Chandra Asri Petrochemical (TPIA IJ; BUY; TP: IDR4,250): Initiation of Coverage – Indonesia’s Largest Chemical Player

ON THE PLATTER:
Petrochemical: Sector Coverage Initiation – A Sleeping Giant Awakens

Leveling up the consumer boom. Indonesia’s continuous robust economic growth and strong structural platform has spurred its GDP growth and boosted income levels, which have in turn fuelled demand for consumer products. The petrochemical industry, which supplies chemical products for packaging, construction, agriculture, textiles, electronics as well as consumer goods, is definitely a key beneficiary of economic growth and would be an interesting proxy to the fast expanding consumer sector.

Solid macroeconomics performance. With a projected GDP growth of 6.3% and modest inflation rate of 5.8% for 2011, we believe that Indonesia’s economy is poised for robust performance. An indication of such expectations is the ever increasing interest from foreign investors to invest in Indonesia’s real sectors. World Bank data showed that the net FDIs of USD26bn in 2010 were three times higher than the pre-crisis level in 2008. The strong foreign investment numbers from investment agency BKPM showed a 52% y-o-y surge in 2010, which is projected to increase by another 22% in 2011.

The rise of Indonesia’s middle class. Domestic demand, which grew by a strong 4.6% in 2010, has been the main engine of the country’s recent economic growth. This is manifested in the consistent rise of the middle class in Indonesia, which has in turn spurred growth in the consumer sector. The middle class made up 56.5% of the total population in 2010 compared with only 37.7% in 2003, according to World Bank. As consumers become more affluent, so will their demand for consumer products, which will subsequently be positive for the petrochemical industry too.

Attractive playing field. Based on the catalysts mentioned above, Indonesia’s petrochemical sector holds promising prospects, as evidenced by recent interest from foreign companies to invest in this highly capitalized industry. It was reported recently that South Korea’s Lotte Group, through Honam Petrochemical, plans to invest USD5bn in Indonesia. There has also been talk that Pertamina is planning a joint venture with Chandra Asri Petrochemical (TPIA) to build an oil refinery.

Lucrative prospects. With rising economic growth and a huge population of about 240m, the potential demand for basic chemicals and polymers in Indonesia looks promising in the medium and longer term as the current consumption per capita is still low compared with its Asian peers. At present, Indonesia is structurally deficient in many petrochemicals and polymers, relying mainly on imports, which provides ample room for production capacity expansion in the coming years. Having said that, we believe that the existing up-stream and down-stream players in the industry will benefit from the positive supply and demand dynamics. Given the highly cyclical nature of the industry, opportunities for expansion abound in the current up-cycle, which is expected to peak in 2015.

Identifying the players. Generally, petrochemical related listed companies are grouped into upstream players, polyester producers (mid-stream to downstream) and plastic packaging producers (downstream). Currently, there is only a single upstream player, Chandra Asri Petrochemical (TPIA), which is the only Indonesian chemical player that manufacturers naphtha cracker. TPIA occupies a very important place the industry in view of its aim to venture further upstream into oil refineries, which may help unclog the supply bottlenecks that have driven downstream players to resort to importing raw materials.

Chandra Asri Petrochemical (TPIA IJ; BUY; TP: IDR4,250): Initiation of Coverage – Indonesia’s Largest Chemical Player

Synergy from the merger. Chandra Asri Petrochemical (TPIA), formed early this year through a merger between Chandra Asri and Tri Polyta Indonesia, has become the largest integrated olefins and poly olefins producer in Indonesia. It also stands out in possessing the only naphtha cracker in Indonesia with an integrated downstream value chain.

Market leader in chemical play. TPIA is a market leader in the domestic petrochemical industry, supplying 55% of the country’s ethylene, 40% of its polypropylene, 40% of polyethylene and 100% of styrene monomer. Owing to constraints on production capacity, most of TPIA’s products are sold domestically. This means that domestic downstream players need to import their raw material and that TPIA enjoys strong captive demand. The group is currently expanding capacity and debottlenecking to cater to domestic demand, which will in turn reduce downstream players’ dependence on imported raw material. We believe this is a good strategy towards achieving economies of scale and in preparing for anticipated the petrochemical upcycle peak in 2015.

Solid infrastructure to uphold robust demand. Indonesia provides a strong platform for TPIA to access the local market and capture demand given the country’s strong GDP growth, rising middle class and low polyolefin consumption per capita compared to the average South-east Asian countries. Apart from its dominant role in serving the booming consumer sector, TPIA also enjoys a strong infrastructure platform in its proximity to its customers and Jakarta’s Central Business District as well as an integrated operation pipeline.

Solid earnings, healthy balance sheet. We expect an earnings CAGR of 35% from 2011-12, mainly supported by strong demand and selling prices. This will translate into an operating margin improvement from 5% and 6% from 2011-12, before reaching 7% in 2013. The group should see a significant earnings jump in 2015 in line with the petrochemical cycle peak. Its balance sheet is generally healthy given its relatively low debts, with a net gearing at no more than 23% from 2011-2015. Despite this, its cash to total asset is currently stands at only 9%-12%, but we expect earnings to gradually improve, with ROE picking up from 11% in 2011 to peak at 33% in 2015.

A premium for its sound fundamentals. We derive a target price of IDR4,250 with our BUY call based on our target 16x 2012 PE. We believe our relatively premium target PE is justified and still holds potential for an upward re-rating given TPIA’s solid fundamentals and promising outlook going forward. Based on a DCF valuation, the stock’s target price of IDR6,974 is appealing. However, we opt not to use DCF valuation for our TP given the currently negative free cash flow to meet its capex for expansion in the near term.

soirce: OSK Nusadana Securities Indonesia - dated 15 September 2011