Strong fundamental recovery over past
few years has been accompanied by
record-high share prices and valuations
Sharp increase in titanium sponge
supply likely to coincide with slowing of
demand growth from 2009
Given stretched valuations and the
market’s tendency to begin discounting
cyclical peaks well ahead of a downturn,
we initiate coverage on Sumitomo
Titanium (5726) & Toho Titanium (5727)
with Underweight (V) ratings
Against a backdrop of surging demand and capacity
shortages, titanium sponge contract prices rose by 30% in
2005, 20% in 2006 and appear poised to rise by a further
30% in 2007. The two Japanese titanium sponge producers
are currently enjoying record-high profits and share prices
(up 14 and 35 fold since the beginning of 2004).
While the near-term outlook remains positive and the longterm
structural growth story continues to be of interest, we
are growing increasingly concerned about what lies in
between. We believe that industry-wide aerospace grade and
premium-grade sponge capacity growth is likely to
accelerate sharply in 2009 just as demand from the
aerospace industry begins to slow sharply. We expect the
resulting deterioration in the supply-demand balance to have
negative consequences for pricing and profits.
Trading at 12x and 15x book and 54x and 56x prospective
earnings, the Japanese titanium stocks appear vulnerable to a
substantial correction. We look for the growing risk posed
by large increases in future capacity to drive significant
multiple compression/absolute share price declines, as the
top of the cycle comes into view. Toho Titanium’s share
price has tended to peak 18-23 months ahead of the
announcement of peak earnings, suggesting potentially weak
share price performance in spite of positive news flow. We
initiate coverage on Sumitomo Titanium and Toho Titanium
with Underweight (V) ratings and one-year share price
targets of JPY10,300 and JPY4,000, respectively, implying
potential downside of 26% and 35%, respectively.
Contents
Investment summary 3
Valuation 10
Buy high, sell low? 10
Titanium: a primer 16
What is titanium and how is it “produced”? 16
Properties & applications 16
Not all sponge created equal 17
Industry structure 18
Increasing fragmentation 19
Increasing commoditisation down the line? 19
Titanium demand 20
Commercial aerospace 20
Stronger, longer order cycle .21
Increasing use of titanium ..21
Military aircraft 22
Industrial applications 22
Consumer applications 23
Capacity growth to accelerate in 2009 24
Capacity growth picking up 24
Explosion in Chinese capacity 25
Increases in sponge capacity elsewhere reasonably straightforward 26
Japan .26
Russia .26
US 27
Ukraine.27
Titanium prices and profits likely to fall from FY Mar-10 29
Risks 33
Disclosure appendix 37
Disclaimer 41
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