The author is an analyst of NH Investment & Securities. He can be reached at email@example.com. -- Ed.
We expect S-Oil to record operating losses for 1Q20 and 2Q20 on large-scale inventory valuation losses stemming from a plunge in oil prices. Demand for refined products is to be drained by the impact of Covid-19 (short-term factor) and the expansion of the electric vehicle market (long-term factor). Maintaining a Hold rating, we lower our TP from W85,000 to W72,000.
To book inventory valuation losses for 1Q20
Considering both expanded uncertainties in global financial markets and dampened consumer sentiment amid the Covid-19 crisis, we have a discount rate of 15% in our TP calculations for S-Oil, in lowering our TP from W85,000 to W72,000. S-Oil’s dividend attractiveness has been marred by deteriorated profitability at its refining business, and sluggish demand for refinery products is to extend over the long term. Accordingly, we maintain a Hold rating.
On a consolidated basis, we expect S-Oil to book large-scale operating losses of 413.5bn (TTL y-y, TTL q-q) for 1Q20. The average oil (WTI) price per barrel fell from US$59.8 in Dec 2019 to US$30.8 in March, leading to massive inventory valuation losses and negative raw material lagging effects (ie, input of high-priced raw materials). Looking at S-Oil’s petrochemicals business, we believe that earnings remain sluggish on: 1) excessive P-X supply and reduced demand; and 2) the use of high-priced raw materials purchased prior to the plunge in oil prices.
Short- and long-term factors to sap demand for refinery products
Should the average oil price per barrel stay below the US$30 mark in 2Q20, the firm will likely need to recognize additional inventory valuation losses. Ongoing weak global demand for refinery and petrochemical products is to harm S-Oil’s 2Q20 shipments. But, we note that Aramco’s Official Selling Price (OSP) per barrel has fallen by US$6 m-m in the early going April, and inventory valuation losses should lessen q-q in 2Q20. Against this backdrop, we forecast that S-Oil’s operating losses will shrink to W273.4bn (RR y-y, RR, q-q) in 2Q20.
Over the near term, the Covid-19 crisis is to sap demand for refinery products. And, over the longer term, demand for gasoline is to decrease structurally on the expansion of the electric vehicle market. Demand for kerosene, gasoline, and diesel are all weakening due to sharp declines in global aircraft and automobile utilization, a situation which is expected to continue until the Covid-19 crisis passes. Meanwhile, with greater expansion of global refining capacity (especially in China and the Middle East) being projected, the oversupply of refined products will likely intensify.