yip’s chemical 葉氏化工 · yip’s extension to eastern china region allows it to capture the...

Yip’s Chemical (葉氏化工)

BUY Target Price: HK$9.80 (+36%) Price: HK$7.23 HKEx Code: 408 Thu, 08 Apr 2010

Keep Growing Equity Research

Industrial/ China .

Key points:

The impressive facts that attract us to Yip’s Chemical (“Yip’s”): 1) It is the 6th best performing stock in Hong Kong in the past 10 years – a 22-bagger (total return) versus 79% for the HSI; 2) Its net profit grew by an 8-yr CAGR of 24% to HK$224m in FY09, with no sign of slowing down; 3) It emerged from the financial tsunami with a record interim profit of HK$227m in 1H10 and a net cash position; 4) It posted a respectable 5-yr ROE of 19%; 5) It has an unbroken series of dividend payment since FY96 with an average payout ratio of 51%.

The fundamentals that support a promising future for Yip’s: 1) Yip’s is the world’s largest acetate solvents maker. With superior economies of scale in this commodity business, it enjoys 5-6% cost advantage, with which it is successfully expanding from South China to East China; 2) Rapid growth in its coating business driven by strong domestic demand, quality product and sensible marketing strategy; 3) An internal hedging system that stabilizes margin; 4) An outstanding management that has also laid a solid management structure to support future growth. Lastly, given the broad end uses of its products, we think Yip’s is a good proxy to ride on China’s economic growth.

BUY. The market is treating this extraordinary company with good growth potential like an ordinary slow-growing industrial stock, undervaluing it at 9.7x FY11E, we estimate. We expect its net profit to grow by 53% in FY10, followed by 17% in FY11 and 21% in FY12. We initiate with BUY and a TP of HK$9.8, based on 13.0x FY11E PE, or 0.60x PEG, giving a 36% upside.

Eric Kwok Oriental Patron Securities Ltd +852 2135 0209 [email protected] Create Lee Oriental Patron Securities Ltd +852 2135 0205 [email protected]

Initial Coverage

Key Data Close price (HK$) 7.23

12 Months High (HK$) 7.25

12 Month Low (HK$) 2.40

3M Avg Dail Vol. (mn) 0.63

Issue Share (mn) 544.13

Market Cap (HK$mn) 3,934.09

Free Float % 43.13

Net cash/share (HK$) (0.69)

Net debt/equity (%) Net Cash

Major shareholder (s) Ip Chi Shing Tony (34.1%) Source: Company data, Bloomberg, OP Research Closing price are as of 7/4/2010 All figures are subject to rounding

Price Chart

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%408 HK MSCI CHINA

Company Background The Group is principally involved in the

manufacturing of and trading in solvents, coatings

and lubricants.

Exhibit 1: Investment Summary Year ended Mar (HK$mn) FY08A FY09A FY10E FY11F FY12F Revenue (mn) 4,648.4 5,089.9 4,620.6 5,821.6 7,173.9 Growth (%) 18.8 9.5 (9.2) 26.0 23.2 Net Income (mn) 275.2 224.2 344.4 403.4 489.6 Growth (%) 23.0 (18.5) 53.6 17.1 21.4 Gross margin (%) 18.5 18.5 21.9 21.1 21.0 Profit margin (%) 5.9 4.4 7.5 6.9 6.8 ROE (%) 21.6 13.7 17.8 18.7 20.2 ROA (%) 14.0 10.7 14.4 14.8 15.8 EPS 0.6 0.4 0.6 0.7 0.9 P/E (x) 12.8 17.3 11.4 9.7 8.0 P/B (x) 2.4 2.1 1.9 1.7 1.5 Dividend yield (%) 3.5 3.5 3.5 4.1 5.0 Source: Bloomberg, OP Research

Oriental Patron Research

8 April 2010 of 28

Table of Contents Table of Contents .......................................................................................................................................... 2

Investment Highlights .................................................................................................................................... 3

Impressive facts ............................................................................................................................................ 5

Company background ................................................................................................................................... 7

Scale advantage in solvents ....................................................................................................................... 11

Coating increasingly important .................................................................................................................... 13

Other notable fundamentals ........................................................................................................................ 16

Financials ................................................................................................................................................... 18

Recommendation ........................................................................................................................................ 20

Risk ............................................................................................................................................................ 21

Financials ................................................................................................................................................... 22

Appendix I: Management Profile ................................................................................................................. 25

Appendix II: ASP and Raw Material Price ................................................................................................... 26

Appendix III: Shareholding .......................................................................................................................... 27


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Investment Highlights Beating HSI by 28 times. Hang Seng Index (HSI) accumulated a total return (share price + dividend) of 79.1% in the previous decade. Within such unexciting general equity return, Yip’s gained 2,236.9% in total return and ranked the 6th best performing stock in the period. A simple comparison shows that one dollar invested in Yip’s for ten years will yield 28 times more return as the investment on HSI portfolio.

Impressive proven track record. Yip’s achieved an impressive 21% and 24% 8-year CAGR growth in revenue and net profit respectively during FY01-FY09. During this period, it posted a steady growth in net profit except in FY09, the year of financial tsunami. Its 5-year average ROE was equally impressive at 19%. Moreover, the dividend payout ratio of Yip’s has stayed above 51% since 1996. Even during financial tsunami in 1H10, the company made HK$228 mn in net profit, up 44% yoy with a net cash position of HK$155 mn.

