2011, the
increase has been anything but sudden, with the
average annual increase being less than 80bps.
This gradual increase in feedstock prices allows
the industry to wean itself off cheap feedstock
over time while developing operational
experience and competitiveness.
Given the experience with liquid feedstock
pricing, we believe that policy makers will adopt a
similar stance to the pricing of natural gas and
ethane as well.
Industry to remain highly competitive vs. prevailing global gas and crude prices
We started this section by highlighting the sharp
increase in the cost advantage enjoyed by Saudi
petrochemical companies driven by the increase
in global energy prices. It is worth mentioning
that just as the cost advantage increased in line
with rising energy prices, there exists a risk of the
advantage shrinking if there were to be a sharp
decline in energy prices.
We believe that policy makers would want to
insulate the cost advantage enjoyed by the
regional petrochemicals sector from any wild
fluctuations in energy prices. Feedstock prices,
even when raised, would likely only be raised to a
level at which the local industry would remain in
the first quartile of the cost curve even in a worst-
case scenario for global energy prices.
Saudi liquids pricing factors
Year beginning Propane factor Butane factor A 180 factor naphtha
01-Jan-02 0.621 0.655 0.658 01-Jan-03 0.632 0.660 0.666 01-Jan-04 0.643 0.665 0.674 01-Jan-05 0.654 0.670 0.682 01-Jan-06 0.665 0.675 0.690 01-Jan-07 0.676 0.680 0.698 01-Jan-08 0.687 0.685 0.706 01-Jan-09 0.698 0.690 0.714 01-Jan-10 0.709 0.695 0.722 01-Jan-11 0.720 0.700 0.730
Source: Saudi Aramco
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A hint as to what policy makers consider a floor for
energy prices is available in the oil price assumption
used while setting annual budgets. Saudi Arabia, for
example, used an average crude price of USD55/bbl
while setting its budget for 2011. It would be
unlikely that the very same policy makers would
then move to considering the current oil price of
USD90/bbl when examining the issue of feedstock
costs for the petrochemical industry.
The table at the bottom of the page outlines our
approach to calculating potential feedstock price
increases for the petrochemical sector. We believe
that the base oil price used to derive industry
competitiveness will be similar to that used by the
Saudi government to set its budget – USD55/bbl.
At that level of crude prices, the marginal cost of
producing a tonne of ethylene is around
USD700/tonne.
Working back from that marginal cost of ethylene
and backing out variable and other operating costs
for the Middle East we get an implied equivalent raw
material cost for the Middle East of USD500/tonne.
At this stage we assume that in order to keep the
competitiveness of the Middle Eastern industry
intact and its cost position firmly within the first
quartile, policy makers would allow a cost advantage
equivalent to the historical average over the 1990-
2010 period of USD375/tonne.
Adjusting for the allowed cost advantage would
imply Saudi ethane costs of USD101/tonne which,
given the ethane requirements for a tonne of
ethylene, translates to an implied gas price of
USD2.1/mmbtu.
Liquids discount unlikely to drop below 25%
Both gas and liquid feedstocks are priced on an
opportunity cost basis. For stranded gas, that
opportunity cost is very low allowing gas to be
priced at a substantial discount to international
prices. For liquids such as propane and butane
which have liquid international markets, the
discount provided to the domestic industry is not a
subsidy, but is in fact a ‘netback’ equivalent price.
In Saudi, for example, if Aramco were to sell
propane in the international market rather than
supplying it to the domestic sector, its effective
net realised price would be significantly lower
than observed market prices on account of supply
chain costs (such as liquefaction, storage,
shipping, distribution and tariffs).
These chain costs are the justification for the
current c30% discount on liquid feedstock prices.
The current schedule for liquids pricing (see table
on page 25) runs up to 2011. We expect to see a
further decrease in the discount, to 25% over the
Potential Saudi feedstock cost framework
Naphtha consumption 3.46 tonne/tonne
Floor Crude price assumption 55 USD/bbl Naphtha costs 495 USD/tonne Raw material costs 1,716 USD/tonne Co product credits 1390 USD/tonne Variable operating costs 300 USD/tonne Incremental costs 80 USD/tonne Marginal cost of ethylene production at crude price of USD55/bbl 706 USD/tonne Working back to derive a Middle East feedstock price in this context Marginal cost of ethylene production at crude price of USD55/bbl 706 USD/tonne less Middle East variable and incremental costs 200 USD/tonne Implied raw material costs 506 USD/tonne less average cost advantage over 1990-2010 period 375 USD/tonne Implied Saudi ethane costs 131 USD/tonne Ethane requirement for a tonne of ethylene 1.29 tonne/tonne Implied ethane costs per tonne 101.3 USD/tonne Implied ethane [gas?] costs 2.1 USD/mmbtu
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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next five years, but believe that given the netback
argument and the fact that the bulk of new Saudi
ethylene capacity has a large proportion of liquids
cracking it is unlikely that the liquids discount
will drop below 25%.
Feedstock pricing forecasts As discussed earlier in the section, we believe that
while there is broad consensus that feedstock
prices in Saudi need to be raised, the decision on
the quantum and timing of the increase will
balance economic considerations with policy
objectives.
While the Saudi government is keen to incentivise
new gas exploration and supply and to ensure
economic resource allocation, it is also cognisant
of the role the Saudi petrochemical industry needs
to play in employment generation. This will likely
be a key consideration driving policymakers to
ensure that feedstock price increases take place in
a phased fashion without shocking the industry or
dramatically altering its competitive dynamic.
We also believe that policy makers will be just as
conservative with their underlying energy price
assumptions when assessing the competitiveness
of the petrochemical industry as they are when
setting the annual budgets. We assess the range of
possible feedstock prices under these constraints
and derive our feedstock pricing framework as
detailed on the previous page.
We raise our forecasts for Saudi gas and ethane
equivalent prices, now factoring in a gradual
increase to USD2.0/mmbtu by 2015, vs a flat
USD0.75/mmbtu previously (see table at the bottom
of the page). We also assume that the liquids
discount will decline by 1ppt each year from the
current 28% before being fixed at 25% in 2014.
HSBC Saudi feedstock pricing assumptions
2011e 2012e 2013e 2014e 2015e
Gas price (USD/mmbtu), New 0.75 1.25 1.50 2.00 2.00 Gas price (USD/mmbtu), Old 0.75 0.75 0.75 0.75 0.75 % Propane Discount, New 28% 27% 26% 25% 25% % Propane Discount, Old 28% 28% 28% 28% 28%
Source: HSBC estimates
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Feedstock price impact driven by product and feedstock mix The increases to our feedstock pricing estimates,
taken in isolation, result in a drop in product
margins for the companies within our coverage.
The extent of the drop in margins, though,
depends on the product portfolio of each company
as well as their feedstock mix.
The biggest increases in our feedstock price
estimates are those for natural gas, which impact
products that are methane based – methanol,
ammonia and urea – the most. While the increase in
gas prices also affects the price of ethane, as ethane
prices are quoted on a gas equivalent basis, the drop
in ethane-based product margins is far lower due to
the higher degree of value added in ethane-based
products versus methane-based products (see table at
the bottom of the page).
For liquids based products, the margin impact is
easier to forecast as the product margins are
directly linked to the discount (c30%) to global
feedstock prices. As the discount is reduced in our
estimates by 1ppt each year through 2015, the
margin impact would be similar (ie a drop of 1ppt
each year for liquids based products).
Impact on product pricing and margins
HSBC crude oil price forecast raised to USD82/bbl for 2011, rising a
dollar a year thereafter
We modify our chemical product price and margin estimates to reflect
higher energy prices as well as changes in feedstock pricing
On average the impact of higher crude prices outweighs higher
feedstock costs
Impact of gas feedstock price increases (methane vs. ethane-based products)
Natural gas price (USD/mmbtu) 0.75 2.00
Methane price (USD/mmbtu) 0.75 2.00 Raw material costs for 1 tonne of methanol 26.25 70.00 Change in raw material costs 43.75 Current methanol price (USD/tonne) 380 Margin impact from cost increase -12%
Implied ethane price (USD/tonne) 36.7 97.8 Raw material costs for 1 tonne of ethylene 47.3 126.2 Change in raw material costs for PE (polyethylene) production 78.85 Current LDPE (low density PE) prices (USD/tonne) 1450 Margin impact from cost increase -5%
Source: HSBC estimates
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Very few companies have either a purely liquid or
purely gas-based product portfolio and therefore
there are multiple moving parts when trying to
assess the impact of a change in feedstock prices
on company profitability. We list the impact of
our feedstock pricing changes on each company
under our coverage assuming constant product
prices below. The rule of thumb is that companies
with the biggest cost advantages and the highest
margins (eg SAFCO) are impacted more on a
percentage basis than companies with the lowest
advantage and margins (eg SABIC).
Of course, one cannot look at product margins on
a feedstock basis alone. Product prices are an
important factor within our margin outlook and
are influenced by both energy costs and supply/
demand. Our bullish long-term supply/demand
outlook (as detailed earlier in the note), coupled
with increases in our oil and gas team’s energy
price forecasts, have resulted in an increase in our
product pricing estimates. In most cases, the
impact from higher product pricing outweighs the
impact of higher feedstock costs.
Changes to HSBC’s oil price forecasts Our global oil and gas team have raised their forecasts
for crude oil prices. The extract below is from the note
“Oil sector outlook” published on 23 January 2011
(Paul Spedding, +44 207 991 6787) highlighting the
rationale behind the change in their oil price forecasts.
Please see the full note for greater detail.
Oil price assumptions
Our Brent assumption for 2011 rises from USD76
to USD82, rising a dollar a year thereafter. We
assume a USD1 premium for WTI.
Oversupply remains
We estimate that OPEC has spare capacity of up
to 6MMbbl/d, or nearly 7% of world demand.
Even assuming not all of this capacity is palatable
to the world’s refining system due to quality,
spare capacity is still probably in the 5MMbbl/d
area. Unlike many other commodities, therefore,
the crude market is not tight; it is potentially in
oversupply.
It is only OPEC’s discipline in keeping crude off the
market since the price collapse in late 2008 that
enabled crude prices to recover to current levels.
What has perhaps been surprising is how stable
crude prices have been during much of 2010, at
least until recently. With hindsight, we suspect
that OPEC was helped by the strong recovery in
its efforts to help oil prices recover from around
USD40 in early 2009.
This meant that it was rarely called upon to
defend the oil price on the downside. So, OPEC
was normally faced with the relatively simple
Impact of feedstock price changes on EBITDA margins *
Company ________ 2012e__________ _________2013e _________ _________ 2014e _________ ________ 2015e _________ New Old New Old New Old New Old
APPC 35.4% 36.7% 33.2% 35.5% 36.3% 39.5% 37.5% 40.6% IQ 47.1% 47.1% 47.3% 47.3% 48.5% 48.5% 48.3% 48.3% Chemanol 47.3% 49.2% 46.4% 49.2% 44.1% 48.8% 43.7% 48.4% NIC 29.2% 29.7% 29.3% 30.2% 31.5% 33.0% 31.7% 33.1% Petrochem 43.8% 43.8% 42.9% 42.9% 46.3% 46.3% 46.4% 46.4% Sahara 37.4% 38.2% 37.7% 39.1% 40.3% 42.4% 41.0% 43.0% Safco 72.4% 76.0% 70.8% 75.8% 67.6% 75.5% 67.6% 75.5% SABIC 32.8% 33.6% 31.6% 32.9% 33.3% 35.3% 33.1% 35.1% SIIG 35.9% 36.1% 36.3% 36.6% 39.5% 39.9% 39.9% 40.3% Sipchem 53.2% 55.9% 52.5% 56.5% 49.0% 55.5% 49.1% 55.6% Kayan 54.4% 54.7% 53.0% 53.7% 54.8% 55.8% 54.3% 55.3% Yansab 51.0% 52.2% 48.9% 50.9% 51.1% 54.1% 51.0% 54.0%
Source: HSBC estimates, * assuming constant product prices
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Natural Resources and Energy Middle East Chemicals January 2011
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decision of how much additional crude to let on to
the market. Some short-term cuts in OPEC
production did prove necessary during 2010 but
they were small and normally only involved Saudi
Arabia taking an active role. At no stage was a
collaborative cut necessary.
With OPEC seemingly in control of the market, it
is in theory in a position to set the price. (In
reality, we believe it is more that its largest
producer, Saudi Arabia, is in a position to do so.)
What price does OPEC want?
At present therefore, the key question is what oil
price does OPEC (or Saudi Arabia) want?
Although there are a range of views (doves and
hawks) within OPEC as to what constitutes an
acceptable oil price, we believe that it is Saudi
Arabia that carries the most weight. It is the
largest producer in OPEC by a factor of two and
accounts for around 60% of spare capacity.
The hawks, including Venezuela, Iran and
Ecuador, seem to regard USD100-120/bbl as an
“adequate” price judging by their comments at the
recent OPEC meeting (14 December 2010).
However, it is Saudi Arabia that matters most, and
for the past 18 months its official policy has been
that oil prices in the USD70-80 range are
“acceptable”. We believe that the Kingdom
believed that this price range was:
Sufficient to fund the financial needs of most
OPEC members, including itself;
Low enough not to derail what appeared to be
a fragile economic recovery; and
Low enough not to encourage a rebound in
investment in non-OPEC projects or
efficiency measures that could take market
share from OPEC.
Move to USD70-90?
However, comments from Saudi Oil Minister Ali
al-Naimi in November implied that the target
band may have widened. On November 1, he
commented at a speech in Singapore that
“consumers are looking for oil prices around
USD70 but hopefully below USD90”.
Comments from the Kuwait Oil Minister echoed a
similar theme when Sheikh al-Abdullah al-Sabah
said after the December OPEC meeting that “we
would rather see it [the oil price] between USD75
and USD90.”
