New Stock Preview | Hong Kong Stock Exchange Receives Third Submission, China's Leading Potash Fertilizer Trader, Mi Gao Group, Faces Raw Material Price Increase Dilemma

2016, after being privatized and delisted from the Toronto Stock Exchange, the MGM Holdings Group Limited (hereinafter referred to as "MGM Group") has made several attempts to re-enter the Hong Kong Stock Exchange in the past two years, but the situation is not optimistic.

According to the Zhongtong Finance APP, MGM Group had submitted listing applications to the Hong Kong Stock Exchange on July 6, 2022, and February 28, 2023, but both ended up being "invalid." On September 22, MGM Group once again submitted an application for listing to the Hong Kong Stock Exchange, with GF Financing (Hong Kong) as the exclusive sponsor. This is also MGM Group's third attempt to enter the Hong Kong Stock Exchange. So, will MGM Group succeed this time?

Significant performance fluctuations and excessive reliance on major products and clients

According to the Zhongtong Finance APP, MGM Group was established in 2003 and is mainly engaged in the production and sales of various potassium fertilizer products, including potassium chloride, potassium sulfate, potassium nitrate, and compound fertilizers. As of now, MGM Group has three potassium chloride granulation lines, 40 potassium sulfate production lines, and three compound fertilizer production lines, operating in five major production facilities in Heilongjiang Province, Jilin Province, Guizhou Province, and Guangdong Province, China.

Currently, the estimated total production capacity of the company's potassium chloride, potassium sulfate, and compound fertilizer products is 390,000 tons, 400,000 tons, and 172,000 tons, respectively. In January 2019, due to changes in regional planning policies by the local government where the Chengdu production facility is located, the company also produced potassium nitrate products at the Chengdu production facility before it ceased production. Currently, the company is planning to build a new production facility in Mianyang City, Sichuan Province, which is expected to be completed in the first half of 2025. After completion, the estimated production capacity of potassium sulfate, potassium nitrate, and compound fertilizer will be 80,000 tons, 60,000 tons, and 200,000 tons, respectively.

Thanks to the advantageous geographical location of its production facilities, MGM Group has cost advantages in delivering products to customers and can respond to customer demands in a timely manner. With this advantage, MGM Group also occupies a place in the fertilizer industry. According to a Frost & Sullivan report, based on potassium fertilizer sales in 2022, MGM Group ranks third among potassium fertilizer companies in China, and among non-reserve potassium fertilizer companies in China, the company ranks second in the same way. The company accounts for approximately 6.0% of China's total potassium fertilizer sales revenue in the same year. Based on potassium chloride, potassium sulfate, and potassium nitrate sales in 2022, the company ranks third, fourth, and fifth among potassium fertilizer companies in China, accounting for approximately 7.0%, 4.0%, and 0.3% of China's potassium chloride, potassium sulfate, and potassium nitrate sales revenue in the same year, respectively. Among the top five potassium fertilizer companies in China, the company is the only fertilizer supplier that offers a comprehensive product line (potassium chloride, potassium sulfate, potassium nitrate, and compound fertilizer).

In terms of performance, benefiting from the stable growth of potassium fertilizer demand in the Chinese market, from the fiscal year 2021 to the fiscal year 2023, MGM Group's revenue was RMB 2.082 billion, RMB 3.841 billion, and RMB 4.723 billion, with year-on-year growth rates of 84.48% and 22.96%, respectively. During the same period, the company achieved net profits of RMB 207 million, RMB 397 million, and RMB 422 million, with year-on-year growth rates of 91.78% and 6.29%, respectively.

It is not difficult to see that as a fertilizer company, the performance growth of Migo Group is not stable. The explosive growth in performance in the 2022 fiscal year is mainly due to a significant increase in the average selling prices of the company's products. It is reported that since 2020, affected by global food security issues and geopolitical tensions leading to tight supply and demand of potassium fertilizers, the average selling prices per ton of the company's potassium chloride, potassium sulfate, and potassium nitrate products have increased from 1,723.9 yuan, 2,328.4 yuan, and 3,726.6 yuan in the 2021 fiscal year to 2,867.7 yuan, 3,281.5 yuan, and 4,006.1 yuan in the 2022 fiscal year. Among them, potassium chloride and potassium sulfate are the main sources of income for Migo Group. Therefore, the sharp increase in the prices of these two products has also led to a significant improvement in the company's performance in the 2022 fiscal year. Although the prices of the products have further increased in the 2023 fiscal year, the growth rate is much slower than that of the 2022 fiscal year, resulting in a relatively slow growth in performance.

