China XLX - An exceptionally strong 3Q (DBSV)

BUY S$0.295 STI : 2,712.41

Price Target : 12-Month S$ 0.40

Reason for Report : Earnings revision

Potential Catalyst: Urea ASP increase

DBSV vs Consensus: Our forecast is among the lowest on the back of weak urea margins.

• 3Q11 net profit surged 263% y-o-y and q-o-q to RMB102.9m on higher margin spreads

• Profitability to normalize in 4Q

• Valuation near GFC trough levels. Maintain BUY and S$0.40 TP

• Key risks are stretched balance sheet and persistent industry overcapacity issue

A strong 3Q. China XLX reported a 263% increase both y-o-y and q-o-q in 3Q net profit to RMB102.9m. This was largely attributable to higher margin spread of RMB150/t as urea ASP surged (+8% q-o-q to RMB2250/t) on the back of temporary supply shortages post power interruption in 1H as well as higher compound fertiliser sales during the peak 3Q. Methanol remained in marginal loss. Overall gross margin expanded by 8.8ppt y-o-y and 6.8ppt q-o-q to 19.8%.

Net gearing was high at 0.71x as of end Sept 2011. It will likely cross 1x net gearing next year as the company increases borrowings to finance the construction of 4th plant. Fund raising exercises through bond or capital markets could be expected in the near term.

Urea prices to ease in 4Q. 9M11 net profit of RMB152.4m exceeded our full year estimate by 5%. We raised FY11F net profit by 23.4% to RMB179.8m on account of the strong ASP in 3Q. This implies net profit of RMB27m for 4Q. We believe urea prices will ease in 4Q after the peak planting season. This will likely drag gross margins down to normal levels of c.13-15%.

Valuation is undemanding. Our TP is unchanged at S$0.40 as we apply a lower target PE multiple of 10.5x vs 12.0x previously against higher FY11/12 EPS. This is in line with -1.5SD from mean, which is justifiable given the current gloomy industry outlook and global economic slowdown. This translates to 1.1x P/BV (-1.0SD). While stock has gone up 13% since our upgrade in mid-Oct, current valuations are attractive at close to GFC trough levels of 0.78x 12-month forward P/BV and 8x PE, offering 33% upside to our TP. Maintain BUY. Key risks remain China XLX’s stretched balance sheet, ASP fluctuations and industry overcapacity concern.