Engro Polymer: Failure to stabilize VCM plant continues to hit bottom-line!

Engro Polymer: Failure to stabilize VCM plant continues to hit bottom-line!

2Q LPS recorded at PKR0.21: Engro Polymer & Chemicals Limited (EPCL) recently announced its financial result for 2QCY11 posting LAT of PKR139mn (LPS: PKR0.21) for the quarter against a loss of PKR269mn (LPS: PKR0.41) last year. 1HCY11 LAT reached PKR207mn (LPS: PKR0.31).

Healthy growth in gross profit despite lower VCM production: Nets Sales registered an increase of 9% YoY to PKR3.9bn during 2QCY11 mainly due to higher prices. Simultaneously, gross margins surged around 470bps YoY during 2Q mainly due to higher in-house VCM production, but still lower than expectation. Integrated PVC-Ethylene margins after deducting fuel cost, hovered around an estimated USD734/ton during 1H.

High interest cost hurting bottom-line: Finance cost was recorded at PKR371mn in 2Q, taking 1HCY11 aggregate number to PKR753mn, up 17% YoY. Resultantly, bottom-line remained negative, as higher finance cost devoured bulk of gross profit expansion.

Investment perspective: At yesterday’s closing price of PKR8.0/share, the scrip trades at CY12E P/E multiple of 5.6x, and offers an upside of 43% to our Jun-12 PT of PKR11.5/share. We have assumed 0% reliance on imported VCM from CY12 onwards, which remains our key assumption to our June-12 PT of PKR12/share. 30% reliance on imports CY12 onwards would trim our CY12 EPS by 51% to PKR0.69, and cut our Jun-12 PT by 8.6% to PKR10.5.

Healthy growth in gross profit despite lower VCM production

Top-line of EPCL witnessed a surge of 9% YoY to PKR3.9bn during 2Q primarily attributable to higher prices. Demand for PVC and Caustic Soda remained stable at the level of 26k tons and 22k tons respectively. Consequently, during 1HCY11, net sales increased by 16% YoY to 7.9bn. Similar to 1Q, higher margins on integrated operations continued to provide support to bottom-line as a result of higher reliance on cheaper in-house VCM. Resultantly, gross margins surged around 470bps during 2Q. In-house VCM production stood at 21k tons in 2QCY11 as against 12k tons in 2QCY10. However, it was still lower than expectation. Integrated PVC-Ethylene margins after deducting fuel cost, hovered around an estimated USD772/ton during 2Q, while 1HCY11 average clocked in at USD734/ton, up 15% YoY. We have assumed slightly higher PVC sales (65ktons) in 2HCY11 with total CY11 off take estimate of 120k tons, while we expect integrated PVC-Ethylene margin after deducting fuel cost at USD749/ton during CY11. We estimate PVC demand to grow at 3-year (CY11-14) CAGR of 4%.

High interest cost hurting bottom-line

Higher finance cost post COD of VCM plant continues to offset operating profit growth from higher gross margins. Consequently, bottom-line during the quarter remained negative. Finance cost was recorded at PKR371mn in 2QCY11, taking 1HCY11 aggregate financial charges to PKR753mn, up 17% YoY. Higher finance cost reflects the effect of partial capitalization of finance cost during 1HCY10 as COD of the VCM plant was achieved on Sept’10.

Investment perspective

At yesterday’s closing price of PKR8.0/share, the scrip trades at CY12E P/E multiple of 5.6x, and offers an upside of 43% to our Jun-12 PT of PKR11.5/share. However, EPCL’s margins and earnings highly dependent on stability of VCM plant as PVC-Ethylene margins are approximately 3.4x of PVC-VCM margins. We have assumed integrated PVC-Ethylene margins (after deduction fuel cost) at USD749/ton during CY11. EPCL’s realized margin per ton of PVC was a mere USD557/ton during 1HCY11, due to 30% reliance on imported VCM. We have assumed 0% reliance on imported VCM from CY12 onwards, which remains a key assumption to our June-12 PT of PKR12/share. 30% reliance on imported VCM CY12 onwards would trim our CY12 EPS by 51% to PKR0.69, and cut our Jun-12 PT by 8.6% to PKR10.5.

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