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LG Chem (051910 KS ) Raise TP on Higher EV Battery Premium

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LG Chem (051910 KS ) Raise TP on Higher EV Battery Premium LG Chem (051910 KS ) Raise TP on higher EV battery premium Chemicals Raise TP by 10% to W450,000 on higher EV battery premium Revise up EV battery valuation to W8.4tr: We are revising up our valuation of LG Results Comment Chem’s electric vehicle (EV) battery business to W8.4tr, applying an EV/EBITDA of 10x to our 2020F EBITDA. Our valuation is still roughly half the estimated value July 20, 2017 (W16tr) of Chinese battery maker CATL (unlisted). Below, we explain our rationale for the upward revision: (Maintain) Buy First, automakers are accelerating their moves into the EV market, as: 1) mass adoption looks set to kick off with the launch of Tesla’s Model 3; 2) Europe’s Dieselgate scandal has stifled diesel car sales; and 3) EVs are increasingly Target Price (12M, W) 450,000 considered critical for automakers to grab hold of China (the world’s biggest auto market), which has announced a new energy vehicle (NEV) credit scheme. Share Price (07/19/17, W) 318,500 Second, despite the recent rise in metal prices, we expect EV production costs to Expected Return 41% decline over the medium term. Based on second-generation EVs currently available on the market, battery cells/packs account for 30% of total production costs, but other items, such as R&D spending, other powertrain costs, and other direct costs , OP (17F, Wbn) 2,898 also make up a significant portion. As part of its modular electric drive (MEB) Consensus OP (17F, Wbn) 2,730 project, Volkswagen plans to develop an integrated EV platform to lower total production costs by 30-40% from current levels. And once third-generation EPS Growth (17F, %) 56.7 batteries arrive on the scene around 2020 , energy density is likely to increase, Market EPS Growth (17F, %) 43.1 while lithium and cobalt requirements should decrease. P/E (17F, x) 11.7 Lastly, we expect LG Chem to maintain its competitive position. Aside from Market P/E (17F, x) 10.2 Panasonic, there are very few battery makers with the ability to serve m ajor global KOSPI 2,429.94 automakers. Chinese suppliers have only just begun to transition from lithium-iron- phosphate (LFP) to nickel-cobalt-manganese (NCM) batteries and are therefore still Market Cap (Wbn) 22,484 limited by lower energy densities. And given the importance of ongoing Shares Outstanding (mn) 78 development, we think industry leaders are better positioned due to their Free Float (%) 64.3 significant R& D experience, as illustrated by recent trends among cathode material Foreign Ownership (%) 37.8 suppliers. Beta (12M) 1.74 52-Week Low 219,500 2Q17 review: Consensus beat; Potential for metal cost pass-through 52-Week High 326,500 Consensus beat and bullish guidance: LG Chem reported 2Q17 operating profit of W726.9bn, beating the market consensus. Chemical earnings surprised to the (%) 1M 6M 12M upside on robust spreads of core products (ABS, etc.), while the battery business Absolute 14.2 17.7 23.0 returned to a profit thanks to strength in the small-sized segment. On its earnings Relative 11.4 0.4 2.1 call, LG Chem said that it expected core chemical cycles to improve in the medium term. Regarding EV batteries, management noted that European carmakers were 130 LG Chem KOSPI 120 stepping up their efforts in the green car segment . On the recent metal price gains 110 (cobalt, etc.), the company said it was currently in talks to pass on the increases; we 100 believe this underscores LG Chem’s strong leverage as a battery maker. 90 3Q17 OP to remain high at W710.8bn: We expect 3Q17 operating profit to remain 80 high at W710.8bn, supported by strong chemical spreads and favorable seasonality 70 7.16 11.16 3.17 7.17 in information & electronic materials (I&E) and batteries. FY (Dec.) 12/14 12/15 12/16 12/17F 12/18F 12/19F Mirae Asset Daewoo Co., Ltd. Revenue (Wbn) 22,578 20,207 20,659 25,218 26,292 27,916 [Oil Refining/Chemicals/Renewables ] OP (Wbn) 1,311 1,824 1,992 2,898 2,986 3,488 OP margin (%) 5.8 9.0 9.6 11.5 11.4 12.5 Yeon -ju Park NP (Wbn) 868 1,153 1,281 2,127 2,273 2,671 +822 -3774 -1755 [email protected] EPS (W) 11,745 15,602 17,336 27,170 29,035 34,124 ROE (%) 7.3 9.2 9.5 14.2 13.4 14.0 Minkyung Kim P/E (x) 15.4 21.1 15.1 11.7 11.0 9.3 +822 -3774 -1732 P/B (x) 1.1 1.9 1.4 1.5 1.4 1.2 [email protected] Dividend yield (%) 2.2 1.4 1.9 1.6 1.6 1.6 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates July 20, 2017 LG