STK [O-PF 14.0%] – Riding on the Coattails of the Free Trade Bonanza

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September 5, 2015.

Century Synthetic Fiber Corp. (STK), Synthetic fiber producer

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– We initiate on STK with a target price of VND38,200 (TSR 14.0%). 42m shares of STK debuted on HOSE on 30th September 2015 at a listing price of VND29,000. The stock has already gained 15.5% in the first 2 days of trading.

– STK is the largest domestic synthetic yarn (PES FY) producer, occupying a sweet spot in the global garment and textile value chain.

– Capacity expansion is the primary growth catalyst for the forecasting period.

– At current price of VND 33,500, STK is trading at a FY15 PER of 12.7x based on our FY15 EPS of VND 2,627 but only 10.3x our FY16 EPS.

STK is the largest domestic synthetic yarn maker in Vietnam, occupying a sweet spot in the global textile & garment value chain as a) PES FY is the world’s most consumed and fastest growing yarn type, b) Vietnam is a fast emerging garment manufacturing hub as China becomes less competitive, c) upcoming and recently-inked FTAs such as TPP and EUFTA will attract foreign investment into Vietnam’s domestic fabric production industry which is currently underdeveloped, d) the growing local capacity in fabric production and strict “Rules of Origins” requirement in major trade pacts will drive demand for locally produced yarn.

STK will witness a 62% jump in total production capacity from end of 2014 to end of 2017, paving the way for strong growth in sales and earnings. With Trang Bang 3 commissioning 50% of annual production capacity this year and ramping up to 100% in 2016, we expect FY16 selling volume will grow 22% vs. FY15. As selling price growth is trivial, volume growth is the main driver of FY16 sales growth of 23%. We believe that the company’s current client base and new clients should be able to absorb the incremental production volume.

2016 is a landmark year for STK. We forecast FY15 and FY16 NPAT will grow 5% and 24% respectively, corresponding to a FY15E EPS of VND2,627 and FY16 EPS of VND3,265. Based on these forecasts, STK is trading at FY15 PER of 12.7x and FY16 PER of 10.3x. The sharp drop in the FY16 PER suggests that the earnings jump next year on the back of capacity expansion has not been fully priced-in.

Financial Statements

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P&L Forecast

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Company at a Glance

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STK is occupying a sweet spot in the global fiber industry

Manmade yarn is fast becoming a preferred alternative to traditional cotton

PES FY (polyester filament) and cotton are the two major yarn types with the former being manmade yarn and the latter coming from natural sources (See Figure 3 for yarn family tree). Cotton was once the “king” of yarn but now it has to pass its throne to PES FY as technology developments have endowed PES FY with many advantages over its natural rival: PES FY can be produced without the threat of weather or disease; with more consistent quality; uses raw materials which are more stable in terms of supply and procurement cost; and has superior characteristics (wrinkle resistance, better durability, and high colour retention, broad applications).

Greater consumer acceptance of manmade fibers… Manmade fibers like PES FY started out as cheap fabrics used mainly in low-end apparel. However, this is no longer true as manmade yarn-based fabrics have continuously gained more acceptances in consumers’ wardrobes. According to the US Commerce Department, apparel mainly made of manmade fiber accounted for 48.5% of total US apparel imports in 2014 in value terms while cotton-based apparel took up 49.5%, the narrowest gap in more than two decades. To put this in perspective, cotton imported apparel made up 60% of apparel imports in 2008. In other words, over 20% growth in volume of imported manmade yarn-based apparel versus a 14% fall in imported cotton apparel over the 2012-14 period.

…together with the growing enthusiasm for manmade fibers among apparel makers… The shift away from cotton started to accelerate during 2008-09 financial crises when retailers struggled to cut costs. Cotton prices peaked at historic highs in 2011 forcing apparel markers to seek alternative materials. Cotton prices continued to stay high, as China, the top cotton consumer, has been stockpiling the fiber. On top of that, farmers in the US, the top raw cotton exporter, have switched from growing cotton to other crops that are more profitable thereby affecting supply and pushing prices up further. Years of high and unstable cotton prices made apparel makers gradually substitute cotton with manmade fiber and textile-makers have invested heavily in reconfiguring their equipment to spin textile from manmade yarn. The superior performance characteristics of manmade fibers and the continued instability of cotton prices mean that this is not just a temporary development.

