china liansu [2128.hk] · china liansu [2128.hk] china liansu is a leading plastic pipe ... wong...

1

June 19, 2012

We expect plastic pipe demand in China to remain robust, with a CAGR of 12.7% over 2010-15, influenced by the 12th Five Year Plan, specifically; 1) in-creased investment in water conservancy projects (up 114%); 2) increasing urbanization (1% increase of urbanization should drive 15% increase in piping system); 3) construction of sewage network (doubling the existing network); and 4) upgrade of traditional piping system.

We forecast 18.8% earnings CAGR in net profit over 2011-13, supported by production capacity growth (doubled in the past three years) and expanding distribution network (total number of distributors increased 180% in the past three years).

We expect gross profit margin to stabilize in 2012 due to; 1) softening material price; and 2) accelerated market consolidation, enhancing pricing power for market leaders.

Key Drivers 0

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(HK$ million)(HK$)

Turnover (RHS) Price (LHS)

China Liansu [2128.HK]

China Liansu is a leading plastic pipe manufacturer in China. With economic data in

the first five months of 2012 falling short of market expectations, we believe the

ground has been prepared for further policy loosening in 2H12. We believe any

stimulus will be focused on certain infrastructure projects, and the plastic pipe indus-

try will be a beneficiary.

We forecast an 18.8% net profit compound annual growth rate (CAGR) for Liansu

over 2011-13 and believe its current valuation is discounting a hard landing for Chi-

na’s economy. The recent share price weakness provides a good entry point and

we are initiating coverage with a BUY rating, and a target price of HK$5.30, equiva-

lent to 9.0x our EPS forecast for 2012. This is in line with the median trading range

since listing in 2010, which we believe is undemanding.

BUY

Close: HK$4.08 (June 18, 2012)

Target Price: HK$5.30 (+30%)

INITIATE COVERAGE: A selective play on potential

stimulus

Price Performance

Market Cap US$1,543m

Shares Outstanding 3,010m

Auditor Ernst & Young

Free Float 30.0%

52W range HK$2.52-$6.96

3M average daily T/O US$3.0m

Major Shareholding Wong Luen Hei

(70.0%)

Source: Bloomberg

Edwin Lee, CFA

(852) 3698-6319

[email protected]

John Mulcahy

(852) 3698-6889

[email protected]

RMB m 2010 2011 2012E 2013E 2014E

Revenue 7,712 10,143 12,275 14,486 16,450

Net profit 1,132 1,261 1,449 1,781 2,082

Net margin 14.7 12.4 11.8 12.3 12.7

EPS 0.38 0.42 0.48 0.59 0.69

Change % 31.7 11.4 15.0 22.9 16.9

P/E 9.2x 7.9x 6.7x 5.5x 4.7x

Yield 3.5% 3.1% 3.7% 4.5% 5.3%

Source: Company, CGIHK Research

Building Material Sector

2

Key Financials


Profit & loss (RMB m) 2010 2011 2012E 2013E 2014E Cash flow (RMB m) 2010 2011 2012E 2013E 2014E

Revenue 7,712 10,143 12,275 14,486 16,450 Profit before tax 1,374 1,557 1,789 2,198 2,570

Cost of sales (5,678) (7,691) (9,319) (10,964) (12,415) Depreciation and amortization 123 174 226 299 369

Gross profit 2,034 2,452 2,956 3,523 4,035 Tax paid (212) (249) (340) (418) (488)

Other income 44 148 55 56 61 Change in working capital (731) (216) (550) (450) (507)

SG&A (533) (768) (921) (1,058) (1,168) Other operating cash flow 97 125 120 124 133

Other expenses (117) (164) (181) (198) (225) Operating cash flow 650 1,391 1,246 1,755 2,077

EBIT 1,426 1,667 1,909 2,323 2,703 Capex (581) (1,054) (1,200) (1,200) (1,200)

EBITDA 1,550 1,841 2,136 2,622 3,072 Net (acquisitions)/disposal (41) (230) 0 0 0

Finance costs (53) (111) (120) (124) (133) Other investing cash flow 158 (92) 0 0 0

