The recent recovery in glove makers’ prospects appear to have some trickle-down effects on previously out-of-favour chemical company LUXCHEM, which derives half of its business from the glove sector. Going forward, we see the potential for the company to benefit from more sector-specific catalysts in the near term, including: (i) the upcoming Lotte Chemicals mega IPO on Bursa, (ii) a full-year contribution from the TMSB acquisition (end-April), as well as (iii) fresh plans to expand its manufacturing capacity at both its Malacca and Perak plants by year-end, which would boost overall production capacity by 30%. We forecast LUXCHEM’s FY17E/ FY18E earnings to grow by 14.2%/ 11.7%, and ascribe a Trading Buy with a TP of RM2.30 based on FY18E EPS of 19.9 sen.

LUXCHEM is an industrial chemical supplier which focuses on four major industries – rubber, latex (gloves), fiberglass reinforced plastic and polyvinyl chloride. As at FY16, business segments are divided into Trading (79.6%) and Manufacturing (20.4%). The Malaysian market accounts for 70.6% of revenue, and export markets accounting for the balance.

Impressive start to FY17. LUXCHEM reported 1Q17 revenue of RM218.1m (+36.4% YoY), driven by higher demand from the trading segment in addition to the contribution from Transform Master Sdn Bhd (TMSB) acquisition (RM45.5m) which was not previously reflected in the 1Q16 numbers. We believe that the increased demand stem from Indonesia and Vietnam on follow-through growth from the previous strong financial year. Coupled with a 36.5% reduction in administrative expenses, NP margins expanded by 1.86ppt to 6.24% (1Q16: 4.38%). Consequently, net profits jumped to RM13.6m (+94.4%).

Focus shifting to regional growth markets. Post the capacity expansion at its Malacca plant from 20k MT to 30k MT (2014) and acquisition of TMSB (in 2016), LUXCHEM’s manufacturing capacity is now operating close to full capacity. Although management has indicated that the domestic market has become saturated, we understand that its focus has now shifted towards high-growth export markets such as Indonesia and Vietnam, which already collectively account for 23.9% of its revenue base (FY16). Of note, revenue from the Indonesian market increased by 35.7% while the Vietnamese market grew by a still more impressive 23.2%, respectively in FY16.

Back in expansion mode. Plans are already in place to expand capacity by 33% for unsaturated polyester resins (UPR) at the Malacca plant from 30k MT p.a. to 40k MT p.a. by this year end. Concurrently, the company also intends to boost annual capacity at the TMSB Perak plant from 9.6k MT to 12.0k (+25%) MT p.a. for the production of chemical dispersion items. Taking the previous bout of expansion in 2014 as a guide, we believe that LUXCHEM could potentially fill its new capacities within a 1-2 year timeframe with the effects of increased capacity filtering down to earnings as early as 1Q18.

Trading Buy with RM2.30 Fair Value. We forecast FY17E/FY18E earnings of RM49.7m/RM55.4m (EPS of 17.8 sen/19.9 sen), driven by: (i) increased revenue from the trading segment, (ii) further ramp up in manufacturing capacity and after inputting new capacities in 1Q18, and (iii) slight 2bps/36bps expansion (8.40%/8.76%) in EBIT margins on higher operational efficiency and economies of scale. We believe LUXCHEM should trade at a PER of at least on par with the FBMSC Index of 11.6x, which comes to a target price of RM2.30 based on FY18 EPS of 19.9 sen. Risks to call include (i) inability to pass through increase costs of raw materials, (ii) increase in competition, and (iii) delays in production ramp-up

Source: Kenanga Research - 15 Jun 2017