China Chemicals:Fertilizers stink fluorine chemicals are cool

Fluorine chemicals rebounding. ASPs of R22, chloroform, methylene chloride, R134a and PTFE have been on the rise (see table below). There are two reasons this is happening: (1) refrigerants (i.e. R22, R134a) entered peak season in March, and (2) supply of chloromethane (CMS) products (e.g. methylene chloride and chloroform) has been restricted because of tighter environmental controls and the low utilization rate of inefficient players. So, while certain chemical subsectors like fertilizers are floundering, companies like L&M Chemicals (746 HK, Price: HK$3.84 [20 May], TP: HK$5.48, Outperform) that deal in chloromethane and other fluorine products will break out in the second half of the year, in our view.

Fertilizer ASPs stuck in a trough. Due to heavy oversupply within the Chinese market, ASPs of urea, DAP, potash and compound fertilizers have suffered sharp YoY declines of 28.1%, 17.9%, 18.9% and 13.6%, respectfully. ASPs even declined from January to May this year, normally peak season for fertilizers. Thus, we advise avoiding fertilizers plays in 2014, especially China Bluechem (3933 HK, Not Rated), China XLX (1866 HK, Not Rated) and Sinofert (297 HK, Not Rated).

Buy L&M Chemicals at the bottom. L&M is one of the largest CMS producers in China, with CMS contributing 41% of its revenue in 2013. Prices of raw materials used in CMS, mainly salt and methanol, are generally very stable due to sufficient supply in China. We expect L&M to deliver strong earnings turnover in 2014F as ASPs of methylene chloride (up 81.4% YoY) and chloroform (up 74.7% YoY) continue to rise based on their current momentum. The company’s revenue, gross profit and operating profit generated HoH growth of 25.6%, 78.8% and 13.1%. We expect these trends to sustain in the medium term.