Excerpts from KGI report
Analyst: Chen Guangzhi, CFA
|Robust amidst cyclical downturn
• 1H20 profitability weakened substantially due to the unfavourable environment such as declining ASP and profit margin in the sector.
• Zero debt and abundant cash in hand, together with positive free cash flow, enable Sunsine to endure the down cycle.
• We maintain OUTPERFORM with a lower TP of $0.47 due to the near-term headwinds of declining ASP and profit margin compression. It is worth noting that the cash per share as of June 2020 was S$0.27.
Enduring through adversities in the down cycle. Rubber chemicals prices completed a bull-bear cycle after the global financial crisis in 2008.
To illustrate the cyclical expansion and decline of profit margin in the sector, we used the average selling price (ASP) spread between rubber chemicals and the main raw materials aniline as a proxy.
The peak-to-peak period lasted exactly a decade, reflecting that the sector went through over-capacity and the ensuing supply-side reform in China.
Driven by the high profit margins, main producers ramped up capacity in 2017 and early 2018, and the incremental supply was put in the market, marking the beginning of the down cycle in 4Q18.
Unfortunately, the COVID-19 pandemic further disrupted the supply and demand balance.
China Sunsine changed to semi-annul reporting this year. 1H20 profitability weakened substantially compared to 1H19, due mainly to the unfavourable macro environment resulting in contraction in both ASP and profit margins.
However, normalisation of profit margin and correction of ASP were expected by the management back in 2018 and 2019.
|"Valuation & Action: We maintain our OUTPERFORM recommendation with a lower target price of S$0.47 due to the near-term headwinds of declining ASP and profit margin compression. It is worth noting that the cash per share as of June 2020 was S$0.27."
-- Chen Guangzhi, CFA
Risks: The risk is the prolonged downturn of the cycle. China Sunsine as the market leader in rubber chemicals industry in China, has been occupying the majority of the market share in both domestic and overseas markets. However, investors should know that the company lacks catalysts apart from the ramp-up of production which depends on market conditions.
The difference from the 2017-2018 period when it was tagged as a growth stock, enjoying both substantial volume and ASP growth, is that Sunsine is now regarded as a value stock.
Therefore, the likely driver of higher price performance lies on the turnaround of macro conditions such as the bottoming out of ASP and the exit of more peers from the market. The recovery of the economy should lead to improvement in profitability but not to what it was during the heydays.
|Moderately positive outlook in 2H20. In 2H20, China will likely remain cautious of sporadic imported spread of COVID19, and will look to a gradual reopening of borders.
Productions and business is expected to continue to recover, but the external demand may not catch up soon as the pandemic is not yet contained.
Therefore, growth must rely on domestic demand.
However, tyre manufacturers’ utilisation rate has not recovered to pre-COVID levels. The weak demand could be prolonged in the near term.
We are cautiously positive on the 2H20 outlook. Firstly, crude oil prices bottomed out in April. Ongoing output cuts and the slow pick-up of oil demand could support oil prices, which will subsequently provide a price floor for chemical products.
Secondly, raw material prices like aniline reached a decade low of RMB4,500/tonne recently, and further decline in prices will drive out more small and medium players in the market.
In other words, long-lasting ASP below breakeven costs will accelerate the balance of supply and demand dynamics.
Lastly, China Sunsine is robust enough to endure the down cycle. It has a clean balance sheet with zero debt and abundant cash (RMB1.3bn as of June 2020, equivalent to S$0.27/share). Its cash flows from operations are firmly positive and enough to cover capex.