(Neutral) Demand recovery remains slow Company Visit Note May 3, 213 earnings to soften in 2Q, but modestly improve in 3Q Demand recovery remains slow and inventories high Maintain Neutral; Near-term inflection point in late 2Q Daewoo Securities Co., Ltd. Oil refining / Yeon-ju Park +822-768-361 yeonju.park@dwsec.com Young-jee Bae +822-768-4123 youngjee.bae@dwsec.com 1. Company visit feedback: Weak 2Q, but a modestly improved 3Q We recently made a round of visits to pure chemicals companies. We observed the demand recovery remains too slow, and thus project 2Q earnings to be weaker than anticipated. We forecast Lotte Chemical s (1117/KS/Hold) 2Q operating profit to moderate to W84.9bn on the input of higher-priced naphtha, weaker EG and butadiene prices, and a narrower spread between paraxylene (PX) and metaxylene (MX). We expect Kumho Petrochemical (1178/KS/Hold) to post a softer 2Q operating profit of W64.4bn due to a fall in synthetic rubber ASP and increased supply pressures in the phenol derivatives unit. After suffering a W8.5bn loss in 1Q, we expect Hanwha Chemical (983/KS/Hold) to swing to an operating profit of W29.2bn in 2Q, aided by narrowed losses at its solar PV subsidiary and a gradual earnings pickup in its chemicals unit. Regarding solar modules, fast-growing demand in Japan (213F installation of 5GW-6GW) has been pushing up utilization at global module makers, while ongoing industry restructuring (including Suntech Power) has been easing overcapacity pressures. That said, we do not expect any sharp recovery in chemicals earnings, and thus recommend taking profits by capitalizing on near-term earnings growth momentum. In 3Q, we look for a broad-based but modest earnings recovery. The input of higher-priced naphtha in 2Q (following price increases in February and March) increased cost pressures for chemicals firms and elevated inventories of several products, including ethylene glycol (EG) and butadiene. In 3Q, we expect reduced inventory burden and seasonal strength to support an earnings pickup. However, upside to margins will likely be muted as several capacity expansions are set for 2H (e.g. Exxon Mobil s Singapore plant). We maintain our Neutral rating on the chemicals sector. In the near term, we see momentum picking up towards the end of 2Q, driven by destocking and strong seasonality. Figure 1. HDPE margin Figure 2. Chinese PMI s seasonality (p) (US$/tonne) 1,5 HDPE (L) Spread (-1M, R) (US$/tonne) 6 56 Avg. after 25 212 213 5 54 1,4 4 52 1,3 3 5 1,2 2 48 1/12 4/12 7/12 1/12 1/13 4/13 7/13 1/13 Jan Mar May Jul Sep Nov Source: Cischem, Source: CEIC, Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S.
May 3, 213 2. Demand recovery remains slow and inventories high Polyethylene (PE) and polypropylene (PP) margins have been robust recently, but this is more likely due to low inventories and temporary supply disruptions in the Middle East than a demand recovery. There is only a limited chance of demand picking up strongly, as Chinese industrial activity is typically soft through July. Additionally, a sharp margin improvement is unlikely even though 3Q is a seasonally strong quarter, given the planned operation of new facilities in 2H (e.g. Sinopec Wuhan and Exxon Mobil Singapore). We estimate Chinese EG inventory remains at over 9, tonnes (the level as of March), implying EG margins are unlikely to improve sharply. PX margins have been moderating due to the completion of refinery maintenance and the operation of new capacities; however, we see limited downside risks from here, as PX-MX spreads need to stay above US$2 for firms to break even. Additionally, we are doubtful of a quick turnaround in synthetic rubber. Manufacturers have been raising utilization on the perception that butadiene prices are too low. But demand remains tepid and inventory levels appear to be rising as a result. In 3Q, inventory could be drawn down and demand may start to pick up, but this is likely to prompt facilities that had been idled due to weak demand to come online in 2H, limiting any margin improvement. Benzene margins remain