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…is spurring the continued steady substitution of cotton by synthetic yarn. According to Technopak, a management-consulting firm, global demand of yarn was about 71m tons in 2005, with manmade yarn accounting for 46% and the balance being natural yarn. By 2011, total yarn demand increased to 84m tons with manmade yarn’s share rising to 59%. Technopak expects demand for manmade yarn to grow at a CAGR of 4% until 2021, double that of natural yarn.

Polyester filament or PES FY took cotton’s crown as the world’s most popular yarn starting in 2013 when it surpassed cotton and accounted for 33% of total world production. In 2014, this number touched 34%, growing from only 19% in 2000. PES FY’s rival, cotton, has been losing its dominance with only 26% in total world’s production in 2014, dropping 6% from 34% in 2000. The total market size for PES FY is worth approximately USD 60b.

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Having the highest growth rate among all yarn categories, PES FY is the driver of the global yarn industry. The entire yarn market was driven by manmade yarn over the period of 2000-2014, within which synthetics enjoyed a CAGR of 5.1% and the sub-category PES FY achieved an 8.1% growth rate, the highest among all yarn types. In contrast, natural yarn grew at a CAGR of only 1.0% during the same period. Cotton, the most important natural yarn, only grew at a CAGR of just 2.2%. –these growth figures are redundant and dilutes the earlier point of strong growth from 2008-2014 period.

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Textile and Apparel production is increasingly moving out of China with Vietnam being a major beneficiary of this exodus

China is the biggest producer and exporter of textile and apparel (T&A) products as well as PES FY, accounting for 40% share of made-ups (ties, home decoration, etc.), 37% of global exports of apparel, and 39% of global exports of fabric of global T&A exports. China accounted for 82.3% of the world’s PES FY total production in 2014, reaching 26.3 million tons. This share dwarfed that of the second and third largest producers India and Taiwan which contributed 3.7% and 2.9% to global PES FY production.

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But T&A production is shifting away from China. China’s competitive advantages lie in the country’s vertically integrated supply chain, diversified range of products and low production cost. However, China is currently facing challenges including rising labour costs and anti-dumping tariffs imposed by many of its global partners. As a result, many companies are moving production from China to emerging regional production hubs like Vietnam. This, in turn, should provide a strong boost to demand for synthetic fibers like PES FY in Vietnam as textile and garment makers seek to secure new yarn sources that are close to their new production facilities.

STK is Vietnam’s top producer of PES FY

STK was founded in 2000 and started out importing POY (Partially Oriented Yarn) as input material to manufacture DTY. In 2008, STK opened the first POY spinning plant in Vietnam and started making POY from PET chips (a downstream derivative of crude oil). As of now, STK’s main product is microfilament yarn from polyester chips (Polyester filament or PES FY) which consists of two sub-categories:

  • DTY (Drawn Texture Yarn) is the most popular sub-category of PES FY. DTY is made by twisting POY to mimic the attributes of cotton such as stretching and texture.
  • FDY (Fully Drawn Yarn) is produced by a process similar to POY manufacturing except that the yarn is produced at higher spinning speeds coupled with intermediate drawing integrated in the process itself. For STK, this is only a supplementary product that is usually only ordered along with DTY.

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STK currently owns two state-of-the-art factories with total annual production capacity of 44,500 tons DTY (40,500 tons) and FDY (4,000 tons). Since STK has been committed to making high quality yarn, all of its factories are equipped with advanced machines from Oerlikon Barmag – a world renowned textile machinery supplier, coupled with modern quality control and management systems such as SAP Business All in One, ISO 9001:2008, and Lean Production. STK also applied WINGS winder (helps to save 25-45% of energy and requires 25% less space than conventional systems; creates thinner, better quality yarn) for POY production and eFK (a spinning solution for manual DTY, which means that STK could provide customized quality yarn satisfying different needs of their customers) for DTY production.

