China XLX Fertiliser boosted its urea supply chain to become a market leader XLX is the 6th largest fertilizer company in China and the largest fertilizer company to use coal as raw material in Henan. As of 2020, major product production capacities were 2.60m tons of urea, 2.35m tons of compound fertilizers, 600,000 tons of methanol, and 50,000 tons of furfuryl alcohol. In February 2021, its third production base in Jiujiang City, Jiangxi Province commenced operation, consolidating its leadership in the fertilizer and chemical industries. Market boom on rise in global agri-product prices; fertilizer, chemical segments Global agricultural prices have been rising since 2020; domestic soybean and corn prices rose 50% to reach record highs. Since May 2021, affected by drought in Brazil and the US, shrinking supply in a variety of crop products, we think agricultural product prices could remain high. The rise in prices of agricultural products has led to rises in the prices of chemical fertilizers and chemical products. In 2021, prices of coal, urea, compound fertilizers and other products have been rising steadily. XLX has benefited from the industry’s boom cycle, and sales and gross profit margins have increased. We believe agricultural product prices will remain high in the next 1-2 years, and fertilizers and chemical products could continue to benefit. In 2H21, as autumn enters the peak season for fertilizer sales, XLX’s main fertilizer business could sustain volume and price increases. Urea supply chain buildout; realizing its strategic goal of low-cost differentiation Currently, the company has a relatively large cost advantage in the urea supply chain. The advanced coal-water slurry gasification process and integrated production technology of melamine have reduced production costs. Its favorable geographical location, combined with a diversified production management model, has enriched the product lines and effectively improved the company’s comprehensive competitiveness. 1)Leading production technology and strong production cost control: XLX was the first company to use advanced coal-water slurry gasification technology in China and its production cost is 31% lower than the industry average. Its comprehensive cost ratio has been about 10ppt lower than the industry for many years. When XLX melamine started production, it adopted the advanced production technology of the Eurotech IV high-pressure method, which effectively reduced cost. It covered the complete supply chain in terms of coal, synthetic ammonia, urea and melamine. 2)Upgraded facilities improved gross margin: The company plans to complete a 9MWp photovoltaic power generation project by the end of October 2021E. And to complete the second phase of a 25MWp project by 2022E. These two projects when rolled out could achieve carbon dioxide emission reduction of 29,200 tons p.a., saving 13,500 tons of coal p.a., reducing outsourcing electricity costs. The company has a special railway line, which helps to reduce transportation costs. 3) The company has a production structure based on the principle of “one head with many tails”. It allows immediate adjustments to product structures and formulas in response to market changes. It could also adjust product structure according to market demand and price levels. At the same time, the company values its independent R&D and has made bold forays into unchartered markets and products. It has developed and promoted three series of high-efficiency urea: energy network, fertilizer control and humic acid. These add value to the products. Valuation and risks Cost advantages in the urea and compound fertilizer industries, and the commissioning of XLX’s Jiujiang base has helped its business expansion and growth. We expect revenue of RMB14.4bn/15.4bn/15.8bn in 2021/22/23E, up 38%/7%/3% yoy, and net profit of RMB1.2bn/1.25bn/ 1.18bn, changing +246%/+3.45%/-5.49% yoy. We assign a 8x PE in 2022E and initiate coverage with a BUY call and a target price of HKD10.Risks include: fluctuating agricultural product prices; fluctuating raw material prices; foreign exchange rate risks; and differences in cross-market valuations. | 