Chemical Fibre – Nylon industry seeing signs of recovery
By UOB Kay Hian
China's chemical fibre industry has likely hit bottom after entering a down cycle from late-4Q08 to early-1Q09. Implications include the plunge in selling prices, lower production, decreased profitability, longer receivables and asset turnover, as well as heavy cutbacks in fixed asset investment.
Since early-2Q09, the chemical fibre industry has begun to experience a recovery, especially from May 09 onwards. The improvement appears quite substantial with production revisiting double-digit growth in May 09. Recall in 4Q08 when prices fell sharply, nylon fibre makers suffered from both sales decline (as a result of lower selling prices) and severe margin erosion
when they had to purchase chips at a higher price level and sold yarn products at a lower price level.
The situation has since reversed and prices are now rising. Thus, we believe the benefits to fibre producers would also double in terms of higher sales and better margins.
The chemical fibre industry will soon enter the strong July-August season when fibre producers will fulfil more export orders for Christmas sales. Business climate and consumer confidence appear to be picking up in many western countries, especially the US.
We therefore expect fibre makers to see more orders rolling in. Although textile and garment exports for July-August could still record a year-on-year (yoy) decline due to relatively high base last year, we believe the chemical fibre industry will still benefit as the stronger demand will help the sector step further out of the trough, heading towards recovery.
Stock Watch
Li Heng
We like Li Heng for its consistent capability to maintain production at full capacity and generate profits when others fail to do so, which generally validates the company's leadership position and enables it to gain additional market share. As the industry recovers, we expect Li Heng to benefit more as a market leader in terms of charging more decent prices and reporting better margins. Maintain BUY on Li Heng with a target price of S$0.29, based on Hong Kong peers' average FY10 PE of 5x.
China Sky
China Sky will also benefit from the industry's recovery. However, the underperformance at its Qingdao Zhongda facility may offset these benefits to some extent. We have also noticed two additional risks from the company's balance sheet. The first is in relation to the rapidly depleting cash – CSky's cash position declined sharply from Rmb880m as at end-4Q08 to Rmb370m as at end-1Q09. The company's detailed explanation of its cash usage was unconvincing.
The second risk is the potential intangible assets write-off – CSky may write-off part of the Rmb208m intangible assets linked to the acquisition of QZ, due to lower-than-expected synergy and efficiency at the plant, which could cause downside risk for both CSky’s net asset value and its bottom line in 2Q09. Hence, we apply a 20% discount on the target PE for CSky to account for
these risks. Maintain HOLD with a fair price of S$0.22, based on 4x FY10 PE. Our entry price is S$0.15.
Disclaimer
We have based this document on information obtained from sources we believe to be reliable, but we do not make any representation or warranty nor accept any responsibility or liability as to its accuracy, completeness or correctness. Expressions of opinion contained herein are those of UOB Kay Hian Research Pte Ltd only and are subject to change without notice. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of the addressee only and is not to be taken as substitution for the exercise of judgement by the addressee. This document is not and should not be construed as an offer or a solicitation of an offer to purchase or subscribe or sell any securities.
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