China XLX Fertiliser - 2Q09: The worst has passed

Worse-than-expected 2Q09 results due to lower product prices and one-off loss. We expect profit to recover in 2H09 given the production ramp-up at new plant. Maintain BUY with target price of S$0.57 based on 8x 2010F PE.
China XLX Fertiliser’s (XLX) turnover was up 7% yoy to Rmb545m, mainly due to the launch of the new urea plant in mid-Apr 09. Gross margin and EBIT margin slid 13ppt yoy to 10.8% and 6.7% respectively, due to declines in the prices of urea, methanol and compound fertilisers, as well as one-off start-up costs for the new plant. Net profit plummeted 75% and 60% yoy respectively to Rmb23m in 2Q09 and Rmb82m in 1H09 (vs our full-year forecast of Rmb226m).


We believe the worst to be over in 2Q09, and earnings could recover in 2H09, due to the smooth launch of the new plant, as well as the stabilisation of urea prices and methanol prices. In 2Q09, the company registered substantial one-off start-up costs for the launch of Phase III in mid-April. The start-up costs will not be repeated in 2H09. With the production ramp-up at the new plant, the company’s urea capacity has increased from 0.72m tonnes to 1.25m tonnes. The company expects the new plant’s utilisation rate to increase throughout the year and reach full capacity next year. Unit cost is lower than that of the two old plants, which helps to drag down overall cost. Urea prices in China have stabilised at Rmb1,600-1,700/tonne due to a rebound in international urea prices and the reduction of urea export tariff, which opens the profit window for Chinese urea exports.

The loss from the methanol segment will narrow as XLX is streamlining facilities to produce less methanol and more urea, as well as reduce the cost of production. Adding to the boost is the rebound in methanol prices. Though net profit for 1H09 reached only 36% of our full-year forecast of Rmb226m, we maintain our profit forecast for 2009, due to the aforementioned factors. Management is going to hold a conference call today so we will provide updates later.

XLX is trading at 6.9x 2010F PE, much lower than the over 10.0x for domestic and global peers. Despite the industry headwinds in the near term, we remain upbeat on XLX, given its strong position amid industry consolidation in the medium to long term. Maintain BUY with a target price of S$0.57 based on 8x 2010F PE.

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China XLX Fertiliser - Proposed dual listing in Hong Kong

CXLX announced this morning that it is contemplating a dual listing of its shares on the main board of the Hong Kong Stock Exchange, so that it can have ready access to different equity markets in the Asia Pacific when opportunities arise. CXLX has appointed professional parties to commence preparatory work for theproposed listing. Further announcements will be made once an application has beenfiled with the Hong Kong Stock Exchange. An EGM will be held at a later date to seek shareholders’ approval.

This proposed dual listing might not work as well as perceived. We believe CXLX’s discount to its Hong Kong peers might not narrow following a Hong Kong listing, given its limited urea export exposure compared with China BlueChemical (3983 HK) and its less diversified portfolio compared with Sinofert Holdings (0297 HK).

Liquidity could be affected. Additionally, it is possible that there will not be any new shares issued for the dual listing, i.e. CXLX will have to “take out” existing shares on the SGX and “transfer” them to Hong Kong. That would undermine its trading liquidity. We also believe that the two markets will not necessarily expose CXLX to a wider range of private and institutional investors.

Situation remains fluid. The listing may or may not occur, pending the results of the preparatory work and market conditions.

But overall picture still bleak. CXLX’s urea ASP stays low, as overcapacity in the Chinese market limits its ability to raise sales volume and ASPs. Management is also uncertain when the oversupply will end. In fact, it has guided that urea prices could remain weak for a period of time. Chinese urea exports remain uncompetitive at the current export tax rate. Additionally, CXLX’s tax holiday has expired and the company will attract a 17.5% tax rate in FY09-11.

Downgrade to UNDERPERFORM from Neutral. Market rumours could have fuelled its share-price rally in recent days, coupled with a broader market rally. We advise investors to lock in gains and downgrade the stock to UNDERPERFORM with an unchanged target price of S$0.34, still pegged at 6.2x CY09 P/E.

China XLX Fertiliser May Sell Shares in September

China XLX Fertiliser Ltd. may seek an initial public offering in Hong Kong in September, Ming Pao Daily reported, without citing anyone.

Company management visited analysts and media representatives last year and had expressed interest in listing its shares in Hong Kong, the Chinese-language newspaper said, without providing further details.

The Henan, China-based maker of urea and methanol was listed in Singapore in 2007.

China XLX - 2Q09 profit may be dragged down by one-off expenses

Margin decline for urea. We expect gross margin for urea to decline in 2Q09 due to the following factors: a) potential one-off expenses during the period, and b) urea price decline exceeds coal cost decline.

One-off items may drag down profit. China XLX (XLX) may see substantial one-off expenses from capacity ramp-up at a new plant and maintenance work at old plants in 2Q09. Ramp-up expenses for the new plant should have been incurred during the trial period April to June. Also, the Group shut down its old plants by a week for regular maintenance.

