Kingboard Chemical (0148.HK) Phillip Securities...

Kingboard Chemical (0148.HK) -- Chemicals division with bright prospect

Phillip Securities Research Pte. Ltd.

January 05 2012 Market Stock Exchange Hong Kong Sector Chemicals

Reuters 0148.HK

Bloomberg 0148.HK HOLD Previous Closing Price: HK$23.70

Target Price: HK$25.50 (+7.6%)

Phillip Research Team � 65 65311240 FAX 65 63367607 � [email protected] Web: www.poems.com.sg MICA (P) 004/01/2011 Ref No: HK2012_0002

What’s new The subsidiary of Kingboard Chemical Holdings (0148.HK), Kingboard Laminates (1888.HK), announced that its Singapore-listed subsidiary, Kingboard Copper Foil Holdings Limited, as of the end of September 2011, recorded a turnover of HK$ 719 million in three months, which reduced by 42.67% annually. The profit attributable to shareholders for the period was HK$ 5.072 million, dropped by 86.7% annually. Enhance the weighting of properties division Group's managements plan to raise the weighting of properties business to 10% - 15% in the next 3 - 5 years. However, developing properties business require inputting large amount of capital and time in order to build up land reserves, which create heavy pressure on Group’s working capital. Remarkable results from chemical division Regarding rapid industrial development in China, market demand for chemical products will continually increase, especially for the methanol business. Methanol and its derivatives have a lot of applications and there is a supply gap in China’s methanol market. Methanol business has a huge room for development and can boost the overall chemical business.

Reiterate “HOLD” rating Our 12-month target price is HK$ 25.50 which is based on DCF valuation. The target price implies 2012 P/E of 5.4x and 0.675 PEG. Compared to HK$ 23.70 of current price, the potential upside for one year is 7.6%. Reiterate “HOLD” rating.

(HK$ m) 2010A 2011E 2012E 2013E 3-Yr CARG

Total revenue 33,892 37,906 41,318 47,928 12.2%

YoY% 42% 12% 9% 16% --

Operating profit 5,470 5,581 6,027 6,961 8.4%

YoY% 59% 2% 8% 15% --

EPS (in HK$) 4.278 4.364 4.713 5.467 8.5%

YoY% 51% 2% 8% 16% --

Source: Company data; Phillip estimates

Kingboard Chemical (0148.HK) January 05, 2012

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Various businesses weighting Group’s business coverage is comprehensive, including the production of laminates, printed circuit boards, chemical products and developing properties. Among them, the production of laminates and chemicals are the most profitable to the Group. In 2011 1H, two businesses accounted for more than 40% of overall profit respectively. Exhibit 1: The weighting of various division in 2011 1H

Source: Company data; Phillip Research Regarding the huge demand for chemicals products in China, we forecast the group will put more resources to develop the chemicals division in the future. The shipment and average selling price of chemicals products rose annually. Among the chemicals, the production of methanol has the greatest potential for development as there is a supply gap in China. On the other hand, laminates and printed circuit board businesses are still affected by the earthquake of Japan in March. The overall profit is mainly driven by the chemical division.

Laminates In 2011 1Q, the demand for laminates was stronger than 2010 4Q. However, the copper price increased, resulting in the increase in the production cost of laminates. The group passed the cost to the customers, causing the average selling price of laminates in 2011 1H increase. In the 2011 2H, the copper price trend fluctuated. Since the gold price exceeded US$ 1900 per oz in August, the gold prices dropped significantly. The decline in copper price was much more than that of gold price. The annual decline in copper price was 21%. Large fall in copper price can reduce the production cost of manufacturing laminates and there will be room for adjusting the average selling price of laminates downward.


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Exhibit 2: The price trend of copper and gold price

Source: CEIC; Phillip Research

However, in the aspect of demand, the global electronics supply chain was impacted badly by the unprecedented earthquake in Japan. Shortage of certain key electronics components caused across-the-board inventory adjustments by the end-customers which in turn dampened the demand for laminates, lowering utilisation rate of production facilities. In addition to the uncertainties in global economy, the demand for laminates will recover slowly. However, despite signs of slowdown in the global economy, the China domestic market remained buoyant. Laminate division strategically expanded the market shares in China.

