This is a top-down analysis. Oil price keeps going up. We also have a food crisis. We have less land for crops. We have converted and diverted a lot of plantation towards biofuels. There is one sub-sector that possibly can "gain" from the above developments. Fertilisers, to be specific. In particular, those that promotes high-yield in crops. Owing to rising prices in soft commodities, governments, enterprises and farmers collectively will use better fertiliser, and more of that even to push up production yield.
Already, potash related companies in Canda has shot up by more than 200% over the last 12 months alone. Well, I don't want to go very far, so I searched for "the relevant fertiliser company in the region. Thanks to a fellow reader (Windsurfer), he has highlighted China XLX Fertiliser (CXLX.SI) to me. Did some research, and it looked very interesting indeed. China XLX Fertiliser raised S$154 million from its IPO recently. It offered 200 million new shares at SG77 cents each.
China XLX Fertiliser Ltd is the largest coal-based producer of urea and compound fertiliser in Henan in terms of production capacity. Besides urea and compound fertiliser, it also produces methanol. Both production plants are located at Xinxiang High-advanced Technology Development West Zone, which is served by a comprehensive network of railway lines and highways.
The company is the sixth largest coal-based urea fertiliser producer in China by capacity. The coal-based fertiliser maker produced an annualised 315,000 tonnes of urea fertiliser last year and could more than double that production. XLX's regional and global counterparts are trading at about 18 times forward PE ratio. XLX made a net profit of S$26 million in the last fiscal year, on revenues of S$180 million.
Electricity costs make up 20% of the company's total expenses, while coal - a key raw material - makes up half. Although coal prices have been on an uptrend, XLX said its coal costs have risen by only about 5% over the last three years. As for its core business, making fertiliser based on coal, XLX does not expect rising coal prices to work against its favour. As usual, we are not the first to discover the stock. Back in March 2008 the stock was trading at SG56 cents, yesterday it was at SG96 cents despite the difficult market environment since March 2008. Its 12 month high-low was SG$1.43-0.56, gee March was the low for the stock, should have posted on this a month or two earlier! Despite the 9% jump in coal prices in the last quarter, it is still operating at a very comfortable 25% gross profit margin. Another 10% jump in coal price will only shave 2 percentage points from the gross profit margin. However, there is a price ceiling imposed on urea in China. While the conditions would dictate a raising of the price ceiling - recent developments in China may delay the move, in particular when the government there has just channeled RM64bn in subsidies to storm affected agricultural areas.
The company is highly attractive because of the cited macro factors, plus the fact that there is a high disparity with international urea prices. The international prices jumped by 38% in 2007 alone on the back of increasing grain acreage and rising demand for biofuel feedstock - further driven by higher crude oil prices. Currently if China urea producers were to export their urea fully, they would reap a gross profit margin of around 45%, that's after taking into account the transportation and logistics costs and a further 25% export tax. However, the disparity would further press the Chinese government to raise the price ceiling. Balancing the need to secure adequate domestic fertiliser supply, ensuring farmers' affordability and the disparity with international prices - Beijing would definitely have to raise the price ceiling. Beijing will just have to spend more on subsidies.
Regional competitors include China BlueChemical and Sinofert, both listed in HK. Valuations have gone up, the company is at 17x forward earnings, but the entire sub-sector should see a massive upgrading in the coming months. I would look for its 12 month high to be broken again sometime this year. (Reference price SG96 cents)
p/s photo: Paula Taylor Punlapa
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