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STK’s positioning in Vietnam’s T&A value chain gives it lots of room for expansion

The bottleneck in “weaving, knitting and dyeing” is hindering Vietnam textile and garment industry from becoming vertically fully integrated

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There is currently not enough capacity in the “weaving, knitting & dyeing” stage. According to Vietnam Cotton and Spinning Association (VCOSA), domestic yarn companies produced a total of 1,044.5 thousand tons of yarn last year. However, 69% of this was exported, leaving only 31% to be processed into final garments by domestic downstream companies. At the same time, these downstream players have to import 6.5b sqm of fabric to produce final garments last year, equivalent to 79% of their total fabric needs. The reason for this apparent paradox is that Vietnam “weaving, knitting and dyeing” industry is underdeveloped with only a few participants. As a result, there is not enough capacity at this stage to help transform the amount of yarn produced domestically into fabric used by garment companies hence driving yarn producers to export most of their products. At the same time, the local fabric manufacturers that do exist are using both local produced yarn and imported lower quality yarn.

There is also a mismatch between yarn grades, types and quality between domestically produced and domestically consumed yarn. Assuming that Vietnam can build up more capacity in the “weaving, knitting & dyeing” stage, the same fabrics made by these factories might not necessarily be suitable for final garment production by domestic players. Vietnam has been importing as much yarn as it has been exporting. The exported yarn has different grades and types which reflected in the discrepancy between average export price and import price. Export price is 35-40% higher than import price, which reflects the fact that Vietnam is exporting high-grade yarn to offshore manufacturers while low-end yarn is being fed to domestic textile makers.

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Vietnam’s textile and garment industry is all about “Cut – Make – Trim” (CMT). Most of Vietnamese garment companies are operating under CTM contracts – the simplest but least value-added portion of the garment production value chain. Under this CTM term, foreign partners will select fabric suppliers by themselves, and then provide those fabrics for Vietnamese CTM companies. Therefore, Vietnamese CTM companies do not have control in choosing their fabric suppliers. This is another reason why Vietnam imports large amounts of fabric despite having substantial domestic yarn production capacity.

In the future, the bottleneck will be gradually eased as 1) the “weaving, knitting and dyeing” industry becomes more developed; 2) large apparel brands move to Vietnam thanks to upcoming FTAs, TPP spur demand for higher quality yarn; and 3) downstream players switch from CTM to OEM or FOB (Original Equipment Manufacturing contract terms which allow them to choose their own input fabric suppliers) thereby creating demand for local fabric production. For the time being, however, exporting remains the primary activity for midstream players like STK.

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STK aims to expand in both directions of the textile value chain

STK is building a vertically integrated production model. As discussed above, STK currently only manufactures PES FY. However, the company is planning for expansion both upstream and downstream in the textile value chain.

  • Upstream – Producing PET chips: STK will cooperate with international partners who have strong financial resources and expertise in technology to build up a PET chips manufacturing plant. STK can both be a major customer of this factory’s output and generate additional sales from new these products to third parties. However, we see this strategy as being quite ambitious and challenging for STK due to the fact that the upstream segment involves knowhow of petrochemical technology. This segment is very capital and technology intensive and would mark a significant departure from STK’s core business.
  • Downstream – Making fabrics though its newly-established subsidiary UNITEX: STK is looking to corporate with existing clients or other fabric and garment companies in Vietnam or overseas in building an integrated supply chain starting from making yarn to weaving and dyeing into fabrics. This will create a captive demand base for STK’s yarn and also take advantage of upcoming FTAs. STK has already taken its first step in this direction by establishing UNITEX Corp. in Jun 2015. UNITEX is a subsidiary of STK engaged in doing spinning and weaving activities. UNITEX has a chartered capital of VND 80b of which STK owns 49.99%. The name of the other investor still remains confidential for the time being. We believe this is a more viable plan compared to the upstream one as it is a more natural extension of STK’s core business and poses lower technology and capital barriers to entry. Additionally, this part of the textile value chain is currently underdeveloped in Vietnam, thereby leading to higher costs associated with imported fabric.

