Q2: Improvements seem more sustainable, Revise TP to SAR85

Q2 2016 results indicate SABIC’s cost cutting efforts coming to fruition as results surpassed market estimates. Revenue at SAR34.5bn was above our expectation of 33.8bn. However, the main beat was at the gross profit level, which came in at SAR11bn bettering our expectation of SAR8.7bn. About 70% of this beat came from corporate and metal segments and remaining from its core petchem business as “other COGS” declined. The company reported a significant 18% q-o-q reduction in costs through improvement in efficiencies and fall in naphtha prices (key feedstock) in Europe and China. While we had factored in the fall in naphtha prices, the improvement in efficiency was above our expectation. We believe the improvement seen in petrochemical and metal segments is likely to be sustainable as the company plans to continue its cost cutting measures. Despite the company’s ability to pay higher dividends, 1H 2016 dividend at SAR2 was lower than SAR2.5 in 1H 2015, as a result of which the stock fell sharply. While cost cutting measures are likely to improve margins, there could be one-off costs in the coming quarters. Post the release of detailed Q2 financials, we have revised our estimates and target price upward to SAR85. We continue to rate SABIC Neutral (5% upside). Key risk is decline in price spreads, which were up sequentially in July.

Valuation and risks

We revise our estimates to reflect the cost cutting measures and Q2 results. We use an equal mix of DCF and relative valuation for our target price. For DCF, we use cost of equity at 11.6% based on a beta of 1.2, and long term growth rate of 2%. Applying a target debt/ capital ratio of 20%, we have a WACC of 9.6%. We use a target forward P/E multiple of 13x based on historical averages. Based on average of these valuation multiples, we arrive at a target price of SAR85 per share, with an upside of 5%.

Key risks are associated with commodity prices, decline in spreads, loss of market share in key markets such as China, impairment losses etc.

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