8 things I learned from the 2017 Lotte Titan Chemical AGM (full version)

Lotte Titan Chemical (LCTITAN) is the largest producers of polyolefin and ranked 4^th largest petrochemical in term of capacity in Southeast Asia with a market capitalization exceeding RM13 billion. In Jul 2017, LCTITAN returned to Bursa Securities with IPO price RM6.50. At present, LCTITAN’s production site in Malaysia consists of 11 plants, 2 co-generation plants and 3 tank farms. They are located on 2 sites in Pasir Gudang and Tanjung Langsat in the state of Johor.

1. LCTITAN (LCT) registered a 4Q17 net profit (NP) of RM377 million, up 64% QoQ and 29% YoY, due to higher utilisation QoQ and higher HDPE-naphtha margin YoY.

QoQ sales revenue up +5.0% (from RM2.016 billion to RM2.117 billion), Profit Before Tax (PBT) up +55.9% (from RM245 million to RM382 million) and EBITDA up +33.3% (from RM 351 million to RM468 million). No debts with strong healthy +RM3.62 billion cash balance on-hand. Sales revenue increased 5% mainly due to increase in average selling price and sales volume. PBT increased by RM137 million due to improved plants utilization rate & operating efficiency +RM 110 Mil and non-operational +RM27 million (3Q17 fixed asset written off to NC1 turnaround, LCUSA associate gain on interest rate swap)

FY17 YoY sales revenue down -3.8% (from RM8.13 billion to RM7.82 billion), Profit Before Tax (PBT) down -33.3% (from RM1.71 billion to RM1.14 billion) and EBITDA down -26.1% (from RM2.12 billion to RM1.57 billion). Group revenue & PBT decreased primarily due to decrease in sales volume was attributed to the two statutory routine turnaround activities at Malaysia complex and lower Indonesia polyethylene plant load due to poor polyethylene economics, caused by tight ethylene supply and high cost resulting in lower production volume. However, partially offsetting the decrease in sales volume by 17.2% increase in average product selling price.

In whole FY17, LCT’s plant utilization has a big loss hit from average utilization 91% (in 2016) drop to 73% (in 2017), majority cause to unexpected events arise, plant shutdown due to (i) water supply disruption 13-days in 2Q17, (ii) small fire incident TE3 in 3Q17 and (iii) DOE environment stop-work order on odour emission in Oct’17). Plant utilization also loss due to (iv) 53-days maintenance shutdown of naphtha cracker #2 in 1Q17 and (v) 33-days maintenance shutdown of cracker #1 in 2Q17 as well. As a result, it have a big hit loss in FY17 revenue & PAT as overall for 2017.

In AGM 2017, LCT’s top executive mgmt stated, there will be no major planned maintenance activities for FY 2018 except for routine maintenance, and they don’t expect any negative impact to the plant utilization rates. LCT already fully comply to all plant maintenance & safety regulations in 2017, there will be no more major plant maintenance in next 5 to 6 years. Mgmt also stressed with high confidence that with completion of the maintenance procedures for the plant, FY18 utilization rate of all plants this year could raise to >90% and drive capacity growth further with TE3 plant (commence Dec’17) & coming PP3 plant (commence June’18).

Based on FY18 new TE3 & PP3 plants additional output capacity coupled with new lean-cost efficient manufacturing technology, this will drive additional 30% output on top of current FY17 output when it run at full capacity for whole year 2018.  

2. Earnings per share (EPS) QoQ grew 59% from 10.42 cents to 16.64 cents. LCT’s earning is returning to its original normalize recovery, expected to hit EPS 20 cents by 1Q18 and subsequent quarters profit since there are no more plant maintenance occurrence for 2018 and assume those One-time unexpected events is clear off.

Moreover, this EPS of 20 cents profit does not include the additional 30% new capacity growth of TE3 & PP3 yet. If this to include additional potential growth of 30%, expected EPS will be 26cents per Quarter. Assume market give LCT’s PE value of 12 (global petrochemical shortage of supply & high China demand – sound realistic), compare to PCHEM (PE = 17), LCT share price might worth of RM12.48 by 2018.

That’s a huge potential gain of 100% increase based on current share price RM6.20 range in reflect to current global petrochemical supply shortage and uprising demand in China as an overall macroeconomic big picture for next 6 to 9mths overview.

3. Since its listing IPO in 2017, LCT was projected with CAGR of 13.4% per annum for its EPS due to its new plant TE3 and PP3 capacity growth with utilization normalize maintain at >90%. However, due to unexpected incident disruption (ex: water supply, fire, DOE stop-order) and plant maintenance shutdown, it direct affect its FY17 expected earning profit growth. Even though in 2Q17 utilization drop to 56%, climb back to 77% in 3Q17, reach back to 86% in 4Q17 and still not meeting to 90% yet, credit should be given to the management for its corporate transparency, improving its utilization back to normalize stage, thus improve its EPS from 10.42 cent to 16.64 cent with good dividend earning payout ratio of 50% of 23cent with good macro-economic scale trend benefit of tighten supply shortage and those non-China export petrochemical companies.

