Operating Earnings Likely to Return to a Profit in 3Q22
The author is an analyst of Shinhan Investment Corp. He can be reached at yjjung86@shinhan.com. -- Ed.
Valuations down to global lows with losses continuing on high costs
Nexen Tire shares have gained 20.6% since the beginning of September, driven by expectations for a return to profit after three quarters of losses. The company's shares had been trading lower on reports of massive quarterly losses, with supply chain disruptions that started last year leading to a hike in costs. Operating margins, which averaged 10% in 2011-2020, plunged into negative territory at -4.1% in 4Q21, -8.1% in 1Q22, and -3.6% in 2Q22. Unable to secure steady earnings typical of the industry, Nexen Tire has seen its share valuations drop to global lows at a 2023F PBR of 0.5x vs. the global peer average of 0.9x and domestic peer average of 0.8x.
2H22 outlook: 1) Upturn in North America sales; 2) decline in costs
Nexen Tire’s 2Q22 results offered a glimpse of hope for improvement in earnings. The company secured 31% of its total sales in North America at a record high of KRW204.5bn (+48% YoY), with both ASP and shipments improving as sales channels recovered from the impact of anti-dumping duties imposed on tire imports into the US. However, losses continued in 2Q22 despite solid sales, with the increased portion of logistics costs (20.5% of total costs) weighing heavily on company-wide profitability.
In 2H22, we expect downward stabilization of major costs to add to the boost from recovering sales channels in the US. With the Shanghai Containerized Freight Index (SCFI) down 19% since the start of September, logistics costs are projected to decline by 30-40% QoQ in 3Q22. Moreover, the price of key raw material natural rubber fell further by 8% in September after reaching a peak in 2Q22. All in all, we believe operating earnings will return to a profit of KRW10.8bn (+736% YoY) in 3Q22.
Retain BUY and raise target price to KRW10,000
We retain BUY on Nexen Tire and raise our target price to KRW10,000, based on a 2023F PBR of 0.62x. The company's ROE is expected to average 6.9% in 2023-2024. Our target price is based on the conservative PBR valuation model in reflection of concerns over the economic conditions in European countries, which accounted for 33% of the company’s sales in 2Q22. We believe further share price upside will hinge on demand in Europe in 2H22.