As China continues its rapid recovery from Covid-19 lockdowns, strong demand for dimethylformamide (DMF) is likely to benefit SGX-listed Chinese chemical firm Jiutian Chemical.
With DMF’s ASP rising from RMB 4,512/tonne ($919.26) in 2QFY2020 to RMB5,925/tonne in 3QFY2020, UOB Kay Hian analyst Clement Ho sees strong earnings potential in the world’s second-largest DMF manufacturer. As of Nov 3, 2020, spot price for DMF is hovering at RMB 11,950/tonne.
“There has been exceptional demand for DMF, on the back of the strong industrial recovery in China following pandemic lockdowns. The fine chemical has a diversified range of applications, being a feedstock in the production of polyurethane, pharmaceutical and agrochemical products, as well as a universal industrial solvent that can be used as an absorbing agent,” Ho writes in a broker’s report on Nov 3.
He has initiated coverage of the stock with a “buy” call, setting a target price of 16 cents with a 64.9% upside, pegged to a 5.0 times FY21 price-to-earnings ratio.
The good news came off the back of strong earnings in 2QFY2020, when its net profits turned around from a RMB7 million loss in 2QFY2019 to RMB32.7 million due to lower methanol prices - its primary raw material.
This was in contrast to a RMB2.9 million profit in 1QFY2020. Jiutian also experienced a 140% y-o-y gross profit surge to RMB53.5 million, even though it saw a 6% slip in revenue to RMB276.3 million due to lower DMF sales volumes then.
“For 3QFY2020, we are anticipating an 18.6% sequential increase in net profit to Rmb38.8m, (3Q19: Rmb2.4m), mainly due to a spike in gross margin to 39% (3Q19:11%, 2Q20: 22%) from higher ASP of DMF. This comes despite the assumption that utilisation rate will be at 50%, as Jiutian is expected to carry out its annual scheduled maintenance in 3Q, which should reduce production by 20-25 days,” Ho remarks. Hovering at an average of 12% in 2016-2019, he expects adjusted gross margin to more than double in 2020 due to better ASPs and lower feedstock costs.
The upswing is likely to be sustainable as demand for industrial products “made in China” looks to remain stable as other manufacturing nations continue to struggle with Covid-19. Jiutian’s rival Zhejiang Jiangshan Chemical - the second-largest DMF producer in China - has also shut down its production facility in Jiangshan City, Zhejiang due to urban planning. With 180,000 tonnes of annual capacity removed from global supply, Jiutian could pick up the slack.
Financially, Jiutian has recently completed a share placement for 170 million new shares in 20 October, enlarging its share capital by 8.5%. With this placement largely conducted by a new base of institutional shareholders, investor confidence in the counter could be boosted. Jiutian will also benefit from the fact that its largest shareholder, Anyang Longyu (HK) Development is a subsidiary of Henan Energy and Chemical Industry Group, one of Henan’s province’s largest state-owned enterprises with total assets amounting to RMB 258 billion.
See also: Jiutian Chemical seeks to raise $10.3 mil in proposed placement of 170 mil new shares
Despite the share enlargement, earnings per share could rise from 1HFY2020 to 2022. EPS is expected to leap from 1.96 fen to 10.1 fen in 2020. Going forward, EPS could reach 16.1 fen and 21.5 fen in 2021 and 2022 respectively.
Jiutian also boasts solid free cash flow (FCF) generation, which is expected to be solid across 2020-2022. “Estimates suggest FCF of Rmb142m, Rmb431m and Rmb529m for 2020F, 2021F and 2022F respectively,” remarks Ho. The firm’s balance sheet is therefore expected to improve greatly from a 2019 net cash position of RMB 281 million to (3.1 S cents) to an estimated RMB 423million (4.2 S cents) in 2020 and RMB 850 million (8.5 S cents) in 2021.
And these benefits can be obtained for a bargain, with the share currently trading at 3 times 2021 price-to-earnings ratio based on a conservative DMF ASP of RMB7,000/tonne. Should DMF prices remain above an average RMB8,500/tonne, P/E ratio could potentially inch towards -0.5 standard deviation and historical averages of 12.7 and 20.4 P/E ratio respectively. Its closest peer China Sunshine Chemical Holdings has a historical 5-year average P/E ratio of 5.7.
In the long-run, the Market Research engine sees the global DMF market expected to grow at 4% CAGR to US$853 million ($1.16 billion) between 2020 and 2025, which will benefit Jiutian’s long-run prospects. Ho predicts that demand for feedstock such as DMF would persist as global manufacturers slowly regain access to logistics in global supply chains after Covid-19-related disruptions.
“Larger DMF producers such as Jiutian will benefit as there will be a need for factories to stock up on inventory supplies to a level higher than before, in the event of subsequent pandemic lockdown waves,” Ho observes.
As of 1.41pm, Jiutian Chemical is trading upwards 5.15% at 10 cents.
