IGI Securities Limited – Day Break(16-01-2020)

Karachi, January 16, 2020 (PPI-OT): Chemicals: EPCL: Issuance of Preference shares; negative bearing on earnings

According to the notice issued, EPCL may issue preference shares with different rights and privileges having face value of PKR 10 each aggregating up to PKR 3.0bn.

The said amount will be utilized for funding capex requirement for PVC expansion and debottlenecking of Vinyl Chloride Monomer (VCM). The company intends to avail tax benefit which we think falls under section 65 (E) of income tax ordinance. Our calculation suggests the impact on earnings is negative.

We have a BUY call on the scrip based on our Dec-20 target price of PKR 45/share, offering 32% upside from its last closing. The company is currently trading at CY20 P/E of 7.3x, offering a dividend yield of 4.4%.

As per the stock notice issued EPCL plans to raise PKR 3.0bn through preference shares. The said amount will be utilized for funding capex requirement for PVC expansion and debottlenecking of Vinyl Chloride Monomer (VCM). The company intends to avail a tax credit which we think falls under section 65 (E) of income tax ordinance after meeting the criteria. Our calculation suggests the impact on earnings is negative.

EPCL to raise additional PKR 3.0bn through preference shares

According to the notice issued, EPCL may issue preference shares with different rights and privileges, having face value of PKR 10 each to individuals, companies, body corporates, commercial banks, DFIs, financial institutions, mutual funds, provident/ pension/ gratuity funds/ trusts etc.

For funding PVC expansion and VCM debottlenecking project

The total amount aggregates up to PK 3.0bn which will be utilized to expand the company’s PVC capacity and debottlenecking of VCM production capacity. To note, the initial capex for the projects amounted to PKR 7.6bn, of which PKR 5.4bn was raised through right share issue. Addition of new equity amount raises the total amount to PKR 10.6bn. Rather than seeking loan from banks for additional funding, the company in this way has maintained its leverage position. On a positive note, the company can avail a tax benefit through equity injection.

Investment falls under the criteria of section 65 (E) of Income Tax Ordinance

As per the section 65(E) of the income tax ordinance the company can avail tax credit if it invests an amount equivalent to at least 70% of the total project cost through issuance of new shares. Our analysis suggests, the company meets this criteria as the total equity portion comprises of ~80% of the project cost (PKR 10.6bn) taking into account addition of PKR 3.0bn through preference shares. More so, the benefit can be availed for a period of five years beginning from the date of setting up or commencement of commercial production from the expansion project which in the case of ECPL is for a period of 2020-2024 we think.

The net impact on earnings is negative

As per our calculation the impact is negative on earnings. For calculating preference dividend we have assumed 13% KIBOR and kept it constant for the years 2020-2024. The preference dividend comes at PKR 495mn or PKR ~0.5/share (100mn pref. shares). For tax credit, we have followed calculation methodology stated under sub-section (3) of 65E ordinance as making use of separate accounts for expansion is beyond our scope. We have used equity amount of PKR 17.5bn as per Sep-19 company accounts.

Recommendation

We have a “BUY” call on the scrip based on our Dec-20 target price of PKR 45/share, offering 32% upside from its last closing. The company is currently trading at CY20 P/E of 7.3x, offering a dividend yield of 4.4%.

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