Looking at the breakdown of business revenue structure, as of the 2021, 2022, and 2023 fiscal years, the sales of potassium chloride and potassium sulfate accounted for approximately 85.2%, 96.7%, and 95.3% of the company's total revenue, respectively. The remaining revenue mainly comes from the sales of potassium nitrate, compound fertilizers, as well as by-products and other products (mainly including hydrochloric acid and fertilizer additives as by-products of the potassium sulfate manufacturing process).

Among them, the proportion of potassium chloride has been increasing year by year, from 60.1% in the 2021 fiscal year to 85.1% in the 2023 fiscal year. The proportion of potassium sulfate revenue has decreased from 25.1% in the 2021 fiscal year to 10.1% in the 2023 fiscal year. It is not difficult to see that the performance growth of Migo Group is basically determined by potassium chloride.

In addition to excessive dependence on potassium chloride, Migo Group's heavy reliance on major customers is also evident. According to the prospectus, Migo Group's top five customers are mainly tobacco companies, agricultural reclamation companies, and agricultural comprehensive companies. In the 2021, 2022, and 2023 fiscal years, the sales of Migo Group's largest customer accounted for 27.9%, 22.4%, and 20.0% of the total revenue, respectively. The sales proportions of the top five customers during the same period were 58.1%, 59.4%, and 52.4% of the total revenue.

In addition to relying on major customers, MiGao Group also has a high concentration of purchases from the top five suppliers. According to the prospectus, in the fiscal years 2021, 2022, and 2023, MiGao Group's purchases from the largest supplier amounted to approximately 451 million yuan, 707 million yuan, and 977 million yuan, accounting for approximately 22.4%, 19.1%, and 29.2% of the total purchases, respectively. During the same period, the purchases from the top five suppliers amounted to approximately 1.532 billion yuan, 2.485 billion yuan, and 2.491 billion yuan, accounting for approximately 75.9%, 67.0%, and 74.4% of the total purchases, respectively.

Therefore, it can be seen that MiGao Group's performance not only excessively relies on potassium chloride but also shows a clear dependence on major customers and major suppliers. Once the demand from major customers declines, the company's performance will be significantly affected. Moreover, if major suppliers increase prices, the company may also face the risk of rising raw material costs and declining gross profit margins.

The significant increase in cost of goods sold makes it difficult to escape the impact of raw material prices.

As the largest source of revenue for MiGao Group, fluctuations in the price of potassium chloride will have a significant impact on the company's performance. For MiGao Group, which does not have its own potassium resources and relies on external procurement, the purchasing cost of potassium chloride will also significantly affect the company's gross profit margin.

Potassium chloride has always been the most commonly used potassium fertilizer in China and can be used for growing a variety of crops. With the vigorous development of agriculture in China, the demand for potassium chloride is increasing. According to Sullivan's report, in 2022, China's sales volume of potassium chloride reached 15.38 million tons, accounting for 77.4% of the total sales volume of potassium fertilizers. The sales volumes of potassium sulfate and potassium nitrate reached 3.73 million tons and 0.76 million tons, respectively. Looking ahead, it is predicted that the market size based on sales volume of potassium fertilizers will further increase. The sales volume of potassium chloride will increase from 16.53 million tons in 2023 to 18.05 million tons in 2027, with a compound annual growth rate of 2.2% from 2023 to 2027. The sales volumes of potassium sulfate and potassium nitrate will reach 4.46 million tons and 0.91 million tons, respectively, with compound annual growth rates of 3.0% and 2.5% from 2023 to 2027.

Due to the limited potassium resources in China, a large part of the annual demand for potassium chloride is met through imports. In 2022, approximately 50% of China's total sales volume of potassium chloride came from foreign countries. According to data released by the General Administration of Customs of the People's Republic of China, the import volume of potassium chloride increased from 7.456 million tons in 2018 to 7.935 million tons in 2022, with slight fluctuations. In 2022, Canada, Belarus, and Russia were the top three importers of potassium chloride to China, accounting for approximately 30.2%, 24.1%, and 21.5% of China's total imports of potassium chloride, respectively.