Urea prices softened in May-Jun 09. Industry sources say that average ex-factory price of urea in Henan edged down from Rmb1,720/tonne in 1Q09 to Rmb1,700/tonne in 2Q09 due to seasonality. During the high season in Mar 09, urea price in Henan topped Rmb1,900/tonne before declining to Rmb1,800/tonne in Apr 09 and below 1,600/tonne now.

Anthracite coal price only dropped in Jun 09. Anthracite coal price in Henan remained at about Rmb1,200/tonne in Apr-May 09 before falling below Rmb1,000/tonne.

Methanol segment still making losses. Despite having rebounded from the trough of Rmb1,200/tonne as at end-08 to Rmb1,500-1,600/tonne, exfactory price of methanol remains below XLX’s unit cost of >Rmb1,900/tonne. Compound fertiliser. Sales of compound fertilisers should decline in 2Q09. According to industry sources, farmers are starting to switch from compound fertilisers to nitrogen, phosphate and potash due to cost considerations.

Maintain profit forecasts. Despite the poor results expected for 2Q09, we maintain our earnings forecasts for 2009-11. We expect profit to resume growth next year, driven by the full-year contribution from the new plant. A recovery in urea and methanol prices next year could also spur profit growth.

Consolidation in China urea industry. Standing at the cash breakeven point of urea producers in general, urea prices in China are stabilising at Rmb1,600/tonne and downside is limited. Consolidation in China’s urea industry is speeding up, with the expansion of large low-cost producers edging out small high-cost plants. About 10% of China’s urea capacity (6m tonnes) has been shut down. As its production costs are 15-20% lower than competitors’, XLX is set to expand its market share.

Contribution of Plant III. The new plant – Plant III – completed the trail run in Apr-Jun 09 and started commercial production in Jul 09. It is expected to reach full utilisation next year. The capacity ramp-up expenses are one-off. In addition, Plant III will start contributing to profit in 2H09. Given its more advanced technology, the new plant boasts a unit cost that is Rmb50/tonne lower than the two old plants’ average cost of Rmb1,350/tonne, implying higher margins.

Recovery in international urea prices in 2010. With the drop in global urea demand and prices, the export window for Chinese urea producers was closed in Feb-Jun 09. This aggravated the oversupply in China’s urea market, dragging down domestic urea prices. We expect the recovery in international urea prices – a result of easing credit conditions and higher grain prices – to spur domestic urea prices next year.

XLX is trading at 6.1x 2009F PE and 4.7x 2010F PE, much lower than the average PE for domestic and global peers. Despite the industry headwinds in the near term, we remain upbeat on XLX, given its strong position amid the industry consolidation in the medium to long term. Maintain BUY with a target price of S$0.57 based on 8x 2010F PE.

China XLX Fertiliser: 1Q09 net profit slumps 47.6% to RMB59.1m

Net profit for 1Q09 decreased by 47.6% YoY to RMB59.1m. This is inline with our expectations. Reasons for the decline: (1) first quarter is usually weaker taking into consideration the seasonality of its business; (2) 1Q08 base was high due to the sale recognition of about 14,000/tonnes consignment stock of urea which was sold at the end of Dec 07. Management believes that they could exceed our FY09 net profit forecast of RMB199.1m due to its third plant coming on stream earlier than expected. However, we maintain our conservative net profit forecast as we foresee an oversupply of urea in China.

1Q09 revenue remained flat decreasing by 0.4% to RMB480.3m which was inline with our expectations. Revenue decrease was due to these key reasons: (1) Average ASP for methanol and compound fertiliser (CF) decreased by about 35.4% and 10.8% respectively compared to 1Q08; (2) Sales quantity of methanol and compound fertiliser decreased by 21.9% and 8.5% respectively. The decline in methanol and compound fertiliser revenue was partially offset by a urea service income of RMB37.9m. If not for this service income, 1Q09 revenue would have been RMB442.4m.

High anthracite coal prices are a concern as it continues to squeeze net profit. 1Q09 average anthracite coal price increased 38% YoY to RMB1,150/tonne. This caused net profit margins to shrink 11.1ppt to 12.3% during the period under review. As of Apr 09, anthracite coal price is about RMB1,250/tonne. In our forecast, we assume that FY09 average anthracite coal prices will be about RMB1,140/tonne. However, we do not neglect the possibility of coal prices remaining higher than our forecast. In our sensitivity analysis, we believe that if coal prices remain at RMB1,250/tonne for the remainder of FY09 this will reduce our net profit assumption by 41.3% to RMB116.9m which will translate to a target price of S$0.22.

Maintain NEUTRAL. We maintain our NEUTRAL call for China XLX and raise our target price from S$0.29 to S$0.345 based on 4.8x FY10 P/E. We believe its stronger FY10 earnings (due to full utillisation of third plant and better ASP for urea) will limit share price downside, although FY09 will be a tough year.

