Investment Highlights

• Lotte Chemical Titan Holdings Bhd (LCT) started off as a polypropylene producer in August 1991. Since then, the group has grown into an integrated chemical producer of polyolefins and olefins. As of 2016, LCT commands a 53.0% share of the country’s polyethylene production capacity and is the sole polypropylene producer in Malaysia. The group is also ranked as the fourth largest producer of polyolefin products in Southeast Asia by production capacity in 2016.

• LCT core products include the production of: (i) polyolefins, comprising of polyethylene and (ii) polypropylene, comprising of ethylene, propylene and other derivatives. Todate, the group operates 14 plants in Malaysia and Indonesia, employing approximately 1,419 employees.

• In order to expand its current production, the bulk of its IPO proceeds (RM5.77 bln or 97.4%) will be spent on setting up additional three plants. LCT also does not discount the possibility of merger and acquisitions, if opportunity arises, to expand its presence– backed the group’s sturdy balance sheet with a net cash position of RM965.0 mln as of 31st December 2016.

• Having reported a net loss of RM19.2 mln in 2014, the group’s bottom line mounted a quick turnaround, raking in RM613.2 mln and RM1.32 bln in net profits in 2015 and 2016 respectively. Revenue, however, declined at an average rate of -2.8% per annum over the past three years (2014-2016) to RM8.14 bln. At an indicative offer price of RM8.00 per share, LCT trades at a 2016 PER of 15.0x, a slight discount vs. its regional peers at 15.8x, thereby implying a slight share price upside potential.

Group Background

Lotte Chemical Titan Holding Bhd (LCT) was incorporated on 3rd August 1991 as Flexiscope (M) Sdn Bhd – a polypropylene producer and subsequently grown into an integrated petrochemical manufacturer that was listed on the Main Market of Bursa Malaysia as Titan Chemicals Corporation Bhd on 23rd December 2005. The group was then privatised and de-listed by South Korean conglomerate, Lotte Chemical Corporation in 2011. Following the privatisation, LCT ramped up their production capacity and diversified their product portfolio through the commissioning of the new Tertiary Butyl Alcohol (TBA) plant in Pasir Gudang, Johor as well as embarking on the construction of a TE3 project and a PP3 plant in 2015 and 2017 respectively. The TE3 plant, which is situated at Indonesia, is expected to be completed in 2017 and commence commercial production in 2H2018. LCT’s production volume have been ramped up to 2,703 KTA (thousand metric tonnes per annum), from 2,398 KTA in 2009. The group’s brands include TITANEX, TITANZEX, TITANPRO and TITANVENE. Based on LCT’s production capacity of 2,703 KTA in 2016, the group was ranked as the 4th largest polyolefin products producer in Southeast Asia with 42.0% capacity share in Malaysia and 29.0% capacity share in Indonesia. On the local front, LCT commands 53.0% capacity share in polyethylene production and 100.0% capacity production in polypropylene in Malaysia.

Business Model And Future Plans

LCT, as an integrated petrochemical producer, produces two principal product categories: (i) polyolefins - comprising of polyethylene and polypropylene, and (ii) olefins - comprising of ethylene, propylene and other derivatives such as butadiene, TBA benzene and toluene. A total of RM6.48 bln, or 79.6% of its revenue in 2016 was derived from the polyolefin products segment, while the remainder came from olefins and derivatives products (RM1.66 bln or 20.4%).

LCT’s products are divided into two segments:

(i) Polyolefins

The polyolefin products segment, which is the main contributor to LCT’s revenue over the past three years, accounts to RM6.48 bln, or 79.7% of the group’s total revenue in 2016. The aforementioned segment’s average selling prices (ASP) fell 1.4% Y.o.Y to RM4,880 per tonne in 2016 due to decline in feedstock prices which was in tandem with the general decline in international prices. LCT operates eight plants that produce a wide range of polyolefin products with a combined capacity of 1,015 KTA of polyethylene and 440 KTA of polypropylene products.

Polyethylene The contribution of polyethylene constitutes between 34.0%-36.0% to the group’s total revenue over the past three years. Polyethylene is the world’s most widely-consumed thermoplastic by volume. LCT produces three types of polyethylene namely; (i) HDPE, (ii) LDPE and (iii) LLDPE. Polypropylene The contribution of polypropylene amounts to between 22.0%-24.0% of the group’s total revenue over the past three years. Presently, LCT is the sole polypropylene producer in Malaysia and LCT plants are able to manufacture 28 grades of polypropylene comprising of 12 polypropylene homopolymer and 16 grades of polypropylene random and impact copolymer.

(ii) Olefins and derivatives

The olefins and derivatives products segment accounts to RM1.66 bln, or 20.4% of the group’s total revenue in 2016. The aforementioned segment’s ASP improved 1.5% Y.o.Y to RM2,452 per tonne in 2016, lifted by the increase in ASP of butadiene, coupled with the weaker Ringgit against the US Dollar.

