2018 outlook: supply discipline prolonged cycle, non-PE even better

21 December 2017ChemicalsAsia PetrochemicalEnergyChemicalsInitiation of CoverageAsiaIndustryAsia PetrochemicalDate21 December 2017Deutsche BankMarkets Research2018 outlook: supply disciplineprolonged cycle, non-PE even better2018 another good year for chemicals earnings; initiating Korean coverageThe outlook for the petrochemical sector continues to be positive; Asian chemicalcompanies' weighted spreads will likely be maintained despite a high base. Weare bullish based on prolonged peak earnings driven by supply side discipline,potential further delays or cancellations in projects and stringent environmentalmeasures disrupting supply. Hence, the key themes in 2018 are: 1) ethylene cyclesoftens but with limited damage to spreads; 2) non-PE continues to strengthen inthe absence of naphtha cracker (NCC) additions; and 3) environmental constraintsboosting the chlor-alkali chain cycle. Thus, we initiate our Korean coverage withBuy ratings on LG Chem & Kumho Petrochem, and Hold ratings on Lotte Chem& Hanwha Chem.Ethylene cycle rolling off but spreads sustain at high levelWe expect PE chain spreads will ease back from their peak but remain healthy,after a highly profitable 2017. Based on our global ethylene model, 2018/19Eutilization rate will decline to 89% / 88%, still within mid-cycle. With the additionalgas-ethane-based supply from the US, we continue to see risks of delays,outages, and slower ramp-up, and even Chinese ban on recycled plastics importsto support the cycle. Best leverage to theme: PTTGC, Lotte Chem, & Chandra Asri.Non-ethylene: structurally upbeat with synthetic rubber leading the wayTight supply demand is heading for the non-PE cycle given limited NCC additionsgoing forward since 67% of 2018E/19E new additions to capacity are gas-ethane-based, which focus on ethylene. We expect the non-PE utilization rate to increaseby 1.5% yoy in 2018E while synthetic rubber is the best product area with +4.3%yoy improvement. In our view, Asia naphtha crackers with good exposure tonon-PE will enjoy this imminent upcycle. Best leverage to the theme: LG Chem,Kumho, SPC, & IRPC.Chlor-alkali: supply constraints driving upcycleWith ongoing environmental inspections in China, the medium-term outlook forchlor-alkali is improving. China accounts for 44% of global name plate capacity ofPVC/caustic soda. Looking at caustic soda / PVC, c.86% of China's capacity (37%of global) is carbide based. China's stringent environmental requirements wouldcut utilization rates and gradually fade out the inefficient capacity. If we assumeVitus LeungResearch Analyst+852-2203 6158Johnson WanResearch Analyst+852-2203 6163Wattana PunyawattanakulDeutsche TISCO Investment Advisory Co. LtdResearch Analyst+66-2-633 6464Harshad KatkarResearch Analyst+91-22-7180-4029Key ChangesCompanyTarget PriceRatingIRPC.BK7.00 to 7.90-0338.HK5.80 to 5.20-TPIA.JK5,124.00 to5,310.00-PTTGC.BK77.00 to 95.00Hold to BuySource: Deutsche BankTop picksSPC - H (0338.HK),HKD4.29BuySiam Cement (SCC.BK),THB482.00BuyKumho Petrochemical(011780.KS),KRW96,100.00BuyLG Chem (051910.KS),KRW398,500.00BuySource: Deutsche BankDeutsche Bank AG/Hong KongThis research has been prepared in association with Deutsche TISCO Investment Advisory Co. Ltd. The opinions containedin this report are those of Deutsche TISCO Investment Advisory Co. Ltd.Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE ’ SREPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OFPRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU.Distributed on: 21/12/2017 13:00:00 GMT7T2se3r0Ot6kwoPa 21 December 2017ChemicalsAsia Petrochemical15% of China's carbide-based capacity were to go offline, it would boost globalutilization rate by 4ppts. Best leverage to the theme: Hanwha Chem.Top picks: LG Chem, Kumho, IRPC, and SPC-H; upgrading PTTGC to BuyWe initiate LG Chem (Buy), Kumho Petrochem (Buy), Lotte Chem (Hold), andHanwha (Hold). We prefer LG Chem (for its diversified non-PE profile with EVbatteries), Kumho (for SBR exposure), IRPC (for PP exposure and OP recovery),and SPC-H (for non-PE exposure, FCF/dividend yield). We value the sector byapplying SOTP, EV/EBITDA, and DCF methods. Finally, we upgrade PTTGC to Buyas we note it is a clear beneficiary of healthy PE prices going forward.RisksDownside risks: volatile crude oil and downstream chemical products prices;lower-than-expected GDP growth; and unforeseen geo-political changes. Upsiderisks: continuous global capacity expansion delays; stronger OECD downstreamdemand recovery; and unexpected mergers & acquisitions.