Although Naimi has subsequently reiterated that
Saudi Arabia still favours a USD70-80 price range
(13 December 2010), the lack of any comment
about action to lower prices has meant crude
prices have remained comfortably above the ‘old’
Saudi target range since early November.
Several members of OPEC, including Saudi
Arabia, commented since the OPEC meeting that
the crude market was balanced, the implication
presumably being that the move into a new range
was due to speculative activity.
Oil price assumptions (USD/bbl)
Brent 2010a 2011e 2012e 2013e
New 79.1 82 83 84 Old 79.1 76 77 78 Futures 92.6 92.4 92.1 WTI New 79.7 83 84 85 Old 79.7 77.2 77 78 Futures 91.1 91 90.2
Source: Bloomberg, HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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But another theme that has been articulated by
some OPEC members is that although nominal
prices are acceptable, real prices are not. We
believe this is a reference to the rise in soft
commodity prices, which OPEC members tend to
import. Having kept the oil price in a range that
many consumers and producers see as acceptable,
it is perhaps not surprising that some OPEC
members might feel aggrieved at such an upward
move in the price of their import bill.
Long-term competitive position?
Unlike some in OPEC, Saudi Arabia policy on oil
prices appears to take into account its long-term
competitive position (in addition to its short-term
funding requirements). In order to ensure that
future generations can benefit from its oil
reserves, it considers the impact its pricing
decisions might have on supply and demand in the
long term. The marginal costs of non-OPEC
production vary, but we believe the following are
reasonable guidelines.
Canadian tar sands (Greenfield): USD80-90/bbl.
US Gulf, Ultra Deepwater/Deep reservoir (eg
Paleogene): USD60-70/bbl.
US Gulf, Deepwater (eg Miocene): USD30-
40/bbl.
Brazil Presalt, Ultra Deepwater/Deep
reservoir: USD35-40/bbl.
We estimate that in aggregate, OPEC members
need around USD60-70/bbl to balance their
budgets. This means that OPEC is unlikely to be
able to back conventional deep-water projects out
of the market without some members suffering
short-term financial pressures.
However, tar sands projects could be deterred at
prices below USD90. It was noticeable during
2009 and early 2010 that few of these projects
made much progress towards taking a
development approval. From an OPEC
perspective, another reason for deterring tar sands
projects is that they have extremely long profiles
(40 years potentially). In addition, they do not
decline like conventional oil fields and so could
be considered a ‘perennial’ problem once
production starts.
We would also argue that it would make sense for
OPEC to set an upper limit to the oil price that did
not lead to major energy-efficiency initiatives or
substitution of oil by other energy sources.
We believe that USD90/bbl is probably an
important level in all these respects. In our view,
with prices below USD90/bbl, investment in new
tar sands projects will be constrained. In addition,
unless mandated by governments, we doubt the
trend to more efficient energy usage will
accelerate materially.
It may be that the trigger price is lower than
USD90/bbl. Total’s CEO commented in early
December that:
“USD70-80 starts to be a little bit low to invest in
these more difficult environments.”
(He was referring to Canadian tar sands and
deepwater, high-pressure, high-temperature
projects in the US Gulf of Mexico.)
We think therefore that there are very good
reasons for Saudi Arabia to try and limit any
increase in oil prices over USD90.
Supply demand balance
Demand reverting to trend?
Demand for crude products looks to us to have
increased by around 2MMbbl/d in 2010, the
fastest annual rate of growth since 2004. Unlike
2004, however, much of this increase seems due
to the ‘recapture’ of 2009’s ‘lost’ demand. We
expect 2011 to see lower growth of around
1.4MMbbl/d as the 2010 base benefited from
unusually cold winter weather. For 2012 and
beyond, we expect annual demand growth to
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Natural Resources and Energy Middle East Chemicals January 2011
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average around 1.7MMbbl/d. We see modest
growth within the OECD, with the main drivers of
growth being non-OECD Asia (especially China),
the Middle East and Latin America.
Supply growth rate to slow?
Non-OPEC supply (including bio-fuels), which
accounts for around 60% of global output, has
risen on average by around 0.5MMbbl/d since
2003. This is well below the 1.2MMbbl/d rise in
global demand. Although we believe 2010 is
likely to see non-OPEC output rise by around
1.3MMbbl/d, we believe the rate of growth will
slow in 2011 and beyond as decline rates
accelerate. Some new large projects in Brazil and
Kazakhstan should provide growth, but these are
needed to offset the underlying decline rate of the
non-OPEC base, which we believe is at least 5%
or 2.5MMbbl/d.
We therefore expect the amount of oil that the
market needs from OPEC will rise over the next
several years. Some of this growth is likely to be
met by natural gas liquids (NGLs) from OPEC
and biofuels, but the call for conventional crude
oil is still likely to rise in our view.
The call on OPEC crude rises steadily until 2015,
suggesting a tightening market.
OPEC capacity
At present, we believe that OPEC has spare capacity
of around 6MMbbl/d, although around 1MMbbl/d of
that may not be able to be produced at short notice or
may not be suitable for many of the world’s lower
quality refineries. According to the IEA, additional
OPEC capacity of around 1.5MMbbl/d is due on
stream by 2015, around two-thirds of that coming
from Iraq. However, the level of production from
Iraq is hard to predict as it depends on:
Investment in water injection facilities, crude
pipelines, storage and export terminals.
The pace of investment by the oil companies
that have signed production agreements with
the Iraqi government.
The sanctity of contracts (in the past, the
opposition has said it will revoke some
contracts).
Preventing insurgents from damaging
infrastructure or disrupting development work.
In theory, the contracts that Iraq has signed with
the oil industry have the potential to deliver peak
production of 12MMbbl/d some time around
2016-17. But the IEA estimate of 1.1MMbbl/d
added by 2015 suggests that the peak is unlikely
to be reached this decade, in our view.
However, the IEA estimate is likely to be too low,
in our opinion, as two of the projects, BP’s
Rumaila and ENI’s Zubair are making good
progress. These two projects are ahead of the
others and could reach their interim target of
OPEC production capacity (MMbbl/d) OPEC spare capacity (MMbbl/d)
28
30
32
34
36
38
2009 20 10 201 1 2 012 201 3 2014 2015
OPEC 10 Iraq
0
2
4
6
8
200 8 2009 2 010 e 20 11e 2012 e 2013 e 20 14e 2 015 e
Source: IEA, HSBC estimates Source: IEA, HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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producing 2.8MMbbl/d by the end of 2014, an
increase of 1.5MMbbl/d. We see Iraqi production
rising from 2.5MMbbl/d to 4MMb/d in 2015 with
new projects offsetting a natural decline rate of
around 500Mbbl/d over the period. (The level of
Iraqi output remains a key uncertainty for the
direction of the oil price in the longer term.)
We estimate that this would take OPEC’s overall
capacity from around 35MMbbl/d currently to
around 37MMbbl/d by 2015. This increase will
help meet some of the increase in demand that we
anticipate. However, there will still be a reduction
in OPEC’s spare capacity under our estimates.
Under this forecast, the amount of spare capacity
in OPEC falls close to that seen during the 2008
oil price spike. That does not necessarily mean
that we will see a repeat of USD150 oil prices as a
key factor in 2008 was a shortage of middle
distillate due to temporary issues. These included
the China Olympics, the cut-off of Argentine gas
supplies to Chile, and an explosion at a gas
processing plant in Western Australia. These
caused increased demand for diesel to fuel
portable power generators at a time of the year
when the refining system is geared up to produce
gasoline. Nevertheless, it seems to us that as we
progress towards mid-decade, the risks of a tighter
crude market developing increase.
Why USD82?
We believe that it is risky to assume that the Saudi
target of USD70-80 has definitely moved
upwards. The Kingdom’s response to price spikes
in the past has been subtle, a gradual increase in
production combined with quiet comments
regarding the level of oil prices it views as
acceptable.
We believe that there will be a gradual increase in
Saudi output if prices stay above USD90. But we
also believe that it makes sense for the Kingdom
to manoeuvre prices so that they sit in the top half
of its acceptable range. We would also note that
the two most common benchmark crudes, Brent
and WTI, are extra light crudes which trade at a
premium to the OPEC basket. The basket, which
is made up of a mix of crude with a range of
different gravities (densities), tends to trade at a
USD2-3/bbl discount to Brent.
Our USD82 assumption is therefore close to the
top end of the ‘official’ Saudi price target of
USD70-80 for the OPEC basket and the middle of
the ‘unofficial’ range of USD70-90.
Product price forecasts Our chemical product price forecasts are driven
by our ethylene supply/demand model and our
proprietary ethylene cost curve, which are used to
forecast ethylene prices. Our ethylene cost curve
is in turn driven by our oil and gas team's revised
crude price forecasts for 2011-15.
Given the importance of ethylene as a key
intermediate chemical, once we have our ethylene
price model and a few other raw material price
estimates, we can forecast prices for a suite of
downstream petrochemicals – polyethylenes,
polyesters, glycols and the styrene chains.
These products constitute the bulk of the product
portfolio for the MENA petrochemical universe
and the pricing table at the bottom of the next
page is the starting point for our financial models
as these prices, along with the installed capacity
base for each company, drive our top-line
forecasts.
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Margins are unique to each company as they vary
according to the price paid for feedstock, the product
portfolio and the location of capacity (SABIC has a
substantial non-Saudi capacity base). The net impact
of changes in both our product and feedstock pricing
forecasts are discussed individually in the company
sections that follow.
Changes to our valuation framework We use a DCF methodology to value the chemical
companies under our coverage and have updated
our risk free rate and country risk premium to
reflect the new HSBC Strategy team assumptions
(for more details see the note of 20 December
2010, Cost of Equity). Our updated assumptions
for Saudi include a 3.5% risk free rate and a 6%
country risk premium, which gives us a pre-beta
adjusted cost of equity of 9.5% vs. our earlier
estimate of 11%.
We also move to using stock specific betas vs. an
earlier sector beta assumption of 1. These stock
specific betas are based on a two year historical
correlation between the individual stock prices
and the Saudi Tadawul index and are listed on the
table at the top of the next page, along with our
new costs of equity for each company and the
changes to our WACC estimates.
For Industries Qatar, our updated assumptions for
Qatari cost of equity include a 3.5% risk free rate
and an 8% country risk premium, which gives us
a pre-beta adjusted cost of equity of 11.5% vs. our
earlier estimate of 11%. The beta calculation for
IQ is based on a two year historical correlation of
the stock price with the Qatari DSM Index.
We are also rolling forward all our DCF’s to 2011
start dates from 2010.
HSBC chemical product pricing assumptions
Product (USD/tonne) 2011e 2012e 2013e 2014e 2015e
ABS 2,656 2,666 2,733 2,816 2,790 Ammonia 375 375 375 375 375 Ammonium Phosphates 345 345 345 345 345 Benzene 872 838 873 933 998 Cumene 1,055 1,021 1,056 1,124 1,177 Cyclohexane 981 976 1,015 1,076 1,151 Ethylene 1,050 1,108 1,108 1,246 1,246 Ethylene Dichloride 613 636 633 671 669 Ethylene Glycol 717 750 752 829 831 HDPE 1,352 1,415 1,420 1,563 1,569 LDPE 1,373 1,437 1,443 1,588 1,594 LLDPE 1,377 1,436 1,440 1,573 1,578 Methanol 328 332 336 340 344 Mixed Xylenes 823 776 782 813 837 PET 1,232 1,180 1,277 1,404 1,631 Phenol 1,172 1,219 1,259 1,337 1,406 Polycarbonate 2,529 2,539 2,603 2,682 2,657 Polyester Fiber 1,215 1,294 1,408 1,514 1,547 Propylene 1,194 1,159 1,187 1,265 1,289 Polypropylene 1,400 1,417 1,434 1,451 1,468 Polystyrene 1,200 1,281 1,314 1,406 1,461 PVC 973 1,086 1,081 1,155 1,192 Urea 350 350 350 350 350 MTBE 777 769 789 814 830 Acrylic acid 1,613 1,571 1,605 1,698 1,727 VCM 779 869 865 924 953 Butanediol 2,084 2,126 2,147 2,169 2,190 Acetic acid 605 607 609 612 614 VAM 912 936 937 991 992
Source: HSBC estimates
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Changes to our cost of equity and WACC
RfR ERP Adjusted Beta New CoE Old WACC New WACC
SABIC 3.50% 6.00% 1.47 12.32% 9.43% 9.78% SAFCO 3.50% 6.00% 0.8 8.30% 9.95% 7.24% Yansab 3.50% 6.00% 1.39 11.84% 7.86% 8.66% Kayan 3.50% 6.00% 1.19 10.64% 7.80% 7.71% IQ 3.50% 8.00% 1.11 12.38% 10.00% 11.10% Sipchem 3.50% 6.00% 1.09 10.04% 9.10% 8.47% Sahara 3.50% 6.00% 1.35 11.60% 8.90% 9.27% APC 3.50% 6.00% 1.22 10.82% 8.90% 8.73% Tasnee 3.50% 6.00% 1.25 11.00% 9.10% 9.14% SIIG 3.50% 6.00% 1.17 10.52% 8.90% 8.52% Petrochem 3.50% 6.00% 1.19 10.64% 8.90% 8.60% Chemanol 3.50% 6.00% 1.08 9.98% 9.10% 8.14%
Source: Bloomberg, HSBC estimates
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Why is SABIC different
SABIC has three key differentiators, which set it
apart from the rest of the Middle Eastern chemical
industry: a diverse product portfolio, a fully-
owned supply chain and marketing platform and
direct exposure to developed markets.