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EUFTA and TPP will favour the Vietnam garment industry and, in particular, vertically integrated yarn-forward producers over the medium term

The US, EU, Japan and Korea are among the biggest importers of Vietnam apparel. Shipments of Vietnam apparel to Japan and Korea already enjoy zero import duties. However, EUFTA and TPP will help unlock a potential in the US and Europe which already are bigger consumers of Vietnam apparel but currently only import a small portion of their fabric from Vietnam.

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The recently inked Vietnam-EU FTA (EUFTA) and long-awaited TPP will confer significant advantages to Vietnam apparel manufacturers. The US and EU are Vietnam’s first and second biggest apparel export markets, accounting for 46% and 16% of total apparels export in 2014, respectively. However, current import duties on apparel shipments from Vietnam to these countries are quite high – averaging 12% in EU and ranging from 5.6% to 14.9% in the US. Getting these two trade agreements passed will immediately reduce import duties to zero.

Strict Rules of Origin (ROO) in both trade pacts will spur the development of an integrated textile production value chain in Vietnam. TPP is already famous for its stringent “Yarn Forward” requirement but Vietnam-EU FTA also has its “Fabric Forward” rule. These rules dictate how many stages of production must take place within a FTA-related country in order to qualify for duty preferences. This, in turn, bolsters the case for vertically integrated value chains in member countries in order for them to enjoy the full benefits of duty exemption.

As discussed earlier, most apparel manufacturers in Vietnam are merely doing cut-and-sew under CTM contracts with a great amount of inputs imported from countries not involved in either trade agreements, namely China, Taiwan and Korea. The only solution for Vietnam to boost garment exports on the back of these FTAs is to develop capabilities across the textile value chain. Therefore, we believe TPP and EUFTA will catalyse the development of an integrated textile value chain in Vietnam and boost garment exports from Vietnam, in the long run.As of now, TCM (Thanh Cong Textile Garment Investment Trading JSC) is the only listed company that possesses a fully-integrated garment-making process hence can immediately gain from TPP when it is finalised but local fibre/yarn/fabric producers such as STK would ride on the coattails of these trade liberalization movements due to increasing demand for domestically produced inputs.

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However, free trade agreements are a double-edged sword, also bringing fierce competition. Upcoming FTAs will also open up Vietnam’s textile market to international competition. In the short run, these FTAs will create an immediate spike in demand for locally produced materials hence benefiting yarn manufacturers like STK. However, FTAs will also attract international midstream players to open their factories in Vietnam and compete with local players like STK in long run. Many fabric and garment producers, especially from mainland China, Hong Kong and Taiwan (non-TPP countries) have already set up yarn and fabric factories in Vietnam.

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STK is currently one of the only two premium PES FY producers in Vietnam but competition will intensify in the coming years.

Competition between local producers will get stronger

For now, STK has only one head-to-head domestic competitor. Currently, there are only five PES FY manufacturers in Vietnam namely Century Synthetic Fiber Corp. (STK), Formosa Hung Nghiep Limited, Hualon Corp,. Dong Tien Hung Limited (Dutihutex), Petroleum Petrochemical and Fiber JSC (PVTEX). However, only STK and Formosa Hung Nghiep target premium customers with high quality products. STK’s strategy to compete with Formosa is to offer the same level of quality but prices that are 1-2% lower.

Nevertheless, competition will intensify in the long run and STK needs to get ahead in the game. As discussed above, recently signed and upcoming free trade agreements will attract new FDI projects across the value chain hence intensify competition in the long run. These multinational corporations coming into Vietnam have competitive advantages over local firms such as brand awareness, large existing customer base, international connections and large-scale production. Established relationships with existing clients will help domestic players like STK to maintain market share. However, it is getting more difficult to win over new customers. Therefore, to keep up, domestic players including STK have to continuously improve their products and customer service.

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Exports to be mainstay over the medium term with domestic sales to become long term growth driver

Exports account for 77% of total revenue. The aforementioned oddities of the Vietnam textile industry explains why exports accounts for over three-quarters STK’s revenue. Currently, STK’s customer base comprises of more than 250 clients around the world of which 50% are in Europe (mainly Turkey), 27% are in Asia (Thailand, Taiwan, Korea, Japan, etc.) and 23% are Vietnam-based clients. STK sells its yarn as input materials for international fabric makers such as YRC, Tongsiang, Golden Empire, Huge Rock etc. These companies, then, use the yarn to manufacture fabrics and supply to world famous apparel brands such as Nike, Puma, Adidas, Uniqlo, Reebok, etc.

