• Maintain NEUTRAL, new TP of MYR0.65 (15.5x P/E on FY21 EPS of 4.2 sen), -9% expected total return. Our higher TP implies 15.5x P/E, +2.5SD from the 5-year average P/E. This is justified, in view of the liquidity in the market and Luxchem’s sturdy financial position, ie net cash balance sheet and positive cash flow. Within the chemicals space, Petronas Chemicals (PCHEM MK, SELLl, TP: MYR4.76) is trading at 23x of FY21 EPS, while smaller peer Samchem is valued at a historical P/E of 8.1x.

• 1Q20 core net profit of MYR10m in line. Looking ahead, the spike in demand from the rubber glove sector is not expected to fully mitigate the slowdown in economic activities. Also, increasingly competitive pricing may pressure Luxchem’s trading margins, as players unload their inventories. We cut FY20-22F earnings by 6-9%, but raise our TP to reflect the increase in market liquidity.

• Results generally in line. Luxchem’s revenue declined by 14% YoY to MYR174.5m on a lower contribution from the trading segment. Its blended PBT margin improved 114bps to 7.5%, the highest in 12 quarters – due to the significant jump in its manufacturing (1Q20 revenue: MYR31m) PBT margin to 29.5%, from the 18.3% in 1Q19. We understand that this was due to timing issues, as material prices rose, which benefited its inventories. Its trading segment’s (1Q20 revenue: MYR143m) PBT margin shrank to 2.5% (1Q19: 4.6%, 4Q19: 5.6%), primarily from losses incurred by its Indonesian trading subsidiary, which in turn was adversely affected by a steep IDR depreciation in the quarter. We expect both segments’ PBT margins to normalise in the coming quarters, as 1Q’s variance drivers are not sustainable. Other income of MYR4.1m (1Q19:769k) was due to a favourable USD/MYR movement.

• Earnings estimates revised down. We cut FY20-22 earnings estimates by 9%, 6% and 7% to reflect the slower demand growth, as the spike in demand from the glove sector is not enough to offset the weaker demand from other industries. Additionally, near-term margins could face some pressure as industry players are unloading their inventories which were procured at higher price levels (before oil prices fell sharply). We understand that the company has written down 670k of inventories in 1Q20 – this is not expected to happen again in 2Q20.

• Risks. Upside risks are a sharp V-shaped recovery in demand for its unsaturated polyester resin products, better-than-expected margins and further strengthening of the USD/MYR rate. Downside risks are a contraction in product margins and further depreciation of the IDR vs MYR.

Source: RHB Securities Research - 15 Jun 2020