• The wave of new capacities in the US, leveraging on shale gas, and expectation of slower global economic growth has affected ASP and taken a toll on product spreads. The commercial operation of RAPID would also reduce LCT’s product premium.

• We estimate that for US$50/mt drop in spread, LCT would lose c.RM400m in profits. Given the market down-cycle, we lower our 2019-21F earnings forecasts by 42-83% which culminates to -38% CAGR over 2018-2021F.

• We believe the risk-to-reward ratio is not compelling at current level. Downgrade to TRADING SELL (from BUY) with a new TP of RM2.90 (from RM7.25) which values the stock at 12x 2019F PE.

• Risks to our call include: i) US-China reaching a trade deal and boost global economy; ii) higher profit contribution from US associate; and iii) better-than-expected plant utilization.

Falling deeper into market down-cycle

The wave of new petrochemical supply in the US, leveraging on shale gas (Table 1), coupled with the expectation of slower GDP growth in the wake of the US-China trade tension drove the industry deeper into the market down-cycle. The slowing demand led to lower ASP while naphtha costs has risen in tandem with crude oil prices. These narrowed naphtha-PE spread which now at c.US$560/mt (Chart 1), from US$600/mt (-8%) in 4Q18 and US$685/mt (-18%) in 2018.

Narrower product premium ahead of new local capacity

In the past, LCT’s products command c.US$80-100/mt premium to the benchmark price (Chart 3). However, we expect the premium to narrow going forward with the onset of PChem’s RAPID complex coming on stream in 2H2019.

Challenging earnings outlook

We reduce our FY19-21F earnings forecast by 42-83% (Table 5) on lower product spread assumption (Table 2). Against our base case, we estimate profits to erode by c.RM400m for a US$50/mt contraction in spread. That is despite new earnings stream from US shale gas project and full-year contribution from the 200k MTPA PP3 plant. Our revised forecasts imply earnings to decline at -38% CAGR over 2018-2021F.

Downgrade to TRADING SELL with new TP RM2.90

We downgrade the stock to TRADING SELL (from BUY) with a new TP of RM2.90 (from RM7.25). This is arrived based on GGM methodology which implies a fair EV/ROIC multiple of 0.3x (Table 6). We think valuations appears lofty while risk-to-reward ratio is not compelling at current level. Key risks to our call are: i) improving economic outlook should US-China reach a trade deal; ii) higher profit from the US associate; and iii) better-than-expected plant utilisation.

Source: BIMB Securities Research - 26 Mar 2019