November 10, 2016 Xinyi Glass [0868.HK] Share price weakness offers a re-visit opportunity. Maintain BUY. Shares of Xinyi Glass (XYG) have been under pressure recently, in our view because of (a) concerns about downstream demand from property developers in response to tightening policies released by the China Construction Sector - Chinese government ; (b) the peak in the float glass price; (c) a potential natural gas price hike; and (d) profit-taking, given the broad-based market correction. Despite concerns about downstream demand, Building Materials the float glass price has held up well, with the average float glass price in key cities in China down only 0.6% from end-Aug to 9 Nov 2016. The YTD average float glass price in key cities has increased 12.5% YoY, up from the 11.1% YoY increase in Jan-Sep 2016. The resilience of the float glass price is due to better downstream demand, which is attributable partly to stable construction activity. According to XYG management, the Company hasn’t experienced a slowdown in float glass shipments. Regard- ing a potential natural gas price hike, at this stage, XYG hasn’t received any formal notice from gas BUY suppliers. Management also highlighted that XYG will enjoy favourable pricing from gas suppliers, so the magnitude of a natural gas price hike will be less than what the news flow suggests. We also be- lieve that the market has missed the news flow on the change in export tax rebates by the Chinese Close: HK$5.93 (Nov 9, 2016) government on auto glass, which is positive for XYG, as it will see a 4% reduction in the cost of sales. XYG management believes that the float glass up-cycle will last longer, given the Chinese govern- Target Price: HK$8.69 (+46.5%) ment’s supply side reforms and the construction cycle. After the recent share price correction, XYG is now trading at a 7.0x 2016 PER and an estimated yield of 7.0%. With its undemanding valuation, we maintain our BUY call with a target price of HK$8.69 (based on a 10.5x 2016E PER, lower than its historical average and the average of its listed peers). Share Price Performance Investment Highlights (HK$) (HK$ million) 8 400 XYG to benefit from new tax rule. The Chinese government raised tax rebates on exports of auto glass (no: 70071190 and no: 70072190) from 13% to 17% with effect from 4 Nov 2016. This 6 300 is positive for XYG, as the costs of sales of exports of auto glass (about 23% of total turnover based on our estimation for 2016) will see a 4% reduction. The cost savings will translate directly 4 200 into a higher gross margin. Based on our estimation, XYG’s gross margin in the auto glass seg- ment will improve from 48% to 51%, which we forecast will increase 2016 net profit by 3.3% on a 2 100 full-year basis. It seems that the market has missed the news flow regarding the increase in ex- port tax rebates. We will keep communicating with XYG and see when the actual impact of the 0 0 Nov15 Jan16 Mar16 May16 Jul16 Sep16 change in export tax rebates emerges. Turnover (RHS) Price (LHS) Increase in energy costs manageable. News reports indicate that PetroChina is likely to raise Source: Bloomberg, CGIS Research the non-residential natural gas price starting 20 Nov 2016, according to the NDRC 2015 gas price Market Cap US$2,976m adjustment document. PetroChina is empowered by the NDRC to raise the float base gas price by up to 20% to ensure sufficient natural gas supply in the winter season (Nov-Mar). At this stage, 3,554.9m XYG hasn’t received formal notice from gas suppliers of a price hike. XYG management also Shares Outstanding highlighted that XYG will enjoy favourable pricing from gas suppliers. The float glass industry is entering the low season, so the impact of a potential natural gas price hike on XYG will be man- Pricewaterhouse- Auditor ageable. The impact of a natural gas price hike will be temporary and it shouldn’t have a signifi- cant impact on XYG production costs in 2017 on a full-year basis. We note that individual cities, such as Quanzhou and Xi'an, have recently lowered their residential and non-residential retail gas Free Float 45.6% prices. We still believe that the Chinese government is unlikely to raise the natural gas price sig- 52W range HK$3.48-7.53 nificantly, as it would contradict the strategy of encouraging natural gas usage. Float glass price holding up well. Despite concerns about downstream demand, the float glass 3M average daily T/O US$11.9m price has held up well, with the average float glass price in key cities in China down only 0.6% Major Shareholder Mr Lee Yin Yee from end-Aug to 9 Nov 2016. After the recent fall from the peak in mid-Sept 2016, the YTD aver- age float glass price in key cities has increased 12.5% YoY, up from the 11.1% YoY increase in (20.3%) Jan-Sep 