Action

Shenyang Chemical released 3Q results. In 3Q, sales revenue fell 12.2% YoY to Rmb6.60bn, and net profit attributable to shareholders slipped 1.2% YoY to –Rmb136mn or –Rmb0.21/sh, short of what we expected.

Reasoning

The refining and chlor-alkali business remained soft as prices of major refining and chlor-alkali products (e.g. p ropylene oxide and polyether glycol) stayed low. In addition, acrylic acid and ester products that previously had a high gross margin also saw their profitability decline notably due to weak demand and large new capacity expansion in China. The company’s gross margin was only 5.85% in 3Q.

Shenyang Chemical plans to acquire a 99.33% equity interest in Bluestar Chemical through issuing up to 158mn new shares at Rmb4.46/sh to Bluestar Group. The deal is pending regulatory approval. Bluestar Chemical focuses on producing polyether glycol, but this product has weak profitability due to overcapacity amid the slowdown of overseas and domestic economies.

The company’s refining and chlor-alkali profitability remains weak, with gross margin at ~6% for gasoline & diesel products and 10% for PVC paste resin. We believe refining and chlor-alkali profitability will not improve given the supply surplus. Thepolyether glycol business to be acquired is not promising either, in our view.

Valuation and recommendation

We slash our 2013/14 EPS estimates by 193.5% to –Rmb0.29 for 2013 and by 119.6% to –Rmb0.13 for 2014. Downg rade to HOLD.

Risks

Weaker -than-expected profitability of acquisition target; co ntinued weakening of refining and chlor-alkali industries.