Extraordinary Cash Flow Drives These China XD Plastics Yankee Bonds With 9% Yields!

Jul. 9.14 | About: China XD (CXDC)

Summary

The operating income of China XD Plastics is over 10 times greater than interest expenses.

Very high yields for the relatively short 4.67 year (February of 2019) maturity of these notes!.

The Chinese automotive modified plastics market experienced a nearly three fold increase between 2008 and 2012, and the automotive industry in China is said to be still in its infancy!.

China-XD-Plastics-Co-Ltd.gif

Each week we screen thousands of corporate bond listings to find what we believe is currently the best corporate bond for investors needing or seeking higher yields with the least amount of risk possible relative to its projected return. This week, we consider the senior notes (in US dollars) from a fully owned subsidiary of the China XD Plastics Company (NASDAQ:CXDC), one of China's specialty chemical companies engaged in the development, manufacture and sale of modified plastics primarily for automotive applications. Couponed at 11.75% and guaranteed by China XD Plastics, these relatively new and unrated Yankee bonds were well received in the bond market place and now trade at a premium that effectively lowers its yield to maturity to about 9%. After reviewing its recently released fourth quarter and full year 2013 financial results, we think the premium pricing is justified and see the high cash flow and approximately 9% overall yields of this issue as sound diversification and a strong addition to our high yielding managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.

A look at the issuer

A leading specialties chemical player, China XD Plastics Company Ltd. was founded in 1985 and is headquartered in Harbin, China. The company holds the largest number of auto manufacturer product certifications among domestic Chinese players, has an industry leading R&D team of over 110 professionals, an advanced National Level Enterprise R&D center, and over 200 advanced testing equipment. It currently has three production facilities with 88 advanced production lines, and a customer base of over 300 auto parts manufacturers across China. Major end users are automakers, with the company's products ultimately utilized by 8 of the 10 largest auto makers in China and more than 23 automobile brands manufactured in China, including leading brands such as Audi (OTCPK:AUDVF), BMW (BAMXY), Toyota (NYSE:TM), Mazda (OTCPK:MZDAF) and Volkswagen (OTCPK:VLKAY). With its advanced customer-oriented R&D technologies and production capabilities, it appears to us that China XD Plastics is a definitive leader in a large, fast growing market with high barriers to entry. Furthermore, the Company is gaining gradual penetration into higher-end and more diversified applications that include electronics, medical devices, high-speed trains, ships, and aerospace. In November 2009 China XD Plastics listed on the NASDAQ and was the first Greater China modified plastics material company listed in the United States.

What has impressed us the most about this company is its steady and robust revenue and profit growth:

(in millions of US dollars)

2009

2010

2011

2012

2013

Revenues

135.7

250

381.6

599.8

1,050.80

Operating Income

17.6

33.7

76.9

111.9

185.6

Click to enlarge

Statistics by the China Association of Automobile Manufacturers ("CAAM") in 2013 indicate that China's production volume of automobiles increased from 5.7 million units in 2005 to 22.1 million units in 2013, AND China has exceeded the United States to become the world's largest auto market as measured by the number of automobiles sold. According to a Frost & Sullivan report, the Chinese automotive modified plastics market has experienced rapid development from 2008 to 2012, with nearly a three-fold growth in terms of revenue and sales volume during this period. The report also states that the market demand for modified plastics is projected to reach 25.5 million MT in 2017, representing compound annual growth rates ("CAGR") of 10.5% and 19.9% by sales volume and revenue from 2013 to 2017. Furthermore, the Chinese automotive modified plastics market is expected to sustain rapid increase in terms of revenue and sales volume, with CAGR of 26.3% and 16.6% from 2013 to 2017, respectively. This continuously growing demand for automotive modified plastic in China is due to the fast growing Chinese automotive market, increasing use per unit of plastic content in automobiles and favorable government incentives and regulations.

The automotive industry in China is still in its infancy with passenger car ownership of 81 vehicles per 1,000 inhabitants in 2012, which is significantly below Europe's average of 491 and United States' average of 802 according to National Bureau of Statistics, US Department of Energy, Eurosta, Frost & Sullivan. Approximately 30.5% of the automotive modified plastic consumed in 2012 was imported from outside of the PRC or manufactured by multinational and joint venture companies. However, we see domestic producers such as China XD Plastics as being likely to gain even larger market share from imports, as it is able to manufacture products with comparable quality at highly competitive prices and close proximity to its customers.

