We visited Li Heng’s plant last week. Market prices of raw materials prices appear to havestabilized at around RMB15,000/ton since November. Li Heng’s nylon yarn prices have alsodeclined in tandem with raw material costs to about RMB21,000/ton, a 16% decline fromNovember. We estimate single digit gross margins in 4Q08, given that Li Heng is still digestingthe higher-priced raw materials purchased in 3Q08.

Capacity utilization rates have held up in both October and November at around 90%. Theconstruction of the polyamide chip plant is on track for trial production possibly by Jun’09. Costbenefits from vertical integration are likely to be reaped only from FY10F factoring in thegestation period. Addition of 90,000 mt in capacity is likely to be deferred to 4Q09, with

Industry players anticipating pro-export measuresThe Chinese government has unveiled policies to stimulate domestic demand. However, itappears that the industry is banking on 1) expiration of export quotas to the US in 2009, 2) likelyincrease in export tax rebate rate by 3 ppt to 17%, and 3) slower yuan appreciation – all pro-export measures – to sustain their earnings. We believe that domestic consumption has notemerged as a key driver to industry growth.

We are reducing our FY08F revenue and earnings estimates by 3% and 9% on expectations of aweaker 4Q mainly as a result of plunging ASPs. The management expects sales volume growthin FY09F due the full year contribution from the capacity expansion in early 2008, thoughabsolute sales value will fall due to lower ASPs. Chances are high that industrial demand in 2009will continue to shrink and raw material prices is unlikely to be supported, leading to even lowerproduct prices. Our gross margin estimates are lowered to 26% in FY09F from 27%, in line withthe management’s take on normalized industry margins.

Our DCF target price is lowered to $0.31. Quarterly result could get worse before it gets better.Measures such as increasing export tax rebates and lowering import taxes on raw materialscould mark the bottoming of industry profits in 2009, similar to policies and the accompanyingresults seen in 1998-99. Our FY08/09F EPS estimates are 15% and 36% below the meanestimates. With possible downside to ASP, we believe further earnings downgrades by themarket are highly likely.