Number 1 in acetate solvents maker in the world. Yip’s solvents businesses comprise: (1) raw solvents, widely used in industries such as coatings, tannery, medicine; (2) mixed solvents (thinners) are mostly used in the toys, electronics, printing and furniture industries. In terms of sales volume, Yip’s acetate solvents ranked 1st in the world. Solvents are commodity in nature; quality makes no major difference. The key way to compete is the scale. With the number one position, the company enjoys scale advantages over peers.

Dominant position in Southern China market. In Southern China, Yip’s enjoys a dominant position with approximately 60% market share, according to management. Its acetate solvents capacity is 310,000t, which is 7-8 times larger than the next player in the region. With this scale advantage, Yip’s enjoys a 5-6% gross margin advantage the bulk purchase of material with its leading position.

Entering Eastern China market. In Eastern China, Yip’s capacity for acetate solvents is 120,000t, as compared with 270,000t for the regional leader. Nevertheless, the company enjoys favorable bulk purchase price at the company level, with its total capacity at 430,000t. Thus, the company is able to replicate its cost advantage from Southern China market to Eastern China market. Besides, In Eastern China, most solvents producers are State Owned Enterprises (SOEs), which operate with higher administrative costs and a bulky distribution network. Barely 3 months after production started in its Taixing plant, utilization has risen steadily to around 60%, with management expecting full utilization rate by end of 2010.

Growing importance for coating. Coatings (mainly paints and inks) are used in a wide range of industries, such as construction and project refurbishment, food and gift packaging, toys, electronics, furniture, and printing all consume different kinds of coatings. Coating makers compete on quality, brand awareness and distribution network. Coating segment had grown to account for 49% of operating profit in 1H10 as compared with the ratio in FY05 at 29%.

Emphasis on quality. Quality takes an important role in Yip’s. The company is the first insulating coatings producer in China to attain Underwriters Laboratories (UL) certification. In addition, the laboratory of its Huiyang plant is fully qualified under the China National Accreditation Services for Conformity Assessment. And Yip’s production of planographic (UV) inks is recognized by Mattel, the world largest toy’s manufacturer (in terms of revenue), as Brand A inks supplier. In 2007, Mattel recalled 21 mn units of toys, which were manufactured in China, due to the poisonous substance in the paint for toy. Yip’s won the approval from Mattel as a Brand A ink manufacturer and captured market share from other paint manufactures. The incident demonstrated the quality of Yip’s products.


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Related diversification. Yip’s started its coating business in 1982 with the industrial paint. The company expanded continuously in previous decades on this segment: Yip’s acquired “Ad-Coat” for electronic insulating coatings in 2003 and acquired "Pak Lam Choice" for digital electronic coatings in 2008. Yip’s leveraged its expertise in industrial paint to unlock the value from these businesses. To give an example, the company bought “Pak Lam Choice” brand in 2008 as the brand did not fulfill the environmental requirement by the authorities. Yet, Yip’s was able to expand in a steady pace in this.

Brand building and distribution enhancement. Unlike market leader Nippon Paint, Yip’s has been promoting its product to distributors by giving a higher margin (a “push” strategy). Yet, Yip’s commenced advertising on CCTV for the first time in 2009 for the attention from retail level (“pull”). The company is penetrating into tier 2, 3 cities, which can be seen from its composition of retails stores location: in tier 1 cities, number of stores for Yip’s is 500 – 600; while for tier 2 and tier 3 cities, it is over 5,000. We believe Yip’s can capture rising demand in these areas with an effective mix of “push” and “pull” strategy, as evidence by 23% yoy volume growth in 1H10.

Internal hedging stabilize gross margin. Yip’s operating margin is stabilized under a natural hedge system between solvents and coating business: acetate solvents prices promptly reflects price of materials (which is positively correlated to oil price); and thus Yip’s can gain through stock gains as raw material price surge; whereas, coating consumes solvents as material and suffers from raw material price hikes. The resultant effect is a stabilized margin for the company. From FY05 to FY09, crude oil prices ranged from USD44.77 to USD144.87; yet, Yip’s gross profit margin were relatively stable at approximately 6 - 8%.

Capable management ensures growth sustainability. Yip’s was started as a family business. Chairman and previous Chief Executive Officer (CEO), Mr. Ip Chi Shing started Yip’s at 1970s. Mr. Ip stayed as head of the company for nearly 20 years. In 2008, Yip’s promoted Mr. Wong Kam Yim as the new CEO. This marked Yip’s change from a family business to one run by professionals. Yip’s established the Board of Executive Committee (BEC) and Management Committee (MC). BEC acts as an active overseeing body and focus on setting long term strategies for Yip’s; whereas, MC executes plans from BEC and supervises the operation of subsidiaries. Furthermore, Yip’s has a vigorous management trainee program to train future leaders. For a company of Yip’s size, this is quite impressive, in our opinion.

Proxy for China’s economic growth. Yip’s extension to Eastern China region allows it to capture the two major industrial areas in China: Pearl River Delta and Yangtze River Delta. Further, end-use of Yip’s covered a wide range; for instance, food and beverages, toys, printing, telecommunication, electronics, etc. Together with the penetration of coating segment into tier 2, 3 cities, Yip’s is a good proxy of China’s economic growth, in our view.

