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QUARTERLY EARNINGS UPDATE 2Q13

DANANG RUBBER JSC (DRC:HOSE)


HOLD
1-Y TP 42,500 VND

New tires for a new course

Trang Pham
trangph@ssi.com.vn +84-4 3 936 6321 ext 537
Current price (VND) Target Price (12M): Recommendation (12M): Short-term Rating (<3M): Sector Rating: Date of Report: 40,000 42,500 HOLD HOLD Neutral 13 August 2013

In order to protect sales from stagnant demand, besides an official discount of ~3% in 1H13, DRC had to conduct significant price cut of ~ 10% on average for its main products. Therefore, although natural rubber accounts for around 40% CoGS and its price has dropped ~ 21% YoY, gross profit margin of DRC did not improve at a corresponding pace. Ending 1H13, DRC has completed 47% sales and 60% profit target for the year. We see the trend of change in product mix of DRC: In 1H13, the company increasingly sold agriculture tires and OTR tires, with 1H13 volume equivalent to 146% that in 2012. We think that this is a smart strategy of DRC to focus on niche market to protect sales amid current weak demand. This also implies that DRC might gain more market share in this segment. In our recent quick visit to tire agents and tire distributors in Ho Chi Minh City area, we are confirmed that DRCs product position is concrete. What we found is that DRCs product competitiveness is high, especially for heavy truck tire and OTR tire. With various specifications, DRC is dominant in niche market for container tractor- head and tractors operating in mining field. Earnings estimate revision: For 2013, as we see that DRC conducts larger selling price cut than expected, thus we revised net sales from VND 3312 bn to VND 3201 bn ( growing 11% YoY) while newly estimated PBT comes at VND 496 bn, up 19% YoY and lower than our previous estimate of VND 520 bn. 2013 EPS would be VND 4,477 Management provides guidelines for 3Q13: VND 830 bn in net sales (adding 27% YoY and 8% QoQ) and VND 120 bn in PBT (up 22% YoY but down 18% QoQ). For 2014, we set a growth of 24% in net sales and -8.5% in PBT. Sales growth stems from new product lines (incremental sales of VND 1,050 bn) while deteriorating profit is due to higher interest expense and higher depreciation expense (which eats up CoGS).

Key figures Market Cap. (USD mn): Market Cap. (VND bn): Outstanding shares (mil) 52-week high/low (000s, VND) Average 6-month volume Foreign ownership (%) State ownership (%) Management ownership (%) Stock performance 154 3248 83 19.4/42.5 834,736 21.3% 51% N.a

Investment Opinion:
We suggest to HOLD the stock for the time being at the 1-yr TGP of VND 42,500/shares, meaning 8% upside from market price as of August 12.

Short-term view:
Company Snapshot

Source: Bloomberg

We believe that 2Q13 fruitful earnings result and high dividend have priced in the stock price. In coming 3-6 months, there would be no significant upside catalyst for DRC, especially when the new plant comes to operation might resulting lower profit QoQ. However, we are convinced that year plan is easily to be surpassed and 2013 business result would still turn out to be positive. Investors could wait for price retreat for an attractive entry level. Financials (unit) Net revenue Gross profit Pretax income Net income EPS (VND) Debt/Equity BVPS (VND) P/E P/B EV/EBITDA 2010 2,160 376 261 196 6,376 0.30 23,830 6.27 1.68 4.20 2011 2,637 416 264 198 4,282 0.54 19,160 3.99 0.90 3.70 2012 2,785 594 417 313 4,515 0.76 17,071 5.69 1.52 5.49 2013F 3,201 753 496 372 4,477 1.00 19,152 8.73 2.04 4.44 2014F 3,956 799 436 340 4,098 0.88 22,270 9.54 1.76 4.42

Da Nang Rubber JSC was equitized in 2006 with Vietnam Chemical Corporation (Vichem) holding 51% ownership. DRC manufactures tires and tubes for bicycles, bikes, cars and truck, for the last of which, DRC is the domestic market leader. DRC has more than 100 1st-tier agents nationwide, more than 10 are manufacturers and big corporate consumers, and 25 countries of export. Together with two other tire companies under Vichem, The Southern Rubber Industry JSC (HOSE:CSM) and Sao Vang Rubber JSC (HOSE: SRC), the three firms are now accounting for 50% of total domestic cars/trucks tire market, and more than 70% domestic motorbike and bike tire market.