SABIC’s product portfolio spans the entire range
from basic commodity chemicals to ‘differentiated
commodities’, unlike other companies in the region
which are mostly focussed on one or two product
chains. This broad range allows SABIC
opportunities to integrate downstream that are not
available to other companies with the sector. SABIC
also has a fully developed in-house supply chain and
distribution system, and a global distribution
footprint, which allows the company to maximise
netbacks on its production. Furthermore, as the only
regional company with significant asset exposure to
the US and Europe, SABIC should benefit through
2011 from an improving fundamental environment
within developed markets.
2011: What to expect
Volume Growth: SABIC should be one of the
few chemical companies in the region to see
volume growth in 2011, as its affiliate Saudi
Kayan (35% stake) is expected to start
commercial production by H2 2011. Kayan is by
far the biggest plant that SABIC has ever built,
and should be a key contributor to the company’s
revenue and earnings growth in 2011.
Heading back to normality at SIP: SABIC’s
Innovative Plastics business (SIP) which was
acquired from GE Plastics in 2007 has been a drag
on the company’s results for the last couple of years.
At its peak though, the unit had EBITDA of
cUSD1bn on an annual basis and we estimate that
the business could return towards those levels of
earnings by the end of the year from current levels of
SABIC
Operating leverage in 2011 from improving fundamentals at the
Innovative Plastics unit
Volume growth from commercial production at Saudi Kayan
Reiterate Overweight (V) rating, raising target price to SAR130
from SAR110
SABIC: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 184,404 164,399 196,223 168,480 198,439 170,492 EBITDA 57,240 52,978 62,651 57,753 62,815 58,342 Net Income 26,845 23,700 31,805 27,300 32,237 27,900 EPS 8.95 7.90 10.60 9.10 10.75 9.30 EBITDA Margin 31.0% 32.2% 31.9% 34.3% 31.7% 34.2% Net Margin 14.6% 14.4% 16.2% 16.2% 16.2% 16.4%
Source: HSBC estimates
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cUSD200m. Bayer has a MaterialScience business
which is similar in assets and geographic spread to
SIP and in its Q3 2010 earnings release, Bayer stated
that it expected its unit to be back to pre-crisis
earnings levels by the end of 2011, much earlier than
previous expectations. We would expect to see a
similar improvement in earnings at SIP which would
be a key driver of SABIC’s y-o-y earnings growth in
2011.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts, and the update to our cost of equity
assumptions as explained earlier. The changes to our
financial forecasts are detailed in the table at the
bottom of the previous page.
Valuation and risks Valuation
Our preferred methodology for valuing commodity
chemical companies is DCF. In our DCF valuation
we model cash flows and EBITDA explicitly up to
2015, after which we build in semi-explicit cash
flow forecasts running off a sales growth assumption
and a profitability metric through to 2018.
Thereafter, we move to a terminal valuation phase.
For our WACC calculation, we have updated our
assumptions for the risk free rate and country risk
premium to reflect the new HSBC Strategy team
assumptions. These changes have been detailed
earlier in the note. Our new cost of equity for
SABIC is 12.3% (vs. 11% earlier) and includes a
risk free rate of 3.5%, a market risk premium of 6%
and a beta of 1.47.
We are lowering our cost of debt to 4% from 6%
earlier to reflect the most recent SABIC bond
issuance in October 2010 which was priced at
165bps over benchmark mid-swaps of 2.17% i.e. at
3.8%. This cost of debt assumption and a 30% debt
weighting (unchanged) lead to our WACC estimate
of 9.78% (up from 9.43%). Under our research
model, for stocks with a volatility indicator, the
Neutral band is 10 percentage points above and
below the hurdle rate for Saudi stocks of 9.5%.
Our new DCF-derived target price for SABIC is
SAR130 (vs SAR110 previously) and implies a
21% potential return from current levels. This is
above the Neutral band of our ratings model, so we
maintain our Overweight (V) rating on the stock.
Risks
Cyclicality: All of SABIC’s products are
commodity products, whose earnings are inherently
cyclical and driven by industry operating rates and
supply/demand fundamentals. Although we would
argue that the cycle for each product is different and
so provides a degree of offset, there is no denying
that earnings are linked to global GDP growth as
well as being affected by supply cycles for the
products themselves.
Operating risks: In addition to normal business
risk in the petrochemicals market, we see other
potential risks that are more difficult to assess, both
in terms of probability and effect. Such risks
include interruption to production from operating
problems or explosions. As the bulk of SABIC’s
production is based in Saudi Arabia, some
investors may associate it with increased risk of
political strife. However, the more practical,
everyday issue is the normal risk attached to a
production process involving potentially explosive
hydrocarbons – an area in which global standards
of health and safety are rigorously applied.
Kayan start-up: Saudi Kayan is expected to start
commercial operations in 2011 and should
generate a key part of SABIC’s earnings growth
this year. There are typically some teething
problems during the start-up phase of a greenfield
project. Any such operational issues at Kayan
would represent a downside risk to our
Overweight (V) rating on SABIC.
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Financials & valuation: Saudi Basic Industries Co Overweight (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 103,092 152,529 184,404 196,223EBITDA 28,536 47,669 57,240 62,651Depreciation & amortisation -9,933 -10,120 -11,728 -12,255Operating profit/EBIT 18,603 37,550 45,512 50,396Net interest -3,076 -3,635 -3,057 -2,532PBT 17,085 35,001 43,455 48,864HSBC PBT 17,085 35,001 43,455 48,864Taxation -800 -2,163 -1,738 -1,955Net profit 9,062 21,577 26,845 31,805HSBC net profit 9,062 21,577 26,845 31,805
Cash flow summary (SARm)
Cash flow from operations 25,876 51,997 48,891 57,477Capex -24,158 -11,154 -11,656 -12,181Cash flow from investment -22,884 -11,154 -11,656 -12,181Dividends -3,750 -10,800 -13,350 -15,900Change in net debt 7,211 -18,781 -9,013 -14,291FCF equity -263 39,756 36,235 44,296
Balance sheet summary (SARm)
Intangible fixed assets 21,734 21,734 21,734 21,734Tangible fixed assets 159,988 161,023 160,951 160,876Current assets 108,030 115,317 122,479 129,646Cash & others 57,122 65,903 64,916 69,207Total assets 296,232 304,553 311,644 318,736Operating liabilities 36,961 44,506 48,101 49,289Gross debt 107,015 97,015 87,015 77,015Net debt 49,892 31,112 22,099 7,808Shareholders funds 108,243 119,020 132,514 148,419Invested capital 195,669 187,665 192,147 193,761
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -31.6 48.0 20.9 6.4EBITDA -38.8 67.1 20.1 9.5Operating profit -49.2 101.8 21.2 10.7PBT -54.2 104.9 24.2 12.4HSBC EPS -58.9 138.1 24.4 18.5
Ratios (%)
Revenue/IC (x) 0.5 0.8 1.0 1.0ROIC 9.4 18.4 23.0 25.1ROE 8.6 19.0 21.3 22.6ROA 6.8 12.1 14.5 15.7EBITDA margin 27.7 31.3 31.0 31.9Operating profit margin 18.0 24.6 24.7 25.7EBITDA/net interest (x) 9.3 13.1 18.7 24.7Net debt/equity 32.9 19.2 12.6 4.1Net debt/EBITDA (x) 1.7 0.7 0.4 0.1CF from operations/net debt 51.9 167.1 221.2 736.1
Per share data (SAR)
EPS Rep (fully diluted) 3.02 7.19 8.95 10.60HSBC EPS (fully diluted) 3.02 7.19 8.95 10.60DPS 1.70 3.60 4.45 5.30Book value 36.08 39.67 44.17 49.47
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 3.5 2.3 1.8 1.6EV/EBITDA 12.8 7.3 5.9 5.2EV/IC 1.9 1.8 1.8 1.7PE* 35.5 14.9 12.0 10.1P/Book value 3.0 2.7 2.4 2.2FCF yield (%) -0.1 12.6 11.5 14.1Dividend yield (%) 1.6 3.4 4.1 4.9
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 107.25 Target price (SAR) 130.00 Potent'l return (%) 21.2
Reuters (Equity) 2010.SE Bloomberg (Equity) SABIC ABMarket cap (USDm) 85,904 Market cap (SARm) 321,750Free float (%) 30 Enterprise value (SARm) 346382Country Saudi Arabia Sector ChemicalsAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
2434445464748494
104114
2009 2010 2011 2012
2434445464748494104114
Saudi Basic Industries Co Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Earnings power demonstrated
Yansab is a single-project company, with no
exposure to capacity growth beyond the ramp-up of
existing production facilities. Given limited growth
opportunities and minimal maintenance capex – the
plant is less than a year old – we believe Yansab is
an exceptional cash generation story.
The company started commercial operations in
March 2010 and had EBITDA margins of 51% for
the first three quarters of 2010. We estimate that
the company will generate EBITDA of SAR4.4bn
in 2011, with free cash flow net of interest
expense and maintenance capex of SAR3.3bn.
This, compared to the current market
capitalisation of SAR27.2bn, represents a free
cash flow yield of c12%.
We believe that with the earnings power of the
company demonstrated, the start-up discount on
the stock should be eliminated as execution and
project start-up risks start are reduced.
2011: What to expect
Robust MEG pricing: We expect MEG prices to
continue to benefit from the current record levels
of price delta between cotton and polyester fibre.
The current price delta between cotton and
polyester fibre stands at USD1,780/tonne – over
5.2x the average of the differential between 2000
and 2009, which should spur greater polyester
demand. This substitution demand drives pricing
for the raw materials used to make polyester such
as paraxylene MEG. For details see our 5 January
2011 note, 2011: Year of the rabbit. Yansab has
the greatest exposure to rising MEG prices within
our coverage. A USD100/tonne change in MEG
prices has a SAR0.44 impact on Yansab’s EPS.
Cash returns: 2011 will be the first full year of
operations for Yansab. We believe that since
Yansab will not have further avenues of growth
through expansion, the focus will shift to cash
returns, as the company’s earning power is fully
demonstrated. The firm’s cash generation ability
Yansab
MEG prices expected to remain robust in the medium term
Focus to shift to cash returns
Reiterate Overweight (V) rating, maintain target price of SAR65
Yansab: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 7,808 7,756 8,819 8,185 8,926 8,232 EBITDA 3,987 3,687 4,397 4,103 4,372 4,114 Net Income 2,526 1,918 2,911 2,405 2,869 2,492 EPS 4.49 3.41 5.18 4.28 5.10 4.43 EBITDA Margin 51.1% 47.5% 49.9% 50.1% 49.0% 50.0% Net Margin 32.3% 24.7% 33.0% 29.4% 32.1% 30.3%
Source: HSBC estimates
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should allow ample room for substantial cash
returns to shareholders along with debt
repayment.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the previous page.
Valuation and risks Valuation
Our preferred methodology for valuing
commodity chemical companies is DCF. In our
DCF valuation we model cash flows and EBITDA
explicitly up to 2015, after which we build in
semi-explicit cash flow forecasts running off a
sales growth assumption and a profitability metric
through to 2018. Thereafter, we move to a
terminal valuation phase.
Our new cost of equity for Yansab is 11.8% (vs.
11% earlier) and includes a risk free rate of 3.5%,
a market risk premium of 6% and a beta of 1.39.
We are lowering our cost of debt for Yansab to 4%
from 6% earlier to reflect the current annualised
interest rate that Yansab currently pays (3.6%). This
cost of debt assumption and a 40% debt weighting
(unchanged) lead to our WACC estimate of 8.66%
(up from 7.86%).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our DCF-derived target
price for the company of SAR65 implies a 40%
potential return from current levels, which is
above the Neutral band of our model, so we
maintain our Overweight (V) rating on the stock.
Risks
Plant shutdown: Yansab began commercial
operations in Q1 2010, and any design or equipment
issues tend to manifest themselves during the first
year of operations. Though there were no major
problems in 2010, the company had a two-week
shutdown due to technical issues in Q3 2010. Any
further production problems would hurt Yansab’s
earnings in 2011 and would represent a downside
risk to our Overweight (V) rating on the stock.
MEG pricing: MEG prices were up 41% y-o-y in
2010, as the interfibre substitution between cotton
and polyester, due to high cotton prices, helped
propel MEG prices upwards. Though we believe
MEG prices will remain strong in the medium
term, they represent a downside risk to our
Overweight (V) rating on the stock, due to the
high sensitivity of Yansab’s bottom-line to these
prices.
