Yingde Gases (OTC: YINGY) Consistently Negative Free Cash Flow Business Earning Low Returns Relative to Cost of Capital and Deceptive Bargain Valuation with 50%+ Downside Investment Idea Submission for 2015 UChicago Seeking Alpha Case Competition Research Analysts: Lavine K. Hemlani, Vincent Lo Key Statistics* (as of April 24, 2015) –in Hong Kong $, unless otherwise specified (FY December year-end) Ticker OTC: YINGY ~30% Price Appreciation Share Price US$8.84 13 in April Without Any Change in Underlying Market Capitalization $12,625.7 mm 12 Business Value Cash & ST Investments $758.1 mm 11 Total Debt $12,689.3 mm 10 Total Enterprise Value $24,701.7 mm EV/(EBITDA – LTM Capex) 49.5x 9 Net Debt/EBITDA 3.7x 8 Steel Industry Exposure** 70.1% 7 Free Cash Flow Negative for last 6 (CFO – Capex) 8 out of 9 years Cost of Borrow ~50 bps 5 52 Week High / Low $12.25/ $6.23 4 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Dividend Yield 3.6% Source: CapitalIQ, Company filings, Bloomberg. Financial year end as of December 31. Note: Figures reported in RMB millions on company filings. 1 RMB = HK$ 1.25 and 1 RMB = US$ 6.21 as of April 26, 2015. * All key statistics (e.g. Market Cap, EV, Debt, comps) throughout refer to Yingde’s primary listing on the Hong Kong stock market (Ticker:2168) in HK$ except for the stock price in US$ that relates to the secondary listing on the OTC markets. **As of December 31 2014, small-to-medium sized steel mills accounted for 70.1% of total installed oxygen capacity under long-term contracts from existing facilities. Guidance projects steel exposure to remain at 70%+ going forward. Summary of Investment Thesis 11. Low Return on Capital Business Model Heavily Exposed to Stressed Steel Industry 22. Highly Leveraged Balance Sheet Accentuated by Eight Years of Consistently Negative Free Cash Flows 33. Stock Rose ~30% in Two days for no Fundamental Reason even as Yingde Has Structurally Weakened 44. At 11x Trailing P/E, Yingde’s “Bargain” Valuation is Misleading Disclaimers: 1. This write-up is submitted solely for the 2015 UChicago Seeking Alpha Undergraduate Case Competition 2. This write-up is only for information purposes and does not constitute an offer or recommendation of a security of any type at any time 3. The author does not hold a position and disclaims any obligation to notify the market of any changes 4. The reader agrees not to invest based on this write-up submitted solely for an investment idea contest and to perform his or her own diligence and research and form an independent view 5. The write-up is merely the opinion of the author based on publicly available filings and extensive industry research UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) 1 May 4, 2015 Low Return on Capital Business Model Heavily Exposed to Stressed Steel Industry Yingde’s primary customer base is the mid-sized steel mill. Yingde is not immune to customer credit risk as evidenced by multiple major steel mills refusing to make payments and operating below capacity. Yingde supplies industrial gases to small-to-medium sized Chinese steel, chemical and nonferrous metal manufacturing clients. The business relies on substantial leverage to fund upfront heavy capital expenditures to construct Air Separation Units (“ASUs”) near a client’s factory. ASUs separate air into more useful gas compounds (see Appendix, Exhibit 1 for full distillation process), which are directly pipelined to the client’s factory (Appendix A, Exhibit 2). Today, Yingde operates 64 facilities across China with an additional 27 already under-development (Appendix A, Exhibit 3). Yingde’s massive upfront investment is compensated by long-term (~15 to 30 years) minimum-take-or-pay contracts (see Appendix A, Exhibit 4 for sample take-or-pay contract cash flows) that act, in some ways, as a form of off-balance sheet financing for customers. These contracts dictate pre-determined prices and minimum purchase commitments (typically at 80% of operational volume 1), and include price adjustment clauses to pass on inflationary pressure and electricity cost volatility to end-users. Theoretically, such clauses should protect Yingde from margin pressure and volatile market cycles. Additionally, Yingde sells any excess gas (not utilized by factories) to merchant clients (e.g. liquid gas distributors) on a spot market basis. This side business is contingent on underlying market dynamics and free market price volatility. Highly Exposed to Stressed Steel Sector Yingde’s steel clients2 account for a whopping 70.1% of sales. Given the recent excess capacity and inefficiency in the steel industry, the government is attempting to structurally reform and consolidate steel mills. The shrinking market will most negatively impact smaller3 steel mills, which are Yingde’s primary customer base. Notably, steel mill profitability is already stressed with prices near a 20-year low (additional background on why the Chinese steel industry will increasingly slump in Appendix, Exhibit 4). Channel checks indicate that two major steel customers (~5–7% of sales) have stopped making contractual payments, forcing Yingde to file lawsuits. In fact, Moody’s downgraded Yingde’s bonds (January 2015) citing "its heavy exposure to the weak steel industry and the outstanding litigation against a major customer” 4. Despite bad debt provisions of RMB 233 million, the ongoing dispute has caused overdue receivables to rise by RMB 460 million (Appendix A, Exhibit 6). Two additional customers (~5% of sales) have shut down plants and stopped utilizing Yingde’s gas. As a result, utilization levels have dropped to ~80% (~90% two years ago). Lower capacity utilization coupled with high operating leverage has further deteriorated the capital-intensive firm’s profitability. Yingde Generates Low Returns on Capital and Requires Major Upfront Capital Expenditures By nature, Yingde operates in a low margin business where 80%+ of cost of sales is dominated by electricity and utility costs (remaining costs include D&A and labor) of operating the ASUs (once built). As will be illustrated, management’s incessant deployment of capital expenditures (“build, build, build” mantra) to fund more upfront investments on ASU contracts has not materialized into cash flows. Yingde generated 13.6% Return on Equity (“ROE”) in FY2014. What seems like a “decent” double-digit figure for a terribly capital intensive business is actually being artificially bolstered by rapidly growing financial leverage. With ROE dwindling down from 37.6%, leverage has also concealed Yingde’s deteriorating underlying economics. Using a DuPont analysis, we can deconstruct the elements driving the declining ROE. The company’s net margins and asset turnover have declined such that ROE without the impact of financial leverage (i.e. the equity multiplier) ratio (2.9x in FY2014) has been in the ~5% range since FY2012 (15.2% in FY2008) (Appendix, Exhibit 7). This single-digit return is significantly below the company’s presumed double-digit cost of capital (given the cost of debt itself on August 2014 issued 7.25% coupon high yield bonds maturing in 2020 is a staggering 14%+ yield5). Source: Company filings, CapitalIQ, public news articles, industry reports, channel checks, sell-side reports, management. 1 http://www.citics.com.hk/file%5Cresearch%5C2989_Yingde%20Gases%202168HK%20-%203%20Jul%2012%20ENG.pdf 2 Industrial gas is used by steel mills in blast furnaces given its ability to lower coke expense ratios, raise iron production levels and increase furnace temperatures. 