Oversupplied and nowhere to hide
Worldwide urea capacity looks set to grow by 5.9% CAGR (2012-16e) on the back of 2% CAGR demand growth. The price of urea has fallen to China marginal cost; but 1) supply should continue to outstrip demand through 2016e and 2) our Asia coal analyst remains bearish on local coal prices - nowhere to hide. We expect urea, potash and phosphate Y/ y comps to continue to slide 2014/ 13. We downgrade Sinofert to Hold from Buy on the back of oversupply in the industry and expectations of continued soft prices in the coming years.
Adjusting prices 2013-14 and margins
We have taken down our full year 2013 urea, potash and phosphate prices by 15%, 12% and 3%, respectively. Prices started to fall June/ July and we see no relief to the oversupply for 2014. India, China and Brazil set the marginal price on fertilizers. China has successfully engineered to a slower GDP growth scenario / demand structure; Brazil’s economy has come to a standstill and we suspect the Rupee will continue to struggle under a US “tapering” scenario. There is not much buying power out there, in our opinion.
Investment thesis
Sinofert’s margins are thin and price risk is unavoidable. The corporate structure is sub-optimal but hopefully moving in the right direction. When urea, potash and phosphate prices start to rise, we should see a decent P&L. Management is taking the right steps with the balance sheet and seems to be taking the right M&A steps - it just feels like it might take forever. We see minimal upside to the share price on the back of soft global fertilizer prices.
Valuation and risks:
We value Sinofert from a DCF model. We use a China RFR rate of 3.1% and ERP of 5.6%. Our COE is 10.2% and WACC is 8.2%. Our TG rate is 1% which is our estimate for LT urea demand in China. We also consider PE and PB-ROE valuations. The principal risks to our Hold rating include: 1) higher / lower than anticipated fertilizer prices; 2) on-going M&A activity; and 3) changes in government subsidies to the China fertilizer industry.