Analysis

Analysis of the IPO of Lotte Chemical Titan Bhd

Dear Readers

Seeking to raise a massive RM5.3 billion, Lotte Chemical Titan Bhd’s (“LCT“) initial public offering (“IPO“) is said to be the largest IPO in Malaysia since August 2012 and the largest in Southeast Asia since May 2013.

An IPO is one of the many avenue which a company, seeking to raise funds, offers a portion or all of its shares to be purchased by the general public. The general public then become part-owners of the newly listed company.

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Introduction of the initial public offering

About 30% of LCT, or approximately 740.5 million shares, will be offered for subscription at a retail price of RM8.00 (subject to final retail price which then depends on the demand for the IPO).

Of the 740.5 million shares, 684 million shares will be set aside for institutional investors. Cornerstone investors which will take the plunge are said to be Permodalan Nasional Bhd, Maybank Asset Management Sdn Bhd, Maybank Islamic Asset Management Sdn Bhd and Eastspring Investment Bhd and Great Eastern Life Insurance (Malaysia) Bhd. They represent 18.4% of the would-be-floated shares or 136 million shares.

The general public can only subscribe to an allocated 48 million shares (24 million to bumiputeras and 24 million to non-bumiputeras), via balloting.

The controlling stake of LCT will remain with South Korea’s Lotte Chemical Corp (“LCC“) (70%) which is part of the Lotte group, a South Korean conglomerate, well-known for its confectioneries.

Introduction of the business

LCT is for all intents and purposes, a petrochemical company. It manufactures principally two types of products:

  1. polyolefins, comprising of polyethylene and polypropylene; and
  2. olefins, comprising of ethylene and its derivatives such as butadiene, tetra-n-butylammonium (“TBA”), benzene and toluena
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LCT’s Pasir Gudang Plant

Polyolefins are used as building-blocks in an extensive range of consumer and industrial products such as packaging films, trash bags, automotive parts, plastic bottles, caps, compound for wires and cable insulation. LCT supplies their products to plastic fabricators in the packaging, household, automotive and construction industries.

On the other hand, olefins are feedstocks in the production of polyolefins products. To put simply, olefins are used as raw materials to make polyolefins products.

In FY2016, product sales of polyolefins contributed 80% of LCT’s revenue. Polyolefins, as they are higher up the value chain, contribute to a higher gross profit than olefins.

In 2016, LCT is the fourth biggest producer of polyolefin in Southeast Asia with regard to production capacity.

LCT’s products are sold domestically and overseas. In FY2016, LCT’s customers are located in 60 countries such as Indonesia (28.5%), Southeast Asia (9.7%), China (11.3%), Indian sub-continent, South Korea, Oceania and Europe (collectively about 11.8%). In the same financial year, the domestic market contributed to roughly 38.7% of LCT’s revenue.

Pasir Gudang and Tanjung Langsat are where LCT concentrates its operations. They are 12 kilometres apart and there is an underground pipeline which delivers feedstocks from Pasir Gudang to Tanjung Langsat.

Risk

As a petrochemical company, LCT’s earnings are affected by the volatility of crude oil prices. The major component in the production of LCT’s products is naphtha and it constitutes a majority of LCT’s cost of goods. The price of naphtha correlates with crude oil prices. Therefore, a significant volatility in crude oil prices may affect the costs of procurement of naphtha thus putting pressure on LCT’s profit margin. This is because the sale price of LCT’s finished products may lag behind the price increase of the procurement of naphtha.

In addition, an environment of high crude oil prices would translated to lower operating margins as the cost of higher crude oil prices may not necessarily be passed on to LCT’s customers. Demand and quality of products are amongst other factors which influence the sale price of LCT’s finished products.

In an industry where price competitiveness is the major selling point, I would expect profit margin to be squeezed when competition amongst petrochemical manufacturers intensifies. The main competitors to LCT include Petronas Chemicals Group Bhd (“Pet Chem“) and PT Chanda Asri (Indonesia). Consideration however must be accorded to the fact that once Pet Chem has completed the RAPID project in Pengerang, Johor, the market competitiveness may intensify. The effect of the RAPID project is may be more pronounced with regard to LCT as the RAPID project is relatively close, in distance, to LCT’s plants in Pasir Gudang and Tangjung Langsat.

Also, the supply and demand of petrochemical products are dependent on market conditions.

Other noteworthy risk is currency fluctuation in particular RM/USD as raw materials such as naphtha are purchased in USD. Overseas transaction for the sale of LCT’s finished products are USD-denominated.