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Financials & valuation: Yanbu Petrochemical Overweight (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 0 5,910 7,808 8,819EBITDA -29 2,998 3,987 4,397Depreciation & amortisation 0 -938 -947 -961Operating profit/EBIT -29 2,060 3,040 3,436Net interest 0 -373 -450 -450PBT -29 1,687 2,590 2,986HSBC PBT -29 1,687 2,590 2,986Taxation 0 -42 -65 -75Net profit -29 1,645 2,526 2,911HSBC net profit -29 1,645 2,526 2,911
Cash flow summary (SARm)
Cash flow from operations -1,787 3,065 3,201 3,728Capex -1,471 -174 -188 -284Cash flow from investment -1,455 -174 -188 -284Dividends 0 -489 -759 -878Change in net debt 3,242 -2,402 -2,254 -2,566FCF equity -3,258 2,891 3,014 3,444
Balance sheet summary (SARm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 18,916 18,152 17,393 16,716Current assets 2,208 2,333 3,775 5,376Cash & others 606 932 1,966 3,311Total assets 21,124 20,485 21,168 22,092Operating liabilities 845 1,126 1,263 1,374Gross debt 14,611 12,536 11,315 10,094Net debt 14,006 11,604 9,349 6,783Shareholders funds 5,668 6,824 8,590 10,623Invested capital 19,673 18,427 17,939 17,407
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue 32.1 12.9EBITDA 33.0 10.3Operating profit 47.6 13.0PBT 53.5 15.3HSBC EPS 53.5 15.3
Ratios (%)
Revenue/IC (x) 0.0 0.3 0.4 0.5ROIC -0.2 10.5 16.3 19.0ROE -0.5 26.3 32.8 30.3ROA -0.1 9.7 14.2 15.5EBITDA margin 0.0 50.7 51.1 49.9Operating profit margin 0.0 34.9 38.9 39.0EBITDA/net interest (x) 8.0 8.9 9.8Net debt/equity 247.1 170.1 108.8 63.9Net debt/EBITDA (x) -479.5 3.9 2.3 1.5CF from operations/net debt 26.4 34.2 55.0
Per share data (SAR)
EPS Rep (fully diluted) -0.05 2.92 4.49 5.18HSBC EPS (fully diluted) -0.05 2.92 4.49 5.18DPS 0.00 0.87 1.35 1.56Book value 10.08 12.13 15.27 18.89
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 6.4 4.5 3.7EV/EBITDA 12.6 8.9 7.5EV/IC 2.0 2.0 2.0 1.9PE* 15.8 10.3 8.9P/Book value 4.6 3.8 3.0 2.5FCF yield (%) -12.5 11.1 11.6 13.2Dividend yield (%) 0.0 1.9 2.9 3.4
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 46.30 Target price (SAR) 65.00 Potent'l return (%) 40.4
Reuters (Equity) 2290.SE Bloomberg (Equity) YANSAB ABMarket cap (USDm) 6,953 Market cap (SARm) 26,044Free float (%) 40 Enterprise value (SARm) 37648Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
10152025303540455055
2009 2010 2011 2012
10152025303540455055
Yanbu Petrochemical Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Diversified portfolio Tasnee is a holding company with interests in
petrochemicals and manufacturing. The
petrochemicals business, which accounts for over
85% of the company’s revenues, is made up of
investments in Cristal (66% stake, TiO2), Saudi
Polyolefins (75% stake, polypropylene plant), SEPC
(45.3% stake, 1mtpa integrated ethylene cracker),
and SAMC (44.5%, integrated acrylics plant,
scheduled to come onstream in Q3 2012). The
manufacturing business consists of a number of
small scale battery, packaging and services
businesses and accounts for c15% of Tasnee’s
revenue.
2011: What to expect
Strong TiO2 market: We expect strong pricing
power within the TiO2 segment for the next 12-18
months, as the TiO2 market should remain
undersupplied well into 2012, given the lead times
for adding new capacity. This segment constitutes
35% of Tasnee’s earnings and will be a key
contributor to the company’s earnings in 2011.
For more details, see our 1 November 2010 note,
Tasnee: Painting a stronger picture.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts, and the update to our cost of equity
assumptions as explained earlier. The changes to our
financial forecasts are detailed in the table at the
bottom of the page.
Tasnee
We see strong pricing power within the TiO2 segment for the next
12-18 months
Leverage to TiO2 pricing to drive earnings growth in 2011
Reiterate Overweight (V) rating and raise target price form SAR40
to SAR44
Tasnee: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 17,051 18,614 16,304 17,695 17,697 18,853 EBITDA 4,903 4,785 4,503 4,278 5,123 4,806 Net Income 1,865 1,761 1,833 1,636 2,325 2,045 EPS 3.68 3.47 3.62 3.23 4.59 4.03 EBITDA Margin 28.8% 25.7% 27.6% 24.2% 29.0% 25.5% Net Margin 10.9% 9.5% 11.2% 9.2% 13.1% 10.8%
Source: HSBC estimates
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Valuation and risks Valuation
Our cost of equity for Tasnee is unchanged at
11% and includes a risk free rate of 3.5%, a
market risk premium of 6% and a beta of 1.25.
We use a 5% cost of debt assumption and a 30%
debt weighting (both unchanged) which yields a
WACC estimate of 9.14%.
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR44 (vs
SAR40 previously) implies a 31% potential return
from current levels, which is above the Neutral
band of our model, so we maintain our
Overweight (V) rating on the stock.
Risks
Project delays: SAMC is currently in the
construction phase and is scheduled for
commissioning in Q3 2012. We are, however,
assuming a 2013 start-up. Any delays would have
a negative impact on our valuation for Tasnee.
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Financials & valuation: National Industrialization Overweight (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 10,863 16,676 17,051 16,304EBITDA 2,477 4,677 4,903 4,503Depreciation & amortisation -983 -1,392 -1,249 -1,268Operating profit/EBIT 1,494 3,285 3,654 3,235Net interest -625 -706 -513 -388PBT 1,064 2,730 3,320 3,033HSBC PBT 1,064 2,730 3,320 3,033Taxation -92 -31 -133 -121Net profit 519 1,509 1,865 1,833HSBC net profit 519 1,509 1,865 1,833
Cash flow summary (SARm)
Cash flow from operations 491 6,605 4,386 4,279Capex -2,616 -941 -1,021 -1,023Cash flow from investment -1,790 -862 -1,021 -1,023Dividends -461 -760 -937 -912Change in net debt 1,441 -4,983 -2,428 -2,345FCF equity -2,192 5,512 3,186 3,071
Balance sheet summary (SARm)
Intangible fixed assets 3,697 3,697 3,697 3,697Tangible fixed assets 18,505 18,200 17,972 17,727Current assets 9,867 12,076 11,822 11,084Cash & others 3,585 6,333 5,935 5,378Total assets 33,168 34,993 34,511 33,528Operating liabilities 5,581 7,557 7,651 7,569Gross debt 16,015 13,779 10,954 8,053Net debt 12,429 7,447 5,019 2,674Shareholders funds 7,790 8,539 9,466 10,387Invested capital 22,903 20,084 19,906 19,561
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue 8.2 53.5 2.2 -4.4EBITDA 41.0 88.8 4.8 -8.1Operating profit 53.2 119.9 11.2 -11.5PBT 51.3 156.6 21.6 -8.6HSBC EPS -13.6 164.1 23.6 -1.7
Ratios (%)
Revenue/IC (x) 0.5 0.8 0.9 0.8ROIC 6.4 15.1 17.5 15.7ROE 6.9 18.5 20.7 18.5ROA 4.7 9.9 10.6 9.7EBITDA margin 22.8 28.0 28.8 27.6Operating profit margin 13.8 19.7 21.4 19.8EBITDA/net interest (x) 4.0 6.6 9.6 11.6Net debt/equity 108.5 55.6 32.1 15.2Net debt/EBITDA (x) 5.0 1.6 1.0 0.6CF from operations/net debt 3.9 88.7 87.4 160.0
Per share data (SAR)
EPS Rep (fully diluted) 1.13 2.98 3.68 3.62HSBC EPS (fully diluted) 1.13 2.98 3.68 3.62DPS 0.56 1.50 1.85 1.80Book value 16.91 16.85 18.68 20.50
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 3.0 1.7 1.6 1.6EV/EBITDA 13.2 6.2 5.7 5.9EV/IC 1.4 1.4 1.4 1.4PE* 29.7 11.2 9.1 9.3P/Book value 2.0 2.0 1.8 1.6FCF yield (%) -10.8 25.7 14.0 12.9Dividend yield (%) 1.7 4.5 5.5 5.4
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 33.50 Target price (SAR) 44.00 Potent'l return (%) 31.3
Reuters (Equity) 2060.SE Bloomberg (Equity) NIC ABMarket cap (USDm) 4,532 Market cap (SARm) 16,976Free float (%) 80 Enterprise value (SARm) 28876Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
8
13
18
23
28
33
38
2009 2010 2011 2012
8
13
18
23
28
33
38
National Industrializatio Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Downgrading on disappointing execution, continued delays We are downgrading Sahara to Neutral (V) from
Overweight (V) due to the disappointing
execution on the Al Waha project, which has
resulted in a reduction in our target price. The trial
run at Al Waha began in April 2009 with
commercial operations scheduled to start from Q4
2009. However the commercial start-up has been
delayed several times, and is now scheduled for
the end of Q1 2011. Al Waha now accounts for
c40% of our valuation for Sahara and the repeated
delays coupled with continued start up risks has
resulted in an assumption of lower operating rates
and value for the asset. We reduce our target price
for Sahara from SAR30 per share to SAR25.
2011: What to expect
Al-Waha start-up: Commercial operations at Al-
Waha are now scheduled to begin at the end of Q1
2011. A successful start-up would help reduce
some of the execution risk associated with the
project as well as drive earnings and revenue
growth for the company.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts, and the update to our cost of equity
assumptions as explained earlier. The changes to our
financial forecasts are detailed in the table at the
bottom of the page.
Sahara Petrochemical Co.
Execution on Al Waha disappointing with multiple start-up delays
Cutting operating rate assumptions for Al Waha due to continued
execution risks
Downgrade to Neutral (V), reducing target price from SAR30 to
SAR25
Sahara: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 1,122 2,071 2,397 2,188 2,975 2,842 EBITDA 359 587 764 635 994 980 Net Income 524 546 493 469 647 654 EPS 1.79 1.87 1.68 1.60 2.21 2.23 EBITDA Margin 32.0% 28.4% 31.9% 29.0% 33.4% 34.5% Net Margin 46.7% 26.4% 20.6% 21.4% 21.7% 23.0%
Source: HSBC estimates
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Valuation and risks Valuation
We use a DCF to value Sahara. Our new cost of
equity for Sahara is 11.6% (vs. 11% previously)
and includes a risk free rate of 3.5%, a market risk
premium of 6% and a beta of 1.35. We use a 4%
cost of debt assumption and a 30% debt weighting
(both unchanged) which yields a WACC estimate
of 9.27% (vs. 8.9% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR25 (SAR30
previously) implies a 12% potential return from
current levels, which is within the Neutral band of
our model. We therefore downgrade our rating on
the stock to Neutral (V) from Overweight (V)
Risks
Plant start-up delays: Sahara has yet to start
commercial production at its Al Waha
polypropylene unit. Initially expected to start in
Q4 2009, the plant has faced delays on technical
issues. Management expects the plant to finally
commence commercial production at the end of
Q1 2011. Any further delay to the start-up of the
facility represents a downside risk to our rating
while a sooner-than-expected or more successful
start-up would represent upside risks to our
Neutral (V) rating.
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Financials & valuation: Sahara Petrochemical Co. Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 0 0 1,122 2,397EBITDA -83 -7 359 764Depreciation & amortisation 0 0 -144 -213Operating profit/EBIT -83 -7 215 551Net interest 0 0 -107 -162PBT 78 394 614 758HSBC PBT 78 394 614 758Taxation -1 -5 -25 -30Net profit 77 389 524 493HSBC net profit 77 389 524 493
Cash flow summary (SARm)
Cash flow from operations -238 200 583 771Capex -634 -722 -741 -411Cash flow from investment -815 -722 -741 -411Dividends -38 -190 -263 -249Change in net debt 627 797 421 -112FCF equity -622 -923 -664 -9
Balance sheet summary (SARm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 4,170 4,892 5,489 5,687Current assets 791 644 919 1,675Cash & others 555 484 409 767Total assets 5,980 6,554 7,427 8,380Operating liabilities 351 0 201 429Gross debt 2,276 3,002 3,348 3,594Net debt 1,721 2,518 2,939 2,827Shareholders funds 2,945 3,144 3,405 3,649Invested capital 4,055 5,051 5,798 6,166
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -100.0 113.6EBITDA 113.2Operating profit 156.3PBT 405.1 55.6 23.6HSBC EPS 406.9 34.6 -5.9
Ratios (%)
Revenue/IC (x) 0.0 0.0 0.2 0.4ROIC -2.4 -0.2 3.8 8.8ROE 3.3 12.8 16.0 14.0ROA 1.4 6.2 9.9 11.2EBITDA margin 0.0 0.0 32.0 31.9Operating profit margin 0.0 0.0 19.2 23.0EBITDA/net interest (x) 3.4 4.7Net debt/equity 51.5 71.2 76.1 65.1Net debt/EBITDA (x) -20.8 -343.3 8.2 3.7CF from operations/net debt 8.0 19.8 27.3
Per share data (SAR)
EPS Rep (fully diluted) 0.26 1.33 1.79 1.68HSBC EPS (fully diluted) 0.26 1.33 1.79 1.68DPS 0.13 0.65 0.90 0.85Book value 10.07 10.75 11.64 12.47
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 7.9 3.8EV/EBITDA 24.8 11.8EV/IC 1.9 1.7 1.5 1.5PE* 85.0 16.8 12.5 13.2P/Book value 2.2 2.1 1.9 1.8FCF yield (%) -10.6 -15.7 -11.1 -0.2Dividend yield (%) 0.6 2.9 4.0 3.8
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 22.30 Target price (SAR) 25.00 Potent'l return (%) 12.1
Reuters (Equity) 2260.SE Bloomberg (Equity) SPC ABMarket cap (USDm) 1,742 Market cap (SARm) 6,523Free float (%) 33 Enterprise value (SARm) 8415Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
7
12
17
22
27
32
2009 2010 2011 2012
7
12
17
22
27
32
Sahara Petrochemical Co. Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Strong recent performance limits upside Petrochem shares are up 48% since the start of
2010, while SIIG has been flat over the same
period. This has closed the valuation disconnect
between the two companies flagged in our April
2010 note, Shifting into focus, which was the
primary driver for our buy case on Petrochem.
Given recent gains we believe that there is limited
upside from current levels, particularly as the start
of commercial operations, which could be the
next catalyst for the stock, is at least six to nine
months away. We maintain our target price of
SAR25 and downgrade the stock to Neutral (V)
from Overweight (V).
2011: What to expect
Start of commercial operations: Petrochem
expects Saudi Polymers to begin commercial
operations in Q3 2011. We are, however,
assuming a 2012 start-up in our estimates. The
beginning of commercial operations will be the
driving factor for Petrochem in the medium term.
