Chinese Stocks Are Starting to Look Like Bargains

Investing in China is more difficult than normal these days, prompting some to question if it’s worth the effort. And it’s not going to get much simpler in the immediate future, but volatility in the coming months may present opportunities for long-term investors.

Chinese officials have been pursuing the country’s largest and most popularly owned internet businesses since canceling Ant Group’s expected public offering last autumn. Beijing struck again on July 2, starting a cybersecurity assessment of DiDi Global (ticker: DIDI) and ordering the company’s app to be removed from app stores, as it tightened data security and standards for businesses listed overseas.

The decision, which came just days after raised $4.4 billion in the year’s largest IPO, caused the stock to plummet by a fifth of its value on July 6 and shook other Chinese internet stocks. Investors are bracing for further scrutiny of internet companies’ data practices and other regulatory actions, as the KraneShares CSI China Internet exchange-traded fund (KWEB) has dropped 15% since June 30.

Gavekal Research’s head of research, Arthur Kroeber, said, “We now know this is a regulatory quagmire, and those that expose themselves to the industry are taking on a lot of volatility.” “If you have a long-term view, this will be one of the next decade’s growth stories, and you must ride it out. If you’re looking for something more immediate, you might claim it’s too difficult and return in a year when things have settled down.”

The flurry of regulatory actions has produced the kind of ambiguity that attracts bargain hunters. Technology behemoths like Alibaba Group Holding (BABA), whose stock has dropped 11% this year, are catching value managers’ attention. However, care is advised, particularly for investors in shares of Chinese businesses listed on the New York Stock Exchange. Regulatory pressures may persist. Kenneth Zhou, a lawyer at Beijing law firm WilmerHale, adds, “It’s probably just the beginning of the enforcement activities.”

China’s regulatory push has been portrayed by fund managers as an attempt to acquire greater control and put in place safeguards for fast-growing digital businesses and internet behemoths. It’s also a means for Beijing to cope with rising US-China tensions, which are being exacerbated by new legislation in Washington that sets the stage for Chinese firms to be delisted if they don’t provide more auditing disclosures within three years.

One source of concern for Chinese officials is the vast amounts of data acquired by Chinese internet companies listed in the United States, which might pose a national security risk.

In a recent research note, Rory Green, director of China and Asia research at TS Lombard, wrote, “Data control is turning up to be a major internal and geopolitical problem, with direct equity market ramifications for businesses operating on both sides of the Pacific.”

Beijing is attempting to establish greater control over Chinese businesses, even those that are publicly traded. Many of China’s biggest digital companies, including Alibaba, Tencent Holdings (700.Hong Kong), and JD.com (JD), are registered in the Cayman Islands and employ a variable interest entity (VIE) structure to avoid Chinese foreign ownership limitations. The complicated structure, which is usually overlooked by investors, is a gray area since it prevents foreigners from owning a share in a Chinese firm. Instead, they must rely on China to keep promises made to the firm.

China has mostly ignored the extralegal system for decades, but it is suddenly paying more attention. According to Bloomberg News, Beijing is considering requiring firms that utilize this structure to get clearance from the Chinese government before listing overseas. Companies that have already been listed may need to get clearance for any secondary offers.

Analysts and money managers predict that China will not be able to reverse the VIEs, which are utilized by the country’s largest and most successful firms and would take decades to dismantle. Many others are also doubtful that the US would follow through on its threat to delist the country.

VIE inspection, on the other hand, may be used by Beijing to establish greater control over firms and to fight back against US authorities’ demands for more transparency. Indirectly, the investigation would likely reinforce Beijing’s attempts to get local businesses to return home, a push that has already resulted in secondary listings in Hong Kong for Alibaba, Yum China Holdings (YUMC), and JD.com.

Analysts predict that increased scrutiny will limit, if not halt, the number of Chinese firms going public in the United States in the near future. It may also reduce the number of U.S.-listed Chinese firms that appeal to do-it-yourself retail investors, which now stands at over 240 with a combined market value of over $2 trillion. According to Louis Lau, manager of the Brandes Emerging Markets Value fund, any of these that are unable to achieve secondary listings in Hong Kong or China may go private.

Stocks listed in the United States may see more volatility as a result. Whenever feasible, fund managers and institutional investors, including Lau, have gravitated toward stocks listed in Hong Kong or mainland China. Mutual or exchange-traded funds are the greatest method for ordinary investors to have access to these international listings, as well as the more locally oriented equities that certain fund managers choose.

Money managers are better equipped to deal with the logistical challenges posed by US-China tensions, such as the repercussions from a recent executive order prohibiting US investment in firms with connections to China’s military complex, according to Washington. The S&P Dow Jones Indices and the FTSE Russell agreed earlier this month to delist more than 20 Shanghai and Shenzhen-listed companies.

Other firms might be blacklisted, resulting in similar consequences, according to Reuters, which reported on July 9 that the Biden administration is contemplating adding more Chinese entities to the prohibited list due to alleged human rights violations in Xinjiang.

