China Energy

.Zhangjiagang Phase 2 expansion brought forward by six months. CEGY
announced that Phase 2 expansion at its Zhangjiagang facility (involving 700,000
tonnes of additional capacity) should be completed at end-2008, six months ahead
of the original schedule of 1H09. We estimate this would increase its FY09
turnover by 42%.
• Capacity to be lifted four-fold by 2010. CEGY also announced plans to build
two new DME plants in Ningbo and Tianjin, with capacity for 1m tonnes each. We
expect construction to commence in 2009. When ready at end-2010, annual
capacity for DME should increase by four-fold to 4.6m tonnes. Fuelled by the
aggressive expansion, we project a 5-year revenue CAGR of 91% for FY06-11.
• Raised EPS forecasts by 1-25% for FY07-09. We have factored in higher sales
from the full-year impact of accelerated expansion in FY08 and FY09. We have
also assumed different DME prices for the respective regions, as we think the
price differential is too big to justify a single average DME price.
• Target price lifted to S$1.94 from S$1.75. We have increased our DCF valuation
from S$2.48 to S$2.78, after incorporating our earnings upgrade but also a higher
WACC of 14%. We have used a higher beta of 1.2 (up from 1.0) to reflect risks
from the lack of an execution track record and China Energy’s short operating
history. Our new target price is S$1.94, still based on a 30% discount to DCF
valuation. This translates into 16x CY08 P/E, which we believe is undemanding
given its attractive 3-year EPS CAGR of 82% and projected ROEs of 26-50%Zhangjiagang Phase 2 expansion brought forward by six months. CEGY
announced that Phase 2 expansion at its Zhangjiagang facility (involving 700,000
tonnes of additional capacity) should be completed at end-2008, six months ahead
of the original schedule of 1H09. We estimate this would increase its FY09
turnover by 42%.
• Capacity to be lifted four-fold by 2010. CEGY also announced plans to build
two new DME plants in Ningbo and Tianjin, with capacity for 1m tonnes each. We
expect construction to commence in 2009. When ready at end-2010, annual
capacity for DME should increase by four-fold to 4.6m tonnes. Fuelled by the
aggressive expansion, we project a 5-year revenue CAGR of 91% for FY06-11.
• Raised EPS forecasts by 1-25% for FY07-09. We have factored in higher sales
from the full-year impact of accelerated expansion in FY08 and FY09. We have
also assumed different DME prices for the respective regions, as we think the
price differential is too big to justify a single average DME price.
• Target price lifted to S$1.94 from S$1.75. We have increased our DCF valuation
from S$2.48 to S$2.78, after incorporating our earnings upgrade but also a higher
WACC of 14%. We have used a higher beta of 1.2 (up from 1.0) to reflect risks
from the lack of an execution track record and China Energy’s short operating
history. Our new target price is S$1.94, still based on a 30% discount to DCF
valuation. This translates into 16x CY08 P/E, which we believe is undemanding
given its attractive 3-year EPS CAGR of 82% and projected ROEs of 26-50%

