Wednesday, January 31, 2007
A Couple of Glass Makers from Heaven and Hell Part II
From hell - ZJ Glass (739)
JZG is almost the exact opposite of Xinyi, though it's only one step up in the value chain. It's the 4th largest float glass manufacturer in China but with a capitalization (domestic + H shares) of $1.25b or only 1/5 of Xinyi's.
First, it's been operating in a severely over-supplied domestic float glass market (since 2004), which at one point last year forced some firms to close production as the selling price was so low at $50 per weight case (JZG's unit cost was $64). All major players had to sit down and agreed on a joint price hike as the whole industry was losing money (which nevertheless could suggest a bottoming-out). The price stabilized at around $70 per weight case (JZG's avg. selling price was $66). The other contributing factor was the surge in heavy oil price (73% YOY for 2006 1st half), which might come down in 2nd half with the drop in crude oil prce (or not because of the price fixing mechanism).
JZG managed to lessen the impact by focusing on higher quality automotive grade glass and recently ultra-thin glass for electronics, but it still reported 66% decline in profit in 2005 and a net loss in 2006 interim (EBIT was close to breakeven though). The loss was a 1st since listing. Like Xinyi it also pursued vertical integration by building an upstream soda ash plant in Qinghai and breaking into the downstream processed glass market. But both fronts are not showing success so far.
Qinghai soda ash plant started production last year and contributed 18% to the 2006 interim turnover of $580m. 70% of output (in volume) was light ash for non-glass applications and 30% was dense ash for glass production, which was said to increase in the future. Segmental information showed 37% of output (in RMB) was consumed by JZG and the rest was sold to the market. The business reported a loss before interest and tax but management told things would improve when capacity is better utilized (2006 expected utilization: 66%). They also cited that the building of the Qinghai-Tibet railway had disrupted deliveries. However, it appears that JZG has simply moved from one over-supplied market to another! Even management quoted the national supply of soda ash would reach 15.5m tonnes in 2006, outgrowing the national demand of 13m tonnes. Selling price dropped by 28% to RMB1,350 per tonne in 2006 1st half compared to that of 2005, though the price didn't change much within the 6 months. The only bright spot is there's 5-year profit tax exemption followed by 50% reduction for the following 5 years. This may not last under profit tax reform though.
Processed glass business performed worse with production volume, selling price, and turnover all declined in 2006 1st half. Total sales was only 7% of turnover.
Unlike Xinyi's management who are wary of debt financing, ZJG loaded up the balance sheet with debt pretty hard, so hard that total debt was $3.3b at 2006 interim. NAV was only $1.3b. Current ratio was 0.4 and net gearing was 186%. In typical Chinese fashion 2/3 of the debt was short term and management claimed they would have no problem renewing it, which might have some grounds as ZJG still managed to borrow $125m more in 2006 1st half to finance the working capital of the soda ash plant! However I don't expect this can continue for long as capacity expansion is the prime target under austerity measures. Finance cost was a high $76m in 2006 1st half.
$1.6b was spent on the soda ash plant and there's planning for a second phase of it which will cost another $1.6b ($385m was spent already). In the interim account ZJG reported a total capital commitment of $7.3b, of which $6.3b is for more float glass production lines! This makes ZJG look more like a builder than a glass factory. Of course all these expansions were planned in 2004 and now everything is put on hold indefinitely.
For as demon as ZJG can be it has attracted funding from the IFC, who together with a fund put in $800m, $260m by equity (1/4 of the then capital) and $540m by loan. Proceeds would go into retiring short term debt and the new loan would be long term with semi-annual repayment starting July 2008. Proforma net gearing would come down to 124% and current ratio would improve to 0.52. I guess maybe the soda ash plant project fits into the IFC agenda of developing the rural China.
After injection Chairman Feng's stake would be diluted to 55% (400m shares out of 721m). This is another bright spot as ZJG has avoided equity financing until now. Corporate governance is supposed to improve gradually marked first by the step down of the Chairman's wife and daughter from the board replaced by two management staff. Chairman Feng has also provided personal guarantee and pledged 120m domestic shares as security for the loan.
With IFC's involvement ZJG becomes an interesting turnaround bet. For one I think ZJG is not heading into big troubles any time soon as bankers (not Chinese bankers) are conservative and should have done their math before lending. IFC was impartial and wasn't throwing good money after bad one. As the placing was completed after June 2006 they should've known better about the float glass and soda ash business. And second with IFC as the chief lender I think ZJG will focus on debt repayment over the next few years (read: no more senseless expansion). This will cut down interest expense as debts are repaid gradually, which will increase future profits.
Over the last 5 years (up to 2005), ZJG made about $200m in 3 years and $80m in 2 years. In 2005, it made $74m on an avg. price of $70 per weight case of float glass. Let's assume conservatively that with the soda ash plant 2007 profit is $100m. Depreciation is about $300m a year which together with profit will go into retiring debt. Interest savings (assume 6.5% on debt) after tax will be $17m a year, and $51m in 3 years. This will give a 15% annualized profit growth, which may be higher if ZJG has a break from the profit tax reform. Against a $1.26b capitalization, prospective p/e will become 10.8x, 9.4x, and 8.3x. There's also upside from the recovery of the float glass market and increase in efficiency of the soda plant. But equally things could get uglier than already is and IFC may not be the lender of last resort for the second time.
ZJG is a speculation, which means there's considerable upside but also real risk of losing one's capital. But what more can you expect from a company from hell.
