Lotte Chemical Titan – Rising Gearing Levels A Major Concern, Research Houses Say

Lotte Chemical Titan Holding Bhd’s (LCT) FY23 core net loss of RM895m was 20% narrower than forecasts as LCT held back on sales in order to mitigate losses at the gross level.

CGSCIMB, in its Company Note today (Jan 31) reiterates a reduction on LCT, with the key de-rating catalyst being potentially higher oil prices from the Middle East conflicts hurting spreads.

The factors driving higher petrochemical selling prices and spreads since late-Dec 2023 are unlikely to be sustainable, in CGSCIMB’s view.

QoQ reduction in 4Q23 core net loss may not be repeated

LTC’s 4Q23 core net loss of RM149m was 35% narrower than 3Q23’s RM230m core net loss, because Lotte Chemical Titan (LCT) curtailed sales volumes by 11% qoq to mitigate losses, even though production was flattish qoq. Since 3Q22, LCT has been making cash losses (negative gross margins); hence, cutting back sales in 4Q23 has the effect of capitalising  production costs in the balance sheet as inventory, which will be expensed into the P&L as cost of sales only when the inventory is actually sold in future quarters.

Hence, LCT’s core net losses could widen again in future quarters. Higher tax credits also contributed to a narrower core net loss in 4Q23 vs. 3Q23. Separately, LCT’s 4Q23 was impacted by a RM40m write-down of inventory to NBV (vs. RM174m writeback of previous write-downs in 3Q23), which CGSCIMB excluded from their computation of core earnings; hence, 4Q23 loss after tax was wider vs. 3Q23.

Product selling prices and spreads have risen since late-Dec 2023 because of the mid-Jan 2024 Winter Storm Heather in the US, which curtailed PE and MEG production, and due to ongoing plant maintenance in the Middle East. But these factors are transitory, and the upcoming Lunar New Year could dampen buying again, unless global demand roars back in 2H24F, CGSCIMB said.

Rising debt and falling cash levels to burden LCT in the future

LCT closed FY23 with a net gearing of 35% (vs. a net cash position at end-FY22). CGSCIMB expects the net gearing level to rise to 96% at end-FY24F, 119% at end-FY25F, and 140% at end-FY26F. LCT had no borrowings at end-FY22, but debt rose to RM5.9bn at endFY23, with RM407m of short-term working capital funding for its existing operations and RM5.5bn of long-term US$ debt to fund the 51%-owned Lotte Chemical Indonesia New Ethylene (LINE) project, which involves building a new naphtha cracker and new downstream plants in Java, Indonesia.

LCT targets to begin commercial operations of LINE in 2H25F; it may suffer cash losses if market dynamics remain challenging.

The LINE project financing may reach RM11bn in total, and interest costs will hit the P&L only upon the start of commercial operations (the financing carries no interest during construction). LCT’s cash balances fell 42% yoy to RM761m at end-FY23, due to losses from its existing operations; it may need to borrow more for working capital funding.

These factors combined may exert a heavy burden for LCT from FY25F and beyond, which is a major de-rating catalyst. We have not modelled in any impact from LINE in CGSCIMB’s earnings forecasts, as LCT may choose to defer operations until market conditions improve.

Upside risks include an unexpected upturn in global demand and prices.

Meanwhile, Maybank Investment Bank Berhad (Maybank IB) said post-adjustment for full-year figures and a slightly lower blended utilisation rate of 67%/70%, Maybank IB’s FY24-25E core earnings are revised to -MYR648m/+MYR103m (from -MYR723m/+MYR76m previously).

Maybank IB maintains SELL with a higher TP of MYR0.95 (from MYR0.83 previously), based on an unchanged FY24E P/B of 0.15x, reflecting near-trough historical P/B as they continue to expect huge losses in FY24E on LCT.

4Q23 losses narrower than expected

LCTITAN’s 4Q23 core net loss of -MYR154m (3Q23: -MYR237m) brought FY23 cumulative core losses to -MYR892m (FY22: -MYR616m); this was adjusted for: i) MYR5.3m loss on forex; ii) MYR0.2m inventories written off; iii) MYR1.1m PPE written off; iv) MYR2.0m allowance on trade receivables; v) MYR145.9m reversal of inventories to NRV; and vi) MYR6.5m fair value gain on derivatives. The results came in above expectations vs. Maybank IB/consensus FY23 core net loss forecasts of -MYR1.1b, mainly due to: i) lower-than-expected tax rates; and ii) lower-than-expected sales volumes (note that LCTITAN makes losses per unit sales in current environment).

1Q24E likely to still be heavily loss-making

Accounting for a 6-week lag, input naphtha prices (based on the Naphtha Japan Index) was flattish QoQ (-2%) from mid-Oct 2023 till mid-Jan 2024.

Polymer prices have also been relatively flat – which effectively caps the upside to ASPs in 1Q24. With expectations of still elevated costs coupled with flattish ASPs, Maybank IB strongly believes that LCTITAN’s net loss will still be large in 1Q24, underscoring the fact that the group is not out of the woods.

FY24E would still be a tough year

As product ASPs across the board look to remain weak, management has guided a suboptimal plant utilisation rate of 65-70% in FY24E (FY23: 67%) as margins remain squeezed and below breakeven across the board.

Maybank IB thinks FY24E will still be a tough year ahead for LCTITAN with soft macro climate for downstream petrochemical products, coupled with elevated naphtha prices (due to the high crude oil price environment).

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