Chemicals/ Oil refining

Transcription

1 Chemicals/ Oil refining Chemicals: Overweight Oil refining: Neutral Three keywords BD and SBR chain spreads Pure chemical plays Decline in complex refining margin ratio Top picks Kumho Petrochemical (1178, BUY, TP W151,) 213F 214F 215F PE (x) PB (x) EV/EBITDA (x) EPS (KRW) 4,534 1,719 19,443 BPS (KRW) 57,69 65,558 82,332 Likely strong recovery in the coming upcycle as a pure chemical play Recent rise of the BD-naphtha spread China s falling SBR inventory and greater tire production Lotte Chemical (1117, BUY, TP W27,) 213F 214F 215F PE (x) PB (x) EV/EBITDA (x) EPS (KRW) 11,258 22,824 29,349 BPS (KRW) 192, , ,846 Likely strong recovery in the coming upcycle as a pure chemical play Large sales weighting of general-purpose chemicals Recent rise of the BD-naphtha spread 12M sector performance Buy pure chemicals Investment summary SBR oversupply to ease: Time to eye BD-SBR chain As styrene butadiene rubber (SBR) capacity grew 9.4% in 213, the market is concerned about oversupply. However, we believe the issue will fade out given the strong growth of tire manufacturing in China. Driven by global tire makers, capacity in China will increase 6.4% in 214 and 8.8% in 215. Our analysis suggests tire capacity growth is the key driver of the SBR-butadiene (BD)/styrene monomer (SM) spread and indicates a better spread in 214. Combined 214F OP of five chemical firms to grow 66% YoY We see three positives are ahead for Korea s chemicals industry in 214: 1) The recovery of developed economies, Western Europe in particular. 2) Regaining of market share (measured by sales) in Asia after constant declines since 27. 3) A widening spread (margin) for core products backed by China s rising demand, mainly for synthetic resin. As such, Korea s five big chemical companies LG Chem, Lotte Chemical, Kumho Petrochemical (KKPC), Hanwha Chemical and Samsung Fine Chemicals (SFC) should report combined OP of W4.7tn in 214F, up 66% from W2.8tn in 213F. However, combined OP in 214F of the three refiners S-Oil, GS Caltex and SK Innovation should amount to W3.1tn, down 12% YoY. We see three major hindrances to the refining industry s growth. 1) Structural profitability erosion of the refining business due to a falling complex refining margin (complex margin). 2) Weak gasoline prices, a key variable to the refiners share performance. 3) A narrowing spread for BTX, the mainstay petrochemicals that generate 5% of the refiners OP. Top picks are Kumho Petrochemical and Lotte Chemical Our top picks are Kumho Petrochemical (KKPC) and Lotte Chemical. Our analysis of previous cycles indicates that pure chemical companies made the biggest share price leaps during industry upcycles. Prices for BD and SBR chains turned upward and real demand for tires shows signs of recovery. As such, it would be fair to turn expectations into confidence. On the other hand, we recommend a conservative approach to refiners. Figure 1. Combined OP of five chemical companies (1Q11-4Q14F) 4, 3, (p) Rel.to KOSPI (%p, RHS) Chemicals sector index (p, LHS ) (%p) 5 2,5 (W bn) Chemicals 2, -5 2, 1, Nov-12 Feb-13 May-13 Aug-13 Nov-13 Matthew Yang matthew.yang@truefriend.com Bohwa Hong bohwa.hong@truefriend.com ,5 1, 5 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13F 1Q14F 3Q14F Note: LG Chem, Lotte Chemical, KKPC, Hanwha Chemical and SFC Source: Company data, Korea Investment & Securities 62

