Sijia Group ( 思嘉集團 ) BUY Target Price: HK$6.25 (+46%) Price: HK$4.28 HKEx Code: 1863 Mon, 25 Oct Re-rating deserved. Company Update.

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1 . Sijia Group ( 思嘉集團 ) BUY Target Price: HK$6.25 (+46%) Price: HK$4.28 HKEx Code: 1863 Mon, 25 Oct 2010 Re-rating deserved Equity Research Industrial/ China Company Update Key Data Close price (HK$) Months High (HK$) Month Low (HK$) M Avg Dail Vol. (mn) 2.68 Issue Share (mn) Market Cap (HK$mn) 3, Free Float % Net cash/share (HK$) Net debt/equity (%) Net Cash Fiscal Year 12/2008 Major shareholder (s) Lin Shengxiong (61.5%) Source: Company data, Bloomberg, OP Research Closing price are as of 27/8/2010 All figures are subject to rounding Price Chart Company Background The Group is principally engaged in the design, development, manufacture and sale of polymer processed high strength polyester fabric composite materials and other reinforced composite materials and conventional materials, as well as downstream related inflatable and waterpro of products targeting the outdoor leisure, recreation and sports consumer market. Eric Kwok/ David Yuan Oriental Patron Securities Ltd / eric.kwok@oriental-patron.com.hk david.yuan@oriental-patron.com.hk Key points: Re-rating deserved. We organized a plant visit to Sijia Group ( Sijia ) in Fuzhou on Oct 11. We were excited to see management working diligently to materialize various expansions as promised. We also noticed that investors increasingly understand and appreciate Sijia s competitive edge and high growth, which we believe is triggering a re-rating of the undervalued stock. 2 new end-products factories in Sichuan and Hubei. Two end-products factories are set up in Sichuan and Hubei, for biogas tanks and waders, to get closer to the clients and save logistics and labor costs. Both facilities will commence full production by the end of FY10 and contribute RMB320mn revenue annually, we estimate. 11 TPU production lines in Fuzhou phase II plant. Sijia will ramp up its TPU capacity by adding 10 more production lines within 1H11. It has completed R&D and sampling with clients using the existing 1 production line. We now estimate the contribution from TPU products will be RMB110mn in FY11, which is larger than we expected. A new base in Shanghai for 5 new products. Sijia will set up a new production base in Shanghai for membrane structure, water-proof coil and 3 other new products. The facility is expected to start production by 3Q FY11 and achieve full capacity in three years. We believe the base will generate annual revenue of RMB 1.7bn-1.8bn at full utilization. Reiterate BUY with a TP of HK$6.25, at 9x FY11E PE, implying 46% upside. The stock is trading at 6.2x FY11E PE, still deeply undervalued. We revised up our FY11~12E revenue by 4% and 7% to factor in the rapid expansion. Though we estimate gross margins will be slightly lower than previous forecast, for difference in end-product mix, we see no need to worry, as Sijia s strong new pipeline will secure current high margin and high growth. We revised FY10~FY12E EPS by -5%~+2%. Reiterate BUY with a TP of HK$6.25, at 9x FY11E PE, not demanding given 52% net profit CAGR FY10-12E. Exhibit 1: Investment summary Revenue ,004 1,565 2,298 Growth (%) 101% 90% 76% 56% 47% Net profit Growth (%) 146% 186% 81% 58% 44% Gross margin 39.8% 45.4% 46.6% 46.8% 46.5% Net margin 20.0% 30.0% 30.8% 31.2% 30.6% ROE 41.7% 48.8% 24.1% 30.0% 33.2% EPS (basic) P/E P/B Dividend Yield 1.0% 0.0% 3.1% 5.0% 7.1% Source: Bloomberg

2 2 new end-products factories in Sichuan and Hubei Commence within FY10. Sijia is setting up two end-products factories in Chengdu, Sichuan Province and Hanchuan, Hubei Province. The two factories are both completed with equipments ready. Sijia is now hiring and training workers. Trial production has taken place last month. Sijia plans to commence scale production by end of FY10. Getting closer to clients. Chengdu has the most developed biogas industry and many large scale biogas service companies. Sijia s Chengdu plant will mainly produce biogas tanks with an annual capacity of 100k, equivalent to ~RMB120mn sales. Sijia now sells ~60% of its biogas tanks and materials in Chengdu. By setting up the plant, Sijia will certainly work closer with its major clients. Hanchuan has several major whole-sale markets for wader and related products. Sijia s Hanchuan plant will produce waders with an annual capacity of 3m pieces, equivalent to RMB195mn to RMB225mn sales. We believe the new plant will promote Sijia s sales and distribution of wader products. Saving labor and logistics costs. The relocation of end-products capacity will save labor and logistics costs. Sijia now produces all end-products in its Xiamen factory. The labor costs of the two new factories are 30% lower than in Xiamen. The logistics costs will also be lower. As end-products are packaged and are larger in size than materials, it is more economical for Sijia to transport the materials to its major markets and produce on site. More high value-added work in Xiamen. In the future, the capacity in Xiamen will be used for high value-added work such as trial production of new end-products and production of high-end products for export, as the workers in Xiamen are better trained. Sijia is in progress of sampling and negotiating with a major aquatic leisure brand with ~USD600mn sales on ODM/OEM cooperation. 11 TPU production lines in Fuzhou phase II plant Sijia is ramping up its TPU-based material capacity in its Fuzhou phase II plant. A new generation reinforced materials with enormous market potential. TPU-based material provides characteristics superior to PVC-based material, such as higher strength and better tolerance to extreme temperature. Most importantly, it is absolutely safe and hazardless in contact with food/water/medication, while PVC-based materials are not. Thus, it has enormous market potential in f&b, healthcare, and personal care sector. Larger revenue contribution than we forecasted. Sijia has completed R&D and sampling with the existing 1 production line. Given the positive response from clients, Sijia will import 10 more production lines from Italy and Taiwan within 1HFY11. We estimate that the revenue contribution will be RMB110mn in FY11, which will exceed our previous forecast of RMB70mn. 25 October 2010 Page 2 of 5