3 These small-to-medium sized steel mills are not targeted by larger international competitors (e.g. Praxair, Linde, Air Liquide). Yingde cannot compete with international customers on larger projects as it is inferior on the basis of 1) supply capacity 2) product quality and 3) financing capacity. http://www.gasworld.com/hot-topic-gases-in-china-whats-really-happening/5243.article 4 https://www.moodys.com/research/Moodys-downgrades-Yingde-Gases-to-Ba3B1-outlook-negative--PR_317137 5 As of April 27, 2015, Yingde’s 7.25% coupon bonds maturing in 2020 have a yield of 14.233%. http://finra-markets.morningstar.com/BondCenter/Results.jsp 2 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Yingde’s capital intensive business model has thus been consistently destroying value for shareholders with returns on capital being materially below than the cost of capital, while the scale of the compounded value destruction has been obscured by unsustainable levels of financial leverage. In aggressively chasing growth, management has deployed excessive capital (average Capex as a percentage of sales was ~50% since FY2008) to fund upfront capital investments (Appendix, Exhibit 8). Yingde is artificially bolstering revenues at the expense of already negative free cash flows, forcing the reoccurring need to come to market and raise debt to stay alive. Earnings quality has materially deteriorated as capital expenditures have typically been double that of operating cash flows and many multiples of D&A as seen below. Diligence indicates that most, if not all, capital expenditures have been growth related rather than for maintenance purposes. We wonder when, if ever, management will apply the brakes and stop enamoring inorganic revenue and EPS growth targets with inefficient capital expenditures (return on capital is materially below cost of capital) that are incapable of generating cash flows or creating value. Yingde’s Best Times are Over: Intensifying Competition is Evaporating Returns on Capital Further Our primary diligence indicates that Yingde achieves a 14%+ Internal Rate of Return (“IRR”) on contracts, relative to a previously secured 30%+6. Yingde is thus suffering (and will continue to suffer) from a material decline on its already weak return on capital profile by aggressively signing new long-term contracts. While lower IRRs can be partly attributed to the weaker Chinese macroeconomic sentiment as well as the overcapacity in the stressed steel sector, management cited intensifying competition (10+ new entrants since 2008), as the primary reason for EBIT and net margin contraction since FY2008 (Appendix, Exhibit 9). Thus new contracts are compounding value destruction for shareholders at a faster rate than before as their expected return on capital will deviate even further from weighted average cost of capital. In the past, Yingde would aggressively secure contracts through price competition (i.e. through offering low cost services as domestic ASUs are ~30% cheaper than international units, albeit at a lower quality). Such an advantage is thus no longer a key differentiating factor since ruthless domestic competition can offer similar prices for identical end products (i.e. hot air). Notably, one of Yingde’s major suppliers, Hangyang, has entered the ASU service market and now directly competes with Yingde on bidding for new projects. Intensifying competition in such a capital-intensive industry could translate into even more non-value accretive capital expenditures in defending market share and staying competitive. As we will see in section two, the ability to raise or refinance debt to fund more capital expenditures at this juncture is waning. 2 Highly Leveraged Balance Sheet Accentuated by Eight Years of Consistently Negative Free Cash Flows Yingde’s negative FCF and wafer-thin cash balance will be insufficient to meet Capex, interest expense and imprudent capital allocation. Liquidity shortfall could cause Yingde to default. Such a de-rating catalyst is likely given suppressed steel mill payments on top of a concentrated customer base and will cause long term investor base to capitulate. Rather Than Self-Finance Capex, Management Has Issued an Irresponsible Amount of Debt Even after 12 years of operation, Yingde strictly refrains from funding its cash-guzzling growth through mediocre self-generated cash flows (as if the company is a fast growing, start-up operation). Yingde’s balance sheet is extremely levered at 3.7x Net Debt/EBITDA posing major liquidity and bankruptcy risks. Alarmingly, the company’s EBITDA less capital expenditures to interest ratio is below 1x (Appendix, Exhibit 10). In fact, Yingde’s Capex adjusted interest coverage ratio has been negative for every year except FY2014! Since FY2008, Yingde’s total debt spiraled from RMB 934 million to RMB 9.8 billion (60%+ CAGR). Yingde’s balance sheet will keep weakening as management has to come to market to stay alive under the mounting pressures of cash-strapped customers choking Source: Company filings, CapitalIQ, public news articles, industry reports, channel checks, sell-side reports, management. 6 Page 88 - Deutsche Bank China Chemicals Tour Industry Report (21 March 2014) discusses lower (relative to previous years) project IRR with Yingde’s management. http://www.wisburg.com/wp-content/uploads/2014/09/%E5%BE%B7%E6%84%8F%E5%BF%97%E9%93%B6%E8%A1%8C-China-Chemicals-Tour%EF%BC%9AThegrowth-enggine-is-modestly-returning.pdf 3 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 payments, intensifying domestic competition and an incessant focus on unnecessary, non-value accretive market share, installed capacity and revenue growth targets (Appendix, Exhibit 11). Amidst Yingde’s accumulation of leverage and eight years of negative free cash flows, Moody’s cut the corporate family rating for Yingde in January 2015 from Ba2 to Ba3 7. Investors must recognize that the ratings cut can increase Yingde’s borrowing costs and make it increasingly difficult to raise future funds in the capital markets (reducing future refinancing capacity). Despite the January 2015 rating cut, Yingde has done little to improve the pressured cash flow situation prompting Moody’s to reconsider another rating cut in March 20158. Another rating cut (or a downgrade from other credit rating agencies) could act as major de-rating catalyst for Yingde’s long-term orientated mutual fund investor base to capitulate (see section four). Despite its alarming leverage, management displays no intention of halting the accumulation of leverage to fund heavy capital expenditures for new on-site customer contracts. Such imprudent capital stewardship has already led to previously breached debt covenants. In fact, in FY2012, Yingde breached a covenant causing ~30% of debt to be paid immediately, creating massive strain on its liquidity (Appendix, Exhibit 12). Ultimately, the covenant breach was only resolved when Yingde’s lender later decided to alter the agreement and waive the breach. Potential to Default On Loans Given No Cash Flows and Poor Cash Collection from Weak Customers Despite their inability to generate cash flow, Yingde’s management has irresponsibly followed the “build, build, build” mantra to aggressively book new contracts, which is burning through their finances. Yingde’s inability to later collect payments from such aggressively acquired customers, although masked by rising revenues, weighs heavily on cash flows. Whatever cash they do