Saudi petchem profits could rise but margin pressures persist

October 18, 2024, 7:55 AM

Petrochemical companies are likely to show less profit in the third quarter because of high feedstock prices

Petchem Q3 profits look promising
Sabic has better performance
Margins to remain around 13%

Saudi Arabian petrochemicals producers’ third-quarter earnings are likely to be better than the dismal results in the same period last year, but are unlikely to spark a stock price rebound as investors await further evidence that the industry is mounting a sustained recovery.

The kingdom’s stock index of listed “materials” companies, which includes petrochemicals manufacturers as well as the likes of cement makers, slumped to a 45-month low in early August.

This decline reflects ongoing difficulties in the industry. In the 2023 financial year, Saudi Basic Industries Corp (Sabic) – the country’s third-largest listed company – made its first annual net loss since at least 1990 as a result of a product supply-demand imbalance that sent margins tumbling to two-decade lows.

Sabic’s performance has improved this year. Majority-owned by Saudi Aramco, Sabic reported a second-quarter net profit of SAR2.18 billion, up 85 percent year on year.

Financial services company EFG Hermes forecasts Sabic’s third-quarter profit will be about SAR1.6 billion, down 27 percent quarter on quarter but still a marked improvement on the prior-year period when it made a net loss of SAR2.88 billion.

“Q2 will be 2024’s peak quarter for profitability for most Saudi producers, Sabic included,” says Yousef Husseini, director of chemical equity research at EFG Hermes in Cairo.

The likely quarter-on-quarter profit decline will partly be a result of stubbornly high butane and propane feedstock prices, says Husseini.

These gases are commonly used for heating and cooling in much of Asia. Higher summer temperatures caused demand to swell, so even when oil prices fell towards $70 those of butane and propane moved little.

Peak demand for butane and propane is from December to February, so they are likely to increase in price during this period.

“It's mainly margins that are moving the needle for Saudi petrochemical companies’ earnings and those are declining as we move into the fourth quarter,” Husseini says.

Saudi Arabian petrochemical manufacturers’ margins will remain about 13 percent in Q3, Citi Bank estimates. This is close to last year’s milestone lows.

“There’s been little change in the macro environment from the second quarter to the third quarter for petrochemicals, so Saudi producers’ Q3 earnings are unlikely to excite,” says Oliver Connor, vice-president of energy equity research at Citi in London.

Sabic’s stock is trading close to 4.5-year lows at SAR72.8 riyals per share. Citi has a price target for Sabic of SAR77. According to Citi estimates, that would give Sabic a price-to-earnings ratio of about 16 based on its forecast for Sabic’s 2026 net profit, although it is currently trading at a much higher PE ratio.

“A PE of 16 is about Sabic’s average over the past decade, so the stock isn’t especially cheap,” says Connor.

“If there’s a steeper recovery in the sector and Sabic’s PE falls to below that long-run average and it provides a dividend yield of 5 percent then perhaps it becomes a more positive equity story.”

In the so-called trough period of the petrochemicals industry’s economic cycle it is normal for Saudi producers’ PE ratios to be elevated, Husseini says, because investors believe prices and margins will return to mid-cycle levels and earnings will rebound.

“The challenge currently is that there’s little visibility as to when we will get back to mid-cycle levels – [it is] likely it will be in a few years,” he says.

In the meantime, investors will be reluctant to build positions aggressively without clearer signals on improved demand and plant utilisation rates, Husseini says. Saudi facilities operate considerably below capacity.

“We've already had a couple of false starts, with the chemical sector rallying on improved Chinese purchasing managers’ indices earlier in the year for example, but most of these gains were given back once Chinese economic data tempered in the following months,” he says.

“I expect we are likely to get a few more false starts as investors are keen not to miss the upside once the cycle turns and are thus likely to build equity positions early, rather than late.”