by winston » Wed Feb 02, 2011 1:56 pm
Not vested
Risk
Surging raw materials prices.
In China's plastic pipe industry, product pricing is typically determined either through competitive bidding process or individual negotiations with the distributors or direct customers.
Product pricing is dependent upon production costs and the prevailing market prices for similar products. Raw material costs is the largest component of Liansu's cost of sales, according for about 90% of the cost of sales, fluctuations in raw material prices can have a significant effect on the pricing policies of Liansu.
The principal raw materials for plastic pipes and pipe fittings are plastic resins such as PVC, PE and PP-R. Prices for plastic resins are generally subject to cyclical fluctuations and other market disturbances, including as a result of refinery capacity.
In China, where PVC resins are primarily manufactured using coal and limestone, as opposed to petrochemicals that are primarily used in other parts of the world, PVC prices have been impacted by changes in PVC manufacturers` electrical and labor costs, changes in coal prices and fluctuations in the price of petrochemical based PVC resins on the global market.
In short term, due to the continuous improvement in global economies and surging inflation in emerging market, especially in China, we believe the price of plastic resins is going to elevate in 2011. There will be a bigger pressure on Liansu's profit margin and net margin in 2011 due to the raising costs.
Uncertainty about policy risk in China.
China government is intensifying efforts to fight inflation and excess liquidity by raising the reserve requirement ratio (RRR) and interest rate hikes. China Liansu derived almost 100% of its sales from China's domestic markets in 2009.
The nature of plastic pipes and pipe fittings is that demand correlates highly with construction activity (residential, commercial and infrastructure). Construction activity reached a high level in 2009, partly due to the government's Rmb four trillion stimulus package.
However, China government's contraction monetary policy will have an adverse effect on FAI and real estate investment and hence a decreasing demand of Liansu's product.
Valuation
For the year 2010, Liansu is benefited from an expanded production scale and a continued improvement in production efficiency and productivity. Liansu is constructing an additional production bases in Changchun, Jilin.
It is expected to begin operation in the first quarter of 2011, with production capacities planned to reach 66,300 tonnes. Liansu additionally plans to identify suitable land in Sichuan and Shaanxi to further enhance its coverage over these regions.
Our forecast is mainly base three assumptions,
1. Robust historical growth of Liansu will be sustainable in future
2. Liansu's expansion plan will be implemented on schedule
3. Rebounding on ASP of Liansu's products.
We use the multiple comparables approach for the valuation of Liansu. The target 2011 P/E is calculated from the average P/E of the peer companies minus a 10% margin of safety which protect the investment when Liansu's performance fall short of our expectations.
We rate Liansu a BUY with a 12-month target price of HK$9.1, based on 15x P/E for 2011. Currently Liansu is trading at HK$7.6, implying a 20% upside potential.
Source: Phillips
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