Sherman projects LOTCHEM’s acquisition price of Rs 26

Sherman Security has maintained a ‘hold stance’ on the acquisition of Lotte Chemical Pakistan Limited (LOTCHEM) with a target price of Rs26. The research report has revealed LOTCHEM’s acquisition and potential future benefits.

LOTCHEM is the only scrip that has generated an abnormal return of 144% so far in CY22TD. We highlighted LOTCHEM at the beginning of the year with a ‘Buy’ rating with an upside potential of 35%.

However, the stock surpassed our return expectation mainly due to improvement in its margins and news regarding a potential acquisition.

After digging deep into the likely implications of the potential acquisition of LOTCHEM, we believe the market has already priced in the future benefits.

LOTCHEM’s acquisition Price

We maintain a ‘Hold’ stance on LOTCHEM with a target price of Rs26, Sherman said in a research report.

The stock is offering CY22 and CY23 dividend yields of 14% and 5%, respectively.

Acquisition to overshadow expansion plans; Payout expected to improve With the potential acquisition of 75% in the offing, it expects PTA expansion plan by LOTCHEM will be shelved for the time being as the majority of the potential acquirers (Novatex & ICI Pakistan) are looking for backward integration (already customers of the company).

It believed that the focus will shift towards obtaining synergies rather than enhancing market share. Moreover, as per management, expansion of the minimum plant capacity of 800kt will cost around Rs80bn (US$350-400mn).

Hence, the substantial capital requirement will further act as a deterrent to expansion in the near term.

Thus, following the acquisition, it has also expected payouts will be higher (100% versus the historical 50%) due to the absence of a strong rationale to retain earnings.

Moreover, from the acquirer’s viewpoint, payouts are likely to improve in order to pay off the debt for the acquisition (transaction cost of Rs34bn based on current price).

Assuming the acquirer increases payout to 100%, the CY23 dividend yield is estimated at 10%.

This is assuming that cash reserves of Rs11bn (net of dividend announced in 2Q) available with the company will not be used for payout.

Price premiums are not likely to sustain Due to supply chain issues emanating from Russia Ukraine conflict, covid restrictions in China, and imposition of anti-dumping duty on Polyester Staple Fibre imports, the company was able to realize higher PTA prices in the local market during 1HCY22.

Moreover, the artificial suppression of imports by the coalition government also aggravated the domestic PTA supply situation causing a higher price premium compared to the historical average.

To note, domestic PTA demand hovers approximately at 800k tons, as LOTCHEM caters to around 500k tons while the rest is being imported.

With the import restrictions likely to be eased in the coming months, we expect price premiums for LOTCHEM to normalize from 4QCY22/1QCY23 onwards.

Thus, the company’s recurring earnings are expected to revert to around Rs3.2/share on an annualized basis. International PTA-PX margins to normalize International PTA-PX margins are currently trading at US$170/ton.

Due to evolving covid situation in China, PTA and Paraxylene (PX) prices are showing divergent trends in the Asian region, resulting in higher margins.

However, once the covid restrictions ease in China, we expect margins to start normalizing. Hence, our base case margin assumption for CY23 is US$110/ton, which is similar to the 10-year average.

Additionally, any US$20/ton change in our base case assumption would alter annualized earning estimates by Re1/share, it added.