Idea of the week: LG Energy Solution attractive green bond for ESG investing

Highlights:

• LGES is the third largest battery manufacturer in the world with a total EV battery market share of 16%

• Earnings remains strong with KRW 33 trillion in sales in FY23, boosted by strong EV demand growth in the past 2 years.

• Credit metrics remains strong with good short-term liquidity contributed by large cash holdings. However, planned capex in 2024 may weigh down on credit metrics as debt is likely to further increase.

• The yield to maturity of LGENSO 5.625% 25Sep2026 Corp (USD) at 5.55%  is an attractive option for Malaysian investors as local yields remains low.

Background

LG Energy Solution (LGES) established in 2020 as a split-off from LG Chem’s battery business is listed on the Korea Exchange with a current market capitalisation of KRW 95 trillion, making it the third largest company in Korea by market capitalisation. Similarly, LG Energy is currently the third largest battery manufacturer in the world with a total EV battery market share of 16%.

LGES’s primary business is the production of lithium-ion batteries for EVs, capitalising on the growth in demand for EV vehicles in recent years. The group mobile and IT battery division remains a stable business for the group contributing an estimated 20% of total sales.

LGES earnings boosted by strong EV market growth

Table 1: LGES Profitability (KRW billion – unless otherwise stated)

LGES has managed to capitalise on the strong global demand for EVs, recording an all-time high sale of KRW 33.7 trillion with an operating profit of KRW 2 trillion, representing a margin of 6.4%.

However, the group recorded a 30% year-on-year (YoY) dip in 1Q24 sales from KRW 8.7 trillion to KRW 6.1 trillion while operating profits dropped 75% YoY to KRW 157 billion. The drop in sales is mainly due to a slowing EV sales growth in major markets such as the US and Europe. This weighed down on their profitability as utilization rate adjustments led to fixed cost burden for the company. However, as EV demand still remains strong, management has given guidance of improving sales in 2H24 from new EV models from US customers such as GM.

Joint Venture with leading automotive OEMs to boost sales

LGES has made significant progress in increasing their capacity, especially through joint venture with leading automotive OEMs in the world who are also looking to grow their EV offerings. At present, they have joint ventures for battery manufacturing with General Motors, Hyundai and Honda which effectively secures sales of batteries to these companies in the region. This year, a new plant which is a joint venture with Hyundai and a capacity of 10GWh has started operation in Indonesia, extending their network in the currently growing EV market of South East Asia.

Furthermore, LGES has further expanded their presence in America to capitalise on the incentives provided under the Inflation Reduction Act (IRA). The current tax credit will help spur the supplies of batteries in the US tax credit of up to USD 35 per KWH for domestically produced battery cells and USD 10 per KWH for domestically produce battery modules. On the demand side, a subsidy of USD 7,500 to incentivise EV uptake will also help support demand for EVs in the US.

For reference, the company has recorded KRW 678 billion in IRA tax credits for FY2023, representing 31% of operating profit in 2023. In 1Q24, the company would have recorded a loss if not for a boost of KRW 189 billion from the IRA tax credits realised. As the tax credit is expected to continue to 2030, we believe LGES is poised to benefit from it as they have poured in significant investments in their US operations with planned capacity of 215 GWh/year in 2025.

Credit metrics remains strong but debt expected to increase

Table 2: LGES Credit Metrics

The recent EV market boom has spurred a spike in capital expenditures for battery manufacturers like LGES. Capex increased from KRW 4 trillion in FY21 to KRW 10.9 trillion in FY23 mainly to meet the increasing demand and also the added incentive from the IRA has made investing in the US cost effective for LGES. As such, their total debt has also increased to KRW 10.9 trillion in FY23 from KRW 6.9 trillion in FY21. However, despite the added borrowings for capex, net gearing and current ratio improved in FY23 compared to FY21 as increased profits improved their balance sheet.  Nevertheless, short-term liquidity remains strong, with cash at a comfortable level above short-term debt.

In 2024 however, the company is expected to further take on more debt as seen in 1Q24 where total debt rose to KRW 12.8 trillion from KRW 10.9 trillion as planned capex still remains high. Nevertheless, with current gearing ratios and net debt to EBITDA levels, the company can comfortably take on more debt without putting a strain on their credit profile.

LGES bond is suitable for ESG investing with an attractive yield

LGENSO 5.625% 25Sep2026 Corp (USD) is a green bond issued to raise funds for LGES green projects such as low-carbon transportation. The green financing framework used by LGES in February has received the highest rating of SQS1 (Superior) from Moody’s.

LGES credit rating of BBB+ / Baa1 (S&P / Fitch) with the bonds similarly rated, the current YTM of 5.55% is attractive for investors, especially those who are climate conscious and into ESG investing. Also, the bond is available on our BE allowing investors to invest a small amount to add in a green bond in their bond portfolio.

Table 3: LGES bond

Related Risk

LGES sales are affected by the overall demand of EVs as their main business comprises of manufacturing batteries for EVs. Demand for EV in 1Q24 has showed signs of slowing growth with sales growth in US at 15% YoY for 1Q24 as compared with the 40% growth seen in 2023 while Europe 1Q24 only recorded a 5% YoY growth as compared to 20% in 2023.

Demand for EV in China remains strong, however, the battery manufacturing market in China is dominated by CATL and BYD with both groups currently has an overcapacity of battery manufacturing. Despite the slowing growth in the US, where LGES is actively expanding, we believe the IRA tax credit will continue supporting EV demand there while LGES will be able to benefit from the additional battery tax credit.

Secondly, while LGES can benefit from the US tax incentives for battery manufacturers, it has also drawn in investments from other battery manufacturer and has brought the battery manufacturing capacity that is operational or committed for to already be sufficient to meet projected demand by 2030. As such, the market remains very competitive with a significant drop in EV demand to significantly affect plant utilisation rates and affect profitability.

Conclusion

LGES credit ratios still remain strong despite large capex to increase capacity as profitability and cash flow contributed positively. Furthermore, the added implicit backing from their parent company LG Chem also provides some security for LGES bond investors.

Lastly, despite slower growth in EV sales in 1Q24, we believe the transition to EV will continue as the industry outlook for EV remains positive with clear electrification targets from the largest automakers.

With a yield to maturity of 5.55%, we believe it is an attractive investment for Malaysian investors as local yields remain low. We recommend investors looking for stable income with ESG considerations to consider LGENSO 5.625% 25Sep2026 Corp (USD).

Declaration:  For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds  LGENSO 5.625% 25Sep2026 Corp (USD) and the analyst who produced this report holds a NIL position in the abovementioned securities.

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