• We reiterate our BUY recommendation on Luxchem Corporation (Luxchem) with unchanged forecasts and fair value of RM2.74/share. Our fair value is pegged to 15x FY18F FD EPS.

• Luxchem recorded a net profit of RM8.7mil in 2QFY17, representing declines of 36% QoQ and 34% YoY. However, we consider the results within our forecast and the market expectations as the group's top-line result continued to register sturdy YoY growth of 16%, while profit margins were affected by temporary factors.

• During 4QFY16-1QFY17, there was a sudden spike in the price of butadiene (used in the production of nitrile latex) due to a temporary shortage in the market. The shortage was likely caused by production cuts/shutdowns in Hangzhou and Ningbo City to temporarily reduce air pollution and also an explosion at BASF's (largest chemical producer in the world) Ludwigshafen plant in Germany.

• However, butadiene prices (and hence nitrile latex) quickly normalised in 2QFY17, forcing the group to sell its old inventories at unfavourable prices. This has resulted in the decline in profit margins in 2QFY17, but the adverse impact was alleviated by the group's efficient inventory turnover of 0.8-1.2 months.

• Cumulatively, 1HFY17 net profit of RM22.3mil (+11% YoY) remains on track, accounting for 45%of our full-year forecast and 47% of consensus. In comparison, 1H net profits averaged 44% of full-year results in the past 5 years. We also highlight that 1HFY17 revenue already accounted for 52% of our full-year forecast. We expect earnings to catch up in the coming quarters as margins moderate after the group replenishes new inventories and reprice its products.

• We continue to like the company for:
  i) the stable growth prospects in its latex division from rising glove demand (8-10% p.a.), which is underpinned by stricter hygiene standards;
  ii) good earnings visibility in its PVC segment given the sturdy growth of intermediate inputs in the domestic construction industry (15% CAGR from 2011-2016); and
  iii) the capacity expansions in its wholly-owned Luxchem Polymer Industries (+33%) and Transform Master (+25%).

Source: AmInvest Research - 27 Jul 2017