manage to scramble, management immediately deploys on capacity expansion (or uses as pedestal to raise more debt), at the cost of shareholder value creation, all for the sake of chasing bolstered top-line revenues and earnings growth targets. The lack of cash flows is particularly concerning for Yingde because of its excessively accumulated debt. Not only do short-term borrowings and current portion of long-term borrowings (RMB 1.7 billion) account for ~19% of the total borrowings (RMB 9.1 billion), but given their 520 million RMB finance cost recorded in FY2014, the liquidity outlook for Yingde is dire at best (Appendix, Exhibit 13). With a Capex-adjusted interest coverage ratio of 0.9x and remaining cash balance of RMB 606.4 million, investors should be weary of just how Yingde is going to cover its upcoming interest and operational expenses (including total accounts payable of RMB 2.4 billion!). To make matters worse, in attempting to protect its stock price, management has been raising Yingde’s dividend payout (FY2014: 40%) and is engaging in a major share buybacks (RMB 240 million authorized October 2014). Comically, management has paid over RMB 1.0 billion in dividends in the last four years and already expensed more than RMB 60 million of share buybacks in FY2014. Such capital allocation decisions are alarming (and somewhat puzzling) given that the cumulative value of negative free cash flows have already recorded a net deficit of over RMB 9.0 billion since FY2008. Imprudent capital stewardship is amplifying liquidity stress to Yingde’s already wafer-thin cash balance and will further wane access to capital markets. Given its major customer and steel end market concentration risks outlined earlier, Yingde is at a key inflection point where only one more customer payment problem could force the company to potentially default on its loans and/or go into bankruptcy. Such a de-rating catalyst is especially more likely considering that the January 2015 Moody’s credit downgrade will make refinancing increasingly difficult. The company has not and cannot resort to raising equity to save the day from a potential liquidity shortfall (last material equity issuance was during the IPO in FY2009). As such, it is unlikely that management will be able to continue to ‘kick the can down the road’ for much longer as Yingde begins to crush under its own weight. 31. Stock Rose ~30% in Two days for no Fundamental Reason even as Yingde Has Structurally Weakened Between April 8th/10th, Yingde’s primary HK stock listing appreciated ~30% from ~HK$5.9 to HK$7.5, without any changes to the underlying value of the business, making Yingde’s OTC a timely short opportunity 7 8 https://www.moodys.com/research/Moodys-downgrades-Yingde-Gases-to-Ba3B1-outlook-negative--PR_317137 https://www.moodys.com/research/Moodys-Yingde-Gases-ratings-pressured-by-weak-cash-flow-in--PR_321078 4 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Change in Regulation (not Intrinsic Value) Caused Influx of “Hot” Capital Driving HK Markets to 7 Year High Yingde’s stock experienced an unprecedented, abrupt upward appreciation between April 8th and April 10th creating a timely short investment opportunity. We do not see this price action as a reflection of any paradigm shift in Yingde’s existing business operations or future growth potential. Instead, we attribute this ~30% share price increase to the ramping up of the Hong Kong StockConnect program, which allows mainland investors to invest in Hong Kong shares, and Hong Kong investors to purchase Chinese shares. While the program was originally launched in November 2014, many investors were hesitant to utilize the opportunities offered by this program given regulatory risks and strict qualification requirements. As a result, the maximum (RMB 10.5 billion) daily quota provided by the program was never fully utilized up until recently. Early April saw a surge in southbound trading volume because Chinese “regulators said money managers no longer need to be part of the Qualified Domestic Institutional Investor program to invest in Hong Kong shares via the city's exchange link” 9. This change in regulation allowed China based mutual funds to finally access investment opportunities causing a rapid influx of new “hot” capital flows into the Hong Kong stock market. Chinese investors drove the Hang Seng Index to its highest level in seven years, and the Hang Seng China Enterprises Index (index of mainland companies listed in Hong Kong) also rose to its highest level since 2011. Presumably, Yingde was a target for many mutual funds (as a result of many perceived salient investment features masked by a deceptive “bargain” valuation and poor quality of earnings, to be outlined further in section four), and therefore, its price was heavily affected by this tweak in regulation. Comparing Yingde vs. the Hang Seng Index’s recent price action illustrates this point clearly (Appendix, Exhibit 14). We can only assume that the over-hyped promise of exponentially rising booked revenues, installed production capacity, market share and total number of facilities (Appendix A, Exhibit 7) can be thought to be what captured pent up Chinese mainland investor appetite during the recent regulation change. In fact, such eagerly disclosed growth orientated factors were arguably driving the “hot” capital inflows that caused Yingde’s IPO book to be oversubscribed by an unbelievable 37.44x10 back in October 2009. To some degree, investor over-excitement can be attributed to an unblemished history of “promising” statements from management such as: “Yingde will double its production capacity in six to 24 months and investors are expected to benefit from the growth of the company in two years” 11 - Yingde’s CFO Xu E (mentioned during stock market IPO opening). As already discussed, such exponential low return on capital growth has a track record of destroying rather than creating value for shareholders. Evidently, management has prioritized growth-influenced metrics (like installed capacity, number of facilities, EPS etc.,) over maximizing shareholder value realization and generating free cash flows. As a comical testament, the company’s share price today is equal to its IPO price (HK$7.0) on October 8, 2009! Observing the chart, Yingde’s share price spike occurs at around the exact same time that the Hang Seng Index takes off. The price action is also accompanied by a hike in volume. As such, we do not see the share price increase as a reflection of any changes in Yingde’s fundamentals. We believe that the increase in Yingde’s share price is entirely unjustified, especially in light of its structurally weakening business and deteriorating balance sheet. Given the recent January 2015 Moody’s downgrade amidst such worsening business and customer economics, equity markets are evidently defying the logic of debt capital markets. 