Recommend BUY at HK$9.8. We initiate the counter with a BUY call on grounds of its sustainable growth on both solvents and coating segment, which is backed by a solid track record and capable management. We derive our target price from price-to-earnings (PE) and PE Growth (PEG) methodology. Our target price on the counter is HK$9.8 (36% upside), implying 13x FY11PE or 0.60x PEG.


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Impressive facts Beating HSI by 28 times. In the previous decade (from 31 Jan 2000 to 29 Jan 2010), Hang Seng Index (HSI) accumulated a total return of 79.1%, or an annual equivalent return at 6.0%. The growth is not exciting as there were a few crises during the decade. Yet, we spotted a stock that gained 2,236.9%, or an annual equivalent return of 37.0%. One dollar invested in this company for ten years yielded 28 times the return on a HSI portfolio. And this stock is the 6th best performing stock in the previous decade. It comes as a surprise that this No. 6 is an industrial stock: Yip’s Chemical.

Exhibit 2: Share price performance, Yip’s vs. HSI

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408 HK HSI

Source: Bloomberg, OP Research

Exhibit 3: Total Return in 10 years (Jan 2000 - Jan 2010) Company Name Ticker Ranking Percentage of total return Hengan International 1044 HK 1st 4313.29% Orient Overseas International 316 HK 2nd 4186.26% Daphne International 210 HK 3rd 3261.20% Aeon Stores 984 HK 4th 3000.23% Luk Fook Holdings 590 HK 5th 2707.62% Yip's Chemical 408 HK 6th 2233.51% KTP Holdings 645 HK 7th 2082.49% China Resources Land 1109 HK 8th 1904.52% Coslight Technology 1043 HK 9th 1803.47% Denway Motor 203 HK 10th 1444.43%

HSI Index

79.35% Source: Company, OP Research * Total return includes share price appreciation and dividend. We excluded (1) companies with listing history shorter than 10 years and (2) companies that changed its core business during the period.

Impressive proven track record. Yip’s achieved an impressive 21% and 24% 8-year CAGR growth in revenue and net profit respectively during FY01-FY09. During this period, it posted a steady growth in net profit except in FY09, the year of financial tsunami. Its 5-year average ROE was equally impressive at 19%. Moreover, the dividend payout ratio of Yip’s has stayed above 35% since FY96. Even during financial tsunami in 1H10, the company made HK$228mn in net profit, a record high, up 44% yoy, and ended with a net cash position of HK$155mn.


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Exhibit 4: Revenue

Exhibit 5: Net Profit

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Unbroken dividend record. As above mentioned, Yip’s accumulated 2,233% total return in the previous decade. And it is worth noticing that nearly half of this return was derived from dividend income. As for dividend for Yip’s, the company kept a unbroken dividend history since FY96, with an average dividend payout ratio at 51% in the period.


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Company background Established in 1971, Yip’s Chemical (Yip’s) focuses on the production and sale of petrochemical products. Core businesses comprise solvents and coatings. The two segment generated a revenue of HK$1,425 mn (53% of total) and HK$1,092 mn (41% of total) in 1H10 (6 months ended 31 Sep 09) respectively; while the two segment accounted for an EBIT of HK$151 mn (50% of total) and HK$146 mn (47% of total) in the same period. Yip’s is headquartered in Hong Kong and has 17 manufacturing plants in China and a sales network covering major Chinese provinces and cities.

Regarding solvents, Yip’s produced (1) raw solvents like ethyl acetate and butyl acetate with acetic acid, butanol and ethanol as major raw material. These products are widely used in industries such as coatings, tannery, medicine and adhesives. (2) Mixed solvents (thinners) are mostly used in the toys, electronics, printing and furniture industries.

Exhibit 6: Raw solvents production

Acetic acid Butanol Ethanol

Ethyl acetate Butyl acetate

Source: Company, OP Research

As for coating, it can be further categorized into paints and inks. On paints, Yip’s produces both industrial and household paint, which consumes resin, acetate, color powder and solvents. Paints products are used in variety of industries: construction and project refurbishment, toys, electronics, furniture and printing industries; while inks are used mainly for food and gift packaging.


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Exhibit 7: Paints production

Resin Acetate

Color Powder Solvent

Industrial Paints/ Household Paints/

Inks


There are eight brands for Yip’s products: “Bauhinia” for paints, “Bauhinia Variegata” for inks, “Golaxxo” for specialty varnishes, “Da Chang” for resins, “Ad-Coat” for electronic insulating coatings, "Pak Lam Choice" for digital electronic coatings, “Hercules” for lubricants, and “Pacoil” for specialty lubricants.

Exhibit 8: Revenue breakdown in 1H10 FY09

Solvents58%

Coatings36%

Lubricants5%

Others 1%

Solvents52%

Coatings40%

Lubricants5%

Others 1%

1H10

Source: Company


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Exhibit 9: 2009 EBIT

Exhibit 10: 1H10 EBIT

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Exhibit 11: Factories and sales outlet in China

Source: Company


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Exhibit 12: Time Line for Yip’s

1970s : Founding Period

• On October 25, 1971, Hang Cheung Hong, a shop named Hang Cheung Hong, at 425 Queen’s Road West, commenced business in selling petrochemical products, which later became Yip's Chemical Holdings Limited.

• With the philosophy of "Diligence breeds success” and “Sincerity wins trust”, Hang Cheung Hong consolidated its position and explore new business opportunities in the petrochemical industry.

