The Edge Singapore

 

September 14, 2009

 

Corporate: China Gaoxian braves IPO plunge amid industry slump; new products boost earnings

 

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| By Leu Siew Ying |

 

For 11 years, Cao Xiangbin slogged in China's state-owned textile factories until he had saved enough money to set up his own polyester fibre plant in Fujian province in 1997.

 

Twelve years on, he is now ready to ramp up the production of new products and is tapping the Singapore market this week for nearly $80 million to fund the expansion. But last Thursday, at the IPO of its listing vehicle China Gaoxian Fibre Fabric Holdings, Cao could not help but feel disappointed that the listing price was not higher than the 26 cents on offer.

 

It is understandable why Cao, like most S-chip CEOs, says his stock is undervalued. China Gaoxian is entering the market at a time when other textile players are reporting weak numbers and the market is deeply suspicious of S-chips. Just a few weeks ago, when it launched its IPO roadshow, Mainboard-listed synthetic leather manufacturer Sino Techfibre and nylon yarn maker China Sky Chemical Fibre released weak 2Q2009 results that had a bearing on China Gaoxian's offer price, its underwriters say.

 

The irony is that Singapore was picked because its "excellent" corporate governance regime would be good for the company's image, Raymond Wong, China Gaoxian's chief financial officer (CFO), tells The Edge Singapore. "We chose Singapore because, in China, we are not an industry leader but, in Singapore, we are among the leaders," adds Cao.

 

Indeed, China Gaoxian's IPO price is offered at a steep discount to those of its peers. In a research note published last Thursday, DMG and Partners says the stock, at 26 cents, is trading at 5.2 times forward earnings compared with 11.9 times for its peers. Yet, the brokerage says the company should be better able to protect its margins, given its business focus on higher-end products.

 

China Gaoxian is the largest company in the polyester segment in China and also the largest to list in Singapore, say company officials. In terms of production capacity, it is comparable with Mainboard-listed nylon yarn maker Li Heng Chemical Fibre Technologies, which was running at full production capacity of 167,000 tonnes at end-2008 and is adding 90,000 tonnes of new capacity by 2010.

 

But up until 2007, China Gaoxian's two wholly owned subsidiaries in Changle and Huzhou were producing only fully drawn yarn (FDY), a high-tensile strength and semi-dull yarn that can be spun into wrinkle-resistant fabric for use in making apparel and home furnishings. Revenue from FDY, which enjoyed an average gross profit margin of 28.2% in the past three years, rose to RMB1.34 billion ($196 million) in 2007 from RMB1 billion in 2006 but sales fell to RMB732 million last year as the company freed existing resources to introduce four new products to maximise earnings as part of its listing preparation. In April 2008, Cao had enlisted the help of Collins Stewart, an independent financial advisory group, to whip the company into shape for its IPO. Making the company palatable for investors took two years.

 

New product mix

 

to maximise earnings

 

For years since its inception, the company manufactured only FDY at its two factories in Changle in Fujian province and in Huzhou in Zhejiang province. The three new products China Gaoxian added last year are drawn textured yarn (DTY), used to produce textile with a matt appearance like cotton and wool; blended polyester yarn, used for suits, gowns and sports apparel; and triangular-fibre yarn, or artificial silk. This year, it introduced a fourth product - warp-knit fabric. The company plans to phase out direct sales of FDY because of its low gross profit margin (GPM). It will instead use the yarn in-house to produce warp-knit fabric.

 

China Gaoxian says the new products did not require significant investment as they could be manufactured with existing machines. All that were needed were new moulds and for the technicians to make adjustments to the manufacturing processes. However, the new product mix lifted earnings by almost 48% to RMB390.4 million and revenue by 37% to RMB1.83 billion. Meanwhile, average GPM rose to 30.4%, from 29.5% in 2007, when the company was producing only FDY. GPM for 2008 ranged from 26.3 % for FDY to a high of 36.7% for triangular-fibre yarn. This strong performance stood out against a backdrop of declining earnings reported by the chemical-fibre sector, which was badly affected by depressed export demand for textile and garments. Li Heng, whose plant is also in Changle city, reported earnings falling 10% to RMB814 million in FY2008, although its revenue rose 34% to RMB3.7 billion. Others fared worse. China Sky Chemical Fibre's earnings were down 39.7% and its revenue fell 7.9%; and Sino Techfibre's earnings shrank 20%, although sales rose 3%.

 

Cao's explanation for his company's performance against the market trend is that its downstream customers cater to the domestic market. "Our products are locally consumed. Our downstream customers are producing textiles and garments for the local market," he says, adding that the company was also shielded from the impact of the financial crisis by the four new products, which generated a new revenue stream.

 

To investors who are sceptical about how successful these new products would be over the long term, both Cao and underwriter UOB KayHian say demand for them exceeds supply. According to data from the China Chemical Fibre Economic Information Network cited by the company, polyester fibres account of 82% of all chemical fibres used by China's textile industry. Half of the supply for highly differentiated yarn, like those that China Gaoxian produces, has to be met by imports.

 

Plans for IPO proceeds

 

Under its IPO, China Gaoxian is issuing 380 million shares, comprising 375 million placement shares and five million public shares, at 26 cents each, to raise $78.2 million. The offer closes on Sept 16 and the shares will be listed for trading on Sept 18. CFO Wong says, of the IPO proceeds, $33 million will be used to buy 150 machines to expand production of premium differentiated polyester yarn, and $35 million will be used to expand fabric production at its new plant in Changle. The company expects to expand yarn-production capacity to 241,300 tonnes by 2010, from 176,200 tonnes now. Its fabric-production capacity of 17,000 tonnes will be increased by stages to 81,900 tonnes in three years.

 

But is there the risk of oversupply, given that China's polyester industry is already huge? According to a 2008/09 world survey by Swiss textile machinery manufacturer Oerlikon Barmag, China's share in the industry grew to 66% last year from just 27% in 2000 and 12% in 1990. The country's polyester industry has also shown a significant increase in excess supply, with production capacity rising faster than consumption. However, higher exports partly helped compensate for slowing domestic demand and lifted factory utilisation slightly to avoid a fall below 60%.

 

The UOB KayHian report on China's chemical-fibre sector in January showed polyester filament inventory rising 56% y-o-y to 542,000 tonnes in August 2008. At China Gaoxian, company officials say the inventory turnover fell to 33 days in FY2008, from 59 days in FY2007. "It's mostly raw materials. We have very little finished products because we produce to meet orders," says Wong.

 

And there could be more good news. A UOB KayHian report on the chemical-fibre sector in June says the sector had likely hit bottom and begun a recovery since early 2Q2009. Li Heng's share price has shot up 60% on institutional buying since the company announced its results on Aug 11; China Sky is up 43% and Sino Techfibre rose 35% since Aug 14. But not everybody is as upbeat. An OCBC research note on Li Heng on Aug 26 says the company is not calling a sustained recovery just yet. It says Li Heng believes the performance of its seasonally slower 4Q will be a better indicator of whether the chemical-fibre industry has truly recovered.

 

So, while founder Cao may not be happy with his IPO price, he should at least take heart that the market as a whole is firm at this point and that most of the recent IPOs have so far done fairly well. If investors have a good experience with China Gaoxian, it might make them more confident about the new products it has started producing and help lift the stock higher.

 

September 17, 2009