Share of asso/JCEs 0 (0) 0 0 0 Investing cash flow (464) (1,376) (1,200) (1,200) (1,200)

Profit before tax 1,374 1,557 1,789 2,198 2,570 Change in debt (516) 1,194 102 61 137

Income tax expenses (241) (296) (340) (418) (488) Net share issues/(repurchases) 1,630 5 0 0 0

Profit after tax 1,132 1,261 1,449 1,781 2,082 Dividends paid 0 (303) (362) (445) (520)

Minority interest 0 (0) 0 0 0 Other financing cash flow (142) (267) (120) (124) (133)

Net profit 1,132 1,261 1,449 1,781 2,082 Financing cash flow 972 629 (380) (508) (517)

EPS (RMB) 0.38 0.42 0.48 0.59 0.69 Forex effect/others (19) (29) 0 0 0

DPS(RMB) 0.11 0.10 0.12 0.15 0.17 Net change in cash 1,139 615 (334) 47 360

Balance sheet (RMB m) 2010 2011 2012E 2013E 2014E Key ratios 2010 2011 2012E 2013E 2014E

Cash & cash equivalent 1,500 2,115 1,781 1,827 2,187 Sales growth (%) 44.9 31.5 21.0 18.0 13.6

Inventory 1,139 1,294 1,678 1,973 2,297 Gross profit growth (%) 67.6 20.6 20.6 19.2 14.6

Accounts reveivables 952 1,096 1,719 1,883 2,303 Net profit growth (%) 75.8 11.4 15.0 22.9 16.9

Other current assets 23 2 2 2 2 EPS growth (%) 31.7 11.4 15.0 22.9 16.9

Total current assets 3,615 4,507 5,178 5,685 6,789 Gross profit margin (%) 26.4 24.2 24.1 24.3 24.5

Fixed assets 1,706 2,471 3,444 4,345 5,176 Net profit margin (%) 14.7 12.4 11.8 12.3 12.7

Goodwill & intangibles 2 3 3 3 3 ROA 20.1 16.2 15.4 16.4 16.3

Other non-current assets 306 811 811 811 811 ROE 28.3 25.3 23.9 24.0 23.2

Total assets 2,014 3,285 4,258 5,159 5,990 Net-debt-to-equity (%) Net Cash Net Cash 1.1 1.1 Net Cash

Short-term debt 630 70 185 191 204 Inventory turnover (days) 60.5 57.7 58.2 60.8 62.8

Accounts paybles 683 849 1,305 1,316 1,552 Receivable turnover (days) 27.2 25.7 25.7 27.0 27.5

Other current liabiltiies 95 114 114 114 114 Payable turnover (days) 15.3 10.3 11.0 13.5 13.7

Total current liabilities 1,408 1,033 1,604 1,621 1,871 Quick ratio (x) 1.6 2.8 1.7 1.8 1.9

Long-term debt 154 1,675 1,662 1,717 1,840 Current ratio (x) 2.6 4.4 3.2 3.5 3.6

Other non-current liabilities 63 96 96 96 96 Interest-coverage ratio (x) 26.9 15.1 15.9 18.7 20.3

Total liabilities 217 1,771 1,758 1,814 1,937

Share capital 131 132 132 132 132 Reserve 3,873 4,855 5,942 7,278 8,840 Key assumptions 2010 2011 2012E 2013E 2014E

Shareholders' equity 4,004 4,987 6,074 7,410 8,971 ASP (RMB) 9,644 10,325 10,411 10,583 10,775

Minority interests 0 0 0 0 0 Sales volume ('000 tonnes) 789 961 1,152 1,338 1,494

Total equity & liabilities 4,004 4,987 6,074 7,410 8,971 Designed capacity ('000 tonnes) 1,151 1,521 1,851 1,951 2,056

BVPS (RMB) 1.33 1.66 2.02 2.47 2.99

3

1) Water conservancy should take the lead in infrastructure invest-

ment. Based on the 12th Five-Year-Plan, covering the period 2011-

2015, the investment in water conservancy projects should increase

from RMB840bn in 2006-10 to RMB1,800bn in 2011-15, up 114%, sup-

porting our view of increased demand for piping systems. In addition,

Chinese media reports suggest that environmental protection and farm-

ing-related facilities will be key focus areas for China’s likely stimulus

plan, again underlining potential demand for piping.