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

REVIEW ON 2Q13FINANCIAL RESULTS


(bn VND) Net sales Gross profit EBIT EBITDA Pretax profit Net income NI attributable to shareholders 2Q13 770.3 196.5 147.3 147.3 146.1 109.6 109.6 2Q12 775.7 157.6 116.3 116.3 115.1 86.3 86.3 YoY -0.7% 24.6% 26.6% 26.6% 26.9% 27.0% 27.0% 1Q13 608.0 146.2 105.3 105.3 104.2 78.2 78.2 QoQ 26.7% 34.4% 39.9% 39.9% 40.1% 40.2% 40.2% Completion of 2013 target 47% Margin 2Q13 25.5% 19.1% 19.1% 19.0% 14.2% 14.2% 2Q12 20.3% 15.0% 15.0% 14.8% 11.1% 11.1% 1Q13 24.0% 17.3% 17.3% 17.1% 12.9% 12.9% 2012 21.3% 15.3% 17.0% 15.0% 11.2% 11.2%

60%

Focus on OTR tires to boost sales


In 2Q13, net sales increased 26.7% QoQ mostly on seasonal reason and stood almost identical YoY. Given the fact that on average DRC officially cut selling price by 3% since September 2012, unchanged sales imply the fact that volume has advanced YoY. Net profit escalated 27% YoY and 40% QoQ, mainly stemming from improved gross profit margin from 20.3% in 2Q12 and 24% in 1Q13 to 25.5%. Ending 1H13, DRC has completed 47% sales and 60% profit target for the year. In 1H13, automobile tires & tubes account for 82.2% of total sales, following by motorbike tire & tube (8.3%) and bike tire & tube (6%). Sales volume of heavy truck tire, light truck tire and OTR tire reached 97,483; 221,165 and 41,402 units respectively. These volumes represent 43%, 49% and 146% those in 2012. For the whole year, DRC sets the target of selling only 680,000 bias tires (4% lower YoY) and we do think that the company would surpass this plan as in 1H13, DRC already sold 360,000 units. We also see the trend of change in product mix of DRC: In 1H13, the company increasingly sold agriculture tires and OTR tires, with volume equivalent to 146% that in 2012. We think that this is a smart strategy of DRC to focus on niche market to protect sales amid current weak demand. This also implies that DRC might gain more market share in this segment. Recently, we have conducted a quick visit tour to tire agents and tire distributors in Ho Chi Minh city area, and are confirmed that DRCs product position is concrete. What we found is that DRCs product competitiveness is high, especially for heavy truck tire and OTR tire. With various specifications, DRC is dominant in niche market for container tractor- head and tractors operating in mining field. For the same product specification, DRC selling price is around 15% lower than imported products like Bridgestone, Michelin. However, we also see that low quality Chinese product like Jikyu has large discount (~16%) for radial tire in the same product specification.

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

Average selling price cut to hold back GPM improvement.


If we just simply ignore lagging factor (which is important yet we cannot verify) we will see the relatively negative correlation of Natural rubber price and GPM of tire makers in general and DRC in typical. We observe a continuous momentum of improving GPM in 2Q13 of DRC as average (quarterly) rubber price in 2Q13 retreated 21% YoY and 14% QoQ. In 2Q13, GPM increased to 25.5% from the level of 24% in 1Q13, in comparison with 21.3% in 2012. Figure 1: Quarterly GPM of DRC (LHS) and average selling price (assuming that companies stock rubber 1 quarter in advance)

35.0% Gross margin (%) 30.0% 25.0% 20.3% 20.0% 15.0% 10.0% 5.0% 0.0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 15.4% 17.1% 12.2% 18.3% 16.0% 20.7% Average NR price 28.8% 24.0%

6,000 5,000 25.5% 4,000 3,000 2,000 1,000 0

Source: DRC, VRA However, in order to protect sales from stagnant demand, besides a discount of ~ 3% in 1H13 (which was recorded as sales deductions), DRC had to conduct significant price cut of around 10% on average. Therefore, although Natural rubber accounts for around 40% CoGS and its price has dropped around 21% YoY, gross profit margin of DRC did not improve at a corresponding pace. Nevertheless, we see the trend of GPM improvement for bias tire product is consistently supportive for DRC in coming quarters on expectation of continuous weak NR price toward this year-end.

