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Company background

Established in 1991, Lotte Chemical Titan (LCTitan) is proud to be Malaysia’s first standalone producer of polyolefins and Malaysia’s largest integrated producer of olefins and polyolefins, and one of the largest polyolefin’s producers in Southeast Asia after acquisition of PT Lotte Chemical Titan Nusantara, Indonesia’s largest polyethylene plant. Their products are supply to many manufacturers of the following products including healthcare products such as face shields, sanitizer bottles, masks, gloves and syringes. Other products include fertilisers (a range of nitrogen, phosphate, and compound fertilisers) and methanol.

Investment thesis

Riding the upcycle in commodities as a result of demand recovery

The operating margins in the petrochemical has historically been cyclical affected by change in supply and demand affecting utilisation rates which are key factors to profitability. The demand and supply balance may favour one position for an extended period of time and may not rebalanced quickly as described below.

Sustained margin amid continued tight supply and demand recovery

JP Morgan Chase & Co expects LCTitan to post strong earnings in 2Q21 though it anticipates some normalisation into 2H21 after recovery of supply disruption as a result of the Uri storm. The investment bank expects spreads to remain healthy into 2H21 and 2022 as it forecasts FY22 polyethylene (PE) and polypropylene (PP) spreads to be between US$600 and US$675 per tonne versus US$710 and US$850 per tonne range currently. This can be seen in a larger magnitude of increase in the ASP of plastic resins when compared to price of naphtha, the main raw material used.

Rising ASP of fertilizer may also contribute to the profit of LCTitan as shown in the chart below.

Increasingly higher plant utilisation rate

The average plant utilisation rate was higher at 88% in 1Q21 compared to 66% in the corresponding period which was attributable to the plant’s major statutory turnaround activities that commenced in March 2020.

Major trend in growth

An upsurge in demand for polyolefins in the renewable energy sector namely the solar power industry and parts of battery casing is propelling the polyolefins market growth. The rapid increase in demand from the packaging industry in a variety of applications, including geomembranes, plastic films, and bags is expected to drive the growth of polyolefins market size. Additionally, the rapid expansion of the consumer base, such as aerospace and automobiles, in developing countries such as India and China. The product is also increasingly used in the construction sector for its application as roof membranes.

Expansion plan

LCtitan strategic expansion initiative to develop an Integrated Petrochemical Facility (“IPF”) known as the LOTTE Chemical Indonesia New Ethylene Project or the LINE Project. The RM18 billion joint venture will develop a 1 million tonne per year naphtha cracker and other related downstream facilities in Merak, Cilegon, Banten Province, Indonesia. The LINE Project is expected to be completed in 2023.

LCtitan believes that the LINE Project is an attractive business proposition due to Indonesia’s dependency on petrochemical imports from other Southeast Asia countries because of its insufficient domestic production. The country is also expected to remain a large net importer of polyolefins and the domestic plastic demand gap is expected to further widen following the rising population and healthy consumption growth.

Financials

FY21-FY22 could be see a potential recovery in earnings for LCTitan from the impact of Covid-19, with some normalisation of ASP in the 2H21. Moving forward, I am bullish on the back of improving margin and cheap valuation when compared to PChem.

Annual

Quarter

LCTitan has reported posted strong earning for 1Q21 which matched the FY19 net profits.

Reasonable balance sheet and rising net tangible asset (NTA)

LCtitan has a net cash position of RM 4.7 bil and NTA of RM 5.48. However, it is expected that the capex on its joint-venture greenfield cracker in Indonesia would drain LCTitan cash position in the coming years. It was initially guided by the management at US$4.4 billion over three years and LCTitan 51% portion would be RM9 billion. Hence, Maybank IB raised Lotte Chemical’s FY22 and FY23 capex to RM2 billion and RM2.5 billion respectively.

Valuation

JP Morgan Chase & Co expects LCTitan to post strong earnings in 2Q21 though it anticipates some normalisation into 2H21. The investment bank expects spreads to remain healthy into 2H21 and 2022 and upgraded their December 2022 TP to RM5.50 from RM4.

As it is difficult to ascertain the impact of capex on their cash flow, using historical record, discounted cash flow valuation method gives LCTitan a fair value of RM 4.26 – RM4.52. The valuation of LCTitan is also considered as cheap vs PChem (EV/EBITD of 1.57 vs 11.3)

Key take away

LCtitan valuation can be considered as dirt-cheap when compared to PChem. At current price of RM 3.10, the favourable risk-to-reward ratio to ride the commodities upcycle.

Risks

Covid-19

Pandemic-related lockdown imposed by the respective local governments may affect economic activities and growth although more developed countries are easing restriction due to greater vaccination activities.

Margin compression due to rising cost of raw materials

The naphtha feedstock or raw material price fluctuation may affect operation margin.

Change in supply and demand balance

Unfavourable shift in the balance could affect profitability as highlighted earlier.

Higher CAPEX for LINE project

Affecting cash position of LCTitan

What the price is saying?

Briefly, LCTitan share price has been on long term downtrend following IPO. Recent price movement suggests that LCTitan price is in an upward trajectory. Further details would require further discussion. Join our public telegram group for more idea sharing at https://t.me/theglimpsestocks

Disclaimer

The information contained in this article is based on data obtained from internet. However, the data and/or sources have not been independently verified and as such, no representation, express or implied, are made as to the accuracy, adequacy, completeness or reliability of the information.

Investors are advised to make their own independent evaluation of the information contained in this article and seek independent financial, legal or other advice regarding the appropriateness of investing in any equities discussed in this article. Under no circumstances should this article be considered as an offer to sell or a solicitation of any offer to buy any securities referred to herein.

Disclosure

I am long LCTitan. This article is written as an expression of personal opinions. I have no business relationship with any company mentioned in this article. Join our public telegram group for more idea sharing at https://t.me/theglimpsestocks

References

1. https://disclosure.bursamalaysia.com/FileAccess/apbursaweb/download?id=206558&name=EA_DS_ATTACHMENTS
2. https://www.lottechem.my/company/line-1.asp
3. https://fred.stlouisfed.org/series/PCU325211325211
4. https://themalaysianreserve.com/2021/05/04/lotte-chemicals-spread-to-sustain-in-2h21/
5. https://www.theedgemarkets.com/article/lotte-chemical-titan-expects-outlook-improve-strong-polymer-product-asps
6. https://www.marketwatch.com/press-release/polyolefin-market-2021-2024-worldwide-industry-growing-at-a-cagr-of-5-2021-05-16