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Deutsche Bank Markets Research Asia China Energy Oil & Gas Industry China Fertilizer Date 3 November 2016 Forecast Change Finding support but limited upside on global supply gluts; sole Buy - CBC Remaining cautious, on prolonged trough cycle; Buy – China BlueChem (CBC) ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Vitus Leung Research Analyst (+852 ) 2203 6158 vitus.leung@db.com Johnson Wan Research Analyst (+852 ) 2203 6163 johnson.wan@db.com Key Changes Company Target Price Rating 3983.HK 2.10 to 1.91(HKD) - 0297.HK 1.10 to 0.94(HKD) - 000792.SZ 20.00 to 18.50(CNY) - Source: Deutsche Bank Top picks China BlueChemical (3983.HK),HKD1.54 Buy Sinofert (0297.HK),HKD1.02 Hold QSLI (000792.SZ),CNY18.81 Hold Source: Deutsche Bank Companies Featured China BlueChemical (3983.HK),HKD1.54 Buy 2015A 2016E 2017E P/E (x) 12.1 – 23.8 EV/EBITDA (x) 2.8 5.2 3.2 Price/book (x) 0.6 0.5 0.5 Sinofert (0297.HK),HKD1.02 Hold 2015A 2016E 2017E P/E (x) 39.3 – – EV/EBITDA (x) 2.5 -10.6 -1.4 Price/book (x) 0.6 0.5 0.5 QSLI (000792.SZ),CNY18.81 Hold 2015A 2016E 2017E P/E (x) 70.1 74.8 37.4 EV/EBITDA (x) 19.5 17.7 15.2 Price/book (x) 2.1 1.5 1.4 Source: Deutsche Bank We expect a prolonged trough cycle in fertilizers. New low-cost urea and potash capacity are set to outpace demand growth. Recently, urea prices have recovered due to China production halts and feedstock cost push; however, we believe material recovery is unlikely, as China is likely to withdraw export tariffs in 2017, capping the recovery whilst partly restoring Chinese makers’ profitability. We cut 17E China urea/potash ASP by 14%/13%, resulting in EPS cuts of 47%/112%/52% for CBC/SNF/QSLI whose earnings are highly sensitive to changes. CBC is our sole Buy, as a low-cost producer with export capability, and its 0.4x P/B valuation with net cash B/S limits the downside, in our view. China urea production halts accelerated in 2H, supporting near-term urea price The Chinese urea production run-rate has fallen to c.60%, with daily output of <150ktons in Sept, down 30% from c.210ktons in 1H16, driven by uneconomical pricing, with c.85% of urea producers loss-making in 1H16. Capacity removal is set to speed up in 2016; CNFIA expressed that there was 4mntpa of urea capacity removed in 1H16, double the 2015 amount, and it aims to remove 16mntpa urea capacity by 2020. But there is new thermal coal-based urea capacity (lower-cost) offsetting the removal. We believe it would take a low-for-longer margin to remove low-efficiency capacity permanently. Outlook remains sluggish – feedstock coming down structurally Besides production halts, the short-term urea price recovery was driven by: 1) feedstock cost push, on revived coal prices, with the China thermal coal price climbing to the RMB600/ton level (+64% since Jan), leading to an anthracite coal price surge, 2) autumn planting applications; 3) a surge in industrial demand for melamine products, of +c.35% yoy. Conversely, the China urea cost structure is shifting down; we hold a long-term backwardation view on the China thermal coal price of RMB450/ton. Potential ending of export tariff in 2017 helps profitability but caps LT recovery China nitrogen / phosphate fertilizer exports dropped 22% / 27% yoy in 9M16. Our base case for urea exports is to expect a further drop in 2017E, because of a production halt in unprofitable plants. However, the soft export volume could be lifted by the potential export tariff withdrawal, which will restore some profitability to fertilizer producers in exports. On a longer-term trend, this will delay a urea price recovery. The 2016 sharp decline in fertilizer exports was driven by: 1) margin erosion in exports (higher cost in China); 2) fierce competition. Conversely, China potash imports dropped by 29% yoy in 9M16 due to high potash inventories, while demand dropped -14% yoy. Valuation and risks; Buy CBC; QSLI missed on 9M results We cut our 17E EPS on CBC / SNF / QSLI by 47% / 112% / 52%, respectively, on the back of lower fertilizer prices and demand. CBC is our sole Buy in the China fertilizer segment, as a low-cost producer with a net cash balance which is still making strong +ve operating cash flow during the current trough cycle. Moreover, CBC could flex its balance sheet for the acquisition of better-return assets. We revise our