As investing in China becomes more challenging, the rationale for choosing a fund manager who can handle these hurdles and invest locally is becoming stronger. Failure to do so might cost you a lot of money. Over the last three months, the iShares MSCI China A ETF (CNYA) has gained 3%, while the Invesco Golden Dragon China ETF (PGJ), which invests in U.S.-listed Chinese firms, has lost 14%.

“Regulation is here to stay,” says the author. “Investors will just have to get accustomed to it,” says Tiffany Hsiao, a portfolio manager for Artisan’s China Post-Venture strategy. “This is capitalism with a Chinese flavor. China is, without a doubt, still a communist country. It supports capitalism in order to spur innovation and increase production, but it is critical for successful businesses to pay back to society—as Chinese authorities will remind you.”

As a result, she believes that investors should look outside the widely owned internet behemoths to discover equities that will profit from the increased regulatory scrutiny that the behemoths will be subjected to. Veteran investors are emphasizing selectivity, looking for firms that aren’t in the crossfire in local markets.

“A firm might have strong fundamentals and exciting potential but be blindsided by government intervention, which is becoming more active,” says David Semple, manager of the VanEck Emerging Markets fund (GBFAX). “Being involved necessitates a higher level of conviction than usual.”

Semple is drawn to firms he knows, in industries that may be impacted by regulation, but not to the extent that investors believe.

One example is China’s efforts to reduce child-care expenses and encourage families to have more children by targeting after-school course providers. Semple, on the other hand, sees potential in China Education Group Holdings (839.Hong Kong), which may make purchases as Beijing compels state institutions to sell associated private colleges.

Semple prefers Tencent, the top holding in his fund, over Alibaba, another holding, among the major internet firms. Tencent has an edge over Alibaba because of its Weixin messaging and videogaming brands, which offer a high-quality, low-cost flow of consumers for its other companies, according to Semple.

According to Martin Lau, managing partner and portfolio manager at FSSA Investment Managers, which manages $37 billion, Tencent has discreetly cooperated with the government’s regulations, with CEO Ma Huateng keeping a low profile. Given the anger directed against Alibaba and Ant co-founder Jack Ma, this is a plus.

The basics of many Chinese internet firms are good. According to Xiaohua Xu, a senior analyst at Eastspring Investments, complying with the rigorous laws on acquiring and securing user data would likely limit their earnings in that sector.

Alibaba and other online businesses, like as JD.com, are accessible to value investors. However, investors’ growth expectations are expected to be recalibrated as Beijing implements new policies and evaluates previous agreements, causing volatility. Furthermore, heavily held U.S.-listed Chinese firms, such as Alibaba, might serve as proxies for investors’ concerns about China.

Despite the red signs, investors should keep China on their radar. According to Jason Hsu, chairman and chief investment officer of asset management Rayliant Global Advisors and co-founder of Research Affiliates, “If you are buying growth, the globe has two engines: the US and China.” However, he points out that the United States is more costly. “And wherever there is risk—and the world perceives China as hazardous, and that bias is deepening—that implies opportunity.”

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TMB Bank Solid start but stronger quarter still ahead 

■ 1Q21 net profit at THB2.8bn, -33% yoy but up 125% qoq, was led by declining provision expense, while topline generation remains soft. 

■ Net profit growth is likely to slow in 2Q21F from higher provisions, while we expect synergy from completed integration to remain a key catalyst in 2H21F. 1Q21 ahead from lower-than-expected provision expense TMB reported 1Q21 net profit at THB2.8bn, -33% yoy but +125% qoq. The results were 7% ahead of our estimate, led by lower-than-expected credit cost of 158bp vs. our estimate of 190bp. We expect the strong quarter to act as a near-term re-rating catalyst for TMB. 

With its integration process expected to be completed in 2Q21F, we foresee further benefits from cost savings in 2H21F. Soft start for its topline growth amidst macro-headwinds TMB Bank continued to report a contraction in its loan portfolio by 1.1% qoq, as the bank continued to focus on de-risking its portfolio with selective loan growth against the current macro-headwinds. NIM contracted 6bp qoq from a less favourable portfolio mix, previous rate cuts and competition in the mortgage segment. 

Non-NII did not see as strong of a recovery as peers, as it was largely dragged by a seasonal slowdown in auto insurance sales, while mutual fund fees remained strong. Opex decline was also within expectations as TMB recognised a one-time early retirement programme in 1Q21. As such, we expect CIR to trend down in upcoming quarters to 44% in FY21. 

We expect improving NII to be a key driver of PPOP growth in FY21F, along with tighter cost control, as TMB continues to run down its low yield portfolio and shift to greater retail lending. Brace for higher provisions in the coming quarters Around 14% of its total loan portfolio remained under the bank’s relief programme as of Mar 21, unchanged from Dec 20. These customers were mainly borrowers who qualified for the second phase of relief measures. While credit cost was lower than expected in 1Q21, TMB did not provide further clarification on provisioning in the quarter. 

