24 January 2014 Asia Pacific/Japan Equity Research Major Chemicals (Chemicals/Textiles (Japan)) / MARKET WEIGHT Chemical sector Research Analysts SECTOR REVIEW Masami Sawato 81 3 4550 9729 [email protected] Keyword: Innovation Maiko Saito Investment strategy 81 3 4550 9936 [email protected] ■ In 2014, we believe "green innovations" and "life innovations" are key to the longer term growth of chemical makers. ■ Green innovation: In the environment/energy field, solar cells and rechargeable lithium-ion batteries (LiB) should attract greater attention, while lightweight carbon fiber composite materials (CFRP) and their contribution to improving the fuel efficiency of automobiles and aircraft become increasingly important to efforts to reduce energy consumption and CO2 emissions. We believe companies to watch include Toray Industries (3402), Teijin (3401), Mitsubishi Chemical Holdings (4188), Kuraray (4023), Hitachi Chemical (4217), and Ube Industries (4208). ■ Life innovation: For their prospective innovations that could promote greater use of generics and help lower the cost of pharmaceuticals, we are focusing on Nippon Kayaku (4272), a major domestic maker of generic anti- cancer drugs and biosimilars, and Denki Kagaku Kogyo (4061), which we expect to expand its diagnostic reagent business. In addition, we look for Asahi Kasei (3407) to expand its pharmaceuticals business and, over the medium term, its home dialysis business. We think JSR (4185) is interesting for the medium-term growth potential of its drug discovery support business. Finally, Sanyo Chemical Industries (4471) and Nippon Shokubai (4114), two producers of super absorbent polymers (SAP) used in absorbent materials, should benefit from the global growth in demand that we expect for disposable diapers. Focus stocks ■ Mitsubishi Gas Chemical (4182, OUTPERFORM, TP ¥1,050): Likely to see profits rise in FY3/15 on higher prices of methanol and expanded market share for its bismaleimide-triazine (BT) materials. Our top pick for 2014. ■ Kureha (4023, OUTPERFORM, TP ¥660): Should benefit from expanding demand for its polyglycolic acid (PGA) as a material for molded products used in shale gas extraction. ■ Sanyo Chemical Industries (4471, OUTPERFORM, TP ¥1,010): A pioneer in SAP. Sales growth should outstrip overall market growth owing to a new grade of SAP for disposable diapers. ■ Toray (3402, OUTPERFORM, TP ¥850): As well as carbon fibers, expansion of North American business and strengthening of the life innovation businesses are likely to enhance medium-term prospects. ■ Asahi Kasei (3407, OUTPERFORM, TP ¥920): Continues to post record profits; over medium term, could use its extensive network of homeowners to build its home dialysis business. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 24 January 2014 2013 sector review Share price performance during 2013 Our chemical sector coverage universe had a tough year in 2013, underperforming TOPIX Tosoh was the year’s best by 14% for the entire period and 8% for the second half. Just seven of 22 stocks performer, followed by outperformed for the year, with the other 15 underperforming. The top performer was Tokuyama Tosoh on a strong bounce-back in profits as fallout from the Nanyo plant fire tapered off and the company streamlined its urethane operation. Next was Tokuyama, which was coming off the sector’s worst performance in 2012. Tokuyama’s gains were driven by a restructuring plan that included a full writedown of domestic polysilicon facilities and looks set to boost free cash flow and reduce financial risk. The best performer for 2H alone was Kureha. We attribute this to investors’ expectations Kureha was the top for a medium-term contribution from polyglycolic acid (PGA) resins after President Yutaka performer in 2H Kobayashi said at last November’s 1H results briefing that they are being increasingly used in shale gas extraction. Figure 1: CY2013: Chemical sector stock performance Figure 2: 1H FY2013: Chemical sector stock performance relative to TOPIX relative to TOPIX Tosoh Kureha Tokuyama Tosoh Kureha Nippon Soda Nippon Soda Sumitomo Chemical Asahi Kasei Asahi Kasei Nippon Kayaku Tokuyama Sumitomo Chemical Nippon Kayaku Mitsubishi Gas Chemical Ube Industries Denki Kagaku Kogyo Denki Kagaku Kogyo Sanyo Chemical Sanyo Chemical Toray Industries Toray Industries Nippon Shokubai Nippon Shokubai Zeon Mitsui Chemicals Hitachi Chemical Teijin JSR Hitachi Chemical Shin-Etsu Chemical Mitsubishi Gas Chemical