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Engro Polymer & Chemicals (EPCL): Earnings revised, Buy maintained

• We are revising our earnings estimates for Engro Polymer and Chemicals (EPCL), where we cut our 2020E earnings estimate by 25% owing to a weak 1H2020 amidst COVID-19 outbreak.
• While the pandemic brought down PVC sales by 33% YoY and Caustic sales by 41% YoY during 1H2020, it has also led to delays in the PVC expansion project, which was due to come online by 4Q2020.
• The earnings revision for 2020E would have been much higher had it not been for international PVC-Ethylene margins, which have surpassed our expectations, averaging at US$476/ton in YTD 2020 (current: US$525/ton).
• The revision in margins results in upwards revision of our 2021-2022F earnings forecasts for EPCL by 4-5%. Our PVC-Ethylene margin assumption for 2021E stands at US$425/ton.
• We maintain our ‘Buy’ call on EPCL with a Target Price of Rs50. The stock trades at 2021F P/E of 6.7x.
• Please refer to our detailed report on EPCL titled ‘Strong Margins and Capacity Expansion to drive earnings; Initiating Coverage with a Buy’ dated ‘Feb 20, 2020’ for more details.

1H2020 result below expectations

• In 1H2020 company had booked a profit of Rs223mn (EPS: Rs0.24), down by 86% YoY compared to Rs1,544mn in 1H2019 (EPS: Rs1.7).
• During 1H2020, PVC sales went down by 33% YoY to 66K MT from 98k MT in 1H2019 primarily due to COVID-19 related lockdowns and restrictions.
• Caustic sales were down by 41% YoY to 24K MT in 1H2020 vs. 41K MT in the same period last year due to decline in demand from the textile sector.
• Gross margin declined by 8.6ppts YoY to 14.2% in 1H2020 from 22.8% in 1H2019 due to lower efficiencies amid lower volumetric sales and increase in gas prices.
• In 2Q2020, core delta was down by 11% QoQ at US$453/tons compared to US$509/ton in 1Q2020 amid weak demand due to the pandemic and accumulation of inventory in China. However core delta started increasing from 3Q2020 as demand started pick up worldwide.
• EPCL had closed down its production activities amid gas leakage incident (from Mar 06, 2020 to Mar 16, 2020 ) and government mandated lockdown amid COVID-19 (from Mar 24, 2020 to Apr 20, 2020).

Impact of GIDC

• After the Supreme Court’s judgment on Gas Infrastructure Development Cess (GIDC), company has to pay outstanding amount of Rs5,506mn (15% of its market capitalization) in twenty four equal monthly installments.
• EPCL has already provided for GIDC in their accounts, hence their earnings are unlikely to be affected.
• As of Jun 2020, company was siting on cash and cash equivalent amounting to Rs8.0bn, sufficient to pay outstanding due amount. However company was earning interest income on the amount invested in T-bills and other government papers, which will hurt their recurring other income.
• Going forward, the court has restrained the Federal Government from charging Cess until, the Cess-revenue collected and that which is accrued so far but not yet collected, is expanded on the projects.

We expect the company to go into review of the Supreme Court decision. If the company opts to not accrue GIDC from here forth, the impact of earnings is likely to be around Rs0.8/share per annum.