Highlights

• Lotte Chemical Titan (LCT) is an integrated producer of olefin and polyolefin (raw material for plastic product manufacturing), operating in Malaysia and Indonesia, using oil-based naphtha as its feedstock. In addition, it also produces other derivative products including butadiene, TBA, benzene and toluene.

• Indonesia Integrated Petrochemical Facility. Out of the total IPO proceeds worth RM5.8bn, RM4.9bn would be spent on an integrated facility in Merak, Indonesia. It would be built next to its existing Indonesian plants and the new facility would be able to feed all of the existing facilities with ethylene (feedstock for polyethylene). Out of the 1000KTA new ethylene capacity, 450 KTA would be feed into existing facility (cost savings) and remaining 560KTA would be sold to 3 rd party. Earnings impact would only come in 2023.

• TE3 and PP3 project. TE3 project involves the extension on its current facilities in Malaysia and it would be completed in 2H17. PP3 (new propylene plant) will be completed in 2H18. Overall, the group’s capacity would be improved by 15-20% approximately depending on market conditions. That aside, current idling OCU plant (which produces propylene) would be ramped up to produce feedstock for PP3 plant.

• Product spread appears toppish. Post 2017, global polyolefin capacity surplus over demand is expected to widen further due to US shale-based capacity expansion and methanol-based China capacity additions. Nexant has forecasted cash margin (product spread) for petrochemicals in Asia to narrow in 2018 (lower petrochemical production profitability). Our argument is further supported by significant expected capacity addition in ASEAN by 2020, with PCHEM adding 1.4m MT polyolefin capacity while SCG would add another 1.4m MT.

Risks

• Cyclicality of product spreads resulting in highly volatile margins.

• Cost overrun on incoming expansion plan.

• Spike in oil price.

Earnings

• We expect core net profit CAGR of -4.8% over the period of 2017-2019. This is premised on the assumptions of (i) gradually lower revenue/MT (ii) narrowing EBITDA margin from 25.6% to 19.1% caused of lower expectation of product spread due to global capacity expansion and (iii) 7% growth in product volume (3-year CAGR) after factoring in TE3 and PP3 capacity. US shale gas JV earnings are not factored in.

Valuation

• We believe that LCT should be fairly priced at RM7.39 pegged to 12x FY18 PER. It is valued significantly lower than its Malaysian peer, PCHEM (NOT RATED), which is currently valued at 16x PER due to (i) smaller size compared to PCHEM (ii) higher volatility in product spread due to its naphtha-based feedstock (highly correlated to oil price) compared to PCHEM which uses ethane (gas-based feedstock) which is more stable and (iii) lower EBITDA margin.

Source: Hong Leong Investment Bank Research - 28 Jun 2017