Tough for LC Corp to find buyer for LC Titan

TA Research's Ong says that it will be difficult to find a buyer as the petrochemical industry is still plagued by oversupply and poor product spreads.

IT is no secret that South Korean chemical company Lotte Chemical Corp (LC Corp) is mulling disposing of its stakes in loss-making Malaysian unit, Lotte Chemical Titan Holding Bhd (LC Titan).

Selling its stakes in LC Titan is among the options for LC Corp as it has been dragged by the Main Market-listed petrochemicals producer, which posted its seventh consecutive quarterly loss for the quarter ended Dec 31, 2023 (4Q23) mainly due to volatile feedstock costs and slowing demand.

The RM186.48mil net loss was, however, narrower than its RM333.64mil net loss from a year earlier, amid lower feedstock costs and foreign-exchange gains.

Full-year net loss widened to RM780.29mil from RM731.06mil in financial year 2022 (FY22), as revenue declined 23.68% to RM7.65bil from RM10.19bil mainly due to a decline in margin and share of loss from Lotte Chemical USA Corp.

Most analysts anticipate LC Titan’s core net losses could further widen in subsequent quarters, especially 1Q24, which is likely to be heavily loss-making.

“LC Titan has been making cash losses (negative gross margins) since 3Q22.

“Hence, cutting back sales in 4Q23 has the effect of capitalising production costs in the balance sheet as inventory, which will be expensed into the profit and loss as cost of sales only when the inventory is actually sold in future quarters,” CIMB Securities Research points out.

As such, it didn’t come as a surprise when the Korea Economic Daily reported that LC Corp had initiated the process of selling its shareholding in LC Titan. On March 7, LC Titan told Bursa Malaysia that LC Corp is considering various “strategic measures” related to the company.

An LC Titan spokesperson tells StarBizWeek, “No decisions have been made thus far. We will immediately notify the market once we receive updates from LC Corp.”

But finding the right buyer will be challenging, given the current operating environment.

TA Research analyst Ong Tze Hern says that it will be difficult to find a buyer as the petrochemical industry is still plagued by oversupply and poor product spreads currently.

“Considering that LC Titan is a naphtha-based producer, which in general has higher cost than gas-based producers, I expect the potential buyer to be an integrated petroleum company with upstream involvement to lower the feedstock costs,” he says.

Given the current circumstances, what kind of valuations can LC Corp command?

Ong says since LC Titan is making losses even at gross level at this juncture, the acquisition price would likely be valued using a discount to net book value.

“LC Titan was taken private in 2010 at a total value of US$1.25bil (RM4bil using the average exchange rate in 2010) before being listed at RM6.50 per share or RM14.8bil valuation (2.5 times more than the acquisition price) in 2017.

“Currently, the net book value is at RM5.05 per share or RM11.5bil. It is difficult to determine what multiple of book value will LC Corp be asking for, but I expect it to be between 0.6 times and 0.9 times price to book value (RM3 to RM4.50 per share).

“The final transaction price, if any, would likely be at the lower end of the range or even lower than the range if LC Corp is desperate to exit,” Ong adds.

What is also weighing on LC Titan is its rising debt and falling cash levels.

According to CIMB Securities Research, the company’s net gearing level is expected to rise to 96% at end-FY24, 119% at end-FY25 and 140% at end-FY26.

In FY23, its net gearing was 35% versus a net cash position as at end-FY22.

The research house notes that LC Titan’s debt rose to RM5.9bil as at end FY23, with RM407mil of short-term working capital funding for its existing operations.

For potential buyers, they will also need to take into account the possibility of cash losses upon commencement of commercial operations of LC Titan new plants, targeted for the second half of next year.

As it is, the company’s debts swelled after taking a US$2.4bil long-term debt to fund the Lotte Chemical Indonesia New Ethylene (Line) project, which involves building a new naphtha cracker and new downstream plants in Java, Indonesia.

LC Titan holds a 51% stake in PT Lotte Chemical Indonesia, which is the owner of the Line project, while LC Corp, which is the guarantor of the loan facility, holds the remaining 49%.

CIMB Securities Research says the Line project financing may reach RM11bil in total, and interest costs will hit the profit and loss only upon the start of commercial operations.

To make matters worse, it may have to borrow more to fund its operations, given its cash balances have decreased 42% year-on-year to RM761mil as at end FY23, due to losses from its existing operations.

Given the above twin factors, LC Corp may be willing to let go its Malaysian operations at a huge discount unless it chooses to defer operations of its new plants until market conditions improve.

The project will raise LC Titan’s production capacity by 65%, is set to complete by 2025 and help it capture the market in Indonesia, currently a petrochemical products net importer.

FY24 will continue to be a tough year for LC Titan on the back of soft macro climate for downstream petrochemical products, coupled with elevated naphtha prices and its parent company will need to opt for desperate measures to cut its losses.