Rating: Neutral
Target Price: SAR105
Closing Price: SAR100

Steep Q-o-Q pullback in earnings as operations were weak across the board
Earnings fell 29% Q-o-Q to SAR3.7bn (-25% Y-o-Y), missing both our and consensus estimates by c20%. While we had expected lower earnings this quarter, following the decline in the majority of petrochemical prices (ethylene -10%, PE -5%, PP -4%, MEG -16%, methanol -20%), fertiliser prices, (urea -18%) and higher steel costs, we did not expect it to be so severe. Beyond the lower prices, SABIC noted that costs were also higher Q-o-Q, and that losses at the steel division expanded to SAR483mn from SAR35mn last quarter and profit of SAR86mn in 2Q16. Note that the results were affected by a one-off SAR278mn related to a write-down of assets at Ibn Rushd, but even adjusting for this, earnings would have been substantially below our forecast. 
 
Cost inflation surprising, in light of lower LPG and naphtha prices
Revenues were down 5% Q-o-Q, but were in line with our expectations, with the large miss mainly due to lower-than-expected margins (GP margin of 31% vs. 1Q17 of 37% and EFGe of 36%) on much higher-than-expected costs, as COGS increased Q-o-Q against our expectation. We are surprised that costs were higher Q-o-Q, as LPG and naphtha prices declined substantially (propane –17%, butane –27% and naphtha –10%), which should have provided some cost relief. While it is possible the company had a significant amount of higher cost inventory from 1Q17, this alone would not account for the significant jump in costs Q-o-Q, in our view. In addition to the higher-than-expected costs, the large losses from the steel division widened the miss, as we had only expected steel earnings to fall by cSAR150mn Q-o-Q, but earnings actually declined by cSAR450mn.
 
2H17 outlook: Prices to remain muted, but COGS likely to normalise, going forward
It is not yet clear what caused the substantial cost inflation Q-o-Q, but we suspect that a combination of higher cost inventory, as well as a heavy shutdown schedule this quarter, were the main factors, in which case, COGS are likely to normalize, going forward, which should provide some relief to earnings. Looking into 2H17, chemical prices remain muted and beyond a continued rise in oil prices, we believe prices are likely to remain near current levels, in light of elevated inventory levels, lackluster demand and increasing supply. Prices could pick up as we approach end of 3Q17 on demand seasonality, but inventory levels would have to normalise before any meaningful rally occurs, in our view. 

Yousef Husseini