Business ModelSimilar 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.
Balance SheetSince 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.
- 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).
The Steel IndustryThis 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.
ValuationTo 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!
CashflowsThey have always generated CFO, but spent more in investments:
ReceivablesReceivables 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:
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.
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.
SummaryCheap, 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.