Yingde Gases

This is a cheaper version of Air Liquide and Praxair.  Yingde Gases is the largest bulk industrial gas producer in China:

By end of 2013, they say they had a 47% market share.  Currently selling for 11 times earnings and growing fast,  compared to 16-18 times for Air Liquide, and 20 plus times for Praxair.

Business Model

Similar to Air Liquide and Praxair (build plants next to customer, long term take-or-pay contracts), with a few differences:

• The MNCs prefer to build in clusters (p6) in certain regions, to enhance their reputation and pricing power, and take advantage of regional synergies.  Yingde is less selective in this, and will build isolated plants.
• Yingde has a more sales from on-site/pipeline, less from merchant (13% in 2012, 11% in 1H13).
• Yingde only invests in China, the others allocate capital globally and can avoid China if they don't like the opportunities there.

Yingde, in short, borrows lots of money, sets up a plant next to a factory, and then gets a utility-like stream of payments over the next 10-15 years.  It takes about two years for a plant to achieve profitability.  They are still expanding:

Balance Sheet

Since their business relies on debt, lets look at it first:

• Total debt at 7bn (mostly long term) is about 6 times (2013) earnings before tax.  Or 3.7 times EBIDTA.  High.
• Most of it is bank plus other loans (3.15bn) and senior notes (2.6bn) - 8.1% yield, due in 2018.   Also medium term loans 800K.
• The 8.1% 2.6bn RMB senior notes are actually in USD.   Did not find any information about currency hedging or swap.  Currency risk if the RMB drops against USD.
• Roughly 1bn is due this year, another billion in the year after, and 4.5bn due in 2-5 years.
• Some swaps, to achieve mix of floating and fixed debt - they receive floating rate and pay fixed rate - hedge against rising rates.  Couldn't find how much.  Not important since the debt is all short or medium term anyway.

Looks like they have reached their borrowing limit:

• In 2012 they breached debt covenants; these covenants were later removed.
• Moodys gives them a stable Ba2 rating, but says a "downgrade could be triggered if Yingde Gases further increases debt leverage".
• New shares were issued on Oct 2013 (1.25% dilution) and convertible bonds and warrants were issued on Dec 2013 (potential 2.2% dilution). 

A significant risk is that they rely on short or medium term funding.

The Steel Industry

This is a risk. 55% of Yingde's 2012 sales were to steel customers (p17), and 71% of their installed capacity is for the steel industry.  Although protected by take-or-pay contracts, these will be no good if their customers go under, and may not even help if the customers simply force renegotiations.  In mid-2012, Yingde confirmed that 18% of its capacity was operating below minimum-take-or-pay level (p1).  This was during a during a period when steel margins were negative - they have since recovered (p10):

In the long term,China's steel industry still has excess capacity:

• It is estimated there is 500 mt of global overcapacity.  China produces 50% of the worlds steel, and has an estimated 250-300 mt excess.  
• Despite the recent bounce, longer term the excess may take 7 to 20 years to grow out of.
• Predictions are for low, single-digit growth in China's steel capacity this year.
• Recent steel plant closures in China may be just for show.
• 50% of China's steel production is controlled by state or provincial govts.  These will be the hardest to shutdown.

Although Yingde has now moved into the chemical and coal industries, half its new contracts in 2012 were still for the steel industry.  New contracts in 2013 were better, with just under 30% capacity of new contracts for steel.

Valuation

To get an idea of valuation, estimate their earnings if they stopped taking on new contracts now.  Based on capacity under construction at end 2013, earnings and CFO would increase by 25% in two years.  Then they could pay off their debt in 4 years.  At HKD 6.60, this would be a PE of 8.25.

They show no sign of stopping however, in 1H13they announced 6 new contracts (240,000 Nm3/hr).  In 2H13 they announced another 8 projects (405,000 Nm3/hr).  A total 30% increase from our expected expected 2016 output!

Cashflows

They have always generated CFO, but spent more in investments:

And from their new contracts announced end 2013, there is no sign of them slowing CFI to generate free cash flows in the next 4 years.

Receivables

Receivables have slipped a little in 2013, up 50% while revenue only up 38%.  But looking at a chart of revenue divided by receivables, it seems OK:

I've included 1H13 above because that's when there was a slowdown.  No effect here.

Receivables that were over 3 months old grew by 56% in 2013. See if they go down in 1H14.

Not a red flag yet, but bears watching.

Others

Abdereen Asset Management owns 13%.These guys are value investors and usually do their homework.  No way they can quickly sell such a large stake.

Summary

Cheap, if they succeed.  Their current price may be 8X earning in two years time, and 6X earnings in another two.  Their ongoing operations have no threat from competition.  The risk is that their customers go under, or just don't fully pay.  If that does happen, it will probably be a sudden event -  not something that gradually creeps up.  Combined with their large debt, and no sign of slowing growth, that makes me a little nervous.

It will probably be fine, with a small chance of something bad happening.  Its priced low because of China's well known overcapacity problem.  The trouble is: if there was a crisis and the stock did drop 40-50%, I could not be reasonably certain that the company would survive.

I haven't decided whether to buy yet.  If I buy, limit to 2% of my portfolio.  Risky stocks can be part of a 'basket-of-stocks', not part of a concentrated portfolio. 

Edit: 26/Apr/2014.  Decided not to buy.  The reasons for the low price - steel overcapacity - are real.  Also risk of RMB depreciation.  And I don't want to hold a basket of stocks.