1980s：Expansion Period

• Yip’s began to purchase raw materials in China as well as expand presence in the China market.Taking advantage of China’s economic reforms, Yip’s became one of the early forerunners to develop innovative, high-tech chemical products, expand into new product areas and create its own brands.Yip’s set up Hang Cheung Petrochemical Factory in Shenzhen, its first factory in China.

1990s： Thriving Period

• Yip’s established its headquarters in the newly completed Yip’s Chemical Building, in Fanling, New Territories.In August 1991, Yip’s was listed on the Stock Exchange of Hong Kong (Stock code: 408). Yip’s developed steadily, initiating various mergers and acquisitions, while continuing to invest new production facilities and setting up sales offices in China.

21st Century：Marching Steadily

Forward

• Adhering to the mission of focusing on its core businesses, Yip’s expanded rapidly with remarkable results.

• New factories in Huiyang, Zhongshan and Zhejiang were constructed and equipped with the most advanced automatic production lines and facilities, increasing productivity significantly. Yip’s undertook several acquisitions to enhance overall competitiveness.

• Efforts are devoted to improving corporate governance to ensure Yip’s steady and sustainable development and growth.

Source: Company


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Scale advantage in solvents Yip’s solvents businesses comprise: (1) raw solvents, widely used in industries such as coatings, tannery, medicine; (2) mixed solvents (thinners) are mostly used in the toys, electronics, printing and furniture industries. In terms of sales volume, Yip’s acetate solvents ranked 1st in the world. Solvents are a commodity in nature; quality is important, but is not the key for differentiation. The key way to compete is the scale. Yip’s enjoys a 5-6% gross margin advantage through bulk purchase of material with its leading position. The company is approximately 60% larger than the 2nd largest player nationwide, in terms of capacity; as such, Yips enjoys an absolute scale advantage over peers.

Exhibit 13: Solvents revenue

Exhibit 14: Solvents EBIT

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Dominant position in Southern China market. Total market size of acetate solvents is approximately 1,776,000t in 2008. With a total capacity of 430,000t in 1H10, Yip’s is taking approximately 24% capacity in China. Specifically, in Southern China, Yip’s enjoys a dominant position in solvents with approximately 60% market share, according to management. Its acetate solvents capacity is 310,000t, while the second player’s capacity is approximately 40,000 tonnes, which means Yip’s is 7-8 times larger than the next player in the region.

Entering Eastern China market. In Dec 2009, Yip’s completed and added 120,000 tonnes acetate solvents production facilities in Taixing in Eastern China; thus boosting the total capacity of Yip’s on solvents by 38% to 430,000 tonnes. The largest player in the region possesses 270,000t capacity in Eastern China, which is 1.25x of Yip’s at 120,000t. Nonetheless, Yip’s is still enjoying a favorable bulk purchase price at the company level, with its total capacity at 430,000t. Thus, the company is able to replicate its cost advantage from Southern China market to Eastern China market. Besides, In Eastern China, most solvents producers are State Owned Enterprises (SOEs), which operate with higher administrative costs and a bulky distribution network. As such, we expect Yip’s market share in Eastern China to grow over time.

Still a growth driver. In 1H10, Yip’s record a 26% yoy drop in the revenue in solvents segment as ASP fall with commodity price; yet, the EBIT of the segment posted a 6% yoy growth. A key reason was that Yip’s was able to post 15% growth in sales volume despite the financial tsunami. Overall, the company is growing in line with the GDP growth in the Southern China market; while for Eastern market, the latest figure from Yip’s management is that the Taixing plant is already working at approximately 60 - 70% of the capacity in recent


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months and the company is expecting the plant to reach full capacity in end 2010. This shows that Yip’s is capturing more market share in the region. We believe with this twin driver, solvents segment can grow at an above GDP growth rate.


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Coating increasingly important Coatings (including industrial paints, household paints and inks) are used in an extensive range of industries, such as property, food and beverage packaging, gift packaging, toys, electronics, furniture, and printing. With such broad end uses for its coating products, we believe Yip’s is a goof proxy for China’s domestic consumption.

Exhibit 15: Coating revenue

Exhibit 16: Coating EBIT

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Exhibit 17: 1H10 coating revenue composition

Household Paints34%

Industrial Paints26%

Ink40%

Source: Company, OP research

The company operates six brands for coating, “Bauhinia” for paints, “Bauhinia Variegata” for inks, “Golaxxo” for specialty varnishes, “Da Chang” for resins, “Ad-Coat” for electronic insulating coatings, "Pak Lam Choice" for digital electronic coatings.

Exhibit 18: Coating brands under Yip’s

Coatings



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Emphasis on quality. Coating makers compete on quality, brand awareness and distribution network. Yip’s is the first insulating coatings producer in China to attain Underwriters Laboratories (UL) certification. In addition, the laboratory of its Huiyang plant is fully qualified under the China National Accreditation Services for Conformity Assessment. A proof of the high quality attained by Yip’s products is its usage in Ferrero’s Kinder Surprise, on a tiny toy inside a chocolate egg. Yip’s production of planographic (UV) inks is recognized by Mattel, the world largest toy maker, as Brand A inks supplier. In 2007, Mattel recalled 21 mn units of toys, which were manufactured in China, due to the poisonous substance in the paint for toys. Yip’s won the approval from Mattel as a Brand A ink manufacturer and captured market share from other paint manufactures. The incident demonstrated the quality of Yip’s products.

