April 4, 2011 Company Report OCI (010060 KS) Chemicals Polysilicon price to exceed expectations Yeonju Park +822-768-3061 [email protected] Initiate coverage with Buy call and TP of W670,000 Hannah Yoon We initiate our coverage on OCI with a Buy call and a target price of W670,000 +822-768-4161 (based on a 2011F P/E of 15x; the value of the polysilicon business was derived by [email protected] applying a target EV/EBITDA of 8x to the average of its 2011F~2013F EBITDAs). Considering OCI is forecast to show a CAGR of a whopping 53% until 2012, we believe that our optimistic 2011 earnings forecasts are reasonable. Greater-than-expected solar power demand to drive up polysilicon prices In 2011, solar power demand is anticipated to exceed the market consensus forecast. In the aftermath of the earthquake in Japan, major European nations and the U.S. are likely to maintain generous subsidies for the solar power industry. With Buy (Initiate) a drop in installation costs, generous subsidies would result in a higher internal rate Target Price (12M, W) 670,000 of return, which would drive demand, as in 2010. Share Price (04/01/11, W) 498,000 Expected Return (%): 34.5 34.5 Strong solar power demand should further tighten the already-tight supply of EPS Growth (11F, %) 65.8 polysilicon. In the polysilicon market, only a few firms with cost and quality Market EPS Growth (11F, %) 20.9 competitiveness are capable of achieving aggressive capacity expansion. In light of P/E (X) 11.2 OCIÊs high quality products and strong cost competitiveness (two key elements of Market P/E (04/01/11F, x) 10.8 its polysilicon businessÊ competitiveness), we believe that the company will be able KOSPI(04/01/11F) 2,121.01 to maintain its competitive position in both the near term and the long term. The Market Cap (Wbn) 11,514 company has proved its stellar competitiveness by developing core equipment for Shares Outstanding (mn) 23 Avg Trading Volume (60D, '000) 216 polysilicon production (jointly with GT Solar) and significantly expanding production Avg Trading Value (60D, Wbn) 87 volume through debottlenecking. Dividend Yield (11F, %) 0.7 Free Float (%) 65.9 2011 OP to reach W1.2tr (up 68% YoY), beating expectations 52-Week Low 183,000 With polysilicon prices staying high on the back of greater-than-expected solar 52-Week High 498,000 power demand, the companyÊs 2011 earnings are likely to beat the market Beta (12M, Daily Rate of Return) 1.0 consensus estimate. We forecast OCIÊs operating profit to come in at W290.5bn in Price Return Volatility (12M Daily,%,SD) 2.7 1Q11 and W340.9bn in 2Q11. Production costs are likely to plunge from 4Q11 Foreign Ownership (%) 28.5 once the debottlenecking facility at the third factory begins full operations. As such, Major Shareholder(s) Lee Su Young et al. (32.58%) we forecast full-year OP to reach W1.2tr (up 68% YoY). Miraeasset Asset Management (9.22%) Price Performance (%) 1M 6M 12M Absolute 33.9 44.3 159.4 Relative 24.5 31.3 136.0 § Earnings & Valuation Metrics OP EV/ Share price Sales OP NP EPS EBITDA FCF ROE P/E P/B FY Margin EBITDA 290 KOSPI (Wbn) (Wbn) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) (%) (x) 240 12/09 2,102 538 25.6 385 18,161 695 -279 28.4 12.0 3.4 7.8 190 12/10 2,606 717 27.5 617 26,912 936 209 34.9 12.3 3.7 8.4 140 12/11F 3,396 1,206 35.5 1,032 44,624 1,570 243 40.1 11.2 3.7 7.3 90 12/12F 3,980 1,681 42.2 1,395 60,321 2,154 735 37.2 8.3 2.6 5.0 40 12/13F 4,292 1,479 34.5 1,265 54,699 2,095 707 25.3 9.1 2.1 4.9 3/10 7/10 11/10 3/11 Source: Company data, Daewoo Securities Research estimates Please read carefully important disclosures at the end of this report. I. Valuation .......................................................................................................................................3 II. Corporate overview.....................................................................................................................6 1. Emerged as the second largest polysilicon maker ...................................................................6 1) Polysilicon: Core raw material for solar cells....................................................................... 8 2) Petro & coal chemicals: Stable growth expected .............................................................. 10 3) LED sapphire ingot: Ready to advance into the market on cost savings.......................... 11 III. Industry outlook .......................................................................................................................12 1. Solar cell market outlook.........................................................................................................12 1) Demand growth to exceed expectations; Market to grow to 100GW in 2020................... 12 2) Europe: Largest solar power consumer............................................................................. 