In our view, provisions in 1Q21 have yet to include additional provisions against the new wave of Covid-19 in Thailand which began in late-Mar/early-Apr. As such, we expect TMB’s credit cost to trend up in 2Q21F, and we keep our current credit cost assumption of 188bp intact given the current economic outlook. NPL ratio increased further in 1Q21 to 2.75% from 2.5% in 4Q20. The rise in NPL was partly due to the slow natural resolution of NPLs during the quarter. 

We expect the deteriorating trend to continue throughout FY21F, with NPL ratio likely reaching a peak at 3% by end-FY21F. Further benefits from merger to be highlighted in 2H21F We reiterate our Add call with an unchanged target price of THB1.33, based on 0.6x FY21F P/BV. 

We expect TMB to report one of the strongest PPOP growth in FY21-22F as it continues to leverage synergies arising from the merger and completion of integration by 3Q21F. Strong PPOP growth remains a key catalyst. Downside risk is higher-than-expected NPL formation as customers exit its relief programme.

Valuation and recommendation Further benefits from merger to be highlighted in 2H21F We expect TMB to report one of the strongest PPOP growth in FY21-22F as it continues to leverage synergies arising from the merger and completion of integration by 3Q21F. 

We reiterate our Add call with an unchanged target price of THB1.33, based on 0.6x FY21F P/BV. Strong PPOP growth remains a key catalyst. Downside risk is higher-thanexpected NPL formation as customers exit its relief programme.

– By CIMB Bank Research

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Astec Lifesciences: While the stock is currently trading at 30.4x FY22F EPS, we value the company at 25x FY23F EPS, the long-term mean P/E, to arrive at our TP of Rs1,073.

We value the company at an eight-year mean valuation as:

1. Core PAT growth will likely be 13.9% CAGR over FY21F-24F. This is lower than FY13-21 PAT growth of 34.7%. We forecast revenue to be 15% CAGR for FY21F-23F, lower than FY13-FY21F revenue growth of 16.2%. While revenue has mimicked past growth, earnings growth is lower and we value the company at a historical mean valuation. We do not assign any premium to it.

2. We expect EPS growth of 13.9% CAGR for the company, in line with peer average EPS growth for FY21F-24F. Astec’s RoE of 19.22% is slightly higher than the average of peers (under our coverage) of 17.5% for FY23F. However, in terms of size, Astec is much smaller than its peers, business is highly concentrated in a single chemical class and the company has not got a track record like Bayer, UPL, SRF, NFIL or PI. Hence, we value the company at its historical mean valuation, which is lower than its peers by 60%. Astec’s peer group comprises Rallis (Rallis IN, Add, TP Rs355, CMP Rs270), SRF (SRF IN, Add, TP Rs6,227, CMP Rs6,226), PI Industries (PI IN, ADD, TP Rs2,600, CMP Rs2,500), Vinati Organics (VOL IN, Add, TP Rs1,603, CMP Rs1,580), Navin Fluorine (NFIL IN, Hold, TP Rs2,599, CMP Rs3,085).

3. After a projected decline of 180bp in gross margins in FY21F, we expect it to bounce back 150bp over the next three years. However, Astec is at present in a declining chemical class, hence there are pricing pressures. At the same time, rising crude oil prices will lead to rising raw material costs. So, it is possible margins could be a negative surprise.

4. We forecast revenue to be 15% CAGR (FY21-24F) and PAT 13.9% CAGR for FY21F-24F. There are near-term headwinds as PAT growth will remain below consensus, however the company is diversifying into herbicides which is a long-term positive. Risk balances reward, hence, Hold.

Downside risks

1. We expect gross margins to bounce back by 150bp as prices are likely to recover for tebuconazole after a dismal FY21F. However, if prices do not bounce back, gross margin will not recover. Hence, EPS will be lower than our estimates.

2. We expect Astec to be able to pass on the crude oil-linked rise in raw material cost. However, if the company is unable to do so then gross margins and EPS will be lower than our estimates.

Upside risks

1. We build in a slow plant ramp up, which Astec Lifesciences is putting up at a cost of Rs0.8bn. We estimate the revenue in the first year at Rs0.3bn, however a faster ramp-up/ new order could surprise us positively.

2. We expect the domestic enterprise business to grow at 12% CAGR over FY21-24F. However, a sudden rise in fungus attacks on rice/ food and vegetables could increase the use of SBI-triazole fungicides (like tebuconazole) which will be positive for Astec’s revenue and EPS.

– By CIMB Bank Research

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Astec’s molecules are facing serious demand issues

The prognosis for this market is not good, in our view

• The SBI-triazole market was largely flat in 2019, rising just +0.4% to reach US$3,212m over CY12-19. This market was flat over CY14-19, declining by 2.1% CAGR (Source: IHS Markit).

• The impact of COVID-19 is likely to be higher for SBI-triazoles, given a higher relative exposure in the maize and oilseed rape/canola segments, which were impacted somewhat by the downturn in biofuel demand and, therefore, prices in 2020.

