Buy calls for Engro Polymer & Chemicals

Experts initiate coverage on Engro Polymer and Chemicals Limited (EPCL), with a ‘Buy’ rating and a Target Price of Rs78 per share, offering an potential total return of 60% (including dividend yield of 21%). The company is set to post 5-year earnings (2021E-2025F) CAGR of 13%.

We believe EPCL is set to reap the benefits of (1) uptrend in PVC-Ethylene core delta, (2) PVC expansion of 100K tons, (3) improving Caustic Soda dynamics and  (4) expansion in Hydrogen Peroxide (HPO) segment.

Uptrend in PVC-Ethylene core delta: The international PVC-Ethylene Core delta  had touched its all-time high of US$1,088/ton in Mar-2021 as against last 10-year’s average of US$370/ton and 2021 YTD average of US$896/ton. These margins at least in the near future are expected to remain sturdy as global PVC market is undergoing supply constraints, while ethylene’s market (raw material of PVC) is going through capacity expansion globally. That said, we estimate EPCL’s core delta to average in at US$880/ton in 2021E and US$550/ton in 2022F, with a long-term assumption of US$500/ton.

PVC expansion came at appropriate time: We believe EPCL’s capacity expansion came at an appropriate time given pickup in construction activity backed by construction package. Pertinently, 50-60% of EPCL’s PVC sales are directed towards the construction sector. EPCL has expanded PVC capacity by 100K tons (51% of existing capacity) to 295K tons and VCM capacity by 50k (25% of existing capacity) to 254K tons. Both plants have commenced COD in 1Q2021 and 2Q2021 respectively. This can potentially enable EPCL to cater to 100% local PVC demand. However in case of low domestic demand, EPCL could route more production into export markets.

Improving Caustic Soda dynamics: Caustic Soda is a allied product for EPCL and is primarily used in textile, soap and detergent sectors. Amid early recovery from COVID-19 outbreak we have witnessed significant increase in textile exports which resulted in increase in demand for caustic soda. Furthermore, soap and detergent segments also provide impetus for growth as increase in usage driven by changing life style due to COVID-19 (hygiene focus). This segment is expected to contribute 12% in 2021 to total topline.

Adding Diversity to portfolio: To broaden range of its product portfolio, EPCL has announced to enter into Hydrogen Peroxide (HPO) segment with total CAPEX of US$30-35mn. The plant is expected to commence COD in later part of 2022. We expect HPO plant to add Rs0.40/share to the bottom line in 2023.

Attractive Dividend Yield: EPCL offers an attractive yield of 25% and 12% based on its earnings of 2021E and 2022F respectively which is higher than current 10-year government paper yield of 10.5% and market yield of 7%. Going forward, we estimate EPCL continue to pay 70% of earning as dividend considering the company is still in growth phase of business cycle unlike its group company Engro Fertilizers (EFERT) which is in maturity stage.

Valuation: We have arrived at DCF based target price of Rs78 per share, offering a potential total upside of 60%. We have taken Risk free rate of 10.5%, and risk premium of 6% which makes the cost of equity to 16.5%.

Key Risks: (1) sharp decline in PVC-Ethylene margins, (2) delay in COD of HPO project, (3) higher-than-expected increase in gas prices, and (4) reduction in duty protection.

Courtesy – AHCML Research

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