Titan Chemicals sets price range for IPO

Will an attractive valuation counter concerns about the petrochemicals cycle?

Titan Chemicals Corp Berhad began international roadshows yesterday (May19) for a $213 million to $283 million IPO on the Kuala Lumpur Stock Exchange (KLSE). The company is offering 438 million shares, equivalent to 25% of its enlarged share capital.

The retail order book will close on June 6 and the institutional order book on June 9. International and Malaysian institutions are being offered 72% of the deal (subject to clawbacks) and retail investors the remaining 28%.

The deal is being marketed at M$1.85 to M$2.45 per share, with the retail price fixed at M$2.17. This represents a range of 5.6 to 7.4 times forward earnings based on the average 2005 profit forecast of the four bookrunners: CIMB, DBS, Goldman Sachs and Mayban Securities. On a 2006 basis, it equates to a P/E range of 4.6 to 6.1 times.

The company's financial year-end is December.

On an EV/EBITDA basis, the deal is being pitched on an 2005 range of 4.4 to 5.1 times and a 2006 range of 4.6 to 5.3 times.

The deal appears to have been very attractively valued both in comparison to the domestic market, as well as regional and global comparables. Non syndicate bankers say it needed to be because it will not prove plain sailing at a time when there is considerable uncertainty about the petrochemicals cycle.

Specialists say that chemical companies typically trade at a 30% to 40% discount to the average P/E of their local stock exchanges. In Malaysia's case this is currently 13 times forward earnings, which means that Titan is coming at 43% discount relative to the most expensive end of the range and a 57% discount at the bottom end.

Regionally there are a number of comparables. A basket of stocks comprising: Taiwan's Formosa Plastics and Formosa Petrochemicals; Korea's Hanwha Chemical; Honam Petrochemical and LG Petrochemical; Thailand's Thai Olefins and Thai Aromatics; India's Reliance Industries; China's Shanghai Petrochemical and Yizheng Chemical currently averages about 7.5 to eight times 2005 earnings.

However, there are some big regional variations, with the Koreans and the Thais coming in at the bottom end of the scale on low single digit multiples and the Taiwanese at the other end on low double digit multiples. Globally, US and Japanese chemical companies are currently averaging about 15 to 16 times 2005 earnings, with the Europeans slightly behind at roughly 13 times.

There are two main reasons why Titan is being pitched relatively cheaply despite the cost competitive advantages it derives from its integrated status. Firstly the company is in debt reduction mode and the stock is unlikely to be a big dividend yielder like LG Petrochemical (7.2% forward yield) and Shanghai Petrochemical (6.7%).

Secondly and more importantly, a number of houses have begun to express concerns about the petrochemicals cycle and the impact significant new capacity expected out of the Middle East in 2007 will have on the high prices the sector has been enjoying. A number of houses have started to put out research suggesting the cycle has peaked following evidence of falling spot prices. Over the past month, the spot price of ethylene has dropped about 17% and propylene about 4%.

Credit Suisse First Boston, for example, published a research report in mid-April that said, "Capacity growth for ethylene, the basic building block of petrochemical products, is expected to accelerate to 4.5% in 2005 and 5.9% in 2006, from a low of 0.3% in 2004. As such we believe that cracker margins and operating rates reached their peak in 2H04 to 1Q05."

However, other houses still believe the cycle will continue, or believe it may experience a camel hump, whereby there is a slight dip before prices stabilise and rise again. One reason for this optimism is that a shortage of refining capacity has pushed some companies into petrochemical feedstocks and other products to the benefit of suppliers like Titan.

But the big swing factor as ever is China, which now accounts for 30% of world polymer demand, but faces ongoing supply problems despite significant domestic capacity expansion. Standard & Poor's says this is one of the main reasons why ASP's (Average Sale Prices) of polyethylene and polypropylene increased 54% and 35% to $995 and $972 per metric ton in 2004.

China is a big market for Titan, which accounts for 25% of its total production. Aside from being able to take advantage of soaring demand on the Mainland, Titan is also expected to benefit from a 2% reduction in the 10% to 12% import tariff it presently faces.

Titan specialises in naptha cracker processing and operates two naptha cracker plants and five polymer plants at a $1.45 billion site in Johor-Bahru Malaysia. It has total polymer and aromatics production capacity of about 1.1 million tons per year.

As an integrated producer, it manufactures ethylene and propylene using naptha as its main feedstock. These two are then used to manufacture polymers such as polypropylene and polyethylene. Polymer products are sold on to companies that manufacture a wide range of consumer and industrial applications as diverse as plastics packaging and synthetic fabrics such as nylon and rayon.

Titan also produces some aromatics products such as benzene and toluene. About 47% of its production is sold domestically and it has a 50% market share of the domestic polypropylene market and 30% share of the polyethylene market.

Specialists say Titan is highly cost competitive thanks to its integrated single site facilities and sits in the top quartile in terms of lowest global cash costs per site. The company's use of naptha rather than natural gas as its main feedstock gives it a cost advantage over US competitors, while its location close to Pasir Gudang port lowers its transportation costs.

In 2004, it reported an EBITDA margin of 26%, high by industry standards. According to CSFB research, the Asian chemical industry average stood at about 15%, versus 20% in the US and 18% in Europe.

But, this has not come without a cost. Titan had to enter a debt restructuring in 2001 after breaching its covenants during the Asian financial crisis. Analysts say the group got hit by a perfect storm - reaching the peak of its capex programme to build the Johor site just as the cycle entered a steep downturn as oil prices soared and plastics demand plunged.

In March 2004, the company attempted to tap the international high yield bond market in order to ease liquidity concerns. However, the deal fell by the wayside at a time when all Asian high yield deals struggled to tempt US investors without paying a high premium.

Instead, it went on to secure a $700 million amortizing term loan. Part of the proceeds from the IPO will be used to partially re-pay this loan: a move that should not only improve the group's debt profile, but prompt a ratings upgrade from BB- by Standard & Poor's.

In a recent ratings report the agency said that, "A successful equity issue and the use of issue proceeds to reduce debt, will have the potential to result in a revision of its outlook to positive, or even a rating upgrade."

According to S&P Titan currently ran a debt to EBITDA ratio of 3.2 times in 2004 and a gearing ratio of 67%. This represented a significant improvement over 2003 when debt to EBITDA stood at 6.8 times and gearing was up at 80%.

Titan's ability to improve its financial profile has been the direct result of strong product prices and demand. In March when S&P wrote its report, it said it believed the company would be able to continue de-leveraging down to industry averages because of supportive industry fundamentals.

The agency has also said that if prices remain stable Titan's fund from operations (FFO) should be adequate to cover both its debt repayments and capex. The company has earmarked M$281 million ($74 million) in 2005, M$251 million in 2006 and less than M$100 million in subsequent years to improve efficiencies through de-bottlenecking.

Specialists believe that even if global investors believe there is little upside to the current cycle they may still buy the stock because of strong underlying support from Malaysia itself. The fact that the Malaysian market offers very few high quality private sector companies is likely to be one of the biggest selling points of the deal.

As one observer puts it, "It should never be underestimated just how desperate Malaysian institutions are to diversify away from the government-linked companies, which dominate the local stock market and generate pretty low returns. This is a large deal by local standards; the company is a national leader in its field and the valuation looks attractive relative to the overall market."

Alongside the four lead managers, co-leads are BNP Paribas Peregrine, CLSA and RHB Securities.