China XLX Fertiliser Ltd - Riding on China’s Agriculture and Alternative Energy Drive

One of China’s largest and lowest-cost coal-based urea producers. Based
in Henan, the most populous and largest fertiliser consuming province in China,
and located near coal-rich Shanxi (150km), XLX is the largest coal-based urea
producer in Henan and the sixth-largest one in China, with two plants and a
combined capacity of 680k tpa (315k tpa + 365k tpa). Due to its larger scale,
proximity to coal mines, advanced technologies and self-generation of electricity
(self-sufficiency at 35%), XLX, as a coal-based urea producer, has the lowest
cost in Henan and the fourth-lowest cost in China (Rmb1,136/tonne, at least
20% lower than industry average).
Resources advantage and low processing cost are the keys. Given that urea
prices are on an uptrend in tandem with rising raw material prices (natural gas
and coal) worldwide. Producers like XLX with resource advantage and lower
processing costs, would benefit the most from the trend. It is because the
company could ride on rising product prices and simultaneously see more
modest increase in raw material cost, implying margin improvement. With
additional Rmb735m of cash raised from the IPO, XLX could grab the
opportunities to acquire small players and revamp them into more efficient
producers through restructuring.
Riding on strong product prices. We expect urea and methanol prices in
China to rise 1-3% p.a. in 2007-09, based on the robust supply-demand
dynamics and hike in natural gas and coal prices. China’s urea demand could
grow 5% p.a. in 2007-09, given its drive to raise grain output. Urea capacity in
China could grow slower than consensus of 5% p.a., as rising natural gas prices
and power tariffs will likely force small players to shut down. Lending support to
domestic urea prices is strong overseas prices, partly due to the US’ push for
bio-fuel. Methanol prices will be underpinned by the development of methanol
fuel and DME as substitute to diesel and LPG.
Less vulnerable to fluctuations in coal prices. With its two plants located only
150km from coal mines in Jincheng and transportation cost accounting for only
one-fourth of total coal purchase cost, XLX is less vulnerable to the coal
transportation bottleneck and hence should see more modest hike in coal costs
in the coming years. Due to the closure of small coal mines in Shanxi, XLX’s
average coal purchase cost rose 18% in 2005 and 9% in 2006, lagging far
behind national average. We expect it to remain flat in 2007 (vs 10-15% for
national average), given the abundant coal supply from Jincheng.
A further 5-6% cost reduction by 2009. XLX plans to add two power
generators to raise its self-sufficiency in electricity to 70% by 1Q08. The project
could contribute a cost saving of Rmb11m (8.5% of FY06 net profit) p.a. to XLX.
The company also intends to construct a railway extension from Xinxiang
Railway Station into its new plant by end-08, which will enable it to load and
unload raw materials and products directly at the plants. We estimate it to
contribute an additional cost saving of Rmb9m (Rmb16-20/tonne). With the
above two projects and improvement in efficiency, we expect XLX’s total unit
cost to fall 5% by 2009.