Ube Industries:Upside potential for both earnings and valuation

Not only higher than expected results in FY17

    We have reviewed our earnings estimates based on results and a company visit. Thecaprolactam (CPL) spread has currently widened to a level significantly above thecompany plan. Full-scale shipments of battery separators for xEVs in advanced countriesare also expected from July-September and this should emerge as a profit growthfactor due to growth for coating type separators, which have high added value. Wealso forecast profit growth of 10% yoy in FY18driven by the chemical business, mainlythe nylon lactam chain and separators. We expect the company's profit growth tostand out among diversified chemical makers that face risk of a profit decline in FY18.

    Medium-term plan FY18OP target of ￥50bn looks achievable

    We have raised our FY17OP forecast from ￥44bn to ￥45.5bn. We have raised theconstruction materials business by roughly ￥1bn due to a recovery in domestic demandfor cement, and the chemical business by roughly ￥500m on effects from cheaper rawmaterials due to lower ammonia prices and higher volume for polyamide. Comparedwith the company plan of ￥40bn, we think CPL, for which the spread assumption is$775/tonne, and cement, with a domestic demand growth assumption of +1% yoy,are particularly likely to be higher than planned. We have also raised our FY18forecastfrom ￥48bn to ￥50bn.

    CPL to benefit from environmental regulation

    The CPL-benzene spread has widened to $973/tonne. According to the Japan ChemicalDaily on 18August, capacity utilization has been restrained mainly at themanufacturers in the Northern region in China due to environmental audit. As theseason with strong demand for winter clothing is coming soon, the spread is likely toremain firm for a while. We maintain our FY17spread assumption of $900/tonne, andsee an increasing probability that our assumption will come true.

    Valuation: PER looks very undemanding

    We are lifting our PT from ￥330to ￥360to reflect the revision to our earnings forecast,based on a FY18E PER of 12.0X (previously FY17E PER of 12.7X). The stock is currentlytrading at a FY17E PER of 11.2X, which looks attractive on historical comparisons.Meanwhile, a PBR of 1.0X does not seem to fully factor in a likely recovery in ROE onthe back of robust profit growth and sustained shareholder returns.