Xinyi Glass: a play on auto and construction

This week, we look at an industrial company listed in Hong Kong: Xinyi Glass (0868.HK). While glass may not sound exciting, it is an indirect play on two industries that should continue to show high demand over the medium-term in China. The auto and construction industries both use large amounts of glass and last year, Xinyi Glass derived 60% and 20%, respectively, of its revenues from making glass aimed at these two industries. Xinyi not only sells glass in China (about 44% of revenues in 2007 were from glass sold in Greater China) but in North America (30% of revenues) and Europe (10% of revenues) as well. As the outsourcing of glass production to cheaper facilities in Asia should be an ongoing trend, Xinyi Glass is well positioned to benefit.

Based on 2007 actual earnings, the stock trades at a P/E of 13X. Whether this is expensive or cheap heavily depends, in our view, on whether margins can hold up or not. Most analysts expect Xinyi glass to continue to show high levels of revenue and earnings growth (on the order of 30% earnings growth for 2008). Such high levels of earnings growth are predicated on the assumption that margins don’t fall too much. So far, Xinyi Glass has been successful in passing through rising raw materials costs to its customers through higher glass prices, better product mix and ongoing cost controls. Over the long-term, it would not be surprising if net margins fell from the mid-20’s range to a low double-digit or even single digit level. It is, after all, still an industrial company and large glass producers in other parts of the world don’t earn such high margins. How quickly this occurs is the critical question. If Xinyi Glass can sustain its growth rate and current margin structure for a couple more years, than the shares will likely prove to be a bargain at the current price.