Household paint brand awareness to be enhanced. ICI Dulux (ICI) and Nippon Paint (Nippon) are leaders in household paints market. ICI entered China in 1898 and Nippon entered China in 1992; both parties devoted much into the advertising expenses on public media. Yip’s entered China in the 1980s and the company did not invested much on advertising the household paint. According to a research done by Yip’s, the brand awareness of Bauhinia brand ranked 4th in China, right after Nippon, Dulux and Huarui.

Enhance distribution with high margin. Yip’s tries to compete in a different way; the company gives a higher margin to attract distributors. We believe this “push” strategy is sensible as distribution network, especially in 2nd and 3rd tier cities, is always a headache in China.

Enhance brand awareness with CCTV advertisement. On the “pull” side, Yip’s recognizes the importance of brand awareness for the household paint market. In Jul - Nov 2009, it launched TV advertisement for Bauhinia on CCTV channel 1 (general), 2 (finance), 3 (arts) and 8 (drama) for the first time. Distributors reported favorable response in end sales following the ads. We think this mix of “push” and “pull” strategies has been quite effective, as witnessed 23% growth in the sales volume for household paint in 1H10.

Focus on 2nd and 3rd tier cities. Yip’s is trying to penetrate into second and third tier cities by extending its sales network, which can be seen from its composition of retails stores location: in tier 1 cities, number of stores for Yip’s is 500 – 600; while for tier 2 and tier 3 cities, it is over 5,000. We are positive for this move and we expect the segment can ride on robust economic growth in the second and third tier cities.

Exhibit 19: Production facilities and sales network, Bauhinia (left) vs. Nippon Paints (right)



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Inks benefit from growth in food and beverages industry. Yip’s commenced its inks production in mid 2009 in Tungxiang, Zhejiang with the environmental friendly ink, non-benzene inks. The company involves in inks for food packaging, shopping bags and tobacco packaging, with renowned clients like Tingyi (0322 HK) and Want Want (0151 HK). The market size is estimated at 150,000t, according to Yip’s. China government requires food and beverages products to use environmental friendly ink printing since mid 2009. Yip’s was able to capture nearly 100% market share at that time by being the dominant supplier, thus resulting a better margin. The figure converged to 60 – 70% in recent months as new competitors entered the market. We believe the outlook is still positive on grounds of the growing demand for food and beverages companies. As in 1H10, ink contributed 50% of the coating revenue; up from 25 - 30% in FY06.

Industrial paint affected by export. Yip’s industrial paints are used in variety of industries. It can be easily understood that this segment is positively correlated to industrial activities in China. As in Southern China, majority of the manufactures are export oriented, Yip’s industrial paints segment was given a hard hit during financial tsunami. As compared with household paints 23% volume growth in 1H10, industrial paints sales volume was up only 12%; while the turnover dropped 25% yoy. Nevertheless, Yip’s is extending its industrial paints segment into Eastern China market, which is another important industrial base in China. Our sense is that, the industrial paints products will be growing at a lower rate as compared with ink and household paints.

Growing importance for coating. Coating segment accounted for 53.2% of revenue in 1H10; whereas the ratio was only 36.0% in FY06. For EBIT, the segment made up 49% of the total in 1H10, up from 33% in FY06. The segment posted CAGR growths of 17.2% and 16.7% in the revenue and operating profit respectively in FY06 – FY09. More importantly, coating marked a sales volume growth of 12% yoy in 1H09; within which, the household paints and inks together contributed 23% yoy sales growth in total. On top of that, Yip’s is preparing for further expansion in this segment; as witnessed by (1) acquisition of a land of 60,000m2 in Tungxiang in Eastern China for the expansion of ink and industrial paint production; (2) acquisition a land of 20,000m2 in Zhongshan for the expansion of ink production; (3) a target on the capacity expansion target for coating by 60% by 2013, according to management.


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Other notable fundamentals Internal hedging stabilize gross margin. Yip’s operating margin is stabilized under a natural hedge system between solvents and coating business. Acetate solvents prices reflect volatilities in raw materials, thus Yip’s can gain through stock gains when raw material price surge; whereas, coating consumes solvents as one of the material and suffers from raw material price hikes. Thus the selling prices for coatings typically lag raw material price trends by 6 – 9 months. Yip’s can minimize the impact from raw material prices fluctuation. As witnessed from that, from 2005 to 2009, crude oil prices ranged from USD44.77 to USD144.87; yet, Yip’s operating margin were relatively stable at 6-8%.

Exhibit 20: Operating margins

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1H07 2H07 1H08 2H08 1H09 2H09 1H10

WTI Crude reference, USD per barrel Solvents Coatings Total

Source: Company

Capable management ensures growth sustainability. Yip’s was started as a family business. Chairman and previous Chief Executive Officer (CEO), Mr. Ip Chi Shing (aged 61) started Yip’s at 1970s. Mr. Ip stayed as head of the company for nearly 20 years. In 2008, Yip’s promoted Mr. Wong Kam Yim (aged 48) as the new CEO. This marked Yip’s change from a family business to one run by professionals.

Yip’s established the Board of Executive Committee (BEC) and Management Committee (MC). BEC comprises Chairman, CEO, Chief Operation Officer (COO), Chief Financial Officier (CFO) and all other executive directors. BEC acts as an overseeing body and focus on setting long term strategies for Yip’s. MC comprises CEO, COO, CFO, General Manager (GM) of ink business, GM of industrial paint business, GM of solvents business, Financial Controller (FC) of Yip’s and FC of Bauhinia. MC keeps the general managers of each business abreast of the strategic direction set by BEC while allowing them to focus on the day-to-day operation of individual business. We believe this structure will enable Yip’s to grow with its increasingly broad range of products without losing focus or control.


