Top Picks: S-Oil, LG Chem, SKC, Kolon Industries
The authors are analysts of Shinhan Investment Corp. They can be reached at jinmyung.lee93@shinhan.com and cgh815@shinhan.com, respectively. -- Ed.
Oil refining: Structural uptrend in refining margins
We expect to see the oil refining industry enjoy a structural uptrend with tight market supply to continue in 2H22. Refining margins are forecast at USD15 per barrel in 2H22 (vs. USD13/bbl in 1H22), based on: 1) recovery in demand from the shift to an endemic phase; 2) limited increase in supply from OPEC+ members and the US; 3) decrease in crude oil supply from Russia; and 4) low inventory levels of petroleum products. Rising margins of transportation fuels (gasoline, diesel and aviation fuel), in particular, are expected to keep overall margins at high levels through 2H22.
For 1Q22, domestic oil refiners registered combined operating profit of KRW4.4tr (+210% YoY) from refining businesses, with the hike in global oil prices leading to massive inventory valuation gains and strong refining margins. The uptrend in oil prices will likely slow down in 2H22, but brisk earnings should continue on the back of strong refining margins led by transportation fuels. Korean oil refiners should emerge as the biggest beneficiaries of the rise in margins of middle distillates, with kerosene and diesel accounting for 37% of their total output. For full-year 2022, we expect oil refiners under our coverage to report an all-time high combined operating profit of KRW6.9tr (+238% YoY) from refining businesses.
Chemicals: Gradual improvement from 2Q22 bottom
Rising cost burden from oil price hikes, sluggish China demand and increasing market supply are weighing heavily on chemicals at the moment. However, industry bottlenecks are expected to ease towards 2H22, helping to resolve the imbalance between market supply and demand. Downstream demand should recover from the steep drop as semiconductor supply/demand returns to normal levels and ocean freight rates stabilize downward from current high levels. As a result, we expect the price spreads of chemical products to gradually recover after bottoming out in 2Q22.
For the uptrend to continue, we will need to see stronger demand from China and steadier oil price trends. Although unclear when lockdown measures will be lifted, China is highly likely to expand infrastructure investment in 2H22 to shore up its economy. While global oil prices are expected to remain high through end-2022, a gradual easing of supply/demand imbalances should help to limit further upside. We may not see an actual industry turnaround in 2H22, but market conditions should continue on a recovery track if oil prices stabilize and demand from China improves going forward.
Top picks: S-Oil, LG Chem, SKC, Kolon Industries
Favorable conditions should continue for the refining sector through 2H22, with demand recovering from the easing of pandemic restrictions and supply disrupted by geopolitical issues. Refining margins are expected to continue on a structural uptrend, driven by limited investment in upstream projects, recovering demand for transportation fuels, and historically low inventory levels. We recommend S-Oil, the biggest beneficiary of the oil refining sector upturn, as our top pick.
Chemicals, on the other hand, should see limited improvement through 2H22, given high oil prices and uncertain demand from China. Stocks look attractive at historical low valuations, but we recommend focusing on select companies with bright prospects given persistent worries over market conditions. Our top picks in chemicals are LG Chem, SKC, and Kolon Industries. LG Chem and SKC are expected to deliver solid earnings from their mainstay business (chemicals) through sales of high-margin products, and enjoy further growth from new businesses (battery materials). Kolon Industries is projected to see structural improvement in earnings based on solid fundamentals and capacity additions.