4 At 11x Trailing P/E, Yingde’s “Bargain” Valuation is Misleading At HK$7.0, we believe Yingde presents at least 50% downside, realized over a 12 month horizon as customer payments increasingly falter amidst unrealistic consensus estimates on a weak balance sheet P/E is Deceptive Given Grossly Inflated Accounting Earnings Relative to Economic Realism What investor would not find a utility-type company offering “predictable” and “stable” long-term contracts, trading at 11x P/E ratio and 3.6% dividend yield highly attractive? Investors are attracted to the company as it seemingly operates (at a significant discount) analogous long-term minimum-take-or-pay contracts that other established global industrial gas companies (e.g. Praxair, Linde, Air Liquide) offer. Such a business model is considered attractive due to the usual salient investment characteristics like “high switching 9 http://www.bloomberg.com/news/articles/2015-03-30/china-stock-index-futures-rise-on-pboc-easing-signal-silk-road http://www.asiape.com/apergc/apergc_issues/apergc0911.html 11 http://www.chinaknowledge.com/Newswires/News_Detail.aspx?type=1&NewsID=27729 10 5 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 costs”, “high barriers to entry”, “amicable oligopolistic industry” and “low risk of business obsolescence”. However, Yingde’s “bargain” valuation is deceptive given no cash flows, excess leverage and ballooning receivables. However, investors should be cautious to value the company based on its rear-view mirror. As it has been demonstrated in above sections, we expect Yingde’s future earnings to be drastically different from its past earnings due to rising steel mill counterparty risk, waning financing and refinancing capacities (that are inordinately required for future “expansion”) and unfavorable market dynamics. Yingde’s poor operating economic reality has materially diverged from its reported accounting earnings, which are inherently subject to the whims of management’s over-hyped growth promises. Thus, we note that $1 of reported accounting earnings is not necessarily $1 of true economic earnings (i.e. more like 50 cents per dollar). Yingde’s Quality of Earnings is Rapidly Deteriorating for Several Reasons Earnings quality is poor due to the following reasons: 1) negative free cash flows are materially deviated from reported net income; 2) accounts receivables have risen twice as fast as sales; 3) aggressive revenue recognition (‘bill and hold’) policies mask customer credit risk; and 4) consistently massive outpacing between capital expenditures and D&A by many multiples (as outlined in section one). Notably, Cash Flow from Operations has stayed relatively stagnant at ~RMB 900 million between FY2011 and FY2014 while EBITDA almost doubled during this period (Appendix, Exhibit 15). EBITDA does not take into consideration the rising working capital requirements of greater number of facilities as well as ballooning interest expense. This earnings quality discrepancy was already cited by Moody’s negative ratings outlook12. Moreover, Yingde’s capital-intensive nature has caused free cash flows to be consistently negative for the last 8 out of 9 years (Appendix, Exhibit 16). Primary diligence indicates that Yingde continues to expand capacity with expected FY2015 capital expenditures of ~RMB 2.0 billion, particularly into steel projects, even amidst the sector’s obvious overcapacity. As such, FCF is very likely to remain negative while management’s enamored top-line revenue and EPS accounting growth (that do not create value for shareholders) will persist until they can no longer “kick the can down the road” through debt refinancing. Finally, as a typical warning sign for investors, accounts receivable has grown significantly faster relative to top-line revenues. Between FY2008 and FY2014, accounts receivable grew at 68.0% CAGR from RMB 127 million to RMB 2.8 billion whereas top-line revenues grew at 32.7% CAGR from RMB 1.4 billion in FY2008 to RMB7.7 billion in FY2014 (Appendix, Exhibit 17). Clearly, Yingde has extended credit too easily to certain on-site stressed steel customers in an effort to juice up business results and pad short-term financial metrics (particularly top-line revenue growth). Accounting earnings are thus being distorted by a “bill and hold” aggressive revenue recognition policy that masks the difficulties in collection of cash payments. In fact, in the last four years, Days Sales Outstanding (Appendix, Exhibit 6) has risen from 29 to 72 days indicating the rising difficulty of collecting cash payments. Further, the company is filing a lawsuit against a major steel mill customer (as outlined in section one) for RMB 406 million+ of overdue receivables and has stopped receiving payments from other major steel mill customers, further choking cash flows relative to inorganically booked revenues (from higher debt-fueled facility count). Yingde Should be Valued on the Basis of Normalized Free Cash Flows Rather than Accounting Earnings Instead of looking at reported earnings, which can be manipulated in a whole host of ways through Yingde’s aggressive accounting, a more accurate yardstick would be using Yingde’s cash flows. Ultimately, cash is what allows Yingde to continue to operate, pay off its debt, and create value for shareholders (or at least a facade of creating value). Not surprisingly, valuing Yingde on a normalized cash flow basis actually makes it seem overvalued as will be discussed. In order to better reflect the returns available to shareholders, we believe that the EV/Normalized FCF multiple is much more indicative of Yingde’s true valuation. Unfortunately, in Yingde’s case, since they have not turned positive FCFs for the last 8 years, an EV/FCF multiple is not meaningful. Instead, we turn to the EV/LTM Operating Free Cash Flow multiple, where we adjust EBITDA for LTM capital expenditures (Appendix, Exhibit 18). Using this multiple, we find that Yingde trades at 49.5x, compared to a peer median of 24.5x! Thus, on a more 12 https://www.moodys.com/research/Moodys-downgrades-Yingde-Gases-to-Ba3B1-outlook-negative--PR_317137 6 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 comparable scale, despite being in a worse financial and operating position compared to its multinational competitors, Yingde still manages to trade at a valuation of more than twice that of its peers. The stock appears to be grossly overvalued (compared to peers) when factoring in capital expenditures. Moreover, at a 3.7x Net Debt/EBITDA Yingde is the most levered gas provider amongst its peers by a wide margin (median multiple of 2.2x). Competitor capital intensity (Appendix, Exhibit 19) is materially lower than that of Yingde without the significant risks of steel mill counterparty risk and customer credit exposure. Furthermore, Yingde’s competitors have a diversified revenue stream, are generating positive free cash flows, conduct more efficient and sizable global operations and utilize multiple modalities of gas transmission (e.g. on-site, cylinder, pipeline – see Appendix, Exhibit 2). Yingde does not even deserve to trade even with its competitors, let alone maintain a large premium. 