China Sunsine Chemical Holdings - CIMB Research 2018-01-19: Rubber Chemicals Specialist

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CHINA SUNSINE CHEM HLDGS LTD. CH8.SI

China Sunsine Chemical Holdings - Rubber Chemicals Specialist

• China Sunsine Chemical trades at 5.1x CY18F ex-cash P/E, at a 48% discount to its Chinese rubber chemicals peer Shandong Yanggu Huatai Chemical.
• ASPs for accelerator products rose 25% y-o-y in 9M17 amid crackdown on pollution in China.
• Boost in production capacity to kick in by 1H18F, fuelling 7% growth in total capacity.
• Sunsine’s earnings have tripled since FY13, and we believe the company is set for continued earnings growth as the industry consolidates.
• Initiate coverage with ADD and a Target Price of S$1.50, based on 9.8x CY19F P/E (20% discount to global peers’ average.

COMPANY BACKGROUND

Demand driven by tyre and rubber producers 

From state-owned enterprise to family-owned company 

• China Sunsine Chemical’s business was first established as a state-owned enterprise under the name of “Shanxian Organic Chemical Factory” in 1977, during when the current chairman, Mr. Xu Chengqiu, joined the firm. 
• The factory was initially engaged in the manufacturing of various chemical products and started to develop a series of low-pollution rubber antioxidants and rubber accelerators in 1988 and 1994, respectively. It began to export its products to overseas customers after obtaining the export licence in 1996. Mr Xu Chengqiu, together with 43 employees, subsequently led a management buyout for a total consideration of Rmb1.04m in Dec 1998 and continues to retain a majority stake in the company till today.
• Since the buyout in 1998, the firm has expanded both its product range and customer base, and subsequently invested in a sulphur recycling facility and wastewater treatment plant in Jun 2003 to promote environmental friendliness.
• China Sunsine was listed on the SGX Mainboard on 5 Jul 2007 at S$0.39 per share.

Chemical products rely on global rubber demand 

• China Sunsine Chemical is primarily engaged in the production of rubber chemicals which comprise rubber accelerators (RAC), insoluble sulphur (IS) and antioxidants (AO). These are essential rubber chemicals that are used in the production of rubber and rubber-related products. The bulk of its chemicals are sold to tyre makers that consume most of the global supply of rubber, driven by the growth in the global automotive industry. 
• According to the company, every 100 tonnes of rubber produced consumes 6 tonnes of rubber chemicals.

Three key production facilities 

• China Sunsine Chemical operates three production facilities that are located in Shanxian, Dingtao, and Weifang in Shandong province, China. Its Shanxian plant is its biggest plant, which is situated on c.600mu of land, and produces rubber accelerators, insoluble sulphur and antioxidants. Dingtao plant (c.280mu land) focuses only on the production of insoluble sulphur whereas its Weifang plant (c.280mu land) produces only rubber accelerators. 
• The Shanxian facility is also equipped with a centralised coal-fired heating plant (Guangshun heating plant) that generates steam and electricity for Sunsine’s use.
• The group holds the land use rights to the land parcels on which its production plants are situated. The earliest expiry of these land use rights is on 5 Sep 2056.

Serving the top global tyre makers 

• According to the management, China Sunsine Chemical serves over 1,000 customers globally and two-thirds of the global top 75 tyre makers. 
• Products are sold to renowned tyre manufacturers in the world and in China, including nine of the world’s top 10 tyre manufacturers, such as Bridgestone Corporation (5108 JP, Not Rated; contract secured in 2003), Michelin Group (Cie Generale des Etablissements Michelin, ML FP, Not Rated; in 2006), Goodyear Tire & Rubber (GT US, Not Rated; in 2006), Pirelli & C (PPAMF US, Not Rated; in 2005) and Sumitomo Rubber Industries (5110 JP, Not Rated; in 2005), and some of the leading tyre manufacturers in China, such as GITI Tire (600182 CH, Not Rated) and Shandong Hengfeng Rubber & Plastic Co Ltd (Unlisted). About one-third of Sunsine’s products were exported to overseas customers in FY09-16.

Benefits from industry consolidation 

A new “normal” amid escalating ASP? 