Chem I. EV battery premium to expand 1. Tesla, Dieselgate fallout, and China to spur EV market growth We expect LG Chem’s EV battery business to enjoy a higher valuation premium going forward. EV market growth is accelerating, and LG Chem is anticipated to maintain competitive advantages in the global battery market. Although many automakers have been targeting the expansion of EV sales over the medium to long term, progress has been for the most part relatively slow. Recently, however, automakers have been stepping up their efforts, expanding investments in battery production capacity based on comprehensive road maps. In our view, the pickup in activity in the EV space is being driven by the following factors: 1) Tesla is nearing the launch of the Model 3. The new EV model is projected to have a range of at least 300km per charge with a price tag of US$35,000-40,000. The company said preorders have already reached 400,000 units. Tesla is targeting sales of 500,000 units in 2018, and plans to gradually expand annual sales volume to 1mn. Until recently, EVs have accounted for only a fraction of the global auto market, with annual sales volume of 40,000- 50,000 per model. However, if the Model 3 sells well, EVs should gain increasing prominence in the overall vehicle market going forward. 2) Dieselgate has stifled diesel car sales in Europe, with the percentage of diesel cars in total new car sales falling from 52.1% in 2015 to 49.9% in 2016. Amid continuing uncertainties over diesel vehicles, automakers’ new diesel model launches and retail sales have been depressed. Recently, Daimler, which is under investigation for emissions fraud, decided to recall 3mn diesel vehicles. This unfavorable environment appears to be propelling European automakers to shift to EVs. 3) China is strengthening its push to increase the number of EVs on its roads via various measures, including subsidies. In June, the country announced an NEV credit scheme, which requires EVs and plug-in hybrid EVs (PHEVs) to account for 8% of automakers’ sales by 2018, and 12% by 2020. The new scheme will also reward EVs with longer ranges. In light of the average range of current EVs, China’s EV sales volume is projected to increase from 400,000- 500,000 in 2017 to 800,000 in 2018 and to 1.2mn in 2020. Thus, EVs are increasingly considered critical for automakers to grab hold of China (the world’s biggest auto market). Figure 2. Share of diesel cars in new car registrations in Figure 1. Tesla shares gained sharply on Model 3 expectations Europe (US$) (%) 400 56 Diesel vehicles as a % of new European car registrations 55 350 54 300 53 250 52 51 200 50 150 49 100 48 1/15 7/15 1/16 7/16 1/17 7/17 2011 2012 2013 2014 2015 2016 Source: Bloomberg, Mirae Asset Daewoo Research Source: ACEA, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 2 July 20, 2017 LG Chem 2. EV market to expand despite rising metal prices The uptrends in lithium and cobalt prices are the biggest causes for concern in the EV market. Lithium and cobalt mining is dominated by a small number of players, and the process of progressing from exploration to production takes several years. Accordingly, the recent surge in demand is sharply pushing up prices. However, we forecast a meaningful decline in EV production costs for the following reasons: 1) EV makers will likely achieve economies of scale in the near future, and the development of relevant technologies is progressing rapidly. For second-generation EVs currently available on the market, battery cells/packs account for 30% of total production costs; however, other items, such as R&D spending, other powertrain costs, and other direct costs, also make up a significant portion. As EVs account for only a niche part of the overall vehicle market, fixed costs still impose a heavy burden. Notably, as part of its MEB project, Volkswagen plans to develop an integrated EV platform to lower total production costs by 30-40% from current levels. Powertrain production costs are also likely to decline. For EV motors and inverters, production costs are anticipated to decrease via R&D and scale effects. In addition, EV manufacturers are making efforts to reduce required battery capacity by improving efficiency. 2) The development of third-generation batteries is now underway. In order to expand battery capacity, major battery makers, including LG Chem, have been increasing nickel content and reducing cobalt content in cathode materials, while mixing silicon with graphite for use in anode materials.
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