Radial plant to start commercial operation from 3Q13


We see on the balance sheet that by end of 2Q13, fixed asset of DRC increases by VND 1545 bn, which represents for the new plant. Up to date, DRC finances 70% total CAPEX by bank loan (~VND 1000 bn). Machinery and equipment packages are worth USD 37.5 mn (~VND 800 bn), the remainders are construction and other packages. Lending cost will be adjusted every quarter.

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

DRCs management asserts that demand for radial tire (both in export and domestic markets) is potential, as long as DRCs products obtained certificates of quality required by specific markets (DOT for the North American market, VMAC for Eurozone, SNI for Asean market). It was announced on DRCs website that on the new plant inauguration day, DRC signed the contract of providing 120,000 tires per year for Stamford Tires international. According to the management, half of product specifications have been handed over and the testing phase is almost finished.

Consistent inventory policy


We observe that DRCs policy of stocking material seemingly have been consistent in recent years. The firm stocks raw material at highest volume by end of every years fourth quarter when it expects NR price would go up during leaf-shredding season happening from February to May. Raw material normally accounts for 30-40% inventory. Figure 2: Inventory level as percentage of sales of DRC (LHS) and CSM

60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

Source: companies quarterly FSs

Why DRC has lower Gross profit margin but higher net profit margin than CSM in recent 6 quarters? (Figure 3, 4)

DRC offers larger selling price cut than CSM on different distribution model: DRC focuses on exclusive 1 -tire distributors, directly offering them selling price cut while CSM has more small-scaled agents, requiring the company to pay higher marketing expenses and promotion. In 1H13, DRC conducts a price cut of around 10% for its main products while CSMs price cut at only ~5% on average. We suppose that slowing demand, especially from public investment, port& logistics has caused DRC to largely reduced selling price to protect sales.
st

Besides, DRCs sale reductions (mainly discount) was always higher than CSM: for instance in 1H13, DRC: 2.8% vs. CSM: 1.2%. (figure 5)

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

However, CSM normally has higher and increasing selling expense than DRC, as CSM had to do more advertisements and marketing activities, which lowers net profit margin of CSM (figure 4) Similarly, CSMs administrative expense is higher than DRC as CSM has cumbersome corporate structure with more plants located in different locations and larger distribution network. CSM also has higher financial expense than DRC. (figure 7,8)

Figure 3,4: DRC and CSMs Gross profit margin (LHS) and Net profit margin (RHS) in recent 10 quarters
60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% CSM DRC

16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

DRC

CSM

Source: Companies data Figure 5, 6: DRC and CSMs sales reduction as percentage of sales (LHS) and selling expense (RHS) as percentage of sales
7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%

DRC

CSM

4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1Q112Q113Q114Q111Q122Q123Q124Q121Q132Q13 Source: Companies data DRC CSM

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

Figure 7,8: DRC and CSMs administrative expense as percentage of sales (LHS) and fiancnial expense (VND mn)
8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 10,000 40,000 30,000 20,000 DRC CSM

60,000 50,000 DRC CSM

Source: Companies data

OTHER CORPORATE EVENTS/DEVELOPMENTS

DRC recently announced that the deadline for automobile bias tire plant removal is extended till June 2014; therefore, we believe that DRC would be able to manage operation so that impact on production is minimal.

Recent movement of SBV to devalue VND by 1% has caused VND 4 bn increase in forex loss and VND 6bn unrealized forex loss (while it was nils in the same period last year). DRCs exposures to USD/VND exchange rate including: USD-denominated bank loan on radial plant and the USD amount to import synthetic rubber and other materials (which used to be largely offset by USD-denominated revenue from export sales).

DRC has completed dividend payment for 2012 in May 13. Since then, stock price gained 19%, which was in line with our expectation.