Exhibit 3: Estimated revenue and EBIT margin of laminates

Source: Company data; Phillip Research


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Printed Circuit Board (PCB) PCBs products are also affected by the earthquake in Japan and there is a supply shortage in the supply chain of electronic products. Worse still, the demand for conventional PCBs is weak. Therefore, The Group focused on expanding high density interconnects “HDI” business. HDI is the fastest growing areas in the printed circuit board industry, which can be applied to the camera, data communications, automotive electronics and mobile phones. Mobile phone industry is one of the most widely used area. HDI business will benefit from the increase in the production of high-end electronic products like smart phones.

In 2011 1H, the revenue of PCB dropped by 11% yoy. We expect that the annual revenue of PCB in 2011 will be HK$8 billion only. But with the rapid development of smart phones, the demand for printed circuit boards increased and we expect the revenue from PCB division in 2012 will return to the level of 2010. Exhibit 4: Estimated revenue and EBIT margin of PCB


Chemicals Methanol Methanol is commonly converted to formalin, which is used in the manufacturing process of plastics, plywood, paints, explosives and permanent press textiles. Methanol is also blended in gasoline as methanol fuel for use by vehicles. Methanol and its derivatives like Dimethyl Ether, Acetic Acid and Methyl tert-butyl ether can be applied widely.


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Table 1: The applications of methanol’s derivatives Derivatives Applications

Dimethyl Ether (DME) - Mixed with liquefied petroleum gas for heating - Used as a transportation fuel and as a substitute for diesel

Acetic acid - Production of a variety of compounds used in the manufacture of pesticides, chemicals and pharmaceutical products

Methyl tert-butyl ether - Used as a gasoline fuel components

Source: Company data; GasTechn; Phillip Research Methanol demand in China increased rapidly in recent years. But the local methanol production cannot fulfill the demand. It is expected that the supply shortage in China’s methanol market will be 40,000 tons in 2011. With the industrial development in China, the supply gap will keep being expanded in the future. In addition to natural gas based methanol plant joint venture with China BlueChemical, the methanol business has huge room for growth.

Exhibit 5: Monthly methanol production in China

Source: Company data; CEIC; Phillip Research


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Exhibit 6: Production and demand of methanol in China

Source: Company data; CEIC; allbusiness; asiachem; Phillip Research

Exhibit 7: Price trend of methanol


Phenol/Acetone The Group allocates more resources to develop chemical division. In 2010, a new phenol/acetone plant with an annual capacity of 300,000 tons was developed. The capacity enhancement plan for the existing phenol/acetone plant in Huizhou expected to be completed in 2011, in order to catch up the huge demand for phenol and acetone in China.


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Exhibit 8: Price trend and applications of phenol


Exhibit 9: Price trend and applications of acetone


Overall results of chemical division In 2011 1H, Group’s chemical division posted remarkable results. Chemical division revenue soared 38% to HK$9,078.4 million with EBITDA up 73% to HK$1,442.9 million in 1H 2011. Regarding rapid industrial development in China, market demand for chemical products will continually increase, especially for the methanol business. Methanol and its derivatives have wide applications and there is supply gap in China’s methanol market. Methanol business has huge room for development and can boost the overall chemical business. We expect the weighting of chemical division will keep rising to be over 50% in 2012. The chemical division will be the most profitable business to the Group.


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Exhibit 10: Estimated revenue and EBIT margin of chemicals


Properties division The Group started to engage in properties business since 2008. The first residential development project is Shanghai Yu Garden in Kunshan and its earnings will be recognized in 2H 2011. In addition, pre-sale for another residential project, Kunshan Qiandeng Yu Garden, is also expected to commence in 2H 2011. The properties division is expected to generate stable and attractive returns for the Group. Apart from Shanghai, the Group’s key investment properties in eastern and southern China continued to generate stable rental income. Group's managements plan to raise the weighting of properties business to 10% - 15% in the next 3 - 5 years. However, developing properties require inputting large amount of capital and time in order to build up land reserves. The Group held a land bank of over 3 million square metres of gross floor area located at prime sites in major cities such as Guangzhou, Shanghai and Kunshan in China. And Rental income from the properties division jumped 72% to HK$100.3 million in 1H 2011. However, the rental income from properties division in 2011 1H accounted for less than 1% of overall turnover. The group had spent HK$ 2.6 billion on properties held for development. Developing properties creates heavy pressure on Group’s working capital.