Speedy expansion Capacity expansion in Zhangjiagang brought forward by six months. Phase 2 expansion (700,000 tonnes p.a.) at the Zhangjiagang facility is expected to be completed at end-2008, six months ahead of the original schedule of 1H09. With the
earlier-than-expected expansion, DME’s estimated output for FY08-09 could rise by
44% and 22% respectively. We estimate that full-year contributions from the
additional capacity would increase its FY09 turnover by 42%Five-year plan in place, capacity to be lifted four-fold by 2010. CEGY also
announced plans to build two new DME plants in Ningbo and Tianjin, with capacity for
1m tonnes each. Based on a unit investment cost of Rmb1,350/tonne, we estimate
that each plant would cost about Rmb1.4bn. We note that the Chinese government
has raised the minimum project size for new DME projects to 1m tonnes p.a. Hence,
we expect CEGY’s potential expansion in new regions to involve projects of a similar
scale.
Construction for the plants will be carried out in two phases over FY09-10, with a
similar timeline as the Zhangjiagang facility. We project 300,000 tonnes p.a. from
each plant by end-2009 (assuming no material impact in FY09), and the remaining
700,000 tonnes p.a. 12 months later. When ready at end-2010, annual capacity for
DME should increase by four-fold from 0.9m tonnes in FY07 to 4.6m tonnes in FY10.
Fuelled by the aggressive expansion, we project a 5-year revenue CAGR of 91% for
FY06-11.
Rapid capacity expansion to tap lucrative Guangdong market. We understand
that LPG prices are generally Rmb600-1,000/tonne higher in Guangdong than in
Shandong. Priced at a 5% discount to local LPG prices, DME therefore fetches
Rmb4,600/tonne in Guangdong vs. Rmb3,800/tonne in Shandong. Given the
premium in selling prices, management is upbeat on Guangdong’s prospects and
plans to ramp up its Guangzhou capacity as quickly as possible.
Phase 1 construction (200,000 tonnes p.a.) at Jiutai Guangzhou has been completed
and is undergoing trial runs. As planned, CEGY expects to acquire Jiutai Guangzhou
from Jiutai Energy for about Rmb220m in Jun 07. We believe Phase 2 construction
should commence immediately after the acquisition and could take about 16 months.
Phase 2 will add 1m tonnes of annual capacity, 11% more than the 0.9m tonnes p.a.
announced during the IPO. Using a conservative ASP assumption of Rmb4,550/tonne
and capacity utilisation rates of 75-87% for FY07-09, we expect the Guangzhou
facility to account for 34% of total turnover in FY08, rising to 49% in FY09.Could turn to debt-financing. CEGY had net cash of Rmb954m as at end-Mar 07,
which would not be sufficient to pay for the Rmb1bn capex and working capital
required for the construction of Phase 2 in Zhangjiagang and the additional 100,000
tonnes of capacity in Guangzhou. CEGY plans to raise about Rmb1.5bn in 2H07,
likely in the form of debt, to support its expansion.Expect a modest 2Q but sterling 2H07. According to industry indicative data,
current methanol prices of Rmb1,760/tonne are 27% below the levels in 1Q07 and
our earlier expectation of Rmb 2,000/tonne. We expect the lower-than-expected
methanol prices to dent methanol sales in 2Q07. However, CEGY should turn from a
net seller to a net buyer of methanol when its new DME capacity comes on stream in
2H07. Soft methanol prices (key raw material) bode well for CEGY as they would
ease the margin pressure on DME.
Methanol prices likely to remain soft in FY07. The recent decline in methanol
prices could be largely attributed to an influx of new methanol producers attracted by the rapid escalation in methanol prices in 2H06. China, for example, went from a net
importer of 300,000 tonnes of methanol in 3Q06 to a net exporter of 200,000 tonnes
in 1Q07. This reflects the huge incentive for Chinese producers to export amid the
high prices. Going forward, we expect the forced exit of smaller methanol plants from
reduced selling prices. As such, we expect methanol prices to hover at Rmb1,800-
2,000/tonne, still high relative to historical norms.
Centralised procurement base in Singapore for possible entry into international
markets. Additionally, CEGY announced plans to set up a centralised procurement
and marketing centre in Singapore, which would place CEGY in a better position to
secure bulk discounts for methanol imports from the Middle East, particularly Saudi
Arabia. We believe that extending its presence outside China could be the first step in opening up its access to international markets and promoting DME as an alternative
fuel.manage the volatility in methanol prices is crucial for the sustainability of its margins.
In addition, we note the company’s short operating history and possible execution
risks involved in its massive expansion over the next five years.

Valuation and recommendation

Raised EPS forecasts by 1-25% for FY07-09. We are assuming different DME
prices for each of CEGY’s plants (Shandong, Guangzhou and Zhangjiagang), as we
now think that the Rmb600-1,000/tonne price differential is too large to justify the use of an average DME price (Shandong price, which we used previously). Our projected
88% yoy EPS growth for FY08 is underpinned by the full-year impact of Phase 1
expansion at Guangzhou and Zhangjiagang. FY09 projected EPS growth of 124%
yoy should be fuelled by the full-year impact of Phase 2 capacity expansion and
larger contributions from higher-margin sales in Guangzhou.
Target price lifted to S$1.94, still based on a 30% discount to DCF valuation. Our
DCF valuation has climbed from S$2.48 to S$2.78 following our earnings upgrade,
albeit tempered by a higher WACC of 14%. We have used a beta of 1.2 (previously
1.0) to reflect higher risks but potentially higher returns in the DME business. Our new target price of S$1.94 translates into 16x CY08 P/E, which we believe is
undemanding given its attractive 3-year EPS CAGR of 82% and projected ROEs of
26-50%.