Intermarket Securities Limited updates its investment case on LOTCHEM with a Buy rating from Neutral and a new Dec’21 TP of PKR18.0/sh. We have raised our CY21/22f EPS estimates to PKR1.94/1.85 (up c.50%), in the backdrop of healthier-than-expected PTA-PX spreads, says a report of research house.

The revision in our estimates stems from (i) improved outlook for PTA-PX spreads, (ii) higher demand from the Textile space, and (iii) healthy cash balance and an unlevered balance sheet.

Prospects for demand have rebounded considerably from CY20 lows, amid robust demand from the Textile sector (8% yoy growth in Textile exports during 1HFY21) and other upstream products.

Update estimates as spreads remain in the healthy zone

We have revised our estimates on Lotte Chemicals Ltd (LOTCHEM), with a Buy rating and December 2021 TP of PKR18.0/sh (up from PKR15.0/sh earlier). This is driven by c.50% higher EPS estimates for CY21/22f EPS of PKR1.94/1.85. The estimate revision emanates from several factors, namely (i) significant improvement in international PTA-PX spreads, (ii) revitalized sales amid robust demand from Textile sector, and (iii) strong financial position. The recent uptick in spreads (c. US$130/ton presently) – having surged by 35% from an average of US$97/ton during 4QCY20 – has propelled the recent stock price rally, up 30% from the recent bottom in Nov’20. We anticipate the spreads to remain in the healthy zone (above US$120/ton) for the remainder of CY20. Beyond CY20, however, we have kept spreads around US$110/ton – close to the LT average.

Spreads can be volatile during CY21

While we have a constructive view on medium-term spreads, they are likely to follow a volatile path during 2021.The recent surge in PTA-PX spread was driven by an oversupplied PX market in Asia. We had expected them to come under pressure from new PTA capacities in China by 4QCY20 (c.7.9mn tons pa) while the pandemic worsened demand; but the commissioning of these plants has been delayed until 2QCY21. It is possible that spreads will compress when these plants are online. The new plants can boost PX demand and moderate its oversupply. Furthermore, the spreads are expected to be exposed to the recent Chinese PTA inventories, standing at a record high of c.4mn tons, well above the typical stock level of 1.0-1.5mn tons. However, the spreads are expected to resume the upsurge 3QCY21 onwards (after a short-lived constriction), as Zheijang (China) and Aramco (Saudi Arabia) will add new PX capacities of cumulative 5.85mn tons, which can again flood the PX market and lift PTA spreads. Hence, by end-2021, we expect spreads to remain in the healthy zone.

Demand to remain elevated

Demand from the upstream Textile industry remains robust as export order books have been filled to near-maximum levels, partly due to rerouting of Western orders out of China and India. This trend is expected to persist going forward. LOTCHEM retains a solid financial position with cash & equivalents of PKR14.3bn (PKR9.5/sh) and an unlevered B/S. If the present momentum in demand continues for long (presently 750,000-800,000 tons pa), LOTCHEM might consider another expansion in future. Thus, it aims to retain significant cash buffer should the opportunity arise. This also provides a hedge against any downside volatility in spreads.