As revenues and earnings start to flow through,
the earnings power of the company should be
demonstrated and help reduce the execution risk
typically associated with a greenfield project.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
National PetrochemicalCompany (Petrochem)
Strong recent performance and catch-up in valuation versus SIIG
limits Petrochem’s upside from current levels
Start-up of Saudi Polymers should be the next catalyst
Downgrade to Neutral (V), maintain target price of SAR25
Petrochem: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 0 0 6,924 6,960 8,884 8,872 EBITDA -10 -10 2,794 2,952 3,604 3,766 Net Income -29 -9 611 707 1,130 1,228 EPS -0.06 -0.02 1.27 1.47 2.35 2.56 EBITDA Margin NA NA 40.4% 42.4% 40.6% 42.4% Net Margin NA NA 8.8% 10.2% 12.7% 13.8%
Source: HSBC estimates
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with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the previous page.
Valuation and risks Valuation
We use a DCF to value Petrochem. Our new cost
of equity for Petrochem is 10.6% (vs. 11%
previously) and includes a risk free rate of 3.5%, a
market risk premium of 6% and a beta of 1.19.
We use a 4% cost of debt assumption and a 30%
debt weighting (both unchanged) which yields a
WACC estimate of 8.6% (vs. 8.9% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our DCF-derived target
price for the company of SAR25 implies a 7%
potential return from current levels, which is
within the Neutral band of our model. We
therefore downgrade our rating on the stock to
Neutral (V) from Overweight (V)
Risks
Saudi Polymers start-up: There are typically
some teething problems during the start-up phase
of a greenfield project. As Saudi Polymers is
Petrochem’s only asset, any operational delay in
the Saudi Polymers project would have a
significant negative impact on our earnings
estimates and valuation for the company, and
represents a downside risk. Conversely a faster
than expected start-up represents an upside risk to
our Neutral (V) rating.
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Financials & valuation: National Petrochemical Co Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 0 0 0 6,924EBITDA -9 -9 -10 2,794Depreciation & amortisation -14 0 0 -1,084Operating profit/EBIT -23 -9 -10 1,710Net interest -1 -1 -1 -708PBT -9 -11 -11 1,002HSBC PBT -9 -11 -11 1,002Taxation -53 -90 -20 -40Net profit -60 -99 -29 611HSBC net profit -60 -99 -29 611
Cash flow summary (SARm)
Cash flow from operations 655 -97 -31 1,122Capex -9,012 -5,000 -5,500 -217Cash flow from investment -9,092 -5,000 -5,500 -217Dividends 0 0 0 -153Change in net debt 5,097 5,531 -753FCF equity -8,426 -5,097 -5,531 905
Balance sheet summary (SARm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 11,170 16,170 21,670 20,804Current assets 3,276 2,676 1,645 3,861Cash & others 3,272 2,675 1,645 2,397Total assets 14,581 18,980 23,449 24,799Operating liabilities 967 967 967 1,508Gross debt 8,712 13,212 17,712 17,712Net debt 5,440 10,536 16,067 15,314Shareholders funds 4,757 4,659 4,629 5,088Invested capital 10,208 15,204 20,704 20,760
Ratio (%)
Revenue/IC (x) 0.0 0.0 0.0 0.3ROIC -3.1 -0.7 -0.2 7.9ROE -2.5 -2.1 -0.6 12.6ROA -0.7 -0.5 -0.1 6.8EBITDA margin 0.0 0.0 0.0 40.4Operating profit margin 0.0 0.0 0.0 24.7EBITDA/net interest (x) 3.9Net debt/equity 112.2 221.9 340.6 277.1Net debt/EBITDA (x) -627.4 -1157.4 -1680.9 5.5CF from operations/net debt 12.0 7.3
Per share data (SAR)
EPS Rep (fully diluted) -0.13 -0.21 -0.06 1.27HSBC EPS (fully diluted) -0.13 -0.21 -0.06 1.27DPS 0.00 0.00 0.00 0.32Book value 9.91 9.71 9.64 10.60
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 3.9EV/EBITDA 9.6EV/IC 1.6 1.4 1.3 1.3PE* 18.3P/Book value 2.4 2.4 2.4 2.2FCF yield (%) -74.6 -45.1 -49.0 7.8Dividend yield (%) 0.0 0.0 0.0 1.4Note: * = Based on HSBC EPS (fully diluted) Issuer information
Share price (SAR) 23.35 Target price (SAR) 25.00 Potent'l return (%) 7.1
Reuters (Equity) 2002.SE Bloomberg (Equity) 3569689Z ABMarket cap (USDm) 2,992 Market cap (SARm) 11,208Free float (%) 17 Enterprise value (SARm) 21834Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
1113151719212325
2009 2010 2011 20121113151719212325
National Petrochemical Co Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Pure-play polypropylene producer APC is a pure-play polypropylene (PP) producer.
It has the highest leverage to polypropylene prices
within our coverage universe as it is one of the
few Saudi companies whose feedstock is entirely
linked to crude prices and therefore its margins
vary depending upon the change in polypropylene
and crude prices.
As a single plant entity the growth options for APC
are fairly limited. The company has paid out c98%
of its earnings as dividends for 2009- H1 2010.
2011: What to expect
Price leverage: APC has a high structural
leverage to PP prices. A rising crude oil price
scenario typically implies rising PP, as well as
naphtha, prices (as a rule of thumb, a USD1/bbl
change in the crude oil prices translates into a
USD9/tonne change in the naphtha price and a
USD20/tonne change in the polypropylene price),
leading to margin expansion/contraction for APC
depending on the direction of the change. We
expect APC to benefit from rising crude prices in
the near term.
Dividend policy: APC has paid out close to 100%
of its earnings as dividends for 2009 and H1 2010.
As a single plant entity, APC has limited options
for expansion. If no expansion takes place, we
believe the company will continue to maintain its
high dividend payout ratio.
Advanced Petrochemical Company (APC)
Significant leverage to higher polypropylene prices and a strong
dividend yield play
Firm fundamentals mostly priced in at current levels
Maintain Neutral (V) rating and target price of SAR30
APC: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 2,053 2,131 2,100 2,144 2,149 2,155 EBITDA 620 665 624 677 633 689 Net Income 365 395 367 419 384 439 EPS 2.58 2.79 2.60 2.97 2.72 3.10 EBITDA Margin 30.2% 31.2% 29.7% 31.6% 29.4% 31.9% Net Margin 17.8% 18.5% 17.5% 19.6% 17.9% 20.4%
Source: HSBC estimates
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Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the previous page.
Valuation and risks Valuation
We use a DCF to value APC. Our new cost of
equity for APC is 10.82% (vs. 11% previously)
and includes a risk free rate of 3.5%, a market risk
premium of 6% and a beta of 1.22. We use a 4%
cost of debt assumption and a 30% debt weighting
(both unchanged) which yields a WACC estimate
of 8.73% (vs. 8.9% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our DCF-derived target
price for the company of SAR30 implies a 12%
potential return from current levels, which is
within the Neutral band of our model, so we
maintain our Neutral (V) rating on the stock.
Risk
Commodity Prices: APC has high leverage to PP
prices. Any significant changes to the correlation
between PP and naphtha price movements would
constitute a risk to our earning estimates and
valuation for the company, either to the downside
or the upside.
Operating rates: As a single plant entity, APC’s
earnings have a high degree of sensitivity to its
operating rates. Any significant outages remain a
key downside risk to our earning estimates and
valuation of the company.
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Financials & valuation: Advanced Petro Chemical C Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 1,467 2,017 2,053 2,100EBITDA 358 586 620 624Depreciation & amortisation -184 -212 -208 -207Operating profit/EBIT 174 374 413 417Net interest -48 -34 -34 -36PBT 127 341 380 383HSBC PBT 127 341 380 383Taxation 0 -4 -15 -15Net profit 127 337 365 367HSBC net profit 127 337 365 367
Cash flow summary (SARm)
Cash flow from operations 435 271 564 562Capex -11 -25 -25 -38Cash flow from investment -46 -25 -25 -38Dividends -70 -212 -212 -212Change in net debt -331 -23 -327 -312FCF equity 419 245 537 523
Balance sheet summary (SARm)
Intangible fixed assets 83 83 83 83Tangible fixed assets 2,498 2,322 2,139 1,970Current assets 833 1,022 1,203 1,348Cash & others 309 257 428 554Total assets 3,414 3,426 3,425 3,400Operating liabilities 261 224 225 232Gross debt 1,474 1,400 1,244 1,058Net debt 1,165 1,143 816 504Shareholders funds 1,670 1,796 1,949 2,104Invested capital 2,844 2,945 2,772 2,614
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue 0.5 37.5 1.8 2.3EBITDA -2.2 63.8 5.9 0.6Operating profit -31.7 115.3 10.4 1.0PBT -39.7 169.4 11.4 0.6HSBC EPS -39.7 166.2 8.3 0.6
Ratios (%)
Revenue/IC (x) 0.5 0.7 0.7 0.8ROIC 5.8 12.8 13.9 14.9ROE 7.7 19.5 19.5 18.1ROA 5.0 10.8 11.6 11.8EBITDA margin 24.4 29.0 30.2 29.7Operating profit margin 11.8 18.5 20.1 19.9EBITDA/net interest (x) 7.5 17.3 18.4 17.4Net debt/equity 69.8 63.6 41.9 23.9Net debt/EBITDA (x) 3.3 2.0 1.3 0.8CF from operations/net debt 37.3 23.7 69.1 111.6
Per share data (SAR)
EPS Rep (fully diluted) 0.90 2.39 2.58 2.60HSBC EPS (fully diluted) 0.90 2.39 2.58 2.60DPS 0.50 1.50 1.50 1.50Book value 11.81 12.70 13.78 14.88
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 3.4 2.4 2.2 2.0EV/EBITDA 13.8 8.4 7.4 6.9EV/IC 1.7 1.7 1.7 1.6PE* 29.8 11.2 10.3 10.3P/Book value 2.3 2.1 1.9 1.8FCF yield (%) 11.1 6.5 14.2 13.8Dividend yield (%) 1.9 5.6 5.6 5.6
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 26.70 Target price (SAR) 30.00 Potent'l return (%) 12.4
Reuters (Equity) 2330.SE Bloomberg (Equity) APPC ABMarket cap (USDm) 1,008 Market cap (SARm) 3,775Free float (%) 47 Enterprise value (SARm) 4917Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
12141618202224262830
2009 2010 2011 2012
12141618202224262830
Advanced Petro Chemical C Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Natural Resources and Energy Middle East Chemicals January 2011
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Margin expansion yet to materialise Chemanol started commercial operation of its
expansion project towards the end of Q2 2010.
The project includes a 231ktpa methanol plant
which is part of the company’s backward-
integration plan. The plant was intended to
eliminate the company's dependency on market-
priced methanol by allowing it to produce its own
methanol at cash costs of below USD80/tonne
(based on a gas price of 0.75 USD/mmbtu).
Chemanol’s Q3 2010 net income was, however,
disappointing at a net loss of SAR15.6m, versus
SAR8.8m in Q2 2010. Reported financials show
no impact yet from the integration project on the
margin front and we believe that the company will
need to deliver on the promised margin expansion
from the integration project over the next few
quarters or run the risk of seeing the shares
derated. The stock currently trades at the high end
of the range for regional petrochemical multiples
at 15.1x 2011e.
2011: What to expect
Integration impact: 2011 will be the first full
year of operations for Chemanol’s methanol
integration project. Despite capital expenditure of
cSAR1bn, the new project has not delivered any
increase in margins yet and we believe that
delivery on margin expansion will be the key
driver of Chemanol’s share price in the near term.
Potential rights issue overhang: Chemanol took on
an additional USD85m of short-term debt, beyond
the initial project financing, due to cost overruns at
the methanol expansion project. The conditions of
this new loan stipulate repayment by the end of 2011
by means of either excess operating cash or a rights
issuance. On our estimates Chemanol will find it
difficult to generate that amount of cash flow
through operating activities alone by the end of
2011. We therefore believe that a rights issue before
Chemanol
Margin expansion yet to materialise
Potential rights issue remains an overhang
Maintain Neutral (V) rating, raising target price from SAR14 to
SAR17
Chemanol: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 762 788 810 805 816 808 EBITDA 355 387 377 397 370 395 Net Income 121 152 150 169 150 174 Eps 1.00 1.26 1.24 1.40 1.24 1.44 EBITDA Margin 46.6% 49.1% 46.6% 49.3% 45.3% 48.9% Net Margin 15.9% 19.3% 18.5% 20.9% 18.3% 21.6%
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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the end of 2011 is quite likely and constitutes a
potential overhang for the stock.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the previous page.
Valuation and risks Valuation
We use a DCF to value Chemanol. Our new cost
of equity for Chemanol is 9.98% (vs. 11%
previously) and includes a risk free rate of 3.5%, a
market risk premium of 6% and a beta of 1.08.
We use a 5% cost of debt assumption and a 30%
debt weighting (both unchanged) which yields a
WACC estimate of 8.14% (vs. 9.1% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR17 (SAR14
previously) implies a 12% potential return from
current levels, which is within the Neutral band of
our model, so we maintain our Neutral (V) rating
on the stock.
Risks
Potential rights issue overhang: As mentioned
earlier Chemanol had to take on an additional
USD85m in short-term debt due to cost overruns
at the methanol expansion project. The loan must
be repaid by the end of 2011 by means of either
excess operating cash or a rights issuance. We
believe a rights issue before the end of 2011 is
quite likely and could be a potential overhang for
the stock, creating a downside risk.