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STK’s is taking very good care of existing customers… Unlike domestic customers who are more likely to value price and availability; international clients care more about quality, infrastructure, and business ethics of their suppliers. It takes approximately 6 months for a client to select a new yarn supplier. Therefore, when a supplier is chosen, it is unusual for an international client to switch to a new one unless there are compelling reasons. STK emphasizes good customer service to differentiate itself from competitors. To strengthen their relationship with customers, they conduct surveys every six months asking for feedback from their customers on their products and service quality. According to STK, the company is currently able to meet only 20% of its existing clients’ total demand for PES FY. Also, as these customers grow – especially those who increase their buying from Vietnam in order to benefit from FTAs – STK should have an increasing captive pool of demand to support sustained growth over the medium term.

…while actively seeking new ones to mitigate concentration risk. Although pushing sales to existing clients is a safe and easy growth strategy, we do not see STK doing this forever. On the buyers’ side, fabric makers need to diversify their own yarn supplier base to reduce dependency on any single supplier. As a result, we believe no single yarn supplier can take a major share of each client’s input volume, which consequentially caps the percentage of STK’s products in any client’s yarn purchase. For the same reason – and also to reduce undue dependence on a given client – STK is diversifying its customer base. The result of this diversification has been reflected in STK’s falling contribution of top 10 and 20 clients to total revenue over the past four years.

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Domestic sales only accounted for 23% of the company’s revenues but could become an important growth driver. STK’s domestic clients include textile corporations like TCM, who also heavily depend on exporting activities. These textile exporters seek out products from STK because their buyers require high-standard products that require high quality input materials that only a few local firms are able to supply. STK and Formosa Hung Nghiep are the two suppliers that meet requirements. Moreover as early stated, Vietnam’s involvement with multiple FTAs will further boost Vietnam’s textile and garment exports, in turn driving demand for quality yarn.

According to STK, their customer base is growing in both size and quantity which includes existing customers ramping up capacity and new FDI projects. STK expects to see 80-90% of FDI flows into downstream “weaving & dyeing” and “cutting & sewing” segments with only 10-20% of it flowing into “spinning” or yarn production segment, which implies that yarn demand in Vietnam will grow faster than yarn production capacity. STK customers’ demand is expected to increase more than 40,000 tons in 2016, of which STK’s incremental capacity (15,000 tons total of Trang Bang 3) can only meet approximately 40%.

Earnings outlook: 2016 to be a landmark year for STK

Additional capacity from Trang Bang 3 and Trang Bang 4 to support a jump in top-line

New capacity addition continues to be a sales growth catalyst. STK’s total revenues grew at an impressive CAGR of 31% during FY09-14, reaching VND1,458b last year. The growth was mostly thanks to increasing volume (volume sold grew a CAGR of 25% FY09-14) rather than increase in average selling price (ASP only grew at a CAGR of 5% FY09-14). We see volume growth continuing to drive growth over the forecast period for three main reasons:

  1. PES FY selling price, which is highly correlated to oil prices and PET chip price, remains weak; and
  2. All three of STK’s existing production plants (namely Cu Chi, Trang Bang 1 and Trang Bang 3) are already running at full capacity; and
  3. STK is currently unable to meet the growing demand of its existing customers.

According to management, STK currently only meet 20% of the total yarn demand of its existing customer base, leaving an estimates shortfall of 128,000 tons. To capitalize on this, STK has invested into two news production plants Trang Bang 3 and Trang Bang 4 which will bring another 23,000 tons of capacity online between end 2014 and end 2017, equivalent to 62% of end 2014 capacity; most of this will be commissioned in 2016.