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SWOT Analysis Strengths � The Group has a natural gas based

methanol plant joint venture with China BlueChemical, which can increase the methanol production in order to fulfill the huge demand for methanol from China.

� The Group held a land bank of over 3 million square metres of gross floor area located at prime sites in major cities such as Guangzhou, Shanghai and Kunshan in China, which assist the Group to develop properties division.

Weaknesses � Laminates and PCB businesses are

greatly impacted by the earthquake in Japan happened in March. There is a supply shortage in the supply chain of electronic products. In addition to the uncertainties of global economy, the demand for the products from oversea declined.

� The rental income from properties division in 2011 1H accounted for less than 1% of overall turnover.

Opportunities � Benefited from the increase in the

production of high-end electronic products like smart phones, the demand for HDI increases. HDI is the fastest growing areas in the printed circuit board industry.

� With the industrial development in China, it is expected that the supply shortage in China’s methanol market will be 40,000 tons and the supply gap will keep being expanded.

Threats � Developing properties require inputting

large amount of capital and time in order to build up land reserves, which create heavy pressure on Group’s working capital.

� Raising labour cost and the appreciation of RMB reduce the international competitiveness of Group’s products.


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Valuation We use DCF for valuation. According to Bloomberg data, the Group’s beta and equity risk premium are 1.2 and 13.8% respectively. Assume the risk-free rate (US 10-year Treasury yield) is 1.5%. The Group’s WACC is calculated as 13.6%. We forecast the free cash flow in the next 10 years and the free cash will grow at 2% of terminal growth rate after 2020.

Table 2: DCF

Source: Bloomberg; Company data; Phillip estimates

Table 3: Sensitivity analysis

Source: Phillip estimates


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According to DCF valuation, the 12-month TP of Group is HK$ 25.50. We forecast the earning per share in 2011, 2012 and 2013 are HK$ 4.364, HK$ 4.713 and HK$ 5.467 respectively, with 8.5% of 3-year CARG. The target price implies 2012 P/E of 5.4x and 0.675 PEG. Compared to HK$ 23.70 of current price, the potential upside for one year is 7.6%. Reiterate “HOLD” rating.

Peer valuation table

Prices are as close of 04 January 2012; "na" entries are excluded from the calculation of averages Source: Bloomberg; Phillip Research


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Exhibit 11: PE band Exhibit 12: PB band

Exhibit 13: ROE Exhibit 14: Dividend yield

Source: Company report; Bloomberg; Phillip Research

Latest Max. Median Min. +2 SD +1SD Average -1 SD -2 SD PE 5.5 25.43 10.10 2.48 18.94 14.45 9.96 5.47 0.98 PB 0.7 3.29 1.52 0.38 2.88 2.27 1.66 1.05 0.44 ROE 15.3% 58.40% 15.62% 5.55% na na na na na Dividend yield 4.2% 12.22% 5.20% 0% na na na na na Source: Bloomberg; Phillip Research


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Financial statements

Source: Company data; Phillip estimates Source: Company data; Phillip estimates

Source: Company data; Phillip estimates


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Ratings History

Rating Date Closing price (HK$) Fair value (HK$) Remarks

Buy 23-03-2007 32.90 35.60

Buy 14-11-2006 31.90 33.0

TRADING BUY Share price may exceed 10% on the upside over the next 3

months, however longer-term outlook remains uncertain

BUY >15% upside from the current price HOLD -10% to 15% from the current price SELL >10% downside from the current price

TRADING SELL Share price may exceed 10% on the downside over the next 3 months, however longer-term outlook remains uncertain

Phillip Research Stock Selection

Systems We do not base our recommendations entirely on the above quantitative return bands. We consider qualitative factors like (but not limited to) a stock's risk reward profile, market sentiment, recent rate of share price appreciation, presence or absence of stock price catalysts, and speculative undertones surrounding the stock, before making our final recommendation

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