China Sunsine Chemicals Holdings

[portuser]

Cityfarmer is concerned about higher aniline price impacting adversely on China Sunsine's profitability:
"...The ASP has significant impact on the company revenue, and profits. A simple sensitivity test on FY2015, a reduction of -10% in overall ASP, with all others remain the same, will eliminate almost all the net profit in FY2015.
... The price variance of +-10%, will translate to +-15-30 RMB mil differences in net profit, accordingly to company annual reports. The net profits were 220 RMB mil (FY2014, a peak), and 77 RMB mil (FY2013, the year before)."

The full text on price risks in page 87 of annual report reads:
"The Group is exposed to the market price for its principal raw materials which relate mainly to aniline. If prices for aniline had increased/decreased by 10% (2014: 10%) with all other variables including tax rate being held constant, the effects on net profit will be RMB 15,648,000 (2014: RMB 30,020,000) lower/higher."

Profit would decline only when all other variables were held constant.  In other words, product prices were assumed to remain when aniline price rose.

Those who have followed Sunsine know that besides supply demand situation, the prices of products and aniline have been moving in the same direction, and this is best illustrated as below.

Aniline price plunged from RMB 11,200 in August 2014 to RMB 5,300 in February 2016, as oil price tanked, and brought the selling prices (RMB/tonne) of rubber accelerators and anti-oxidants (the two groups with aniline as a major input) down as well:

....................................3Q 14........1Q 16.......2Q 16

Rubber accelerators......22,826.......17,333......17,080
Anti-oxidants................15,555.......10,226......10,213

"With the international crude oil prices remaining depressed, which has resulted in our main raw material prices remaining at low levels, our selling prices may continue to come under pressure." has been the familiar refrain in Sunsine's quarterly results announcement. 

The common perception that higher raw material prices hurt profitability does not hold here. 

Even when aniline was cheap, Sunsine earned RMB 49m in 2Q 16.

And it should be noted that while product prices were lower in 2Q than 1Q, gross profit margin of 27.3% was 3.1 percentage points higher, the result of sharing fixed cost among higher output.   

On 8 September Sunsine shed more light on its performance. 

First, in 2Q rubber accelerator production was in high gear, with utilisation hitting 98%. .    

Second, 2Q profit would have been higher if not for the RMB 6.6m provision of 'safety production', which may be reversed.
 
Aniline price has since rebounded, crossing RMB 6,000 in April, RMB 7,000 in early September, and RMB 8,000 lately. This bodes well for Sunsine.

The new 30,000-tonne TBBS (a high-grade accelerator) factory will bring Sunsine's accelerator capacity to 117,000 tonnes, about 23% of world's market share.

The technology for producing most rubber accelerators is simple, but treating waste is a challenge.

Lax enforcement in the past resulted in many rubber accelerator firms treating the wastes inadequately or not at all. 

In its 2Q results announcement, Sunsine stated that "with environmental regulations in China getting more and more stringent, and environmental protection inspection becoming more frequent, we believe that some smaller rubber chemical producers which fail to meet the stringent standards will continue to face suspension of their production by the authorities, which will benefit us."

Sunsine's attention to clean production processes is paying off.  In Chairman's words, "[r]elying the fundamentals built over the years, especially the emphasis on environmental protection measures, the Group was able to further strengthen its market leadership position by taking advantage of the China Government’s enforcement of stringent environmental protection policy."

And its two new products, insoluble sulfer and 6PPD, are bearing fruits now, as the data at the end of this mail show. With continual R&D, there are good demands for Sunsine's products even though they lag behind those of the leaders in quality.   

Flexsys and Sinorgchem, respectively the dominant producers of insoluble sulfer and 6PPD, are highly profitable, with their well-protected production technologies.

-------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Sales volume (tonne) of anti-oxidants 

2012........................5,183   (when 6PPD was first sold)
2013......................12,281
2014......................19,903
2015......................21,640
2016 (6 months)....15,061   (10,124 was the corresponding figure for 2015)

Sunsine does not disclose the individual sales volumes of its three anti-oxidants (TMQ, 5PPD and 6PPD).  

The overall anti-oxidant capacity is 45,000 tonnes, of which 30,000 belong to 6PPD.


Sales volume (tonne) of insoluble sulfer

2008..........................464   (when insoluble sulfer was first sold)
2009.......................3,468
2010.......................4,413
2011.......................7,873
2012.....................10,724
2013.....................11,948
2014.....................12,102
2015.....................15,417
2016 (6 months).....9,153   (6,859 was the corresponding figure for 2015)

The current insoluble sulfer capacity is 20,000 tonnes. Sunsine has the necessary infrastructure to add another 20,000 tonnes. 

[CityFarmer]

There are few questions to be answered, before the conclusion.

