Li Heng Chemical Fibre Technologies - 2Q09: In line; 3Q09 to improve further with ongoing recovery

Li Heng reported 2Q09 net profit of Rmb38.0m, down 88.9% yoy. On a qoq basis, however, 2Q09 net profit almost quadrupled from 1Q09’s Rmb10.2m, which was in line with our expectation. A forex gain of Rmb13m in 2Q09 as opposed to the Rmb21m forex loss in 1Q09 was the main reason for the prominent qoq improvement. Otherwise, the company actually saw a slight qoq decline at the gross profit level in 2Q09 because the poor performance in April, which was the weakest month in terms of selling prices and margins, had dragged down the overall outcome in 2Q09.

Revenue declined 61.2% yoy to Rmb453.3m due to a 50.9% yoy decline in average selling prices (ASP) and a 21.0% yoy decline in sales volume. Li Heng ran at full capacity in 1H09, but since it produced different types of yarn, the maximum amount it could produce was less than its originally designed capacity.

Gross margin for 2Q09 deteriorated further to 10.6% from 12.9% for 1Q09. This was also due to the negative effect of a weak April. Gross margin was below 8% in April, gradually expanding as the market recovered since May, and approached 15% in June.
The chemical fibre industry continued to see a recovery in 3Q09. According to Li Heng, there has been quite a significant improvement in July and August, with selling prices rising about 10% based on ASPs in 1H09. Thus, we expect gross margin for 3Q09 to climb to over 15% given such a huge increase in selling prices.
The fluctuation in the exchange rate of S$/Rmb appeared to have largely stabilised in the last two months as compared to that in the previous quarters. As such, we expect the impact of the forex gain/loss on Li Heng’s bottom line to decrease, making its future performance more predictable. And as the company continued to witness improvements in its operations, operating factors such as margin expansion and selling price hikes would dominate the changes in the results.

Looking ahead, with the ongoing favourable trend in the market, we expect Li Heng to record an over 10% qoq increase in 3Q09 revenue, a 40-50% qoq jump in gross profit, and over 30% qoq increase in net profit.

Li Heng remains our top pick in the chemical fibre sector as we like its ability to maintain production at full capacity and to generate profits when others are incurring losses, which generally validate the company’s leadership position. 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 5x 2010 PE.

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