Investment Highlights

• We reiterate our BUY recommendation on Luxchem Corporation (Luxchem) with a lower fair value of RM0.84/share (previously RM0.91/share), based on 15x FY19F FD EPS (rolled forward from FY18F). We have trimmed our FY18F-FY19F net profit forecasts by 13-17% on the account of stiffer competition in the unsaturated polyester resin (UPR) industry and the weaker USD vs. the MYR (USD/MYR).

• Luxchem's 1QFY18 core net profit came in slightly below expectations at RM9.9mil, representing a YoY decline of 25% but a QoQ improvement of 4%. The core net profit accounted for 18% of our full-year forecast and 19% of consensus estimate.

• The YoY decline in 1QFY18 net profit was mainly attributed to a 12% depreciation in the USD/MYR (3.9248 in 1QFY18 vs. 4.4464 in 1QFY17), along with a 4% YoY contraction in volume due to minor supply constraints in the latex industry. In addition, the group’s UPR manufacturing arm, Luxchem Polymer Industries (LPI), was operating at circa 88% capacity in 1QFY18, down from nearly 100% in 2017. Nevertheless, these negatives are partially offset by upward trending chemical prices, especially in the fiberglass reinforced plastics (FRP) and polyvinyl chloride (PVC) industries. Altogether, Luxchem registered a 10% YoY contraction in revenue.

• Going forward, management believes the UPR industry will become increasingly competitive with the entry of Eternal Materials – a prominent Taiwan-based chemical company. Eternal Materials’ new facility in Tanjung Langsat Industrial Complex, Johor is expected to commence manufacturing UPR and other synthetic resins by 2QCY18. This will pose a challenge for the group to fill up the new capacity at LPI, which became available in April, increasing UPR capacity from 30K MT/year to 40K MT/year. This segment typically contributes about 30% of the group’s turnover.

• On a brighter note, management has indicated that the demand for latex and other related chemicals remains sturdy on the back of an expansion spree in the glove industry. The segment, which also contributes circa 30% of the group’s turnover, is expected to be the main growth driver for FY18F.

• We continue to like Luxchem due to its: 1) exposures to industries with stable and commendable growth such as glove (latex) and construction (PVC); 2) good earnings visibility backed by large clientele (~1,000 customers) and wide applications of its chemical products; and 3) capacity expansions in the group's manufacturing arms, LPI (+33%) and TMSB (+44%).

• At this price, Luxchem appears undervalued with a CY18F PE of 11x vs. its peer average of 15x. Dividend yield remains attractive at ~4%, especially for a company with decent growth.

OTHER UPDATES

• Building sales teams to penetrate overseas market

The group is currently building a sales team in Vietnam to remodel its sales strategy to direct selling instead of going through distributors. This is expected to improve trading margins going forward and give Luxchem better control over its customers as well as its marketing process (distributors are unable to explain some product applications).

We are hopeful that the move would yield similar results to the group’s Indonesia segment. We highlight that the Indonesia segment, which contributes circa 12% of group revenue, grew sturdily by 41% in FY17. This comes after the group built a sales team in the country and introduced PVC products to the local customers. Luxchem plans to replicate the success with Vietnam.

Source: AmInvest Research - 2 May 2018