1. A common view, is the company is capturing market share, with lower selling prices, thus the down-trend in average selling prices (ASPs). Is it true?

I am not so sure. Bigger market share with lower prices, is making sense, ONLY you can gain pricing power later. I don't think the company has pricing power, before, now, and will get it in foreseeable future. Then why? The company is in asset-heavy biz. Production utilization is important to cover the fixed costs. The utilization rate, based on published data, was around 80% in the last 5 years. It was a good job done. Gaining bigger market share, wasn’t the intention, but a by-product of optimum production utilization, IMO

2. Isn’t it the down-trend of ASPs, consistent with the lower raw material cost, which means the cost is pass-through to customers?

It sounds logical. Is it a norm of cost pass-through, or just a coincident? I am having an opinion, that the selling prices, is determined by market demand and supply, rather than on any customer pre-arrangement. Few historical incidences to support the argument.

In 2009, the post-Olympic effect had driven down the selling prices, with higher raw material cost. Market forces had determined the selling prices, rather than raw material price.

In 2012, the selling prices had been driven down, even with a significant hike in material cost. Again market forces had determined the selling prices. The net profit of the company was at a historical low, with net profit margin of 2-3%

The opposite, was happening. In 2014, selling price hike due to new regulation, amid a lower material cost. I don’t think, the cost-pass-through works only in favor of the company at all time.

Will the same happen on selling prices, on the next occurrence of higher material cost? There is no apparent reason, it wouldn’t. I am sure it is out of the company management control, but at the mercy of market demand and supply. Material cost, is one of the forces in market price setting, but more forces in play in China, which I will elaborate more in next question.

One last note on the topic. Does it mean the Chairman is misleading? No, I respect the integrity of the Chairman. I believe he is honest, but we need to listen with perspective, with his role.

It seems no usage of hedging to stabilize both the material and product pricing. It might due to no related tools are available in China.

3. The company is a market leader in volume, as well as cost. Assuming an efficient market, the company will eventually benefit from optimum pricing with its market leadership, after all short-term volatility. Why not?

IMO, the market will remain at over-cap for a long time, with the poor outlook in chemical manufacturing and tire markets. International export fell due to anti-dumping measures, and domestic consumption fell, due to lower GDP growth. Both aren't short-term blip, but a long term trend. Will the chemical manufacturing sector consolidate in near future, with new environmental rules? I am having an opinion, that it plays a part, but not significant. The sector is asset-heavy, with long-term investments, and labor intensive. The reacting to market, take years, if not forever. One supporting fact, was intensive competition resumed in FY2016, after the new rule implementation in FY2014/15, which have the historical high profits of more than RMB 200 million.

The China market, will continue stay in a very competitive market, even after the new environmental rule. The selling pricing is volatile, but the costs are sustainably going up, mainly in labor and depreciation (due to more capex) expenses. In IPO year (2007), the company spent 2 RMB cents and 5 RMB cents on depreciation and labor expense, on every RMB of revenue, respectively. In latest FY2015, the costs went up to 5 RMB cent and 9 RMB cents per RMB of revenue, respectively. The uptrend sustains in 2016 1H result.

I am opting out, not due to certainty of poor performance, but high uncertainty of good performance, with various uncontrollable factors, i.e. the relatively higher risk.

Constructive comments are welcomed, to validate the thesis, as part of learning for all of us.

(a very long post, and not vested)

[CityFarmer]

I have done the regular review on the company. In short, a well-planned and managed company, but the sector biz risk is too uncertain for a bet.

thought you been saying that u look at company first rather than sector? so sector biz is a concern for you too now?
 
Do I sense a change in ur analysis method or is this a special case? ;D

The focus is still on company fundamentals. To be precise, it is the company exposure to sector biz risk, is too uncertain for a bet. It is still a bottom-up approach, but probably broader consideration when analyzing the company fundamentals.

[weijian]

Thank you for your insightful thoughts and views. What count is realised gain and paper gain. I am doing all right on these 2 aspects. The cushion allow me to hold on to the investment comfortably (paper gain) and allow me to liquidate in time when sign of trouble surfaces. So far, the investment thesis remains unchanged to me as far as sunsine is concerned so I will continue to be vested. Sometimes too much theories make you overthink too much and do too little. Ouch to you too!😎

What fascinates me, is all these theories that I picked up from Daniel Kahneman/Amos Tversky's writing, is showing up realistically as I review my own/other mistakes or from the behavior of crowds/views in this forum. I am hooked.

I do agree we shouldn't make practice out of theory (I used to fall into that trap) and I hope to perfect the art of making theory out of practice one day.