• According to media reports, production from smaller players was halted or shut down due to the government’s efforts to curb pollution and impose stringent environmental standards on rubber chemical factories. In Aug 2017, the Chinese government imposed targets on 28 cities to trim their heavy air pollution days.
• The cities affected were Beijing, Tianjin and 26 other cities in the smogcongested provinces of Hebei, Shandong, Henan and Shanxi, with stricter reduction targets imposed on Beijing, Tianjin and Shijiazhuang, Hebei provinces.
• The ASP of Sunsine’s RAC output has risen over the past five quarters, from Rmb17,000/tonne in 2Q16 to Rmb22,300/tonne in 3Q17. Its production output was minimally affected by the government’s air pollution crackdown as Sunsine produced 61,600 tonnes of RAC in 9M17, compared to 61,500 tonnes in 9M16.
• Competitor cited surging prices for accelerators in 4Q17 Sunsine’s close competitor, Shandong Yanggu Huatai Chemical (300121 CH, Not Rated), released its FY17F performance forecast on 11 Jan 2018, estimating FY17F net profit to be in the range of Rmb196m-220m, which would translate into y-o-y growth rate of 25-40%. What we found interesting was that the company reported a surge in transaction prices for its accelerator products in 4Q17, which would lead to a boost in overall margins and net profit growth.

Steady margins as costs are passed on in most cases 

• The ongoing environmental scrutiny by the authorities has reportedly led to escalating prices of aniline, one of the key raw materials required for Sunsine’s production of RAC. Management believes it would be able to pass the higher costs on to its customers in view of its leading position in the RAC market. With the exception of FY12 and FY13, when average prices of aniline spiked up 9% yoy in 2012 due to the limited supply of benzene (a raw material for aniline), the company has delivered gross margins of around 26% since FY08.
• We expect gross margin to be sustained at c.27% in FY18-19F with China Sunsine Chemical increasing production output of rubber chemical products with future expansion in production capacity. 
• Management guided that its two new 10,000-tonne production lines – one for the production of TBBS rubber accelerator and the other for the production of IS – could start commercial production by 1H18F after obtaining the necessary approvals from the authorities. China Sunsine Chemical’s rubber accelerator capacity was 95% utilised, while its capacity for IS was 100% utilised in FY16.

Rising demand for rubber tyres will continue to drive growth for rubber accelerator products 

• According to statistics from the company, China’s rubber tyre production registered 6.8% CAGR in 2009-16 or an average of 30m tyres p.a., reaching 610m pieces in 2016. Research and Markets reported that the global rubber tyre market registered 4.5% CAGR over the same period, with an output of 2.9bn units in 2016. 
• We expect the growth trends in rubber tyre production to continue to be supported by rising per capita income in China and emerging markets, where motor vehicle ownership rates are increasing. This would in turn fuel the demand for rubber processing chemicals.

Market leader 

Top global rubber accelerator producer and expanding 

• According to the management, China Sunsine Chemical has the largest production capacity for rubber accelerators globally, at 87,000 tonnes p.a., which accounted for 26% of China’s total output of 331,000 tonnes and nearly 15% of the global rubber accelerators market of over 600,000 tonnes in 2016. 
• China Sunsine Chemical's closest rivals are Kemai Chemical (Unlisted) (2016 capacity: 51,000 tonnes) and Shandong Yanggu Huatai Chemical (30,000 tonnes). These top 3 players had a total capacity of 168,000 tonnes in 2016. Its overseas competitors include Flexsys Rubber Chemicals (Unlisted) for IS and Lanxess Corporation (LXS GR, Not Rated) for RAC.
• According to the China Rubber Industry Association, China Sunsine Chemical’s market share in China has steadily grown from 16% in FY07 to 25% in FY16, and its production output of RAC reached 83,000 tonnes p.a. at end-FY16 and 42,000 tonnes p.a. at end-1H17. To cater for further demand growth, the group plans to add an additional 10,000-tonne production line of TBBS at its Shanxian plant. This would enable it to increase output, given that its capacity was 95% utilised in FY16.

Solidifying its top spot in China’s insoluble sulphur market 

• China Sunsine Chemical is also the leading producer of insoluble sulphur in China, with a production capacity of 20,000 tonnes p.a., which accounted for 24% of China’s total production output of 83,000 tonnes in 2016. 
• Its top competitors include Shandong Yanggu Huatai Chemical and Jiangxi Hengxingyuan Chemical (Unlisted), which have annual capacities of 10,000 tonnes and 5,000 tonnes, respectively. 
• China Sunsine Chemical is also planning to add an additional 10,000-tonne production line at its Dingtao plant to boost production capacity for insoluble sulphur, for which the management expects commercial production to begin in 2H18F after the necessary government approvals are obtained.