strong in part from tighter supply in the US. ABS and BPA margins, on the other hand, are projected to stay sluggish due to large downstream capacity expansions. Figure 3. PX margin Figure 4. Synthetic rubber and butadiene price (US$/tonne) 8 6 Xylene PX-Xylene (MT) 1, 8 SBR-BD SBR-BD (-1M) 4 6 4 2 2 1/1 7/1 1/11 7/11 1/12 7/12 1/13 7/13 Source: Cischem, 9/12 11/12 1/13 3/13 5/13 Source: Platts, Figure 5. Chinese natural rubber inventory level Figure 6. Chinese inventory level (' tonne) 3 25 2 (cents/kg) Natural rubber inventories (L) 6 Natural rubber price (R) 5 (' tonne) 18 15 12 Toluene Styrene Mixed Xylenes 15 4 9 1 5 3 6 3 1/1 7/1 1/11 7/11 1/12 7/12 1/13 Source: Shanghai Futures Exchange, 2 1/12 7/12 1/13 Source: CEIC, 2
May 3, 213 3. Company visit notes and earnings forecast updates Lotte Chemical PE and PP margins have been robust recently due to low inventories, high prices in North America, and temporary supply disruptions in the Middle East. Margins are anticipated to stay at current levels rather than widen further. Despite the input of high-priced naphtha in 2Q, the company s earnings may improve if spreads remain unchanged. Demand recovery has been slow for EG and butadiene. EG prices are anticipated to remain range-bound in 2Q due to high inventory. Synthetic rubber producers raised utilization on the perception that butadiene prices are too low, but demand remains tepid. As a result, capacity expansions, scheduled for April-June, have been delayed. Aromatic compounds also remain sluggish due to a narrower PX-MX spread and a turnaround of the TPA factory. To sum up, PE and PP spreads recovered, but EG and butadiene spreads and aromatic margins narrowed, which should weigh on the company s 2Q earnings. But we expect earnings to recover in 3Q. The company is reviewing various options to secure mid/long-term growth, including greater investments in non-ethylene chemicals, and feedstock outsourcing. Kumho Petrochemical Table 1. Lotte Chemical s quarterly and annual earnings Synthetic rubber ASP fell due to lower butadiene prices, but spread widened. Demand is recovering steadily, but not as fast as expected. Butadiene rubber facilities are operating at full capacity in May after completing turnarounds in April. But this is more driven by stockpiling than by actual demand recovery. Tire demand seems to be recovering, and should pick up further after end-2q. Inventories are not low yet. Sales of solution styrene butadiene rubber (SSBR) are not impressive due to low demand for eco-friendly tires amid an economic downturn. Synthetic resin demand started to pick up seasonally, but margins remain flat QoQ. Phenol derivative margins are falling due to increased supply (capacity expansion at LG Chem, etc.). Precision chemical margins remain more or less unchanged QoQ. 212 213 1Q 2Q 3Q 4Q 1Q 2QF 3QF 4QF (Wbn, %, US$/W, US$/bbl, US$/tonne) 212 213F 214F Revenue Total 3,85 3,949 4,132 3,972 4,171 4,168 4,28 4,344 15,93 16,963 18,29 Olefin 2,13 2,184 2,475 2,424 2,522 2,636 2,721 2,786 9,96 1,665 11,544 Aromatics 1,189 1,76 96 874 989 895 924 941 4,98 3,749 3,73 Titan 649 726 719 73 69 637 636 617 2,824 2,58 2,782 Operating Total 23-48 194 23 117 85 177 131 372 51 639 Profit Olefin 154 19 166 6 129 96 153 118 399 495 673 Aromatics 44-8 -9-25 3-5 21 19 2 37-32 Titan 8-68 34-22 -15-6 3-5 -48-23 -1 Pretax profit 225-33 23-9 117 85 179 127 387 58 624 Net profit 182-14 157-9 114 68 143 11 316 426 499 OP margin 5.3-1.2 4.7.6 2.8 2. 4.1 3. 2.3 3. 3.5 Net margin 4.7 -.4 3.8 -.2 2.7 1.6 3.3 2.3 2. 2.5 2.8 US$/W 1,131 1,152 1,14 1,7 1,8 1,12 1,8 1,8 1,123 1,5 1,5 Dubai oil 116 16 16 18 18 11 15 15 19 15 1 HDPE-naphtha 311 435 385 394 464 516 5 45 381 483 529 EG-naphtha 42 45 99 151 152 146 18 18 84 164 225 Butadiene-naphtha 2,441 1,544 1,28 739 866 581 9 1, 1,483 837 1,525 Source: 3