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  1. Trang Bang 3 selling volume. Trang Bang 3, with total designed capacity of 15,000 tons, has started to operate commercially with 50% capacity starting September 2015 (equiv. 7,500 tons) and will see full 100% commission capacity commissioned in 2016, taking STK’s total capacity to 44,500 tons ending 2015 and 52,000 tons in 2016. We assume FY15 selling volume of Trang Bang 3 to be 90% of its commissioned capacity in the period of Sep-Dec of 2015 since the 7,500 units of commissioned annual capacity in this period is only operational for four months of the year; this gives us 2,250 tons of incremental selling volume in 2015. Note that while it seems aggressive for us to assume 90% incremental selling volume to newly commissioned capacity ratio from the very get-go, Trang Bang 3 already has a “warm up” trial production run period from July to September 2015. For 2016, we expect Trang Bang 3 to continue to run with 7,500 commissioned capacity for 1H before commissioning full capacity in 2H. Incremental selling volume as a % of newly commissioned capacity for this second phase is also expected to be 90% from the beginning, resulting in an incremental 10,125 tons sold coming from Trang Bang 3 in 2016.
  2. Trang Bang 4 selling volume. STK will invest USD13m into Trang Bang 4 factory in 2016 and expects to commence operations in 2017 with 100% of designed capacity commissioned in 1Q. The plant has 8,000 tons of designed capacity including fixed volume of 3,000 tons of DTY and 4,000 tons of FDY. For this plant, we are being more conservative in assuming incremental selling volume to reach 50%, 80% and 90% of the designed capacity for 2017, 2018 and 2019 respectively (translating to 4,000 tons, 6,400 tons and 7,200 tons sold), because we expect selling volume to increase gradually as additional capacity is absorbed by STK’s expanding customer base.

The year 2016 will see the most pronounced effect of new capacity addition. With Trang Bang 3 commissioning only 50% of its capacity this year, we forecast FY15 total selling volume to grow by a modest 7.6% vs. FY14, reaching 35,550 tons. However, Trang Bang 3 ramping up commissioned capacity to 100% in 2016, we expect FY16 selling volume to grow 22% vs. FY15 to touch 43,425 tons. As selling price growth is trivial (see pricing analysis in following part), volume growth is the main factor driving total sales to reach VND 1,404b FY15 (-3.7% vs. FY14) and VND 1,738b FY16 (+23.8% vs. FY15). 9M15, STK selling volume and total sales reached 23,600 tons and VND 949, completing 66% and 68% of our forecast respectively.

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Weak oil prices dampen sales, but boost GPM

STK prices its final products by applying an absolute markup on PET chip input cost. STK employs a price matching mechanism, which means buying input materials and selling final products at spot price in all of their contracts. Therefore, STK is able to reduce the risk of volatile price for both PET chips (input materials) and PES FY (final products). STK executes this price matching mechanism by applying an absolute raw material “cost plus” or “price gap” markup on PET chip unit prices to set its yarn prices. STK aims to maintain this price gap between USD 0.8-0.9/kg on average, in line with historical levels.

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In our valuation, we forecast ASP using an assumed raw material “cost plus” markup on forecasted PET chip prices. As consensus for crude oil prices remains bearish for the period of FY15-20, we use a crude oil price assumption of USD 55/bbl for 2015 going forward. Consequentially, PET chip prices should stay at USD 0.94/kg for the forecasted period of FY15-20.

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For 2015, we expect the price gap to be maintained at the same level as in 2014 reaching USD 0.84/kg, which based on our PET chip cost assumption of USD 0.94/kg, resulted in an FY15 ASP of USD 1.78/kg for STK’s PES FY finished product. We assume price gap will fall slightly to USD 0.83/kg in 2016 and settle at a sustainable level of USD 0.8/kg for following years. The difference between price gap in 2015 and 2016 versus following years is attributed to 1) STK’s ability to maintain ASP price stickiness compare to PET chip price will diminish through time i.e. STK has to pass on the effect of lower PET chip cost to customers; 2) new capacity will create certain pressures on selling price; and 3) New competitors are expected to enter the market attracted by upcoming FTAs.

Price gap expansion supported GPM. Since STK uses a cost markup on PET chip prices to determine its selling price, movement of PET chip prices effectively translates into GPM expansion or contraction. For 2015 and 2016, we expect GPM to touch 17.7% (+310 bps vs. FY14) and 16.4% (-128 bps) respectively.

