Surya Esa Perkasa (ESSA) is engaged in two businesses: 1.) LPG refinery – which started production in 2007, and 2.) Ammonia – through 60% effective ownership in Pancar Amara Utama (PAU) – which is expected to commence production in Q12018. It is owned by reputable investors such as Garibaldi Thohir (also the President Director), TP Rachmat and Jonathan Chang. On the technical side, ESSA has Chander Vinod Laroya who owns Indorama.
The LPG business produces LPG & condensate, with capacity of 190tons/day of LPG and 500barrels/day of condensate. All LPG is sold to Pertamina, at a selling price of CP Aramco less $6/Mt. Meanwhile, Condensate are sold to traders and large aromatic companies.
ESSA’s LPG refinery is located near Lembak field in South Sumatera, which is operated by Pertamina EP. Everyday, ESSA receives 60mmcfs of raw natural gas from the Lembak field. ESSA takes the heavy hydrocarbons which are used to create condensate, and propane and butane which are combined to create LPG. The remaining ethane and methane are then sent back to the Pertamina EP pipeline. The gas supply contract commenced in 2007 and will end in 2022.
For 2018, I assume ASP at the Dec-2017 Saudi Aramco LPG price of $590/Mt less $6, or $584/Mt. I believe this is conservative given that oil price has been in an uptrend, hence we can expect even higher LPG selling prices. For Condensate prices, I assume a WTI of $65/bbl, and a discount to WTI of 40%, resulting in an ASP of $39/bbl. I also assume a gross margin of 55%, in accordance with higher LPG prices.
With the prospect of bullish oil price as world economic growth is great, I believe my assumptions are conservative enough. Hence, I believe a 10x P/E multiple is justified, considering: 1.) conservative earnings assumptions, resulting in short-term upside with bullish oil price 2.) volatile LPG prices, 3.) Limited growth in LPG business
Value of LPG business: 1,417bn (or Rp99/sh)
ESSA’s ammonia business (PAU), produces ammonia which is used 70% for fertilizers and 30% for explosives. PAU has a production capacity of 2000tons/day.
BUYER: PAU has an agreement with Mitsubishi that Mitsubishi will purchase 100% of PAU’s production. The selling price will be calculated based on the Fertecon ammonia index. The buyer will have to pay PAU if it decides to cancel or delay offtake delivery that leads to a production shutdown. (Note that Mitsubishi also has a significant stake in PAU).
SUPPLIER: PAU gets its gas supply (its raw material) from the Senoro gas field, operated by a Joint Operating Body Pertamina Medco Tomori Sulawesi. It is a joint venture between Pertamina, MedcoEnergi, Mitsubishi, and Kogas. PAU purchases its gas supply using a price adjusting mechanism (adjusted for ammonia prices), giving the gas supplier upside/downside according to ammonia prices.
Reading through analyst reports, it seems that the relevant ammonia price is the Gulf price. Hence, current ammonia price is ~$300/ton. Ammonia price track the oil price, and it seems that it lags the oil price movement.
According to a research report, where ammonia price is >$400/ton, we can expect PAU to book gross margins of +45%. Factors to consider for gross margin assumption: 1.) Petronas Chemical’s fertiliser division booked 42% EBITDA margin in 2017, 2.) High operating leverage, 3.) PAU’s gas purchase price is adjusted to ammonia prices (hence there should be less gross margin volatility), 4.) PAU should be a relatively low cost producer (for supplying Asian countries with ammonia) supported by its advantageous geographic location, similar to in Malaysia.
Earnings Forecast – PAU
Given that ammonia prices is a lagging indicator of crude oil prices, we can expect ammonia price to be much higher in 2018 and 2019 than the current $300/ton, as oil price is in an uptrend. I will be providing three scenarios for ammonia prices.
With PAU only expected to commence production by the end of Q12018, I will use 2019 as the basis for my earnings forecast.
- 90% capacity utilisation, 2019 production = 657kt
- Loan from IFC (at 5.5%-6% I/R at current LIBOR) – not tax deductible since it is not tax withholding
Bear Case – Ammonia Price: Rp300/ton, Gross Margin: 40%
Base Case – Ammonia Price: Rp350/ton, Gross Margin: 42.5%
Bull Case – Ammonia Price: Rp400/ton, Gross Margin: 45%
Fair Value – Base Case – 2019
As a target P/E multiple, I will use a 12x multiple on the base scenario, given PAU still has the ability to increase its utilization beyond 90%, the potential for further upside in ammonia prices, and downside risk from the prospect of increasing interest rates worldwide.
Ammonia business fair value = Rp4,073bn
Consolidated = Rp1,417bn + Rp4,073bn = Rp5,490bn = Rp384/sh
Book Value (post Rights Issue): Rp2,084bn
- At Rp292/sh, MCap = Rp4,176bn, P/BV = 2.0x
Key Risks to Target Price
- Change in commodity prices: oil, LPG, Ammonia
- Interest Rate Risk: as ESSA has a significant portion of its loans (from IFC) with variable rates (according to LIBOR + a predetermined margin)