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Business Review - For the year ended December 31, 2011
Rare Earth Business
The turnover of the Group’s continuing operations of rare earth business increased by over 150% from HK$693,702,000 last year to HK$1,765,808,000 while gross profit margin also increased to more than 50%.
Rare earths are becoming increasingly important in the wide range of industrial applications, and their role in the global economy has become more widely appreciated around the world. These trends, together with Chinese Government’s protective policies, especially the “National Guideline to Support the Sustainable and Healthy Development of Rare Earth Industry from the State Council”, have driven the strong domestic and overseas demand for rare earths and led to an unprecedented surge in rare earth prices in the first half of 2011. Prices of some of the rare earth elements have seen growth in multiples of up to five to seven times during the first half of 2011. Although the prices of rare earth products have started to reduce from their peak last July to August due to the reduction of inventory by traders and deferred procurement by customers, prices still registered substantial hikes in annualised terms. Domestically, the average selling prices of most rare earth products were several times higher than in 2010. The prices of praseodymium oxide and neodymium oxide tripled while those of dysprosium oxide, ytterbium oxide and yttrium-europium co-precipitates were four-to-five times higher. Prices of samarium oxide, gadolinium oxide and cerium oxide soared more than six-fold. Facing stricter export quota limits, export prices have been significantly higher than domestic sales prices. The average export prices of ytterbium oxide, gadolinium oxide and holmium oxide have been nearly doubled those of domestic prices during the year under review, while those of samarium oxide, yttrium oxide and neodymium oxide were more than three times higher.
During the year under review, various responsible authorities in China conducted large scale environmental protection inspections on all the rare earth enterprises in the country. Enterprises which failed to meet the relevant standards would be forced to suspend operations. These requirements and their subsequent enforcement show the determination of the Government to protect the environment of the nation and all the rare earth enterprises attached importance to this move. The Group has constantly promoted environmental protection and has already complied with environmental protection standards. However, as a leading enterprise in China’s rare earth industry, it has devoted more resources in upgrading its production facilities and sacrificed part of the production time to continually conduct self-evaluation exercises on its environmentally-friendly production. Despite of the decrease in production volume during the year under review, the Group’s achievement in environmental protection has gained recognition from responsible Government authorities. Apart from the drop in production volume, the gradual decline in the average selling price of domestic rare earth materials in China in the second half of the year and the intervention of the China’s customs on the export price of rare earth products have also affected the export market. In response to the rising price trend, some of the overseas customers have decided to take a wait-and-see attitude and reduced their inventory. As a result, most of the rare earth enterprises in the country did not fully utilise their export quotas in 2011. Nevertheless, the Group has used all of its allocated export quota through its Hong Kong arm. During the year under review, the Group sold approximately 2,000 tonnes of rare earth oxides, down by more than 30% compared to last year.
As for downstream products, Wuxi Xinwei Fluorescent Materials Company Limited, one of the Group’s wholly-owned subsidiary, completely suspended production of fluorescent materials in the second half of 2011. Alternatively, Phase I of the production facility of OSRAM (China) Fluorescent Materials Co., Ltd., which was jointly invested by the Group and OSRAM GmbH, commenced trial production in July 2011, with some output placed on the market. As some of the equipment requires a longer time for the production team to complete testing for full operation, the factory has not commenced mass production and is expected to generate notable profit contribution for the Group after it ramps up for full production later in 2012. This facility, deploying some of the world’s most advanced equipment, will ensure that its operation and procedures are executed in an environmentally-friendly manner.
For rare earth metals, since rare earth oxides are a key raw material of rare earth metals yet the price rises of rare earth metals lagged behind that of rare earth oxides, hence the Group concentrated its effort to boost the sales of rare earth oxides which enjoys higher gross profit margins. This shift caused a drop in sales of rare earth metals of approximately 80% to less than 100 tonnes for the Group’s subsidiary – Heping County Dongye Rare Earth Company Limited. Nevertheless, as the average selling price of its products more than tripled when compared to last year, the turnover decreased by only about 30%.
Geographically, as the export prices were far higher than domestic prices, the proportion of turnover generated by the export market increased from 18% on average to around 37%, with Europe, Japan and the US occupying 20%, 9% and 7% respectively, and the PRC market accounting for the remaining 63%. As for upstream rare earth salts business, the Chinese Central Government has stepped up efforts to implement stronger restrictions on the mining of rare earth resources, leading to the dominance of state-owned large enterprises in the market. This policy has adversely affected the Group’s supply of raw materials at its rare earth salts production lines in Hunan. From January to July 2011, Jianghua Yao Nationality Autonomous County Xinghua Rare Earth Company Limited, a subsidiary of the Group, has produced less than 1,500 tonnes of rare earth salts products. In view of the Chinese Government’s tighter controls in the extraction of rare earth mines, the Group adjusted its development strategy to match the national policy by disposing of its entire interest in the subsidiary at a consideration of RMB257,000,000 in August 2011, an increase of RMB47,000,000 over the acquisition price of RMB210,000,000 in 2008. This move led such business to become discontinued operation. After factoring in the appreciation of Renminbi in the past few years, such discontinued operation presented a profit of HK$15,661,000 in the financial statements of the year, less than the profit of selling 5,200 tons of rare earth salts products last year. After disposal, the Group has managed to restructure its business by focusing more on the development of its middle and downstream businesses.
Refractory Materials Business
Total turnover of the Group’s refractory materials business rose slightly by around 6% from HK$423,053,000 in 2010 to HK$447,546,000 and the gross profit margin was about 21%.
During the year under review, the demand from the glass and steel industries has slowed down and therefore the demand for refractory materials has lagged behind that of other businesses. In 2011, the average selling price of the Group’s ordinary refractory materials increased slightly when compared with last year. For example, the price of alumina-graphite bricks rose by about 10% against last year while the price of magnesiaalumina spinel bricks and fused magnesium-chrome bricks grew by less than 20%. Total sales volume decreased by around 10% to about 40,000 tonnes over last year. The drop of sales volume has pushed up the average cost of the products and the gross profit margin of refractory materials for export to Japan has also declined. As a result, overall gross profit margin of the ordinary refractory materials has shrunk to about 17%.
As for high temperature ceramics, after several production lines were shut down in mid-2010, only the workshop for the Sialon product series remained in operation in the whole year of 2011. During the year under review, the Group sold a total of approximately 4,500 tonnes of products, a drop of approximately 60% when compared with last year. The average selling price remained at a level similar to last year’s, fluctuating within a 10% range and the gross profit margin was about 20%.
Regarding the magnesium grain business, the sales volume of the Group’s fused magnesium grain slightly increased by about 5% over last year to 16,000 tonnes, with the average selling price remaining at a similar level to that of 2010. The gross profit margin was about 16%. The Group’s high purity magnesium grain project commenced production in late 2010. It has sold approximately 43,000 tonnes in the year, with sales amount exceeding HK$60,000,000 and a gross profit margin of around 24%.
In June 2011, the Group set up another joint venture, Yixing AGC Ceramics Co., Ltd., with Asahi Glass Ceramics Co., Ltd. from Japan to construct a plant to produce shaped and sintered refractory materials for the cement industry. Introducing advanced Japanese technologies to China, the major part of the factory, including a high temperature tunnel kiln, is to be completed soon. A trial run is scheduled in April 2012. Its annual production target is 34,000 tonnes and the total investment cost is US$29,800,000.
By market segment, the total turnover of the refractory materials business was similar to that of the previous year, with 78% for the domestic market in China and 22% for export.
Source: China Rare Earth (00769) Annual Results Announcement
