On expansion trail. Time may be ripe to enter.

SYNOPSIS: We visited Li Heng Chemical Fibre’s (LHCF) plants recently in Changle City, Fujian Province Based on relative valuation, we think a fair price to enter is between $0.65-$0.74.

INVESTMENT SUMMARY:
All of LHCF’s products are marketed under brand names “Liyuan” and “Liheng”. Liyuan’s production facilities are located at Jinfeng Industrial Zone, with site area of 47,514 sqm while Liheng’s are located in Binhai Industrial Zone, with site area of 325,151 sqm. Both sites are just 10-15 mins apart.

The plants are situated within clusters of wrap-knitting garment and textile manufacturers, which are primarily the group’s customers. Management estimates that they command slightly less than 10% of market share based on their capacity in FY07. They are also optimistic about an 18-25% growth in domestic nylon consumption this year.

COMPANY GROWTH DRIVERS INFY08
We witnessed Liyuan Phase III and Liheng Phase II expansion at their respective sites; both of which started operations in March this year. 6 nylon yarns production lines (23,000 mt) were added in Liyuan phase III, while 13 nylon yarns production lines and two DTY texturizing machines (52,000 mt) were added in Liheng Phase II. As such, maximum production capacity increased to 167,000 mt as of 1Q08 from 92,400 mt in FY07.

LIHENG PHASE III EXPANSION IN 3Q09
LHCF is constructing the facilities for Liheng Phase III expansion on their land in Binhai Industrial Zone. This is expected to add another 18 nylon yarns production lines and 20 DTY texturizing machines, increasing the maximum annual capacity by 90,000 mt to 257,000 mt by 3Q09.

A polyamide chip (PA-6) plant is also being built on the site, boosting a capacity of 80,000 mt of the PA-6 chips, the main raw material for nylon yarns production. The PA-6 chips will feed directly into the production of the nylon yarns at Phase III and provide significant cost savings. At the same site will also be an R&D centre being set up to address the area of product innovation to maintain their industry leading position. About RMB1.1b of the RMB1.3b in net proceeds from IPO will be utilized for these purposes and counted as capex in FY08-09.

Looking beyond 2009, management pointed that there is still 40% of land remaining after Liheng Phase III, enough for about two more phases of expansion!

DIVERSIFIED CUSTOMER BASE
We also visited two of LHCF’s customers in Changle City, who manufacture fine lingerie, undergarments and other casual wear. Each accounts for just 1-2% of LHCF’s sales and is a small proportion of their 170-strong customer base in the PRC. According to management, LHCF supplies about 30-50% of each of their customers’ nylon requirements and no customer account for more than 5% of revenue. The customers import their remaining nylon requirement mainly from Taiwan, South Korea, Japan and Malaysia. This affirms LHCF’s claim to be one of P R C ’s f e w manufacturers of quality, high-end nylon yarns, as they are the main domestic supplier sought by some of their customers.

RELATIVE VALUATION
F o r e i g n competitors listed overseas include Toray Industries Inc. (36x FY08P/E) of Japan and Hyosung Corp (11xFY08P/E) of Korea, whose highend nylon products are widely accepted in the PRC. Based on consensus FY08 P/E, Singapore-listed chemical fibre companies trade at steep discounts to their overseas listed counterparts. LHCF closely tracks its Singapore listed peer, China Sky, in valuation. We recommended not subscribing during the IPO on 7 Mar due to an apparent sector de-rating and negative sentiment towards S-chips.

At this point, we see a few possible entry points. With China textile companies trading at 3.8-4.6x FY09 P/E, we estimate a fair price to enter the stock is between $0.65-0.74. The stock closed at $0.71 yesterday. We would not pursue aggressively but would rather wait for opportunity to accumulate. Following some adjustment to our earnings estimates, we derived $0.94 as our fair value, supported by 8x FY08 P/E.

[This article is contributed by NRA Capital Pte. Ltd., a licensed Financial Adviser by the MAS. Readers of this content are bound by the same terms & conditions of our website www.netresearch-asia.com .]