Lottery Chemical's performance last year was better than expected, with revenue and net profit rising by 18% and 24% respectively. Sales of the company's main products, DSD acid and other dyes, remained stable during the period, but revenue from the division fell 13% year-on-year due to a 12% year-on-year drop in average selling prices. However, the sales of mononitrotoluene also increased by nearly 1.2 times last year, coupled with the increase in the average selling price, which contributed to the overall profit growth of the Group. In addition, the acquisition announced in February is expected to be completed in the second half of the year and bring financial contribution. Upgrade the rating and target price to recommended and HK $5.80.
The price of DSD acid stabilized. PNT is the main raw material of DSD acid, and because Lottery is the world's largest producer of DSD acid, it is also the world's largest PNT buyer. Last year, the Group significantly expanded its production capacity of mononitrotoluene and reduced its procurement of external 85%PNT, resulting in an oversupply of the latter, which led to a drop in the production cost and price of DSD acid. The average price of DSD acid fell 12% in 2016, dragging down revenue by 13% year-on-year. Due to factors such as inventory consumption and the rebound in oil prices, DSD acid prices have stabilized this year, driving the increase in revenue in this segment.
Sales of mononitrotoluene doubled. Lottery's revenue and earnings growth last year was mainly driven by a 116 per cent year-on-year increase in sales of mononitrotoluene to 37851 tonnes, as its production capacity doubled to 80, 000 tonnes in March last year. Mononitrotoluene includes PNT and ONT, while ONT is mainly used to produce OT. After the lottery increased production, PNT was used to produce DSD acid to reduce external dependence and reduce costs, while ONT and OT were used to manufacture herbicides and increase revenue sources. Thanks to industry consolidation, the division's average selling price rose 17 per cent last year, and gross profit margin expanded sharply from 8.6 per cent the year before to 26.1 per cent last year. As its production capacity is still underutilized, it is expected to further boost revenue by increasing sales this year.
Increase production and acquire to consolidate the leading position. The production capacity of DSD acid and DMAS increased by 1.8% and 50% respectively by the end of this year, which is expected to further expand their market share. In addition, the lottery announced in February that it would acquire a 75% stake in Yingchuang Sanzheng Fine Chemicals, which mainly produces cyanuric chloride. On the one hand, it will vertically strengthen the production of downstream OBA products, and on the other hand, it will expand horizontally ONT and OT products. Production expansion and acquisitions will help lottery customers further consolidate their industry leadership and broaden their revenue sources.
Upgrade to recommendation and target price to HK $5.8. It is expected that the acquisition and creation of Sanzheng will be completed in the second half of the year, and its revenue and profits in the second half of the year will be incorporated into the results of Lottery Chemical. In addition, its production expansion plan will further boost its revenue and earnings growth next year, upgrading its rating to recommended. Based on 17 times this year's forward price-to-earnings ratio, that is, the average price-earnings ratio plus 1 standard deviation, the target price will be raised from 4.42 to 5.80.