SPC: Downgrade to Underperform from Buy; PO S$2 – Merrill Lynch
We reduce our PO on SPC to S$2 from S$10 to reflect our new cautious view on the Asian refining sector and SG Complex margin revisions in 2009/10. Additionally, we sight the company’s accounting complexity and rapidly rising working capital as major risks. Thus, we change our PO basis from DCF to trough cycle valuation applying 2.5x 2009E EV/EBITDA, which is a 50% discount to the sector’s benchmark valuation and implies 2009E P/B of 0.5x.
Comments
We reduce our PO on SPC to S$2 from S$10 to reflect our new cautious view on the Asian refining sector and SG Complex margin revisions in 2009/10. Additionally, we sight the company’s accounting complexity and rapidly rising working capital as major risks. Thus, we change our PO basis from DCF to trough cycle valuation applying 2.5x 2009E EV/EBITDA, which is a 50% discount to the sector’s benchmark valuation and implies 2009E P/B of 0.5x.
2008-10E earnings revisions and valuation changes
Assuming that Asia’s growth will slow on the back of OECD recession, we forecast SG Complex margins at $7.2/bbl (down 20% from previous estimate) for 2009 and $7.0/bbl (down 10%) for 2010. Reflecting this, we lower SPC’s 2009 and 2010 net profit estimates by 32% and 17%, respectively. Currently SPC is trading at 2009E P/E of 3.9x, EV/EBITDA of 2.9x and P/B of 0.6x.
Worst case scenario, margins can fall to US$4/bbl
Our base case assumes Asian GDP and oil demand would still grow in 2009. Assuming Asia too falls into a recession, we believe SG complex refining margins could fall to US$4/bbl. SPC’s 2009E EBITDA and net profit could potentially fall 51% and 75% respectively below our current estimates.
No earnings visibility; taking a prudent stance
SPC was our regional refining top pick. However, the higher-than-expected accounting risks, rapidly increasing working capital and the sharp turn in both refining and E&P business outlook lead us to alter our stance. The unusual extent of the profit deterioration in 3Q08 and the lack of catalyst from a sector perspective lead us to recommend investors to exit the stock.