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This article first appeared in The Edge Malaysia Weekly on August 7, 2017 - August 13, 2017

AFTER a long day of meetings with investors following the announcement of Lotte Chemical Titan Holding Bhd’s poor second-quarter results, president and CEO Lee Dong Woo looks a little tired as he sits down with The Edge.

Seated in LCT’s boardroom, he is flanked by members of the company’s management team — eight of them.

He speaks slowly; English is not his first language. His frustration is evident. Perhaps it is a combination of the language barrier and the circumstances that have led to the interview.

“I do not understand it,” he says, shaking his head in disbelief. Lee is genuinely perplexed by the selldown in LCT’s share price.

He argues that at the revised initial public offering price of RM6.50, the company’s shares were already offered at a bargain. Surely, investors made fully informed decisions based on the prospectus when they agreed to subscribe for the IPO.

But five minutes into the interview, as he struggles to find the words to explain the situation, his management team jumps in to answer questions on his behalf. Over the course of the hour-long interview, Lee would say little else.

Here is an excerpt from the interview:

The Edge: Were you surprised that the share price fell as much as it did when you announced your results?

LCT management: We expected the share price to drop because the results were not what the market had expected. But we had not expected it to fall this much. There were simply a number of unexpected events in 2Q2017, a perfect storm.

 

So, what happened?

Syarikat Air Johor informed us in April that it would cut the water supply for one day of maintenance. Our plant needs a lot of water, so we stored water for one day. But when SAJ resumed supply 24 hours later, its water plant broke down again and we suffered water disruption for 11 days. 

By then, we had depleted our water reserves. Without water, we had to bring the whole complex to a shutdown.

By the time this event happened in April, we knew that there would be 75,000 tonnes production loss. This was shared and disclosed in the roadshow.

But the overall impact carried over on a month-to-month basis — we could not have the full details until we closed our accounts.

 

How could you not know the full impact?

Normally, feedstock delivery is planned one to two months in advance. But in the event of an unplanned shutdown, there is no consumption. And because of the limited storage space, we had to discuss with our suppliers to delay the delivery of feedstock.

But at that time, we did not know the prices in May and June.

Feedstock prices fell in the second quarter, so we realised higher inventory costs. The plant shutdown did not allow us to consume the feedstock previously purchased and therefore the chance to buy feedstock at lower prices in May and June.

Since we cannot forecast prices, we could not fully understand the financial impact of the water cut. When we closed the books in July, we were then made aware of the higher inventory consumption impact. 

Additionally, margins were lowered by the laggard effect of product price and feedstock cost.

 

If there had been no change in feedstock prices, what would have been the impact?

About 31% of the quarter-on-quarter drop in Ebitda [of RM232 million] was due to the direct impact from the water cut (about RM71.9 million). This includes the production loss, as well as losses from having to burn hydrocarbons through flaring.

 

And what about the indirect knock-on costs?

As disclosed in the prospectus, LCT undertook a turnaround of Nafta Cracker 2 (NC2) in February and March which meant that ethylene and propylene could not be produced. As some polymer plants resumed operation earlier than NC2, we arranged for ethylene and propylene supply. This caused our production cost to be high, carrying over in to the second quarter.

This added another RM46 million in costs.

Without the water cut, the impact of the turnaround [on 2Q] would have passed through much quicker.

 

Do you think the institutional investors and analysts expected the water disruption to have such a big impact on earnings?

We did not hide anything.

Even if at that point they asked us to work out the impact, we could not do so.

However, it is quite common in the industry. When a plant comes to a halt, besides production loss, there are other costs — like fixed costs and incidental costs.

 

Even if you had not known the exact cost, could you have foreseen that it would be sizeable? Did you communicate it?

Looking at a full year, we did not think it was that material at that point in time. After all, we could always catch up on lost production.

 

You chose not to disclose it because you decided it was not material?

No, no. Firstly, we could not quantify [the exact impact]. Secondly, we looked at the 75,000 tonnes. Over the full year, it is not material. Our annual production [last year] was 2.7 million tonnes.

 

Did you anticipate the risk of knock-on effects to have the potential to be substantial?

Not to my knowledge. Like I said, it can go either way.

 

But isn’t that the definition of risk?

But it cannot be gauged on any number. We did not want to give the wrong guidance. The factors that led to Q2 results could not be reasonably determined before the books closed.

 

Were you asked about it?

I think we met like 150 groups of people. I can’t quite remember. I don’t think anybody focused on it. 

 

On the contrary, fund managers say they asked about the impact of the water shortage, but were told it was not a major issue. But you say everything was disclosed. How do you reconcile these two perspectives?

We have been meeting them, and they are asking these same questions.

Of course we told them about the shortage. But the magnitude [of the costs], like what we are telling you now, was not known until the end of the quarter.

If we had known that it was of that magnitude at the time, we would have disclosed it.

 

What are you going to do to prevent a repeat of such an incident?

We are considering better insurance cover, but it would cost more. Our current business interruption insurance only covers interruptions exceeding 45 days. This disruption lasted 11 days. Additionally, we are doing feasibility studies on water contingency plans.


 

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