Sector Top Picks: LG Chem, SKC, Hanwha Solutions
The authors are analysts of Shinhan Investment Corp. They can be reached at jinmyung.lee93@shinhan.com and cgh815@shinhan.com, respectively. -- Ed.
Chemicals outperform the market on China demand recovery expectations
Chemical companies under our coverage recorded an average one-month return of 3%, outperforming the KOSPI that fell 7%. Market conditions remained sluggish with oil prices high, demand weak, and supply on an uptrend. However, the combined price spread of chemical products jumped by 8% in June on growing expectations for an upturn in demand with China emerging from lockdown and announcing fiscal stimulus measures. Strong performances were posted by LG Chem, SKC and Hanwha Solutions, with non-chemical businesses adding a boost to growth in addition to chemicals.
Upbeat outlook intact for 2H22 market conditions but concerns remain
In 1H22, chemical market conditions were hit hard by rising costs, weak demand, and increasing supply. As a result, share valuations of pure-play chemical producer Lotte Chemical dropped to historical lows at a PBR of 0.4x. Despite growing fears over global recession and inflation, expectations are still high for a rebound in market conditions in 2H22 backed by fiscal stimulus measures in China, the largest consumer of chemicals in the world. In addition, naphtha cracking centers (NCCs) are seeing improvement in relative cost competitiveness, with naphtha prices dropping 11% from the 2Q22 peak despite high oil prices. Meanwhile, the cost competitiveness of ethane cracking centers (ECCs) weakened as ethane prices soared 51% from 2Q22 bottom levels.
Yet, concerns continue to linger over high oil prices and rising chemicals supply led by China. We see limited downside in share prices and price spreads in the near term, but believe it will take some time for market conditions to start recovering in earnest. Given mixed expectations and concerns over market conditions, we recommend focusing on sure bets instead of uncertain investments.
Chemical sector top picks are LG Chem, SKC and Hanwha Solutions; Hyosung Chemical is a stock of interest
Our sector top picks are LG Chem (cathode materials), SKC (copper foil), and Hanwha Solutions (photovoltaics). Stronger earnings from specialty chemicals (caustic soda, PG, POE, etc.) will likely offset relatively weaker earnings from basic petrochemicals, and the brighter growth potential of non-chemical businesses should add a boost to the share performance of diversified companies vs. pure-play chemical producers.
Hyosung Chemical is a stock of interest with the resumption of plant operations in Vietnam and decline in propane prices (12% MoM drop seen in Saudi Aramco's June contract price), both major catalysts for the stock, expected to drive steep earnings growth in 2H22.