According to the Dolphin Research, the distribution of global potash reserves is relatively uneven, with the majority of recoverable reserves concentrated in a few countries. Among them, Canada, Belarus, and Russia are the top three countries with the highest reserves in the world. According to data from the US Geological Survey (USGS), these three countries accounted for over 60% of the global potash reserves in 2022. China has approximately 170 million tons of potash reserves (in terms of K2O equivalent), ranking fourth in the world. However, most of China's potash reserves have low grades or are difficult to extract from deep brine deposits.

According to USGS data, the global potash fertilizer production in 2022 was 50.2 million tons, with Canada accounting for 40% of the global potash mineral production, followed by China at 15%, Russia at 13%, and Belarus at 8%. Due to the Russia-Ukraine conflict and international sanctions against Belarusian producers, China's share of potash production is expected to slightly increase in 2023. However, due to the impact of reserves, it will be challenging for China to achieve significant growth in potash production.

Therefore, it is common practice for Chinese potash fertilizer producers and suppliers to rely on a few overseas potassium chloride producers for potassium chloride supply, and the Dolphin Research is no exception. In the fiscal years 2021, 2022, and 2023, the Dolphin Research purchased approximately 927,000 tons, 1.31 million tons, and 1.01 million tons of potassium chloride from external sources, with total procurement amounts of approximately 1.568 billion yuan, 3.209 billion yuan, and 3.026 billion yuan, accounting for approximately 77.7%, 86.6%, and 90.4% of the total procurement amounts during the same period, respectively. In 2023, in terms of quantity, the company's purchases from domestic suppliers accounted for 93.2%, while purchases from overseas suppliers accounted for 6.8%.

Indeed, the Dolphin Research's direct purchases from overseas account for a relatively small proportion, but the prices of potassium chloride purchased domestically are even higher than those purchased directly from overseas. According to the prospectus, the average purchase prices per ton of potassium chloride from overseas suppliers by the Dolphin Research were approximately 1,539.8 yuan, 2,657.4 yuan, and 2,297.9 yuan in the fiscal years 2021, 2022, and 2023, respectively. And during the same period, the average purchase prices per ton of potassium chloride from domestic suppliers were approximately 1818.4 yuan, 2366.6 yuan, and 3047.1 yuan, respectively. Meanwhile, Dolphin Research's proportion of potassium chloride purchases from domestic sources increased from 54.7% in the 2021 fiscal year to 93.2% in the 2023 fiscal year. Although domestic potassium chloride prices are higher than those obtained through direct overseas purchases, Dolphin Research significantly increased its domestic procurement proportion. This may be due to the conflict between Ukraine and Russia, forcing Dolphin Research to accept higher prices for domestic purchases.

In the face of continuously rising raw material costs, Dolphin Research acknowledges that its gross profit margin will be affected. Among the cost of goods sold, the cost of direct materials accounted for approximately 95.9%, 97.9%, and 97.5% of the total sales cost from the 2021 fiscal year to the 2023 fiscal year, respectively. Among all direct materials, the procurement cost of potassium chloride accounted for approximately 77.7%, 86.6%, and 90.4% of the total procurement cost of all direct materials during the period. If the price of potassium chloride continues to rise and the company is unable to pass on the cost to downstream customers, the company's revenue and profit growth rate will further slow down, and even negative growth may occur.

It is worth mentioning that despite the continuous increase in costs, Dolphin Research plans to continue expanding production. Regarding the use of funds raised through this IPO, the company stated in the prospectus that it will build facilities for granulation, processing, packaging, and storage of potassium chloride in the Heilongjiang logistics and production center. After the completion of the Heilongjiang logistics and production center, Dolphin Research's potassium chloride production capacity is expected to increase from 390,000 tons to approximately 1.39 million tons, and its storage capacity will increase by 500,000 tons.

Further expansion is expected to enhance the company's scale in the industry. However, without being able to pass on costs and escape the situation of rising raw material prices, large-scale expansion may instead erode the company's profits and even lead to losses.