A secular growth story

Plastic pipe demand in China should grow at a CAGR of 12.7% over 2010-15

Investment in water conservancy projects should increase 114% in the 12th Five-Year-Plan.

Figure 1: Demand of plastic pipe in China

Source: Market Avenue

According to consultancy Market Avenue, plastic pipe demand in China

should grow at a CAGR of 12.7% over 2010-15 to 10.4m tonnes by

2015. While official spending figures for the piping market in China are

unavailable, we believe pipe consumption should record strong growth

in the next few years, driven by the Chinese Government’s 12th Five-

Year-Plan. The relevant highlights from the Five Year Plan are; 1) in-

creasing investment in water conservancy projects; 2) increasing ur-

banization; 3) establishment of sewage treatment system; and 4) up-

grade from traditional pipes.

4

Figure 2 FAI for Water conservancy projects in China

Source: The Ministry of Water Resources

2) Urbanization drives demand for piping systems. According to

www.environment-China.org, the demand for city water should in-

crease by 3.2bn m3 for every 1 percentage point (ppt) increase of ur-

ban population each year during 2011-15, which translates into 15%

p.a. growth in demand for piping. In our view, the continuing urbaniza-

tion trend in China should underpin demand for plastic pipe as 70% of

pipe demand comes from water supply and drainage systems. China

expects to increase its urban population by one ppt each year during

2011-15, driving strong demand for piping systems.

Piping systems are typically installed late in the construction cycle and

the large new starts for social housing construction during 2011-12

should create significant piping demand over 2013-15. Based on the

projected development of 36m social housing units during 2011-15,

we estimate total investment at RMB5trn. Based on discussions with

construction companies, we estimate about 5% of the total investment

in housing will be attributed to piping. The market size for city piping

should thus be as large as RMB250bn over 2011-15.

Figure 3: Accumulative FAI for water conservancy projects in

China

Source: Wind

Figure 4: Length of pipelines in China

Source: Wind

Figure 5: China urban population and total population

Source: Wind

Demand for city water and piping systems supported by urbanisation

5

Total invest-ment in new water pipelines

Total sewage pipelines (km)