Operating rates: In our estimates, we build in
operating rates of 90% for the company in 2011
and 95% thereafter. Any significant variation in
the operating rates would constitute a key risk,
either on the upside or downside, to our Neutral
(V) rating on the stock.
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Financials & valuation: Methanol Chemicals Co. Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 402 606 762 810EBITDA 59 136 355 377Depreciation & amortisation -27 -87 -163 -163Operating profit/EBIT 32 50 192 214Net interest -9 -31 -66 -58PBT 24 19 126 156HSBC PBT 24 19 126 156Taxation -2 -4 -5 -6Net profit 22 15 121 150HSBC net profit 22 15 121 150
Cash flow summary (SARm)
Cash flow from operations 67 84 242 300Capex -551 -27 -41 -41Cash flow from investment -474 -27 -41 -41Dividends 0 0 -61 -75Change in net debt 408 -57 -141 -184FCF equity -488 57 201 259
Balance sheet summary (SARm)
Intangible fixed assets 2 2 2 2Tangible fixed assets 2,507 2,474 2,352 2,230Current assets 486 543 677 727Cash & others 271 289 392 425Total assets 3,032 3,056 3,068 2,996Operating liabilities 175 195 185 188Gross debt 1,448 1,409 1,371 1,221Net debt 1,177 1,120 979 795Shareholders funds 1,411 1,425 1,486 1,561Invested capital 2,550 2,534 2,454 2,345
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -29.5 50.7 25.6 6.3EBITDA -19.4 131.7 161.0 6.2Operating profit -30.1 54.1 287.5 11.5PBT -38.1 -23.7 579.6 23.5HSBC EPS -42.3 -32.7 715.7 23.5
Ratios (%)
Revenue/IC (x) 0.2 0.2 0.3 0.3ROIC 1.2 1.6 7.4 8.6ROE 1.6 1.0 8.3 9.8ROA 1.1 1.3 6.0 6.8EBITDA margin 14.6 22.4 46.6 46.6Operating profit margin 8.0 8.2 25.2 26.4EBITDA/net interest (x) 6.2 4.4 5.4 6.5Net debt/equity 83.4 78.6 65.9 51.0Net debt/EBITDA (x) 20.0 8.2 2.8 2.1CF from operations/net debt 5.7 7.5 24.8 37.7
Per share data (SAR)
EPS Rep (fully diluted) 0.18 0.12 1.00 1.24HSBC EPS (fully diluted) 0.18 0.12 1.00 1.24DPS 0.00 0.00 0.50 0.62Book value 11.70 11.82 12.32 12.94
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 7.4 4.8 3.6 3.2EV/EBITDA 50.5 21.4 7.8 6.9EV/IC 1.2 1.1 1.1 1.1PE* 82.8 123.0 15.1 12.2P/Book value 1.3 1.3 1.2 1.2FCF yield (%) -27.3 3.2 11.2 14.4Dividend yield (%) 0.0 0.0 3.3 4.1
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 15.15 Target price (SAR) 17.00 Potent'l return (%) 12.2
Reuters (Equity) 2001.SE Bloomberg (Equity) CHEMANOL ABMarket cap (USDm) 488 Market cap (SARm) 1,827Free float (%) 60 Enterprise value (SARm) 2910Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
910111213141516171819
2009 2010 2011 2012
910111213141516171819
Methanol Chemicals Co. Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Returns from acetyls project have been disappointing Sipchem started commercial operations at its Phase
II plants in 2010. The acetic acid and carbon
monoxide plants commenced commercial operations
in June 2010, while the acetyls plant started in
August 2010. While Sipchem’s revenue was up 22%
and 37% q-o-q in Q2 2010 and Q3 2010,
respectively, the net income changes were +8% and
-4% for the same periods. And although Sipchem
reported strong revenue growth in Q4 2010, due to
the strength in methanol prices which were up 26%
q-o-q, the company missed consensus estimates. We
think it is therefore fair to say that, to date, returns
from the acetyls start-up have been well below
expectations and that better execution at the new unit
will be key to meeting estimates in 2011.
2011: What to expect
Phase II operations: 2011 will be the first full year
of operations of the Phase II plants. The near-term
driver for Sipchem will be the ramping up of
operations at the Phase II plants, particularly as the
results from H2 2010 have not been very impressive.
Phase III projects: Sipchem recently announced
the award of Engineering Procurement and
Construction (EP&C) contracts for it Phase III
projects. In December 2010 the company awarded
the EPC contract for a 200ktpa ethylene vinyl
acetate (EVA)/LDPE project and another contract
for a 100ktpa ethyl acetate (EA)/butyl acetate
(BA) plant in January 2011. The company expects
both the plants to be operational in Q2 2013.
Sipchem is planning to raise SAR1.5-2.0bn in Q1
2011 to finance the investments in these new
projects.
Sipchem
Phase III of acetyls project to be the medium-term catalyst
Stock looking fully valued at current levels
Maintain Neutral (V) rating, cutting target price from SAR30 to
SAR29
Sipchem: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 2,727 2,780 2,781 2,905 2,808 2,912 EBITDA 1,458 1,552 1,429 1,646 1,408 1,653 Net Income 533 600 524 674 521 690 EPS 1.60 1.80 1.57 2.02 1.56 2.07 EBITDA Margin 53.5% 55.8% 51.4% 56.7% 50.1% 56.8% Net Margin 19.5% 21.6% 18.8% 23.2% 18.5% 23.7%
Source: HSBC estimates
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Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the previous page.
Valuation and risks Valuation
We use a DCF to value Sipchem. Our new cost of
equity for Sipchem is 10.04% (vs. 11%
previously) and includes a risk free rate of 3.5%, a
market risk premium of 6% and a beta of 1.09.
We use a 5% cost of debt assumption and a 30%
debt weighting (both unchanged) which yields a
WACC estimate of 8.47% (vs. 9.1% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR29 (vs
SAR30 previously) implies a 12% potential return
from current levels, which is within the Neutral
band of our model, so we maintain our Neutral
(V) rating on the stock.
Risk
Operating risk: Sipchem’s carbon monoxide unit
had a technical outage in Q3 2010, which led to a
two-week shutdown at its acetic acid unit. Given
the interdependence between the various units of
Sipchem, we believe that any problems the
company faces when ramping up production from
its new plants would represent a downside risk to
our estimates, while a faster-than-expected ramp
up represents an upside risk.
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Natural Resources and Energy Middle East Chemicals January 2011
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Financials & valuation: Saudi International Petro Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 830 1,903 2,727 2,781EBITDA 347 1,064 1,458 1,429Depreciation & amortisation -179 -322 -520 -520Operating profit/EBIT 168 742 938 908Net interest 27 -93 -154 -138PBT 210 658 793 779HSBC PBT 210 658 793 779Taxation -40 -23 -32 -31Net profit 141 408 533 524HSBC net profit 141 408 533 524
Cash flow summary (SARm)
Cash flow from operations -114 576 1,348 1,421Capex -1,532 -104 -104 -156Cash flow from investment -1,532 -104 -104 -156Dividends -333 -102 -133 -131Change in net debt 1,991 -119 -934 -974FCF equity -1,659 356 1,059 1,096
Balance sheet summary (SARm)
Intangible fixed assets 31 31 31 31Tangible fixed assets 9,569 9,352 8,935 8,571Current assets 2,218 2,197 2,948 3,552Cash & others 1,831 1,730 2,264 2,839Total assets 11,818 11,580 11,914 12,154Operating liabilities 1,465 915 1,021 1,044Gross debt 4,481 4,260 3,860 3,460Net debt 2,650 2,530 1,596 622Shareholders funds 4,922 5,228 5,628 6,021Invested capital 8,522 8,935 8,629 8,272
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -51.4 129.1 43.3 2.0EBITDA -70.1 206.7 37.1 -2.0Operating profit -82.2 340.7 26.4 -3.2PBT -75.3 212.5 20.6 -1.7HSBC EPS -73.8 189.9 30.5 -1.7
Ratios (%)
Revenue/IC (x) 0.1 0.2 0.3 0.3ROIC 1.8 8.2 10.3 10.3ROE 2.8 8.0 9.8 9.0ROA 1.8 6.2 7.7 7.3EBITDA margin 41.8 55.9 53.5 51.4Operating profit margin 20.3 39.0 34.4 32.7EBITDA/net interest (x) 11.4 9.5 10.4Net debt/equity 45.4 39.8 22.8 8.2Net debt/EBITDA (x) 7.6 2.4 1.1 0.4CF from operations/net debt 22.8 84.5 228.6
Per share data (SAR)
EPS Rep (fully diluted) 0.42 1.23 1.60 1.57HSBC EPS (fully diluted) 0.42 1.23 1.60 1.57DPS 0.00 0.31 0.40 0.39Book value 14.77 15.69 16.88 18.06
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 14.6 6.4 4.2 3.9EV/EBITDA 35.1 11.5 7.9 7.6EV/IC 1.4 1.4 1.3 1.3PE* 61.0 21.1 16.1 16.4P/Book value 1.7 1.6 1.5 1.4FCF yield (%) -17.4 3.7 10.6 10.8Dividend yield (%) 0.0 1.2 1.5 1.5
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 25.80 Target price (SAR) 29.00 Potent'l return (%) 12.4
Reuters (Equity) 2310.SE Bloomberg (Equity) SIPCHEM ABMarket cap (USDm) 2,296 Market cap (SARm) 8,600Free float (%) 66 Enterprise value (SARm) 12267Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
13151719212325272931
2009 2010 2011 2012
13151719212325272931
Saudi International Petro Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Running ahead of fundamentals Industries Qatar (IQ) stock has rallied sharply in
the last six months and is up more than 40% since
the start of H2 2010. This rally is explained by
two factors: stronger fundamentals for IQ’s
products -fertilisers and petrochemicals - and a
stronger macroeconomic environment for Qatar,
including the award of the 2022 Fifa World Cup.
We believe that both of these factors are more
than adequately priced into the stock and that the
risks to the current share price are to the
downside, particularly if there are any delays to
the commercialisation of the QAFCO V plant
which is expected in Q2 2011.
We have raised our target price for IQ from
QAR110 to QAR135, but still downgrade the
stock from Neutral to Underweight based on
valuation.
2011: What to expect
Volume growth in fertilisers: QAFCO V is
scheduled to come online in Q2 2011, while
QAFCO VI is now delayed, with start-up scheduled
for H2 2012. QAFCO V has a design capacity of
1300ktpa of urea and 1500ktpa of ammonia, while
QAFCO VI has a 1300ktpa urea capacity. We
expect fertiliser volumes for IQ to increase by c32%
and c24% in 2011 and 2012, respectively.
Changes to our estimates and valuation
There are two major moving parts impacting our
estimates: changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts; and the update to our cost of equity
assumptions as explained earlier. For Qatar, there are
no changes to our feedstock pricing assumptions.
The changes to our financial forecasts are detailed
in the table at the bottom of the page.
Industries Qatar
Pricing and volume gains fully priced in at current levels
Timely start up of fertiliser plant a key risk in 2011
Downgrade to Underweight from Neutral, raise target price from
QAR110 to QAR135
IQ: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 14,881 14,138 16,995 16,429 17,453 17,009 EBITDA 7,156 6,328 8,033 7,376 8,315 7,790 Net Income 6,179 5,347 6,938 6,272 7,110 6,571 EPS 11.23 9.72 12.61 11.40 12.93 11.95 EBITDA Margin 48.1% 44.8% 47.3% 44.9% 47.6% 45.8% Net Margin 41.5% 37.8% 40.8% 38.2% 40.7% 38.6%
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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Valuation and risks Valuation
We use a DCF to value Industries Qatar. Our new
cost of equity for IQ is 12.4% (vs. 11%
previously) and includes a risk free rate of 3.5%, a
market risk premium of 8% and a beta of 1.11.
We use a 6% cost of debt assumption and a 20%
debt weighting (both unchanged) which yields a
WACC estimate of 11.1% (vs. 10% previously).
Under our research model, for stocks without a
volatility indicator, the Neutral band is 5
percentage points above and below the hurdle rate
for Qatari stocks of 11.5%. Our new DCF-derived
target price for the company is QAR135 (vs
QAR110 previously). Our target price for IQ has
increased despite the increase in our cost of equity
as there are no changes to our feedstock price
assumptions for Qatar to offset the effect of the
increase in product prices. Our new target price of
QAR135 implies a -12% potential return from
current levels, which is below the Neutral band of
our model. We therefore downgrade our rating on
the stock to Underweight from Neutral.
Risks
Plant start-up timelines: A faster-than-expected
start-up to IQ’s capacity expansion projects under
construction would have a positive impact on
earnings and constitute an upside risk to our
Underweight rating.
Energy price movements: The prices of most of
IQ’s products - be they fertilisers or
petrochemicals, are tightly correlated with crude
oil prices. A sharp increase in global energy prices
– particularly the price of crude oil – represents an
upside risk to our Underweight rating on
Industries Qatar shares.
