Concerns Outweighed by Potential Upside Triggers
The authors are analysts of Shinhan Investment Corp. They can be reached at yjjung86@shinhan.com and ik.jung@shinhan.com, respectively. -- Ed.
Market focus shifts to 2H21 growth amid easing of negatives
The secondary battery sector was weighed down by several negatives in February-March, such as: 1) interest rate hikes; 2) automakers increasing efforts to make their own battery cells; 3) sluggish EV sales in Europe; 4) prolonged legal battle between LG Energy Solution and SK Innovation; 5) rising prices of metals used as raw materials; and 6) share price declines of EV makers led by Tesla.
In April, we are seeing an upturn in investor sentiment towards the secondary battery sector on dissipation of some negatives. Tesla shares hit bottom at end-March. LG Energy Solution and SK Innovation reached a settlement in their legal fight on April 12, helping to improve market sentiment towards domestic battery stocks. Concerns remain over possible disruption in EV production amid chip shortages and growing competition for form factor dominance, with some automakers recently switching to prismatic batteries. But we believe such concerns are outweighed by potential upside triggers.
1Q21 preview: Solid earnings across the sector
Contrary to market concerns raised at the start of the year, secondary battery companies are forecast to have recorded solid earnings in 1Q21. We now expect LG Chem and POSCO Chemical to deliver earnings surprises. In the past, both companies failed to draw investors’ attention even with strong earnings results, which were mostly driven by non-battery businesses such as petrochemicals and refractories. Earnings surprises for 1Q21, however, were likely propelled by margin gains in secondary batteries. LG Chem should have secured operating margin of 4.8% from secondary batteries, marking a 7.1%p YoY growth, on higher capacity utilization for cylindrical batteries and reduction in provisions related to mid/large-size batteries. POSCO Chemical likely saw increased profit contribution from the cathode materials division, which turned positive in 1Q21.
Ecopro BM should have met market expectations for operating profit growth of 90.5% YoY. Some shipments were deferred from last year to 1Q21 due to external issues (freight rate hikes, etc.). Iljin Materials likely secured solid earnings from subsidiary IMM Technology, the company’s key growth engine, on normalization of production. Sluggish earnings from other subsidiaries should have resulted in weaker-than-expected growth in overall operating profit (40.4% YoY).
Recommend materials stocks with client/market expansion potential in 1H21
In 1H21, we expect to see strong share price performance from secondary battery materials companies with the potential to add new clients (direct supply to automakers, etc.) and expand overseas. As in 2020, aggressive fund-raising and investment plans for client/market expansion could trigger a rally in shares. With SK IE Technology posting a high IPO subscription rate from institutional investors, the market will likely witness increasing investor preference for materials companies with a diversified clientele. We recommend Ecopro BM, L&F, and Chunbo as our top picks among materials stocks.
Long-term triggers for an upturn in investor sentiment towards battery cell companies include: 1) build-up of entry barriers in terms of production yield and price competitiveness through preemptive large-scale investments; 2) early adoption of next-generation battery technologies at commercially-applicable levels; and 3) improvement in technologies to physically increase battery energy density to compete on par with Chinese players’ cell-to-pack (CTP) batteries. In the near term, battery cell companies will need to secure massive orders from EV startups or EV-producing automakers to draw investors’ attention. We thus recommend focusing on LG Chem, which has received orders from multiple EV startups in North America.