2 Three keywords 1. BD and SBR chain spreads BD and SBR chain prices recover thanks to strong downstream tire industry Additional upside for the spread of polyethylene (PE) derivatives, the mainstay of a chemical company, appears limited given huge gains since early-213. In contrast, the spreads for the BD and SBR chains continued to dip through end-july. Prices for the BD and SBR chains entered a recovery phase supported by the picking up downstream tire industry. The BD and SBR chains should enjoy the biggest spread increase among chemicals. Figure 2. PE product prices and spread Figure 3. BD product prices and spread Figure 4. SBR product prices and spread 1,6 1,55 1,5 65 PE_Naphtha (R) PE 6 2,5 2, Butadiene-Naphtha (R) Butadiene 1,2 1, 2,7 2,5 SBR -BD/SM (R) SBR 1,1 1, 1,45 1,4 1,35 1,3 1, ,5 1, ,3 2,1 1, ,2 1, ,7 6 1, ,5 5 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Source: Cischem, Korea Investment & Securities Source: Cischem, Korea Investment & Securities Source: Cischem, Korea Investment & Securities The BD price has picked up to USD1,69/tonne and the SBR rose to USD2,25/tonne. We can see the higher BD (raw material) price is pushing the SBR-BD spread wider. The SBR price will continue to reflect the earlier gains of BD given 1) a historically tight correlation between BD and SBP (R-square 89%) and 2) real demand growth that is believed to have recently driven up the BD price (stockpiling is difficult for BD). BD and SBR prices to return to 212 levels In 4Q13F, we predict the price for BD will average USD1,696/tonne (+48% QoQ) and SBR USD2,34/tonne. While a low comparison base makes the price gains look greater, we view it as a path to normalcy. The prices will return to the 212 level in 214. Table 1. BD and SBR quarterly prices and spreads 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13F F 214F Price BD 3,412 2,533 2,142 1,73 1,856 1,414 1,144 1,696 2,924 2,448 1,527 2,262 SBR 3,412 3,69 2,594 2,352 2,358 2,58 1,72 2,34 3,766 2,857 2,15 2,826 Spread BD-Naphtha 2,41 1,66 1, ,9 1, ,4 SBR-BD/SM , Source: ICIS, Cischem, Korea Investment & Securities 2. Pure chemical plays Pure chemical firm shares gained the most during the upcycle Historically, shares of pure chemical companies tended to rise the most sharply when the chemicals/refining business cycle was on an upswing. And in general, the chemicals sector outperformed refining. 63

3 Chemical shares had five s and five s since 2 Chemical companies enjoyed strong, even marvelous share price gains when the industry cycle was up. According to our analysis, the chemicals sector experienced five s and five s for share prices from 2 through 1H13. The shares gained by an average of 465% during the s. Of note, share price gains were outstanding for pure chemical companies such as Korea Petrochemical Ind., KKPC and Lotte Chemical. Figure 5. Chemicals: Five share price s since 2 1% 5% 8% 4% LG Chem Hanwha Chemical Korea Petrochemical KKPC KKPC 3% 2% Chemicals Kospi 1% % -1% 1st 2nd 3rd 4th 5th Note: 1) A company in a box represents the best outperformer of each. 2) 1 st : April 2-April 22 2 nd : October 22-December 23 3 rd : June 24-March 25 4 th : July 26-October 27 5 th : November 28-April 211 Source: Korea Investment & Securities Refining shares had four s and four s since 27 The refining sector shares had four s and four s from 27 through 1H13. When an was in play, the refining shares rose 79% on average, a slower gain than chemicals. Stripping out the third, the refining stocks gains would only be 3%. Figure 6. Refining: Four share price s since 27 but the magnitude was less than chemicals 2% SK Innovation SK Innovation S-Oil GS 15% Oil ref ining Kospi 1% 5% % -5% -1% 1st 2nd 3rd 4th Note: 1) A company in a box represents the best outperformer of each. 2) 1 st : July 27-November 27 2 nd : March 28-September 29 3 rd : February 21-April th : June 212-January 213 Source: Korea Investment & Securities 64

4 Chemicals trade at more attractive valuations than refining The chemicals sector now trades at 11.8x PE and 1.x PB, 4% and 33% discounted, respectively, to the five-year trailing averages. In contrast, the refining sector s 15.9x PE and 1.1x PB represent a 33% premium and 14% discount to the five-year averages. 3. Decline in complex refining margin ratio OPM on a structural drop Complex refining Margin ratio falls Generally, the complex refining margin (complex margin) is a key determinant of the refiners mid/long-term earnings trend. However, the three refiners recent OP trends are quite different. Their complex margin stood at USD1.33/bbl in 212 and USD9.8/bbl YTD 213, which are similar to the 211 level at USD1.17/bbl. However, the three refiners should post combined OP of W3.5tn in 213 (W3tn in 212) and fall way below W6.6tn in 211. Why are refiners not as profitable as they were when the complex margin remains at USD1/bbl, a level similar to the previous boom cycle? It is because refiners have not passed higher raw material (crude oil) and overhead costs on to final product prices. Although the per-barrel complex margin is still USD1, its percentage term compared with Dubai crude, called the complex refining margin ratio, has halved from 2% in the mid-2s to 1% at present. Figure 7. Complex margin: Per barrel vs. percentage Figure 8. Complex margin vs. three refiners refining OPM 12 (USD/bbl) Complex margin Complex margin % (R) 3% 9% Industry OPM Complex margin % (R) 3% 1 25% 7% 25% 8 2% 5% 2% 6 15% 3% 15% 4 1% 1% 1% 2 5% -1% 5% F % -3% F % Source: Petronet, Korea Investment & Securities Note: Three refiners are S-Oil, SK Innovation and GS Caltex Source: Petronet, company data, Korea Investment & Securities Recently soft complex margin also hinders mid/long-term profit growth Moreover, the complex margin is steadily falling. As the simple refining margin (simple margin) has already turned negative (currently -USD.47/bbl), refiners are bound to make operating losses from the simple CDU business alone. The complex margin fell 39% to USD6.28/bbl compared to last year. Recently, the complex margin has been poor because gasoline prices that account for 26.6% of the margin and have recently begun to fall. Unlike diesel, a popular industrial fuel, gasoline demand is mostly for autos. Gasoline prices should remain soft as the summer driving season ended early. 65