50%+ Implied De-Rating as Investors Capitulate to Faltering Customers and Unsustainable Debt Burden We estimate that for a terribly capital intensive business generating no cash flows, artificially boosting reported earnings through aggressive accounting and yielding sub-par single digit returns on capital materially below cost of capital (after stripping out FY2014 financial leverage ratio of 2.9x and considering reported earnings are inflated), investors should be willing to pay no more than a normalized (stripping out non-recurring items) P/E of between 5 – 6x, implying at least a ~40% downside to the near 52-week high stock price of USD $8.65 (Appendix, Exhibit 20). Given that the business has been losing money across cycles, we are confident about this valuation, especially considering that we have not even accounted for the possibility that Yingde could very well end up defaulting on it’s loans, leaving us with a stock price near USD $0. Several de-rating catalysts exist (lost lawsuit over overdue receivables, further downgrades, potential default) to realize the implied 50%+ downside over a 12-month horizon (See Appendix, Exhibit 20 for a detailed discussion of the viability of such catalysts). At HK$7.0 investors are grossly over-paying 49.5x EV/(EBITDA – Capex) for a leveraged business struggling with cash-strapped steel mill customers, ballooning overdue receivables, poor quality of earnings, intensifying competition headwinds, several tangible de-rating catalysts and consistently FCF negative for the last 8 years Risks to Investment Thesis: Share Buyback: On October 30, 2014, Yingde’s management announced that they intended to buy back shares as they believed had been “trading at a level which significantly undervalues the Company’s performance and underlying value”. Under Yingde’s repurchase mandate, the Board is authorized to spend up to HK$300 million to repurchase shares up to 10% of the total shares outstanding. The share buyback on an already leveraged balance sheet may act as a defensive hurdle against a short position in the company. Merger or Acquisition Target: The Chinese gas industry is dominated by large MNCs (e.g. Air Liquide, Linde, Air Products etc.,) sitting on cash piles. Given its current market position and mid-sized market cap, Yingde could become a potential acquisition for one of the larger multinationals looking to increase their foothold in China. For example, Linde acquired BOC for US$14 billion in 2006 allowing for rapid Chinese market share gains 13. In such an event, Yingde could be acquired at a sizeable premium to current share prices. However, any company looking to acquire Yingde would also have to take on its substantial debt balance, low return on capital (relative to cost of capital) profile and stressed primary customer base. Such considerations dampen the probability of an acquisition. Merchant Sales are a “Swing Factor” in Overall Profitability: Our channel checks indicate that merchant market sales (11.8% of FY2014 sales) generate substantially higher margins relative to on-site contracts. A way to think of why merchant margins are higher is analogous to the "cigar butt" approach touted by Warren Buffett where any excess capacity not used by customers essentially represents a "free puff" that can be sold to other customers. Recently , the volume of merchant gas sold as % of total gas sold has been on the decline. Merchant revenues also suffered at the expense of lower merchant prices (particularly argon as seen in Appendix, Exhibit 22). However, if merchant gas prices recover significantly, Yingde’s operating profits could unexpectedly experience an unpredictable, sizeable upswing that would allow the company to surprise earnings targets (Appendix, Exhibit 23). Source: Company filings, CapitalIQ, public news articles, industry reports, channel checks, sell-side reports, management. 13 http://www.bloomberg.com/news/articles/2015-03-30/china-stock-index-futures-rise-on-pboc-easing-signal-silk-road 7 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Appendix Exhibit 1: Air Separation Process Yingde Uses Cryogenic (Low Temperature Distillation) Process for Air Separation Source: Yingde Global Offering Prospectus (2009). 8 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 2: Yingde Supply Chain Mix Yingde Offers Customers Industrial Gases Through Various Supply Modes (Pipeline, compressed, liquid) On-Site Gas Supply is primary mode of gas transport by situating ASU near facility and pipelining over the supply. Any excess gas is sold in merchant market on spot market basis Source: Company filings. Exhibit 3: MTOP Contracts Cash Flow Analysis MTOP Business Model Achieves Cash Flow Stability ~3 years After Intensive Upfront Capex Channel Checks indicate that Yingde incurs RMB 200 – 300 million for every onsite customer with average lead time (construction phase) of 12 months Year -1 Year 0 Year 1 Construction commences Upfront Capital Investment Year 2 Year 3 … Year 30 Supply Commences Profit/Loss Revenue Inflow = Volume x Unit Price Contracts produce an annuity-like stream of payments that cover start-up/relevant costs to provide incremental return. Excess capacity is sold to merchant market 2 -3 years after on-site commencement 9 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 4: Additional Background Information on China Steel “China’s crude-steel production is set to decline…Why? Two reasons; consumption that has passed the peak and exports cannot maintain high increases. I’m sure steel production will decrease.” – Deputy General of China Iron & Steel Association (CISA) Volatile Steel Industry Suffers from Overcapacity and is Undergoing Multi-Year Structural Consolidation China’s steel industry had previously boomed (15% CAGR between 2000 and 2013 14) given the massive industrialization investments in infrastructure and real estate. The golden boom period in addition to the slowing economic growth (which relied heavily on steel manufacturing) has recently created an unprecedented imbalance between demand supply and demand. Global steel overcapacity is estimated at 300 to 600 million tones, of which over half is attributed to Chinese steel manufacturing15. Notably, such a level of overcapacity will take years (if not decades) to completely unwind, particularly as the majority (~50%) of steel is produced by Chinese Stated Owned Enterprises (“SOEs”). The industry is expected to grow by a meager 0.8% (1.0% in 2014)16, if at all. Chinese steel mill profitability has already been hard hit with prices near a 20 year low17. The government has drafted several exit mechanism incentives for many loss-making, poorly-regulated mills with huge sunk costs as it attempts to slash capacity and raise efficiency. Industry-wide consolidation will induce additional headwinds, especially on tier 2 & 3 clients, who are already facing deteriorating capacity utilization. Exacerbating the issue of overcapacity is the inaccuracy of official figures from the Chinese National Bureau of Statistics. In fact, one estimate illustrates that Chinese steel capacity was under-quoted by 40 million tones18 (approximately equivalent to Germany’s annual production). Source: Company filings, CapitalIQ, public news articles, industry reports, channel checks, sell-side reports, management. 14 http://www.ft.com/cms/s/0/ea7af92e-b1e9-11e4-8396-00144feab7de.html#axzz3Y0A71no6 15 http://marketrealist.com/2015/01/massive-overcapacity-plague-steel-industry-2015/ 16 Yingde Global Offering Prospectus (2009.. 