Weak Q2; Expect tepid product prices in Q3 but improvement in costs. Maintain Neutral.
SABIC reported weak Q2 numbers with top-line and bottom-line declining 5.2% and 29% q-o-q respectively, missing both our and consensus estimates. Lower product prices and sales volume, higher cost of sales, weak performance of affiliates ( particularly listed Petchem companies and Hadeed) and impairment charges at Ibn Rushd weighed heavily on Q2 earnings. So far in Q3, average prices are trading lower than Q2 levels across most Petchem and fertilizer products, which could result in sequentially lower Q3 revenue. Though sales could decline, costs are likely to improve resulting in better quarterly performance in Q3. More than near term performance, the primary driver for SABIC will be the outcome of key large projects, currently under feasibility stage. Based on our valuation model, we reiterate our earlier Neutral rating with a revised fair value of SAR95/share (average of relative and DCF valuations). The stock is currently trading at EV/2018 EBITDA of 8.2x, at a discount to global peers, similar to historical levels (Figure 6). We expect SABIC to pay DPS of SAR2.5/share in H2 (5.1% yield – forward 12M), given its robust FCF and optimal debt structure.Q2 details:
a) Q2 revenue declined 5.2% q-o-q , primarily due to lower product prices coupled with lower sales volumes at its 100% owned subsidiary, Saudi Iron & Steel Company (Hadeed). Q2 top-line came in slightly lower than our (- 3.2%) and consensus estimates (~2%). Major chunk of the topline miss (vs our estimate) could be attributable to weaker than expected sales volume at Hadeed and lower Petchem sales at its listed subsidiaries (Yansab, Kayan and SAFCO). b) Despite a mid-single digit drop in product and lower feedstock prices, gross profit plunged 21% q-o-q in Q2 due to higher ‘other cost of sales’, particularly at its metal segment (8% q-o-q increase as per our calculation), resulting in gross margin of 30.8% in Q2, lowest since Q1 2016. c) SG&A is likely to have declined ~11% sequentially, in line with our expectation. SABIC charged an impairment of SAR578mn (SAR278mn, SABIC’s share) at its affiliate, Ibn Rushd during the quarter, pushing operating profit 35% q-o-q lower to SAR5.4bn, its lowest level in the last five quarters. d) Hadeed reported a net loss of SAR483mn in Q2 due to weak top-line and high operating costs. e) Overall net profit dropped ~29% qo-q as the weak operating performance, particularly at Hadeed plant, is likely to have been partially offset by improved non-operating items and lower minority distribution (more than 50% q-o-q drop in our view).Valuation.
We have revised our top-line and bottom line estimates lower around 3-4%, respectively to reflect weak Q2 results and latest price deck. Consequently, we have lowered our TP to SAR95/share based on our valuation model (average of relative and DCF valuations) but remain Neutral on SABIC. The stock is currently trading at an EV/EBITDA of 8.2x on our 2017E and 2018E EBITDA maintaining its discount compared to global peers as seen in Figure 6. Moreover, the stock has already increased ~8% this year and hence, we believe the most positive fundamentals are already priced in at the current level.
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