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Oil Refining/Chemicals Positioning for 2015

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Oil Refining/Chemicals Positioning for 2015 Oil Refining/Chemicals Positioning for 2015 Limited recovery expected until year-end; Top picks are LG Chem, Hyosung, Neutral (Downgrade) Toray Chemical, & SK Innovation The chemicals industry has slowed since mid-August, largely due to: 1) weakening Industry Report demand from China and Europe, 2) oversupply of non-ethylene and downstream October 6, 2014 products, and 3) uncertainty over China’s economic policies. Supply is likely to expand further once the peak season ends and naphtha cracking center (NCC) maintenance is completed; therefore, the market is forecast to remain rather stagnant until year-end . Daewoo Securities CCCo.,Co., Ltd. Meanwhile, oil refining margins and oil prices have fallen due to tepid demand from emerging markets. Further d eclines seem unlikely, but we also do not expect any sharp [Oil Refining/Chemicals] recovery, given 1) structural demand contraction, and 2) capacity expansions scheduled Yeon-ju Park for year-end or early next year in the Middle East. +822-768-3061 We maintain LG Chem, Hyosung, Toray Chemical Korea, and SK Innovation (attractively [email protected] valued) as our top picks. These stocks are likely to perform strongly in spite of Young-jee Bae unfavorable market conditions. +822-768-4123 Positioning for 2015 [email protected] We present the following investment strategies to counter the deteriorating market conditions. 1) Hyosung’s polyketone business deserves attention. Hyosung (Buy/TP: W95,000) is the first company to commercially produce polyketone. Its use of carbon monoxide and ethylene/propylene as feedstock has dramatically reduced production costs. Polyketone produced at Hyosung’s pilot facilities received positive feedback from several customers (including European compounding companies). As a result, the company has decided to complete construction of its mass production facilities (a 50,000-tonne plant) earli er than scheduled (June 2015 March 2015). The performance of the new plant will be assessed from March-July 2015. If successful, the project is likely to provide a significant boost to Hyosung’s enterprise value, but such expectations have not yet been p riced in. Furthermore, even considering the downbeat earnings outlook for 2H, the stock still looks inexpensive. We thus believe downside risks to the stock are limited. 2) Kumho Petrochemical (Trading Buy/TP: W90,000) is anticipated to bottom in 4Q. Increased supply, rather than low demand, is causing the synthetic rubber industry’s downturn. Tire demand has risen in 2014 , but synthetic rubber supply has risen even further. However, we expect synthetic rubber capacity growth to fall in 2015 after peaking in 2014, and thus believe the industry is bottoming. Also positive is that Kumho is expected to double its energy capacity by 2016. Butadiene prices will likely decline in 4Q due to low seasonal demand, but Kumho Petrochemical’s share price is anticipated to bottom along with butadiene prices. Polyketone (newly developed by Hyosung) characteristicscharacteristics and applications Source: Hyosung, KDB Daewoo Securities Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. October 6, 2014 Oil Refining/Chemicals C O N T E N T S Oil refining and chemicals 3 1. Expect limited recovery until year-end 3 2. Three strategies in preparation for 2015 7 Key Recommendations 17 LG Chem (051910 KS) 18 Hyosung (004800 KS) 21 Toray Chemical Korea (008000 KS) 24 Huchems Fine Chemical (069260 KS) 27 Lotte Chemical (011170 KS) 30 Kumho Petrochemical (011780 KS) 33 SK Innovation (096770 KS) 36 GS Holdings (078930 KS) 39 S-Oil (010950 KS) 42 OCI (010060 KS) 45 Hanwha Chemical (009830 KS) 48 KDB Daewoo Securities Research 2 October 6, 2014 Oil Refining/Chemicals Oil refining and chemicals 1. Expect limited recovery until year-end The oil refining and chemicals industries are anticipated show limited recovery through the end of this year. We maintain LG Chem, Hyosung, Toray Chemical Korea, and SK Innovation (attractively valued) as our top picks, because these stocks are likely to perform strongly in spite of unfavorable market conditions. 