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STK is naturally hedged against foreign exchange risk and will benefit from tax incentives

STK cash flow is safe from FX risk… STK export sales account for 77% of total sales while imported materials make up approx 70% of COGS (approx. 60% of total sales value) providing a natural hedge against FX fluctuations in daily transactions but also allows the company to borrow in USD at a low interest rate (~1.7% for short term debts and ~3.0% for long term debts).

…but dollar-denominated borrowing creates residual FX risk. Ending 2H15, STK’s outstanding long term debt balance was VND 659b (~USD 30m), of which VND 559b (85% of total debt balance) is to finance Trang Bang 3. When VND depreciates, STK will have to record foreign exchange loss on the re-valuation of its debt balance. For 2015, assuming VND depreciates 5% against USD, we expect STK to record VND 27b unrecognized foreign exchange loss. In 2016, STK will invest VND 274b (~USD 13m) in Trang Bang 4, of which 70% will be funded by USD denominated debts. Assuming VND depreciates 2% against USD in 2016, we expect a total of VND 14b unrecognized foreign exchange loss will be recognized.

Tax incentive for three out of four production plants. As STK is operating in a industry which is encouraged by the Vietnam government, three of STK’s production plants (Trang Bang 1, Trang Bang 2, and Trang Bang 3) will receive tax incentives for 10 years, in which zero tax will be apply in the first two years, 10% per year in the next four years and 20% each for the rest. We forecast STK’s average income tax weighted by selling volume originating from each production plant to be 14.5% and 11.9% in 2015 and 2016 respectively

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We forecast FY15 and FY16 NPAT will touch VND111b (+5% vs. FY14) and VND 138b (+24% vs. FY15), respectively corresponding to a FY15E EPS of VND2,627 and FY16 EPS of VND3,265.

Dividend policy

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STK maintained a decent dividend policy in prior years with payment in cash or in shares. However, for the FY15-17 period, we expect STK to not pay cash dividend in order to fund the capex plan for the Trang Bang 3 and Trang Bang 4 projects.

Valuation

We initiate on STK with target price of VND38,200, implying that there is a 14.0% upside to the current price of VND33,500. Our target price is derived from weighted average of 5-year DCF (50%) and target PER multiple (50%). For the target PER, we use 10.6 TTM PER which is the median of the regional peer set.

Our target price translates to a FY15 PER of 14.5x and a FY16 PER of 11.7x. At the current price, STK is trading at VCSC’s FY15 PER of 12.7x.

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DCF Valuation

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Peers comparables

As STK is the only listed midstream player in Vietnam’s textile value chain and is competing directly with global peers in export markets, we use the median PER of regional midstream peers of 10.6x as our target PER multiple.