EARNINGS ESTIMATE REVISION


2013-2014 is the transitional period: For 2013, as we see that DRC conducts larger selling price cut than expected, thus we revised net sales from VND 3312 bn to VND 3201 bn ( up 11% YoY) while newly estimated PBT comes at VND 496 bn, up 19% YoY and lower than our previous estimate of VND 520 bn. 2013 EPS would be VND 4,477.
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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

Management provides guidelines for 3Q13: VND 830 bn in net sales (adding 27% YoY and 8% QoQ) and VND 120 bn in PBT (up 22% YoY but down 18% QoQ). We suppose that DRC will count sales and profit from new product lines in to estimation. If the plan for 3Q13 is met, DRC will completed 72% revenue plan and 89% profit plan for this year. We do believe that 3Q13 target is attainable. For 2014, we set a growth of 24% in net sales and -8.5% in PBT. Sales growth stems from new product lines (incremental sales of VND 1,050 bn) while deteriorating profit is due to higher interest expense and higher depreciation expense (which eats up CoGS). In 2014-2018 period, revenue and profit CAGRs are estimated at 16.1% and 16.7% respectively, which are sound for a growth company like DRC.

INVESTMENT OPINION
The newly completed radial tire plant is the key factor to pump up growth for DRC in the long term It is estimated that current demand for radial tire in Vietnam market is around 3 million, of which demand for heavy truck tire is approximately 1 million. New plant with focus on heavy truck tire having capacity of 300,000 units in the first phase and 600,000 in the second phase is set to carter this market, which is now fully controlled by import products. 1-yr TGP of VND 42,500/shares, meaning 8% upside from current market price is derived from combination of DCF (fair value of share comes at VND 46,758/share) and Multiple valuation (target 1-yr PER of 9x). We suggest to HOLD the stock for the time being. Short-term view: We believe that 2Q13 fruitful earnings result and high dividend have priced in the stock price. In coming 3-6 months, there would be no significant upside catalyst for DRC, especially when the new plant comes to operation might resulting lower profit QoQ. However, we are convinced that year plan is easily to be surpassed and 2013 business result would still turn out to be positive. Investors could wait for price retreat for an attractive entry level. Catalyst to watch in short-terms: Raw material price, especially natural rubber price: Any further dip may triggers positive sentiment for investors Selling of new products: better than planned selling volume or gaining new contract might be positive for DRC

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

APPENDIX
VND Billion Balance Sheet + Cash & Cash equivalent + Short-term investments + Account receivables + Inventories + Other current assets Total Current Assets + LT Receivables + Net Fixed Assets + Investment properties + LT Investments + Goodwill + Other LT Assets Total Long-Term Assets Total Assets + Current Liabilities In which: short-term debt + Non-current Liabilies In which: long-term debt Total Liabilities + Contributed capital + Share premium + Retained earnings + Other capital/fund Owners' Equity NCI Total Liabilities & Equity Cash Flow CF from operating activities CF from investing activities CF from financing activities Net increase in cash Beginning cash Ending cash Liquidity Ratios Current ratio Acid-test ratio Cash ratio Net debt / EBITDA Interest coverage Days of receivables Days of payables Days of inventory Capital Structure Equity/Total asset Liabilities/Total Assets Liabilities/Equity Debt/Equity ST Debt/Equity 2011 78 0 300 822 14 1,213 0 384 0 8 0 16 408 1,622 549 287 189 187 737 462 3 243 176 884 0 1,622 2012 76 0 212 722 45 1,054 0 1,405 0 8 0 20 1,433 2,487 534 117 771 771 1,305 692 3 335 151 1,182 0 2,487 2013F 3 0 270 808 2 1,084 0 1,930 0 0 0 22 1,952 3,036 559 171 1,151 1,151 1,710 831 -135 582 48 1,326 0 3,036 2014F 140 0 334 1,042 3 1,519 0 1,820 0 0 0 28 1,849 3,367 784 316 1,042 1,042 1,826 831 -135 798 48 1,542 0 3,367 VND Billion Income Statement Net Sales COGS Gross Profit Financial Income Financial Expense Selling Expense Admin Expense Income from business operation Net Other Income Income from associates Profit Before Tax Net Income Minority interest NI attributable to shareholders Basic EPS (VND) BVPS (VND) Dividend (VND/share) EBIT EBITDA Growth Sales EBITDA EBIT NI Equity Chartered Capital Total assets 2011 2,637 -2,221 416 8 -65 -51 -50 258 6 0 264 198 0 198 4,282 19,01 4 0 279 320 2012 2,785 -2,191 594 4 -45 -60 -82 412 5 0 417 313 0 313 4,515 16,89 9 2,000 426 472 2013F 3,201 -2,448 753 7 -104 -70 -96 489 6 0 496 372 0 372 4,477 19,15 2 1,500 566 732 2014F 3,956 -3,157 799 8 -173 -87 -119 429 8 0 436 340 0 340 4,098 22,27 0 1,500 565 735