2016. The resilience of the float glass price is due to better downstream demand, which is attributable partly to stable construction activity. According to XYG management, the Company hasn’t experienced a slowdown in float glass shipments. Mark Po, CFA — Senior Analyst Other growth areas. XYG is trying to capture the growth potential of China’s growing aftermarket (852) 3698-6318 automobile glass segment by offering direct sales to customers. The aftermarket automobile glass segment is now dominated by XYG and Fuyao Glass [3606.HK], both of which are presently focus- [email protected] ing on the wholesale market. Key Financials (in HKDm) 2013 2014 2015 2016E 2017E Wong Chi Man, CFA — Head of Research Revenue 9,936.1 10,861.1 11,460.3 13,394.3 14,571.5 Change (YoY %) 17.8 9.3 5.5 16.9 8.8 Gross Profit 3,137.0 2,733.4 3,132.7 4,746.2 5,171.8 (852) 3698-6317 Gross Margin % 31.6 25.2 27.3 35.4 35.5 Net Profit 3,521.9 1,364.3 2,111.9 3,281.4 3,626.2 Net Margin % 35.4 12.6 18.4 24.5 24.9 [email protected] EPS (Basic) 0.89 0.35 0.54 0.85 0.93 Change (YoY %) 189.9 (61.3) 54.8 57.6 10.5 DPS $0.240 $0.150 $0.265 $0.418 $0.461 ROE (%) 31.8 11.1 16.9 24.0 23.3 Dividend Yield (%) 4.05 2.53 4.47 7.04 7.78 PER (x) 6.6 17.1 11.1 7.0 6.3 PBR (x) 1.9 1.9 1.8 1.6 1.4 FCF Yield (%) 1.41% -0.79% 4.50% 7.43% 9.31% Capex (m) (3,752.3) (1,729.0) (1,967.0) (1,700.0) (1,500.0) Free cash flow per share 0.1 (0.0) 0.3 0.4 0.6 Net Gearing (%) 33.6 42.0 37.2 33.3 27.0 Source: Bloomberg, CGIS Research 1 Figure 1: Results highlights Results Highlights (HKD m) 1H 2014 2H 2014 1H 2015 2H 2015 1H 2016 2H 2016E Revenue 5,034 5,827 5,283 6,177 5,885 7,509 Cost of sales and services (3,697) (4,430) (3,873) (4,455) (3,844) (4,804) Gross profit 1,337 1,397 1,410 1,723 2,041 2,705 Other income and other gains and losses 247 152 287 307 147 245 Distribution and selling expenses (268) (340) (312) (367) (351) (403) Administrative expenses (472) (558) (441) (494) (533) (600) Finance costs (25) (14) (26) (24) (44) (18) JV & Associates 57 80 161 157 312 469 Profit before tax 876 716 1,079 1,301 1,572 2,398 Income tax expense (114) (114) (138) (128) (202) (279) MI (0) (0) (2) (0) (0) (192) Profit for the period 762 602 939 1,173 1,369 1,927 Gross margin (%) 26.6 24.0 26.7 27.9 34.7 36.0 Operating margin (%) 17.9 12.5 20.9 21.4 27.5 32.2 Net Margin (%) 15.1 10.3 17.8 19.0 23.3 25.7 Turnover by products (HKDm) Automobile glass 1,781 1,813 1,897 1,890 1,990 2,072 Construction glass 1,079 1,477 1,206 1,445 1,220 1,644 Float glass 2,175 2,538 2,180 2,843 2,675 3,794 Gross margin by products (%) Automobile glass 42.1 41.5 44.1 44.6 48.7 47.4 Construction glass 37.0 34.1 31.7 35.6 39.0 38.7 Float glass 8.6 5.6 8.7 12.9 22.3 28.6 Source: Company, CGIS Research Figure 2: Key assumptions for XYG 2012 2013 2014 2015 2016F 2017F Turnover (HKDm) Automobile glass 3,077.8 3,287.2 3,593.2 3,786.6 4,062.1 4,357.7 Construction glass 1,574.6 2,154.5 2,555.5 2,651.5 2,863.6 3,285.9 Float glass 3,780.6 4,494.3 4,712.4 5,022.2 6,468.6 6,927.9 Total 8,433.0 9,936.1 10,861.1 11,460.3 13,394.3 14,571.5 YoY Change (%) Automobile glass 6.8 9.3 5.4 7.3 7.3 Construction glass 36.8 18.6 3.8 8.0 14.7 Float glass 18.9 4.9 6.6 28.8 7.1 Total 17.8 9.3 5.5 16.9 8.8 Volume Automobile (piece) 12,110.0 12,889.0 13,582.8 14,571.1 15,631.3 Construction(sqm) 16,363.0 19,380.0 20,107.5 22,620.9 25,448.4 Float glass (tonne) 2,927.0 3,510.0 3,856.8 4,435.3 4,657.0 YoY Change (%) Automobile (piece) 6.4 5.4 7.3 7.3 Construction(sqm) 18.4 3.8 12.5 12.5 Float glass (tonne) 19.9 9.9 15.0 5.0 ASP Automobile (HKD/piece) 271.4 278.8 278.8 278.8 278.8 Construction (HKD per sqm) 131.7 131.9 131.9 126.6 129.1 Float glass (HKD per tone) 1,535.5 1,342.6 1,302.2 1,458.4 1,487.6 YoY Change (%) Automobile (HKD/piece) 2.7 0.0 0 0 Construction (HKD per sqm) 0.1 0 (4.0) 2.0 Float glass (HKD per tone) (12.6) (3.0) 12.0 2.0 Gross margin (%) Automobile glass 42.8 43.3 41.8 44.3 48.0 48.0 Construction glass 37.2 39.9 35.3 33.9 38.9 38.9 Float glass 8.6 19.0 7.0 11.1 26.0 26.0 Blended 26.4 31.6 25.2 27.3 35.4 35.5 Net margin (%) 14.1 35.4 12.6 18.4 24.5 24.9 Cost (HKDm) S,G&A (1,056.7) (1,250.9) (1,638.0) (1,614.5) (1,887.0) (2,052.9) Financial Expenses (57.3) (59.7) (38.1) (50.2) (45.4) (62.7) YoY Change (%) S,G&A 18.4 30.9 (1.4) 16.9 8.8 Financial Expenses 4.2 (36.2) 32.0 (9.5) 37.9 CAPEX (HKDm) 1,435.3 3,752.3 1,729.0 1,967.0 1,700.0 1,500.0 Net Gearing (%) 35.8 33.6 42.0 37.2 33.3 27.0 Source: Company, CGIS Research 2 Figure 3: Earnings projection Income Statement (HKDm) FY2013 FY2014 FY2015 FY2016F FY2017F Cash Flow Statement (HKDm) FY2013 FY2014 FY2015 FY2016F FY2017F Revenue 9,936 10,861 11,460 13,394 14,571 Net Income 3,282 1,227 1,796 2,692 2,908 Growth yoy% 17.8% 9.3% 5.5% 16.9% 8.8% Depreciation & Amort.