INSIGHT: Korea petchems down but not out

09 January 2009 15:05  [Source: ICIS news]

By Malini Hariharan

South Korean petrochemical companies have often been singled out as being very vulnerable to an industry downturn given their heavy reliance on imported naphtha and product exports.

The last quarter was brutal with most companies implementing aggressive production cuts to keep inventories under control as demand in China and other key markets collapsed. And there is consensus in the industry that 2009, especially the first half, will be challenging.

“It is going to be matter of survival,” said a senior executive from Honam Petrochemical.

Hopes are being pinned on a recovery in market conditions in the second half of the year but a lot will depend on the how quickly the global economy rebounds and Chinese demand returns.

China is a key destination for Korean exports and producers may have no option but to cut back production if Chinese demand shrinks. 

Sector operating profit is expected to decline sharply with one brokerage estimating a 30% fall in 2009 and a 10% drop in 2010.

Honam Petrochemical is widely cited as being most sensitive to the downturn because of its heavy exposure to core petrochemicals.

Hanwha Chemical, LG Chem and SK Energy are in a better position thanks to their more diversified product portfolios. 

However, Hanwha’s future prospects are also dependent on whether parent company Hanwha Group goes ahead with a Won6500bn ($4.9bn) acquisition of Daewoo Shipbuilding & Marine Engineering Co (DSEC).

Hanwha Group emerged as the preferred bidder for DSEC in October 2008 but has been struggling to find money to fund the deal. According to a local media report, it is under pressure from Korea Development Bank, DSEC’s main creditor, to complete the acquisition by the end of January.

Hanwha Chemical is expected to be heavily involved in this deal as it is one of the most profitable companies in the Hanwha Group stable.

“The acquisition offers no synergy. Hanwha Chemical being an affiliate is being punished,” said a financial analyst.

While there is unanimity that business conditions in 2009 will be tough there is also some hope local producers will not be as badly hit as some Japanese and Taiwanese companies or over leveraged European and US producers.

“Most Korean producers have already prepared for this situation. We expanded our capacity to reduce production cost. I think we can survive the next trough better than the Japanese, small Chinese and European companies,” said a second source from Honam.

The company completed a major cracker expansion last year to become one of Korea’s largest ethylene producers. It expanded its polyethylene (PE) plants and started up new monoethylene glycol (MEG) polypropylene (PP) plants.

Yeochun Naphtha Cracking Centre (YNCC), the olefins joint venture between Hanwha Chemical and Daelim Industrial, added volume at its  No1 cracker in 2007. And LG Chem also expanded its Daesan cracker in the same year.

Financial analysts concur that expansions have helped Korean companies improve their competitiveness. They also draw attention to the relatively healthy balance sheets and low level of gearing at these companies.

“We are going to see bad business conditions in Q1 and Q2, but companies have enough cash to endure. Most of the revamping and debottlenecking projects were carried out with limited capital expenditure. This should be helpful,” said a second analyst.

Another plus is the restructuring that has taken place after the 1997 financial crisis which has cut down the number of players and streamlined operations.

Just this month Honam merged its subsidiary Lotte Daesam Petrochemical which it had acquired from Hyundai Petrochemical in 2003.

LG Chem integrated its business with LG Petrochemical in 2007 while in the previous year it merged subsidiary LG Deasan Petrochemical, also acquired from Hyundai in 2003.

A healthy balance sheet gives room for Korean companies to participate in acquisition opportunities over the next couple of years. While buying rather than building is likely to make more sense during a downturn some analysts believe that it would be advisable for Korean companies to focus on Asian assets as they have more business experience in this region.

As for more restructuring within Korea, it is probably still too early to say if and when this will happen.

“We will really have to look at what happens in H1 2009. If it is like the fourth quarter of 2008 then the pressure to restructure will increase,” said the first analyst. 

But there could be some obstacles for further consolidation. While companies know that they need to be bigger to survive government antitrust regulations could come in the way. Companies will have to convince the government that the industry is a global one and Korean players need to build up scale to effectively compete with international producers.

The other hurdle could be the strong cash position that most companies currently enjoy. “Everyone wants to be a winner now and not a loser,” pointed out the first Honam source.

Ultimately companies may not have much of a choice, especially if the downturn turns out to be an extended one.

($1 - Won0.000753)

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By: Malini Hariharan
+65 6780 4359

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