UPDATE on China Sunsine Chemical (SGX:CH8)

I went over to the recent FY2018 3Q results briefing of China Sunsine on 8 November 2018. The event was well-attended by several heavyweights such as Robert Stone and Chia Kee Koon. Throughout the whole briefing, Mr Tong (Chief Financial Officer) handled the barrage of questions adequately. He quoted industry statistics and facts.

Many of shareholders were concerned about the upcoming new supply of TBBS, the cyclicality of the industry and margins. There were many analysts from various houses (Credit Suisse, etc) too.

In this article, I will write down some of the pointers which I analysed wrong about China Sunsine (CS).

The Company is Not Entirely Cyclical 

While it was easy on my part to classify CS as a commodity-based company, here are three reasons why it is not.

A More Stable Gross Profit Margin

The biggest raw material for their rubber accelerator is aniline. The prices of aniline fluctuate according to a variety of industry factors. As CS based its average selling price of accelerators on a “cost-plus” basis, it’d reduce the price of their end product whenever the price of aniline falls. CS aims to maintain a gross profit margin of 30%.

While the price of their accelerators fall and rise accordingly, how is CS able to grow its revenue over time?

Using this formula, Gross Profit = Gross Profit Margin x Volume.

The business may earn a lesser gross profit in absolute terms however that is compensated by the growing volumes of accelerators. Their annual capacity is 89k, 20k and 45k tonnes for accelerators, insoluble sulphur and anti-oxidant respectively.

Adding on to that, China released a “Battle for a Blue Sky” initiative to reduce environmental pollution. It caused smaller producers to exit out of the industry and it is consolidating further to top 5 players controlling almost 60 – 70% of the industry’s output. Through an industry mechanism, the top 5 players do not engage in aggressive pricing to undercut each other. It is heading towards healthy growth.

This means lesser competition and new supply will be planned properly to avoid overcapacity issues.

Less Dependent on New Car Sales

I thought that CS is heavily dependent on new car sales. It was revealed that 70% of the sales are the replacement for old tires while the remaining is for new cars.

(Source: Statista)

 
source: tradingeconomics.com

Two charts above demonstrate the increasing addressable market available for CS. For example, while vehicle sales may fluctuate depending on economic conditions, the number of car ownership is on the rise.

High Barrier to Entry

Being a big supplier to customers such as Bridgestone, Goodyear, Hankook, and Michelin, CS underwent several successful tests which were made possible by its accumulated know-how in the speciality chemical. While the raw material is aniline, the finished product is a niche. Apart from that, the government industry does not grant approvals for new entrants that easily anymore.

The management also shared, to draw a comparison with themselves, an investor could use Shandong Yanggu Huatai (SHE:300121).

Hope this helps to correct the earlier analysis I made on China Sunsine! Volume growth is key to offset any decline in Average Selling Price. If the industry consolidates further, it’d be good for the profitability margins of China Sunsine and Shangdong Yanggu.