MARKET ARTICLE (REF #003-OCT-2020)
At the time of writing this article, China listed Shandong Yangu Huaggu Huatai’s share price has appreciated by 48% over the last 12 months, while China Sunsine’s share price has retreated by 30%. Hence, China Sunsine can be viewed as a laggard play behind the recovery on China’s auto sales! The former is trading at 32.7x P/E while the latter is trading at just 3.5x P/E ex-cash.
China Sunsine’s 1H20 earnings were affected by the Covid-19 pandemic whereby sales volume fell by 7% to 76,320 tonnes and net profit consequently fell to RMB82.4 million for the six months ended June 2020. However, the Company appears to be seeing light at the end of the tunnel as production and sale of vehicles in China have picked up and look set to be driving strong demand for China Sunsine’s products.
Booming auto sales imply healthy 2H 2020 demand. According to the China Association of Automobile Manufacturers, automobile sales in China grew year-on-year for the sixth consecutive month to 2.57 million vehicles in September (+12.8% year-on-year), following sales of 2.12 million vehicles in August (+11.6% year-on-year). Media reports have attributed the robust demand to industry promotions and local government policies and subsidies to support the auto industry. Spending on domestic infrastructure projects has also spurred demand for commercial vehicles such as trucks. According to media reports, the strong sales momentum has sustained into October with retail sales exceeding dealer expectations and that some dealerships have even run out of inventory.
These data translate into healthy demand for China Sunsine’s rubber chemical products in 2H 2020 as auto manufacturers raise production to replenish their stock of finished products.
Market leader in rubber chemicals. China Sunsine produces additives and other chemicals that are added to rubber used in making tyres. It is a global top three producer of rubber accelerators and PRC top three producer of insoluble sulphur with annual capacities of 97,000 tonnes and 30,000 tonnes respectively. Its nearest competitors have capacities of 51,000 tonnes for rubber accelerators and 20,000 tonnes for insoluble sulphur. For rubber accelerators, China Sunsine has a global market share of 20% and PRC market share of 33%.
As a market leader, China Sunsine enjoys strong economies of scale, high industry staying power and will be a good proxy to the global economic recovery post Covid-19.
Gross margin has stabilized. Following the decline in gross margin to 17.1% in 4Q 2019 (when selling prices fell and raw material costs increased), China Sunsine’s gross margin improved to 23.2% in 1H 2020, as raw material prices fell more than selling prices. This also indicates that ASP of 13.6K in 2H 2019 is a floor. Recent channel checks indicate that raw material prices have recovered to 2H19 levels. That said, selling prices should rebound given healthy customer demand. All in, gross margin of >20% looks sustainable going forward.
[There is the risk that competitors keep prices around 13.6K and lead to margin compression back to 17%. This is unlikely as selling prices should move up somewhat considering healthy demand and higher raw material costs. See below for computation to adjust for this risk.]
Strong balance sheet and trading at low multiples. As of 30 June 2020, China Sunsine has cash of S$267 million on its balance sheet, no bank borrowings and net working capital (excluding cash) of S$102 million. Based on a share price of S$0.395 and 970.72 million shares outstanding, China Sunsine has a market capitalisation of S$383.4 million, against a net book value of S$518 million as of 30 June 2020. Hence, it is trading at only 0.74x P/B.
Annualising 1H 2020 net profit of RMB82.4 million, China Sunsine is trading at 11.6x P/E. However, this includes cash on its balance sheet. Given that it has no bank borrowings, its enterprise value (market capitalisation less cash on balance sheet) is a mere S$116.5 million, translating to a highly attractive enterprise value to earnings ratio of 3.5 times.
Capacity expansion cements earnings growth. The Company plans to raise capacity from 172,000 to 192,000 tonnes of products by the end of 2020. Assuming a typical utilization rate of 95%, the estimated output is in the range of 182,400 tonnes. Assuming an average selling price of RMB14K per tonne (13.6K is the approximate floor) and a sustainable gross margin of around 20% (the company has historically done better than this), the annual gross profit may be in the range of RMB510.7 million (compared to RMB242 million in 1H 20).
On an annualised basis, this means that China Sunsine annual earnings rate could be in the range of RMB185 million in a worst-case scenario that assumes stiff competition keeps gross margin depressed. (RMB510.7m less two times RMB242m of gross profit in 1H20, less 25% tax, add back two times PAT of RMB82.4 in 1H20). Actual earnings could be higher.
Using the worst-case scenario earnings, applying a P/E multiple of 6 – 10 times and adding back S$267 million of cash on balance sheet, China Sunsine is worth S$488.7 to S$636.6 million or 50 to 65.5 cents per share. This translates to upside of 27% to 66% even without factoring any earnings upside from margin expansion and capacity expansion in 2021.
[The Company has been active in buying back its shares and has bought back 4.9 million shares in 2020 with the last purchase done on 1 October 2020 at S$0.340 per share. Using this share price as a floor, we are looking at a positive risk/reward ratio of upside of 10 to 15 cents versus downside of 6 cents at the current share price.]
Disclaimer: This article is written for general information only and itself and its contents are not meant to be construed as any form of trading and investment recommendation or advice to readers. The data and figures are based on publicly available information. Any consensus or projections provided herein are subject to execution risk and no warranty is provided. Changes may occur without prior notice. Trading and investment involve risk.
Market & Analytics Team
ALA Advisors Pte Ltd