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Exhibit 21: Yip’s management system


Yip’s has a management trainee (MT) programme for nurturing future leaders. The company recruits bright fresh graduates at early 20s and send them to different subsidiaries to learn about a thorough picture of the company. Some of the former trainees have already advanced to senior positions, such as general manager of a subsidiary or a member of the group MC. This shows the seriousness of Yip’s in training future leaders. For a company of Yip’s size, this is quite impressive, in our opinion.

Proxy for China’s economic growth. With the extension to Eastern China region, the company is able to capture the two major industrial areas in China: Pearl River Delta and Yangtze River Delta. Further, end-use of Yip’s covered a wide range; for instance, food and beverages, toys, printing, telecommunication, electronics, etc. Together with the penetration of coating segment into tier 2, 3 cities, Yip’s is a good proxy of China’s economic growth, in our view.


8 April 2010 of 28

Financials FY10 (ending Mar 2010). We expect Yip’s FY10 net profit to rise by 54% yoy to HK$344mn and revenue to drop by 9% yoy to HK$4,620mn. The company reported a strong result in 1H10, with net profit rising by 44% yoy to HK$228mn, a record high. Revenue was 13% lower on account of lower raw material and commodity prices. The growth in 1H10 net profit was mainly driven by:

1) Volume growth. Sales volume of solvents and coatings grew by 14% and 12% yoy respectively despite the global financial crisis;

2) Margin expansion. EBIT margin rose to 11.3% in 1H10 versus 7.1% in 1H09. Solvent margin was buoyed by the sequential recovery in commodity prices during 2009. Yip’s usually raises ASP as input costs rise. As such, a steep rise in input price led to a steep rise in margin under FIFO. On the other hand, coating margin benefited from product mix improvement and the lagging effect of bottom-low raw material costs in 2H09.

For 2H10, we expect Yip’s to earn HK$116mn, accounting for 34% of full year net profit. The second half usually accounts for 40% of full year profit. However, given the exceptionally high margin in 1H10, we expect a lower percentage contribution from 2H10 as margins return to a more normal level.

FY11 & FY12. We expect FY11 and FY12 revenue to rise 26% and 23% respectively, driven mainly by volume growth in both solvent and coating, we think:

1) Solvent. We believe the successful inroad into the Eastern China market will significantly boost Yip’s solvent volume. Barely 3 months after production started in its Taixing plant, utilization has risen steadily to around 60%, with management expecting full utilization rate by end of 2010. This means the production volume of solvent at end 2010 will be nearly 40% higher yoy.

2) Coating. We think Yip’s household paint and ink products will benefit from the strong growth in China’s domestic consumption. Its focus on quality, distribution and brand enhancement are delivering solid results, as witnessed by the 23% volume growth in these products in 1H10.

We expect Yip’s net margin to rise from an average of 5.9% in FY07-10 to 6.9% in FY11 and 6.8% in FY12. In our opinion, Yip’s margin will benefit from: 1) better economies of scale in its solvent business, given the significant volume growth mentioned above; 2) product mix improvement, given increasing contribution from high margin household paint and ink products. These two divisions contributed 74% of revenue in 1H10, versus 65% in FY06. As the growth rates of these products continue to outpace that of industrial paints, we believe their contribution will continue to rise.

We expect FY11 net profit to grow by 17% to HK$403mn. Although 17% net profit growth seems to be lower than its historical average, it mainly reflects the exceptionally high margin in 1H10 which drags down yoy comparison. For FY12, we expect net profit to grow by 21%, in line with 8-year net profit CAGR at 20+%.


8 April 2010 of 28

Exhibit 22: Revenue forecast by segment

0

2,000,000

4,000,000

6,000,000

8,000,000

FY08A FY09A FY10E FY11F FY12F


HK

$ '0

00



8 April 2010 of 28

2

Recommendation Recommend BUY at HK$9.8. We initiate the counter with a BUY call on grounds of its sustainable growth on both solvents and coating segment, which is backed by a solid track record and capable management. We derive our target price from a price-to-earnings (PE) and PE to growth (PEG) methodology. Yip’s is now trading at 9.7x FY11 PE. Our target price on the counter is HK$9.8 (36% upside), implying a 0.60x FY11 PEG or 13x target FY11PE. Given Yip’s strong track record and promising growth potential, we believe our PEG target is relatively conservative.

Comparables. There are several listed companies in Hong Kong involving in the business of paints; for instance, Petroasian Energy Holdings, CNT Group. Yet, Yip’s business comprises not only paint, but also inks, solvents and lubricants. We do not perceive these listed peers as a good comparables to Yip’s.

DCF valuation crosscheck. Cross checking with our Discounted Cash Flow (DCF) with the assumption of 1.5% terminal growth rate and 8.5% WACC, based on a risk free rate of 3.0% and a beta of 0.74, the fair value of Yip’s is HK$9.4, which is similar to our PE-based target price.