17 http://www.cnbc.com/id/102525697 18 “The China Iron and Steel Association (CISA) said in August that crude steel output stood at 822 million tonnes last year, more than 40 million tonnes higher than official figures from the National Bureau of Statistics” http://www.scmp.com/business/commodities/article/1667650/china-steel-data-masks-scale-overcapacity 10 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 5: Production Facility Network (As of December 31, 2014) Yingde Operates 64 Facilities (61 Of Which Were On-Site) And Has Plans For Developing Another 27 Facilities Source: Company filings. Exhibit 6: Overdue Accounts Receivables Rising & Days Sales Outstanding Doubling Accounts Receivable Past Due and Days Sales Outstanding Rising Exponentially ¥1,000 ¥800 ¥600 ¥400 ¥200 29 0 Past due accounts receivable have risen from negligible in 2008 to RMB 837 million in 2014 as customers struggle to make payments on time. During the same period, the average cash collection period has more than 46 36 from 29 to 62 doubled days. 101 57 72 837 80 70 60 52 54 49 50 329 40 210 111 30 ¥0 20 2008 2009 2010 AR Past due 2011 2012 Collection Period 2013 2014 Source: Company filings 11 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 7: Declining ROE & DuPont Analysis ROE has Materially Declined Since FY2008, Even After Being Artificially Boosted by Rising Financial Leverage Net Income 2008 2009 2010 2011 2012 2013 2014 426.0 571.0 577.2 831.0 770.0 908.0 904.0 34.0% 1.1% 44.0% (7.3%) 17.9% (0.4%) 1,133.1 3,775.5 4,352.8 4,991.3 5,486.0 6,124.7 6,635.6 233.2% 15.3% 14.7% 9.9% 11.6% 8.3% 15.1% 13.3% 16.6% 14.0% 14.8% 13.6% Growth Over Prior Year Shareholders Equity Growth Over Prior Year Return on Equity 37.6% DuPont Deconstruction Shows Returns With and Without Impact from Financial Leverage Rising Leverage Pads Returns Net Income Sales Net Profit Margin % Total Assets Asset Turnover (Sales/Assets) Shareholders Equity Returns W/o Financial Leverage Financial Leverage (Assets/Equity) Return on Equity Total Debt/EBITDA Source: Company filings. 2008 2009 2010 2011 2012 2013 2014 426.0 571.0 577.2 831.0 770.0 908.0 904.0 1,413.1 2,067.0 3,007.2 4,251.1 4,976.2 6,904.6 7,743.2 30.1% 27.6% 19.2% 19.5% 15.5% 13.2% 11.7% 2,809.8 5,674.2 7,634.7 9,824.8 14,793.1 16,551.8 19,250.8 0.50x 0.36x 0.39x 0.43x 0.34x 0.42x 0.40x 1,133.1 3,775.5 4,352.8 4,991.3 5,486.0 6,124.7 6,635.6 15.2% 10.1% 7.6% 8.5% 5.2% 5.5% 4.7% 2.48x 1.50x 1.75x 1.97x 2.70x 2.70x 2.90x 37.6% 15.1% 13.3% 16.6% 14.0% 14.8% 13.6% 1.60x 1.70x 1.70x 2.40x 4.60x 3.90x 4.00x The faster Yingde deploys debt-funded Capex with returns on capital < cost of capital, the faster it destroys shareholder value (even if revenue and accounting EPS growth meet expectations treadmill) Exhibit 8: Cash Flows vs. Revenues vs. D&A At the Expense of Free Cash Flows, Yingde has Deployed Heavy Capex to Bolster Top-Line Revenues & EPS Capex to Fund New ASUs 2008 2009 2010 2011 2012 2013 2014 670.0 888.0 1,930.0 2,178.0 3,782.0 2,691.0 2,013.0 32.5% 117.3% 12.8% 73.6% (28.8%) (25.2%) 1,411.7 2,065.7 3,004.9 4,240.3 4,955.9 6,865.5 7,716.2 47.5% 43.0% 64.2% 51.4% 76.3% 39.2% 26.1% Growth Over Prior Year Total Operating Revenues Capex as % of Revenues Cash From Operations 514.0 478.0 732.0 975.0 919.0 954.8 925.0 130.4% 185.8% 263.7% 223.4% 411.5% 281.8% 217.6% Depreciation & Amortization 76.9 114.7 159.0 279.4 357.6 516.9 695.1 Capex as multiple of D&A 8.7x 7.7x 12.1x 7.8x 10.6x 5.2x 2.9x Capex as % of CFO Source: Company filings. Declining earnings quality as Capex has outpaced D&A for last 9 consecutive years 8 Year Average 49.7% 244.9% 7.9x CapEx as % of sales has widely fluctuated from 26.0% to 76.0% 12 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 9: EBIT & Net Margins Yingde’s Net and EBIT Margins have Materially Dwindled Since FY2008 34.7% 35.0% 30.0% 25.0% 15.0% 5.0% 26.2% 30.2% 25.7% Take or pay contracts with cost passing clauses do not protect against company-wide declining EBIT and net margins 22.2% 27.6% 19.2% Intensifying competition has deteriorated margins and returns as changing landscape offers lower IRRs than previously signed contracts 2008 2009 2010 EBIT Margin % 22.2% 23.3% 19.6% 15.5% 13.2% 2011 2012 Net Profit Margin % 2013 11.7% 2014 Source: Company filings. Exhibit 10: CAPEX adjusted Interest Coverage FY2014 Interest Coverage is Positive for the First Time Since FY2008 Cumulative (EBITDA – Capex) of negative RMB 4.4 billion since FY2008 EBITDA Finance Costs Capex to Fund New ASUs EBITDA - Capex (EBITDA - Capex)/Interest Coverage 2008 2009 2010 2011 2012 2013 2014 567.0 736.0 1,124.0 1,367.0 1,450.0 2,024.0 2,480.0 58.5 61.2 128.2 126.7 209.8 381.6 520.0 670.0 888.0 1,930.0 2,178.0 3,782.0 2,691.0 2,013.0 (103.0) (152.0) (806.0) (811.0) (2,332.0) (667.0) 467.0 -1.8x -2.5x -6.3x -6.4x -11.1x -1.7x 0.9x Source: Company filings Yingde has barely generated enough EBITDA, let alone free cash flow, to cover Capex 13 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 11: Misleading Results of Excessive Growth Capital Expenditures On the Surface, Heavy Capital Expenditures Have Resulted In Dramatic Revenue, Market Share, Capacity and Facilities Between 2009 and 2014 Yingde’s proudly markets its unprecedented ~3 fold growth in revenue on its 2014 Investor Presentation Revenue (RMB mln) 10000 7716 6866 5000 3005 4956 4240 0 2010 2011 2012 2013 Capacity and Existing Facilties 2000 2014 1749 1566 1500 1000 500 940 693 55 57 1042 45 35 41 36 21 28 2010 2011 25 0 15 2012 Capacity ('000 Nm/3 hr) Proudly markets its on-site gas market share gains based on tonnage through aggressively signing new contracts 2013 2014 Existing Facilities Installed oxygen capacity grew from 0.4 million Nm3/ hr to 1.75 million Nm3/ hr (322% growth rate). installed oxygen capacity grew from 0.4 million Nm3/ hr to 1.75 million Nm3/ hr (322% growth rate). On-Site Market Share by Revenue 60% 46% 40% 65 36% 40% 42% 30% 20% 0% 2010 Yingde 2011 Linde-BOC 2012 Air Liquide 2013 Praxiar 2014 APCI “Despite a decline in the industrial gas market growth rate from 2012 to 2014, Yingde has managed to outperform the China industrial gas market average.” – Trevor Strutt, COO Source: Company filings. Note: Nm3/ hr refers to normal cubic meter per hour, a flow rate metric describing the level of flow under standard conditions of zero degrees Celsius and 1 atmospheric pressure. 14 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 12: Debt/EBITDA Covenant Levels Yingde has Previously Breached Covenants and Total Debt19/EBITDA has Spiraled Domestic Debt Covenant: 4.5x Debt/EBITDA International Debt Covenant: 4.75 Debt/EBITDA 5.0 4.6 4.0 3.0 2.0 3.9 4.0 2013 2014 2.4 1.6 1.7 1.7 2008 2009 2010 Breached debt covenants in 2012 (later removed) that required 30% of outstanding debt to be paid 1.0 0.0 Debt/EBITDA 2011 Domestic Covenant 2012 International Covenant Source: Company filings. Exhibit 13: Borrowing Breakdown Relative to RMB606 Million Wafer-Thin Cash Balance, Yingde has Major Long-Term Borrowings Upcoming Investors must wonder how Yingde will pay for short-term and upcoming debt (and RMB 2.4 billion payables) when EBITDA adjusted Capex interest coverage is not even 1x. Long-term borrowings have grown at 62.5% CAGR between FY2008 and FY2014 (FY2008: RMB 400.4 million) Source: Company filings. Source: Company filings, CapitalIQ, public news articles, industry reports, channel checks, sell-side reports, management. 19 Total Debt = Total Borrowings + Current Portion of Long Term Borrowings + Obligations under Finance Leases. 15 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 14: Yingde Share Price vs. HSI Yingde’s Stock Price Appreciated From HK Connect Program and Not Improvement in Fundamentals Yingde Gases vs. HSI (Feb 2015 - ) 30000 10 ~30% Price Appreciation Between April 8th /10th Without Any Change in Fundamentals 28000 9 8 26000 7 24000 6 5 22000 4 20000 3 Volume (Yingde) Volume (HSI) HSI Yingde YINGY Exhibit 15: EBITDA vs. Cash Flows from Operations Despite “Robust” Revenue & Accounting Earnings Growth, EBITDA And CFO Has Been Increasingly Divergent EBITDA EBITDA Margin % CFO CFO as % of EBITDA Source: Company filings. 