Action

We downgrade Tiansheng New Materials from ACCUMULATE to HOLD, but keep our TP at Rmb8.00, implying 139x 2014e P/E. We believe profitability of both the company and the industry faces some headwinds in the near term, and that fundamentals are unlikely to support further expansion of valuation.

Reasoning

2013 results disappointed: Operating revenue rose 16.54% YoY to Rmb605mn but net profit attributable to shareholders plunged 455.8% YoY to a loss of Rmb69.7mn. Excluding non-recurring items, net profit attributable to shareholders collapsed 1,291% YoY to a loss of Rmb73.7mn, or Rmb0.25/sh.

The loss was mainly due to increased operating costs, the disappointing operating results of projects funded by the proceeds from its IPO, and increased financial expenses amid rising debts and falling interest income.

Expenses surged in 2013: 1) Administrative expenses increased 43% YoY to Rmb102mn. As Tiansheng’s production and operational facilities are mainly located in the Yangtze River Delta region, Tiansheng has higher raw material, transportation, energy and labor costs than the nation-wide average; 2) selling expenses rose 34.12% YoY to Rmb49.96mn due to marketing efforts; 3) financial expenses surged 132.1% YoY to Rmb27.04mn as the company borrowed more and interest income declined.

The company made great efforts to explore markets through reducing gross margin amid fierce market competition. For example, products for wind power plants posted a gross margin of 16.46% in 2013, down 15.8% from a year earlier. In addition, provisions for bad debts surged 71.7% to Rmb20.56mn due to the worsening financial conditions of downstream clients, which directly undermined Tiansheng’s operating results. In order to deal with the tough market conditions, Tiansheng invested more than Rmb16.22mn to develop new applications and new products, up 24% YoY. It will likely launch PP, PMI and other new structural foams to reduce dependence on wind power plants.

Earning forecast and valuation

After a two-year slump, the wind power industry is likely to recover modestly helped by favorable policies, which should boost demand for PVC structural foams. We trim 2014e EPS by 33.5% to Rmb0.06 but keep our 2015 forecast at Rmb0.12.

Risks

Slow growth of downstream wind power plants; weaker-than-expected performance of new products.