• On the back of higher DMF ASP of Rmb6,195/tonne (+36.4% y-o-y, +37.3% q-o-q), 3Q20 revenue rose to Rmb267.0m (+8.8% y-o-y) but slipped 3.4% q-o-q due to a lower utilisation rate of 44% (3Q19: 49%, 2Q20: 56%) for Anyang Jiutian DMF plant arising from the scheduled maintenance shutdown of 20 days in Sep 20.

Benefitted from greater operating leverage.

• Jiutian Chemical's 3Q20 gross margin expanded to 31.4% (3Q19: 7.7%, 2Q20: 19.4%) on:
  1. higher product prices; and
  2. lower cost for methanol, a major raw material for DMF, due to depressed crude oil prices.
• This translated into positive operating leverage for Jiutian Chemical, which recorded a spike in net margin to 19.5% (3Q19: negative; 2Q20: +11.8%).

Spot DMF prices softening but elevated prices sustainable.

• While spot prices for DMF have softened to Rmb9,350/tonne as at 11 Nov 20, it remains 34% above our initial estimate of Rmb7,000/tonne for 2021.
• Management cited the surge in demand for DMF was driven by strong growth in the local and export markets for its end-products, as well as rising demand from users in the lithium batteries and semiconductor sectors in China.

Spike in gross margin.

• Hovering at an average of 12% in 2016-19, adjusted gross margin is expected to more than double to 32% in 2020 (9M20: 22%) due to better ASP and lower feedstock cost. The cost of methanol is expected to remain in check going into 2021. As Jiutian Chemical’s feedstocks are primarily derivatives of crude oil, we expect raw materials costs to rise 12%, in tandem with the estimated growth forecast for crude oil prices by our commodities team.

Solid FCF generation.

• Along with the strong operating leverage that will catapult earnings trajectory, free cash flow (FCF) generation is expected to be solid across 2020-22. Our estimates suggest FCF of Rmb183m, Rmb467m and Rmb542m for 2020-22 respectively. This will help improve Jiutian Chemical’s balance sheet significantly, with net cash increasing from Rmb281m (3.1 cents) in 2019 to an estimated Rmb464m (4.6 cents) in 2020 and Rmb927m (9.2 cents) in 2021.

Demand and selling prices appear to be sustainable.

• The demand for industrial products manufactured in China looks set to continue as other manufacturing nations are still suffering from COVID-19. Additionally, Zhejiang Jiangshan Chemical, the second-largest DMF producer in the world, shut its production facility in May 20, pulling out 180,000 tonnes of annual capacity. This resulted in a supply shortage for DMF and catapulted Jiutian into the second spot with its annual capacity of 150,000 tonnes of DMF.

Earnings revision

• We raise our Jiutian Chemical's 2020 revenue estimate by 5.6% from Rmb1,076.6m to Rmb1,137.4m to account for the higher-than-expected 3Q20 results. This lifts our 2020 net profit forecast by 16.6% to Rmb213.7m (2019: Rmb225.8m loss).
• We raise our 2021 DMF ASP assumption by 2.9% from Rmb7,000/tonne to Rmb7,200/tonne. This raised our Jiutian Chemical's 2021 revenue estimate by 2.3% to Rmb1,531.4m. Adjusted gross margin is also expected to improve 4.7ppt y-o-y to 37% as a result of higher product prices, translating into a stronger operating leverage for Jiutian Chemical. As a result, our 2021 net profit estimate is higher at Rmb357.2m (+23.3%).