Exhibit 23: Discounted Cash Flow HK$ mn

FY09A FY10E FY11E FY12E FY13F FY14F FY15F

EBITDA

393 534 619 752 842 926 1,019 Add: Working capital adjustment 227 2 (457) (52) (177) (194) (214) Less: Capital expenditure 140 160 180 185 185 204 224 Less: Income tax paid (ungeared) 82 81 95 119 129 147 161

Free cashflow

397 294 (113) 396 351 381 419 6,089 yoy growth

-25.9% -138.3% -451.0% -21.9% 8.4% 10.0%

Discount factor

1 0.92 0.85 0.78 0.72 0.67 0.61 Present value

294 (104) 336 275 275 279 3,734

Sum of discounted NCF

Terminal value

Fair enterprise value

5,090 Add: Cash and equivalents 730 Less: Market value of debt 517 Less: Minority interest 195 Fair equity value

5,107

Number of issued shares, m 541 Fair equity value per share 9.44 P/DCF Multiplier 1 Fair equity value per share,

HK$9.44



8 April 2010 of 28

Risk Difficulties in enhancing brand awareness. ICI Dulux and Nippon Paints dominated the household plant market in China with substantial advertising expense. Though Yip’s tried to promote through distribution networks and some TV advertisement, the company may not be able to increase the sales volume on this segment considering the strong brand awareness of the two brands mentioned above. Thus it may affect our earnings forecast.

Dependence on large clients on inks. For inks segment, the client base comprises only a few food and beverage manufacturers. With a concentration on the client base, Yip’s bargaining power is relatively weaker. Further, the threat of losing a client in this segment comes more important.


8 April 2010 of 28

Financials Exhibit 24: Income Statement Year ended Mar (HK$ mn) FY08A FY09A FY10E FY11E FY12E Turnover 4,648 5,090 4,621 5,822 7,174 COGS 3,788 4,146 3,610 4,595 5,666 GP 860 944 1,010 1,227 1,508 SG&A 586 697 609 768 946 Other operating profit 97 78 71 89 110 EBITDA 425 393 534 619 752 Dep & Amor 53 67 62 71 80 EBIT 372 325 472 548 672 Interest Inc / expense 30 29 (9) (11) (14) Others 41 50 5 10 10 EBT 383 346 486 570 695 Tax 63 82 81 95 119 MI 44 40 61 72 87 NP 275 224 344 403 490

Dividend 121 134 138 161 196 EPS (basic), HK$ cents 0.57 0.42 0.64 0.75 0.90 DPS, HK$ cents 0.25 0.25 0.25 0.30 0.36 Source: Company, OP Research

Exhibit 25: Balance Sheet Year ended Mar (HK$ mn) FY08A FY09A FY10E FY11E FY12E Cash & eq 456 730 991 939 1,316 AR 962 833 800 1,262 1,283 Inventories 487 387 372 591 594 Other current assets 397 276 276 220 206 Total current assets 2,301 2,225 2,439 3,013 3,399 Net PP&E 783 887 990 1,104 1,214 Total investments 12 12 12 12 12 Other LT assets 107 115 93 50 25 Total non -current asset 902 1,015 1,095 1,166 1,251 Total assets 3,203 3,240 3,535 4,179 4,650 AP 388 343 297 522 492 ST debt 739 449 408 514 633 Other current liability 297 347 400 400 400 Total current liability 1,424 1,139 1,105 1,436 1,526 LT debt 137 67 116 116 116 other long term liability 13 7 20 20 20 Total noncurrent liability 150 75 136 136 136 Total liability 1,574 1,214 1,241 1,572 1,662 Capital and reserves 1,449 1,830 2,037 2,279 2,573 MI 180 195 257 328 415 Total equity 1,629 2,026 2,294 2,607 2,988 Source: Company, OP Research


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Exhibit 26: Cash Flow Year ended Mar (HK$ mn) FY08A FY09A FY10E FY11E FY12E Net profit 275 224 344 403 490 Dep & Amort 53 67 62 71 80 Change in NWC (87) 227 2 (457) (52) Others 55 34 34 34 34 CFO 296 552 441 51 551 - - - - - Capex (95) (140) (160) (180) (185) Investment 18 - - - - Others (364) 104 122 143 99 CFI (440) (36) (38) (37) (86) - - - - - Debt raised 326 (371) 7 106 119 Equity raised 15 264 - - - Dividend paid (107) (124) (138) (161) (196) Others 36 (11) (11) (11) (11) CFF 271 (242) (142) (66) (88) - - - - - Net CF 127 274 262 (53) 378 Cash beginning 234 456 730 991 939 Exchange rate change 95 (0) - - - Cash ending 456 730 991 939 1,316 Source: Company, OP Research

Exhibit 27: Ratio Year ended Mar (HK$ mn) FY08A FY09A FY10E FY11E FY12E Efficiency

Days in AR 67.25 64.34 64.49 64.64 64.74 Days in Inv 43.59 38.46 38.36 38.26 38.16 Days in AP 42.19 32.21 32.36 32.51 32.66 Cash Conversion Cycle 68.65 70.60 70.50 70.40 70.25 Liquidity Current ratio 161.5% 195.3% 220.8% 209.8% 222.8% Cash ratio 32.0% 64.0% 89.7% 65.4% 86.3% Net Gearing 25.8% -10.5% -20.4% -11.8% -19.0% Profitability ROA 14.0% 10.7% 14.4% 14.8% 15.8% ROE 21.6% 13.7% 17.8% 18.7% 20.2% Gross margin 8.0% 6.4% 10.2% 9.4% 9.4% Net margin 5.9% 4.4% 7.5% 6.9% 6.8% Valuation PB 2.42 2.12 1.92 1.72 1.52 PER 12.75 17.26 11.36 9.70 7.99 PEG 0.55 (0.93) 0.21 0.57 0.37 Dividend yield 3.46 3.46 3.52 4.12 5.01 Growth momentum Turnover growth 18.8% 9.5% -9.2% 26.0% 23.2% GP growth 8.5% 9.7% 7.0% 21.4% 22.9% NP growth 23.0% -18.5% 53.6% 17.1% 21.4% Source: Company, OP Research