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Natural Resources and Energy Middle East Chemicals January 2011
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Financials & valuation: Industries Qatar QSC Underweight Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (QARm)
Revenue 9,656 12,071 14,881 16,995EBITDA 3,846 5,723 7,156 8,033Depreciation & amortisation -525 -578 -808 -928Operating profit/EBIT 3,322 5,145 6,348 7,105Net interest -100 -144 -199 -199PBT 5,037 5,687 6,337 7,115HSBC PBT 5,037 5,687 6,337 7,115Taxation -125 0 -158 -178Net profit 4,909 5,687 6,179 6,938HSBC net profit 4,909 5,687 6,179 6,938
Cash flow summary (QARm)
Cash flow from operations 4,301 6,182 6,612 7,583Capex -4,829 -3,000 -3,000 -3,000Cash flow from investment -872 -3,000 -3,000 -3,000Dividends -4,400 -2,833 -3,080 -3,465Change in net debt 3,573 -350 -532 -1,118FCF equity -487 2,757 3,423 4,374
Balance sheet summary (QARm)
Intangible fixed assets 96 96 96 96Tangible fixed assets 8,115 10,537 12,729 14,802Current assets 9,358 10,021 11,272 12,989Cash & others 5,834 6,183 6,715 7,834Total assets 27,117 30,202 33,645 37,435Operating liabilities 2,062 2,293 2,638 2,955Gross debt 5,998 5,998 5,998 5,998Net debt 165 -185 -717 -1,835Shareholders funds 19,047 21,901 25,000 28,473Invested capital 9,673 12,177 14,744 17,098
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -34.5 25.0 23.3 14.2EBITDA -46.6 48.8 25.0 12.3Operating profit -50.7 54.9 23.4 11.9PBT -30.8 12.9 11.4 12.3HSBC EPS -32.5 15.9 8.7 12.3
Ratios (%)
Revenue/IC (x) 1.1 1.1 1.1 1.1ROIC 37.3 47.1 46.0 43.5ROE 26.3 27.8 26.3 25.9ROA 18.4 20.3 20.0 20.1EBITDA margin 39.8 47.4 48.1 47.3Operating profit margin 34.4 42.6 42.7 41.8EBITDA/net interest (x) 38.6 39.8 35.9 40.3Net debt/equity 0.9 -0.8 -2.9 -6.4Net debt/EBITDA (x) 0.0 0.0 -0.1 -0.2CF from operations/net debt 2611.0
Per share data (QAR)
EPS Rep (fully diluted) 8.92 10.34 11.23 12.61HSBC EPS (fully diluted) 8.92 10.34 11.23 12.61DPS 5.00 5.15 5.60 6.30Book value 34.63 39.82 45.45 51.77
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 8.5 6.8 5.5 4.7EV/EBITDA 21.4 14.3 11.4 10.0EV/IC 8.5 6.7 5.5 4.7PE* 17.1 14.8 13.6 12.1P/Book value 4.4 3.8 3.4 3.0FCF yield (%) -0.6 3.4 4.2 5.3Dividend yield (%) 3.3 3.4 3.7 4.1
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (QAR) 153.00 Target price (QAR) 135.00 Potent'l return (%) -11.8
Reuters (Equity) IQCD.QA Bloomberg (Equity) IQCD QDMarket cap (USDm) 23,108 Market cap (QARm) 84,150Free float (%) 30 Enterprise value (QARm) 82067Country Qatar Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
49
69
89
109
129
149
169
2009 2010 2011 2012
49
69
89
109
129
149
169
Industries Qatar QSC Rel to DSM 20 INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Natural Resources and Energy Middle East Chemicals January 2011
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Pure play on nitrogen fertiliser SAFCO is a pure play on nitrogen fertilisers.
Further expansion options are limited as any new
gas allocation for expansion is unlikely. Given the
limited room for new capacity expansions,
SAFCO has been a cash cow for SABIC (which
owns a 43% stake) and has paid out c90% of its
earnings as dividends since 2007.
2011: What to expect
Nitrogen market outlook: Nitrogen market
fundamentals recovered over Q3 2010, with urea
prices up from lows of USD220/t in mid-June to
USD400/t, based on spot Middle East prices (fob
basis). The recovery was primarily driven by
greater demand from India and Brazil (which we
believe is likely to stay strong in 2011),
production cutbacks in China, and China's early
urea export tax application.
We believe that further nitrogen fertiliser price
appreciation will be limited going into 2011, due to
supply from new projects coming on stream, mainly
from Algeria, Qatar and Pakistan. Two of these
projects, Sorfert in Algeria, and QAFCO V in Qatar,
will be almost entirely directed into the export
market, together selling 1.25m tonnes in 2011e,
2.65m tonnes in 2012e and 3.54m tonnes in 2013e.
These capacity increases represent c50% of
additional global supply and should add 3.5% to the
global urea traded volume in 2011. However, we
think rising Russian, Ukrainian and Chinese
production costs will more than offset the effect of
Saudi Fertiliser Company (SAFCO)
Pure play nitrogenous fertiliser company with leverage to rising
fertiliser prices
Yield play with limited growth potential
Maintain Neutral (V) rating, raise target price from SAR135 to
SAR190
SAFCO: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 4,394 3,961 4,399 4,186 4,644 4,186 EBITDA 3,345 2,948 3,196 3,132 3,293 3,075 Net Income 3,188 2,625 2,984 2,804 3,073 2,772 EPS 12.75 10.50 11.94 11.22 12.29 11.09 EBITDA Margin 76.1% 74.4% 72.6% 74.8% 70.9% 73.5% Net Margin 72.6% 66.3% 67.8% 67.0% 66.2% 66.2%
Source: HSBC estimates
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Natural Resources and Energy Middle East Chemicals January 2011
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low-cost exports from Qatar and Algeria on the
general level of prices.
Our cost curve suggests a weighted average cost for
urea trade of USD144/t in 2011, almost 11% higher
y-o-y in spite of the Algerian and Qatari projects.
That said, upside from spot urea prices of USD400/t
is limited, in our view, given that cash margins are
healthy for high-cost marginal producers. For more
details see our December 2010 report, The Fertile
Crescent - Countdown to the rebound.
Dividend policy: SAFCO is essentially a yield
play given its limited growth profile and high
dividend payout ratio. We expect the company to
continue with its high dividend policy as capacity
growth for the company is constrained by new gas
allocations, which are unlikely in our opinion.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts, and the update to our cost of equity
assumptions as explained earlier. The changes to our
financial forecasts are detailed in the table at the
bottom of the previous page.
Valuation and risks Valuation
We use a DCF to value SAFCO. Our new cost of
equity for SAFCO is 8.3% (vs. 11% previously)
and includes a risk free rate of 3.5%, a market risk
premium of 6% and a beta of 0.8. We use a 4%
cost of debt assumption and a 20% debt weighting
(both unchanged) which yields a WACC estimate
of 7.24% (vs. 9.95% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR190 (SAR135
previously) implies a 5% potential return from
current levels, which is within the Neutral band of
our model, so we maintain our Neutral (V) rating
on the stock.
Risks
Nitrogen fertiliser prices: Lower gas prices to
Ukraine (a marginal cost producer) and poor
weather in India and Latin America (the two
largest growing import markets), which could
pressure urea pricing, are key downside risks to
our Neutral (V) rating on SAFCO.
Operating rates: Any changes from the expected
operating rates constitute a key risk, to the
downside or the upside, to both our earnings
estimates and valuation of the company.
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Financials & valuation: Saudi Arabian Fertilizer Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 2,741 3,609 4,394 4,399EBITDA 1,916 2,727 3,345 3,196Depreciation & amortisation -258 -250 -356 -423Operating profit/EBIT 1,658 2,477 2,989 2,773Net interest 0 63 58 63PBT 1,900 3,114 3,287 3,076HSBC PBT 1,900 3,114 3,287 3,076Taxation -96 -72 -99 -92Net profit 1,804 3,042 3,188 2,984HSBC net profit 1,804 3,042 3,188 2,984
Cash flow summary (SARm)
Cash flow from operations 2,108 3,315 3,374 3,425Capex -202 -64 -694 -1,331Cash flow from investment 98 -64 -694 -1,331Dividends -1,250 -2,745 -2,880 -2,678Change in net debt 1,032 -570 142 520FCF equity 1,870 2,741 2,498 1,917
Balance sheet summary (SARm)
Intangible fixed assets 190 190 190 190Tangible fixed assets 3,452 3,266 3,604 4,512Current assets 4,056 4,476 4,551 4,089Cash & others 2,650 3,220 3,077 2,557Total assets 8,808 9,041 9,454 9,900Operating liabilities 1,203 1,140 1,245 1,385Gross debt 590 590 590 590Net debt -2,060 -2,630 -2,488 -1,968Shareholders funds 7,015 7,311 7,620 7,926Invested capital 3,846 3,572 4,023 4,849
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue -47.7 31.7 21.8 0.1EBITDA -56.0 42.3 22.7 -4.5Operating profit -58.5 49.4 20.7 -7.2PBT -56.7 63.9 5.5 -6.4HSBC EPS -60.1 68.6 4.8 -6.4
Ratios (%)
Revenue/IC (x) 0.7 1.0 1.2 1.0ROIC 41.2 65.2 76.3 60.6ROE 24.0 42.5 42.7 38.4ROA 19.3 33.4 33.9 30.2EBITDA margin 69.9 75.6 76.1 72.6Operating profit margin 60.5 68.6 68.0 63.0EBITDA/net interest (x) Net debt/equity -29.4 -36.0 -32.7 -24.8Net debt/EBITDA (x) -1.1 -1.0 -0.7 -0.6CF from operations/net debt
Per share data (SAR)
EPS Rep (fully diluted) 7.22 12.17 12.75 11.94HSBC EPS (fully diluted) 7.22 12.17 12.75 11.94DPS 4.69 10.98 11.52 10.71Book value 28.06 29.25 30.48 31.70
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 15.3 11.5 9.5 9.6EV/EBITDA 21.9 15.2 12.4 13.2EV/IC 10.9 11.6 10.3 8.7PE* 25.0 14.8 14.2 15.1P/Book value 6.4 6.2 5.9 5.7FCF yield (%) 4.2 6.2 5.7 4.4Dividend yield (%) 2.6 6.1 6.4 5.9
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 180.50 Target price (SAR) 190.00 Potent'l return (%) 5.3
Reuters (Equity) 2020.SE Bloomberg (Equity) SAFCO ABMarket cap (USDm) 12,048 Market cap (SARm) 45,125Free float (%) 42 Enterprise value (SARm) 41386Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
67
87
107
127
147
167
187
2009 2010 2011 2012
67
87
107
127
147
167
187
Saudi Arabian Fertilizer Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Integrated basic petrochemicals play SIIG is a combination of three separate basic
chemical projects, two of which are already
operating (SCP and JCP), while Saudi Polymers is
under construction and is expected be on stream
by Q3 2011 according to management. The
projects have a high degree of integration, which
allows for significant cost savings – benzene
produced at SCP is supplied to JCP to make
styrene and that styrene will be further converted
into polystyrene within the Saudi Polymers unit.
The key driver for SIIG’s earnings in the near
term is the completion of the Saudi Polymers
project, which we expect will contribute over 65%
of SIIG’s earnings after 2012.
2011: What to expect
Saudi Polymers start-up: Saudi Polymers is
expected to begin commercial operations in Q3
2011 according to management. We are, however,
assuming a 2012 start-up in our estimates.
SIIG, which owns a 47.4% stake in Petrochem,
has an effective 30.8% stake in the Saudi
Polymers project. The start of commercial
operations at Saudi Polymers is the key near-term
catalyst for SIIG, in our opinion.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's oil
price forecasts, and the update to our cost of equity
assumptions as explained earlier. The changes to our
financial forecasts are detailed in the table at the
bottom of the page.
SIIG
Saudi Polymers start-up to be the key short-term catalyst
Limited upside from current levels
Maintain Neutral (V) rating, raising target price from SAR19 to
SAR25
SIIG: Changes in estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 3,788 7,025 10,872 14,126 12,829 16,042 EBITDA 834 927 3,651 3,985 4,439 4,867 Net Income 463 293 1,059 846 1,584 1,275 Eps 1.03 0.65 2.35 1.88 3.52 2.83 EBITDA Margin 22.0% 13.2% 33.6% 28.2% 34.6% 30.3% Net Margin 12.2% 4.2% 9.7% 6.0% 12.3% 7.9%
Source: HSBC estimates
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Valuation and risks Valuation
We use a DCF to value SIIG. Our new cost of
equity for SIIG is 10.52% (vs. 11% previously)
and includes a risk free rate of 3.5%, a market risk
premium of 6% and a beta of 1.17. We use a 4%
cost of debt assumption and a 30% debt weighting
(both unchanged) which yields a WACC estimate
of 8.52% (vs. 8.9% previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR25 (vs
SAR19 previously) implies a 13% potential return
from current levels, which is within the Neutral
band of our model, so we maintain our Neutral
(V) rating on the stock.
Risk
Saudi Polymers start-up: There are typically
some teething problems that occur in the start-up
phase of a greenfield project. Any such
operational delay in the Saudi Polymers project
would have a negative impact on our earnings
estimates and valuation for the company, while a
faster-than-expected start-up represents an upside
risk to our Neutral (V) rating.
