This article first appeared in The Edge Financial Daily on May 10, 2019
Chemical Company of Malaysia Bhd
(May 9, RM2.14)
Maintain buy with an unchanged target price of RM3.08: We recently spoke with the management of Chemical Company of Malaysia Bhd (CCM) and the following were some key takeaways.
Moving forward we can expect average selling price (ASP) for caustic soda to have an upward bias on the back of expected (1) production moderation in China due to a recent explosion in Tianjiayi Chemical factory in eastern Jiangsu province (reported 78 casualties) resulting in greater scrutiny by the Chinese authorities, (2) Japan and South Korea manufacturers are expected to undertake a six-week statutory shutdown for maintenance in April and May, and (3) major importers have received their Bureau of Indian Standards (BIS) certification signalling exports to India (about 30% of Japan’s export volumes) to resume thus diverting cargoes away from the Asean region.
Its chlor-alkali plant Pasir Gudang Works 1 (PGW1) reactivation remains on track for early second half of 2019 (2H19). We expect a progressive ramp-up in production as the new plant will take some time for testing and commissioning before it can run up to speed. Nonetheless, PGW1 will be the the group’s main driver of earnings moving forward. We expect the capacity installed — 20,000 electro chemical unit (ECU) or 50% increase in total capacity — will replace about 28% of imports for caustic soda (total imports about 143,000 tonnes per annum) and completely replace acids imports in the country (about 43,000 tonnes per annum). PGW1 allows CCM to better position itself to take advantage of market dynamics which remain in a supply deficit while demand is growing.
CCM is also expanding its capacity for Kleeners, a cleaning solution for ceramic formers supplied to glovemakers. By the first quarter of 2020 (1Q20) its factory in Bangi, Selangor will house an additional 10,800 tonnes per annum (+90% year-on-year [y-o-y]) production capacity. The expansion will be funded internally with the bulk of the capital expenditure spent on storage tanks. In financial year 2018 (FY18) Kleeners accounted for about RM15 million in sales or 17% of total sales from CCM’s polymer division.
Seasonally, 1Q is expected to be a weaker quarter by virtue of fewer working days. Furthermore, some of the oleo-chemical plants and clients in general would undertake their statutory shutdowns during the Chinese New Year week; thus volumes would also be lower. We can also expect a lower y-o-y in 1Q19 versus 1Q18: recall that caustic soda ASP was about US$650 per tonne in 1Q18 compared with US$382 per tonne in 1Q19. For the polymer segment, we also expect a weaker quarter on the back of pre-stocking in 4Q18.
The polymer segment is US dollar bound with an inverse relationship with the greenback. A higher US dollar will result in lower gross margins as about 85% of input costs are denominated in the greenback. For the chemical segment, caustic soda benefits from a strong US dollar as its input costs are denominated in ringgit but ASP is referenced to US dollar. We estimate that a 1% change in US dollar-ringgit exchange rate would result in a 0.7% to 0.8% uptick in earnings for CCM.
CCM was recently awarded a three-year contract to supply 351,000 tonnes of caustic soda (contract value of RM315.9 million at current prices) to Petroliam Nasional Bhd (Petronas). We were surprised by the timing of the announcement of the tender result as we had anticipated a delay, given the recent explosion in Pengerang, Johor. The sheer size of the volumes awarded highlights Petronas’ confidence in CCM. The contract award validates our thesis that CCM is an undervalued alternative proxy to the Refinery and Petrochemical Integrated Development Project (Rapid) play relative to Dialog Group Bhd (TP: RM3.76 — FY19-20 price-earnings ratio [PER] of 42.1 and 34.3 times).
Our TP is a function of FY19 earnings per share (EPS) of 23.7 sen pegged at a price-earnings (PE) multiple of 13 times. The stock is currently trading at an attractive FY19-20 PER of 9.1 and 8.3 times with an implied dividend yield of 5.5% to 6%. CCM remains an underappreciated proxy to the glove sector and Rapid integrated petroleum complex. At this juncture the turnaround and growth story remains intact. — Hong Leong Investment Bank Research, May 9