Investment Highlights

• We maintain our BUY recommendation on Luxchem Corporation (Luxchem) with a lower fair value of RM0.74/share, pegged to a 15x FY19F FD PE (previously RM0.81/share).

• We adjust FY18F-FY20F earnings downwards by 5-12% to account for lower utilization at Luxchem’s unsaturated polyester resin (UPR) manufacturing arm, Luxchem Polymer Industries (LPI), for FY18 onwards and to factor in expansions for its Transform Master (TMSB) manufacturing arm for end-FY18F and FY19F.

• Luxchem’s 3QFY18 core net profit came in below our expectations at RM9.5mil (QoQ: -6%, YoY: +4%). For the cumulative period of 9MFY18, the group’s core net profit came in at RM29.2mil, accounting for 69% of our full-year forecasts and 67% of consensus estimates.

• 9MFY18 core net profit fell 7% YoY as EBITDA margin worsened by 0.6ppt mainly due to:

(i) Headwinds faced by LPI amid intense competition and a slower market continuing to hurt margins, subsequently affecting the group’s ability to fill up its 40K MT/year capacity. LPI’s utilization remains unchanged at around 70% since July 2018. Overall manufacturing PBT was dragged by LPI despite margin improvements from TMSB, as LPI contributes a bigger share of the manufacturing pie.

(ii) Declining raw material prices and weaker USD against the MYR impacts trading margins: Average butadiene and PVC resin prices declined by 8% and 3% respectively, translating to lower selling prices. Meanwhile, Luxchem’s exports, which are primarily USD-denominated and contribute 30% of group revenue, would be negatively impacted by a weaker USD against the MYR. YTD, the USD against the MYR declined 8% YoY. Overall, Luxchem’s trading segment contributes approximately 83% of group revenue.

• On a quarterly basis, 3QFY18 results were up 4% YoY due to revenue improving by 13% largely from the trading segment. This was coupled with lower share option expenses and operating expenses, where Luxchem issued a lower number of options with a lower fair value per option, and made lower provisions for doubtful debts in 3QFY18.

• Local sales marginally improved (+0.5%) mainly amid higher sales from TMSB. Meanwhile, export sales fell 2%, especially due to lower sales in its major exporting countries, Vietnam and Thailand due to lower sales from LPI.

• TMSB is currently operating at near-full capacity of 13.8K MT/year (vs. 80% utilization in July 2018), denoting rising demand in latex and latex-related products tied to the glove sector. Latex contributes around 30% of group total revenue. By the end of CY2018, capacity is expected to reach 15K MT/year, with a target of 17K MT/year capacity by early next year (+13% vs. current capacity). We have factored the planned capacity expansions into FY19F earnings, in line with earlier guided target expansion to 20K MT/year in the next few years (+18% vs. current capacity).

• Moving forward, we expect TMSB to continue to benefit from the growth in the glove sector, where the Malaysian Rubber Glove Manufacturers Association (MARGMA) expects revenue of RM18.8bil in 2018 (+16% from 2017) amid robust global demand, with Malaysia expected to supply 63% of the world’s rubber gloves. Over the next 2 years, MARGMA shared that Malaysian glove players would want to grow the market share further to 68%.

• Overall FY18F results is expected to be flattish due to challenges faced in the UPR industry for LPI and slower-thanexpected progress in its export markets, further exacerbated by a weaker USD against the MYR and on average weaker chemical prices YoY. This is despite TMSB’s positive contribution to the group earnings.

• We reiterate our BUY recommendation on Luxchem due to: 1) its exposure to industries with stable and commendable growth such as the glove sector (tied to latex and latex-related products); 2) good earnings visibility backed by large clientele (~1,000 customers) and wide applications of its chemical products; and 3) capacity expansions planned for the group’s manufacturing segment, particularly in TMSB for FY19 onwards, driven by growth in the glove sector.

Source: AmInvest Research - 26 Oct 2018