2008 2009 2010 2011 2012 2013 2014 567.0 736.0 1,124.0 1,367.0 1,450.0 2,024.0 2,480.0 40.1% 35.6% 37.4% 32.2% 29.1% 29.3% 32.0% 514.0 479.0 732.0 974.0 919.0 955.0 925.0 90.7% 65.1% 65.1% 71.3% 63.4% 47.2% 37.3% Earnings quality is increasingly deteriorated with wider & wider discrepancy 16 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 16: Free Cash Flows Yingde’s Business Model has Realized Increasingly Negative Free Cash Flows for 8 out of last 9 Years FY2006 was the only FCF positive year (barely) 426 199 155 2000 831 577 571 908 770 904 Earnings quality deterioration with markedly different negative FCF to net income 0 91 (483) (156) (410) (1198) -2000 (1088) (1203) (1736) Capex to fund ASUs are typically twice that of cash flow from operations and distort the reliability of accounting earnings -4000 (2863) Since 2008, the accumulation of negative FCF has burnt a hole of over RMB 9.0 billion! -6000 2006 2007 2008 Cash From Operations 2009 CapEx 2010 2011 2012 Free Cash Flow 2013 2014 Net Income Source: Company filings. Exhibit 17: Receivables Aggressively Recorded Receivables Grew More than 2x as Fast as Booked Revenues Since FY2008 Trade & Other Receivables 2008 2009 2010 2011 2012 2013 2014 126.7 371.6 748.9 1029.2 1319.7 1792.4 2844.6 193.3% 101.5% 37.4% 28.2% 35.8% 58.7% 2065.7 3004.9 4240.3 4955.9 6865.5 7716.2 46.3% 45.5% 41.1% 16.9% 38.5% 12.4% Growth Over Prior Year Total Operating Revenues 1411.7 Growth Over Prior Year 08' - 14' CAGR 68.0% 32.7% Source: Company filings. Exhibit 18: Adjusted EV/EBITDA vs. Competitors Comparable Companies Analysis: “Discounted” P/E and EV/EBITDA are Highly Misleading Company Name Yingde Share Price (Trading Currency) Price-toEarnings Enterprise Value (US$) LTM EBITDA (US$) EV/LTM EBITDA LTM Capex (US$) LTM Implied EBITDAUnlevered LTM LTM EV/(EBITDANet Free Cash FCF Capex LTM Capex) Debt/EBITDA Flow (US$) Yield HK$7.00 11.3x 3,199.2 389.6 8.2x 325.0 64.6 49.5x 3.7x (171.7) NM Linde EUR 180.13 30.5x 46,236.8 4,031.5 11.5x 2,125.4 1,906.1 24.3x 2.2x 1251.8 2.7% L'Air Liquide SA EUR 119.30 24.7x 51,776.1 4,177.1 12.4x 2,065.4 2,111.7 24.5x 1.7x 994.8 1.9% Praxair US$122.46 21.4x 45,038.4 3,885.0 11.6x 1,689.0 2,196.0 20.5x 2.4x 1315.8 2.9% Air Products US$150.06 31.6x 38,450.4 2,662.1 14.4x 1,739.6 922.5 41.7x 2.2x 36.8 0.1% Median 24.7x 11.6x 24.5x 2.2x (Discount)/Premium to Peers -54% -29.2% 102.0% 68.2% Source: CapitalIQ as of April 25, 2015. 17 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 19: Yingde vs. Competitors (Capital Expenditures as a % of Revenue) Yingde’s Capex has been Aggressively Growth Driven and as a Percentage of Sales Outrivals Peers 100% Yingde’s capital intensity is more volatile and much greater relative to international competitors 80% 60% 40% 20% 0% 2007 2008 Yingde 2009 2010 2011 Air Liquide Linde-BOC 2012 APCI 2013 Praxair 2014 Source: Company filings Exhibit 20: Implied Share Price Several De-rating catalysts Could Cause Yingde to Drop at Least 50% in the Next 12 Months HKD RMB FY 2015 Capital Expentitures 2500 2000 Assumed from Management Guidance FY 2014 EBITDA 3100 2480 Corporate filings FY2015 EBITDA 3255 2604 Conservative 5% assumption FY2015 EBITDA - Capex Net Debt 755 604 12076 9661 Shares Oustanding Implied EV (24.5x Median Multiple) 1.82 billion Assumptions: As of FY2014 Corporate filings 18512 14809 3.54 2.83 Implied Downside to Current Price -49.5% -49.5% Currently trading @ HK$7.0 / RMB 5.6 Implied EV (20x Multiple) 15100 12080 Still a very generous multiple 1.66 1.33 -76.3% -76.3% Implied Share Price Implied Share Price Implied Downside to Current Price Currently trading @ HK$7.0 / RMB 5.6 Source: Company filings, CapitalIQ. Note: Figures reported in RMB millions on company filings. 1 RMB = HK$ 1.25 as of April 26, 2015. 18 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 De-rating Catalysts for 50% Implied Downside 20 1. Most noticeably, if Yingde loses its lawsuit against the state owned enterprise steel mill, they will be unable to recover the RMB 406 million of receivables that they are currently owed and record material impairment losses. Not only will this affect management’s ability to continue coming to market, but it could quite easily negatively spillover into Yingde’s remaining Chinese customers who could be more inclined to breach their contract. 2. Yingde’s future profitability and meager cash flows can continue to be choked if customers keep refusing payments or in the event of early termination of contracts (if customers shut down, go bankrupt or are acquired as part of the Government’s steel industry consolidation process). A complete loss of a customer due to bankruptcy or failing operations will hit Yingde’s top line, and thus cash flows, hard (especially as consensus has turned a blind eye towards this issue causing investors to capitulate). Notably, Yingde has already recorded impairment losses previously on customer receivables due to their respective financial difficulties 20. If the effects of customer strain are substantial enough to create a liquidity shortfall (EBITDA adjusted Capex interest coverage of below 1x in FY2014), Yingde could file for bankruptcy and thus evaporate all shareholder value. 3. Yingde could also lose customers due to the political instability in China, as evidenced by their loss of the China Coal contract (a large state owned chemical enterprise that was supposed to help Yingde diversify away from steel). 4. The consolidation of smaller steel players will make larger steel facilities the new norm. Yingde risks market share losses as ongoing industry consolidation will require larger projects, heavier upfront financing and more extensive technological capabilities going forward. Such projects will be increasingly difficult to win as Yingde would have to bid against international peers (e.g. Praxair, Linde as seen below) with lower product quality, inferior ASU capacity and a waning access to financing that is already evaporating returns on capital (Appendix, Exhibit 21). 5. With their rising debt balance, challenging operating environment and interest expense, it is not inconceivable that either Moody’s will issue another ratings downgrade, or other rating agencies (Fitch, S&P) will issue a rating downgrade for Yingde. In fact, on 19th March 2015, Moody’s released another announcement “Yingde Gases' ratings pressured by weak cash flow in 2014”. Moody’s indicated that “weak cash flow in 2014 continues to pressure its Ba3 corporate family rating and the B1 senior unsecured rating on the bonds issued by Yingde Gases…the ratings outlook is negative.” Both scenarios would impact Yingde’s ability to borrow (need-induced), while also creating negative press and very likely accentuating the probability of Yingde crushing on its own weight. http://www.wsj.com/articles/why-chinese-steel-exports-are-stirring-protests-1426466068 19 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 21: Yingde Competitive Market Position Yingde Cannot Compete with MNCs on the Basis of Supply Capacity, Product Quality & Financing Source: Morgan Stanley, Industry Reports, Company Filings. Exhibit 22: History of Merchant Prices (Argon, Nitrogen, Oxygen) Merchant Market has Seen Stagnant/Declining Prices Cost of Industrial Gases (RMB/Nm3) 5 4 3 2 1 0 2010 2011 Oxygen 2012 Nitrogen 2013 2014 Argon Source: Company filings. 