Action

Downgrade Jiulian from BUY to HOLD because: 1) civil explosives demand should decline due to economicslowdown in China; 2) pricing of civil explosives has been switched from a price cap to market orientation, posingfurther downside risk to their gross margin; 3) issuing 184mn shares via private placement will significantly dilute EPS.

Reasoning

Shrinking civil explosives demand amid economic slowdown. As China’s economic growth in the 13th FYP coulddecelerate from the 12th FYP, growth in infrastructure fixed-asset investment should also slow and hence reducedemand for civil explosives. In addition, civil explosives that had a high margin thanks to pricing cap rules are currentlypriced by market forces, and Guizhou province with balanced demand/supply conditions faces cut-throat competition.In this context, the company’s product prices are likely to continue shrinking.

Civil explosives asset acquisitions underway. Poly Group could complete acquisition of Panjiang Chemical by theyear end and promised to inject it into Jiulian within 24 months. In addition, Poly Group will also likely inject its threecivil explosives arms into Jiulian by 2020, which will expand the company’s industrial dynamite capacity to 442.5kt, thelargest in China. As the only listed civil explosives company of Poly Group, Jiulian could take advantage of Poly Group’sresources to further boost concentration ratio of the Chinese civil explosives industry.

Jiulian plans to raise up to Rmb3bn via a private placement to repay interest-bearing liabilities and replenish workingcapital. The deal is still pending approval of regulators.

Earnings forecast and valuation

The company expects its 2015 net profit to decline 10~50% YoY. We maintain our 2015 EPS forecast of Rmb0.53and lower 2016 EPS estimate by 25% to Rmb0.63 (placement-diluted EPS expected to be Rmb0.34/0.40respectively) as we think asset injection by Poly Group could be slower than expected. The stock is trading at 53x/45x2015/16e P/E. Maintain TP of Rmb30, implying 48x 2016e P/E.

Risks

Slower-than-expected progress in asset injection by Poly Group; further decline in civil explosives demand and prices.