Description

Investment memo

Long idea: China Sunsine (SGX: CSSC SP Equity)

Mkt cap: CNY2.2bn; $297m

EV: CNY943m; $117m

LTM EV/EBIT: 1.2x; LTM P/E: 3.2x

Liquidity: L12M $72k/day; L3M $51k/day

Summary thesis

• This is strong and growing business, with a 15 year track record of healthy profit and FCF, attractive and highly reliable prospects in a growing and durable end market, trading at net cash adjusted price of 1x EV/EBIT, pricing in impending catastrophe that looks nowhere to be seen

Business overview

• Globally leading manufacturer of rubber accelerators, insoluble sulphur and antioxidants, producing the key chemicals required in the rubber vulcanisation process that turns raw rubber sap into the hardened rubber, predominantly used in car tires
• CSSC buy raw compound, mostly aniline (C₆H₅NH₂), and convert this into more processed chemicals known as rubber accelerators, which they sell to the tyre manufacturers
• Core customer base: 1000 customers globally, including 2/3rds of top 75 tire manufacturers (such as Michelin, Bridgestone, Pirelli, Goodyear), who buy the chemicals they require to produce the tires
• C.24% market share globally, c.36% in China 
• 61% sales to China, 27% exported across Asia, 3% US, 5% Europe, 3% RoW

Is this a great business? Yes

• Let’s start with the end market: CSSC sells mostly to rubber type manufacturers, who use the chemicals to ‘vulcanise’ the tyre rubber, ie make it more durable
• While the state of the auto industry is in flux, with ride share and EV breakthroughs themselves causing disruption, the one constant is that all new breakthroughs use rubber tyres
• Indeed, given the extent of the global roadway infrastructure in place, it seems reasonable to assume that rubber tyres will continue to be used to facilitate land-based transport for several decades to come (at the minimum)
• Not only is the existence of the tyre market highly visible far into the future, we can also reasonably expect it to grow on a per capita basis, particularly in the East
• China car penetration is still low (table below) relative to developed economy peers, leaving plenty of headroom for expansion
• Given 61% of the business is in China, this presents a long term tailwind to drive growing sales and profits for years to come
• 
• Better still, only 30% of rubber tyres sold go to new cars: 70% go to replace tyres on used cars. This is a resilient industry that should prove somewhat insulated from the standard auto cycle

• Current mkt position and competition
• CSSC is the #1 business globally for rubber accelerators, and has grown or held its market share every year for the past 15 years, moving from 7% globally to 24% currently:
• 
• Consequently, CSSC rubber accelerator capacity is roughly double its closest competitor:
• 1) China CSSC: 117k tonnes, 2) Yanggu Huatai: 60k tonnes, 3) Tianjin Kemai: 52k tonnes
• This growing mkt share, fuelled organically without external investment, reflects a steadily growing sales tonnage volume:
• 
• NB chart above shows total tonnage of rubber accelerators, insoluble sulphur and antioxidants, vs tonnage number for CSSC vs peers on previous page references rubber accelerator tonnage only

• Profitability: the business has a strong track record at converting its enviable market position into profits and hard cash
• Here is the P&L and margin trajectory over the last 15 years, achieved organically (forecasts are BBG consensus – I would not pay too much attention)
• 
• So a 14% top line CAGR, 15% bottom line CAGR, with margins that fluctuate but crucially have always posited profitability and average out around 15% (OPM)
• Perhaps more importantly, the impressive profitability has turned up on the B.S. as cash – there is no accounting flattery in these earnings:
• 
• Avg FCFE/net income: 50%
• The ‘CFI’ investments, taking up ~50% of the FCF, have largely been growing the tonnage capacity of the business – reinvesting in future growth
• Given the RoIC (removing the excess undeployed cash) has averaged over 20% (32% in FY21), reinvesting in growing the business should, and has, generated attractive profits and cash accruing to the shareholders
• This performance has seen the business pay off its modest debt obligations, to now sit on a cash position 2x its FY21 EBIT:
• 

Competitive advantage

• Given the 15 year track record at growing mkt share, coupled with profit and FCF generation, despite a volatile chemical input cost (Aniline) I would suggest CSSC does enjoy a durable competitive advantage that has allowed it to produce such results:
• Stringent supplier selection process for the tyre businesses
• Based on production capacity, stringent company specific chemical requirements, quality of products and compliance with gov regulations
• I would suggest there is a strong benefit to rubber accelerators only making up 3% of rubber production cost – this isn’t where the tyre businesses will be looking to squeeze their suppliers or reduce cost, as it’s not material for them
• This leaves reliability and track record at producing in a quality and timely manner the more important factor – and the track record suggests CSSC is doing just that
• Capital intensity – land, machinery, safety infrastructure required
• Relatively high technical capability and knowhow
• Gov approvals required for new capacity expansion

