• We initiate coverage on Luxchem Corporation (Luxchem) with a BUY recommendation and a fair value of RM2.74/share. Our fair value is pegged to 15x FY18F FD EPS. The fair value implies an upside of 31% while dividend yield is decent at 4%.
• The PE multiple represents the median of the industrials sector. Luxchem's local competitors, CCM and Samchem, are trading at a TTM PE of 21x and 15x respectively. Its foreign peers, Synthomer and Eternal Materials are both trading at 15x.

• Luxchem is a supplier of industrial chemicals that operates in two segments: (1) trading and distribution of petrochemicals and other products related to rubber, latex, fibreglass reinforced plastics (FRP), coating, ceramic and polyvinyl chloride (PVC) industries; and (2) manufacturing of unsaturated polyester resins (UPRs) and various specialty chemicals for the latex industry.

• We forecast Luxchem's PATAMI to grow from RM43mil in FY16 to RM58mil in FY19F, representing a 3-year CAGR of 10%. This is premised on: i) rising glove demand underpinned by stricter hygiene standards, which would boost sales of latex-related products; ii) good visibility from the PVC segment given the steady growth of intermediate inputs in the construction industry; and iii) capacity expansions in the group's manufacturing arms, LPI (+33%) and TMSB (+25%).

• Luxchem has a diversified clientele comprising close to 1,000 customers. Its large customer base mitigates the concern of supplier switching and excessive reliance on clients' performance. In FY16, there was no single customer that contributed more than 10% of the group's revenue.

• Currently, the group is striving to grow its export markets, especially the higher-growth regions like Indonesia and Vietnam. Management's effort is already coming to fruition, evinced by a CAGR of 19% in its export revenue from FY13 to FY16, outpacing the growth of its domestic sales (7% CAGR).

• As of 31 March 2017, Luxchem was in a net cash position of RM15mil, which represents 4% of its total assets. Luxchem has consistently generated sufficient/excess cash flow from operations (CFO) to finance its cash flow from investing (CFI). The company's sound financial standing coupled with its cash generative business further support our BUY conviction.

BUY WITH 31% UPSIDE AND 4% DIVIDEND YIELD

We initiate coverage on Luxchem Corporation (Luxchem) with a BUY recommendation and a fair value of RM2.74/share. Our fair value is pegged to 15xFY18F FD EPS. The fair value implies an upside of 31% while dividend yield is decent at 4%.

The PE multiple represents the median of the industrials sector. Luxchem's local competitors, CCM and Samchem, are trading at a TTM PE of 21x and15x respectively. Its foreign peers Synthomer and Eternal Materials are both trading at 15x.

We forecast Luxchem's PATAMI to grow from RM43mil in FY16 to RM58mil in FY19F, representing a 3-year CAGR of 10%. This is premised on: i) rising glove demand underpinned by stricter hygiene standards, which would boost sales of latex-related products; ii) good visibility from the PVC segment given the steady growth of intermediate inputs in the construction industry; and iii) capacity expansions in the group's manufacturing arms, LPI (+33%) and TMSB (+25%).

BUSINESS BACKGROUND

Luxchem is a supplier of industrial chemicals that operates in two segments: (1) trading and distribution of petrochemicals and other products related to rubber, latex, fibreglass reinforced plastics (FRP), coating, ceramic and polyvinyl chloride (PVC) industries; and (2) manufacturing of unsaturated polyester resins (UPRs) and various specialty chemicals for the latex industry.

Luxchem's supplies the alpha and omega of industrial chemicals with over 1,000 types of different products (including different grades of one type of chemical). Luxchem's products have wide-ranging end-applications including for gloves, tyres, FRP wall panels, water pipes/hoses and more. The most notable endapplication/user of the company's products lies in the glove industry with 30% of its sales being related to glove production.

Luxchem's products are exported to more than 10 countries. Currently, exports contribute about 30% of Luxchem's sales while the remainder is generated from the local market.

Recently, Luxchem acquired the entire stake in Transform Master (TMSB), a company that manufactures specialty chemicals. The horizontal integration creates even bigger export opportunities for the company, expanding its existing portfolios of both customers and products.

CLIENTELE

Luxchem has a diversified clientele comprising close to 1,000 customers. Its large customer base mitigates the concern of supplier switching and excessive reliance on clients' performance. In FY16, there was no single customer that contributed more than 10% of the group's revenue.

The company's notable customers include locally listed glove companies such as Kossan, Top Glove, Supermax and Hartalega as well as other rubber product manufacturers like Superlon and Wellcall.

FORECASTS AND VALUATIONS

• Earnings to enjoy 10% CAGR from FY16-FY19F

All factors considered, we forecast Luxchem's PATAMI to grow from RM43mil in FY16 to RM58mil in FY19F, representing a 3-year CAGR of 10%. This is premised on:

i) rising glove demand underpinned by stricter hygiene standards, which would boost sales of latex-related products;

ii)good visibility from the PVC segment given the steady growth of intermediate inputs in the construction industry; and

iii) capacity expansions in the group's manufacturing arms, LPI (+33%) and TMSB (+25%).

• FV of RM2.74/share based on 15x FY18F FD EPS

We value the company at RM2.74/share, based on15x FY18F FD EPS. The fair value implies an upside of 31% while dividend yield is decent at 4%.

The PE multiple represents the median of the industrials sector. Luxchem's local competitors, CCM and Samchem, are trading at a TTM PE of 21x and 15x respectively. Its foreign peers, Synthomer and Eternal Materials are both trading at 15x

KEY RISKS

• Depreciation of USD hurts margins

Luxchem's exports are primarily denominated in USD. This means that about 30% of its total revenue is exposed to fluctuation in USD.

On the other hand, the group's purchases of raw materials are settled in the domestic currency of the originating country. We understand that 30% of raw materials are sourced locally, while 15% are sourced from Japan, 10% from China and the balance from other countries such as South Korea. As such, there is no natural hedge for its USD sales, which predisposes the company to currency risk.

Management said that the company does not practise any hedging policy currently. Based on our sensitivity analysis, a 5% appreciation/depreciation in USD against MYR would increase/decrease the group's net profit by 25%, assuming no hedge.

• Stiffer competition

We believe the rising competition locally was partially the cause of the drop in FY16 domestic revenue. In FY16, the local market sales dropped circa 3% YoY, but was cushioned by a 16% growth in exports and the 8-month contribution from TMSB.

Nonetheless, we note that the company has close to 1,000 customers with which it has established good relationship. This allows the company to reap stable revenue streams from its diversified customer base and reduce the risk of supplier switching

Source: AmInvest Research - 14 Jul 2017