China Sky Chemical Fibre (S$1.32) - Initiation of Coverage - Nylon Behemoth

? Nylon behemoth. China Sky is the largest nylon producer in the PRC with a current

annual capacity of 72,000 tonnes p.a. and market share of 6%. The group currently

produces nylon high oriented yarn (HOY) and full drawn yarn (FDY) that are used to

produce high-end products such as ski jackets and coats. The group will start to

produce two other kinds of higher-grade nylon fibre in 2007 and a new super-resilient

range of nylon fibres in 2008, cementing its place as the market leader.Nylon behemoth. China Sky is the largest nylon producer in the PRC with a current

annual capacity of 72,000 tonnes p.a. and market share of 6%. The group currently

produces nylon high oriented yarn (HOY) and full drawn yarn (FDY) that are used to

produce high-end products such as ski jackets and coats. The group will start to

produce two other kinds of higher-grade nylon fibre in 2007 and a new super-resilient

range of nylon fibres in 2008, cementing its place as the market leader.

? Spearheading import substitution. China currently imports a third of its nylon fibres

but is expected to reduce this figure to 20% by 2008, according to management.

Being the largest nylon player in the PRC with an expected capacity of 123,000

tonnes p.a. by 2008, China Sky is at the forefront of capturing this piece of the pie.Spearheading import substitution. China currently imports a third of its nylon fibres

but is expected to reduce this figure to 20% by 2008, according to management.

Being the largest nylon player in the PRC with an expected capacity of 123,000

tonnes p.a. by 2008, China Sky is at the forefront of capturing this piece of the pie.

? Shift in demand to higher-value textiles will boost demand for nylon. Growing

Chinese affluence coupled with the 2005 imposition of textile import quotas by the US

and EU has resulted in higher demand for premium fibres by Chinese textile

manufacturers and exporters alike. Industry statistics shows that the unit value of

synthetic fibre products increased by 12% yoy in 1H06. As nylon is considered

superior in grade to the rest of the synthetic fibres, we believe the spillover effects of

these developments will help to sustain a turnover CAGR of 32% for China Sky from

FY05 to FY09.Shift in demand to higher-value textiles will boost demand for nylon. Growing

Chinese affluence coupled with the 2005 imposition of textile import quotas by the US

and EU has resulted in higher demand for premium fibres by Chinese textile

manufacturers and exporters alike. Industry statistics shows that the unit value of

synthetic fibre products increased by 12% yoy in 1H06. As nylon is considered

superior in grade to the rest of the synthetic fibres, we believe the spillover effects of

these developments will help to sustain a turnover CAGR of 32% for China Sky from

FY05 to FY09.

? SR products the next exciting earnings catalyst. By 2008, China Sky is expected

to launch its latest range of super-resilient nylon fibres. These fibres have the greatest

tensile strength, comfort and stretchability among China Sky?s nylon fibres. As they

typically retail at a 20% premium to existing fibres, they are expected to improve

gross margins to 37% from 34% by FY09. Barring any delays, we believe full-year

contributions will power net profit growth of 47% in FY09.SR products the next exciting earnings catalyst. By 2008, China Sky is expected

to launch its latest range of super-resilient nylon fibres. These fibres have the greatest

tensile strength, comfort and stretchability among China Sky?s nylon fibres. As they

typically retail at a 20% premium to existing fibres, they are expected to improve

gross margins to 37% from 34% by FY09. Barring any delays, we believe full-year

contributions will power net profit growth of 47% in FY09.

? Initiate with Outperform rating and target price of S$1.70. Our target price is

based on DCF valuation (WACC 12.8%, terminal growth rate 0.5%), implying 12.1x

CY07 and a 10.7x CY08 P/Es, which are at premiums to the average for Singaporelisted

peers but deep discounts to the more established Asian peers. We see

catalysts coming from: 1) capacity expansion; and 2) the successful execution of its

ATY, DTY and SR nylon fibres in 1H07 and 1H08 respectively.Initiate with Outperform rating and target price of S$1.70. Our target price is

based on DCF valuation (WACC 12.8%, terminal growth rate 0.5%), implying 12.1x

CY07 and a 10.7x CY08 P/Es, which are at premiums to the average for Singaporelisted

peers but deep discounts to the more established Asian peers. We see

catalysts coming from: 1) capacity expansion; and 2) the successful execution of its

ATY, DTY and SR nylon fibres in 1H07 and 1H08 respectively.