Objectives of the IPO

The main objective of the IPO is to finance capital expenditure to increase production capacity. Most of the funds raised in the IPO will be channeled to finance an integrated petrochemical facility located in Indonesia. The said facility will cost an estimated RM15 billion. The facility, once operational in 2023, will be used to boost production of olefins (feedstocks for the production of polyethylene). A total of  RM4.9 billion from the fund raised from the IPO will be poured into this project. The remaining balance of RM10.1 billion will be funded through borrowings.

Other projects (designated as TE3 Project and PP3 Project) being funded by proceeds from the IPO are enhancement of existing operations in Pasir Gudang. Those projects seek to boost production efficiency and capacity of polypropylene and olefins. Interestingly, the PP3 Project will utilise technology from LCT’s controlling shareholder, LCC. Commercial operation of PP3 is expected to commence in the second-half of 2018.

Financials
LCT profit and loss
LCT’s audited income statement from FY2014 – FY2016 taken from LCT’s Prospectus.

A glance of the above financial statement indicates that, in the last 3 financial years, LCT’s revenue may appear to be under pressure. However, the gradual decrease of LCT’s revenue is not attributed to lower sales volume of its products. In fact, sales volume has increased. The effect of low crude oil prices means that the selling price of LCT’s products are reduced thus affecting revenue.

On the flip side, gross profit and net profit increased tremendously despite lacklustre revenue between FY2014 and FY2016. Again, low crude oil prices contributed to an increased profit margin and earnings. In fact, EPS doubled from 35 cents, in FY2015, to 76 cents, in FY2016.

Untitled
Cash Flow Statement

 

Untitled 2
Balance Sheet – Part 1
Untitled 3
Balance Sheet – Part 2

The overall cash flow is healthy. LCT experienced better cash flow generated from its operating activities in FY2015 and FY2016 thanks to an environment of low crude oil prices. In FY2016, the company was investing heavily to boost efficiency and production. On top of that, a negative cash flow in financing activities, in FY2015 and FY2016, indicates that debts were pared down. As at the end of FY2016, borrowing (short term) are at RM75 million. That only accounts to 0.9% of shareholders’ equity.

Dividend policy

The company proposes to pay around 50% of net profits every year. If all things being equal at the end of FY2017, dividend of 50%, from an EPS of 76 cents, would translate to a dividend of 38 cents per share. At a share price of, say, RM8.00, that would translate to a dividend yield of about 4.75%. This decent dividend yield may be ideal for a dividend play.

Potentials

Potential for growth can be seen from LCT’s commitment to capital expenditures which will increase production and improve production efficiency. This will contribute positively to its earnings down the road.

Untitled 5
Capital expenditure up until 2021
Conclusion

Before I conclude, lets look at the downside risk associated with LCT. Those risks are:

  1. Volatility of crude oil prices.
  2. High crude oil prices.
  3. Competition.
  4. Market conditions.

At this current time and the foreseeable future, I believe that:

  1. Crude oil prices are and/or will be less volatile (within the range of USD50 – 55 per barrel).
  2. Crude oil prices are relatively low to its high of USD100 per barrel in 2014 and the current market condition will remain as a new normal, inevitably with the rise of electric cars and investment in renewable energy
  3. Until RAPID comes online in 2020, it is safe to say that competition dynamics between existing petrochemical players will be somewhat similar and unaltered.
  4. There is a general optimism and consensus that the world’s economy, including Malaysia, is heading for better times. I expect demand for petrochemical will rise in light of better economic prospect.

Further, LCT is entering the IPO with strong financials – a cash reserve of about RM1 billion, positive cash flow and coupled with low borrowing debts. If market conditions remain the same, there is much room for growth for LCT.

Parting thoughts

To wrap up, I want to say that I find it admirable that LCT is getting the needed technical and technological support from LCC, its controlling shareholder, especially in the upgrade of its existing plants in Johore. This reminds me of the uncanny resemblance of the support CSC Steel Holdings Bhd received from its parent company, China Steel Corporation of Taiwan.

If you need to know more of the IPO (and you should), please have a read the IPO prospectus which can be found here.

Important timetable 
  1. Opening of IPO application – 16 June 2017
  2. Closing of IPO application – 28 June 2017
  3. Balloting of application – 03 July 2017
  4. Allotment of IPO shares to successful applicants – 07 July 2017
  5. Listing date (tentative) – 11 July 2017

Do hit the like and share buttons on my Facebook for updates on the IPO.

Reference:

  1. http://www.thestar.com.my/business/business-news/2017/06/16/lotte-chemical-titan-to-raise-rm5pt92b-from-ipo/
  2. LCT’s IPO Prospectus
  3. https://www.nytimes.com/2017/05/25/business/energy-environment/oil-opec-shale-renewables.html
  4. http://www.thesundaily.my/news/1602125
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