Why most Fund Manager & Analyst predict high demand for petrochemical in 1Q18 & beyond 2018

 (source: KE Maybank, date 12th Mar, 2018) - summarise version

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Both PCHEM and LCTITAN had a good 4Q17, which was expected. Both management teams guide that market demand is strong coupled with tight supply in the near term. Furthermore, higher crude oil is pushing for higher petrochemical price. To surmise, we can expect a strong upcoming 1Q18. Stay invested, as both PCHEM and LCTITAN are pushing maximum factory utilization and the results could potentially surprise positively in 1Q18.l

LCTITAN product volumes should improve materially in 2018 as all of its plants are on-line with NO major scheduled shutdowns.

Management guides that production volumes have improved to historical levels as they able to ramp-up production rates smoothly post the turnaround of their naptha crackers. Expected 2018 utilisation rate to be at >90% levels (2017: 73%)  and this will boost strong volume growth on a YoY basis. This will mitigate some of the impact of higher naptha cost, thus improve cost-efficiency output production. 

1Q18 is looking exceptionally strong because:

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1) Many petrochemical producers in the Middle East are undergoing prolonged shutdowns, hence cause tightening global supply;

2) China producers were stocking-up ahead of CNY;

3) China government's air pollution curb has lead to the closure of many local producers that utilize older technology, thus forcing subsitution via imports.

Prices of all the major petrochemicals have thus far risen in 2018 and the latest Global PMI is in firm growth territory. The petrochemicals sector is currently in a sweet spot. Strong industry demand and tight supply are fueling healthy margins.

China is throwing a curveball at the industry

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The Chinese government has implemented several regulations that have significantly impacted its manufacturing sector, and also the demand-supply balance for raw materials globally.

a) China accelerates polluction campaign:

In Sep 2017, China government launched a five-month campaign in 28 northern cities to improve air quality during the winter months. In additional 72 coal-fired electricity plants were closed, along with 44,000 small coal-fired furnaces. The message from government was that it will only tolerate modern technologies that comply with high emission standards. As a result, many production facilities have closed temporarily in order to upgrade their infrastructure whilst others have closed down permanently.

b) China bans recycled plastics:

China had banned the importation of scrap plastic and recycled polyethylene effective 1 Jan 2018. This had taken the global petrochemical industry by surprise as many had doubted China's genuineness to do so, as waste plastic imports is a major raw material for many of its industries. In 2016, China imported 7.3million tonnes of waste plastic which makes up 56% of world imports. All this scrap plastic exclusion will likely be replaced with virgin supply, thus suggesting basic petrochemical price will stay firm.

Valuation:

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1) LCTITAN is Malaysia's largest integrated polyolefin manufacturer and ASEAN's fourth largest; Indonesia's largest polyethylene manufacturer.

2) Ambitious wiht realistic expnasion plans to grow its nameplate capacity by 73% in the next 5 years plan growth (long term) via a combination of Greenfield & Brownfield projects.

3) Signifcant barriers to entry for potential competitors due to regulatory hurdles, capital intensity and technological know-how.

4) On of the lowest cost naphta based petrochemical producers in the world, cost-efficient manufacturer by estimate

5) Global PMI firmly in expansion and tight supply demand dynamic product spreads.

Potential Risk or Downside:

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1) Sudden collapse in petrochemical spreads or extreme volatilty may adverse impact on earnings.

2) Unscheduled factory shutdown, affect utilization rate & product volumes.

3) Naptha prices rises much faster compare to rise in petrochemical prices.

Consensus: LCTITAN set to 'BUY', cheapest ASEAN based petrochemical

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At current share price RM6.45, LCTITAN is still the cheapest ASEAN petrochemicals based on EV/EBITDA and P/BV measures. Coupled with respectable dividend yields, we advocate accumulating LCTITAN shares. LCTITAN has proposed a final 23sen DPS for 2017 (49% divident-earning ratio) which translated into an immediate 4% yield.