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VCSC Information

VCSC Rating System & Valuation Methodology

Absolute, long term (fundamental) rating: The recommendation is based on implied total return for the stock defined as (target price – current price)/current price + dividend yield, and is not related to market performance. This structure applies from 27 May 2015.
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Unless otherwise specified, these performance parameters only reflect capital appreciation and are set with a 12-month horizon. Future price volatility may cause temporary mismatch between upside/downside for a stock based on market price and the formal recommendation, thus these performance parameters should be interpreted flexibly.
Small Cap Research: VCSC Research covers companies with a market capitalisation of up to US$50mn, inclusively. Clients should note that coverage may not be consistent and that VCSC may drop coverage of small caps at any time without notice.
Target price: In most cases, the target price will equal the analyst’s assessment of the current fair value of the stock. The target price is the level the stock should currently trade at if the market were to accept the analyst’s view of the stock, provided the necessary catalysts were in place to effect this change in perception within the performance horizon. However, if the analyst doesn’t think the market will reassess the stock over the specified time horizon due to a lack of events or catalysts, then the target price may differ from fair value. In most cases, therefore, our recommendation is an assessment of the mismatch between current market price and our assessment of current fair value.
Valuation Methodology: To derive the target price, the analyst may use different valuation methods, including, but not limited to, discounted free cash-flow and comparative analysis. The selection of methods depends on the industry, the company, the nature of the stock and other circumstances. Company valuations are based on a single or a combination of one of the following valuation methods: 1) Multiple-based models (P/E, P/cash flow, EV/sales, EV/EBIT, EV/EBITA, EV/EBITDA), peer-group comparisons, and historical valuation approaches; 2) Discount models (DCF, DVMA, DDM); 3)Break-up value approaches or asset-based evaluation methods; and 4) Economic profit approaches (Residual Income, EVA). Valuation models are dependent on macroeconomic factors, such as GDP growth, interest rates, exchange rates, raw materials, on other assumptions about the economy, as well as risks inherent to the company under review. Furthermore, market sentiment may affect the valuation of companies. Valuations are also based on expectations that might change rapidly and without notice, depending on developments specific to individual industries.
Valuation Methodology: To derive the target price, the analyst may use different valuation methods, including, but not limited to, discounted free cash-flow and comparative analysis. The selection of methods depends on the industry, the company, the nature of the stock and other circumstances. Company valuations are based on a single or a combination of one of the following valuation methods: 1) Multiple-based models (P/E, P/cash flow, EV/sales, EV/EBIT, EV/EBITA, EV/EBITDA), peer-group comparisons, and historical valuation approaches; 2) Discount models (DCF, DVMA, DDM); 3)Break-up value approaches or asset-based evaluation methods; and 4) Economic profit approaches (Residual Income, EVA). Valuation models are dependent on macroeconomic factors, such as GDP growth, interest rates, exchange rates, raw materials, on other assumptions about the economy, as well as risks inherent to the company under review. Furthermore, market sentiment may affect the valuation of companies. Valuations are also based on expectations that might change rapidly and without notice, depending on developments specific to individual industries.

Disclaimer

Analyst Certification of Independence
I, Thanh Duong, hereby certify that the views expressed in this report accurately reflect my/our personal views about the subject securities or issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.
Copyright 2013 Viet Capital Securities Company “VCSC”. All rights reserved. This report has been prepared on the basis of information believed to be reliable at the time of publication. VCSC makes no representation or warranty regarding the completeness and accuracy of such information. Opinions, estimates and projection expressed in this report represent the current views of the author at the date of publication only. They do not necessarily reflect the opinions of VCSC and are subject to change without notice. This report is provided, for information purposes only, to institutional investors and retail clients of VCSC in Vietnam and overseas in accordance to relevant laws and regulations explicit to the country where this report is distributed, and does not constitute an offer or solicitation to buy or sell any securities discussed herein in any jurisdiction. Investors must make their investment decisions based upon independent advice subject to their particular financial situation and investment objectives. This report may not be copied, reproduced, published or redistributed by any person for any purpose without the written permission of an authorized representative of VCSC. Please cite sources when quoting.
U.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA by VCSC issued by VCSC has been prepared in accordance with VCSC’s policies for managing conflicts of interest arising as a result of publication and distribution of investment research. Many European regulators require a firm to establish, implement and maintain such a policy. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons being referred to as “relevant persons”). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by VCSC in Australia to “wholesale clients” only. VCSC does not issue or distribute this material to “retail clients”. The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of VCSC. For the purposes of this paragraph the terms “wholesale client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months prior.) Japan: There is a risk that a loss may occur due to a change in the price of the shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case of share trading, VCSC will be receiving a brokerage fee and consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed between VCSC and the customer in advance. Korea: This report may have been edited or contributed to from time to time by affiliates of VCSC. Singapore: VCSC and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. New Zealand: This material is issued and distributed by VCSC in New Zealand only to persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. VCSC does not issue or distribute this material to members of “the public” as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must not distribute it to any third party or outside New Zealand without the prior written consent of VCSC. Canada: The information contained herein is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules. United States: This research report prepared by VCSC is distributed in the United States to Major US Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended) only by Decker&Co, LLC, a broker-dealer registered in the US (registered under Section 15 of Securities Exchange Act of 1934, as amended). All responsibility for the distribution of this report by Decker&Co, LLC in the US shall be borne by Decker & Co, LLC. All resulting transactions by a US person or entity should be effected through a registered broker-dealer in the US. This report is not directed at you if VCSC Broker or Decker&Co, LLC is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that Decker&Co, LLC and VCSC is permitted to provide research material concerning investment to you under relevant legislation and regulations.

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