Reinstating with Hold – soft fundamental outlook limits upside potential
Earnings are set for a strong recovery and ROIC will double to 4% in 2017Efrom 2014, despite poor industry fundamentals as the sales mix shifts tohigher-margin products and cost controls improve. However, these positivesare largely reflected in the share price, even after recent weakness and wereinstate coverage on Sinofert with a Hold and a TP of HK$1.15/share.
Key negative: no silver lining on fertilizer sales volume
The Chinese government will limit fertilizer consumption to a 1% CAGR in2015-2020 and zero after 2020. Therefore, we expect Sinofert’s sales volumeto only increase at a 0.85% CAGR in 2015E-20E after a 16% drop in volumebetween 2012-2015E. Moreover, we expect fertilizer fundamentals in China toremain soft, where China has a 10% new urea capacity in 2015E-17E.
Key positive: 64% EPS CAGR 14-17E on shifting product mix and cost-cutting
Sinofert’s earnings will rebound by a 64% CAGR in 2014-2017E due to1) shifting product mix to enhance margin as modernized farming withbalanced nutrient application will lead to a higher portion of sales of potashand compound fertilizers; 2) stringent cost-cutting measures in the upstreamand marketing divisions; and 3) stronger earnings contribution from QSLI,where capacity is set to grow by 43% by the end of 2016.
Balanced risk/reward at 0.5x 16E P/B and ROIC < cost of capital
Sinofert trades at 0.4x P/B and 10x P/E in 2016E. Although the multiple isdepressed, trading 20% below average historical P/BV, its ROIC is below costof capital. We derive our TP of HK$1.15 using SOTP, where we use DCF (9.7%WACC and 1% terminal growth) for the core business and apply a 46%discount to our QSLI DCF-derived TP. The 46% discount is based on +1SD ofthe historical mean to reflect higher correlation between QSLI and Sinofertshare price. Our TP implies 0.5x P/B and 11x P/E in 2016E. Key risks:1) fertilizer price volatility; 2) unanticipated corporate actions; 3) the NDRC’s13th Five-Year Plan initiatives.