DISCLOSURE: I don't hold 739 at time of writing.
JZG is almost the exact opposite of Xinyi, though it's only one step up in the value chain. It's the 4th largest float glass manufacturer in China but with a capitalization (domestic + H shares) of $1.25b or only 1/5 of Xinyi's.
First, it's been operating in a severely over-supplied domestic float glass market (since 2004), which at one point last year forced some firms to close production as the selling price was so low at $50 per weight case (JZG's unit cost was $64). All major players had to sit down and agreed on a joint price hike as the whole industry was losing money (which nevertheless could suggest a bottoming-out). The price stabilized at around $70 per weight case (JZG's avg. selling price was $66). The other contributing factor was the surge in heavy oil price (73% YOY for 2006 1st half), which might come down in 2nd half with the drop in crude oil prce (or not because of the price fixing mechanism).
JZG managed to lessen the impact by focusing on higher quality automotive grade glass and recently ultra-thin glass for electronics, but it still reported 66% decline in profit in 2005 and a net loss in 2006 interim (EBIT was close to breakeven though). The loss was a 1st since listing. Like Xinyi it also pursued vertical integration by building an upstream soda ash plant in Qinghai and breaking into the downstream processed glass market. But both fronts are not showing success so far.
Qinghai soda ash plant started production last year and contributed 18% to the 2006 interim turnover of $580m. 70% of output (in volume) was light ash for non-glass applications and 30% was dense ash for glass production, which was said to increase in the future. Segmental information showed 37% of output (in RMB) was consumed by JZG and the rest was sold to the market. The business reported a loss before interest and tax but management told things would improve when capacity is better utilized (2006 expected utilization: 66%). They also cited that the building of the Qinghai-Tibet railway had disrupted deliveries. However, it appears that JZG has simply moved from one over-supplied market to another! Even management quoted the national supply of soda ash would reach 15.5m tonnes in 2006, outgrowing the national demand of 13m tonnes. Selling price dropped by 28% to RMB1,350 per tonne in 2006 1st half compared to that of 2005, though the price didn't change much within the 6 months. The only bright spot is there's 5-year profit tax exemption followed by 50% reduction for the following 5 years. This may not last under profit tax reform though.
Processed glass business performed worse with production volume, selling price, and turnover all declined in 2006 1st half. Total sales was only 7% of turnover.
Unlike Xinyi's management who are wary of debt financing, ZJG loaded up the balance sheet with debt pretty hard, so hard that total debt was $3.3b at 2006 interim. NAV was only $1.3b. Current ratio was 0.4 and net gearing was 186%. In typical Chinese fashion 2/3 of the debt was short term and management claimed they would have no problem renewing it, which might have some grounds as ZJG still managed to borrow $125m more in 2006 1st half to finance the working capital of the soda ash plant! However I don't expect this can continue for long as capacity expansion is the prime target under austerity measures. Finance cost was a high $76m in 2006 1st half.
$1.6b was spent on the soda ash plant and there's planning for a second phase of it which will cost another $1.6b ($385m was spent already). In the interim account ZJG reported a total capital commitment of $7.3b, of which $6.3b is for more float glass production lines! This makes ZJG look more like a builder than a glass factory. Of course all these expansions were planned in 2004 and now everything is put on hold indefinitely.
For as demon as ZJG can be it has attracted funding from the IFC, who together with a fund put in $800m, $260m by equity (1/4 of the then capital) and $540m by loan. Proceeds would go into retiring short term debt and the new loan would be long term with semi-annual repayment starting July 2008. Proforma net gearing would come down to 124% and current ratio would improve to 0.52. I guess maybe the soda ash plant project fits into the IFC agenda of developing the rural China.
After injection Chairman Feng's stake would be diluted to 55% (400m shares out of 721m). This is another bright spot as ZJG has avoided equity financing until now. Corporate governance is supposed to improve gradually marked first by the step down of the Chairman's wife and daughter from the board replaced by two management staff. Chairman Feng has also provided personal guarantee and pledged 120m domestic shares as security for the loan.
With IFC's involvement ZJG becomes an interesting turnaround bet. For one I think ZJG is not heading into big troubles any time soon as bankers (not Chinese bankers) are conservative and should have done their math before lending. IFC was impartial and wasn't throwing good money after bad one. As the placing was completed after June 2006 they should've known better about the float glass and soda ash business. And second with IFC as the chief lender I think ZJG will focus on debt repayment over the next few years (read: no more senseless expansion). This will cut down interest expense as debts are repaid gradually, which will increase future profits.
Over the last 5 years (up to 2005), ZJG made about $200m in 3 years and $80m in 2 years. In 2005, it made $74m on an avg. price of $70 per weight case of float glass. Let's assume conservatively that with the soda ash plant 2007 profit is $100m. Depreciation is about $300m a year which together with profit will go into retiring debt. Interest savings (assume 6.5% on debt) after tax will be $17m a year, and $51m in 3 years. This will give a 15% annualized profit growth, which may be higher if ZJG has a break from the profit tax reform. Against a $1.26b capitalization, prospective p/e will become 10.8x, 9.4x, and 8.3x. There's also upside from the recovery of the float glass market and increase in efficiency of the soda plant. But equally things could get uglier than already is and IFC may not be the lender of last resort for the second time.
ZJG is a speculation, which means there's considerable upside but also real risk of losing one's capital. But what more can you expect from a company from hell.
DISCLOSURE: I don't hold 739 at time of writing.
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