The author is an analyst of Shinhan Investment Corp. He can be reached at firstname.lastname@example.org. -- Ed.
Initiate coverage with BUY and target price of KRW120,000
We initiate our coverage of SK Innovation with BUY for a target price of KRW120,000, based on sum-of-the-parts valuation including the value of operations and investment assets. By division, 2020F operating value is assessed at KRW2.0tr for refining, KRW3.2tr for chemicals, KRW3.6tr for lubricants, KRW643.8bn for E&P, KRW3.9tr for materials, and KRW2.6tr for secondary battery. SK Innovation shares are currently trading at a 2020F PBR of 0.48x, down to levels seen in 2014 when operating earnings were in the red. With negatives mostly priced in and concerns seen overblown, we believe now is the time to focus on improvements expected to emerge going forward.
Key investment points: 1) Earnings improvement in 2H20F; 2) ramp-up of VRDS unit; and 3) EV market directionality
First, operating profit is forecast to increase by KRW912.4bn HoH in 2H20 on the upturn in petroleum demand, drop in official selling prices of crude oil, and increase in oil prices. Refining margins will likely climb by USD1.3/bbl YoY in 2020. Second, with its new vacuum residue desulfurization (VRDS) unit in operation from March, SK Innovation is expected to emerge as a direct beneficiary of the International Maritime Organization’s high sulfur carriage ban from 2H20. Third, despite concerns over EV market directionality from the decline in oil prices, we believe growth potential of the secondary battery division remains intact with the tightening of environmental regulations inevitable in the mid/long-term. SK Innovation’s secondary battery capacity is expected to expand from 27GWh at end-2020 to 58GWh by end-2022.
2020 OP forecast at KRW408.2bn (-68% YoY)
SK Innovation's earnings will likely turn to an operating loss of KRW366.6bn (negative swing QoQ) in 1Q20, with losses from refining forecast at KRW413.8bn (negative swing QoQ) and secondary battery at KRW121.5bn (remain negative QoQ). Meanwhile, operating profit from chemicals are expected to reach KRW45.8bn (+KRW38.5bn QoQ), lubricants KRW85.3bn (-2% QoQ), and E&P KRW47.7bn (+16% QoQ) in 1Q20. Inventory valuation losses should sharply increase from the drop in oil prices and weak refining margins should weigh on earnings from the refining division.
For 2020, we forecast operating profit at KRW408.2bn (-68% YoY), including KRW26.2bn (-94%YoY) from refining, KRW351.7bn (+15%YoY) from lubricants, KRW403.1bn (-43%YoY) from chemicals, and KRW84.3bn (-57%YoY) from E&P. Refining earnings are likely to sharply improve from a loss of KRW443.1bn in 1H to a profit of KRW469.3bn in 2H, thanks to the upturn in petroleum demand, increase in oil prices, and addition of the VRDS unit. The secondary battery division should see operating loss widen YoY to KRW425.3bn on initial costs from the ramp-up of plants in Hungary and China.