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Financials & valuation: Saudi Industrial Investment Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 3,760 4,512 3,788 10,872EBITDA 690 795 834 3,651Depreciation & amortisation -203 -273 -304 -1,501Operating profit/EBIT 487 522 530 2,150Net interest -15 -23 -20 -728PBT 472 499 510 1,421HSBC PBT 472 499 510 1,421Taxation -111 -164 -61 -57Net profit 391 378 463 1,059HSBC net profit 391 378 463 1,059
Cash flow summary (SARm)
Cash flow from operations 1,100 330 849 1,921Capex -9,091 -5,528 -5,528 -234Cash flow from investment -8,934 -5,528 -5,528 -234Dividends 0 0 0 -270Change in net debt 4,524 5,198 4,679 -1,417FCF equity -8,115 -5,198 -4,679 1,687
Balance sheet summary (SARm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 14,151 19,407 24,631 23,364Current assets 5,524 7,097 7,603 10,408Cash & others 4,586 5,773 6,480 7,782Total assets 19,675 26,503 32,233 33,773Operating liabilities 2,564 2,672 2,567 3,126Gross debt 9,138 15,523 20,909 20,794Net debt 4,552 9,750 14,429 13,012Shareholders funds 5,482 5,860 6,323 7,112Invested capital 12,525 18,058 23,186 22,864
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue 75.8 20.0 -16.1 187.0EBITDA 212.1 15.1 4.9 337.9Operating profit 1035.6 7.1 1.5 305.7PBT 710.6 5.6 2.2 178.8HSBC EPS 702.8 -3.5 22.6 128.6
Ratios (%)
Revenue/IC (x) 0.4 0.3 0.2 0.5ROIC 4.2 2.3 2.3 9.0ROE 7.3 6.7 7.6 15.8ROA 2.7 1.5 1.6 6.3EBITDA margin 18.4 17.6 22.0 33.6Operating profit margin 13.0 11.6 14.0 19.8EBITDA/net interest (x) 46.1 34.3 41.8 5.0Net debt/equity 57.3 117.8 165.3 132.5Net debt/EBITDA (x) 6.6 12.3 17.3 3.6CF from operations/net debt 24.2 3.4 5.9 14.8
Per share data (SAR)
EPS Rep (fully diluted) 0.87 0.84 1.03 2.35HSBC EPS (fully diluted) 0.87 0.84 1.03 2.35DPS 0.00 0.00 0.00 0.60Book value 12.18 13.02 14.05 15.80
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 4.5 4.9 7.1 2.4EV/EBITDA 24.6 27.9 32.2 7.0EV/IC 1.4 1.2 1.2 1.1PE* 25.5 26.4 21.6 9.4P/Book value 1.8 1.7 1.6 1.4FCF yield (%) -65.2 -41.9 -37.8 13.3Dividend yield (%) 0.0 0.0 0.0 2.7
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 22.20 Target price (SAR) 25.00 Potent'l return (%) 12.6
Reuters (Equity) 2250.SE Bloomberg (Equity) SIIG ABMarket cap (USDm) 2,667 Market cap (SARm) 9,990Free float (%) 80 Enterprise value (SARm) 22158Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
7
12
17
22
27
2009 2010 2011 2012
7
12
17
22
27
Saudi Industrial Investme Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Cost overruns to outweigh earlier start-up Saudi Kayan started test production at the olefins
complex in July 2010, a quarter ahead of our
estimate of an end Q3 2010 date; however the
project cost exceeded the initial estimate of
SAR37.5bn by SAR9bn, and was ahead of our
estimate by SAR6bn. These cost overruns will
inevitably weigh on company profitability. The
resulting interest costs and higher depreciation
expense amount to a cSAR0.30 drop in annual EPS.
2011: What to expect
Start of commercial operations: Saudi Kayan is
expected to start commercial operations in
2011.We are assuming a Q3 2011 start-up in our
estimates. This will make Kayan one of the few
companies in our coverage with significant
volume leverage in 2011.
Execution risk: There is a certain amount of
execution risk involved with any large scale
greenfield project. Kayan started test production
at the olefins complex ahead of time, however it
faced cost overruns. The start of commercial
operations as per schedule will help reduce
execution risk, as the earnings power of the
company is demonstrated.
Changes to our estimates and valuation
There are three major moving parts impacting our
estimates: changes in our feedstock pricing
assumptions as highlighted in the first part of this
report, changes to product price estimates in line
with the increase in the HSBC oil and gas team's
oil price forecasts, and the update to our cost of
equity assumptions as explained earlier. The
changes to our financial forecasts are detailed in
the table at the bottom of the page.
Saudi Kayan
2011 is key as the company’s first plant is expected to start
commercial operations by H2
Execution risks high in start-up phase
Reiterate Neutral (V) rating, raising target price to SAR22 from
SAR18
Kayan: Changes to estimates
____________ 2011e _____________ _____________2012e _____________ ____________ 2013e _____________ New Old New Old New Old
Revenue 5,222 5,986 11,228 11,837 12,705 11,953 EBITDA 2,830 3,088 6,049 6,285 6,783 6,337 Net Income 795 -336 2,055 2,283 2,858 2,430 Eps 0.53 -0.22 1.37 1.52 1.91 1.62 EBITDA Margin 54.2% 51.6% 53.9% 53.1% 53.4% 53.0% Net Margin 15.2% -5.6% 18.3% 19.3% 22.5% 20.3%
Source: HSBC estimates
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Valuation and risks Valuation
We use a DCF to value Saudi Kayan. Our new
cost of equity for Kayan is 10.64% (vs. 11%
previously) and includes a risk free rate of 3.5%, a
market risk premium of 6% and a beta of 1.19.
We use a 4% cost of debt assumption and a
60%debt weighting (both unchanged) which
yields a WACC estimate of 7.71% (vs. 7.8%
previously).
Under our research model, for stocks with a
volatility indicator, the Neutral band is 10
percentage points above and below the hurdle rate
for Saudi stocks of 9.5%. Our new DCF-derived
target price for the company of SAR22 (vs
previously SAR18) implies a 14% potential return
from current levels, which is within the Neutral
band of our model, so we maintain our Neutral
(V) rating on the stock.
Risks
Start-up: We expect Saudi Kayan to start
commercial operations in Q3 2011. There are
typically some teething problems that occur in the
start-up phase of a greenfield project. Any such
operational delay would have a negative impact
on our earnings estimates and valuation for the
company, while a faster-than-expected start-up
represents an upside risk to our Neutral (V) rating.
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Financials & valuation: Saudi Kayan Petrochemical Neutral (V) Financial statements
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Profit & loss summary (SARm)
Revenue 0 0 5,222 11,228EBITDA -17 -8 2,830 6,049Depreciation & amortisation 0 0 -1,163 -2,325Operating profit/EBIT -17 -8 1,668 3,724Net interest 0 0 -840 -1,583PBT -17 -8 828 2,141HSBC PBT -17 -8 828 2,141Taxation 0 0 -33 -86Net profit -17 -8 795 2,055HSBC net profit -17 -8 795 2,055
Cash flow summary (SARm)
Cash flow from operations -939 160 926 3,893Capex -13,410 -13,353 -465 -687Cash flow from investment -13,410 -13,353 -465 -687Dividends 0 0 -225 -630Change in net debt 14,349 13,193 -236 -2,576FCF equity -14,349 -13,193 461 3,206
Balance sheet summary (SARm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 33,168 46,521 45,824 44,186Current assets 2,639 6,077 5,497 6,978Cash & others 2,472 6,077 4,198 4,562Total assets 35,808 52,598 51,321 51,164Operating liabilities 1,217 1,217 1,484 2,114Gross debt 19,113 35,912 33,797 31,585Net debt 16,642 29,835 29,599 27,023Shareholders funds 15,477 15,469 16,039 17,464Invested capital 32,119 45,304 45,638 44,488
Ratio, growth and per share analysis
Year to 12/2009a 12/2010e 12/2011e 12/2012e
Y-o-y % change
Revenue 115.0EBITDA 113.7Operating profit 123.2PBT -109.5 158.6HSBC EPS -109.9 158.6
Ratios (%)
Revenue/IC (x) 0.0 0.0 0.1 0.2ROIC -0.1 0.0 3.5 7.9ROE -0.1 -0.1 5.0 12.3ROA -0.1 0.0 3.1 7.0EBITDA margin 0.0 0.0 54.2 53.9Operating profit margin 0.0 0.0 31.9 33.2EBITDA/net interest (x) 3.4 3.8Net debt/equity 107.5 192.9 184.5 154.7Net debt/EBITDA (x) -987.9 -3729.4 10.5 4.5CF from operations/net debt 0.5 3.1 14.4
Per share data (SAR)
EPS Rep (fully diluted) -0.01 -0.01 0.53 1.37HSBC EPS (fully diluted) -0.01 -0.01 0.53 1.37DPS 0.00 0.00 0.15 0.42Book value 10.32 10.31 10.69 11.64
Valuation data
Year to 12/2009a 12/2010e 12/2011e 12/2012e
EV/sales 11.2 5.0EV/EBITDA 20.7 9.2EV/IC 1.4 1.3 1.3 1.3PE* 36.3 14.0P/Book value 1.9 1.9 1.8 1.7FCF yield (%) -49.7 -45.7 1.6 11.1Dividend yield (%) 0.0 0.0 0.8 2.2
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (SAR) 19.25 Target price (SAR) 22.00 Potent'l return (%) 14.3
Reuters (Equity) 2350.SE Bloomberg (Equity) KAYAN ABMarket cap (USDm) 7,709 Market cap (SARm) 28,875Free float (%) 25 Enterprise value (SARm) 58710Country Saudi Arabia Sector CHEMICALSAnalyst Sriharsha Pappu Contact 971 4 4236924
Price relative
79
1113151719212325
2009 2010 2011 2012
791113151719212325
Saudi Kayan Petrochemical Rel to TADAWUL ALL SHARE INDEX
Source: HSBC Note: price at close of 19 Jan 2011
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Notes
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Notes
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Notes
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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Sriharsha Pappu and Tareq Alarifi
Important disclosures
Stock ratings and basis for financial analysis HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below.
This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website.
HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.
Rating definitions for long-term investment opportunities
Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis:
For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate, regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.
*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,
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stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities
As of 23 January 2011, the distribution of all ratings published is as follows: Overweight (Buy) 48% (23% of these provided with Investment Banking Services)
Neutral (Hold) 37% (20% of these provided with Investment Banking Services)
Underweight (Sell) 15% (22% of these provided with Investment Banking Services)
Information regarding company share price performance and history of HSBC ratings and price targets in respect of its long-term investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.
HSBC & Analyst disclosures Disclosure checklist
Company Ticker Recent price Price Date Disclosure
NATIONAL INDUSTRIALIZATIO 2060.SE 33.50 21-Jan-2011 2, 7NATIONAL PETROCHEMICAL CO PETR 2002.SE 23.35 21-Jan-2011 2, 5SAHARA PETROCHEMICAL CO. 2260.SE 22.30 21-Jan-2011 2, 5SAUDI BASIC INDUSTRIES CO 2010.SE 107.25 21-Jan-2011 1, 2, 5, 7, 11SAUDI INDUSTRIAL INVESTME 2250.SE 22.20 21-Jan-2011 7SAUDI INTERNATIONAL PETRO 2310.SE 25.80 21-Jan-2011 5, 7SAUDI KAYAN PETROCHEMICAL 2350.SE 19.25 21-Jan-2011 1, 2, 5YANBU PETROCHEMICAL 2290.SE 46.30 21-Jan-2011 1, 2, 5
Source: HSBC
1 HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next
3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this
company. 4 As of 31 December 2010 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of non-investment banking-securities related services. 7 As of 30 November 2010, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as
detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this
company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in
securities in respect of this company Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.
For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.
* HSBC Legal Entities are listed in the Disclaimer below.
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Additional disclosures 1 This report is dated as at 24 January 2011. 2 All market data included in this report are dated as at close 19 January 2011, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.
4 As of 31 December 2010, HSBC and/or its affiliates (including the funds, portfolios and investment clubs in securities managed by such entities) either, directly or indirectly, own or are involved in the acquisition, sale or intermediation of, 1% or more of the total capital of the subject companies securities in the market for the following Company(ies) : ADVANCED PETRO CHEMICAL C
5 As of 07 January 2011, HSBC owned a significant interest in the debt securities of the following company(ies) : SAUDI BASIC INDUSTRIES CO
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Natural Resources and Energy Middle East Chemicals January 2011
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Metals and Mining EMEA Andrew Keen +44 20 7991 6764 [email protected]
Thorsten Zimmermann, CFA +44 20 7991 6835 [email protected]
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Chemicals Sriharsha Pappu +971 4 423 6924 [email protected]
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Global Natural Resources & Energy Research Team
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Wh
at p
rice is
righ
t?
By Sriharsha Pappu and Tareq Alarifi
Feedstock pricing changes likely to be announced in 2011. We expect this decision to be
influenced by a combination of both economic and policy factors, and we forecast a phased
increase that does not fundamentally alter the competitive position of the industry
The impact on margins from these feedstock price increases is highest for companies with the
biggest cost advantages (eg SAFCO), while those with lower cost advantages and margins
(eg SABIC) are least affected. The increase in HSBC's energy price forecasts however, outweighs
the impact of higher feedstock costs
Yet despite generally raising our target prices, we are cautious on the sector for 2011 given
recent strong performance, elevated expectations and high valuations. Our top picks in the
sector are Tasnee (OW(V), TPSAR44), Yansab (OW(V), TP SAR65) and SABIC (OW(V), TP SAR130).
We downgrade Petrochem (TP SAR25) and Sahara (TP SAR25) to N(V) from OW(V) and
Industries Qatar (TP QAR135) to UW from N
Disclosures and Disclaimer This report must be read with the disclosures and analyst
certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Natu
ral R
eso
urc
es &
En
erg
y/M
idd
le E
ast C
hem
icals
- Eq
uity
Sriharsha Pappu*
Analyst
HSBC Bank Middle East Limited, Dubai
+971 4423 6924
Sriharsha rejoined HSBC's chemical research team in 2009 after spending one and a half years covering the chemical sector on the
buyside at Dubai Group. Prior to that he was a part of HSBC's US chemicals research team from 2005 to 2008 and has been covering
chemicals on the sell side since 2004. Sriharsha holds a Bachelors degree in Electronics Engineering and an MBA from the Indian
Institute of Management. He was ranked No 3 in MENA in the 2010 Pan European Sell side Extel survey.
Jan
uary
2011
What price is right?Re-evaluating the feedstock price environment
Natural Resources & Energy/Middle East Chemicals - Equity
January 2011
Tareq Alarifi*
Analyst
HSBC Saudi Arabia Limited
+966 1299 2105
Tareq is a cross-sector equity analyst based in Riyadh. He joined the research team in 2008, prior to that he worked as a buy-side analyst
with HSBC. Tareq holds a bachelors degree in Biomedical Sciences from the State University of New York, and an MBA-Finance from
Rochester, New York.
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