EPCL: Respite beyond dismal CY10 already priced in!

LPS of PKR1.23 booked in CY10: Engro Polymer & Chemicals Limited (EPCL) announced its CY10 financial result, where the company posted LAT of PKR814 (LPS: PKR1.23), as compared to LAT of PKR232mn (LPS: PKR0.35).

Top-line ↑ 26% YoY; Gross margins ↓ 200bps: During CY10, net sales registered an increase of 26% to PKR14.6bn due to to healthy PVC demand and firm prices. Simultaneously, gross margins fell by 200bps to 8% during the year (PVC-VCM margins trimmed 38% to USD133/ton in CY10). During 4Q, post COD of VCM plant, gross margins jumped 800bps to 13.5% as integrated PVC-Ethylene margin was recorded at USD453/ton.

High finance cost denting profitability: Finance cost increased to PKR1.4bn during CY10, up 137% YoY as EPCL started expensing interest on LT loans acquired to finance backward integration. Interest coverage ratio for CY10 dropped to 0.83x as against 1.45x in CY09.

We maintain our estimates: At yesterday’s closing price of PKR13.1/share, the scrip is fairly valued given our DCF based December-11 PT of PKR13/share and trades at an expensive CY11E P/E multiple of 24.5x. Hold!

Top-line ↑ 26% YoY; Gross margins ↓ 200bps

During CY10, net sales registered an increase of 26% to PKR14.6bn primarily attributable to healthy PVC demand and firm prices. Simultaneously, gross margins fell by 200bps to 8% during the year as PVC-VCM margins lost 38% YoY in CY10 to average USD133/ton. EPCL had to consume expensive imported VCM due to delays in commencement of the backward integration project. Moreover, expensive spot VCM purchases also contributed to input costs, leading to further attrition in margins. EPCL had abolished its long term VCM procurement contract in CY09, in anticipation of timely commencement of VCM plant. Moreover, during the 4Q gross margins jumped 800 bps to 13.5% on the back of commissioning of VCM plant as integrated PVC-Ethylene margin was recorded at USD450/ton during 4Q. Gross profit for 4QCY10 clocked in at PKR555mn, which lags our CY11 quarterly gross profit estimate of

PKR774mn by 28% as plant did not run on full capacity during 4Q. Assuming EPCL’s CY11 operational performance is similar to 4QCY10, the company would incur an LPS of PKR0.33 during the next year against our CY11 EPS estimate of PKR0.53.

Finance cost to restrict earnings growth

With PKR13.5bn in debt acquired for expansion/backward integration project, CY10 finance cost rose by 137% YoY to PKR1.4bn as the company expensed out borrowing cost related to the VCM project in the second and third quarter. Interest coverage ratio dropped to 0.83x in CY10 as against 1.45x in CY09.

Investment Perspective

Post CY11, decline in finance cost emanating from loan repayment will be the major contributor to earnings growth as we expect a muted increase (CY11-13 primary margin CAGR at 1.4%) in PVC-Ethylene margins. Key risks to our valuation remain the possible disruption in VCM plant that could further weigh down margins and earnings whereas variance in PVC-Ethylene margins can steer earnings on either side. At yesterday’s closing price of PKR13.1/share, the scrip is fairly valued given our DCF based December-11 PT of PKR13/share and trades at an expensive CY11E P/E multiple of 24x. We shall review our estimates once detailed accounts are available.

Economic & Political News

Leverage product launching at KSE by month-end

The much-awaited leverage product – Market Trading System (MTS) – is most likely to be launched at the country’s stock exchanges in the last week of February 2011. Sources said Securities and Exchange Commission of Pakistan (SECP) Chairman Muhammad Ali Ghulam Muhammad during his first visit to Karachi Stock Exchange (KSE), here on Monday discussed the issue with members.
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