It is also noted that the company receives all of its revenues in Renminbi, and the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. Dollar in 2005. Under the 2005 policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies, and this change in policy has resulted in an appreciation of the Renminbi against the U.S. dollar of approximately 26.9% from July 21, 2005 to December 31, 2013. As of December 31, 2013, Xinda Group operated three separate factories located inside of China, one of which it owns the titles to the land and premises, one of which it is in the process of acquiring the titles to, and one of which is leased (through 2018.)

Interest Coverage Ratios

Interest expenses for the year 2013 were reported at $15.3 Million and operating income was $185.6 Million, over 10 times greater than interest expenses.

We like companies with lower debt to cash ratio

Total financial debt at the end of 2013 was $ 441.2 Million, while cash and short term deposits were $ 95.5 Million. On March 8, 2013, Xinda Holding (NYSE:HK) Company Limited, a wholly owned subsidiary of the Company, entered into an investment agreement with Shunqing Government, pursuant to which Xinda Holding will invest RMB1.8 billion (equivalent to US$294 million) in property, plant and equipment and approximately RMB600 million (equivalent to US $98 Million) in working capital, for the Construction of Sichuan Plant. On January 24, 2014, the Company's wholly owned subsidiary, Favor Sea Limited, priced its international offering of guaranteed senior notes. The offering consisted of US$150 million aggregate principal amount of 11.75% guaranteed senior notes due 2019. The Company intends to use the net proceeds from the offering for repayment of indebtedness incurred by its PRC subsidiaries, for capital expenditure on a production base in Sichuan and for general corporate purposes.

We like companies that have good balance sheets

China XD Plastics currently appears to have a market capitalization value of about $320.7 million. Year end cash and debt totals indicate a debt to enterprise value of about 66.5%. While this is higher than we normally prefer, we think that its robust and consistent growth of revenues and earnings would be viewed as appealing to the equity markets should addition equity capital be sought or needed.

We like higher yields

This five year $150 million US dollar denominated debt of Favor Sea Limited, a British Virgin Islands corporation that is the wholly owned holding company for Harbin Xinda Macromolecule Material Co (merged into Xinda Group Material Research as part of a restructuring plan to be eligible for beneficial tax policies for certain regions in China in 2013), was issued in February of 2014. Considering that the nearly 9% yields indicated with these notes is well over 5 times the paltry 1.65% rates that might be achieved with "safe" five year US treasuries, we believe the higher reward potential of these Yankee bonds far outweighs the risks that we can identify.

Risks Considerations

The default risk is China XD Plastic's ability to perform. Considering the its sound margins, sold cash flow, historical and recent performance, and its rapidly growing diversified business as outlined above, it is our opinion that the default risk for this relatively short term bond is minimal relative to its very high return potential.

The hardest risk for us to identify is the geopolitical risk. Since we find it hard to understand many of the political changes even in our own country, perhaps the uncertainties of changes on a foreign soil become less formidable. With that said, it is our opinion that diversification into other forms often serves to reduce risk. Our strategy here, as with other Yankee bonds, is to focus on unique or required services that can be seen as a adding key economic value to the society it's associated with. Considering the high barriers to entry in this specialized segment of China's rapidly expanding Automotive industry, we think China XD Plastics is prominent positioned as one of the best operators in its homeland.

Global economic conditions could deteriorate and further negatively impact the automotive industry, thereby limiting demand for products produced by the Company, which has operations concentrated primarily within the automotive industry. In addition, a large percentage of its sales revenue is derived from sales to a limited number of distributors and a limited number of customers, and its business would suffer if sales to these customers declined.

Any fast growth company in developing markets also has execution and market risks, as companies often encounter unforeseen issues. This is a common risk associated with younger, fast growing companies

We believe that these Favor Sea bonds (guaranteed by China XD Plastics) have similar risks and maturities to other Yankees bonds such as the 9.58% Rolta, the 8.67% Eastcomtrans, or the 12% MNC Investama bonds that we have reviewed previously on our Bond-Yields.com blog.

Summary and Conclusion

It is our opinion that China XD Plastics is positioned well for the future, as one of the leading local providers of modified plastics material, and securely positioned to continue moving forward within a rapidly growing segment of mainland China's economy. It has a fair cash position, excellent earnings, reasonable interest expense coverage, and a sound balance sheet. As a result, we believe these high 11.75% couponed Yankee bonds offer an high 9% yield relative to the financial risks that we can identify, and have marked them for addition to our Fixed-Income1.com and Fixed-Income2.com portfolios.

Issuer: Favor Sea Limited/China XD Plastics
Coupon: 11.75%
Ratings: -/-
Maturity: 2/4/2019
Pays: Semi-annually
CUSIP: G33353AA4
Price: 110.375
Yield to Maturity: ~9%

Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. Durig Capital and certain clients may have positions in Favor Sea 2019 bonds.