China Sunsine | Libration
Updated: May 29
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Management renews share buyback mandate, reaffirming possibility of value-accretive share buybacks
Initial expansion plans remain on-track and unaffected by the pandemic. Management also hinted at future capacity expansion plans in the works, providing headroom for future market share expansion
CapEx to continue to be funded by internal resources, allowing Sunsine to maintain a healthy balance sheet
Utilisation rates remain healthy at 70-80%, higher than our conservative projections of 60%. Competitors have suffered production closures or are running at depressed utilisation levels
Management sees stabilisation of aniline prices, which implies a pickup in absolute revenue figures
Our initiation article on Sunsine (found HERE) on 15th May 2020 argued that the firm would face a confluence of short-term headwinds in the form of the replacement tire downcycle, oil price decline and muted demand due to the COVID-19 pandemic. That said, we walked readers through how Sunsine could emerge stronger from this downturn owing to its strong balance sheet, widening economic moat and robust expansion plans. We last had a fair valuation estimate of $0.59 backed by the P/B-ROE model, implying a re-rating to a fair P/B of 1.1x and upside of 55.3% from the current price of $0.38.
Since then, Sunsine put out a business update on 26th May 2020 which indicated that they were expecting to record lower revenue and profit for FY20, compared to FY19. This was unsurprising given the dampened business conditions. We also attended Sunsine's virtual Annual General Meeting (AGM) on the 27th May 2020 and reviewed Sunsine's response to questions from shareholders. We were impressed by the level of disclosure provided by the company. More importantly there were multiple positive statements made by the management that re-affirm our initial theses.
Written below are our top ten takeaways from Sunsine's AGM and Q&A responses.
Our Top Ten Takeaways from Sunsine's AGM
1. Renewal of Share Buyback Mandate
Under the renewed mandate, Sunsine can buyback up to 10% of the total number of issued shares of the company, equivalent to 96,888,050 shares. In Sunsine's response to queries from SIAS, management validated that the company would execute share buybacks when it deems that its shares are "very undervalued". Since then, Sunsine's share price seemed to have formed a bottom at around the $0.30 level. We believe that management's recent share buyback activity has lent support to the view that the stock is undervalued at that level.
2. Expansion Plans are On Track
Management has verified that the existing production expansion plans are unaffected by the pandemic and will be implemented according to the original schedule. According to the original plans, 20,000 tons capacity expansion of TBBS rubber accelerator will be completed by June 2020, while the 30,000 tons insoluble sulphur and 30,000 tons anti-oxidant TMQ expansion will begin commercial production in 2021. In contrast, Sunsine's peers have announced expansion plans without providing much details. We view that Sunsine is better poised to expand capacity given its more robust financial position. We believe that this is crucial in providing headroom for market share expansion as the entire rubber chemical industry contends with a trough accelerated by the COVID-19 pandemic.
3. Improved Visibility on Sunsine's New TBBS Production Facility
Sunsine shedded more light on the advantages of its automated TBBS production facility in its update. Sunsine cited major benefits such as increased production efficiency, increased product yield by ~2%, and environmental protection benefits for its new TBBS facility. We believe that this will translate to elevated rubber accelerator profit margins when production from the new TBBS production facility commences in June 2020.
4. Funding of CapEx to Come from Internal Resources, Without Borrowings
Management clarified that it will fund its 3 existing expansion projects with internal resources, without any borrowings. We believe that such a move is consistent with management's strategy of a strong and debt free balance sheet, which will enable Sunsine to maintain its exceptional liquidity and leverage metrics compared to its peers.
5. Hints of More Expansion Plans
While management has stated that CapEx for 2021-22 are not expected to be higher than the 2020 level, we believe further strategic expansions would cement Sunsine's market leadership in the rubber chemicals industry.
6. Current Utilisation Rate is Above Our Conservative Projections
Management reported that utilisation rate is at 70-80%, which is above our conservative projection of 60%. They have also announced that they have sold approximately 60,000 tons of rubber chemicals between January and May 2020. We continue to remain optimistic that demand for automobile traffic will increase and that automobile usage will continue to experience a recovery globally. At the same time we also expect intercity automobile travel to gradually pick up, spurred by the increase in domestic tourism. This is supported by a McKinsey survey, which found that 55% of respondents are expecting their next leisure trip to be domestic with self-driving or car rental options being viewed as more acceptable and safer than air transport. We are of the opinion that COVID-19 induces a temporary paradigm shift in the tourism sector where international leisure travel will be diverted to domestic self-drive leisure travel.
7. Reaffirming of Large Cash Position and Confidence in Tiding through COVID-19
Management reaffirmed Sunsine's large cash position and confidence in tiding through COVID-19. Management reported a cash and deposit balance of RMB1.35 bn, an 11% increase from end-FY2019's RMB1.28 bn, and notes receivable of RMB200 mn. Management reassured that while some customers have slowed down their payments due to challenges from COVID-19, they are not expecting any material defaults. Management also expressed their belief that tire demand will eventually normalise as the replacement tire market is relatively stable and inelastic. Management further announced zero job cuts across its businesses and that all employees have returned to work. These complement our thesis that Sunsine's herculean balance sheet will help it to triumph over short-term disruptions by COVID-19.
8. Peers Facing Difficulty and Sunsine in Stronger Position
Management provided brief insights on how other industry players have been performing. Contrasted to Sunsine's relatively satisfactory 70-80% utilisation rates, many of its competitors have suffered production closure or are running at a low production capacity. Recent reports from China confirmed this, showing that Sunsine's peers like Kailun Chemical (Source: Tireworld) and Weilin Chemical (Source: Puyang Hotline) were facing difficulties in resuming production due to various reasons like labour disruptions and financial woes.
Management also elaborated that Sunsine's competitive advantage over its peers is that it provides customers with a full suite of key rubber chemicals at a competitive price. This is further bolstered by cost savings from economies of scale, as well as heightened barriers to entry due to compliance with national environmental protection laws. We thus believe that Sunsine will continue to be in good standing to seize market share while expanding its defensive moat.
9. Management Elaborated on Strategies to Maintain Profit Margins
Management shared that they will focus on lowering costs rather than increasing ASPs during the COVID-19 pandemic. According to management, the group has signed strategic cooperation agreements to obtain better prices of raw materials and guaranteed purchasing volumes, they will also focus internally on improving operational processes to reduce wastage and control costs, as well as continue looking for opportunities to automate production processes to increase productivity.
10. Management Expects Falling Aniline Prices to Stabilise and Gradually Pick Up
Management has opined that they expect the falling aniline prices to stabilise and then gradually pick up. This is consistent with the fact that crude prices have been slowly recovering from all-time lows. Prices of aniline, a derivative of benzene and thus crude, is expected to follow suit. Since the rubber chemical industry seems to adopt a cost-plus pricing model, we are expecting Sunsine's absolute revenue to benefit from recovering aniline prices.
Since our first article, Sunsine's share price has drifted higher to $0.38 as of writing. Moreover, there was no significant downward retracement after the negative profit guidance was issued. This leads us to believe that expectations of a decline in earnings in the short-to-medium term are priced in. We also expect management to continue to execute value-accretive buybacks if the market severely underprices the stock given that the share buyback mandate has been renewed.
With utilisation rates remaining at satisfactory levels and expansion plans on track, management is confident that they would continue to expand sales volume. Barring unforeseen risks, we also remain fairly optimistic that our investment theses will continue to play out.
Thanks for reading,
Shawn and Bryan
Disclaimer: We are long Sunsine at an average price of $0.38. This is not a buy recommendation, this is only for educational and discussion purposes.
Cover photo source: Imthaz Ahamed
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