Chemicals
The author is an analyst for Shinhan Securities. He can be reached at jinmyung.lee93@shinhan.com -- Ed.
Chemical sector at the crossroads of survival
The petrochemical sector is cyclical in nature, where profits generated during an up- cycle are invested during a down-cycle to prepare for the next boom cycle. Capacity additions carried out during a down-cycle may help to defend profits, but the resulting increase in earnings volatility can cause profits to fall at an accelerated pace.
On a global scale, China accounts for 42% of polymer consumption and 47% of downstream production. The country’s continuing efforts to increase its self-sufficiency in chemicals are weighing heavily on Korea's China-dependent chemical exports. In response, Korea's large-size chemical companies have made massive investments for portfolio diversification. Small/mid-sized firms finding it relatively difficult to invest into new businesses have been seeking a breakthrough with the improvement in global competitiveness of existing products and expansion of specialty products.
2H23 outlook: Expectations outweigh concerns, but pace of recovery to be slow
Following the easing of China’s COVID-19 lockdowns, chemical stocks have been rallying on expectations for a recovery in demand from 2H22 record lows. Inventory restocking demand after the Lunar New Year holiday drove improvement in chemical prices and spreads across the board. Strong economic data out of China further added to upbeat expectations for the recovery of the economy. However, concerns over market conditions were rekindled as China’s macro indicators (manufacturing PMI, etc.) fell in 2Q23 from sluggish recovery in demand and high inventory burden.
Nonetheless, we expect improvement in China demand, the key driver of market recovery, to gather pace toward 2H23 as reopening effects and stimulus measures start to make visible progress. With reopening effects expected to benefit services/consumer staples sectors first, followed by investment/real estate before spreading to consumer discretionary (durable goods, etc.) sectors, improvement in chemical market conditions and earnings should start in earnest from 2H instead of 1H this year. With key conditions (recovery of China demand, decline in cost burden, etc.) met for a rebound, we believe market directionality will continue upward, rather than downward, going forward.
Focus on small but strong companies
Domestic companies are likely to see limited benefits from the expected improvement in market conditions in 2H23, given China’s high self-sufficiency in chemical products. However, we hold an upbeat outlook on companies with a stronghold in the global market for products that are largely consumed by China, or those supplying products with high margins and growth potential.
Among domestic companies, we recommend focusing on the small but strong players. Hyosung TNC, in spandex, and Kukdo Chemical, in epoxy, are global leaders in their respective markets that largely cater to demand coming from China. Hyosung Advanced Materials is the global leader in tire cords, and secures high margins and growth potential from carbon fiber. Kolon Industries is the world’s second largest supplier of tire cords, and is expected to strengthen its standing as the third largest producer of aramid fiber through capacity additions.