• There is continuing pressure on triazoles in Europe in terms of potential regulatory action that may constrain future growth if registration renewals are not achieved. This is likely to benefit competing SDHI (succinate dehydrogenase inhibitors) and ‘other’ fungicide segments.

• A positive factor in recent years has been the increasing usage in combination with strobilurins, due to the Septoria fungus developing resistance to this class, and more recently with SDHI products. We believe the SDHI segment is likely to grow faster than all other fungicides, and the triazole segment is likely to benefit in a limited way from its inclusion in mixture products with certain SDHIs.

• Multiple SBI-triazole molecules face substitution risk in Europe.

• Another dampening factor is a strong pipeline of active ingredients targeted at cereal production, many of which feature novel modes of action.

• Tebuconazole, a key Astec product, is on the European Union’s active watch list. Tebuconazole is a generic manufactured by multiple companies and, hence, its prices are likely to remain under pressure. Future growth could come from being a mixture partner to SDHI fungicides Given the success of the SDHI segment of fungicides (8.5% CAGR in sales terms over CY14-CY19, according to IHS Markit), the SBI-triazole group could be used as a mixture partner. This could be a potential growth driver for this group of fungicides.

Within SBI-triazole too, Astec’s molecules are facing serious demand issues Within SBI-triazole, Astec’s molecules are doing worse than the overall segment. Tebuconazole, about 50% of Astec’s overall exports (Source: Corpiness Global Private Limited, an exports data provider), grew at only 1.7% CAGR over CY12- 19 (Source: IHS Markit).

Tebuconazole, propiconazole, bromuconazole are the biggest molecules in Astec’s export basket Tebuconazole, propiconazole and bromuconazole are the biggest molecules in Astec’s export basket. In the last four quarters these molecules formed twothirds of the total exports basket (in value terms).

Molecule realisations fell over the last few quarters Globally the SBI-triazole group of molecules have been replaced by the SDHI molecules. Hence, it is natural that prices of SBI-triazoles molecules are falling. Tebuconazole is the biggest exports molecule for Astec (50% of exports, Source: Corpiness Global Private Limited) and its prices collapsed by ~45% in 2QFY21 over 1QFY21 (Source: Corpiness Global Private Limited).

Poor realisations showed in falling GMs (4QFY20 to 3QFY21) Astec’s gross margins fell due to poorer export realisations. Tebuconazole, particularly, showed deep pricing pressure in 2QFY21, and its realisations fell by 45%.

Top four chemicals formed more than 70% of overall raw material import in FY20 Astec imports more than 90% of its raw material requirements (for FY20). We expect its future dependence on imports to come down as management is focussing on backward integration (Source: 3QFY21 results conference call).

The extent of pricing pressure is visible from the fact that all important raw material prices are falling, despite that GM is declining Almost all raw material prices fell sequentially in the first three quarters of this financial year. However, driven by crude oil prices (which rose by 60% vis-à-vis the CY20 average) raw material prices started rising in 4Q. As crude oil remains strong, we expect further a rise in raw material prices over coming quarters.

Price of Astec’s largest imported chemical (1-(4-chlorophenyl)- 4, 4-dimethyl-3- pentanone) could rise going forward According to Astec Lifesciences, its largest import is the chemical 1-(4-chlorophenyl)-4, 4- dimethyl-3- pentanone and forms ~50% (value terms) of total imports in FY20. 1- (4-chlorophenyl)-4, 4-dimethyl-3- pentanone is synthesised from crude derivatives, and the recent rise in crude price is bound to raise overall cost of production for 1-(4-chlorophenyl)-4, 4-dimethyl-3- pentanone, in our view. Consequently, its prices are likely to rise.

– By CIMB Bank Research

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Astec Lifesciences Ltd Medium-term headwinds, Hold 

■ We forecast revenue growth at 15% CAGR and PAT at 13.9% CAGR over FY21F-24F for Astec Lifesciences

■ The key chemical segment SBI-triazole is facing demand headwinds, but we believe expansion into herbicides provides a growth opportunity. 

■ We value the stock at 25x FY23F EPS, in line with the mean P/E of the last eight years. We initiate coverage on the stock with Hold and TP of Rs1,073. Hopes up by consensus, but medium-term headwinds Astec LifeSciences manufactures a wide range of agrochemicals and pharmaceutical intermediates. Exports, including contract research and manufacturing services (CRAMS), form ~60% of FY21F of revenues.

The company supplies products to such customers as Syngenta, Dow, Bayer AG, Farma Tech International Corporation, etc. Astec is particularly active in the SBI (Sterol Biosynthesis Inhibiting)-triazole group of fungicides, with tebuconazole one of its main molecules. Falling realisations of key products and the likely rise of raw material prices are the key risks in the short term. Globally there is a shift from SBI-triazoles to SDHI fungicides, presenting a key risk in the medium term.

Astec is expanding capacity and trying to mitigate risks by venturing into herbicides, which likely will take time to fructify, in our view. SBI-triazole group of fungicides is facing structural headwinds The SBI-triazole market was largely flat (in sales terms) in 2019, rising just +0.4% to reach US$3,212m in global sales. The SBI triazole market was flat over CY12-19 and declined by 2.1% CAGR over CY14-19 (Source: IHS Markit).

