“World-beating production economics have supported rapid growth. As SABIC brings on more plants, its competitive advantage against marginal producers is now even stronger” says the report entitled “Chemical Pro-action”, by Peter Hutton, Head of Research for HSBC Saudi Arabia and Hassan Ahmed, Chemicals analyst for HSBC in New York.
SABIC is a key player in a round of capacity investment in the Middle East, which will raise the region’s share of ethylene capacity from 10% to 20% by 2010/11. This growth will reduce industry margins but enhance SABIC’s competitive advantage. The report concludes that SABIC’s production cost advantage allows it to supply high growth markets such as China more cheaply even than the lowest cost local producers, and that its high growth expansion strategy will displace existing marginal producers elsewhere in the world rather than competing head on with other new capacity. Furthermore, these marginal producers are now even older and more inefficient than during the last cycle, and will be unable and unwilling to keep producing.
“Investors are concerned that margins will decline to levels seen in previous cycles, but higher oil prices and gas prices in the US add $150/tonne of ethylene to the breakeven costs of marginal producers, a figure which goes straight to the operating margin of industry leaders, notably SABIC”.
With strong cash flows and normalized earnings growth of nearly 10% CAGR to 2010, HSBC recommends SABIC as an “Overweight”, with a target price of SAR 155. “As a global leader in a global sector, SABIC would merit a place in global funds”, yet it is trading at a 40% discount to Dow Chemicals, its closest competitor.
The report is the first published by HSBC Saudi Arabia. HSBC is the first global bank to have set up a sellside research team in Saudi Arabia, to provide analysis on local stocks in the same way as it does throughout its research network.
Peter Hutton, who started working in Riyadh in January commented “This is an important element of our commitment to this important market, allowing us to combine direct local insight with global sector coverage and valuation comparisons”.
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