China Sky: Profit warning

China Sky cautions investors that the Group has swung into losses in 1Q09, as operating environment deteriorated. The demand from customers has weakened further as end consumption for textile products from both domestic and export markets shrank. This has led to softening prices despite firm raw material cost. We have slashed our earnings forecasts for FY09 and FY10 by 69% and 55% respectively on lower sales volumes, ASPs and margins. Maintain FULLY VALUED with a reduced TP of S$0.14.

Worse than expected. The utilisation for China Sky has drifted below 50% level in 1Q09. We believe the ASP has plunged by 20%-30% qoq as demand for nylon yarn continued to slacken. We now expect volume to remain sluggish in 2Q and gradually improve towards the end of 3Q. Overall gross margins in 2009-2010 are expected to normalize to around 15% level vs 20% previously. Based on the lower volume and margin assumptions, our FY09 and FY10 earnings are slashed by 69% and 55% to RMB67m and RMB141m respectively.

Jittery over CEO's pledging of shares. China Sky has recently announced the pledging of the CEO, Mr Huang Zhong Xuan's 19% stake in the group for personal loan and his failing to pay instalments. This has brought about an overhang of China Sky's shares. In addition, business continuity of China Sky could be at stake in the event that Mr Huang, the founder of the group, steps down as the CEO. This is expected to suppress the share price performance in the near term despite any market re-rating.

Maintain FULLY VALUED; TP reduced to S$0.14. Hence, we retain FULLY VALUED on China Sky. Our TP has been revised down to S$0.14, following the earnings revision, still pegged to 0.2x FY09 P/NTA.

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