Pressure continues to build on triazoles in Europe as potential regulatory action may constrain future growth if renewals of registrations are not achieved. This is likely to benefit competing Succinate dehydrogenase inhibitors (SDHI) and ‘other’ fungicide segments, in our view. We believe multiple SBI-triazole molecules are facing substitution risk in Europe.

Another dampening factor is a strong pipeline of active ingredients targeted at cereal production, many of which feature novel modes of action. Tebuconazole, a key product for Astec and ~50% of exports (FY20), is on the European Union’s active watch list. It is a generic agrochemical manufactured by multiple companies and, so, its price is likely to remain under pressure. We value Astec at 25x FY23F EPS, initiate coverage with Hold We forecast revenue to be 15% CAGR (FY21-24F) and PAT 13.9% CAGR for FY21F24F.

There are near-term headwinds as PAT growth will remain below consensus, however long-term positive remains as company is diversifying into herbicides. Risk balances reward, hence, Hold. Upside/downside risks: If tebuconazole prices do not bounce back in FY22F, gross margin will not recover and EPS will be lower than our estimates.

We expect the domestic enterprise business to grow at 12% CAGR over FY21-24F, but a sudden increase in fungus attacks on rice and vegetables could increase the use of SBI-triazole fungicides (like tebuconazole) which will be positive for revenue and, hence, for EPS

Medium-term headwinds, Hold Business analysis Exports form almost 60% of Astec’s revenue in FY20 Exports form 60% of Astec’s revenue in FY20 and have been the main drivers of revenue growth over the past six years. We expect exports revenue CAGR of 12% over FY21F-24F

Exports comprise enterprise sales and CRAMS Astec’s enterprise sales and CRAMS have almost equal weightage in exports. Astec’s key customers are Syngenta, Dow Agrosciences, Bayer AG and Farma Tech International Corporation.

Astec’s key agrochemical exports belong to SBI-triazole group of fungicides, whose market has been stagnant for 7 years Astec’s key exports belong to the SBI-triazole group whose sales were stagnant over the last few years. Last year (FY20) the sales growth rate of the SBItriazole group of fungicides was a meagre 0.4% CAGR (Source: IHS Markit)

– By CIMB Bank Research

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SCC’s Vietnam-based Long Son project Background In 2008, SCC announced that its plan to invest in a new petrochemical complex in Vietnam was under feasibility study.

In Feb 2012, SCC signed a joint venture agreement with Qatar Petroleum International Vietnam (QPI) and PetroVietnam (wholly owned by the Vietnamese government) to invest in Longson Petrochemical Company (LSP) with the aim to construct a mixed-feed olefins cracker with downstream facilities. Originally, SCC held 46% stake while QPI and PetroVietnam held 25% and 29% stakes, respectively. In Mar 2017, SCC announced to SET that it signed a share purchase agreement with QPI to acquire 25% equity stake in LSP.

According to QPI, the company pulled out from the project due to its revised capital and feedstock allocation strategies. Post transaction, SCC’s total stake in LSP increased to 1% from 46% previously. In May 2018, PetroVietnam sold its 29% stake to SCC for THB2.9bn. SCC said at the time that the investment privileges from Vietnamese government were intact. Post the transaction, SCC held 100% of LSP. The total project cost is US$5.5bn.

A loan agreement for US$3.2bn with a 14- year tenor was signed with syndicated lenders in 3Q18. The implied D/E ratio is 1.5:1. The construction started in 4Q18. Key contractors included the consortium of Technip and SK E&C, POSCO E&C, Samsung Engineering, and Hyundai Engineering. According to SCC, the project was 66% completed at end-2020 and should be able to start commercial operations within 1H23. Project details LSP project is located in Vung Tao province (100km from Ho Chi Minh City).

The estimated capacity is 1.65mt of olefins (the proportion of ethylene vs. propylene would depend on feedstock type), 1.35mt of downstream PE/PP and other byproducts (benzene, toluene, crude C4). SCC said the cracker is designed to have high flexibility to use gas (ethane and LPG) up to 80% of total feedstock requirement. SCC said QPI agreed to remain the LPG supplier despite its decision to pull out from the JV. Ethane feedstock (max at 10% of requirement) will be provided by PetroVietnam. SCC signed a 15-year feedstock contract (2mtpa of LPG and naphtha) with QPI in 2Q18

Project IRR hinges on cost competitiveness of feedstock We believe the profitability and IRR of LSP hinge largely on the mix of feedstock and the cost of LPG that SCC and QPI agreed under the long-term contract. Based on our estimates, LPG usage at 60% of total feedstock requirement is the optimal level that would maximise annual EBITDA and net profit for the project, assuming that LPG cost under QPI agreement is sold at a 30% discount to the market price of naphtha.

Assuming that HDPE-naphtha and PP-naphtha spreads are at US$500/t and US$520/t respectively, we estimate that EBITDA accretion from LSP is THB12.0bn. If LPG is sold at a 20% discount to naphtha market price, EBITDA accretion would be lower at THB10.7bn.

