Management expects gradual GPM improvement
We organized Sinofert NDR last week in HK with CEO Mr. Wang and CFO Mr.Gao and Executive Director Mr. Yang. This is the first time CEO to conductNDR in HK. The key highlight of the NDR are 1) potential restructure of Sinofertnon-performing manufacturing assets; 2) China fertilizer market consolidation,especially on nitrogen base, will speed up; and 3) Sinofert expects its grossmargin will improve from 6% in 2015 to gradually improve to 10% level in2020E by cutting low margin sales.
Marketing: lower sales volume on cautious risk control; GPM expansion
Sales volume dropped in 2015 on 1) risk control curbing account receivablerisks; 2) cuts of low-margin sales; and 3) higher vertical integration onproduction-marketing segments. VAT resumption also spoiled 2H15 earnings,as it did not fully pass through to end users amid an oversupply situation.Sinofert started to partner up with retailers to provide one-stop services, fromfertilizer distribution to application and consulting, thus enhancing GPM.
Potential restructuring of non-performing manufacturing assets
Sinofert would restructure its non-performing manufacturing assets; c.1mntpaof its fertilizer capacity would fade out/divest, and it would invest in high valueaddedfertilizer capacity (i.e. water-soluble-fertilizer [WSF], customized blendedfertilizer, control released fertilizer) to capture scientific farming advancementin China. However, Sinofert believes near-term earnings pressure wouldcontinue, as restructuring synergies and economic of scale for new productiontake time to realize. Conversely, with VAT resumptions further hurting thefertilizer industry, management believes poor fertilizer sector economics willfacilitate consolidation/fade-out of inefficient capacity in coming years. Sinofertbelieves 2015 was the first year China urea capacity recorded a net reduction.
2016 another challenging year, while longer-term improvement ahead
Sinofert believes 2016 outlook remains challenging for the China fertilizerindustry on 1) a combination of farmers’ lower 2015 income and uncertain2016 crop floor prices and subsidies, resulting in potentially lower fertilizerusage volume in China; 2) government efforts to reduce fertilizer usage withmore scientific fertilizing; 3) fertilizer production costs (i.e. cancellation ofpreferential treatment) may not fully pass through in a buyer’s market. Sinofertexpects its gross margin to stabilize at 6-7% in the near term and steadilyexpand to 10% in three to five years by restructuring its manufacturing assetsand shifting marketing sales mix to more profitable products. Sinofert budgets Valuation and risks; maintaining Hold rating
We maintain our Hold rating, with an SOTP-derived target price of HK$1.10. Inour view, Sinofert is currently fairly valued, despite its depressed 0.45x 2016EP/B valuation (at the -1 SD P/B level), as its ROIC is below the cost of capital.Upside/downside risk: fertilizer price volatility, unforeseen corporation actions:M&A/divestment/assets valuation adjustment; and policy on farmers’ income.