Investment Highlights

• We increase our FY20–22F net profit forecasts by 4%, 7% and 6% respectively, and raise our FV for Luxchem by 5% to RM0.58 (vs. RM0.55 previously) based on 13x revised FY21F EPS, at a 1x multiple premium to its average historical forward P/E of 12x, to reflect the improved trading sentiment towards glove-related stocks (Luxchem is engaged in latex processing/compounding via a unit called Transform Master or TMSB) on expectations of a prolonged Covid-19 pandemic.

• The upgrade in our forecasts is to reflect improved margins on better economies of scale (largely coming from full utilisation at TMSB) and a higher capacity assumption for TMSB (which is expediting its expansion plans in response to the surge in demand for glove-related products). However, at the current rich valuations, we believe the market has already priced in the earnings upside for this accelerated expansion. Maintain SELL.

• Luxchem’s 1QFY20 results came in above expectations, accounting for 29% of ours and consensus full-year forecast. We believe the key variance against our forecast came from stronger-than-expected margins due to better economies of scale at TMSB as mentioned.

• The group’s 1QFY20’s turnover shrank 14% YoY due to lower sales of chemicals used in the construction, automobile and the electrical sectors (which have been hit by the pandemic). Not helping either, was price cutting in the market by the Chinese players. However, its core net profit increased by 4% YoY mainly due to stronger margins due to better economies of scale at TMSB as mentioned.

• Key highlights from the briefing yesterday are:
  1. Luxchem’s operations have resumed in stages since end-May 2020, following the transition from the movement control order (MCO) to conditional and recovery MCO. During the MCO, TMSB, which fell under “essential services”, was the only unit that was allowed to operate. The resumption of full operations is timely as Luxchem has started to see better flows of orders from both domestic as well as overseas buyers, especially, those from Thailand and the Philippines.
  2. Luxchem is expanding TMSB’s capacity by one-third from 1,500MT/month to 2,000MT/month from July 2020 onwards, driven by the surge in utilisation to 100% (vs. 80% three months ago). It expects glove-related sales to increase by at least 20% this year on strong demand for gloves amidst the prolonged pandemic. However, it does not expect a significant expansion in TMSB’s margins as the market is still well supplied with compounded latex. While there has been a surge in demand for compounded latex from glove makers, there has been reduced demand from other compounded latex users such as clothing and house paint. 3. It is still cautious about the outlook for other chemical products, i.e. those used in the construction, automobile and the electrical industries, given their slow recovery from the pandemic. Meanwhile, competition is flaring up with increased presence of Chinese suppliers in the region (as they diversify geographically amidst the unresolved US-China trade war).
• Moving forward, Luxchem will continue to focus on improving margins by increasing the utilization rates and efficiencies of its manufacturing arms (LPI and TMSB).
• We believe the Covid-19 pandemic cuts both ways for Luxchem. The surge in demand for personal protective equipment such as gloves will drive Luxchem’s latex processing/compounding business. The segment contributes about 35% of its turnover in FY19. On the other hand, a sharp downturn in the global economy due to the pandemic (coupled with the cutbacks in infrastructure spending locally) will hurt demand for chemicals from customers in other sectors such as construction, automobile and the electrical.

Source: AmInvest Research - 15 Jun 2020