Assuming D/E ratio of 1.5:1 and HDPE-naphtha spread of US$550/t, we estimate that the project should achieve an IRR of 11.0% if the project cost is at US$5.5bn. Assuming 15% cost overruns, project IRR could reduce to 9.5%, based on our estimates.

Near-term catalyst from strong chemical spreads; Reiterate Add on SCC and PTTGC We believe the strength in Asian PE-naphtha and PP-naphtha spreads seen during 1Q21 should continue into 2Q21F as Asian polymer supply should remain tight despite the better availability of containers which was one of the key hurdles for US exports.

According to IHS Markit, PE/PP inventory levels fell to less than 34 days and 21 days, respectively, as of Mar 21, lower than historical levels of 36-42 days and 28-30 days. Toyota Motor Corp and Honda Motor Co., Ltd cut auto production in the US in Jan 21, partly due to the shortage of plastic resins (multiple plant shutdowns). With the unmet domestic demand, US-based PE producers are likely to limit export cargoes to Asia, in our view. According to IHS Markit, it would take more than 9 months for US producers to recover the lost production, assuming that average utilisation rate is 95%.

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Asia propylene price to be supported by strong derivative demand.

We estimate that global propylene supply addition should reach 8-9mtpa during 2021-2022F, following naphtha cracker and refinery expansion in China. The startup of propane dehydrogenation projects (PDH) also looks accelerated at 2.8-4.1mtpa during 2021-2022F from 1.0mtpa during 2017-2019. Based on our estimates, 60-90% of additional propylene capacities are from China during 2021-2024F.

While most new naphtha crackers should be able to operate at high utilisation rates, the profitability and utilisation rates of China-based PDH capacity would hinge on imported LPG cost, which could be seasonally costlier in winter. As PDH capacity might not be able to ramp up to full utilisation rates throughout 2021F while coal-to-olefins (CTO) and methanol-to-olefins (MTO) cash costs are relatively high, naphtha crackers could seize some additional market share, in our view.

On the demand side, we believe strong derivative demand, particularly for polypropylene (PP), phenol and acrylonitrile (AN) should continue to support propylene prices. The acceleration of new PP, phenol and AN supply growth should translate into strong Asian propylene demand in 2021F.

PP, which is used for plastic packaging and automotive/electrical parts production, is the biggest outlet for propylene. According to the China Passenger Car Association, passenger vehicle sales increased by 69% yoy in 1Q21, indicating that vehicle demand has reverted back to the pre-Covid-19 levels in 2019. The expectations for higher PP price, which is backed by higher crude oil price, and better demand outlook should accelerate restocking demand in the near term. Chinese government’s policy to support car sales should continue to lead to robust PP demand. Together with alternative usage (e.g. substitution for PE in packaging), growing PP demand should be able to absorb additional PP supply which should reach 5-7mtpa during 2021-2022F, in our view.

Thai-based capacity expansion just in time PTT Global Chemical and SCC have undertaken ethylene capacity expansion projects in Thailand. The main purpose of PTTGC’s Map Ta Phut Retrofit project (new naphtha cracker) is to diversify feedstock to naphtha, given that ethane feedstock availability could gradually decline after 2022F. For SCC’s Map Ta Phut expansion project, the purpose is to eliminate the dependence on ethylene from external parties.

Both projects achieved on-spec production in late-Mar 21 and should start commercial production in 2Q21F. We believe the timing of the project startup is optimal given that Asian demand for ethylene and PE should remain robust in 2021F, especially with limited competition from the US. SCC still has another chemical project that is under construction in Vietnam, which is Long Son Petrochemical project (LSP). According to SCC, the startup date should be within 1H23F. Based on our estimates, global ethylene supply additions should fall to 4-5mtpa during 2024-2025F from 10-12mtpa during 2021-2023F.

We believe SCC would not inject its capital to finance Chandra Asri’s second naphtha cracker in Indonesia as SCC would need to preserve cash for LSP. PTTGC aspires to build a shale gas cracker project in the US. However, Daelim Industrial, which previously agreed to co-invest in the project, withdrew from the JV agreement in July 2020. PTTGC stated that it will continue with the feasibility study for the project and actively find a new partner. The target for the final investment decision (FID) is in 2021, delayed from end-2020 (previously estimated) and end-2018 (the original plan).

SCC’s expanded ethylene capacity SCC’s project to expand ethylene production capacity by 300ktpa at Map Ta Phut Olefin complex (MOC) was completed and achieved on-spec production in late-Mar 21. The project also raised its propylene capacity by 50ktpa. This took SCC’s nameplate ethylene and propylene production capacity to 2.1mtpa and 1.3mtpa, respectively (from 1.8mtpa and 1.25mtpa previously). SCC’s primary objective of increasing ethylene production is to cover its internal ethylene deficit of 200-300ktpa. We believe the expansion plan is good for SCC as the profitability distribution is heavily skewed to upstream ethylene while PEethylene spread was narrow at US$80-100/t during 2019-2020.

