China XLX Fertiliser - Better results, but no cheers yet (CIMB)

NEUTRAL Maintained

S$0.34 Target: S$0.39

Mkt.Cap: S$340m/US$283m

• Good enough but not bullish yet. 2Q11 results prove our point that changing trends have indeed been turning the quarters around. 2Q11 core net profit of Rmb38.1m (+86% yoy, +80% qoq), though below consensus, meets our expectation, reflecting a better sales mix and ASP increases. 2Q11 and 1H11 core EPS forms 24% and 37% of our FY11 forecast respectively, in line as they reflect seasonality. The ASP improvements and stabilising margins are commendable but not reasons to turn bullish just yet, as we remain wary of costlier coal input and fund-raising needs from aggressive expansion. ASPs as a whole could still be volatile because of overcapacity in China while methanol producers are still confronting cost pressures. Our earnings estimates are unchanged, so is our target price of S$0.39, still at 7x CY12 P/E, a 50% discount to peers.

• Better sales mix with improving margins for all. 2Q11 revenue jumped 50% yoy to Rmb943m as a result of higher urea and compound fertiliser volume and higher urea, methanol and compound fertiliser ASPs. Gross profit increased to Rmb123m (+95% yoy) as compound sales volume increased 144% yoy. This was made possible by the shutdown of only Plant 3 for maintenance in 2Q11 vs. all plants shut down in 2Q10. Overall, we note a deliberate shift in the sales mix in favour of compound fertilisers where margins are higher than urea, in 2Q11. This paid off as blended GP margins outpaced cost escalation, backed by ASP hikes.

• Balancing fortunes. As 3Q is the seasonal peak for urea and especially compound fertilisers, profitability in 3Q11 should be better than in 2Q11. We note a moderate recovery in urea gross margins for two consecutive quarters from 4Q10 to 2Q11 due to higher urea prices and lower coal prices. Urea ASPs should stay firm in 3Q11 from the re-opening of the export window. While management will be focusing on the construction of a fourth plant (to be completed in FY13) which is meant to improve cost efficiencies, we remain cautious. We are concerned about the accompanying surge in finance expenses as borrowings and interest rates increase, given a debt-filled balance sheet.