Main causes of the poor NPAT performance. We attribute Li Heng’s huge fall in 1Q09 profitability YoY to the following factors:
(i) Fall in ASPs (RMB16,420/t in 1Q09 versus RMB34,370/t in 1Q08).
(ii) Fall in gross margins (12.9% in 1Q09 versus 34.4% in 1Q08).
(iii) Increase in income tax rate (43.9% in 1Q09 versus 13.1% in 1Q08).
Updates from management. The PA chip plant as part of Li Heng’s Phase III expansion plans has almost been completely installed, and trial testing should commence in Jul or Aug 09. The extra 70,000 tonnes of nylon capacity should come on stream by end 1Q10 (trial testing Jan or Feb 10), and the respective structures have already begun construction. This new capacity will be used for finer yarns that ultimately go towards making sweaters and lingerie. Hence, a lower tonnage of production should pan out, somewhere between 40,000 – 50,000 tonnes per year. Order visibility stands at two months, but customers are noticing a sharp fall in orders after July 09, especially for export segments.
Changes to our estimates. We have further lowered our gross margin assumptions from 15.1% and 16.7% previously to 13.5% and 15.1% for FY09 and FY10 respectively. ASPs have also been slashed from RMB19,350/t and RMB21,340/t previously to RMB16,590/t and RMB18,480/t for FY09 and FY10 respectively. Our production volume assumptions have remained unchanged as Li Heng is still able to maintain a 90% rate of utilisation. As a result, EPS has been reduced 17.9% to 2.8S¢ for FY09 and 7.9% to 4.4S¢ for FY10.
Valuation. We have updated our DCF model and lowered our required return on the market from 20.0% previously to 15.0% to account for an improvement in market sentiment, liquidity and risk aversion. This gives us a new target price of S$0.20 (S$0.22 previously) on the back of lower forecasted earnings. Given the limited upside, we are downgrading the stock to a HOLD.
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