– By CIMB Bank Research

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Despite strong ethylene supply additions, we believe the ethylene-naphtha spread should remain at US$390-415/t during 2021-2022F, which is above the pre-Covid-19 levels of US$375/t in 2019.

The strong demand for ethylene derivatives, particularly polyethylene (PE), and limited arrival of US cargoes should be able to offset the new supply pressure, in our view. In the case of excess supply, we believe the producers at the high end of the cost curve, such as methanol-based producers, are likely to lose market share to the low-cost players (most likely crude-oil-to-chemical complexes). Post 2023F, ethylene capacity additions should fall to 4-5mtpa.

In Jun 20, the National Development and Reform Commission of China (NDRC) granted approval to Shangdong Yulong Petrochemical to build a 400k bbl/day refinery and a 3mtpa ethylene plant (2 lines, 1.5mtpa each) in Shangdong province. The project was previously delayed due to the lack of state approval (reflecting excess domestic refinery capacity).

We believe that the ethylene project is likely to be completed by 2024F, given typical construction lead time of 3-4 years for ethylene projects in China. Some of the projects are being executed outside China. In Sep 20, Hengyi Brunei announced the second phase of its refinery project (280k bbl/day) and a chemical expansion project which included 1.65mtpa of ethylene and 2.5mtpa of purified terephthalate acid at Palau Muara Besar.

The commercial startup target is in mid-2024F. Chandra Asri and Lotte Chemical Titan are looking to add 1.0- 1.2mtpa of ethylene cracker in Indonesia. Siam Cement is also building a new mixed-feed ethylene plant in Vietnam (likely to be completed in 2023F). The US ethane cracker expansion looks slim after 2024F. The projects under construction are Shell at Monaca (1.5mtpa, to start production within 2021F), and Exxon-Sabic JV (1.8mtpa; to start commercial operations in 2022F). PTTGC’s plan to invest in a new ethane cracker of 1. mtpa is still suspended as

of 1Q21, pending the search for a new co-investor after Daelim Industrial withdrew from the project in 2020. The risk to our long-term ethylene demand-supply forecast is more naphtha cracker projects announced by Chinese producers which have a strong execution track record of shortening the construction cycle to less than 4 years.

More MEG expansion with lower focus on PE We estimate that global PE supply additions would reach 6.9-7.4mtpa vs. demand growth of 5.5mtpa during 2021-2022F. Thanks to supply outages in the US, Asian PE prices should remain robust over the next six months, especially with the strong support from plastic packaging and agricultural film demand. As the US PE production could resume to normal operating rates in late-2021F, some pull-back in Asian PE prices is likely but we expect average PE-naphtha spread to hold up at US$550-610/t during 2021-2022F vs. pre-Covid-19 levels of US$410/t in 2019.

As low density polyethylene (LDPE) supply growth remains relatively lower than that of high density polyethylene (HDPE) and linear low density polyethylene (LLDPE), LDPE-naphtha spread should continue to stay higher than HDPE-naphtha and LLDPE-naphtha during 2021-2022F, in our view

Post 2022F, we see rising interest in building new mono ethylene glycol (MEG) capacity, given that Chinese-based ethylene projects are executed by the companies that have existing polyester operations. Zhejiang Petrochemical Company plans to add 1.45mtpa of MEG along with 1.55mtpa of H/L/LLDPE.

The extreme case is seen for Jiangsu Eastern Shenghong which announced in 2019 that it would divert all ethylene produced from the new ethylene plant for MEG expansion (2mtpa) and cancel all PE projects. Hengyi Petrochemical will also use ethylene output to facilitate MEG expansion of 1.2mtpa. This would lead to MEG supply glut in the long term while supply risk would look relatively lower for all PE products, in our view. In particular, we estimate that global MEG supply growth would reach 5.1-5.9mtpa, outstripping the demand growth of c.2mtpa during 2021-2023F.

– By CIMB Bank Research

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Thai Petrochemical: New projects starting up at the right time.

■ We believe new ethylene capacity is well spread out during 1Q-3Q21F while strong ethylene derivative demand should continue to support ethylene price. 

■ Global ethylene capacity addition looks slim post 2022F on limited expansion by US producers and potential delay of some ASEAN projects. 

■ SCC and PTTGC, which have new capacity coming onstream in 2021F, should benefit from ethylene price strength in 2021F, in our view.

New ethylene supply in 2021F is well spread out We expect 8.7mt of new ethylene capacity additions globally in 2021F. Unlike 2020 when new capacity additions were concentrated in 1Q20 and 4Q20, we believe the startup schedule is well spread out during 1Q-3Q21F.

We also believe some ethane-based projects in China may not be able to ramp up production in 2021F. Despite a sharp increase in naphtha costs, ethylene-naphtha spread remains at healthy levels, thanks to continued strong derivative demand in Asia, particularly for polyethylene (PE) and polyvinyl chloride (PVC), as the demand for food and consumer product packaging remains strong during the new wave of Covid-19 cases.