1) Chemicals: End of a strong season and supply growth The chemicals industry has slowed since mid-August, largely due to: 1) weakening demand from China and Europe, 2) oversupply of non-ethylene and downstream products, and 3) uncertainty over China’s economic policies. For chemical producers, the third quarter is typically the peak season, but this year was an exception, because: 1) Chinese polyester producers have seen reduced capacity utilization, 2) Europe’s apparel sales have fallen, and 3) China’s apparel sales (by retailers) have grown at a slower pace. Since August, Europe’s tire replacement demand growth has decelerated, sending natural rubber prices to the lowest level in recent years. Synthetic rubber prices have also failed to rebound. Figure 111.1. MEG spread bottomed out in JuneJune,,,, but the pace of Figure 222.2. Chinese polyester makermakers’s’s’s’ utilization ratioratioratio hashashas recovery has slowed since August remained lowlowlow (US$/tonne) (US$/tonne) (%) 1,500 MEG (L) 600 85 2014 Spread (R) 5-year avg. 80 1,200 400 75 900 200 70 600 0 65 300 -200 60 05 06 07 08 09 10 11 12 13 14 1 4 7 10 (month) Source: Cischem, KDB Daewoo Securities Research Source: Wind, KDB Daewoo Securities Research Figure 333.3. Sluggish Europe apparel sales Figure 444.4. China PMIPMIPMI and Europe PMI have both slowed (1/2010=100) (index) (index) 140 Europe apparel sales index (L) 70 60 US ISM Europe PMI China PMI Europe PMI (R) 130 60 55 120 50 110 50 40 100 90 30 45 07 08 09 10 11 12 13 14 11 12 13 14 Source: CEIC, KDB Daewoo Securities Research Source: CEIC, KDB Daewoo Securities Research KDB Daewoo Securities Research 3 October 6, 2014 Oil Refining/Chemicals We believe that increased supply, rather than low demand, is causing the chemicals industry’s downturn. Although demand has been weaker than expected, China’s chemical products demand has grown. During the five-month period between March and July, China’s nominal demand (production + net imports) for petrochemical products steadily increased. During the same period, the country’s ethylene demand jumped 6.5% YoY. Synthetic rubber demand also expanded, but production increased faster, causing imports to stay flat. Ethylene spread has widened since early this year, but other products have reported narrow spreads, which we attribute to the increased supply of non-ethylene products. China’s nationwide economic stimulus stoked strong demand for non-ethylene and downstream products. As such, capacity expansions increased, causing supply to expand full swing in 2013-14. Heightened uncertainly over China’s economic policies (whether it will address problems through restructuring or through economic stimulus) was also negative for the industry, increasing the volatility of oil prices and the chemicals industry. Since supply is likely to expand further once the peak season ends and maintenance of Asian NCCs is completed, the market is forecast to remain rather stagnant until the end of this year. Butadiene and propylene supply is projected to increase, driven by higher LPG prices (butadiene) and China’s PDH capacity expansion (propylene). Nevertheless, if China or Europe decides to boost their economies, the chemicals market is likely to turn around. China has announced that it will restrain from adopting additional boosting measures, and thus, Europe’s course will be the more decisive factor. Figure 555.5. Ethylene demand in China to grow in 2014 Figure 666.6. China synthetic rubber production and net importimportssss (%) (x) ('000 tonnes) 2,500 Production 30 Demand growth (L) 3 Net imports Elasticity (R) 2,000 20 2 1,500 10 1 1,000 0 0 500 -10 -1 0 03 04 05 06 07 08 09 10 11 12 13 14 06 07 08 09 10 11 12 13 14 Notes: Demand growth calculated based on Mar.-Sept. data each year due to Notes: Demand growth calculated based on Mar.-Sept. data each year due to inconsistency of Jan. & Feb. data inconsistency of Jan. & Feb. data Source: CEIC, KDB Daewoo Securities Research Source: CEIC, KDB Daewoo Securities Research Figure 777.7. China PMI shows seasonal weakness in 4Q Figure 888.8. Asia NCC maintenance peaks in October (index) ('000 tonnes) 56 2012 2,500 2013 2014 Avg. 2,000 54 1,500 52 1,000 50 500 48 0 1 4 7 10 (month) 1 4 7 10 (month) Source: CEIC, KDB Daewoo Securities Research Source: KDB Daewoo Securities Research KDB Daewoo Securities Research 4 October 6, 2014 Oil Refining/Chemicals 2) Oil refining: Refining margins unlikely to fall further or improve markedly For 3Q, oil refineries will likely post poor earnings due to a sharp decline in refining margins and oil prices stemming from slow demand from emerging countries. For the first eight months of 2014, nominal demand (production + net imports) for Chinese petrochemical products inched down 0.3% YoY. In particular, diesel demand fell by 1.2% YoY. The GDP elasticity of petrochemical products fell from 0.3-0.4x to negative territory. Once-solid diesel margins plunged in July-August due to lower-than-expected demand from emerging markets. Lower emerging market demand also dampened oil prices. The International Energy Agency (IEA) revised down its 2014 estimate of global crude oil demand growth to 900,000 bbl/d in September despite the US’s solid annual oil production growth of 1.2-1.4mn bbl/d since 2012. Oil prices remained flat until end-August thanks to production disruptions, particularly in Libya. In September, however, Libya’ oil production recovered, while potential supply issues, including geopolitical tension in Iraq, were addressed, leading to a sharp decline in oil prices.
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