Higher profit: lotte Chemical plant in pasir Gudang, Johor. Maybank iB research has raised the company
KUALA LUMPUR: Lotte Chemical Titan’s (LCT) core net profit for the first quarter ended March 31, 2019 (Q1 FY19) was only 6% of CIMB Equities Research’s old full-year estimate (4% of consensus) due to compressed spreads, and higher depreciation and taxes.
The research house had on Tuesday cut its earnings forecasts and target price to RM3.69 as a result of the Q1 underperformance, based on unchanged CY20F enterprise value/earnings before interest, tax, depreciation and amortization (EV/Ebitda) of four times.
“We downgrade from Add to Hold; spreads in April are even weaker than in Q1 FY19 due to the naphtha price rally, putting Q2, FY19F earnings at risk,” it said.
LCT delivered core net profit of only RM33mil in Q1 FY19, down 86% on-year on the back of on-year declines in average selling prices (ASP) which more than outweighed the drop in naphtha prices.
In addition, depreciation costs rose 31% on-year due to the commissioning of the PP3 polypropylene plant in Pasir Gudang from Sept 1, 2018, and because turnaround costs are now being depreciated over a shorter period.
Effective tax rate rose significantly as reinvestment allowances in relation to the PP3 capex were fully used up in FY18.
On a quarter-on-quarter basis, 1Q19’s EBIT rose a mere 13% vs. 4Q18 despite a 6% pt increase in plant utilisation, as product spreads continued to decline on-quarter.
The higher effective tax rate caused 1Q19’s core net profit to decline from 4Q18.
CIMB Research said in the past, the accepted wisdom was that naphtha prices fell in conjunction with crude oil prices, and that petrochemical product prices would follow suit with a one to two months lag, leading to margin expansion.
However, despite Q1 FY19 average naphtha prices falling 8.5% on-quarter, product spreads generally declined, with HDPE-naphtha spreads falling 8.7% on-quarter, PP-naphtha spreads falling 6.1% on-quarter, and benzene-naphtha spreads down 66% on-quarter.
“This saw the continuation of the weakness seen during 4Q18, and was the result of poor demand from Chinese factories, and the diversion of US polyolefin exports to Southeast Asia from their traditional market in China due to the imposition of 25% import tariffs by China when the US-China trade war broke out.
“From February 2019 onwards, oil prices have staged a rebound, and naphtha prices have followed. While spot product prices have crept up, the increase has not been enough to keep up with rising naphtha prices, hence spot product spreads have declined in Apr from Q1 FY19 averages.
“While LCT is partially protected by lagging naphtha inventory costs, 2Q19F earnings are unlikely to be strong. If such conditions continue for the rest of 2Q19F and into 2H19F, our earnings estimates are at risk.
“We view the global oversupply of ethylene-based petrochemicals (from US-based capacity additions) and heightened competition from Petronas Chemicals’s Pengerang plants (which may start up in 2020F) as the key downside risks.
“The key upside risks could arise from a potential resolution of the US-China trade war and the dismantling of Chinese tariffs on US polyolefin exports, and stronger-than-expected contribution from LCT’s 40%-owned US ethane cracker and MEG plant from 2H19F onwards,” CIMB Research said.
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