Coal-based and methanol-based producers should also remain at a cost disadvantage, enabling naphtha crackers to gain market share, especially when export cargoes from ethane-based plants in the US remain limited. Long-term ethylene demand-supply looks more balanced Post 2022F, global ethylene effective capacity addition looks slim at 4-5mtpa vs. over 10mtpa during 2021-2023F. The projects under construction and that are likely to start up during 2024-2025F are mainly naphtha crackers in China and ASEAN (Vietnam and Brunei) while US ethane-based projects are unlikely to weigh on the ethylene market, reflecting limited new investments during the past few years.

We also see potential delays in Indonesia-based projects which have not yet reached final investment decisions. A key risk to our assumptions is more naphtha cracker projects by Chinese producers which are able to shorten the construction cycle to less than 4 years.

Thai-based naphtha cracker projects onstream just in time Both SCC and PTTGC started their additional ethylene capacities of 300ktpa and 500ktpa, respectively, in Mar 21, which we believe is the perfect time to reap the benefits of ethylene price strength.

In addition, SCC’s Long Son Petrochemical (LSP) project in Vietnam should be able to start production in 2023F when global ethylene demandsupply looks more balanced. We estimate that LSP should achieve 11.0% project IRR. Reiterate Add on SCC and PTTGC Asian integrated PE/polypropylene (PP) spread reached US$662/t in Apr 21, up from US$591/t in 4Q20, supported by strong demand and limited arbitrage cargoes from the US.

According to IHS Markit, it would take over 9 months for US producers to recover the lost production, assuming that average utilisation rate is 95%. Apart from PE/PP price strength, SCC should also benefit from the strong PVC spread while PTTGC should also leverage the strong phenol, Bis-phenol A and acrylonitrile spreads. We reiterate Add on both SCC and PTTGC. We upgraded IRPC to Hold from Reduce on potential refinery stock gains. We maintain Neutral on the Thai chemical sector.

– By CIMB Bank Research

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IRPC thailand Big windfall from crude inventory gain

 ■ As IRPC’s crude inventory holding period is longer than other Thai refiners’, crude inventory gains
were likely as high as US$10/bbl in 1Q21F. 

■ Stronger-than-expected ABS and PP spreads are near-term EPS drivers. Locking in large crude inventory gains in 1Q21F We believe IRPC thailand is likely to report sizeable accounting gains on its crude oil inventory following the sharp increase in global crude oil price in 1Q21.

Based on IRPC’s guidance, its crude inventory holding period is c.60-65 days. This resulted in relatively high inventory gains in Jan-Feb 21 of US$12 per barrel of crude intake per month (the difference between average oil price in Jan 21 vs. Nov 20 and Feb 21 vs. Dec 20 was US$5.3/bbl and US$6.5/bbl, respectively).

Accordingly, we estimate IRPC saw crude inventory gains of US$10/bbl in 1Q21F, relatively larger than other Thai refiners’ c.US$ – 6/bbl, based on our projections. Near-term support from strong chemical spreads IRPC has acrylonitrile-butadiene-styrene (ABS)/styrene-acrylonotrile (SAN) resins capacity of 179ktpa as well as polystyrene (PS) and expanded PS (EPS) capacity of 155ktpa. Due to strong household appliances demand in China and the absence of new major capacity additions, the ABS/PS spreads stayed elevated at US$970/350 per tonne in 1Q21.

IRPC should also benefit from a strong polypropylene (PP) spread of US$626/t in 1Q21 vs. US$640/t in 4Q20 despite the sharp increase in naphtha cost, thanks to resilient demand from auto and electronic parts production. Accordingly, we believe IRPC’s chemical integrated margin increased to US$8.3/bbl in 1Q21F from US$7.8/bbl in 4Q20. Adjusting shutdown schedule to capture strong chemical spreads IRPC guided that it is considering pushing back maintenance activity for its ABS/PS plants from 2Q21F as previously scheduled to 2H21F in order to tap the high ABS spread.

As IRPC already shut its crude distillation unit #1 in 1Q21 for 1 month, feedstock needed for downstream chemical plants should be sufficient in 2Q21-4Q21F. Raise 2021F EPS forecast on inventory gain; upgrade to Hold We raise IRPC’s 2021F EPS by 0 , largely on inventory gains of THB .0bn to be reported in 1Q21F. We also revise up 2022-2023F EPS by 7-37% to reflect higher chemical spread assumptions. With the higher EPS forecasts, our TP is lifted to THB4.2/s, based on 1.05x 2021F P/BV (0.5 s.d. below 2010-2020 mean), and upgrade IRPC from Reduce to Hold as we doubt its ability to reduce operating cost.

We prefer SCC and PTTGC in the Thai chemical sector. Upside risks to our forecasts are better than-expected refinery utilisation rates and stronger-than-expected ABS spread. Downside risks include the reversal of inventory gain to inventory loss if crude oil price falls below US$65/bbl and higher-than-expected operating cost.

– By CIMB Bank Research

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