22.1% 0.3% 3.5% 0.7% 20.0% 50.0% 52.4%

5.6% 47.5% 52.4% 58.2% 33.3% 50.0% 53.4%

15.0% 54.9% 32.9% 19.0% 13.3% 20.0% 22.0%

23.6% 0.4% -0.1% -8.5% 16.3% 0.0% 10.9%

42 -248 176 -30 0 -30

554 -721 164 -3 0 -3

404 -682 206 -72 76 3

286 -60 -89 137 3 140

Valuation PER PBR Dividend yield EV/EBITDA EV/Sales Profitability Ratios Gross Margin Operating Margin Net Margin Selling exp./Net sales Admin exp./Net sales ROE ROA ROIC 4.0 0.9 0.0% 3.7 0.4 5.7 1.5 7.8% 5.5 0.9 8.7 2.0 3.8% 4.4 1.0 9.5 1.8 3.8% 4.4 0.8

2.21 0.69 0.14 0.79 17.68 21.61 6.53 104.1 9

1.97 0.54 0.14 1.28 48.44 21.75 19.86 128.5 5

1.94 0.49 0.01 1.46 8.08 19.61 24.84 114.0 3

1.94 0.60 0.18 1.73 4.38 19.81 17.62 106.9 3

15.8% 10.4% 7.5% 1.9% 1.9% 24.6% 14.7% 18.2%

21.3% 15.1% 11.2% 2.1% 2.9% 30.5% 15.2% 18.7%

23.5% 17.5% 11.6% 2.2% 3.0% 29.8% 13.5% 18.0%

20.2% 14.1% 8.6% 2.2% 3.0% 23.7% 10.6% 15.9%

0.54 0.46 0.84 0.54 0.33

0.47 0.53 1.12 0.76 0.10

0.44 0.56 1.29 1.00 0.13

0.46 0.54 1.18 0.88 0.20

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Date: August 2013

QUARTERLY EARNINGS UPDATE 2Q13

1. RATING
Within 12-month horizon, SSIResearch rates stocks as either BUY, HOLD or SELL determined by the stocks expected return relative to the market required rate of return, which is 16% (*). A BUY rating is given when the security is expected to deliver absolute returns of 16% or greater. A SELL rating is given when the security is expected to deliver returns below or equal to negative 9%, while a HOLD rating implies returns between negative 8% and 16%. Besides, SSIResearch also provides Short-term rating where stock price is expected to rise/reduce within three months because of a stock catalyst or event. Short-term rating may be different from 12-month rating. Industry Rating: We provide the analyst industry rating as follows:

Overweight: The analyst expects the performance of the industry over the next 6-12 months to be attractive vs. the relevant broad market Neutral: The analyst expects the performance of the industry over the next 6-12 months to be in line with the relevant broad market Underweight: The analyst expects the performance of the industry over the next 6-12 months with caution vs. the relevant broad market.

*The market required rate of return is calculated based on 1-year Vietnam government bond yield and market risk premium derived from using Relative Equity Market Standard Deviations method. Our rating bands are subject to changes at the time of any significant changes in the above two constituents.

2. DISCLAIMER
The information, statements, forecasts and projections contained herein, including any expression of opinion, are based upon sources believed to be reliable but their accuracy completeness or correctness are not guaranteed. Expressions of opinion herein were arrived at after due and careful consideration and they were based upon the best information then known to us, and in our opinion are fair and reasonable in the circumstances prevailing at the time. Expressions of opinion contained herein are subject to change without notice. This document is not, and should not be construed as, an offer or the solicitation of an offer to buy or sell any securities. SSI and other companies in the SSI and/or their officers, directors and employees may have positions and may affect transactions in securities of companies mentioned herein and may also perform or seek to perform investment banking services for these companies. This document is for private circulation only and is not for publication in the press or elsewhere. SSI accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or its content. The use of any information, statements forecasts and projections contained herein shall be at the sole discretion and risk of the user.

3. CONTACT INFORMATION
Phuong Hoang Trang Pham Director, Institutional Research & Investment Advisory Research Analyst, Consumer Discretionary phuonghv@ssi.com.vn trangph@ssi.com.vn

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