Gaining market share in antioxidants as well 

• In FY16, China Sunsine Chemical’s antioxidant output of 31,000 tonnes accounted for c.8% of China’s total antioxidant production of 375,000 tonnes. China Sunsine Chemical currently has a capacity of 45,000 tonnes p.a. for antioxidants, providing ample room to cater for further increase in demand. 
• Antioxidants accounted for 17% and 19% of China Sunsine Chemical’s FY16 and 1H17 revenues, respectively.

FINANCIALS

Segmental revenue 

• Rubber accelerators accounted for 71% of China Sunsine Chemical’s 9M17 revenue and antioxidants was the second-biggest contributor at 19%. The remainder came largely from insoluble sulphur (9%). A small 1% of 9M17 revenue came from other chemical products, provision of heating power and a small hotel located in Fu Long Lake area in Heze city, Shandong province, China. 
• China Sunsine Chemical’s top 5 customers accounted for 20% of its FY16 revenue.

Track record in delivering profits and growth 

• Since its listing in 2007, China Sunsine Chemical has consistently delivered positive net profit every year, with net profit rising by an 11.4% CAGR from Rmb83.8m in FY07 to Rmb221.7m in FY16. This compares to its revenue CAGR of 14.1%, rising from Rmb619.5m in FY07 to Rmb2,036.9m in FY16. Net profit growth slowed in FY15 mainly due to lower ASPs across rubber chemical products from the collapse in oil prices and anti-dumping duties imposed on Chinese tyres by the US government in 2015.
• Looking ahead, we project net profit growth of 14% in FY18F and 10% in FY19F on the back of rising ASPs for its products and capacity expansion amid consolidation in the domestic industry.

Net cash with zero debt 

• China Sunsine Chemical had a cash pile of RM463m or S$0.19/share and zero borrowings as at end-3Q17. Management said it would need to rely on its internal cash resources to fund future capacity expansion in view of the credit tightening by Chinese banks. 
• China Sunsine Chemical started to deleverage in FY15 and achieved zero gearing in FY16.

Dividend payout policy of 20% since Jun 2017 

• Prior to the adoption of its formal dividend payout policy in Jun 2017, China Sunsine Chemical consistently paid out DPS of 1 Sct since 2008. At 20% dividend payout ratio, we project FY17F DPS of 2.5 Scts, comprising 0.5 Scts DPS declared in 2Q17 and 2.0 Scts DPS to be declared in 4Q17F. We project FY18F DPS of 3.0 Scts.
• These translate into dividend yields of 2.4% in FY17F and 2.9% in FY18F.

VALUATION & RECOMMENDATION

Earnings gaining momentum 

• Excluding the net profit slump in FY12-13 when the cost of raw materials escalated, China Sunsine Chemical has traded at 12-month forward P/E in the range of 2-8x since its listing. 
• On a P/BV basis, we believe the stepped-up efforts to control pollution in China and the rising ASP of rubber accelerators increased its book value to the current 1.2x CY18F P/BV, above its historical long-term average of 0.8x P/BV.

Initiate with ADD and target price of S$1.50 

• We conservatively apply a 20% discount to its global rubber chemical peers’ average of 12.3x CY19F P/E to factor in a certain degree of country risk premium in China. Our Target Price is based on 9.8x CY19F P/E, compared against a 3- year EPS CAGR of 16% in CY16-19F. 
• China Sunsine Chemical is currently trading at 7.4x CY18F P/E and 5.1x CY18F ex-cash P/E. 
• Key catalysts for the stock are strong earnings growth on the back of higher ASPs and increasing volume output across its rubber chemical products.

KEY RISKS

Forex risks from weakening  US dollar. 

• China Sunsine Chemical’s expenses and purchases of raw materials are denominated in Renminbi, while sales are exposed to Renminbi, US dollar and the Euro as Sunsine sells products to domestic and overseas customers. 
• The company incurred a forex loss of Rmb17.6m in 9M17 due to the weakening of the US dollar against the Renminbi, and we project 4Q17F forex loss to be at a similar level as that of 3Q17 (c.Rmb10m) in view of the weak US dollar.

Margins may be dragged down by rising raw material costs. 

• China Sunsine Chemical’s cost of sales are mainly influenced by the prices of raw materials, such as aniline and other chemicals needed to produce rubber accelerators, insoluble sulphur and antioxidant products. 
• While management said it is generally able to pass on increased costs to its customers, it may not be able to do so in a timely manner, which could lead to sharp decline in gross margins, as seen in FY12 and FY13.

Colin TAN CIMB Research | http://research.itradecimb.com/ 2018-01-19

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