5 Benzene and PX spreads to shrink in 214 Spread widened on slower crude steel production growth in China Favorable PX spread to also narrow on aggressive PTA capacity increase We estimate petrochemicals, including BTX, account for 18% of the Korean refiners total sales. However, with a 5% OP contribution and an average 11% OPM, petrochemicals keep the refiners earnings from being eroded by the refining performance. However, the shield offered by petrochemicals should weaken in 214. Except toluene that is mostly reduced to diesel, benzene-naphtha and paraxylene (PX)-naphtha spreads should drop to USD262/tonne and USD446/tonne, respectively, in 214, compared to USD395/tonne and USD584/tonne in 213. In China, 27% of benzene is produced using the steel industry s by-product coal tar as feedstock. The nation s crude steel production growth has slowed from an average 19.5% in to 9.7% in 211 and 4.2% in 212, and related utilization has recently remained low in the low-7% range. As a result, coal tar-based benzene supply growth has also slowed. Since 211, PX demand has been strong with a sharp capacity increase for purified terephthalic acid (PTA) for which PX is the feedstock. The wide spread could be maintained because PX supply has increased much less than PTA. However, PX capacity growth should outpace that of PTA from 214. At present, many market participants including Korean refiners are concentrating their investment at PX-related facilities. As of 1H13, Korea s PX capacity stood at 6.4mn tonnes. By the end of 214 when capacity additions are completed, the figure should expand 65% to 1.6mn tonnes. In contrast, China s need for aggressive capacity increase has weakened with PTA utilization staying at ~7%. Thus, the PX-naphtha spread should narrow from USD584/tonne in 213F to USD446/tonne in 214F. Figure 9. Chinese steelmakers annual crude steel production volume and utilization Figure 1. Annual capacity growth for PX and PTA and PTA-PX spread (mn tonnes) Crude steel production (L) F 214F F % 16% 14% 12% 1% 8% 6% 4% 2% % PX PTA PTA-PX spread (R) F 215F Source: CISA, Korea Investment & Securities Source: Cischem, Chemlocus, Korea Investment & Securities 66

6 Earnings forecast 1. Key assumptions Table 2. Assumptions for crude oil and petrochemical prices and spreads (USD/bbl, USD/tonne) 1Q13 2Q13 3Q13 4Q13F 1Q14F 2Q14F 3Q14F 4Q14F Crude /naphtha prices Dubai crude Naphtha Refining margin Complex refining margin Complex refining margin (1M lagging) Main product spreads Ethylene-naphtha Synthetic resin avg. naphtha BTX naphtha 1, Source: IEA, Datastream, Petronet, Korea Investment & Securities F chemicals OP to gain 66% YoY 214F chemicals NP to gain 66% YoY In 214, Korea s chemicals industry will enjoy three positives. 1) The recovery of developed economies, Western Europe in particular. 2) Regaining of market share (measured by sales) in Asia after constant declines since 27. 3) A widening spread (margin) for core products backed by China s rising demand, mainly for synthetic resin. As such, Korea s five big chemical companies LG Chem, Lotte Chemical, Kumho Petrochemical (KKPC), Hanwha Chemical and Samsung Fine Chemicals (SFC) should report combined OP of W4.7tn in 214F, up 66% from W2.8tn in 213F. 3. Sensitivity analysis USD is the settlement currency for all chemicals/refined products and raw materials; Each 1% change in the KRW/USD moves EPS by 19.3% on average (W bn) S-Oil GS SKI SFC Lotte LG KKPC Hanwha USD-denominated assets 1, , , USD-denominated debts 5, 358 6, ,591 2, Net exposure 3, , F NP , Change in controlling interest NP based on change in USD-denominated assets NP based on 1% rise , Chg. (%) (86.5) (.4) (31.2) (6.) (8.4) (2.9) (3.) (16.) NP based on 1% drop , , Chg. (%) Source: Company data, Korea Investment & Securities Given that the change in oil prices affects both petrochemical prices and supply-demand, it is difficult to do a sensitivity analysis under controlled conditions; But a steady rise for oil prices has a favorable effect on product spreads given the lead time in raw materials procurement 67

