Advanced Materials Shift And Indonesia Expansion Will Drive Strong Future Upside

Catalysts

About Lotte Chemical

Lotte Chemical is a diversified chemical company engaged in basic petrochemicals, advanced materials, fine chemicals and energy materials with a growing presence in high growth Asian markets.

What are the underlying business or industry changes driving this perspective?

• Ramp up of the Indonesia LINE project in a structurally supply constrained market, where domestic ethylene self sufficiency is low and demand is growing at around 5 percent annually, should drive strong volume growth and higher blended revenue as utilization normalizes and pricing power improves.
• Ongoing portfolio shift toward high value added Advanced Materials, battery related separators and medical applications, alongside specialty fine chemicals such as semiconductor cleans, positions the company to benefit from global electrification and digitalization trends and structurally lift group operating margins and earnings.
• Government backed restructuring of domestic commodity petrochemicals, combined with optimization of Daesan and other NCC assets, is expected to raise utilization efficiency, cut structural losses by hundreds of billions of Korean won and meaningfully improve net margins and cash generation through the cycle.
• Disciplined capital allocation, with the completion of major projects like LINE and a stated commitment to keep new investments within EBITDA, together with divestment of noncore assets, should lower leverage, reduce interest burden and enhance equity value through stronger free cash flow and return on capital.
• Strategic build out in clean hydrogen and energy related materials, including hydrogen power generation, distribution centers and advanced compounds, positions Lotte Chemical at the forefront of the energy transition, creating new recurring revenue streams and supporting higher long term earnings growth versus traditional petrochemical peers.

Assumptions

This narrative explores a more optimistic perspective on Lotte Chemical compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming Lotte Chemical's revenue will grow by 12.2% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from -9.3% today to 3.5% in 3 years time.
• The bullish analysts expect earnings to reach ₩935.4 billion (and earnings per share of ₩14884.89) by about December 2028, up from ₩-1774.9 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as ₩-1167.6 billion.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 8.9x on those 2028 earnings, up from -1.8x today. This future PE is lower than the current PE for the KR Chemicals industry at 11.9x.
• The bullish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.85%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The global petrochemical cycle remains weak for longer than expected, with additional naphtha cracker capacity in China and Northeast Asia driving utilization below the current 84 percent level until at least 2028. This could cap product prices and volumes and delay any meaningful recovery in revenue and operating earnings.
• The Indonesia LINE project operates at suboptimal profitability for an extended period due to industry oversupply, slow demand absorption and early stage stabilization issues. In this scenario, the new capacity adds depreciation and fixed costs faster than it generates cash, which would weigh on group operating margins and net earnings.
• Government led restructuring and planned shutdown or optimization of domestic naphtha crackers at Daesan and Yeosu fail to deliver the anticipated hundreds of billions of Korean won loss reductions. For example, if synergies are smaller than expected or politically delayed, this would leave structural losses and weak net margins embedded in the Basic Chemicals segment.
• Reliance on high value added Advanced Materials, Fine Chemicals and Energy Materials to offset commodity weakness proves optimistic if downstream demand in autos, electronics and batteries stays subdued or faces new competition. This could limit mix improvement and constrain consolidated operating margin expansion and earnings growth.
• Ongoing asset divestments, potential stake sales in Southeast Asian assets such as LCI and tight adherence to an investment within EBITDA policy may restrict growth capital just as competitors scale in higher growth or cleaner energy segments. This would risk market share loss and subpar long term revenue and free cash flow growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Lotte Chemical is ₩138082.55, which represents up to two standard deviations above the consensus price target of ₩88450.0. This valuation is based on what can be assumed as the expectations of Lotte Chemical's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₩165000.0, and the most bearish reporting a price target of just ₩48000.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be ₩26966.1 billion, earnings will come to ₩935.4 billion, and it would be trading on a PE ratio of 8.9x, assuming you use a discount rate of 12.8%.
  
• Given the current share price of ₩74400.0, the analyst price target of ₩138082.55 is 46.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.