This article first appeared in Capital, The Edge Malaysia Weekly on December 9, 2024 - December 15, 2024

SELLING on Petronas Chemicals Group Bhd (PetChem) (KL:PCHEM) and Petronas Dagangan Bhd (PetDag) (KL:PETDAG) appears to have halted as the two FBM KLCI component stocks rebounded from their multiyear lows last week.

The buying interest is, however, not quite proof of a change in sentiment on the two Petronas-linked companies as concerns over their gloomy outlook linger.

The selldown accelerated when PetChem announced a net loss in the third quarter ended Sept 30, pushing the blue chip below RM5 for the first time in over four years. As much as RM20 billion in market capitalisation was wiped out in the last six months due to the petrochemical production overcapacity seen so far.

Similarly, its sister company PetDag’s shares were at their lowest in a decade amid the rollout of the diesel subsidy rationalisation in June. They rebounded following better-than-expected sales volume, profit and dividends for the third quarter. Still, investors are now assessing the potential impact of the RON95 petrol subsidy removal from the top 15% (T15) income group next year.

For the year to Dec 5, PetChem shares have retreated 32.5%, while PetDag’s rebound has minimised its losses to date to 4.8% compared with the 11% gain in the benchmark index in the same period. The recent rebound has raised the question of whether it is still a bargain, or there is more downside ahead.

Analysts covering PetChem cut their earnings forecast after its maiden net loss of RM789 million in the quarter ended Sept 30 (3QFY2024), as a result of foreign exchange losses at its Pengerang facility, and prices of olefins and derivatives (O&D) remaining low despite higher plant utilisation and volume.

In its latest results announcement, the group warns that prices of O&D, used in chemical and polymer products such as plastic packaging, could continue to be soft on weak demand and additional capacity in Northeast Asia. Meanwhile, the fertiliser and methanol (F&M) prices linked to its other key segment is seen to remain stable.

PetChem’s O&D segment’s profit of RM203 million in 9MFY2024 is lower than even that in the same period in the pandemic year of 2020, while the F&M segment’s profit of RM1.27 billion is still around 9% lower than its 10-year average of RM1.36 billion.

Industry researchers such as Fitch have projected that the petrochemical industry downturn will last until the middle of next year due to subdued demand and China’s capacity coming online. Krungsri Research, part of Japan’s MUFG financial group, expects a modest growth in global petrochemical demand of just 2.5% in 2026, from the 3.1% annual average seen in the 2010s.

For PetChem, whose biggest markets are Southeast Asia and Asia-Pacific, this means any improvement will happen at a slow pace. The situation is aggravated by weak economic growth in China and Europe.

“Easing crude oil prices have also capped the upside for polymer prices,” says HLIB Research, which has a “sell” call on PetChem and pegs its target price at RM4. When oil prices are high, PetChem benefits from higher selling prices while its feedstock costs are controlled through favourable long-term contracts. These benefits are lost when oil prices are low.

That said, some are of the opinion that the existing fundamentals have been priced in. “We believe the market has overreacted to the unrealised forex loss,” says CIMB Securities, which has a target price of RM5.41 on the stock. Its Pengerang facility is scheduled for commercial operations before year-end, with a feedstock discount, which is also good news.

“Though we do not discount a further downtrend in share price, we think this is less likely as foreign shareholdings are now at 7.8%, or the lower end, versus its typical range of 7% to 10%,” says AmBank in a Nov 26 note.

Malacca Securities head of research Loui Low concurs. “I think [the price action] should be done. [The overcapacity situation] should be priced in for now.”

Another fund manager with a local firm says the petrochemical sector may be worth a second look amid signs of a recovery.

“The sector has been off the radar for quite a while. Timing-wise, we’re not sure when the supply-demand situation will fully recover but the sector may slowly regain momentum next year,” he adds.

The percentage of “buy” calls on the stock has improved from its multiyear low to about 35% of total analyst coverage — with seven “sell”, four “hold” and six “buy” calls, for an average target price of RM4.95. PetChem closed at RM4.83 last Thursday.

Having said that, at that price, PetChem shares were trading at a forward dividend yield of 3.11%, compared with the 3.67% ­average among the KLCI constituents. Its forward price-earnings ratio (PER) stood at 19.32 times, supported by the KLCI’s rerating in the past year, compared with its long-term average of 15 to 16 times and the index’s average of 19.26 times.

For PetDag, the impact of the diesel subsidy rationalisation that was rolled out in June was smaller than expected. In fact, at around 4.3 billion litres, the sales volume in 3Q2024 was the group’s second highest quarterly volume, behind the 4.37 billion litres in 2Q2024 before the diesel subsidy adjustment fully kicked in, thanks partly to rising jet fuel demand.

In addition, PetDag “benefited from a shift in diesel demand to the commercial segment post-subsidy retargeting, where it has a larger share”, TA Research said in a note dated Nov 26.

At last Thursday’s closing price of RM20.80, PetDag’s forward dividend yield of 4.42% is at the higher part of the KLCI range of between 1.24% and 7.55%. The group is trading at a forward PER of 19.44 times, compared with the KLCI average of 19.26 times.

Looking ahead to 2025, the focus would be on the RON95 retail fuel subsidy rationalisation in the middle of next year.

In a note, RHB Research ascribes a higher discount rate to the stock, considering the petrol subsidy revision overhang. It does not discount “the possibility of this having a negative impact on retail sales volume, including a potential reduction in illegally-exported motor gasoline”, depending on the implementation method.

However, TA Research sees the T15 household income group as “unlikely to significantly reduce consumption” despite their exclusion from the government subsidy.

PetDag recorded 16.3 billion litres in sales in 2023. The diesel subsidy rationalisation impact is seen at 500 million litres a year, or 1.37 million litres a day, according to calculations by HLIB Research in August.

Minister of Finance II Datuk Seri Amir Hamzah Azizan told the Dewan Rakyat in early October that retail diesel sales nationwide fell 25% or seven million litres per day following the June implementation, which was offset by a four million litres per day increase in commercial diesel sales. This is a net reduction of three million litres a day.

For petrol, Amir Hamzah said consumption by non-citizens, the commercial sector and smuggling activities accounted for about 40% of total petrol usage.

In a note, BIMB Securities says that while “9M2024 sales volume came strongly ahead of our FY2024 estimate of 15.5 billion litres, we impute lower sales volume of 15 billion litres in FY2025”.

The last time PetDag sold 15 billion litres was in 2022, when it booked a net profit of RM776.6 million or 78.1 sen per share, with Brent crude oil price at an average of US$102 per barrel (bbl) that year.

Its FY2023 net profit of RM943 million, or 95 sen per share, was on sales of 16.3 billion litres, with a Brent average of US$82.19/bbl.

For PetDag, declining oil prices lead to lower costs for its final products, although this will also be reflected in lower selling prices. The opposite applies when oil prices head north.

Goldman Sachs on Nov 28 projected Brent to average US$76/bbl next year, while JPMorgan sees the commodity being even cheaper at US$73/bbl, compared with the year-to-date average of US$80/bbl.

 PetDag has three “buy”, six “hold” and two “sell” calls, with an average target price of RM19.53.

Aside from sales volume, one emerging trend for the stock is its declining valuation multiples in recent years, from 24 times forward PER in 2022, to 22 times in 2023 and 19 times on average this year.

“[The] longer-term trend of migration to electric vehicles (EVs) and a more fragmented EV charging market compared to fuel retailing are factors that might structurally impact valuation multiples further out,” says TA Research.

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