[portuser]

There has been no assertion that product price is solely determined by aniline price. The following quote is clear:
"Those who have followed Sunsine know that besides supply demand situation, the prices of products and aniline have been moving in the same direction,"

There are many reports on tougher pollution control measures having reduced over-capacity of the rubber accelerator sector.  If they are not to be believed, then one should give Sunsine a miss.

In cutting product prices in 4Q 2011, Sunsine stated the following:
"Due to the slowdown in the PRC economy, the Group reduced its average selling prices to capture a bigger domestic market share and maintain its competitiveness."

The price cut resulted in lower gross profit margin in 2012 and 2013:

Gross profit margin
2009...................22.3%
2010...................22.6%
2011...................24.0%
2012...................17.2%
2013...................18.2%
2014...................27.3%
2015...................26.5%
2016 (6months)....25.8% (27.8% in the corresponding period of 2015)

Had over-capacity persisted, gross profit margin would not have recovered. 

Sunsine's pre-IPO 24,000-tonne capacity in 2006 grew to 152,000 tonnes in 2014. The fuel-efficient steam supply system was also ready for use in that year. 

After IPO, there has been no share placement or rights issue to raise money. 

The capital cost of RMB 700m was paid from IPO money of RMB 260m, retained earnings and bank loans. Retained earnings have also been funding higher working capitals arising from sales that have quadrupled since IPO. Moreover, RMB 235m has been paid as dividends, and RMB 27m spent on share buyback.

Bank loans, which peaked at RMB 367m in 3Q 14 have since come down to RMB 103m, which Sunsine will pay up soon with its RMB 310m cash.

[CityFarmer]

Those who have followed Sunsine know that besides supply demand situation, the prices of products and aniline have been moving in the same direction

A valid question to be asked. Will the selling prices move up, along with aniline price? In other words, will the company able to raise selling prices, with higher raw material cost? If the answer isn’t a resounding yes, then probably the “moving in same direction” might only valid in downtrend, which is consistent with the current competitive market.

You have quoted recent time frame of 2004-2016. How about more input to validate the thesis? In 2012/13, the cost of raw material is high (based on the cost of sales, inventories charges), but selling prices remains low. The net profit margins were 2% (2012) and 4% (2013) then.

Selling price goes low, due to lower material cost, but selling price might not go up, with higher material cost. More factors are in play, which are having poor outlooks, IMO

There are many reports on tougher pollution control measures having reduced over-capacity of the rubber accelerator sector.  If they are not to be believed, then one should give Sunsine a miss.

The important point, is, has the new regulatory, made an impact on the over-capacity? I know there are many “reports” on that, but I saw discrepancies with other facts.

You have quoted Sunsine. Let’s do the same. Mr. Chairman' statement in AR2015 report, one year after new regulation measure, is quoted below. Small players were out, but bigger players still continue in the market, thus market remains highly competitive.

“This was also true for the rubber chemicals industry, which was still facing over-capacity, intense competition, stringent requirements for production safety and environmental protection, and the volatility of raw material prices and selling prices.”

“Overcapacity” and “intense competition” are the key words, in recent Sunsine reports. So you still having difference opinion, from the company management?  

In cutting product prices in 4Q 2011, Sunsine stated the following:
Due to the slowdown in the PRC economy, the Group reduced its average selling prices to capture a bigger domestic market share and maintain its competitiveness."

I agree. The group has reduced selling price, amid the competition. Next question to be asked. Has the company the pricing power to rise prices later, with bigger market share, amid the everlasting competitive market? Pricing power and intense competition, are mutually exclusive, IMO.

(not vested)

[portuser]

Cityfarmer wrote:
"A valid question to be asked. Will the selling prices move up, along with aniline price? In other words, will the company able to raise selling prices, with higher raw material cost? If the answer isn’t a resounding yes, then probably the “moving in same direction” might only valid in downtrend, which is consistent with the current competitive market."

For a given supply/demand situation, higher raw material prices are preferred. Otherwise, the company has not been truthful with its regular refrain lamenting low raw material prices.

A reasonable gross profit margin is what Sunsine is targeting for. Was 2Q 16 gpm of 27.3% not good enough with accelerators selling for RMB 17,080/tonne? 

   
Cityfarmer wrote:
"You have quoted Sunsine. Let’s do the same. Mr. Chairman' statement in AR2015 report, one year after new regulation measure, is quoted below. Small players were out, but bigger players still continue in the market, thus market remains highly competitive.

“This was also true for the rubber chemicals industry, which was still facing over-capacity, intense competition, stringent requirements for production safety and environmental protection, and the volatility of raw material prices and selling prices.”