(Rmb million) 2010 Additions during 2011-15

Beijing 2,400.0 4,479.0 790.0 17.6%

Tianjin 4,700.0 7,519.0 2,906.2 38.7%

Hebei 6,300.0 7,722.0 4,527.8 58.6%

Shanxi 5,200.0 2,498.0 3,478.7 139.3%

Inner Mongolia 4,700.0 7,357.0 1,880.0 25.6%

Liaoning 7,000.0 3,221.0 5,982.7 185.7%

Jilin 5,400.0 2,678.0 5,406.0 201.9%

Heilongjiang 5,400.0 2,544.0 4,485.0 176.3%

Shanghai 7,400.0 5,058.0 1,185.0 23.4%

Jiangsu 18,700.0 22,577.0 11,665.0 51.7%

Zhejiang 12,400.0 15,959.0 7,267.0 45.5%

Anhui 10,000.0 6,635.0 7,300.0 110.0%

Fujian 7,300.0 5,757.0 4,944.7 85.9%

Jiangxi 8,200.0 3,948.0 6,085.0 154.1%

Shandong 9,200.0 12,965.0 8,003.0 61.7%

Henan 7,500.0 7,480.0 5,341.3 71.4%

Hubei 12,100.0 4,462.0 8,423.0 188.8%

Hunan 13,100.0 4,129.0 8,492.0 205.7%

Guangdong 26,600.0 5,366.0 12,483.0 232.6%

Guangxi 6,100.0 2,062.0 3,195.0 154.9%

Hainan 3,400.0 1,110.0 1,388.0 125.0%

Chongqing 4,600.0 4,384.0 2,920.6 66.6%

Sichuan 8,400.0 7,873.0 5,412.0 68.7%

Guizhou 7,600.0 2,639.0 4,891.9 185.4%

Yunnan 10,500.0 3,089.0 7,580.3 245.4%

Tibet 600.0 59.0 354.9 601.5%

Shaanxi 11,200.0 3,946.0 10,320.0 261.5%

Gansu 7,400.0 2,050.0 4,641.2 226.4%

Qinghai 1,100.0 570.0 727.8 127.7%

Ningxia 2,900.0 730.0 2,077.0 284.5%

Xinjiang 3,700.0 4,138.0 2,738.9 66.2%

Xinjiang production and construction unit 3,200.0 1,170.0 2,232.0 190.8%

Total 244,300.0 166,174.0 159,125.0 95.8%

Source: China State Council

Figure 6: Investment plan for sewage and recycle water investment for 12th Five-year-plan

6

In view of the government support we believe the demand for plastic

pipe should record strong growth over 2011-15. The aggressive capaci-

ty expansion should drive Liansu’s revenue in the next few years. In our

opinion, Liansu should benefit from the growing market size, given its

leading market position.

Total length of sewage pipelines will double during 2010-15

We expect to see continuous up-grade of traditional piping system

Figure 7: Government target for usage of plastic pipes

Source: The 10th Five Year and 2015 Development Planning Outline for The State Indus-

try of Chemical Materials for Construction

3) The Chinese government is keen on building pipe for sewage

treatment. According to the detailed 12th Five-Year-Plan, released on

April 19, 2012, around RMB430bn will be invested in the sewage treat-

ment system, of which 56.8% (RMB244.3bn) will be spent on building

and completing the pipeline network, doubling the total length of sew-

age pipe nationwide during 2011-15.

4) We expect continuous upgrade on existing piping system. Ac-

cording to “The 10th Five year plan and 2015 development planning

outline for the state industry of chemical materials for construction”,

plastic pipes have been favoured due to features such as environmen-

tal friendly, durability, high flow capacity, compared with other tradition-

al materials. We expect the use of plastic pipes will continue to be pro-

moted in China and eventually to replace traditional metal and concrete

pipes.

7

With economic data in 1H12 falling short of market expectations we

believe there will be more room for policy makers to fine-tune monetary

policy to support economic growth. We expect the infrastructure and

building material sectors will benefit from the stimulus plan and improv-

ing liquidity in the banking sector (potential rate cuts).

In view of recent accelerated infrastructure project approvals, we be-

lieve construction activity should pick up in 2H12. In our view, the pat-

tern in the new stimulus measures will emerge in time and the plastic

pipe industry should benefit from the potential loosening. As such, we

expect a recovery of construction projects in 2H12 and this should be a

near-term share price catalyst. We expect Liansu to take advantage of

its strong market presence and financial strength to capture more mar-

ket share in the current market situation.

We believe Liansu is well-placed to capture market share, supported

by:

Expanding national capacity

Extending distributor network

1. Expanding national capacity. Despite the challenging economic

environment in 2012 we believe Liansu’s business should continue to

grow, due to its capacity expansion plan and national market consolida-

tion. Liansu’s expansion plan calls for production capacity (designed) to

increase significantly from 1.15 mt p.a. in 2010 to 1.85 mt p.a. in 2012.

We believe the company should benefit from economies of scale which

will lower its production cost, but enables it to tap into a market with

higher growth potential. Liansu’s capacity expansion underpins our

forecast of 19.5% CAGR for revenue over 2011-13.

The plastic pipe market in China is fragmented and currently undergo-

ing consolidation. Based on our discussions with the company and on

media reports, we believe the market consolidation has been accelerat-

ing in 1H12 while small players continue to be eliminated due to intensi-

fied competition and the unfavourable economic environment since

2H11. As such, the remaining players should gain higher market share

and stronger pricing power in the long term.

Rising in a challenging market

Weak economic data in the first five months of 2012 justifies loosen-ing—construction activities should pick up in 2H12.

Liansu’s capacity expansion from2010-2012 should boost reve-nue— we project 19.5% CAGR for revenue over 2011-13.

