[Into the Stock]"Were Expectations Too High?"... Lotte Chemical, How Long Will the Market Adjustment Last?

[Asia Economy Reporter Minji Lee] Lotte Chemical's stock price has been sluggish for an extended period. Amid expectations of increased demand for chemical products during the economic recovery phase, the target stock price was raised to around 500,000 KRW last month. However, the stock price seems unable to gain upward momentum as concerns over supply burdens from new expansions in major countries weigh more heavily.

“They said it would get better... why is the stock price stagnant?”

On the 16th, Lotte Chemical's stock price closed at 275,000 KRW, down 16% from the year's high of 328,000 KRW recorded the previous day. Following the COVID-19 pandemic, expectations for demand recovery led to a roughly 25% increase in February, and the stock price reached a new yearly high the following month. Last month, forecasts suggested the chemical sector was undervalued, anticipating further price gains, but the stock has been hovering around 260,000 to 270,000 KRW. Considering securities firms raised their target prices to the 500,000 KRW range with optimistic outlooks at that time, this is a contrasting trend.

The stock price's failure to gain expected momentum is due to the chemical market entering a correction phase. As chemical spreads declined amid large-scale new expansions originating from China, concerns about the sector's peak out (profit peak) intensified. Lotte Chemical produces 4.09 million tons of ethylene annually, general-purpose plastics PE/PP (2.13/1.74 million tons), PTA (840,000 tons), and MEG (1.83 million tons). If large-scale expansions occur in China and the U.S., the supply of these products could exceed demand, leading to reduced profitability, which the market has factored in.

Recently, a sell report issued by the foreign investment bank Goldman Sachs also negatively impacted investor sentiment. It highlighted China's import substitution efforts for petrochemical products like general-purpose plastics (PE/PP), which could cause market oversupply. Additionally, crude oil prices remaining above $70 could significantly increase ethylene production costs, the raw material for these products, potentially worsening profitability. Due to the company's nature, rising costs are not easily passed on to product prices flexibly.

With the market outlook turning negative, domestic securities firms Samsung Securities and Daishin Securities have lowered Lotte Chemical's stock price targets by 5% and 10%, respectively. Although the targets were reduced, they maintained the view that the market conditions could improve in the second half of the year. Sangwon Han, a researcher at Daishin Securities, said, “Due to excessive concerns about the market, the current price-to-earnings ratio (PER) is around 0.6 times, similar to the lower band during past recessions, indicating undervaluation. The overly pessimistic view that the market and earnings cannot improve further is reflected, but chemical demand is expected to gradually improve in the second half.”

Demand growth expected to match expansions

According to financial information provider FnGuide, major domestic securities firms estimate Lotte Chemical's annual operating profit to grow 128% year-on-year to 459 billion KRW. Sales are expected to increase by about 35% to 4.3332 trillion KRW. Despite growing supply concerns, this reflects an analysis that most of the volume can be absorbed by the market considering the global economic normalization trend.

The net ethylene expansion trend is expected to continue until 2022. This year, net ethylene capacity is projected to increase by 11.67 million tons, a 6% rise compared to last year's 11.5 million tons (6%). In 2022, an additional 11.36 million tons of capacity expansion, representing 5.5%, is predicted.

However, pure demand is also expected to increase significantly in line with the increased supply. According to market research firms, global net ethylene demand growth was initially forecast at 4.14 million tons (2.5%) at the end of last year but has recently been revised upward to 8.26 million tons (5%), reflecting a sharper economic recovery. Hyunryul Cho, a researcher at Samsung Securities, said, “Considering the global GDP growth forecast has been raised to 6%, net ethylene demand growth this year is expected to be about 11 million tons, a 6.6% increase. A significant portion of the expanded capacity can be offset by demand growth.”

Expectations for eco-friendly new businesses... “Will enhance corporate value”

Lotte Chemical is rapidly expanding its new business portfolio by entering the recycled plastics business, investing in battery electrolyte organic solvent facilities, and hydrogen business.

DB Financial Investment predicts Lotte Chemical will grow into the largest recycled plastics company in Korea. Lotte Chemical has set a vision to produce 1 million tons of recycled plastics by 2030 and is preparing to produce PET (C-rPET) using chemical recycling in addition to mechanical recycling. Its own BHET (depolymerized monomer) production plant is progressing toward a chemical recycling goal in 2024, and if successfully completed, it will be the first BHET manufacturing plant in Korea. Seungjae Han, a researcher at DB Financial Investment, said, “We believe it will become the largest recycled plastics company domestically in terms of scale. After 2022, with mass production of chemical recycling, sales and profit contributions from eco-friendly plastics will grow significantly.”

Recently, Lotte Chemical partnered with SK Gas to enter the hydrogen fuel cell power plant business. SK Gas and Lotte Chemical established a joint venture (JV) to build gaseous hydrogen charging stations and hydrogen fuel cell power plants, planning to expand cooperation across various fields. Hyunryul Cho of Samsung Securities analyzed, “Although it will take some time for new businesses to generate sales and profits, the company's strategic shift will act as a catalyst to raise valuation levels in the future.”