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Gloom Over Saudi Petchem Sector May Be Overdone

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The sector's net income slid 18 percent from a year earlier to 8.0 billion riyals ($2.1 billion) in the first quarter of this year, Riyadh-based NCB Capital calculated this week after the companies announced earnings.

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April 25, 2013 1:11 by



Pessimism over Saudi Arabia‘s petrochemical industry has pushed shares in the sector down sharply, dampening the biggest Arab stock market. But the gloom may be overdone, creating chances to buy into some of the kingdom’s biggest firms.

The sector’s net income slid 18 percent from a year earlier to 8.0 billion riyals ($2.1 billion) in the first quarter of this year, Riyadh-based NCB Capital calculated this week after the companies announced earnings.

Even worse, global oil prices have dropped sharply since the start of this month. That threatens to pull down petrochemical product prices later this year, hurting firms’ bottom lines.

This matters for the entire Saudi stock market, because petrochemical shares account for roughly a third of its total capitalisation.

But a closer look at the outlook for petrochemical earnings suggests it is not so grim, many institutional analysts and investors argue – meaning the market could rebound quickly if oil prices stabilise in coming weeks.

A collapse of demand for Saudi petrochemical output is not on the cards, saidFaisal Potrik, analyst at Riyad Capital, who is keeping a “buy” rating on Saudi Basic Industries Corp (SABIC) , the world’s biggest petrochemicals group.

“Demand is still there, especially out of Asia - that’s going to cushion and has been cushioning the impact of any decline in the West,” he said.

 

RETAIL SELLING

Heavy selling of petrochemical shares by retail investors has pushed the sector index down 4.8 percent this month, leaving the overall Saudi market flat. Saudi Arabia is far underperforming most Gulf markets; Dubai, which is not directly exposed to the petrochemical industry, is up 12 percent this month.

There has been plenty of bad news to alarm investors. SABIC said last week that it would cut about 1,050 jobs in Europe and close some operations there because of weak demand on the continent.

Demand is stronger in the United States but the revolution in extracting natural gas there is strengthening some of the Saudi companies’ competitors, by reducing the cost of the gas they use as feedstock.

Meanwhile, the price of Brent crude oil has tumbled 8 percent this month to its lowest level since mid-2012. Petrochemical prices have held up well so far this year – ethylene was around $1,490 a tonne in the first quarter, up 16 percent from the previous quarter – but they could drop if oil prices stay at current levels, since in the long term the markets are closely related.

SABIC announced last week that its net profit sank 10 percent from a year earlier in the first quarter, while sales shrank 3.3 percent. It warned that growth would probably not improve until next year.

 

BETTER THAN EXPECTED

But there are signs that petrochemical firms’ plight is not as bad as some investors are assuming. Although first-quarter profits dropped at many Saudi producers, most actually beat analysts’ consensus forecasts, except for when company-specific factors were involved, said Amer Khan, fund manager at Shuaa Asset Management in Dubai.

In fact, much of the drop in the sector’s profits during the first quarter was due to shutdowns of facilities for maintenance and emergencies – events that did not indicate weakness in the firms’ core business.

PetroRabigh, for example, posted a 658.1 million riyal net loss in the quarter, against a year-earlier profit of 115.8 million riyals – but the loss was due to an unexpected disruption of power and steam supplies from an outside provider. This forced PetroRabigh to halt operations.

Concern that SABIC‘s European layoffs are a sign of things to come may also be overblown. Announcing first-quarter earnings, the firm’s chief executive Mohamed al-Mady described Europe as a “special case” and said he was optimistic about growth in China improving, while the U.S. construction market – a major source of demand for SABIC‘s products – was recovering.

Potrik at Riyad Capital forecast SABIC‘s earnings per share would rise to 8.75 riyals this year from 8.26 last year, meaning the stock, which closed Wednesday at 91.25 riyals, is trading at an inexpensive 10.7 times projected 2013 earnings. He has a target price of 120 riyals for the stock.

NCB Capital has a target of 120.5 riyals for SABIC shares.

“We expect the sector’s earnings to improve in the next quarters of 2013 as most of the shutdowns ended in 1Q13,” it said, predicting petrochemical product prices would remain “broadly flat” this year – not a strong performance, but not as bad as many investors have been fearing.



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