20 Nov. 2009
Stock Guide 20 Nov. 2009
Stock Guide provides a clear and structured profile of some of the companies we have HSI 19,95422,643 been monitoring recently. It is a one-stop collection of company profiles that puts HSCEI 11,26013,470 comprehensive information at your fingertips for quick and easy reference.
Performance (%) 1m 3m 12m For further information, each profile is cross-referenced against our recent in-depth Performance (%) 1m 3m 12m company reports and other research. HSI 6.12.0 13.713.5 (2.6)76.7 HSCEI 1.04.0 11.819.6 107.6 5.1 Stocks will be added to Stock Guide on a regular basis. HSI Performance HSI Performance
(HK$bn) (HK$bn) Contents 35,000 250 35,00030,000 250 200 61 Degrees (1361.HK) 2 30,000 3 25,000 200 AMVIG (2300.HK) 8 25,00020,000 150 20,000 150 Anta (2020.HK) 14 15,000 100 China Foods (506.HK) 19 15,00010,000 100 50 10,0005,000 China Green (904.HK) 24 50 China High Speed Transmission (658.HK) 30 5,0000 0 0Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 0 China Mengniu (2319.HK) 36 Oct 07 Apr 08 Oct 08 Apr 09 Oct 09 China Singyes Solar Technologies Holdings Limited (750.HK) 42 Turnover HSI China WindPower Group Ltd. (182.HK) 48 Turnover HSI China Yurun (1068.HK) 54 Closing 12,960 Clear Media (100.HK) 60 Closing 21,264 52W high/low Comba (2342.HK) 66 26,387/10,676 Sources:52W high/low Bloomberg and Sun Hung Kai22 Financial,620/11 ,344 Coslight Technology Limited (1043.HK) 72 Dachan Food (3999.HK) 78 Dongxiang (3818.HK) 84 HSCEI Performance Dynamic Energy (578.HK) 90 Dynasty Fine Wines Group (828.HK) 96 Eagle Nice (2368.HK) 102 (HK$bn) 250 Fujikon (927.HK) 108 20,000 Fushan International Energy Group (639.HK) 114 200 15,000 Genesis Energy (702.HK) 121 150 Hopefluent (733.HK) 127 10,000 Huabao International Holdings (336.HK) 133 100 Inspur International (596.HK) 139 5,000 50 Jinheng Automotive (872.HK) 147 0 0 Johnson Electric (179.HK) 152 Oct 07 Apr 08 Oct 08 Apr 09 Oct 09 Ju Teng (3336.HK) 157 Turnover HSCEI Kenford (464.HK) 163 Kingboard Laminates (1888.HK) 169 Closing Lee & Man Paper (2314.HK) 175 12,466 Li Ning (2331.HK) 180 52W high/low 13,325/5,565 Little Sheep (968.HK) 185 Meadville (3313.HK) 190 Natural Beauty (157.HK) 195 NewOcean Energy Holdings (342.HK) 201 NWDS (825.HK) 207 Parkson (3368.HK) 213
Solargiga Energy Holding (757.HK) 219 SCUD (1399.HK) 225 Varitronix Int’l (710.HK) 231 Vinda International (3331.HK) 237 VST Holdings (856.HK) 242 Want Want (151.HK) 249 Wasion (3393.HK) 256 Xingda International (1899.HK) 262 All reports are available at: Xinhua Winshare (811.HK) 268 http://www.SHKfg.com Xiwang Sugar (2088.HK) 274 http://www.im.knowledge.reuter.com http://www.tfibcm.com Xtep (1368.HK) 280 http://www.securities.com Yip’sChemical (408.HK) 285 Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification Sun Hungand Kaiother Financial disclosures, refer to the Disclosure Section at the end of the report / note. 1
20 Nov. 2009
361 Degrees (1361.HK) Retail Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 361 Degrees is a leading PRC sportswear enterprise founded in 2003. Products
include athletic footwear, apparel and accessories. Over 99% of revenue is from the Performance (%) 1m 3m 12m mid-range to low-end 361 Degrees brand. In 2008, it accounted for a 4.2% market HSI 2.0 13.5 76.7 share by revenue. The stock listed in Hong Kong on 30 June 2009. HSCEI 4.0 19.6 107.6
The firm has 16 footwear production lines in Jinjiang city, Fujian province. It has no 361 Degrees– Price vs. HSI, Share Data production facilities for apparel or accessories, which has to be outsourced,
accounting for 69.8% of FY09 COGS, up from 37.8% in FY08. (HK$) (HK$m) 5.0 1,600 1,400 4.0 The group shifted its business model in 2008. Under the new model, its products are 1,200 sold exclusively to distributors, which in turn sell to authorized retailers. The new 3.0 1,000 800 model improves distribution efficiency, as the company needs to manage a smaller 2.0 600 400 number of customers. As at 30 June 2009, the network comprised 30 distributors and 1.0 3,277 authorized retailers, all of which were independent third parties. These 200 0.0 0 authorized retailers owned and managed 6,055 retail outlets. 361 Degrees is the third Jun 09 Oct 09 largest sportswear brand by number of retail outlets. Turnover Price HSI
The company introduces new products and receives orders from distributors at sales Price – HK$ 4.38 fairs, which helps it plan production around its purchase volumes, and better 52W high/low (HK$) 4.72/3.03 coordinate raw-material supplies and inventory levels. Shares in issue – millions 2,065.41 Market cap – HK$m 8,963.89 361 Degrees launched a series of influential marketing campaigns in 2008 through 3M avg. turnover – HK$m 45.02 multi-year sponsorships of leading sporting events and top athletes as brand Major shareholders – % spokespersons. Selling and distribution expenses accounted for 10.8% of FY09 Wuhao Ding 18.16 revenue, but helped net profit surge 250% yoy to RMB632m with a 430-bps rise in Source: Bloomberg and Sun Hung Kai Financial net margin to 18.3%. Turnover increased 162% to RMB3,447m..