13 2. Polysilicon supply to remain tight until 2012...........................................................................19 IV. Investment points ....................................................................................................................21 1. Polysilicon prices to stay robust on strong solar power demand ...........................................21 2. Stiff competition after 2013 unlikely to hamper growth...........................................................23 V. Earnings forecasts ...................................................................................................................25 VI. Financial status and risks.......................................................................................................26 Daewoo Securities Research 2 April 4, 2011 OCI I. Valuation 1. Valuation of polysilicon business using a target EV/EBITDA of 8x Target EV/EBITDA: 10% We derived our target price for OCI (W670,000) by applying respective target EV/EBITDA premium to multiple of multiples for all of the companyÊs business divisions to the respective averages of their chemicals sector; 10% 2011F~2013F EBITDAs. We used 2011F~2013F EBITDA numbers to reflect the significant discount to multiple of growth momentum from the companyÊs large-scale polysilicon capacity expansion. Our electronic materials target price, which is equivalent to a 2011F P/E of 15x and a P/B of 5.0x, appears reasonable, sector considering the companyÊs 2011F ROE of 40.1% and its mid- to long-term growth prospects. The value of OCIÊs polysilicon business was derived using a target EV/EBITDA multiple of 8x. Our target EV/EBITDA multiple is equivalent to a 10% premium to the EV/EBITDA of the chemicals sector and a 10% discount to the EV/EBITDA of the electronic materials sector. The 10% premium to the multiple for the chemicals sector reflects the fact that the polysilicon business has high growth potential and high barriers to entry compared to other chemical segments; and the 10% discount to the multiple for the electronic materials sector reflects the expected intense market competition after 2013. Our higher-than-peer- Our target EV/EBITDA of 8x for OCI is 20% higher than that of global polysilicon makers (6x). average EV/EBITDA However, we believe that this premium is justifiable, considering: 1) OCIÊs peers are appears reasonable engaging in low value-added businesses (e.g., cells and modules), and 2) OCI is expected to remain the market leader even amid intense competition after 2013. Table 1. Target price calculation (Wbn, X, Â000 shares, W, %) EBITDA EV/EBITDA multiple Fair value Remarks 10% discount to the average EBITDA of IT material companies Earnings value Polysilicon 1,726.6 8.0 13,812.8 in 2011F~2013F 20% discount to the average EBITDA of chemical companies Non-polysilicon 212.3 5.0 1,061.4 in 2011F~2013F Total 14,874.3 Investment securities value 637.0 20% discount to market value, but no discount to book value Net debt -4.7 Treasury stocks 95.0 Fair shareholdersÊ value 15,421.0 Number of shares issued 23,121.3 Target price 666,963.2 Current price 494,000.0 Target return 35.0 2011F Implied P/E 14.9 2011F Implied P/B 5.0 2011F Implied ROE 40.1 Source: Daewoo Securities Research Table 2. OCIÊs investment securities value (%, Wbn) Company Business Ownership Book value Market cap. Fair value Application OCI materials Special gas and industrial materials 49.1 146.0 697.1 556.0 Market value eTech Construction Construction 5.1 5.7 10.5 8.4 Market value Samkwang Glass Nonmetallic mineral 7.1 22.8 21.5 17.6 Market value Ordeg Auto components 20.0 19.2 19.2 Book value OCI Ferro Chemicals for water waste treatment 50.0 5.7 5.7 Book value Eyang Chemical 50.0 26.9 26.9 Book value DCRE Chemical products and leasing service 100.0 - - Book value Elpion Materials and equipments for solar PV business 63.0 25.9 25.9 Book value OCI Enterprises Inc. Natural soda ash 89.7 97.6 97.6 Book value OCI I&C Data processing and other computer operations 100.0 1.0 1.0 Book value Others 53.3 53.3 Book value Total 404.1 637.0 Source: Daewoo Securities Research Daewoo Securities Research 3 April 4, 2011 OCI Table 2. Valuation comparison of global solar PV companies (x, %) Company P/E P/B ROE EV/EBITDA 10 11F 12F 10 11F 12F 10 11F 12F 10 11F 12F OCI 17.5 13.3 11.4 5.3 3.9 2.9 34.9 34.1 29.8 8.3 8.5 7.2 Tokuyama 22.8 17.1 14.3 0.6 0.6 0.6 3.5 3.5 3.7 4.2 4.1 4.4 MEMC 40.4 11.3 9.5 1.4 1.2 1.1 1.6 9.6 9.8 15.0 6.8 5.7 REC 17.9 16.8 15.7 0.8 0.8 0.8 5.1 5.0 4.8 7.2 5.5 5.6 Wacker Chemie 15.9 13.6 11.6 3.2 2.8 2.4 22.6 21.7 21.9 5.2 6.2 5.4 Polysilicon average 22.9 14.9 12.8 2.0 1.6 1.4 11.9 12.9 12.3 7.3 5.9 5.4 SHARP 22.9 28.1 33.1 0.8 0.8 0.8 0.4 2.9 2.6 4.1 4.3 4.7 Suntech Power 5.8 7.1 7.3 1.1 0.7 0.7 15.0 11.0 9.8 - 6.1 5.8 SunPower 13.9 9.1 7.6 1.0 0.9 0.8 11.8 10.9 13.4 5.2 4.8 4.2 First Solar 19.1 16.0 13.3 3.7 3.0 2.5 21.7 19.4 17.4 11.6 10.7 8.5 Q-cells 1.8 12.0 16.3 0.5 0.5 0.5 -105.2 4.0 4.2 - 6.4 6.1 MOTECH 10.7 12.6 11.5 2.2 1.8 - 1.0 13.6 18.2 - 12.2 - Sanyo Electric - - 60.0 6.5 8.1 7.6 - -24.6 7.1 9.2 8.6 8.4 Solar cell average 12.4 14.2 21.3 2.3 2.3 2.1 -9.2 5.3 10.4 7.5 7.6 6.3 Source: Bloomberg Figure 1.