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Morning Call about – Margin spike brings ST respite hope, LT prospects stay grim -Arif Habib Limited

Karachi, June 06, 2013 (PPI-OT): The stock of Lotte Chemical Pakistan Limited (LOTCHEM) posted an 8% gain since the mid of May-13 as the primary (PTA-Paraxylene) margins are on the recovery mode in the international markets (improving by a hefty 77% to USD 131/ton, compared to an average of USD 74/ton in Apr-13.

According to Arif Habib Limited despites this strong recovery in primary margins, Arif Habib Limited maintains ‘Hold’ stance on the scrip with Dec- 13 DCF-based target price of PKR 8.2/share. The stock is already trading at an expensive PE of 32x based on Arif Habib Limited CY13 earnings estimates for LOTCHEM.

In addition to little or no upside potential chained with higher PE tagged with the company stock, the sector fundamentals like aggressive PTA capacity expansion in the region, subdued PTA demand outlook and low cotton prices, continue to point towards a bleak margin outlook. The recent margin recovery appears more of a seasonal uptick as summer polyester demand is putting a rising trend in the margins, which Arif Habib Limited fear will be short-lived.

Margins jumped a hefty 51% MoM in May-13
PTA margins in the China region jumped by a hefty 51% MoM in May-13, averaging around USD 112/ton compared to USD 74/ton a month back. This strong margins recovery was mainly emanated from a seasonal demand uptick in China. Arif Habib Limited believes this margin recovery will be short-lived as the seasonal summer demand starts fading away in Jun-13 and the PTA’s oversupply factor in the region resumes exerting pressure on the PTA margins.

Higher Px inventory levels to slice high-margin benefit
As per the latest financials, the company has been maintaining high raw material inventory of around PKR 4.9bn at the end of Mar-13 (highest since last six quarters). This roughly translates into Px inventory of 30k tons (40% of the total quarterly Px requirement).

This expensive Px inventory (6% drop in Px price since Mar-13) is estimated to delay the benefit of improving PTA margins, in Arif Habib Limited views. Nonetheless, Arif Habib Limited expects the company’s bottom-line to come out of the red zone in 2QCY13 with PAT of PKR 0.10/share (assuming no major drop in margins during Jun-13) compared to net loss of PKR 0.11/share in 1QCY13.

Aggressive PTA expansion continues to increase supply overhang
Aggressive PTA capacity additions in the region continue to create oversupply situation. During CY12, about 7.4mn tons of PTA capacity was added compared to only 1.6mn tons of new Px, creating a PX deficit of around 3.3mn tons.

The situation is expected to worsen in CY13, where around 11mn tons of PTA will increase this deficit to 3.8mn tons, despite a 3.7mn tons new PX additions. This aggressive expansion coupled with subdued demand from downstream polyester, and relatively lower PX capacity additions, is expected to keep PTA-Px margins under pressure, Arif Habib Limited believes.

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