|Downgrade Xinyi Glass (868) to SELL as float glass segment is yet to recover
Xinyi Glass (XYG, 868, $5.12) reported a net profit of $762mn (EPS$0.194) in 1H14, down 24% yoy. Company declared an interim dividend of $0.09 per share (1H13: $0.13), implying a dividend ratio of 46%. Comment: The result was in line with company’s profit warning in June. Revenue for continuing operations rose 10.1% to $5.0bn. However, gross margin for continuing operations squeezed 5ppts from 32% in 1H13 to 27% in 1H14, mainly due to the underperformance of float glass segment.
Looking into each business segment, automobile and low-E construction (which together accounted for 57% of revenue) are again the relatively stable segments. Automobile glass saw a revenue and gross profit growth of 10.7% to $1.8bn and 5.8% to $750mn respectively, with gross margin squeezed 2ppts to 42% mainly due to the surge of raw material costs (mainly natural gas which had their tariff hike starting June 2013). Despite the sluggish construction activities in China, low-E construction glass revenue increased modestly by 10.0% to $1.1bn thanks to the favorable government policies that promote the use of energy-saving construction materials. Gross profit was largely flat at $399mn, implying a margin contraction of 4ppts to 37%.
Float glass segment was the main source of earnings disappointment. Even though revenue still up 9.6% to $2.2bn (or 43% of revenue) amid increasing sales volume, gross profit was cut by almost half to $188mn in 1H14 and only contributed 14% of overall gross profit (24% in 1H13). As demand from float glass customers remained slow and construction activities still weak in China due to tight liquidity, price of float glass started to slump in May and June, with end-June selling price being 10% lower than the level in end-April. Combined with the surge of raw material costs, gross margin saw a significant contraction of 9ppts to 9% in 1H14.
Looking forward, management holds a pessimistic view on float glass segment in near-term and admits that the industry is still finding the bottom as demand remains sluggish while new supply are still coming to the market. The major consolidating phase for the industry will not emerge till 2Q15, according to the management. As such, we cut our 2H14 gross margin assumption for float glass, auto glass and construction glass to 5%, 43% and 37% respectively. Based on the new revision, our 2014 earnings forecast is now $1,525mn (EPS $0.39), down 24% yoy on an apple-to-apple basis (i.e., consolidate XYS’ earnings as income from associate and excluding the one-off income from spin-off). Counter is now trading at 13.2x 2014 PER that is not attractive in our view as the earnings visibility for float glass segment is low. Despite the price correction of 14% since end-April, we believe the counter is not yet fully reflecting the weak outlook for float glass segment (most analysts are still hoping for a better 2H14). We therefore downgrade the counter to SELL with a revised target price to $4.37, implying an 11x 2014 PER and 1.3x PBR