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MegaChem Limited

Management Online Q&A With Investors

Dear Investors,

Thank you very much for your questions and the opportunities to respond to them.

We hope you have a better understanding of our business through this online exchange.

Your questions are reposted in blue followed by our replies in black.

Best Regards,
The Management Team
MegaChem Limited

1. Dear Puar Hai Kuan, you wrote:

  1. In your previous half year statement (FY2013), you mentioned that the US shale gas boom could lead to some opportunities for Megachem. Could you provide an update on this and if the company is still pursuing opportunities from the shale boom? Also, what is likely to be the impact on the company if oil falls for an extended period of time to $90 per barrel (West Texas)?

    The development of shale gas as a source of cheaper energy in North America is altering the chemicals industry value chain. For chemical companies, the impact of an increased supply of shale gas has been a reduction of the cost of both raw materials and energy cost. The United States (US) could become a major and global low-cost provider of energy and feedstock to the chemicals industry. We view this as an opportunity for us to strengthen our sources of chemical supplies from the US and with it, an increase in our market competitiveness.

    In general, when oil prices rise, costs for the raw materials used to make chemicals also rise.

    Higher raw material costs affect companies that make basic chemicals or commonly known as the commodity chemicals most as the content of oil in such upstream products are high.

    Not immune but less susceptible to the pressures faced by commodity chemical companies, are companies that make specialty chemicals, which are more focused on targeted applications and markets. These are more downstream products whose oil content is smaller and their usage in finished products is also smaller.

    As we are mainly in the specialty chemical business, the direct impact of rising oil prices on us is not as much compared to a commodity chemical company. This is evident in the fairly stable gross profit margin that we were able to maintain over the years.

  2. In April this year, an investment of $3.2m into a piece of industrial land in Klang was made. This comes on top of a recent expansion which cost the company $8.8m ($5.6m for factory building and P&E totaling $3.2m) in FY2012. You mentioned then that there were no plans for further capital expenditure. The company has inevitably taken on more debt in the last few years to support these expansions. Could you give more insight into this new expansion? Also, the company has traditionally been conservative and this recent spate of expansion seems to be quite aggressive. Could you elaborate further?

    The key objectives of this expansion are:

    1. To develop manufacturing as an engine of growth for Megachem to enhance our production capabilities and capacity to meet our customers' diverse demands. It also serves to improve our productivity through better asset utilisation, increased process efficiency and automation.

    2. To manage increasing cost pressures. Faced with increasing warehousing cost, we concluded in 2011 that we had to reduce reliance on third party warehouses by expanding our own warehousing space and hence minimising warehouse cost increases. We thus bought the factory/warehouse building in Singapore in 2011 at a cost of S$5.6 million. Since then the value of this property has appreciated. If we had not bought this property and continued to rely heavily on third party warehouse, we would have faced far greater increases in warehouse costs charged by our third party warehouse operator. In Malaysia we faced similar cost pressures. Prior to buying the piece of land in Klang, we were renting warehouse space from a third party warehouse operator. With this purchase, we will be able to store our inventories within our own premises which will lead to savings in warehouse costs.

    3. To enhance our asset base. These properties are tangible assets which will, in the long term, strengthen our balance sheet.

  3. Megachem embarked on a vision in 2007 to becoming a global integrated player in the specialty chemical business with plans to enter a new phase of growth. Since then your revenue has grown significantly from about 75m in FY2007 to more than 105m in FY2013. However, net profit by any measurements has stagnated. Your recent expansion will add further pressures on profit margins ahead. Also, growth in manufacturing activity has hardly been encouraging despite the capital outlay. In your latest results, management warns again of a volatile and sluggish environment, pointing to the long term potential instead. While businesses are built for the future, I am concerned about management's ability to balance keeping the company profitable, funding growth, paying dividends and managing risks. Would this be a fair comment?

    Despite having grown our revenues successfully, our profits over the last few years have been adversely affected by the following factors:

    1. Depreciation arising from the production facility expansion. The production facility was depreciated over an accounting period of 5 years although the useful lives of the equipments are more than 5 years. They will be fully depreciated some time in 2016.

    2. Currency losses. Increased currency volatility led to foreign exchange losses over the last few years. As our operations now span over 11 countries, currency management becomes increasingly challenging especially in countries such as India and Indonesia. In the first half of 2014, currency movements are generally more favourable to us and as such, our foreign exchange losses have been minimised.

    3. The main reason for the lower profit in the first half of 2014 was the lower contribution from our Thai associate. Its operation has been adversely affected by the political tensions in Thailand.

    Before we embarked on this strategy of building our manufacturing business and expanding our asset base, our borrowings (net of cash) was only S$0.2 million and gearing at 0.2 times at the end of FY2009. It was a very comfortable level from which we could leverage up to execute the business plans we had formulated. As at the end of 1H 2014, our net borrowings (net of cash) was S$12 million and gearing at 0.56 times which we believe is still at a manageable level. On the other hand we have pared down our dividend payment last year to strike a balance between conserving cash for growth and shareholders' return.

2. Dear George Chen, you wrote:

Profit Contributions by associated companies dropped by 56.2% for 1H 2014. You mentioned that it was due to the uncertain political situation in Thailand. Has the situation improved recently after the military took over as the government? Do you think the problem will persist?

The military, having taken over the government, has brought some degree of calm and stability. Thailand's economy has narrowly avoided a technical recession, edging back into positive territory with 0.9 per cent growth in the second quarter of this year. It seems to suggest that things are improving though it is not on very firm footing. However there is no certainty that it will improve further as long as the political impasse remains unresolved.

3. Dear Teo Hwee Ching, you wrote:

It has been 2 years since Chori became a Substantial Shareholder of the company. Has the strategic partnership bore any fruits?

It is important to note that Chori Group, apart from being a substantial shareholder, is also a strategic business partner. The strategic partnership agreement with Chori Group was signed in October 2012 with the objective of mutually expanding both parties' chemicals business through the tapping of our respective marketing expertise and network. Though it has not developed in a big way, we remain committed in our pursuit of this objective.

4. Dear David Koh, you wrote:

You wrote off double the amount of inventory compared to last year but your inventory turnover is still 90 days. Is chemical perishable like food? Do you have a ERP system to keep track of inventory to minimise write off?

Chemicals have long shelf lives as long as they are stored in proper conditions. Although chemical raw materials are not perishable like food products but they nevertheless have expiry dates set by the manufacturers. The provision for inventory is only a proactive and precautionary measure taken by the Management. There is no significant deterioration in the quality of our inventory despite the increased in provision. We use SAP, a reputable ERP system, to manage our inventory.

Dear Investors,

Thank you for all your questions and your interest in MegaChem Limited. We have come to the end of this Q&A session.

We have enjoyed the session and have learnt much from your questions. We hope that through this Q&A, you have gained better insights to our Company and our operations.

Best Regards,
The Management Team
MegaChem Limited

This announcement has been prepared by the Company and the contents have been reviewed by the Company's Sponsor, SAC Capital Private Limited, for compliance with the relevant rules of the Singapore Exchange Securities Trading Limited ("Exchange").The Company's Sponsor has not independently verified the contents of this announcement.

This announcement has not been examined or approved by the Exchange and the Exchange assumes no responsibility for the contents of this announcement, including the correctness of any of the statements or opinions made or reports contained in this announcement.

The contact person for the Sponsor is Ms Alicia Kwan (Tel : (65) 6221 5590) at 1 Robinson Road #21-02 AIA Tower Singapore 048542.