CHINA’S CRUCIAL CHEMICAL FIBRE sector has likely touched the nadir of the downturn and is on the mend.
“China’s nylon fibre industry has seen a substantial improvement since the beginning of the second quarter. We expect Li Heng and China Sky to record quarter-on-quarter earnings improvement for 2Q09,” said UOB Kay Hian analyst Allen Jiao.
China’s chemical fibre industry likely hit bottom after entering a downcycle 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,” he said.
He pointed to the fourth quarter of last year, 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 upcoming export order flurry – though likely to be decidedly less frenzied than before the financial crisis – will nevertheless supply more tailwinds to steer peers out of their ongoing order doldrums.
“The chemical fibre industry will soon enter the strong July-August season when fibre producers will fulfill 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,” Mr. Jiao said.
Although textile and garment exports for July-August could still record a year-on-year decline due to a relatively high base last year, the brokerage believes the chemical fibre industry will still benefit as stronger demand will help the sector step further out of the trough, heading towards recovery.
Hung up on Li Heng
Fujian Province-based Li Heng is UOB Kay Hian’s top pick of SGX-listed nylon makers.
“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,” Mr. Jiao said.
UOB Kay Hian is maintaining a “buy” on Li Heng with a target price of S$0.29 (current price: S$0.20), based on Hong Kong peers’ average FY10 PE of 5x.
Meanwhile, it is staying “hold” on China Sky with a fair price of S$0.22 (current price S$0.16)
“Li Heng has had substantial improvement since May in terms of stronger order flow and higher selling prices.
"Its production remained at full capacity in 2Q09 with monthly output reaching nearly 10,000 tonnes, similar to that of 1Q09,” UOBKH said.
Li Heng is also reaping the benefits of higher selling prices, which provided a much-needed shot in the arm to overall margin fitness.
“Average selling price (ASP) has risen over 10% versus March.
"Gross margin rose in tandem with the ASP movement at around 8% in April, higher than 5-6% in March before strengthening further to 12-13% in May. It is approaching 15% in June.”
Mr. Jiao added that thanks to the “very strong” January performance, Li Heng achieved gross margin of 12.9% for the first quarter.
“We expect 2Q09 gross margin to stay close to the 1Q09 level. However, we believe the gross margin will improve quarter-on-quarter on higher revenue due to higher ASP.”
He added that in contrast to incurring a forex loss of over 20 mln yuan in 1Q09, Li Heng is likely to record a small forex gain in 2Q09, which would further boost the company’s sequential bottom line.
Li Heng’s first quarter-to-March revenue was 473 mln yuan, down from nearly 804 mln a year earlier, while profit attributable to shareholders fell considerably to 10.2 mln yuan.
However, due to adept adjustments to the sail during the doldrums, Li Heng’s first quarter net cash generated from operating activities rose to 253 mln yuan, versus 243 mln a year prior.
“I think we managed a reasonable quarter during such volatile times due to our diligence in managing a few factors of our business operations,” said Li Heng Chairman, Mr Chen Jianlong, in an exclusive interview with NextInsight last week.
Related story: LI HENG: Aiming to emerge leaner, meaner, greener
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