We upgrade Xingda to BUY from Sell as we see multiple positive factors: (1) Shandong SNTON, a competitor of Xingda, is under restructuring and its radial tire cord output has been severely affected, leaving room for Xingda to gain market share; (2) decline in the price of steel wire rod and LNG since mid-2019 helped drive margin expansion; (3) the utilization rate of tire manufacturers (i.e. Xingda’s customer) recovered to 36% last week, up from 9% in early Feb. We reset our earnings forecast in 2019E-21E and lift our TP to HK$3.44 (based on 11x 2020E P/E). Dividend yield of 8-10% in 2019E-21E is attractive.
- Xingda is gaining market share from Shandong SNTON. Shandong SNTON (山东胜通) had an annual capacity of radial tire cord of 400k tonnes in 2016, ranked No.3 in China. However, SNTON then dived into financial difficulties and was unable to pay off its debts in 2019. SNTON is now in the restructuring process and, based on our understanding, maintains only a very low level of production. This has provided Xingda, the largest player with 30% market share, with the opportunity to grab more share. Xingda raised its radial tire cord production capacity from 670k tonnes in 2016 to 728k tonnes in 1H19.
- Decline in raw materials cost a key driver. Steel wire rod is the major raw material cost for the production of radial tire cord, accounting for ~60% of Xingda’s total production cost. China steel wire rod price dropped 10% YoY and 9% YoY in 3Q19 and 4Q19 respectively. Besides, LNG (another cost item that accounts for ~2% of production cost) saw 27% and 17% YoY decline in 3Q and 4Q respectively. The favourable price trend enabled Xingda to expand its gross margin as we understand that Xingda successfully limit the ASP cut in 2H19E. We estimate Xingda’s gross margin to expand to 20.7% in 2H19E, versus 19.2% in 1H19 and 18.2% in 2H18. We estimate the gross margin per tonne to reach ~RMB1,850 in 2019E, the highest level since 2014.
- Utilization rate of tire makers recovering. We note that the utilization rate rebounded sharply from 9% in the first week of Feb to 36% last week, suggesting that production resumption has been on track. We expect the utilization rate to further rebound in coming weeks, which will be positive to Xingda. For Xingda, we understand that workers have gradually returned to work, and the inventory of component is enough to satisfy the production need.
- Earnings forecast. We raise our earnings forecast in 2019E-20E substantially by 40-60% due mainly to higher gross margin assumptions. We expect earnings growth in 2H19E to reach 40% YoY, taking the full year earnings growth to 32% YoY. We expect earnings growth to reach 22% YoY in 2020E, driven by both volume growth and margin expansion.
- New TP of HK$3.44 implies 47% upside potential. We raise our TP from HK$1.95 to HK$3.44. Our target PE of 11x is based on the historical forward P/E since 2012 (we excluded the period before 2012 as high valuation was given to Xingda’s solar wafer wire sawing business). Current P/E of 7.5x is undemanding, in our view. What’s more, Xingda has maintained a high dividend payout policy (74% in 2018) and we expect the Company is capable to maintain ~75% payout going forward, given its strong operating cash flow and net cash position. This will potentially offer dividend yield of 8-10% in 2019E-21E based on our earnings forecast.
- Near-term catalysts: (1) Strong 2019E results; (2) further increase in the downstream utilization rate; (3) policy stimulus to drive the demand for construction vehicles and passenger vehicles.
- Key risks: (1) Increase in raw material price; (2) weakness in vehicle demand; (3) currency risk.
