Pre-marketing for Malaysia's largest initial public offering in five years wraps up later this week, with Lotte Chemical Titan hoping to take advantage of improving foreign sentiment towards the country's equity markets.
In local currency terms, the company's M$5.923 billion ($1.389 billion) flotation will rank as Malaysia's largest since Felda Global Ventures and IHH Healthcare respectively raised M$9.9 billion and M$6.26 billion in the summer of 2012.
Later that year, a M$4.55 billion deal for Astro Malaysia Holdings amounted to $1.49 billion based on 2012 conversion rates.
The currency differential between Astro and Lotte Chemical Titan's offerings emphasises just how weak sentiment towards the ringgit has been in recent years. Foreign investors have been net sellers of a country where they perceive multiple political challenges are hurting long-term economic potential.
That is showing signs of changing (well the inflows at least). The ringgit is up 5.5% since its January 4 low and foreigners have been net buyers of Malaysian equities every month so far this year.
Maybank research reveals foreign equity inflows of M$10.5 billion to the end of May. This has completely reversed outflows of M$8.2 billion in 2016, but is still far short of the M$29.7 billion, which was sold off between 2014 and 2016.
The currency’s rebound has also helped the Kuala Lumpur Composite Index to leapfrog Vietnam and Indonesia in dollar-adjusted performance terms so far this year.
Valuation
Bankers hope the macro-economic backdrop will provide a strong platform for Lotte Chemical Titan’s IPO. The company is being pitched as a play on South East Asia’s consumer growth story since its products are the basis for all manner of plastic items, from shopping bags to car casings.
It has filed for a maximum IPO price of M$8 per share.
This values the company at 13.68 times the syndicate’s M$1.437 billion consensus 2017 profit forecast and 12 times 2018 estimates. The 2017 figure also represents a 9% increase from the M$1.316 billion net profit Lotte Chemical Titan reported in 2016.
A 13.68 p/e ratio means Lotte Chemical Titan will come at a considerable premium to its Korean parent, Lotte Chemical. The latter was trading at 6.14 times 2017 consensus earnings based on Monday’s Won 350,000 close.
Syndicate and non-syndicate analysts believe a premium is justified. The question is how much of one.
Lotte Chemical's share price has had a very good run over the past 12 months, rising 31.06%. In the process, it has outperformed the Kospi, which is up 21.5% over the same period.
However, it has been on the retreat since a Won 407,000 high on February 10 and is down 5.15% year to date, underperforming the Kospi, which is up 16.88% over the same period.
Analysts agree that investors have pulled back because of fears the petrochemical cycle is peaking. Lotte Chemical, for instance, reported record operating margins during the first quarter.
But they disagree whether the cycle is turning: a key consideration for prospective Lotte Chemical Titan investors.
Bankers say investors have also been trying to get their heads around valuation differentials between North and South Asia. LG Chemical, for example, is trading at 11.5 times 2017 earnings, whereas Petronas Chemical is trading around 16.8 times.
Either way, Lotte Chemical is currently valued at a big discount to Asia’s average p/e ratio of 12 times on a 2017 basis.
Some analysts attribute this to the problems engulfing the Shin family behind Korea’s fifth largest chaebol. Lotte Group chairman, Shin Dong-bin, is not only on trial for corruption alongside the country’s former president Park Geun-hye, but also embroiled in a succession dispute with his older brother Shin Dong-joo.
It is the main reason why Lotte Chemical Titan's IPO was held over from 2016. It is coming now because the company wants to raise money for capex.
Some analysts believe it should give the parent’s share price a fill-up given the Malaysian arm accounted for 19% of the latter’s 2016 net income.
Cycle peaking?
Syndicate analysts argue that Lotte Chemical Titan’s capacity additions will help it to maintain strong earnings growth at a time of expanding domestic demand and at the expense of foreign competitors, disadvantaged by Asean’s 10% import tariffs.
Analysts forecast the company will bring an additional 12% of production capacity on stream this year, followed by 6% in 2018 and then 18% in 2019 when a 40%-owned US shale gas project comes on stream.
Most of Lotte Chemical Titan’s earnings are derived from Malaysia and Indonesia (67.2%), which are both net petrochemical importers, implying future upside for local producers. In 2016, a further of 11.3% of sales came from China, 9.7% from the rest of Asia and 11.8% from the rest of the world.
By contrast, Petronas Chemical has a slightly more diversified global footprint, with 33% of 2016 sales to Malaysia, 24% to Asean, 22% to China and 21% to the rest of the world.
Bankers say investors view Petronas Chemical as Lotte Chemical Titan’s closest comparable. And they believe the latter should come at a discount since Petronas Chemical benefits from subsidised feedstock for its gas crackers.
Lotte Chemical Titan uses naptha for its olefin plants, which means investors also need to make a judgement about oil prices.
Syndicate analysts believe that Lotte Chemical Titan’s Southeast Asian focus should partially insulate it from concerns about supply/demand shifts affecting the global cycle.
For some non-syndicate houses like UBS believe the global cycle has another two years to run, while others such as Morgan Stanley and Bank of America Merrill Lynch are far more bearish.
At issue is how much global ethylene capacity is coming on stream after years of underinvestment.
On the one side, UBS believes investors are underestimating the impact of China’s environmental reforms on purported new supply from the country. As a result, it argues that Lotte Chemical will be able to maintain above average return on equity ratios (22% in 2016), which are not currently reflected in its share price.
On the other side, Morgan Stanley is more focused on the US, where up to 8.4 million tons per annum of ethylene production is forecast to come on stream between 2017 and 2019. This compares to an average of three mpta between 2011 and 2015.
Syndicate analysts counter that even if the cycle turns, Lotte Chemical Titan should be able to sustain high profits because it has maintained high utilisation rates, while diversifying its products, raw materials and markets since it was taken private in 2010.
According to S&P Global Market Intelligence data, the Lotte Group purchased the company from a group of investors led by the Chao family and Permodalan Nasional Berhad (PNB) for M$3.672 billion, or 7.6 times forward earnings.
Today, it accounts for 53% of Malaysia’s polyethylene production capacity, 100% of its polypropylene capacity and 57% of Indonesia’s polyethylene capacity according to its regulatory filing.
Deal details
The filing also shows the company is issuing 740.48 million new shares, which equates to 30% of its enlarged share capital.
This splits into a 55.78 million share retail tranche, plus a prospective 400.8 million share institutional tranche and 283.8 million share bumiputera tranche. There is also a 55.5 million share greenshoe.
The deal also has four cornerstone investors, with three (Eastspring Investments, Great Eastern Holding Malaysia and Malayan Banking Asset Management) participating through the institutional tranche and one (PNB back for more Titan) through the bumiputera tranche. The three will take up just under 20% of the institutional tranche.
The IPO is likely to formally launch in mid-June, with order books closing in late June and listing tentatively scheduled for the second week of July.
On trading, Lotte Chemical Titan should yield 3.3% based on the M$8 upper issue price, equating to a 50% payout ratio.
However, analysts also say the deal may have a wider price range than recent offerings given its size and in line with the precedent set by Petronas Chemical, Malaysia’s largest IPO to date.
This former deal raised M$12.85 billion in 2010 and went out with a M$4.50 to M$5.20 price range before pricing at the top.
Joint global co-ordinators for Lotte Chemical Titan’s IPO are Maybank, Credit Suisse and JP Morgan, with CIMB, HSBC and Nomura on joint books.
