This article first appeared in The Edge Financial Daily on November 2, 2018
Lotte Chemical Titan Holding Bhd
(Nov 1, RM4.29)
Downgrade to sell with a lower target price (TP) of RM4.30: Lotte Chemical Titan Holding Bhd’s nine months of financial year 2018 (9MFY18) core net profit of RM682 million (-5% year-on-year [y-o-y]) was within our expectations, but below consensus estimates at 71% and 66% of full-year forecasts respectively.
The year-to-date (YTD) bottom-line decline was largely due to margin squeeze from a spike in naphtha feedstock price. Additionally, higher depreciation and taxes also contributed to the bottom-line rout. Nevertheless, the earnings decline was partially offset by higher associates’ contribution and interest income.
In the third quarter of FY18 (3QFY18), naphtha price surged by 43% y-o-y, but the corresponding increase in product prices was largely muted for polyethylene (PE) (+6% y-o-y), ethylene (+12% y-o-y), and polypropylene (PP) (+11% y-o-y). As a result, 9MFY18 earnings before interest, taxes, depreciation and amortisation (Ebitda) margin compressed to 15% (9MFY17: 20%) despite higher sales volume (+19% YTD).
3QFY18 plant utilisation inched higher to 87% (2QFY18: 82%; 9MFY18: 84%) — resulting in higher production volumes (quarter-on-quarter [q-o-q]: +10%; YTD: +37%) and sustained plant utilisation recovery. To recap, 9MFY17 plant utilisation of 69% was dragged down by turnaround activities at Lotte Chemical’s main cracker in 1QFY17. This was further exacerbated by an 11-day production shutdown at Lotte Chemical’s Johor facility due to water supply interruption.
The strong 9MFY18 plant utilisation was in spite of intentional load down on Indonesian PE and Malaysian PP production in 1HFY18. The former was attributed to weak product spreads, while the latter was due to return of advance propylene feedstock to traders. Nevertheless, we understand that production in Indonesia was ramped up in 3QFY18.
Key takeaways from a conference call are:
* Lotte Chemical’s new PP plant, PP3, is expected to ramp up to full production in 4QFY18. The plant was Ebitda positive in 3QFY18 and provided a marginal one-month contribution; and
* 3QFY18 taxes were marginal, at RM110,000 (effective tax rate: 0.1%) due to reversal of 1HFY18 over provision of tax payables. 4QFY18 taxes are expected to normalise, in line with FY18 effective tax rate guidance of 15% (9MFY18: 11%).
We raise our feedstock price assumptions in FY18, in accordance with the recent price movement. As a result, our FY18 forecast is trimmed by 4%.
We believe that margin pressure will likely be sustained due to weaker product spreads. This is on the back of rising naphtha prices in tandem with traction in oil price ascent. However, the corresponding rise in product prices has been muted due to soft demand. Additionally, the timing lag in product price adjustment will result in inventory lag losses for Lotte Chemical.
Our concerns are echoed by management, which guided for margin compression on the back of: i) subdued product prices due to weaker demand from China; ii) competition in Malaysia and Southeast Asia markets arising from start-up of the Refinery and Petrochemical Integrated Development project at end-2019; and iii) more expensive naphtha feedstock. Additionally, we understand that Lotte Chemical’s industrial customers have been holding back on purchases due to concerns about a full-fledged US-China trade war.
In light of the above, we downgrade Lotte Chemical’s target FY19 enterprise value-to-Ebitda multiple to five times (previous: 7.5 times). We believe Lotte Chemical should ideally trade at a discount versus naphtha-based Southeast Asia peers (average: 7.9 times), given the smaller market capital and capacity. — TA Securities Research, Nov 1