The Chinese government by Mar’18 recently further strengthen and clamped down on the production of petrochemical & chemical products to comply with pollution policy laws. This has caused a big disruption in petrochemical supply as majority Chinese petrochemical factories and chemical manufacturers are required to shut down to upgrade their facilities or to relocate themselves away from major cities. Because of this, non-China export petrochemical companies are expected to win market share from petrochemical products. Plus, LCT’s mgmt. also stated that China’s recent remediation environment will affect the market supply, some non-China export orientated chemical products can be benefit from it, bring a significant positive effect to overall global supply market.

I believe with normalized plant utilization back to >90%, increase ASP price to cater for global supply shortage and China tight environment rule policy, this definitely will improve overall petrochemical industry. This once a life-time opportunity good macro-economic trend will definitely benefit overall petrochemical industry especially for LCT, since it undervalued vs it peer competitor PCHEM and has new 30% additional production capacity growth in FY18.  

4. As stated in AGM, LCT’s mgmt. with confidence believe its margins earning spread will remain largely unaffected by the rising crude oil price, support on the back of favourable supply-demand dynamics in the petrochemical industry. As long as there is demand coupled with a limited supply, margin will be maintained or better. They also hinted that currently there is limited supply capacity, and there are no new plants coming on stream until 2019, thus this give LCT a big advantage due to new capacity output rise from TE3 & PP3 plants of 30% capacity growth. LCT also added they forecast crude oil to be hover between average US$50 to US$70 per barrel this year, which fine for petrochemical industry since demand been there for their products. With current demand, they believe market can absorb any price increased in LCT’s polymer prices.

As long as there is shortage of supply and uprise demand, margin spread for LCT’s profit will be secured and maintain. I believe crude oil will be ease back between US$60 to US$70 range for this year as more US shale oil rig are opening now, quickier-than-expected rise in shale oil output, caused increase in crude oil inventories to market in matter of time.

5. LCT paid a dividend per share of 23.0 cents in 2017, 50% net earnings-payout dividend ratio, convert to immediate 4% dividend payout, ex-date on 16^th May 18. For FY18, the management stated for 2018 dividend payout will be based on company earnings measure performance to determine as if to maintain payout of 50% dividend policy or not. I strongly believe if their whole FY18 net profit earning is good, they will continue practise with this dividend payout ratio, excepted 40% to 50% range, follow same as their competitor PCHEM dividend payout ratio to be on-par with market expectation.

6. LCT mgmt. also stated their products sell in Indonesia and Malaysia currency enjoy slight price premium advantage over international price $USD. So, they are looking to duplicate Malaysian facilities in Indonesia, and increasing it capacity as well. A strong local Ringgit or Rupiah vs USD currency is net-net beneficial to LCT as its raw material supply buy in with USD$ dollar. Malaysia and Indonesia are LCT’s principal markets, accounting ~70% of its revenue as at end FY17, balance is contributed by China, Indian subcontinent, and other Southeast Asian countries at 10% each.   

I believe FY18 upcoming plant TE3 & PP3 additional total output orders will be majority buy-in by China in coming months due to supply shortage with better ASP margin prices. I do ask for LCT’s mgmt. as if there any backlog customer order outlook that cannot meet for 2Q18, need to push out to next month or not, similar to glove maker industry. Recurrent related transactions show sales of goods (namely polyethylene and polypropylene to LCC group) are fully for internal consumption. With current uprising customer order demand, whatever LCT’s products produce will be fully consumed internally by Malaysia & Indonesia’s Lotte subsidiaries group in Korea, China & Indonesia for own-self consumption and trading only. That’s mean there is a huge global supply shortage of end-product in market, unable to support outside market demand at all. This eventually will raise up the ASP product prices for limited supply shortage.

7. Other shareholders asked how will LCT’s mgmt. going to compliance and deal with additional ~1% (hold 76% ownership) of public shareholding spread (currently LCT not meeting Securities Commission (SEC) listing requirement that a listed issuer mist ensure at least 25% of its total shares must be hands of public shareholders, expired on July 24th). Rests assured, replied from LCT’s mgmt. they will NOT sell their ~1% share below IPO price of RM6.50, confidence wait for the right price to sell or ask further extension dateline from SEC. So, in near to short term there will be no major corporate share sell-out below IPO price.

8. To date, LCT has completed plant TE3, commercial operated on Dec’17 and its PP3 project, currently 91% completed, expected to start commencing by June’18, full commissioning expected in 2H18. LCT’s LCUSA plant (40% share JV partnership) in Louisana, USA still work in progress, on schedule commercial operation by July, 2H19. Meanwhile, the group are making final investment decision on its new mega-plan on its Integrated Petrochemical facilities in Indonesia by year-end or early next year 2019 assessment after feasibility studies completed. Once decision is made, construction work will commence, build a naphtha cracker with expected capacity output production of 1,000,000 tonnes of ethylene products. However, this mega project, estimated to cost between US$3.0 billion to US$4.0 billion to build, expected to be finish build by 2023 (5years long term plan), which still in assessment stage. In term of capacity, LCT’s mgmt. stated currently LCT is ranked as number fourth in Asean, as if after mega project Indonesia factory decided to commence and complete by 2023, its production capacity will be the biggest petrochemical in Asean by then. 

Happy Investing!