Demand-driven Recovery Expected in 2H21
The author is an analyst of Shinhan Investment Corp. He can be reached at jinmyung.lee93@shinhan.com. -- Ed.
Review of refining market conditions and 2021outlook
Dubai oil prices have gone up 31% from early October 2020 on the rollout of COVID-19 vaccines and anticipation of demand recovery. The oil refining sector index has also increased 30% during the same period. Spot refining margins, on the other hand, have remained sluggish at around USD1-2/bbl. The upturn in demand has been slower than expected with COVID-19 continuing to spread despite the distribution of vaccines.
We are likely to see a demand-driven recovery in the refining market in 2H21 after the depletion of inventories in 1H21. The distribution of vaccines should help economic activities return to pre-pandemic levels and subsequently drive an upturn in demand for transportation fuels (60% of total petroleum demand). Refining margins are projected to gain USD2.4/bbl HoH in 2H21 on higher demand for transportation fuels. We believe now is the time to accumulate refining stocks considering that they stage a steep rally when refining margins turn upward.
S-Oil: Highest beta among domestic refineries
S-Oil’s 4Q20 operating profit is expected to beat the consensus at KRW142.4bn (positive swing QoQ). Despite unfavorable market conditions, the refining division likely saw operating loss narrow QoQ on inventory valuation gains (KRW54bn) from the rebound in oil prices. The petrochemical division appears to have secured an operating profit of KRW50.3bn (+KRW98.6bn QoQ) thanks to solid olefin spreads. Operating profit from lube base oil should have reached KRW101.6bn (operating margin of 33.1%) due to stronger spreads amid tight supply.
We raise our target price for S-Oil by 8% to KRW90,000, with the target PBR revised up from 1.6x to 1.8x. Expectations have grown that refining market conditions will recover with the rise in oil prices and rollout of vaccines. For 2021, we forecast operating profit at KRW927bn (+KRW1.9tr YoY). Refining operating profit should increase by KRW1.8tr YoY to KRW216.8bn on improvement in oil prices and refining margins (+USD5/bbl).
SK Innovation: Share price gains on main business recovery and EV battery momentum
SK Innovation is projected to have recorded operating loss of KRW154.4bn (continued loss QoQ) for 4Q20, falling short of the market consensus. Refining earnings likely turned negative with inventory valuation gains down significantly from KRW296.8bn in 3Q20 to KRW41.2bn. Despite strong market conditions for olefin, the petrochemical business should have remained in the red due to regular maintenance works. Lubricant earnings appear to have come in near previous quarter levels on rising demand from clients. The EV battery division is expected to have seen QoQ improvement in both sales and profit amid steady growth in shipments.
Our target price for SK Innovation is revised up by 65% to KRW330,000. The value of EV battery business is adjusted upward sharply, reflecting valuation multiple upgrades for EV battery companies. SK Innovation shares have jumped 55% YTD on anticipation that the company may be chosen as a supplier for the third batch of batteries for Hyundai Motor’s electric cars built on the E-GMP platform. Despite the recent rally, SK Innovation has been the weakest performer among battery cell manufacturers since 2020. Its EV business is the most undervalued among peers at KRW153bn/GWh based on 2023. The company plans the most aggressive capacity expansion until 2023. Top-line growth should accelerate from 2021 on shipments of the first batch of E-GMP batteries. We will likely see a re-rating of shares on the recovery of mainstay operations and increase in value of the EV battery business.