As of 2016, the top ten customers of LCT collectively constitute approximately 23.0%, or RM1.87 bln, of its total revenue. The group has also established a long-term business relationship with its clienteles, spanning over 10 years. Meanwhile, the group’s two largest suppliers – Abu Dhabi National Oil Company (ADNOC) and Itochu Petroleum Co. (Singapore) Pte. Ltd. (Itochu) makes up to RM1.07 bln and RM804.0 mln, representing 17.4% and 13.1% of its total input cost in 2016. Going forward, LCT aims to focus increase its production capacity through three new production plants: (i) Integrated Petrochemical Facility. LCT aims to increase their production of polyethylene with the construction of a new manufacturing plant at Merak, Indonesia. Upon completion and commercial operation in 2023, the plant is expected to supply up to 1,000 KTA of ethylene as well as olefins and derivatives. A total of RM4.93 bln or 83.2% of its IPO proceeds will be allocated to fund the abovementioned project. (ii) TE3 Project. LCT has commenced construction of the TE3 Project in 2015. The TE3 projects revolve around the construction of K-COT catalytic cracking reactor that will be attached to the existing NC2 Plant in Pasir Gudang, Johor. The cracker reactor converts heavy feedstock blends into higher olefins product and can maximise the ethylene and propylene production by using existing recycled products. Upon completion in 2H2017, the production capacities of ethylene, propylene and BTX will increase by 93 KTA, 170 KTA and 134 KTA respectively. The estimated total cost of investment is RM1.48 bln, of which RM1.26 bln was already funded while the remainder RM220.0 mln will be funded via its IPO proceeds. (iii) PP3 Project. The PP3 Project commenced in March 2017 involves the construction of new polypropylene production plant. Upon completion in 2H2018, the production capacity of polypropylene is expected to increase by 200 KTA. The total cost of investment amounts to RM620.0 mln and will be fully funded by its IPO proceeds.

Industry Outlook

According to an independent assessment of the petrochemicals industry, the demand for olefins is projected to grow at a CAGR of 3.7% over the next 10-years (2017-2027) to approximately 218.5 mln tonnes. Meanwhile, global demand for polyethylene is expected to increase at a CAGR of 3.9% over the next 10-years to approximately 138.2 mln tonnes. Demand for the above products will be driven by the packaging, automotive, building and construction industries. The petrochemical industry’s margins are subject to cyclicality changes, while the volatility of crude oil prices impacts the production cost and selling prices of various petrochemical products. Crude oil prices have been rangebound between US$40-US$60 per barrel as the measures to trim production by both OPEC and Non-OPEC members were offset by the higher U.S. shale oil production. On the local front, LCT and Petronas Chemicals Group Bhd (PCG) are the two major petrochemical producers. LCT primarily focuses on production of olefins and polyolefins via an integrated naphtha based cracker facility, whilst PCG produces a wide range of petrochemical products including olefins, polyolefins, methanol, ammonia, urea, aromatics and other derivatives.

Based on Malaysia’s 2016 total industry capacity of 3.0 mln tonnes, LCT’s capacity of 1.19 bln tonnes amounts to a 42.0% market share, slightly lower than the national oil company – Petronas. Moving forward, the Refinery and Petrochemical Integrated Development (RAPID) will increase olefins capacity by another 2.0 mln tonnes per annum as well as other downstream derivatives in the value chain of ethylene and propylene in 2020. LCT aims to increase its olefins capacity - ethylene (92,000 tonnes per annum) and propylene (170,000 tonnes per annum) in 2H2017.

Financial Performance And Valuation

Historically, the bulk of the group’s revenue was contributed from the polyolefin products, while the remainder was contributed by olefins and derivative products.

Over the past three years, the bulk of its revenue – slightly below 80.0% of its total revenue was contributed by the polyolefin product. In 2016, its gross profit gained 50.2% Y.o.Y to RM1.98 bln, owing to the decline in feedstock cost and other materials. Meanwhile, the group’s 2016 pretax profit increased 62.8% Y.o.Y to RM1.71 bln, in line with the improvement in gross profit. The group has registered a flattish topline over the past two years at RM8.14 bln. However, its bottom line jumped 114.5% Y.o.Y to RM1.32 bln over the same period, supported by weaker Ringgit against the U.S. Dollar, declining raw material prices and lower effective tax rate at 23.0% in 2016 vs. 41.5% in 2015. In the meantime, the group

has been maintaining a healthy balance sheet with a net cash position over the past three years. At an IPO offer price of RM8.00, LCT’s PER valuation stands at 15.0x, based on 2016 EPS of 53.3 sen and is slightly below its regional peers valuation that is trading at an average PER of 15.8x. This leaves LCT’s valuation at a slight discount, but we think upsides might be limited upon its listing due to its stagnating topline. LCT also adopts a dividend policy of 50.0% pay-out ratio from its future net profit.

Key Management

Tan Sri Dato’ Abdul Rahman bin Mamat is the Independent Non-Executive Chairman of Lotte Chemical Titan Holding Bhd. He was the Assistant Director in MITI, having served several positions over the past 35 years before retiring in December 2010. He holds a Bachelor of Economics (Honours) from University Malaya in 1975 and obtained an Advanced Management Programme qualification from Harvard Business School, Boston, United States in 2004. He also sits on the board of directors of several public listed companies in Malaysia, namely Hiap Teck Venture Bhd, Bioalpha Holdings Bhd, Dagang NeXchange Bhd and Parkson Holdings Bhd. Lee Dong Woo is the Non-Independent Executive Director, President and Chief Executive Officer of LCT. He began his career as a researcher in the Manufacturing Research Office with Honam Petrochemical Corp (now known as Lotte Chemical Corporation) and has over 28 years of experience in the petrochemical industry. He obtained his Doctorate in Polymer Engineering from Chungnam National University, Korea in 2013.

Lee Kwan Ho is the Non-Independent Executive Director of LCT and Vice President of Olefins and Derivatives Business. He joined LCC as Leader of Feedstock Team in 2012 and has amassed over 28 years of experience in the petrochemical industry. He holds a Bachelor degree in Law from Yonsei University, Korea in 1989. Cho Seongtaeg is the Non-Independent Non-Executive Director of LCT. He is responsible for overseeing finance related matters such as finance reporting, analysis, budgeting, corporate finance and treasury function. He has approximately 27 years of experience in the petrochemical industry and holds a Bachelor of Business Administration from Chosun University, Korea in 1989.

Source: Mplus Research - 21 Jun 2017