Valuation

• Trading at a net cash adjusted LTM EV/EBIT of 1.2x (LTM P/E: 3.2x), the stock is priced for catastrophe
• Given 56% of the market cap is backed by the net cash position, downside considered limited, while even moderate continuation of historical performance expected to drive attractive returns 
• A common push back on low valuation businesses seems to be: ‘yes but has it always traded at this low valuation’
• The answer here is simply ‘no’
• The 1.2x LTM EV/EBIT multiple has only been breached twice before in the business’ trading history, with a peak of 10x in 2013 and an average of 4x
•  
• 
• Note the mkt cap bouncing off the cash position through covid

1H22 overview

• Despite China’s well documented current economic struggles, the business posted record 1H profits of CNY430m, +61% YoY vs 1H21
• Sales volume were slightly down -3% YoY, leaving price increases responsible for the improved performance – achieved by more than passing on their input commodity cost increases to their customer base
• In such a challenging operating environment (commodity inflation + China weakness), this impressive pricing power speaks to the competitive advantages and true earning potential of the business
• They’ve since announced two new expansionary projects to add 2x 60k tonnes annually to their chemical production by the end of 2023
• Total investment ~CNY300m, about ¼ of the CNY1.2bn net cash on B.S.
• Given the largest drag on the share performance is the anti-leverage of the large net cash position (and the forgone returns on that capital that could be being earnt), reinvesting 25% of this is a positive step in the right direction to making better use of the idle cash (more below)

Risks / push back

• Given…
• 1) The 15 year track record, the strength of the business model and the resilience and growth of the end market, combined with:
• 2) and absurdly low 1.2x net cash adjusted LTM EV/EBIT
• … I would suggest any ‘normal’ business risks (competition, end market disruption, macro) and more than priced in
• The main risk that jumps out to me as having the potential to derail this investment is fraud: if the cash doesn’t exist, or something to that extent
• This risk is difficult to completely rule out
• I do however think this risk is highly unlikely
• This is a real business with real clients, real machinery and a 15 year track record of conducting business in an honest fashion, with no obvious misdemenous to me
• For what it’s worth, they are listed in Singapore, which seems to have a more prudent regulatory framework than main land China
• Their auditor, Nexia TS, has been working with them for several years, and seems to be a reputable local mid-tier audit firm
• The other ‘problem’ here is the large cash position – this protects the downside but weighs also on the potential upside, since a large increase in the enterprise value would translate to a much smaller move in the equity value (not to mention the forgone earnings on the idle cash)
• I and many other investors listening to past earning calls, have urged the business to return the cash or invest it… the business is now at least investing 25% of this in further capacity expansion, but seems very reluctant and unlikely to pay any material chunk of this back to shareholders
• In an ideal world you’d want the business to spend the cash buying back their own shares at 1x… alas the extremely illiquidity of the stock is preventing this from happening
• The simple maths here is this: they buy back around 50k shares a day typically (they are currently trying to execute a buyback program). There are 255 business days a year - so imagine the impact of buying back 50k shares every day for a whole year. This would be 50k*255= 12,750 shares bought back. Compared to the 970m shares outstanding, this is only 1.3% of the NOSH. So even if they bought these shares back for free, the maximum benefit that accrues to the remaining shareholders is only 1.3% increase in their fundamental value (ie the increase in their stake at no purchase cost). Thus an immaterial benefit sadly
• This does not derail the thesis, but it does compress the range of possible returns in both directions

Expected returns

• Assuming the historical average multiple (which is highly conservative – this is a much more established business than the avg of its 15 yr public life), then that would be 4x EBIT, which diluted by the cash would translate to ~100% return for the equity
• A more reasonable 8x for this business (still seems overly cheap to me given the quality above), would be ~240% return on the shares
• Catalysts?
• Here, just the cash accumulation and rising cash/sh floor should prove to be catalyst enough
• Indeed, through the CV19 related mkt crash, the share price of CSSC exactly hit and bounced off the cash/sh, suggesting the market irrationality thankfully has its limits and the market never let the value fall below the cash position
• At 1x EV/E, continued cash accumulation will rise the floor underneath the stock and provide a decent return even without any (surely deserved) multiple rerating
• Any special cash distribution or investment would reduce the cash drag on returns, while increasing dividend yield - a big positive (albeit an unlikely one given past mgmt messaging)

Catalyst

• Catalysts?
  • Here, just the cash accumulation and rising cash/sh floor should prove to be catalyst enough
    • Indeed, through the CV19 related mkt crash, the share price of CSSC exactly hit and bounced off the cash/sh, suggesting the market irrationality thankfully has its limits and the market never let the value fall below the cash position
    • At 1x EV/E, continued cash accumulation will rise the floor underneath the stock and provide a decent return even without any (surely deserved) multiple rerating
  • Any special cash distribution or investment would reduce the cash drag on returns, while increasing dividend yield - a big positive (albeit an unlikely one given past mgmt messaging)