The author is an analyst of NH Investment & Securities. He can be reached at email@example.com. -- Ed.
Heavily impacted by a plunge in oil prices, SK Innovation is to book large-scale inventory valuation losses for 1Q20. Should oil prices continue to hover around the US$20/bbl-level, additional inventory valuation losses will likely be reflected for 2Q20. However, both a drop in OSP and decreased raw material prices for the firm’s chemicals and lubricants businesses are to act as positive factors for earnings.
Suggest Buy rating; TP of W130,000
With refining margins continuing to weaken, we now apply a target P/B 0.72x in our TP calculations for SK Innovation, the bottom end of the firm’s P/B band over the past 10 years. Accordingly, we lower our TP by 28% from W180,000 to W130,000. But, we maintain a Buy rating, noting: 1) greater valuation merit following a recent sharp fall in the company’s share price; and 2) likely stronger cost competitiveness at the firm’s petrochemical business in line with a sharp decline in oil prices.
To book large-scale inventory losses on oil price plunge
On a consolidated basis, we expect SK Innovation to post hefty 1Q20 operating losses of W839.2bn (TTL y-y, TTL q-q). The average price per barrel for oil (WTI) dived from US$59.8 in December to US$30.8 in March. As a result, SK Innovation is inevitably facing inventory valuation losses and negative time lag effects (ie, input of high-priced raw materials). The quarterly average refining margin decreased at the same time that OSP (crude oil import price) surged, leading to significant deterioration in product margins. Looking at the firm’s chemicals arm, P-X and SM spreads narrowed, but for propylene and benzene, spreads expanded, pushing up operating income.
Inventory valuation losses and weak demand to continue in 2Q20
The firm is likely to remain in the red this quarter—we forecast consolidated 2Q20 operating losses of W266.6bn (TTL y-y, RR q-q). In 2Q20, additional inventory valuation losses are expected if the oil price stays below US$30/bbl. And, the impact of a general shrinking in industrial activity (due to the Covid-19 crisis) is to be reflected in 2Q20 earnings. With OSP having fallen by US$6/bbl m-m from the start of April, the refining margin should improve slightly.