The author is an analyst of Shinhan Investment Corp. He can be reached at email@example.com. -- Ed.
Initiate coverage with BUY and target price of KRW210,000
We initiate our coverage of Lotte Chemical with BUY rating for a target price of KRW210,000. Shares are currently trading at a PBR of 0.42x based on 2020F BPS, falling under the average PBR low of 0.64x recorded during the market downturn of 2013-2015. Oversupply and sluggish recovery of demand should continue to weigh on earnings this year. However, longer-term growth potential secured through aggressive capacity additions, feedstock diversification, and M&As should lead to stronger operating leverage during the upturn in market conditions.
Longer-term growth potential secured from aggressive capacity expansion, JVs, and feedstock diversification
Lotte Chemical's financials remain solid at a net debt ratio of -3%. With its longer-term growth potential strengthened with aggressive capacity additions, we believe share valuations will return to normal once market conditions start to improve. Lotte Chemical USA’s operating profit margin stood high at 24.8% in 2019 and is expected to rise 0.9% YoY to 25.7% in 2020 on the decline in ethane prices. Increased cost competitiveness of naphtha cracking centers (NCCs) on plunging oil prices is a major concern for ethane cracking centers (ECCs). To prepare for future growth, Lotte Chemical has expanded downstream products by expanding into new specialty products through M&As and joint ventures with domestic refiners. A drop in naphtha prices from lower oil prices should help to strengthen the cost competitiveness of NCCs. Ethylene production cost for NCCs should fall to that for ECCs if Brent Crude prices are sustained at USD30/bbl.
2020 OP forecast at KRW428.3bn (-61% YoY)
Lotte Chemical is expected to post operating profit of KRW38.1bn (-73% QoQ) for 1Q20. By division, operating profit should come in at KRW17.4bn (-85% QoQ) from olefin operations, KRW37.7bn (+4% QoQ) from advanced materials, and KRW25.5bn (-22% QoQ) from Lotte Chemical USA. Meanwhile, aromatics and Lotte Chemical Titan are likely to record operating losses of KRW18.6bn (RR QoQ) and KRW13.2bn (RR QoQ), respectively. A notable QoQ drop in olefin earnings is attributable to an explosion at Lotte Chemical’s Daesan NCC and a slump in naphtha prices. Operating loss from aromatics should increase due to continuing supply glut and slowing demand caused by COVID-19. The advanced materials division is projected to see earnings improve slightly thanks to its larger share of high value-added compound products.
For 2020, we forecast operating profit at KRW428.3bn (-61% YoY). Olefin operating profit is expected to reach KRW227.6bn (-69% YoY), advanced materials KRW173.7bn (-4% YoY), and the US unit KRW112.3bn (+46% YoY). Aromatics and Lotte Chemical Titan should each incur operating losses of KRW26.4bn (negative swing YoY, -KRW113bn YoY) and KRW8.9bn (negative swing YoY, -KRW73.9bn). Company-wide operating profit is projected to rebound from 2020 bottom to KRW724.3bn (+69% YoY) in 2021.