Mitsui Chemicals Mitsubishi Chemical Holdings Mitsubishi Chemical Holdings JSR Kuraray Shin-Etsu Chemical Ube Industries Kuraray SUMCO Zeon Teijin SUMCO -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% Source: Thomson Reuters Source: Thomson Reuters Chemical sector 2 24 January 2014 2013 events In 2013, February saw Sumitomo Chemical, Mitsui Chemicals, and Maruzen While stepping up Petrochemical announce plans for the restructuring of operations at their ethylene center realignment of commodity in Chiba. This was followed in August by an announcement from Mitsubishi Chemicals and petrochemical operations, Asahi Kasei Chemicals that they would work toward unification on a single naphtha sector companies also inked cracker in Mizushima. Even as realignment of Japan’s petrochemical industry gathered a number of M&A deals pace, Toray Industries, Mitsui Chemicals, Kuraray and others acquired new businesses overseas overseas. In short, 2013 was a year for business portfolio reshuffling. Figure 3: Ten major announcements in 2013 1 Sumitomo Chemical, Mitsui Chemicals, and Maruzen Petrochemical to restructure their Chiba ethylene center Mitsubishi Chemicals and Asahi Kasei Chemicals to unify naphtha crackers at their Mizushima plants on 2 Mitsubishi's facility, by spring 2016 3 Toray to make full-fledged foray into large tow carbon fiber, with acquisition of US-based Zoltek 4 Mitsui Chemicals purchases dental materials business of German conglomerate Heraeus, for €450mn 5 Toray Industries acquires 56.2% stake in Korea's Woongjin Chemical, for ¥40bn 6 Kuraray to buy DuPont’s vinyl acetate-related businesses, for $540mn 7 Mitsubishi Chemical Holdings completes purchases of pharma-grade capsule maker Qualicaps 8 Mitsui Chemicals transfers all shares in its PTA joint venture in Indonesia, to BP 9 Teijin to reduce polycarbonate resin production capacity in Singapore to 160,000t, from mid-October 10 Zeon completes takeover bid for Tohpe on 21 March, at cost of ¥3.4bn Source: The Heavy & Chemical Industries News Agency, Credit Suisse Chemical sector 3 24 January 2014 2014 investment strategy Keyword: Innovation We expect chemicals to play an increasingly important role in the industrial sector in 2014. Innovations in The Japanese government’s new economic growth strategy centers in part on “green environment/energy and innovation” policies targeting energy and the environment and “life innovation” policies healthcare/medical targeting healthcare, and chemical technology is becoming increasingly crucial for both. technology are key to We see innovation in these areas as the key to chemical makers’ longer-term growth. longer-term growth Green innovation The creation of environmentally friendly products and technologies supports both Expectations high for environmental protection and economic growth, but it also requires innovation. Japan and advances in other countries are positioning energy and the environment as a growth area and therefore environmental/energy promoting the development of related technologies and the creation of related markets. technology Companies have also embraced this as a growth field and are currently concentrating management resources there. Industry made progress in developing new products and technologies in 2013 in such segments as renewable energy, energy-saving, resource cycles, biomass, and water treatment. The chemical sector is part of this effort, and we expect it to make further advances in environmental/energy technology in 2014. A key aspect of green innovation is energy generation and storage. Development of new Progress in developing new products and technologies here—including solar cells and rechargeable lithium-ion solar cells and LiBs batteries (LiB)—is gathering momentum, with some companies offering solutions that combine these two battery types. Companies have also begun full-scale development of hydrogen technologies needed to make effective use of solar and other renewable energy. Another key aspect of green innovation is energy savings and reductions in CO2 emissions. CFRP poised for full-scale The focus here is on lightweight materials that contribute to better fuel efficiency in take-up automobiles and aircraft. In particular, advances in manufacturing technology for carbon- fiber-reinforced polymer (CFRP) have set the stage for full-scale take-up, in our view. The market for bioplastics has expanded sharply over the past few years, reflecting their ability to not only reduce