China XLX Fertiliser - Weakness seen in 1Q09

Higher cost of old inventory will add pressure to short-term margins. In short, ASPs have fallen faster than the rate where old inventory can be cleared. However, this problem is isolated in 1Q09. From a wider group perspective, the impact is muted as urea margins are rising. Urea has a higher contribution to the group revenues and is benefiting from softening raw material prices and the lifting of a price cap. We cut FY09-10 estimates 15% -29% on lower ASP and margin assumptions. Target price reduced to S$0.34 from S$0.39, as we have used a lower P/E target of 4.3x on CY10 earnings (6.2x previously CY09). Maintained Neutral.

China XLX: Too rich for our liking

China XLX (CXLX) is expensive, trading at 6.2x FY09PE and 0.8x FY09P/NTA, at premiums over the average of 4.7x FY09PE and 0.7x FY09P/NTA for S-Shares under our coverage. This premium is unjustified given its bleak industry outlook and low earnings visibility. We trimmed our already 24% below consensus FY09F earnings further by 10% after imputing lower contribution from compound fertiliser. We expect a slew of earnings downgrades by the market, which has yet to fully reflect the urea oversupply situation and recent plunge in compound fertilizer prices. Maintain Fully Valued with target price reduced to S$0.24.

Compound fertiliser facing high feedstock cost and falling prices. Prices of compound fertiliser had been very weak, plunging 50% q-o-q to RMB2000/ton currently (lower than our expectation of RMB2300). This was due to slow demand in 1Q (off-peak season) and a 30% drop in the price of feedstock, phosphorus. CXLX also faces cost pressure due to overstocking of phosphorus at high price in 4Q08. We trimmed our ASP for compound fertiliser by RMB300/ton for 1Q09 and cut FY09F earnings for CXLX by 10%.

Urea remains overshadowed by oversupply. Urea price has risen from RMB1650/ton in January to RMB1900 currently, driven by a rise in coal price from RMB1000/ton to RMB1250 in the past 3 months. But there is still oversupply of urea and the outlook remains bleak. The export window remains shut given depressed international price of US$300/ton (RMB2000) and the 110% export tariff.

Premium unjustified, maintain Fully Valued. The share price has fallen 27% since our downgrade in January. Still, current valuation remains rich at 6.2x FY09F PE and 0.8x FY09F P/NTA. Our target price is reduced to S$0.24, based on 0.7x FY09F P/NTA, in line with the average for S-shares under our coverage and 50% discount to the average trough valuation of its much larger HK & China listed peers.

China XLX - 4Q results came in below expectation

China XLX reported 37% decline in 4Q08 net profit, which is 28% below our estimate. 4Q08 turnover dropped 14.4% to Rmb464m while net profit dropped 37% to Rmb45.7m. The lower-than-expected 4Q08 results were primarily due to a further decline in ASP during 4Q08. Looking ahead, we believe that further downside risk in urea price is limited as it is close to the the cash cost. For the next two years, we believe that volume growth remains the key driver for China XLX. Earnings for 2010 will be mainly driven by the ramp-up of production of its new plant expected in 2H09. Our analyst, Ken Lee, is travelling this morning. We will revisit our earings model and provide more details after we discuss with the management. For the time being, we maintain our 12-month fair value of S$0.57. China XLX remains the most attractively priced fertliser stock in our universe. We will use weakness to accumulate the stock.

China XLX: Wait for the next harvest

We expect China XLX (CXLX) to report weak 4Q08 earnings, plunging 50% qoq and 33% yoy to c. RMB50m. This comes on the back of 30%-40% fall in ASP, which affects the profitability of compound fertilizer and methanol segments. Looking into 2009, the consolidation phase is likely to be accelerated and margin contraction is expected in the transition. The share price has performed well and is now trading above our valuation. Downgrade to Fully Valued.

We expect CXLX to report net profit of c. RMB50m in 4Q08, representing a plunge of 50% qoq and 33% yoy. We believe 4Q earnings are likely to be affected by lower ASP and margin compression of the compound fertilizer and methanol segments. Given the 30%-40% slid in ASPs, gross margin for compound fertilizer will likely drop to around 20% from 30% in 3Q; the Methanol segment may even dip into the red. Fortunately, the key product, urea that accounts for >50% of revenue, should see sequential improvement in 4Q as coal cost decline is greater than the fall in urea ASP.

The urea sector in China is expected to accelerate its consolidation and increase industry concentration in 2009. Given most of the small players are operating at losses currently, many of them are likely to be phased out in the next 6-12months. Meanwhile, margins for urea producers will be compressed in the transition. We expect big players to garner 15%-25% of gross margins vs 30%-40% in 1Q06 to 2Q08, assuming urea prices hover around RMB1600-1650/ton and coal prices about RMb900-1000/ton.

Our TP is maintained at S$0.33. We have cut FY09 and FY10 earnings by 23% each year but have raised valuation peg to 7.0x (vs 5.0x previously) FY09 PEs. This is in line with a 30% discount to global peers average valuation. We also believe that CXLX would benefit from the accelerated consolidation in the longer term. However, current valuation appears stretched at 8.2x 09PE, relative to its global peers as well as other S chips. With the lacking of near term catalyst, we downgrade the stock to Fully Valued.