· A one-stop industrial chemical supplier, Luxchem Corp Bhd (LUXCHEM) focused on industrial chemicals for synthetic rubber and rubber chemicals, unsaturated polyester resins (URP), fiberglass materials and polymer-related products. It started in 1984 as a sole proprietorship and later established its own manufacturing arm in 1998 focusing only in URP, which is mainly for fiberglass reinforced plastic (FRP). It has a 40% market share in the local URP market. Meanwhile, its revenue segment can be segregated into four divisions equally divided into: (i) rubber, (ii) latex, (iii) coating, and (iv) FRP. This also means that half of the group’s revenues are derived from the rubber glove industry.

· A substantial jump in earnings this year. LUXCHEM has been consistently registering RM20m-RM22m net profit annually for the past five years. However, this changed this year with the 1H15 net profit of RM11.4m or RM20.1m if a RM8.7m share option expense was excluded, which mean FY15 earnings could be doubled. This is largely due to the capacity expansion at its manufacturing plant in Melaka to 30,000 MT from 20,000 MT in May last year after adding a new reactor with capex of RM2.5m. This new capacity has since been reflected in its earnings beginning of this year. As such, LUXCHEM could post RM9m- RM10m a quarter as opposed to RM4m-RM5m previously.

· Strong USD is good indirectly, for now. Overall, 70%-80% of raw materials are purchased in USD while c.30% of sales is priced in USD. A stronger USD against MYR does not impact significantly at core earnings level given that any changes in cost is pass-down to customer eventually. However, the significant gain on forex is in the form of noncash forex translation gain/loss. The 1H15 other operating income of RM4.0m was mainly forex gains. Thus, the weak MYR which was at c.4.39/USD in end-Sep vs. c.3.77/USD in end-Jun implies that LUXCHEM could record a substantial forex gain in 3Q15. Nonetheless, this currency effect is a double-edged sword when MYR appreciates against the USD.

· A resilient play for its defensive earnings. Nearly half of its earnings are derived from the defensive rubber glove industry, based on rubber and latex segments. As it is a one-stop centre, all the rubber glove makers are customers of LUXCHEM, which is able to supply a full range of additives and chemicals. On the other hand, we see potential of capacity expansion for its manufacturing segment by adding additional reactor as and when demand arises while the capex for expansion is relatively low as it invested only RM2.5m for the new reactor. Moreover, profit margin for the manufacturing division is higher at 6%-10% at PAT level as opposed to 3%-6% for the trading segment, which could help to improve bottom-line. Based on current capacity, we project FY15E/FY16E earnings to grow at 30%/38% annually.

· Trading Buy at RM1.85. LUXCHEM has bucked the sluggish general market trend and performed fairly well with its share price rising 88% YTD. We believe there is still upside in this defensive play given its steady earnings growth coupled with above average yield of 4%-5%. The dividend yield is based on 50% payout, which is in line with the company’s unofficial dividend payout policy. In addition, LUXCHEM has a healthy set of balance sheet with RM86.8m cash or RM26.1m net cash. Based on FBMSC index valuation of 12.5x, LUXCHEM is fairly valued at RM1.85 per share based on FY16E earnings. This warrants a Trading Buy recommendation.

Source: Kenanga Research - 8 Oct 2015