“Overcapacity” and “intense competition” are the key words, in recent Sunsine reports. So you still having difference opinion, from the company management?  [Image: biggrin.gif] 

The latest information is in 2Q 16 results announcement which reads "with environmental regulations in China getting more and more stringent, and environmental protection inspection becoming more frequent, we believe that some smaller rubber chemical producers which fail to meet the stringent standards will continue to face suspension of their production by the authorities, which will benefit us."

What is the accelerator capacity that has been taken off for not meeting the environmental threshold?  

Is China raising the threshold gradually so that tyre firms still have enough accelerators to produce their wares?

Is the government merely paying lip service and is not intent on weeding out the causes of pollution?  


Cityfarmer wrote:
"You have quoted recent time frame of 2004-2016. How about more input to validate the thesis? In 2012/13, the cost of raw material is high (based on the cost of sales, inventories charges), but selling prices remains low. The net profit margins were 2% (2012) and 4% (2013) then."

The price cut in 4Q 11 lasted for two years, until Government announced in 2014 for stringent measures to be effected in 2015. 

One-off costs were responsible for the low 2012 net profit margin, as explained in the annual report. 

It is difficult to see far ahead. 

As Sunsine does not produce in anticipation of future sales, the high 98% utilisation rate in 2Q16 indicates strong firm demand for its rubber accelerators.

[CityFarmer]

For a given supply/demand situation, higher raw material prices are preferred. Otherwise, the company has not been truthful with its regular refrain lamenting low raw material prices.

A reasonable gross profit margin is what Sunsine is targeting for. Was 2Q 16 gpm of 27.3% not good enough with accelerators selling for RMB 17,080/tonne? 

I don't quite understand why higher raw material is preferred (to company?).

The questions are, what is the reasonable, and can it be sustained by the company? A 27% GPM, is reasonable. Will it drop to 17-18% as in 2012/13, whenever material cost is higher? GPM of 17-18%, means NPM of low single-digit, with the company cost structure. The return is below cost of capital in China, thus unreasonable.

The latest information is in 2Q 16 results announcement which reads "with environmental regulations in China getting more and more stringent, and environmental protection inspection becoming more frequent, we believe that some smaller rubber chemical producers which fail to meet the stringent standards will continue to face suspension of their production by the authorities, which will benefit us."

What is the accelerator capacity that has been taken off for not meeting the environmental threshold?  

Is China raising the threshold gradually so that tyre firms still have enough accelerators to produce their wares?

Is the government merely paying lip service and is not intent on weeding out the causes of pollution?  

I don't have the answers to your questions. China gov is still solving the Coal, and Steel over-capacity issues, after years, even pollution is also one of the concern. The stringent requirements, require more capital as regulatory costs (fixed cost), thus "dumping" is viable option after bigger players fulfilled the new requirements. "Dumping" means depressed selling prices with higher volume.

The price cut in 4Q 11 lasted for two years, until Government announced in 2014 for stringent measures to be effected in 2015. 

One-off costs were responsible for the low 2012 net profit margin, as explained in the annual report. 

It is difficult to see far ahead. 

As Sunsine does not produce in anticipation of future sales, the high 98% utilisation rate in 2Q16 indicates strong firm demand for its rubber accelerators.

One-off costs were there in 2012, but not the main reason for the low NPM. The GPM was already affected.

The utilization rate, was achieved by lowering prices, a disclosed strategy of the company. I would say, demand is high, when volume is going up with a stable, or even higher selling prices.

Last and not least, the historical dividend payout ratio was more than 20% before 2014. The company payout ratio were much lower in 2014/15, around 10%, even with record profits for two years.The decision might consistent with the thesis, which means the future might not be rosy all the time.

[Bluechipfan]

CF ok points taken and thank you for sharing. Sunsine has increased dividend payout in tandem with increased profit. The increase was not quantum leap which is understandable as company was still expanding and there was capex consideration. Now the company is net cash even with the latest expansion plan due for completion next year. I don't think Sunsine cut price for the purpose of achieving high utilisation rate. If that's the case they won't be plan for a new factory. The company anticipate higher demand and thus the new plant, which was originally planned few years back but put off due to poor economy conditions then. As investors we can only rely on our assessment so your sharing is appreciated as it allow for a comprehensive and informed decision. Having said that, I would have to disagree with your negative views and I think I will continue to vest. I am not sure you are already inclined to hold negative view for whatever reason. After all, it is well documented you are not vested and out of the blue, you started this round of 'debate' when you could simply remain not vested when this thread is quiet and calm for few months already. It is not as if someone is blowing the trumpet how good this company is and thereby, you deem fit to post a message of caution, which I would understand perfectly. Anyhow, I do take note of some points raised and would pay attention to my investment in this company. After all, nobody should care more about my money other than myself.

[holymage]

Actually I would thank both CF and bluechip for sharing your views as I learnt something. It's a healthy discussion I personally feel.

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