8

Liansu expanded its distribution network by 180% in the past two years to capture national market share

Figure 9: Market share of top 20 plastic pipes players in China

Source: Market Avenue

2009 2010 2011 2012E 2013E 2014E

Sales volume (000' tonne)

PVC 431 617 754 919 1076 1206

YoY 62.3% 43.2% 22.1% 21.9% 17.2% 12.0%

Non-PVC 135 172 207 233 262 288

YoY 95.1% 27.4% 20.3% 12.7% 12.2% 10.0%

Average selling price (RMB)

PVC 7923 8215 8870 9063 9280 9465

YoY -13.6% 3.7% 8.0% 2.2% 2.4% 2.0%

Non-PVC 13774 14764 15624 15716 15937 16256

YoY -15.8% 7.2% 5.8% 0.6% 1.4% 2.0%

Designed production ca-pacity

906 1151 1521 1851 1951 2056

YoY 27.1% 32.2% 21.7% 5.4% 5.4%


Figure 8: Earnings assumptions for Liansu

2. Extending distributor sales network. National policies and the shift

of regional development focus should support a gradual increase in

demand from the northern and western regions in 2012-15. To capital-

ize on the expanding geographic landscape of demand for plastic pipe,

Liansu is expanding its production capacity and also increasing its na-

tional sales network aggressively (up 180% in the past two years to

1,200 distributors nationwide).

9

The substantial increase in numbers of exclusive distributors should

help Liansu break into new markets effectively. Liansu does not grant

any credit to distributors nor does it accept returns of unsold products.

The higher revenue contribution from distributors should further im-

prove the company’s cash flow as working capital needs are lower than

required for direct sales.

Liansu is well-positioned to further expand due to the aggressive ex-

pansion of production capacity and sales network. Due to its strong

market presence Liansu is confident it can maintain its gross-profit mar-

gin and expects the selling price to increase gradually in the near-to-

medium term. We believe Liansu should continue to capture market

share and become a long-term winner in the plastic pipe manufacturing

market.

Liansu should maintain its leading market position, flowing from ambi-tious expansion plan.

Figure 10: Distributors for Liansu in China

Source: Company

Figure 11: National production breakdown (2007)

Source: Company

Figure 12: National production breakdown (2010E)

Source: Company

10

Liansu has been effective in managing its working capital against the

backdrop of poor conditions in China’s construction industry from 3Q11

resulting from a large number of infrastructure projects suspended or

delayed. The company managed its receivables days (around one

month) and inventory days (around two months) with strong operating

cash flow, thanks to tight control on credit and also more sales through

distributors instead of direct sales, reducing counter-party risk. As the

company will continue to increase its revenue contribution from distribu-

tors in the next few years due to increasing numbers of distributors, we

are not concerned about cash flow management.

Liansu had net cash (cash & cash equivalents of RMB2.1bn) at the end

of 2011. With such a strong liquidity profile, Liansu has abundant finan-

cial resources to fund its further expansion plans over 2013-15. Alt-

hough the company has stressed its development will be organic (self-

built capacity), we do not rule out the possibility of acquisition when/if

opportunities emerge.

Strong operating performance should

continue

Liansu has a strong balance sheet and tightly controlled cash flow management

Figure 14: Net gearing


Figure 15: Operating cash flow & working capital


2008 2009 2010 2011 2012E 2013E 2014E

Receivable days 22.2 23.0 27.2 25.7 25.7 27.0 27.5

Inventory days 60.7 59.0 60.5 57.7 58.2 60.8 62.8

Payable days 14.0 12.1 15.3 10.3 11.0 13.5 13.7

Figure 13: Turnover days


11

Gross-profit margin remains the major concern

We note that Liansu’s gross-profit margin declined from 26.4% in 2010

to 24.2% in 2011, due to the higher material cost and its aggressive

capacity expansion (which may lower the production efficiency in the

short term). However, we expect the gross-profit margin to stabilise in

2012 and gradually pick up in 2013 and 2014 when economies of scale

start to kick in.

For PVC products, the PVC resin manufactured by Liansu usually by

coal and limestone, which all sourced domestically and thus influenced

by shortages in refinery capacity and changes in coal prices. In view of

relatively strong pricing power over its customers and our expectation

of relative stable material cost, we expect the gross-profit margin for

PVC products should stabilize in 2H12.