8 April 2010 of 28

Exhibit 28: Historical PE band

0

2

4

6

8

10

12

14

Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

avg.= 9.08x

+1std.= 11.67x

-1std.= 6.49x

Source: Bloomberg

Exhibit 29: Historical PB band

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

avg.= 1.57x

+1std.= 2.13x

-1std.= 1.01x

Source: Bloomberg


8 April 2010 of 28

Appendix I: Management Profile Mr. Ip Chi Shing, Tony, aged 61, is the co-founder and the chairman of Yip’s. Mr. Ip has over 30 years of experience in the manufacture of and trading in petrochemical products. He is the brother of Ms. Ip Fung Kuen and Mr. Yip Tsz Hin, Stephen, deputy chairmen and executive directors of Yip’s.

Mr. Yip Tsz Hin, Stephen, aged 50, joined Yip’s in 1977. He is a deputy chairman and an executive director of Yip’s and is also the chairman of a number of subsidiaries of the company including Yip’s Ink and Chemicals (Group) Limited, Jiangmen Handsome Chemical Development Limited, Jiangmen Thansome Solvents Production Limited, Huizhou Shengda Chemical Co., Limited and Taixing Jinjiang Chemical Industry Company Limited. He has over 30 years of experience in the manufacture of and trading in petrochemical products.

Mr. Ting Hon Yam, aged 56, has been an executive director of Yip’s since 1994. He is currently responsible for the overall management of Yip’s business affairs in China. Mr. Ting joined Yip’s in 1983 and has over 20 years of experience in the petrochemical industry.

Mr. Young Man Kim, Robert, aged 61, has been an executive director of Yip’s since 2002 and is also the head of corporate communications department of Yip’s. Mr. Young received a Master’s degree in Chemistry from the University of California, Berkeley in 1972 and a MBA from the Chinese University of Hong Kong’s 3-Year MBA Programme in 1981. He has extensive experience in the petrochemical industry, and was the Director for Hong Kong/ Macau for Shell Hong Kong Limited from 1993 to 2000. He is also a member of the Executive Committee of the Hong Kong Housing Society, a member of the Marketing Management Committee of the Hong Kong Management Association, and the vice chairman and a member of the Board of Governors of Friends of the Earth (Charity) Limited.

Mr. Wong Kam Yim, Kenny, aged 48, has been the chief executive officer of Yip’s since 1 April 2008. Mr. Wong was appointed as an executive director of Yip’s in 2002. He is also the general manager of Hong Kong Bauhinia Paints Manufacturing (Greater China) Company Limited, a subsidiary of Yip’s. Mr. Wong graduated from the University of Sheffield in the United Kingdom in 1987 with a Bachelor’s Degree in Business Studies and obtained a Master Degree in Business Administration from the University of Wales in the United Kingdom in 1988. He joined Yip’s in 1996 and has over 15 years of experience in marketing and management.

Mr. Li Wai Man, Peter, aged 52, has been an executive director and the chief operations officer of Yip’s since 1 April 2008. Since joining Yip’s in 2004, Mr. Li has been the assistant director of Yip’s and has also served as a director for a number of subsidiaries of Yip’s. He obtained a Bachelor’s Degree in Mechanical Engineering from The University of Hong Kong and a Master Degree in Business Administration from The Chinese University of Hong Kong. Mr. Li has worked at a multi-national petrochemical company for over 20 years and has extensive experience in engineering, corporate planning, marketing and operations.


8 April 2010 of 28

Exhibit 30: n-Butanol 99.7% Exhibit 31: Ethanol

0

5,000

10,000

15,000

20,000

2002 2003 2004 2005 2006 2007 2008 2009 2010

n-Butanol 99.7% (RMB/Ton, for solvent)

RM

B/T

on

3,000

3,500

4,000

4,500

5,000

5,500

6,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Ethanol (for solvent)

RM

B/T

on


Exhibit 32: Glacial Acetic Acid Exhibit 33: Toluene

0

2,000

4,000

6,000

8,000

10,000

2002 2003 2004 2005 2006 2007 2008 2009 2010

Glacial acetic …

RM

B/T

on)

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

Mar-07 Sep-07 Mar-08 Sep-08 Mar-09

Toluene (1st M)

(RM

B/T

on)


Exhibit 34: Epoxy Resin 6101

10,000

15,000

20,000

25,000

30,000

2002 2003 2004 2005 2006 2007 2008 2009 2010

Epoxy Resin 6101

(RM

B/T

on)

Source: Company

Appendix II: ASP and Raw Material Price


8 April 2010 of 28

Appendix III: Shareholding Exhibit 35: Shareholding structure

Ip Chi Shing34%

Ip Fung Kuen11%Yip Tsz Hin

11%FMR LLC6%

Other38%

Source: Company


8 April 2010 of 28

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yip’s chemical 葉氏化工 · yip’s extension to eastern china region allows it to capture the...

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