Engro Polymer & Chemicals Ltd – expansion makes it attractive

We initiate coverage on EPCL – the only integrated Chlor-Vinyl plant and PVC producer in Pakistan – with a Buy rating and December 2021 TP of PKR57.0/sh. The cornerstone of our thesis is EPCL’s new PVC III capacity (100,000 tons), coming online by 1QCY21, which will help capture the rising PVC demand in Pakistan and ride the construction up-cycle.

We expect core delta to normalize from recent highs (c.US$700/ton) to settle around the still-healthy level of US$400/ton over the medium term. This is backed by the 10yr historical average spread of US$380/ton and global PVC demand expected to have a growth CAGR of c3.5%.

Other reasons for liking are (i) positive exposure to PKR depreciation because of US$ denominated core delta, and (ii) import duties will continue to provide protection from PVC imports and help in tapping its existing market (c.20% imports).

Initiate with Buy rating

We initiate coverage on Engro Polymer & Chemicals Ltd. (EPCL) – the only fully integrated Chlor-Vinyl complex in Pakistan – with a Buy rating and December 2021 TP of PKR57.0/sh. It is the sole producer of PVC, a petrochemical used for producing a wide range of products (mainly construction pipes). EPCL also manufactures and sells Caustic Soda, primarily to the Textile sector. Our Buy stance stems from the new capacity (PVC III, coming online by 1QCY21), which comes online amid robust construction activity in Pakistan. The enhanced capacity will aid in taking over the share of PVC imports and cater to the growth in domestic demand for it. Even though PVC’s core delta is bound to normalize from recent highs (c.US$700/ton); we expect it to remain in the healthy zone of US$350-400/ton over the medium term, as the world emerges out of the pandemic. Further positives include (i) import duty protection of 13% on PVC and (ii) recent PKR depreciation has significantly improved breakeven economics.

PVC capacity expansion to capture existing and new demand

We believe that the addition of 100,000 tons of new PVC capacity (expected to come online in 1QCY21) will allow EPCL to (i) capture captive domestic demand (c.260,000 tons), which is greater than EPCL’s current capacity of 195,000 tons (c.80% of domestic demand), (ii) capitalize on the growth momentum spurred by the construction space and (iii) benefit from PVC’s expanding usage over a wider range of applications, catalyzed by a growing economy and changing consumer preferences. Existing protection of 13% duty on PVC import will enable EPCL to ward off competition, while it ramps up sales. Additionally, Pakistan’s per capita consumption of PVC stands at a mere 1.2kg (lowest in the region), compared to 2.3kg in India.

Healthy spreads with US$ hedge

The core delta (PVC–Ethylene) is presently hovering at multi-year highs but it is likely to normalize in near future. We expect it to settle around US$400/ton in the medium term – close to the 10yr historical average of US$380/ton. Global PVC demand is expected to have a 5yr CAGR of 3.5%, in tandem with the slated capacity expansions, thus it is likely to keep the core delta in the healthy zone, in our view. Even in the absence of very high core delta, EPCL benefits from PKR depreciation courtesy import parity pricing. Historically, EPCL would need minimum US$300/ton of core delta to breakeven; following the PKR deprecation in recent years, we estimate that threshold has improved to about US$270/ton.

(Intermarket Securities Limited)


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