For non-PVC products we believe the margin should slightly decline in

2012 as we believe the demand for non-PVC products should remain

weak in 2H12 due to a sluggish residential housing market (non-PVC

products are more commonly used for private building projects). Moreo-

ver, we believe that Liansu is keen on maintaining its low price strategy

to compete for market share in the future. Therefore, we expect the

gross-profit margin for non-PVC product will weaken in 2012. However,

we see potential upside risk to our conservative assumption on the sof-

tening oil price (non-PVC product is a petrochemical product).

We expect Liansu’s gross-profit margin to stabilise in 2012 and gradually pick up in 2013-14

Figure 16: Revenue & gross-profit margin


12

Figure 17: Breakdown of cost items (FY10)

Source: Company

Figure 18: Breakdown of raw materials (FY10)

Source: Company

Figure 19: PVC price

Source: Wind

Figure 20: PE price

Source: Wind

13

We are initiating coverage on China Liansu with a BUY rating and our

12-month target price of HK$5.30, which is equivalent to 9x our EPS

forecast for 2012, at the mid-trading range since its listing in 2010.

Comparing Liansu with plastic/metal pipe makers in China, we note that

Liansu should record a higher ROE with better cash flow over 2011-13.

Given its stronger financial strength and more profitable business mod-

el, Liansu deserves to trade at a premium to the Hong Kong-listed met-

al pipe makers, in our view.

Valuation

Our target price is equivalent to 9x our EPS forecast for 2012, still 30% below its China-listed plastic pipe peers, which we believe is unde-manding

Figure 21: PE Band

Source: Bloomberg, CGIHK Research

We cross-checked valuation with our DCF model, suggesting a fair val-

ue of HK$5.80. We are convinced that the stock is deeply undervalued

and set our target price based on 9x PER on 2012, still 30% below its

China-listed plastic pipe peers, which we believe is undemanding. Our

target price provides for 32.5% upside to the current share price and

we suggest investors accumulate the stock to enjoy the potential re-

rating.

For our DCF model, we assume a WACC of 11.4%, an adjusted beta of

1.3, a debt-to-EV ratio of 25%, and a terminal growth rate of 2%.

Catalysts and risks

In our view, the share price catalysts include 1) potential policy loosen-

ing in China and 2) announcement of the new three year plan of Liansu

(likely in July-Aug).

On the other hand, key risks to our optimistic view on Liansu include 1)

lower-than-expected demand for plastic pipe in China; 2) delay of new

added capacity; 3) slower-than-expected economic growth in China;

and 4) unable to pass through material cost to customers.

Figure 22: PE Band

Source: Bloomberg, CGIHK Research

15

China Liansu was founded in 1996 and is headquartered in Shunde,

China. The company is the largest manufacturer of plastic pipe and

fitting in China, with 12% market share in 2010. Liansu currently has 13

operational production facilities in 10 provinces of China with a total of

1,200 independent distributors as of the end of 2011.

China Liansu is an one-stop solution provider, providing pre-sale con-

sultation, after-sales services, on-site guidance and technical support.

The company offers a comprehensive range of plastic and pipe fittings,

primarily use PVC, PE, PP-R and other plastic resins to manufacture its

products. These products are used in a variety of piping systems, such

as water supply, drainage, power supply, communication, gas supply,

floor hearing, fire-fighting and agriculture.

Appendix—Company Profile

Figure 24: Shareholding structure

Source: Company

16

Appendix—Production process

Figure 25: Extrusion processing for plastic pipe productions

Source: Company

Figure 26: Injection moulding process for pipe fitting productions

Source: Company

17

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securities or issuer covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject, securi-

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Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong

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Explanation on Equity Ratings

BUY: We expect the total return on the stock to exceed 20% over a 12 to 18 month horizon.

HOLD: We expect the total return on the stock will be between 0% to 20% over a 12 to 18 month horizon.

SELL: We expect the total return on the stock will be less than 0% over a 12 to 18 month horizon.

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