This article first appeared in The Edge Malaysia Weekly on November 30, 2020 - December 6, 2020

THE share prices of Lotte Chemical Titan Holdings Bhd (LCT) and its peer Petronas Chemicals Group Bhd (PetChem) have risen 40.6% and 24.5% respectively since their lows in August, thanks to better product prices over the past few months.

This is because the petrochemical industry has been experiencing supply disruptions from the US as a result of Hurricane Laura, as well as strong demand for polyethylene and polypropylene, which are used in the manufacturing of a host of things, including face masks, personal protective equipment and packaging materials.

Still, analysts have cautioned that incoming supply may outweigh demand.

LCT is Malaysia’s largest integrated producer of olefins and polyolefins, consisting of polypropylene and polyethylene products. Its products are sold to plastic fabricators and trading houses locally and around the world.

In an email interview with The Edge, LCT president and CEO Dr Lee Dong Woo concedes that industry oversupply will persist in the short to medium term, resulting in some pressure on average selling prices (ASPs). Over the longer term, the overcapacity concern could be offset by overall demand growth, supported by a growing population and economic expansion.

He sees continued improvement in the business outlook in 4Q2020, after the reopening of regional economies, especially with the strong recovery in China.

“Our business is closely tied to regional and domestic economic growth, as it is essential to the key manufacturing sector,” says Lee.

He adds that the petrochemical sector’s outlook is also dependent on how US president-elect Joe Biden’s administration manages its relationship with China, after the industry was hit by trade disputes between the two superpowers.

Domestically, LCT’s rivalry with PetChem may intensify in view of rising capacity from the latter’s Refinery and Petrochemical Integrated Development (RAPID) in Pengerang, Johor.

Lee is unfazed, however, saying Malaysia remains a net importer of petrochemicals and that the new supply from PetChem will replace domestic imports.

“Currently, we have some pricing premium for our products, owing to the value-added services LCT provides to its customers.”

While the new supply may erode some of the pricing premium, he stresses that LCT’s market is not confined to the country, but it also exports to Indonesia, China and other Southeast Asian markets.

Malaysia, Indonesia and other Southeast Asian markets contribute 70% to the company’s revenue, while Northeast Asia and other parts of the world contribute the remainder.

LCT operates an integrated petrochemical complex comprising 12 plants in Pasir Gudang and Tanjung Langsat, Johor. In Indonesia, three non-integrated downstream polyethylene plants are in operation.

As naphtha is its feedstock, LCT’s profitability relies on the polymer-naphtha spread trend. Naphtha feedstock prices are highly correlated to crude oil prices. Note that Brent prices have been gaining momentum lately, reaching above US$48 a barrel last week.

In an Oct 28 note, KAF expects the polymer-naphtha spread to sustain at US$550 to US$600 a tonne in the second half of this year, owing to sustaining polyolefin prices of close to US$1,000 a tonne. Naphtha prices are projected to remain subdued at US$350 to US$450 a tonne.

“We expect sustained ASPs in the short term, similar to that observed in 3Q2020 amid further reopening of regional markets as well as post-pandemic recovery, with more vaccines [developed],” says Lee.

During the Movement Control Order (MCO) period, LCT saw lower demand from the industrial plastics segment such as automotive and electrical and electronics, but this was partially mitigated by higher demand from the commercial and disposable food packaging and medical equipment segments.

“Our sales in the domestic market were notably affected during the full MCO in April and May. However, we were able to divert our local sales to the regional markets such as China,” he explains.

LCT’s operating rate was lower in the first half of 2020, owing to the major statutory plant turnaround (shutdown to perform maintenance, repair or overhaul operations), but it is on track to meet the full-year operating capacity target of 80% to 85%.

On average, its budgeted capex for annual routine maintenance is RM200 million to RM300 million.

The pandemic has affected LCT’s expansion, particularly its 51%-owned Indonesia Lotte Chemical Indonesia New Ethylene (LINE) project, which is now under strategic review. The other 49% of the project is held by its South Korea-based parent Lotte Chemical Corp.

The US$4.4 billion (RM18 billion) project is crucial in LCT’s becoming the top-tier petrochemical firm in Southeast Asia, with US$6 billion in revenue by 2024, from US$2 billion in 2019.

The initial arrangement was to commence project construction at end-2020 or early 2021, according to Lee.The capital mix for the project comprises 40% equity and 60% debt.

“We aim for the project to be completed in time to ride the next petrochemical cycle uptrend to maximise our return on investment in the project,” he says.

To enhance its footing in the regional market, LCT is exploring opportunities to develop and expand value-accretive as well as synergistic businesses.

In its financials for the third quarter ended Sept 30, 2020, LCT reported a 13.7% fall in net profit to RM78.77 million from RM91.3 million a year ago, owing to lower revenue, higher share of associate losses and higher operating cost of RM15.9 million resulting from Hurricane Laura.

In an Oct 30 note, Maybank IB Research says it expects LCT to post stronger q-o-q earnings in 4Q, as Lotte Chemical USA Corp plants have fully resumed operations since mid-October after Hurricane Laura, coupled with a higher polymer spread of US$650 a tonne in October against US$589 a tonne in 3Q.

“Though the spread may remain firm in November/December, it could soften in 2021 on new supply from Malaysia’s RAPID as well as China,” the research house says.

LCT has been in a net-cash position since its relisting in July 2017, with RM3.97 billion recorded as at end-September 2020.

However, its share price has more than halved against its initial public offering price of RM6.50, on the back of declining profits in the past years caused by high feedstock costs and low product prices.

The stock closed at RM2.47 last Thursday, valuing it at RM5.7 billion.

Titan Chemical Corp Bhd was taken private in 2011, a year after Lotte Chemical Corp, an affiliate of South Korean retail giant Lotte Group, bought into it.

LCT’s IPO in 2017 received tepid response from investors, prompting it to cut the IPO price by one-fifth to RM6.50, from RM8. The number of shares was also reduced to 580 million, from 740.48 million, owing to the cut in the institutional offering.

Within a month of its listing, LCT shocked investors when it announced a 47.2% q-o-q drop in its 2QFY2017 earnings before interest, taxes, depreciation and amortisation (Ebitda), owing mainly to water disruption at its Johor-based petrochemical plant. Compared with a year ago, 2QFY2017 Ebitda was down 58.1%.

The water shortages occurred in April, before the IPO, but LCT said the full impact was not known until mid-July — after the listing.

It later caught the market by surprise when its net profit slumped 97% to RM10.13 million in the last quarter of 2018 from RM378.15 million a year earlier, owing to margin squeeze.

Its share price had been on a downtrend after it fell below RM4 in April 2019. During the recent market crash in March, the counter even hit an all-time low of 93.7 sen. Year to date, it has rebounded 2.5%.

As LCT is tightly controlled by Lotte Chemical Corp, which has a 76.03% stake, its public shareholding spread of 23.97% falls short of the minimum spread requirement of 25%.

LCT has embarked on a dividend reinvestment scheme to address the shortfall, but this is subject to its ability to declare dividends. It paid a 7 sen dividend in 2019 after a 17 sen payout in 2018.

Lee says LCT has been distributing half of its profit after tax since its relisting in 2017. Its 12-month trailing dividend yield stands at 2.85%.

“It is the board’s intention to continue with the dividend payout subject to the company’s financial performance,” he says.

According to Bloomberg, LCT has two “buy”, five “hold” and two “sell” calls on it, with a consensus target price of RM3.11.

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