3 A new base in Shanghai for 5 new products Why Shanghai? Sijia will set up a new production base in Shanghai for new reinforced material products, such as membrane structure and water-proof coil. Sijia used to plan to build up these capacities in Fuzhou phase II plant. It finally chose Shanghai for exposure to high-end construction market in Shanghai and nearby economically developed Jiangsu and Zhejiang province, on which its new products target. The lease contract has been signed and Sijia expects to finish the construction of plant by March of FY11. Membrane structure is increasingly used for public architectures requiring wide-open column-less space, such as stadiums, exhibition halls, and transportation terminals, because of its light weight, great strength, and self-cleaning feature. Sijia will also supply the membrane structure to its biogas customers to build biogas tanks of 1000m 3 and above for large scale biogas projects, such as livestock farms. The material is now rarely produced in China due to technology and equipment shortage. Sijia has completed sampling of narrow width products and got positive results from clients. It has customized and ordered a production line from an Italian vendor, which will be shipped once the Shanghai plant is completed. Water-proof coil is a construction material used for water-proof treatment of roofs, basements, and walls. The asphalt-based materials widely used in China are toxic to produce and use. The switch to non-toxic water-proof coil is hindered by lack of production in China. Sijia s air-tightness materials and red-mud materials are similar to water-proof coil used in developed countries. Sijia has completed narrow-width products sampling with clients. It has customized and ordered a wide-width lamination line and calender line from Italian and Taiwanese vendors, which will be shipped once the Shanghai plant is completed. Other planned products include wide-width truck cover, wide-width biogas tank material, and roller shutter door material. The facility is expected to start production by 3Q FY11 and achieve full capacity in three years. We believe the production base will generate annual revenue of RMB 1.7bn-1.8bn at full utilization. Reiterate BUY with a TP of HK$6.25, at 9x FY11E PE, implying 46% upside The stock is trading at 6.2x FY11E PE, still deeply undervalued, given Sijia s competitive edge and high growth potential in the reinforced material sector in China. We revised up our FY11E and FY12E revenue by 4% and 7% to factor in the faster than expected expansion. We estimate gross margins will be slightly lower than we previously forecasted, mainly due to difference of end-product mix. We revise down FY10~12E gross margin by 1.8ppt~2ppt, from 48.3%~48.8% to 46.5%~46.8%. However, we see no need to worry, as 1) the difference of product mix is only caused by orders of lower-end inflatable boats, and 2) strong new product pipeline will mitigate the impact of the difference. We are comfortable with Sijia s ability to maintain the current margin and meanwhile grow at a fast pace. Thus, we adjusted our FY10-12E EPS by -5%~ +2%, respectively. We reiterate BUY with a TP of HK$6.25, at 9x FY11E PE, which we believe is not demanding given 52% net profit CAGR FY10-12E. 25 October 2010 Page 3 of 5

4 Exhibit 2: Income Statement Revenue ,004 1,565 2,298 COGS ,230 Gross profit ,068 Selling and distributions costs Administrative and other expenses R&D costs EBITDA Dep & Amor EBIT Net interest costs/(income) Income tax Minority interest Net profit Dividends EPS (basic) DPS (basic) Exhibit 3: Balance Sheet Cash and cash equivalents ,056 Trade and notes receivables Due from related parties Prepayments, deposits and other receivables Inventories Assets of a disposal group classifiedas held for sale Total current assets ,096 1,654 Property, plant and equipment Prepaid land lease payments Intangible assets Total non-current assets Total assets ,453 1,855 2,427 Interest-bearing bank borrowings Trade and bills payables Other payables and accruals Due to related parties Tax payable Current liabilities Interest-bearing bank borrowings Deferred tax liabilty Others Total long-term liabilities Minority interest Issused capital Reserves ,286 1,628 2,120 Total shareholder's equity ,287 1,628 2,121 Exhibit 4: Cash Flow Net cash inflow from operating activities Net cash outflow from investing activities Net cash flows from financing activities Impact of foreign exchange rate Net change of cash October 2010 Page 4 of 5

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Except as specifically permitted, no part of this presentation may be reproduced or distributed in any manner without the prior written permission of Oriental Patron. Oriental Patron accepts no liability whatsoever for the actions of third parties in this respect. 27/F, Two Exchange Square, Tel: (852) October 2010 Page 5 of 5 8 Connaught Place, Central, Hong Kong eric.kwok@oriental-patron.com.hk Fax: (852)