May 3, 213 Hanwha Chemical Table 2. Kumho Petrochemical s quarterly and annual earnings The chemicals unit is improving QoQ. Caustic soda prices are rising as the effects of capacity expansions ease. Given the recent decline in carbide-based PVC inventories, PVC prices may rebound slightly. Low-density polyethylene (LDPE) margins are solid as imports from Iran contracted recently. LDPE demand is also rising but at a slow pace. The company s solar PV subsidiary is utilizing more than 9% of its capacity (as of 2Q). Thus, losses are likely to narrow QoQ. Solar PV demand is robust, mainly in Japan. Polysilicon facilities are scheduled to be completed in early-june, and start production in March 214. The polysilicon industry is expected to pick up next year as supply glut eases. Hanwha L&C is seeing its earnings grow thanks to rising FFCL revenues. The company s joint venture factory in the Middle East (natural gas-based EVA/LDPE production; 25% owned by Hanwha L&C) is scheduled to start commercial production in September. 212 213 1Q 2Q 3Q 4Q 1Q 2QF 3QF 4QF (Wbn, %, US$/W, US$/bbl, US$/tonne) 212 213F 214F Revenue Total 1,621 1,584 1,432 1,247 1,417 1,321 1,443 1,434 5,884 5,615 5,867 Synthetic rubber 871 857 693 617 68 653 674 674 3,38 2,682 2,84 Synthetic resin 342 323 337 287 331 317 314 33 1,289 1,265 1,27 Phenol derivatives 29 271 274 215 277 226 325 327 1,51 1,155 1,247 Energy 45 39 43 42 43 4 45 45 168 173 27 Others 74 94 85 85 86 85 85 85 338 341 34 Operating Total 129 29 45 21 78 64 95 8 224 317 467 profit Synthetic rubber 86 14 12 34 35 52 47 113 167 248 Synthetic resin 12 13 6 1 6 14 8 31 38 51 Phenol derivatives -8 8-2 -5 6 2 3-7 11 23 Energy 22 2 21 18 2 18 23 23 81 83 135 Others 17 1-1 -1 8 5 5 6 18 1 Pretax profit 132 1 44-53 48 46 75 71 134 24 44 Net profit 13 1 4-27 34 37 6 57 126 187 323 OP margin 8. 1.8 3.2 1.6 5.5 4.9 6.6 5.6 3.8 5.6 8. Net margin 6.4.7 2.8-2.2 2.4 2.8 4.1 3.9 2.1 3.3 5.5 Source: Table 3. Hanwha Chemical s quarterly and annual earnings (Wbn, %, US$/W, US$/bbl, US$/tonne) 212 213 1Q 2Q 3Q 4Q 1Q 2QF 3QF 4QF 212 213F 214F Revenue Total 1,695 1,712 1,771 1,784 1,78 1,835 1,965 1,95 6,962 7,486 8,218 Hanwha chemical 915 852 92 866 822 84 961 88 3,553 3,52 3,823 Hanwha Ningbo 7 78 91 89 85 85 85 85 328 34 34 Hanwha SolarOne 142 197 179 221 376 411 419 44 739 1,646 2,56 Others 568 585 581 68 497 5 5 5 2,342 1,997 2, Operating Total 32 45 4-112 -9 29 52 55 5 128 315 profit Hanwha chemical 52 44 59-14 1 24 32 21 141 88 135 Hanwha Ningbo -8-9 -1-7 -7-1 2 3-25 -4 7 Hanwha SolarOne -41-18 -45-149 -28-12 13-253 -27 13 Others 29 28 28 58 17 18 18 18 142 71 7 Equity-method gains 49-14 38 3 15 2 15 12 76 43 141 Pretax profit 21-17 22-84 9-35 9 42-58 24 243 Net profit 4-32 9-93 5-28 7 33-112 17 194 OP margin 1.9 2.6 2.3-6.3 -.5 1.6 2.7 2.9.1 1.7 3.8 Net margin.2-1.9.5-5.2.3-1.5.4 1.8-1.6.2 2.4 Source: 4
May 3, 213 Important Disclosures & Disclaimers Disclosures As of the publication date, Daewoo Securities Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of Lotte Chemical and Kumho Petrochemical as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. As of the publication date, Daewoo Securities Co., Ltd. issued equity-linked warrants with Lotte Chemical and Kumho Petrochemical as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. Stock Ratings Industry Ratings Buy Relative performance of 2% or greater Overweight Fundamentals are favorable or improving Trading Buy Relative performance of 1% or greater, but with volatility Neutral Fundamentals are steady without any material changes Hold Relative performance of -1% and 1% Underweight Fundamentals are unfavorable or worsening Sell Relative performance of -1% * Ratings and Target Price History (Share price (----), Target price (----), Not covered ( ), Buy ( ), Trading Buy ( ), Hold ( ), Sell ( )) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst s estimate of future earnings. The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions. (W) Lotte Chemical 8, 6, 4, 2, 6/11 11/11 5/12 11/12 5/13 (W) 35, 3, 25, 2, 15, 1, 5, Kumho Petrochemical 6/11 11/11 5/12 11/12 5/13 (W) Hanwha Chemical 8, 6, 4, 2, 6/11 11/11 5/12 11/12 5/13 Analyst Certification The research analysts who prepared this report (the Analysts ) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. 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