Leading onsite gas producer
Yingde is one of the largest independent industrial gas suppliers in China. The company has been able to achieve high operating margins (2011: 25.7% vs 16.5% for global peers) due to its significant "onsite" focus, which includes: 1) minimum take-or-pay contracts and 2) electricity (c.80% of costs) pass-through agreements with its customers. Yingde derives 82% of its revenues from the sale of onsite gases and has 36.9% (2011) market share in the business. We initiate coverage with Buy and a target price of HKD9.34/share
At the epicenter of growth
Yingde seems to be executing all the right strategies - it has a large presence (c.60% of installed oxygen capacity) in the steel industry, which is the single largest (25% market share) user of outsourced industrial gas; it is focusing its expansion efforts in key growth areas like coal-to-chemicals; more importantly, it has a large onsite presence (82% vs. 38% average for global peers) that ensures relative stability of earnings. DB’s in-house view on China steel is that production will improve in 2013-14
Investing to support growth
Yingde expects to incur c.RMB6bn in capex 2012-13 (vs. average annual of RMB1.07bn/year during 2006-11) to bring on-line 20+ new onsite facilities. As it expands, Yingde is likely to incur additional SGA/staff cost (+930 new engineers/sales). As it usually takes about two years to achieve profitability from onsite commencement, we expect the company’s margins to ease slightly (2012-13) before seeing strong earnings growth in 2014-15. Yingde is currently trading at 16.2x FY13e P/E, which is a 2% discount to global peers.
DCF-based valuation; risks
We value Yingde using a DCF model based on a WACC of 5.5%, which includes cost of equity of 6.6%, beta of 0.65x, after-tax cost of debt of 4.4% and a debt to capital ratio of 50%. We use Deutsche Bank’s in-house risk-free rate of 2.9%, equity risk premium of 5.7% for China and a conservative terminal growth rate of 0%. Key risks include: 1) a slowdown in China’s economic growth; 2) counterparty risks on take-or-pay contracts; 3) financing capex and 4) competition from local and global suppliers.