Lotte Jeongmil Has Many Reliable Strengths Beyond Urea Solution... China's Power Shortage Actually a Boon

Securities Industry: "Low Sales Proportion of Yososu, No Major Impact"
Profitability Improves Sharply Due to Price Increases in Caustic Soda and Ammonia
Group-Level Expectations for Hydrogen Business Growth Engine

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As the shortage of urea solution originating from China has emerged, related companies are gaining attention. When China halted urea exports to prioritize its domestic demand, an emergency arose in the domestic urea solution market, which had depended on China for 97% of its raw materials. Although the situation has calmed down following the suspension of China’s export restrictions, there are calls for fundamental solutions such as expanding domestic production. Domestic urea solution manufacturers include Lotte Fine Chemical and KG Chemical in the Ulsan Industrial Complex, which account for more than 50% of domestic production, as well as Huchems in the Yeosu Industrial Complex and Aton Industry in the Iksan 2nd Industrial Complex. We analyzed the performance and financial structure of these companies, whose stock prices have been highly volatile due to the urea solution issue.

[Asia Economy Reporter Lim Jeong-su] Lotte Fine Chemical holds a 50% share of the domestic urea solution market. If the supply instability of raw materials caused by China’s power shortage prolongs, repeated production halts of urea solution are inevitable, which will have some negative impact on performance.

However, the urea solution segment (product name: UROX) accounts for only about 5% of Lotte Fine Chemical’s total sales. Since the sales proportion is small and the supply lines for raw materials have been diversified, the shock from production halts is expected to be limited.

Conversely, the reduction in local production in China due to power shortages is pushing up the prices of most chemical products produced by Lotte Fine Chemical. The dominant analysis is that the profitability improvement from price increases will far outweigh the decline in the urea solution segment.

◇ Continued Performance Improvement Despite Production Disruptions and Rising Product Prices = Lotte Fine Chemical is the largest domestic supplier of urea solution, producing 140,000 tons annually. With a monthly production volume approaching 12,000 tons, it holds a 50% market share domestically. This year, it planned to produce a total of 150,000 tons, but some production facilities had to halt operations due to urea shortages, making the plan inevitably disrupted. Although it avoided immediate production stoppages by urgently securing raw urea, repeated production halts due to China’s urea export ban remain a significant risk.

Nevertheless, the securities industry expects this situation will not severely damage Lotte Fine Chemical’s performance. Most forecasts predict a positive impact on earnings. The UROX business segment accounts for a small portion of total sales, and prices of other products and goods have risen due to China’s power shortage, improving profitability.

Lotte Fine Chemical mainly produces chemical products such as chlorine-based products like caustic soda and ECH, and cellulose-based products like mescellose and anycoat. Sales from ammonia products, which are traded goods, also account for 25-30%. Urea solution sales make up about 5% of total sales, which is not significant.

According to the chemical industry, the ECH spread at the end of the third quarter rose 27.4% quarter-on-quarter to $1,535 per ton. Caustic soda prices reached the high $600s per ton, up 105% during the same period. This is the result of a sharp reduction in production volumes at local Chinese factories due to power shortages.

Analyst Wi Jeong-won of Kyobo Securities said, "The likelihood of China’s power shortage being resolved in the short term is low," and predicted, "The strong profitability of Lotte Fine Chemical’s core chlorine-based business will continue for some time." He added, "Although profitability may be damaged by rising urea prices, the company’s high market share allows it to pass on costs to prices, so significant losses are unlikely."

There is also optimism that Lotte Group’s hydrogen business, which is gaining momentum, will become a long-term growth driver for Lotte Fine Chemical. Lotte Fine Chemical’s parent company, Lotte Chemical, is pursuing a project to produce green hydrogen via hydropower in Malaysia and import it to Korea in the form of ammonia. Lotte Fine Chemical is expected to secure new growth engines by leveraging its existing ammonia business.

Jeon Yoo-jin, a researcher at Hi Investment & Securities, evaluated, "Unless the coal-related issues originating from China are resolved, it will be difficult for the prices of major chemical products produced by Lotte Fine Chemical to stabilize downward structurally," and added, "Lotte Fine Chemical has many positive factors for future performance, including securing new growth engines."

◇ Virtually Debt-Free Management... Solid Financial Health = Lotte Fine Chemical boasts excellent financial health, maintaining a long-term debt-free policy. Its EBITDA over the past three years has been around 250 billion to 300 billion KRW annually.

Although large-scale facility investments result in depreciation expenses of about 100 billion KRW annually, the absence of financial costs and the inclusion of equity-method gains from affiliates have kept average net income around 190 billion KRW over the past three years. Supported by improving net income trends, shareholders’ equity increased from 1.1927 trillion KRW at the end of 2017 to 1.9712 trillion KRW at the end of the third quarter this year.

As of the end of the third quarter this year, borrowings stand at only 26.7 billion KRW. There are no market borrowings such as corporate bonds or commercial paper. Considering cash and cash equivalents of 156.9 billion KRW, the company is in a net cash position of about 130 billion KRW. Contingent liabilities are also close to zero.

An investment banking industry official commented, "Since Lotte Fine Chemical was incorporated into the Lotte Group, it has shown the best financial condition," and added, "Even if performance deteriorates, it has the strength to endure and sufficient investment capacity to secure new growth engines."