Luxchem Corp Bhd
(Sept 7, RM1.76)
Downgrade to neutral call with a lower target price (TP) of RM1.88: Coming away from our meeting with management, we are mindful that the current market landscape is challenging and might affect Luxchem Corp Bhd’s earnings growth momentum. 

Key takeaways include softer chemical demand entering the second half of 2016 (2H16); a stronger presence in Vietnam; unsaturated polyester resins (UPR) to face more competition; and Luxchem’s new acquisition of Transform Master Sdn Bhd to grow production capacity in the financial year ending Dec 31, 2017 (FY17). 

Up to 1H16, Luxchem’s reported revenues rose 0.67% year-on-year (y-o-y) and profits climbed by 7.2% y-o-y on the back of stronger contributions from both the manufacturing and trading segments. 

Entering the third quarter of FY16, management expects the chemical industry to become more competitive. In response to a possible slowdown in potential growth, Luxchem notes that customers are adopting more conservative purchasing policies.

Despite that, Luxchem intends to benchmark sales targets at the numbers achieved in FY16 and will continue to strive to improve sales performance.

Luxchem is looking to further strengthen its foothold in Vietnam and Indonesia. The group is currently marketing its plastic-related chemicals and UPR, and aims to sell its latex-related chemicals within these two markets.

Luxchem’s UPR manufacturing segment’s current capacity is at about 30,000 tonnes per year and is fully utilised at the current stage. 

Luxchem is adopting a wait-and-see approach for this segment as it sees further competition in the market. Based on the Malaysian Investment Development Authority website, Eternal Materials Co Ltd, a Taiwanese synthetic polymer manufacturer, is investing US$70 million (RM284.2 million) to set up a manufacturing facility in the Tanjung Langsat Industrial Complex, Johor. 

The new factory will add to the company’s existing capacity of synthetic resins and UPR to fulfil demand from the Southeast Asia market. It is expected to be operational by the end of 2017.

Given the sensitivity of UPR prices, we think Eternal Materials’ entry will pose a formidable threat to Luxchem’s manufacturing segment.

As for Transform Master, we understand from management that FY16 is likely to see flattish results as it is still undergoing some qualifications from customers. 

In terms of production, the current plant’s manufacturing capacity is able to fulfil existing orders. Furthermore, we understand that the company intends to ramp up production capacity in FY17. 

Under a most optimistic scenario, we expect Transform Master to contribute up to RM6 million annually to the group’s pre-tax figures.

Notwithstanding the above factors, we continue to like Luxchem because of its: i) diverse range of manufacturing customers; ii) market leader position in industrial chemicals; iii) steady earnings volume growth; and iv) healthy balance sheet and decent dividend yield of about 4%.

We have a “neutral” rating on Luxchem with a lower TP of RM1.88, after cutting our FY16 to FY17 earnings forecasts by 4.7% and 4.5% as we expect a slight margin erosion and lower turnover due to weak end-user demand from both the latex and plastic sectors.

Currently trading at a 9.3 times price-earnings ratio (PER), valuations appear undemanding when compared with listed peer chemical manufacturers like Samchem Holdings Bhd which trades at a PER of 22 times. — Inter-Pacific Research, Sept 6