7 Top picks Kumho Petrochemical (1178) KKPC: A prime beneficiary of China s falling SBR inventory and rising tire production We maintain BUY on KKPC with a TP of W151, that equals 2.2x 214F PB. The target multiple reflects the 1% premium to the average PB that Kumho Petrochemical received during industry upcycles. We are bullish as 1) the pure chemical play should enjoy the biggest recovery momentum as industry conditions pick up, 2) the BD-naphtha spread, which narrowed sharply until 3Q13, is beginning to widen and 3) demand for synthetic rubber will likely rise on China s dwindling inventory and growing tire production. Lotte Chemical (1117) Lotte Chemical: Likely strong rebound in the coming upcycle as a pure chemical play We maintain BUY on Lotte Chemical with a TP of W27, that equals 1.2x 214F PB. We have three investment points. First, given Lotte Chem and its subsidiaries Lotte Chemical Titan and KP Chemical are pure chemical firms, Lotte Chem will likely make the largest recovery in the coming upcycle. Second, the price spreads for commodity chemicals, such as PE, monoethylene glycol (MEG) and polypropylene (PP), will likely remain solid in 214 and Lotte Chem generates as much as 7.9% of sales from these products. Third, the company s shortcomings have been addressed as the BD-naphtha spread widened recently, ending a substantial narrowing that continued through 3Q13. Risk factors Threats from new processes such as CTO, a tempest in a teacup China s coal-chemical engineering (CTO process) is threatening Korean chemical makers with production based on naphtha. And the US has started shale oil mass-production. But we see only a limited impact on the global ethylene supply-demand cycle given 1) the zero-sum game in the chemicals industry where demand increases proportionately followed by supply and 2) technological limitations for the mass-production of shale oil. Table 3. Portion of raw materials and products by petrochemical process ( tonnes/year) Process Product Olefins Non-olefins Raw material Ethylene (C2) Propylene (C3) Butadiene (C4) BTX (C6) Naphtha cracking center (NCC) Naphtha 31% 15% 11% 24% Coal-to-olefins (CTO) Coal O O X X Ethane cracking center (ECC) Natural gas 75% 2% 3% 5% Source: Hana Institute of Finance, Korea Investment & Securities 68

8 Table 4. Valuations Recommendation & TP Coverage valuation Earnings & valuations Company Sales OP NP EPS BPS PE PB ROE EV/EBITDA (W bn) (W bn) (W bn) (KRW) (KRW) (x) (x) (%) (x) Lotte Chemical Recommendation BUY 211A 6, ,723 6, (1117) TP (KRW) 151, 212A 5, ,959 54, Price (Nov 7, KRW) 13, 213F 5, ,534 57, Market cap (W bn) 3, F 7, ,719 65, F 9, ,443 82, Kumho Recommendation BUY 211A 15,699 1, ,71 171, Petrochemical TP (KRW) 27, 212A 15, , , (1178) Price (Nov 7, KRW) 23, 213F 16, , , Market cap (W bn) 6, F 17,47 1, , , F 18,998 1, , , LG Chem Recommendation BUY 211A 22,676 2,819 2,138 29,69 129, (5191) TP (KRW) 44, 212A 23,263 1,91 1,494 2, , Price (Nov 7, KRW) 283, 213F 23,418 1,888 1,423 19, , Market cap (W bn) 18, F 26,862 2,618 1,92 26, , F 29,83 2,718 1,995 27,141 26, Hanwha Chemical Recommendation BUY 211A 7, ,793 34, (983) TP (KRW) 27, 212A 6, , Price (Nov 7, KRW) 22,85 213F 7, , Market cap (W bn) 3,25 214F 8, ,738 34, F 9, ,34 36, Samsung Fine Recommendation BUY 211A 1, ,889 42, Chemicals (4) TP (KRW) 59, 212A 1, ,878 45, Price (Nov 7, KRW) 45,3 213F 1, ,311 46, Market cap (W bn) 1, F 1, ,97 48, F 2, ,2 52, GS Holdings Recommendation BUY 211A 8, ,171 63, (7893) TP (KRW) 7, 212A 9, ,217 66, Price (Nov 7, KRW) 56,9 213F 9, ,873 71, Market cap (W bn) 5, F 1, ,644 77, F 1,876 1, ,63 83, S-Oil Recommendation Hold 211A 31,914 1,698 1,191 1,229 44, (195) TP (KRW) - 212A 34, ,25 46, Price (Nov 7, KRW) 75,8 213F 31, ,342 48, Market cap (W bn) 8, F 29, ,62 48, F 29,9 1, ,881 51, SK Innovation Recommendation Hold 211A 68,371 2,959 3,169 34,4 157, (9677) TP (KRW) - 212A 73,33 1,699 1,185 12,72 165, Price (Nov 7, KRW) 142, 213F 69,273 1, , , Market cap (W bn) 13,13 214F 69,35 1, , , F 7,314 1, , , Note: November 7 closing prices Source: Company data, Korea Investment & Securities 69