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

• We are revising up our earnings estimates for Engro Polymer and Chemicals (EPCL) for 2020-2022, where revision for 2020 estimate is largely driven by (1) higher-than-expected PVC-Ethylene margins and (2) better-than-expected 9M2020 earnings.
• We marginally revise up our 2021-2022 earnings given that the Supreme Court has allowed GIDC payment over 48 monthly installments instead of 24.
• We maintain our ‘Buy’ call on EPCL with a Target Price of Rs53. The stock trades at 2021F P/E of 6.9x. We expect company’s earnings to grow by an average 30% over the next two years driven by (1) PVC expansion and (2) efficiency projects.

Temporary closure of PVC plants push up PVC-Ethylene margins

• PVC-Ethylene core delta has been witnessing an upward trend in the last few months mainly due to increase in PVC prices.
• PVC prices have increased by 53% to US$1,080/ton from US$705/ton in Jun-2020, while Ethylene prices is up by just 7% to US$735/ton during the same period.
• As a result, PVC-Ethylene core delta has shot up to US$713/ton from US$360/ton.
• This is largely due to suspension of PVC manufacturing facilities (e.g. Vynova, Westlake Chemicals and Formosa Plastics) as they had declared fore majeure due to factors like COVID-19 and Hurricane Laura.
• Majority have resumed production from end Oct-2020 / early Nov-2020, however a large South Korean PVC player ‘LG Chem’ on Nov 05, 2020 has shut down its plant due to fire. The plant is likely to take at least three weeks to become operational.
• Thus we are revising up our core delta assumption for 4Q2020 to US$600/ton from our earlier estimate of US$475/ton.
• However, we maintain our core delta assumption for 2021 at US$425/ton.
• We estimate US$50/ton higher core delta can improve 2021 earnings by ~Rs1.4/share (22%).

3Q2020 result higher than expectations

• In 3Q2020, the company had booked a profit of Rs1,881mn (EPS: Rs2.07), up by 48% YoY compared to Rs1,270mn in 3Q2019 (EPS: Rs1.43). 
• The higher than expected earnings came in due to better than expected PVC sales, which went up by 9% YoY to 48k tons given pent-up demand owing to COVID-19 lockdown during 2Q2020.
• Caustic sales also have seen improvement (18k tons in 3Q2020) mainly due to increase in demand from the textile sector given pickup in export orders.
• Gross margins increased by 8.5ppts YoY to 32% in 3Q2020 from 24% in 3Q2019 due to (1) better efficiencies amid higher volumetric sales and (2) higher core delta at US$550/ton.  

Court allows 48 monthly installments for GIDC payment

• In a recent judgment, Supreme Court of Pakistan has dismissed review petition on Gas Infrastructure Development Cess (GIDC).
• However, as per detailed verdict, company can now pay outstanding amount of Rs5,506mn (14% of its market capitalization) in 48 equal monthly installments instead of 24.
• This takes new monthly installment to ~Rs155mn from previously Rs229mn.
• To highlight, EPCL has already provided for GIDC in their accounts, hence their earnings are unlikely to be affected on this account.

The company had accounted for GIDC in 3Q2020 also, which we expect (already incorporated) not to be the case from 4Q2020 as the court has restrained 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.