Profit warning - upgrade to Buy
The profit warning filed by Sinofert with the HKSE on 21-Jan looks to be priced into the stock. The tax implications were a negative surprise. The losses in 2013 are a result of falling fertilizer prices. Financial comps for YE13 results (to be announced end-March) and 1H14 results (end-August) will likely be miserable. Notwithstanding, both urea and potash are bumping up against marginal cost of production levels and price support should be at hand. We raise our rating on Sinofert to Buy from Hold.
Adjusting 2013 estimates
Sinofert made Rmb 352 mln 1H13 and ~Rmb 30 mln (Sinochem Fert) Jan-Sept 2013. Losses 3Q13 were ~Rmb 320 mln. For 4Q13e we estimate a similar loss ~Rmb 300 mln as fertilizer prices continued to slide. The losses of 2013 are behind us as are nominal price declines, we suspect for urea and potash. Our operating assumptions (2013-16e) are in Fig 5. We expect “Production” assets will continue to underperform (2014e); “Distribution” should do fine and the lack of inventory losses should lead to improvements 2014e / 2013.
Investment thesis
Management’s push to vertically integrate is appropriate. We were corrected by management on our opinion that vertical integration into coal to urea was not likely. There remains an appetite for potash assets, which has proven elusive over the years. As global fertilizer prices improve in the coming years, so should Sinofert’s earnings.
Valuation and risks
We value Sinofert from a DCF model. Our WACC is 9% with COE of 11.4% and after tax COD of 5.8%. We use a China standard Rfr of 4.3% and an Erp of 5.6%. Our TG rate is 2% which is in line with global urea consumption growth. The principal risks to our valuation are: 1) a continued fall in global fertilizer prices; and 2) any unanticipated fair value asset write-downs due to recent price declines