Newly listed Lotte Chemical Titan Holding Bhd (LCT) may blame bad luck and circumstances beyond its control for the 72% year-on-year decline in its second-quarter (2QFY2017) earnings, but there is certainly something to be said about how it has managed investor expectations.

Based on the fall in the petrochemical company’s share price last week — down to RM4.14 at its lowest — it is clear that the investment community was caught unawares by the poor results barely three weeks after the listing.

This is perplexing, given that every event that negatively impacted LCT’s earnings occurred prior to its IPO. So, why were investors not informed of the risk to earnings?

“It comes down to trust. [LCT’s] management did not properly communicate the severity of the water shortage (a water disruption at LCT’s Johor-based petrochemical plant) during the roadshows. On top of that, there was no mention of the TRES (total return equity swap) having such an impact on earnings. All the analyst forecasts are off the mark now. Next time, can we trust what they tell us?” one clearly agitated fund manager tells The Edge.

His frustration is justified. In less than a month of its listing, LCT has lost as much as RM4.7 billion in market capitalisation as funds rushed to cut positions. For perspective, LCT only raised RM3.77 billion in the IPO.

Not only has it burnt the institutional investors that took up the offering but LCT’s abysmal debut has also spoilt the broader IPO market.

Not surprisingly, the regulators are looking into the matter. “The Securities Commission Malaysia and Bursa Malaysia are closely monitoring developments in LCT, including reviewing whether appropriate and timely disclosures have been made to enable investors to make informed decisions,” says an SC spokesperson.

So, what went wrong?

Let’s begin by examining LCT’s “perfect storm”. Compared with the first quarter, its 2QFY2017 earnings before interest, tax, depreciation and amortisation (Ebitda) fell by 47.2% quarter on quarter or RM232 million. LCT’s management cites four main reasons for the fall.

First is the 11-day water disruption at its Johor plant, which accounted for 31% of the quarter-on-quarter fall or RM72 million. Second is the knock-on effects created by the water disruption on inventory cost, driving it up by about RM46 million.

Third comes the super-normal profit of about RM44.1 million that the group enjoyed on butadiene in the first quarter due to record-high prices. But as prices normalised in 2QFY2017, so did LCT’s profit on butadiene sales.

Last is the fact that LCT booked an extra RM40 million non-cash gain on its TRES in 1QFY2017 due to a surge in the share price of the underlying asset — the company’s Jakarta-listed subsidiary, PT Lotte Chemical Titan Tbk (LCT Tbk). But the share price dropped in 2QFY2017, causing LCT to book a RM22 million loss. Overall, this resulted in a net RM62 million quarter-on-quarter swing in earnings.

Could LCT have disclosed more?

Several fund managers and analysts whom The Edge spoke to claim that LCT downplayed the impact of the water shortage during the pre-IPO roadshows.

Note that LCT’s prospectus clearly discloses the 11-day water disruption and the resulting production loss of 75,000 tonnes. Compared with the annual production of 2.7 million tonnes, this looked fairly immaterial.

However, it does not explain the potential financial impact. The direct and indirect costs of the unplanned shutdown hit LCT’s Ebitda by an estimated RM110 million, which means the relatively brief disruption had a disproportionate impact on the company’s earnings.

The reasons for this are covered in the accompanying story in which LCT claims that it could not have estimated the impact of the water shortage, which is why it was not disclosed.

It remains to be seen how LCT’s “we did not know” defence will stand up to regulators’ scrutiny of the pre-IPO due diligence reports that detail all potential risks.

Even so, LCT’s management may be able to argue that it was reasonable to leave out further details of the water disruption, especially if its impact on a full financial year proves to be relatively immaterial.

That aside, the impact of the TRES, which was not flagged as a risk in the prospectus, could certainly have been anticipated. But it was merely explained as a balance sheet item.

As LCT’s management explains it, LCT Tbk’s share price had “shot up to unsustainable levels due to speculation” in the first quarter, when it quadrupled. But by the second quarter, it had almost halved, wiping out most gains — something LCT’s management should be aware of.

Says one fund manager, “For starters, the management should have pointed out that the first-quarter results had been inflated by the TRES gains; RM40 million, that’s almost 10% extra profit. Yes, it is a non-cash item, but it must be disclosed properly or else it is misleading.”

To be fair, the TRES poses little real threat to LCT. The maximum cash loss the company can realise on the TRES is US$4.3 million, and that is only if LCT Tbk’s share price falls to zero.

Similarly, LCT’s management would have known that the super-high profit made from butadiene was not sustainable in the long run, and the normalisation of butadiene prices in the second quarter should have been evident to them. But this was not disclosed.

LCT’s management argues that individually, these items were simply not material. However, it should not look at each item separately but weigh the impact of these events as a whole. In fact, it should have been aware of the “perfect storm” that was brewing in late June as the company headed for its listing.

By keeping mum about it, LCT has lost the trust of its investors.

For sale: LCT shares, 30% off!

Looking ahead, the selldown in LCT’s shares presents an interesting buying opportunity. As the company has stressed over the past week, the negative events were all one-offs. After all, its fundamentals appear to be intact with plant utilisation recovering after the water disruption.

Stripping out the non-cash impact of the TRES, the group’s core net profit should recover in the coming quarters.

To its credit, LCT’s management is working hard to reverse the trust deficit that has emerged. It might take some time but the company can restore confidence by returning its earnings to normal levels.

Note that the group’s 3QFY2017 earnings will be dampened by the scheduled turnaround or overhaul of its first Nafta cracker, NC1. However, this turnaround, which takes place every five to six years, is expected.

On top of that, investors should look out for the listing cost of about RM100 million, which will be booked in the third quarter.

“Some funds may have sold out, but for every seller, there must be a buyer. It looks like other institutional funds have taken advantage of the selling to take up a position in LCT for cheap,” says an analyst. 

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