20 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Exhibit 23: Total and Merchant Gas Volumes Sold (Argon, Nitrogen, Oxygen) Merchant Market is More Profitable (But Unpredictable) Relative to On-Site and Can Provide a Swing Factor 2009 2010 2011 2012 2013 2014 5,383,000.0 6,496,000.0 9,815,000.0 12,660,000.0 17,831,000 20,548,000.0 Oxygen 2,987,000 3,491,000 5,515,000 6,725,000 9,437,000 10,537,000 Nitrogen 2,312,000 2,899,000 4,194,000 5,808,000 8,211,000 9,800,000 84,000 106,000 106,000 127,000 183,000 211,000 NA Merchant Gas Volumes Sold (NM3 '000) Argon Total Gas Volumes Sold (NM3 '000) 429,300 552,100 545,200 820,300 1,109,900 Oxygen 251,600 295,500 216,100 335,600 470,600 Nitrogen 100,400 186,200 251,900 376,500 515,300 77,300 70,400 77,200 108,200 124,000 6.6% 5.6% 4.3% 4.6% 5.4% Oxygen 7.2% 5.4% 3.2% 3.6% 4.5% Nitrogen 3.5% 4.4% 4.3% 4.6% 5.3% 72.9% 66.4% 60.8% 59.1% 58.8% Argon Merchant Gas/ Total Gas Sold Argon NA Source: Company filings. 21 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 Company Financial Summary: FY2014 (Dec-31-2014) Capital Structure Details Principal Due Coupon/Base Description Type (CNY) Rate Maturity Seniority Secured Convertible Currency Amount Due to a Joint Venture Other Borrowings 93.5 NA Dec-31-2015 Senior No No CNY Amount Due to an Associate Other Borrowings 270.0 NA Dec-31-2015 Senior No No CNY Bank Loans Secured Bank Loans Unsecured Convertible Notes and Warrants Unsecured Medium Term Notes Unsecured Obligations under Finance Lease Other Loans Unsecured Senior Notes I Senior Notes II Term Loans Term Loans Bonds and Notes 1,588.1 2,258.3 142.0 NA NA 8.000% 2015 Senior Senior Senior Yes No No No No Convertible CNY CNY USD Bonds and Notes 877.5 5.500% - Senior No No CNY Capital Lease 675.4 NA - Senior Yes No CNY Term Loans Bonds and Notes Bonds and Notes 148.5 2,635.9 1,550.5 NA 8.125% 7.250% 2018 2020 Senior Senior Senior No No No No No No CNY USD USD Repayment Source: Company filing, CapitalIQ. Yingde Financial Summary FY2008 – FY2014 Income Statement Summary Total Operating Revenues 2008 2009 2010 2011 2012 2013 2014 1,411.7 2,065.7 3,004.9 4,240.3 4,955.9 6,865.5 7,716.2 46.3% 45.5% 41.1% 16.9% 38.5% 12.4% 828.2 1,290.5 1,840.8 2,789.4 3,382.8 4,734.7 5,237.3 Growth Over Prior Year Cost of Sales Gross Profit 583.6 775.2 1,164.1 1,450.9 1,573.1 2,130.8 2,478.9 41.3% 37.5% 38.7% 34.2% 31.7% 31.0% 32.1% 93.7 154.8 377.9 359.6 471.4 604.0 682.9 Selling expenses 15.1 18.6 57.7 131.8 181.3 225.5 243.8 Admin. Expenses 79.9 137.5 322.5 238.6 310.4 417.6 466.0 1.4 1.3 2.2 10.8 20.2 39.1 27.0 489.9 620.4 786.2 1,091.3 1,101.7 1,526.9 1,796.1 34.7% 30.0% 26.2% 25.7% 22.2% 22.2% 23.3% 36.5 6.4 10.4 17.1 19.0 78.1 28.0 (58.5) (61.2) (128.2) (126.7) (209.8) (381.6) (520.0) Share of Results of Associates 0 0 0 (0.2) (3.5) (18.4) (10.1) Share of Results of Joint Ventures 0 0 0 0 (0.3) (1.5) (1.1) 467.9 565.5 668.4 981.4 907.1 1,203.6 1,292.8 Gross Margin % Other Costs & Expenses Other Revenue & Income Operating Profit Operating Profit Margin % Finance Revenues Finance Costs Profit Before Tax Income Tax Expense Net Profit Net Income (Attributable to Shareholders) Net Profit Margin % 39.2 33.9 135.2 145.8 135.8 294.0 380.7 428.7 531.6 533.2 835.6 771.3 909.6 912.2 426.0 571.0 577.2 831.0 770.0 908.0 904.0 30.2% 27.6% 19.2% 19.6% 15.5% 13.2% 11.7% Source: Company filings. 22 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 FY2008 – FY2014 Balance Sheet Summary Inventories Trade & Other Receivables 2008 2009 2010 2011 2012 2013 2014 9.6 6.9 30.1 32.3 61.0 68.6 97.8 126.7 371.6 748.9 1,029.2 1,319.7 1,792.4 2,844.6 Receivables Under Finance Lease 1.9 2.1 2.1 2.1 2.1 2.1 2.1 Income Tax Recoverable 0.1 3.1 0.4 6.5 0.4 0 3.8 227.4 114.9 467.6 159.0 503.5 65.0 131.0 28.5 2,102.5 970.5 958.3 846.6 342.5 606.4 394.2 2,601.0 2,219.6 2,187.4 2,733.3 2,270.7 3,685.7 1,752.0 2,191.9 3,822.7 5,076.2 5,966.8 9,400.3 10,014.6 488.7 681.1 1,024.4 992.7 3,793.8 2,551.1 3,055.5 Lease Prepayments 17.2 16.9 65.0 126.2 311.3 317.6 348.9 Intangible Assets 10.2 9.6 12.9 61.6 59.3 56.5 51.8 Receivables Under Finance Lease 13.1 14.8 14.2 13.7 13.0 12.3 11.5 0 0 100.0 399.8 706.2 684.8 483.4 Pledged Bank Deposits Cash & Cash Equivalents Total Current Assets Property, plant and equipment, net Construction in Progress Interest in Associates Interest in Joint Ventures 0 0 0 0 38.5 223.6 268.6 131.8 156.3 368.2 939.7 1,111.3 947.0 1,189.0 2.7 2.7 7.6 27.6 59.8 87.8 141.8 Total Non-Current Assets 2,415.6 3,073.2 5,415.1 7,637.4 12,059.8 14,281.1 15,565.1 Total Assets 2,809.8 5,674.2 7,634.7 9,824.8 14,793.1 16,551.8 19,250.8 Bank and Other Loans 500.3 783.0 784.0 1,115.5 3,263.3 1,194.6 1,721.1 Trade and Other Payables 572.7 479.1 1,244.3 1,363.0 2,448.7 2,181.7 2,422.3 324.1 Other Non-Current Assets Deferred Tax Assets LIABILITIES Obligations Under Finance Lease Convertible Redeemable Preferred Shares Income Tax Payable Total Current Liabilities Working Capital 3.0 3.0 3.0 10.5 37.1 257.1 141.2 0 0 0 0 0 0 7.1 9.8 55.7 73.9 70.2 110.0 186.5 1,224.2 1,274.8 2,086.9 2,563.0 5,819.3 3,743.3 4,654.0 (830.0) 1,326.2 132.7 (375.6) (3,086.1) (1,472.6) (968.3) 2,156.2 (1,193.6) (508.3) (2,710.5) 1,613.5 504.4 400.4 521.2 1,132.1 2,084.8 2,864.8 5,818.6 7,379.6 29.4 28.8 28.1 119.8 487.3 633.8 351.3 0 0 0 0 0 51.0 51.2 11.0 24.6 21.0 53.8 74.6 75.2 71.5 440.7 574.6 1,181.2 2,258.5 3,426.6 6,578.7 7,853.6 426 571 741 831 770 908 904 0 0.0 0.0 0.0 0.0 0.0 0.0 1,133.1 3,775.5 4,352.8 4,991.3 5,486.0 6,124.7 6,635.6 Changes in Working Capital Bank and Other Loans Obligations Under Finance Lease Other Non-current Liabilities Deferred tax Liabilities Total Non-Current Liabilities Net Income Share Capital Reserves Minority Interests Total Equity 11.7 49.3 13.7 12.1 61.2 105.1 107.9 1,144.9 3,824.8 4,366.6 5,003.4 5,547.2 6,229.8 6,743.5 Source: Company filings. 23 UChicago Seeking Alpha Undergraduate Case Competition (OTC: YINGY) May 4, 2015 FY2008 – FY2014 Cash Flow Statement Summary 2008 Net Income Depreciation & Amort., Total Other Amortization 2009 2010 2011 2012 2013 2014 430.1 530.0 577.3 830.8 770.1 907.9 903.9 76.9 114.4 158.3 277.5 352.4 509.9 687.0 - 0.4 0.7 1.9 5.2 7.0 8.1 0.1 (0.1) 0.3 (0.1) 0.4 0.2 0.3 Asset Writedown & Restructuring Costs - - 179.0 - - - (70.3) (Income) Loss on Equity Invest. - - - 0.2 3.7 19.9 11.2 Provision & Write-off of Bad debts - - 13.1 - - - - (Gain) Loss From Sale Of Assets (18.9) 4.7 23.3 (15.4) (63.3) (163.0) (32.2) Change in Acc. Receivable 22.6 (184.0) (232.3) (197.7) (99.8) (454.8) (640.9) Change In Inventories (4.6) 2.8 (17.3) (2.2) (28.7) (7.5) (29.2) 7.6 10.2 30.2 79.7 (21.0) 135.4 87.2 Other Operating Activities Change in Acc. Payable 513.8 478.4 732.4 974.6 919.1 954.9 925.1 (670.0) (888.4) (1,929.6) (2,178.1) (3,782.0) (2,691.2) (2,013.2) Sale of Property, Plant, and Equipment - 0.3 0.0 0.7 3.8 2.5 1.7 Cash Acquisitions - - (47.0) - - 5.2 (5.5) (13.8) Cash from Operating Activities Capital Expenditure - - (112.7) (300.0) (431.2) (129.6) 1.9 2.0 2.2 2.2 2.2 2.2 2.2 Other Investing Activities (72.9) 112.6 (352.7) 308.6 (365.6) 440.0 (64.3) Cash from Investing (741.0) (773.6) (2,439.8) (2,166.6) (4,572.8) (2,370.8) (2,092.7) Invest. in Marketable & Equity Securt. Net (Inc.) Dec. in Loans Originated/Sold Short Term Debt Issued Long-Term Debt Issued 1.4 - - 27.7 516.2 93.5 - 580.7 1,140.5 1,957.4 2,212.8 4,573.6 4,755.2 3,386.2 Short Term Debt Repaid (1.4) - - (27.7) (58.1) (194.9) - Long-Term Debt Repaid (414.7) (737.0) (1,359.9) (831.7) (1,255.8) (3,487.5) (1,549.2) Issuance of Common Stock - 2,092.3 - - - - 1.2 Repurchase of Common Stock - - - (11.7) - - (64.0) Common Dividends Paid - - - (180.7) (234.9) (271.0) (329.3) Other Financing Activities Cash from Financing Foreign Exchange Rate Adj. Net Change in Cash (79.9) (126.4) (4.7) - 0.9 32.0 - 86.1 2,369.4 592.8 1,188.7 3,541.8 927.3 1,444.8 0 (0.3) (17.5) (8.9) 0.3 (15.5) (13.3) (141.1) 2,074.0 (1,132.0) (12.2) (111.7) (504.1) 263.8 Source: Company filing, CapitalIQ. 24