Figure 1: Earnings Summary Year ended 30 June FY07 FY08 FY09 FY10E
Net profit – RMB m 22.9 179.0 632.1 812.3 Recent Reports Date Investment Daily Note Net-profit growth – % 108.2 681.2 253.2 28.5 6 Oct. 2009 EPS – RMB fen 1.5 11.9 42.1 38.7 EPS growth – % 114.3 693.3 253.8 (8.1)
P/E – X 257.3 32.4 9.2 10.0 This document is solely based on DPS – RMB fen 0.0 0.0 6.5 7.7 publicly available information. This report is intended as information Dividend yield – % 0.0 0.0 1.7 2.0 only and not as a recommendation BVPS – RMB N/A N/A 1.3 N/A for any stock. Sun Hung Kai P/B – X N/A N/A 3.1 N/A Financial does not provide research
Oper cash flow/share – RMB fen N/A N/A 36.0 3,862.0 coverage or ratings for this
Net debt (net cash) to share price – % N/A N/A (18.1) N/A company in this report. Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus
Holly Hou
+ (852) 2203 9588 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor2ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: 361 Degrees – Investment Highlights
Key investment positives Key investment negatives Benefits from growing PRC sportswear industry. Rapid Chinese Rising account-receivables turnover. 361 Degrees has extended economic growth raises disposable incomes, which in turn the credit terms it grants to distributors, to help improve their increases per capita retail spending. liquidity and encourage them to expand their retail networks. This caused account receivables to more than double from RMB673m Rapid expansion of retail network. The number of authorized in FY08 to RMB1,591m for FY09. 361 Degrees outlets has more than quadrupled from 1,391 as at end-June 2006 to 6,055 as at end-June 2009. Heavy reliance on distributors. The group relies heavily on its 30 distributors to oversee the operations of its authorized retailers. If Diversifying product range. 361 Degrees introduced apparel they fail to do so, this could significantly hurt the operations of items in February 2005 and accessories in September 2007. It is authorized retailers in an entire area, as well as affect the brand developing new lines for children’s footwear and apparel. image and prospects. Extensive brand promotion. The 361 Degrees brand is well Fiercely competitive sportswear market. Brand equity is the recognized in the PRC. It uses traditional mass media advertising, decisive factor in sportswear, so tight competition may lead to a plus integrated media and special events. It also sponsors sports drastic increase in marketing costs. Selling and distribution events and top athletes. expenses accounted for 10.8% of group revenue in FY09. New business model adopted in 2008. Under the new model, the Higher effective tax rate. A tax exemption of 12.5% was lifted in company only needs to deal with 30 exclusive distributors, rather January 2009. The effective tax rate will increase to 25% gradually. than many individual retailers. This helps reduce selling and administration expenses. Targeting the mid-range to low-end mass market. Li Ning and Anta are also in this segment, but 361 Degrees has lower ASPs. This could help it better penetrate inland provinces and lower-tier cities, where there is huge growth potential. Efficient inventory management. As the company only manufactures or outsources after receiving orders from its distributors, it can better manage inventory and raw-material levels. Inventory turnover has dropped from 64 days in FY07 to 26 days this year. A leading brand in the PRC. 361 Degrees is China’s third largest sports brand by number of retail stores, and the fastest-growing brand among the top 10. Asset-light business. The company operates some production lines, but outsources so much of its production that this is the largest COGS component, up from 37.8% of COGS in FY08 to 69.8% in FY09. This means an asset-light business, freeing up resources to expand the retail network, and higher ROE and ROA, which were 44.7% and 24.2% for FY09.
Source: Sun Hung Kai Financial
Figure 3: 361 Degrees – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
SSS growth much higher than the market expects. Slower-than-expected SSS growth. Faster-than-expected consolidation can help the company expand Increasing raw-material prices dragging down margins. market share. In 2008, small manufacturers accounted for 32% of Higher-than-expected outsourcing prices. the market. Fast expansion by local and overseas competitors. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 3 20 Nov. 2009
Industry Dynamics Rapid growth in the Chinese economy has driven expansion in the consumer retail market and the sportswear industry. Economic growth has accelerated along with urbanization (up 11.8 ppts from 2004 to 2008) and increases in disposable income per capita, leading a shift in consumption from low-end sports brands to mid-range to high-end brands.
According to the National Bureau of Statistics, nominal GDP posted a 22.3% CAGR from US$1,932bn in 2004 to US$4,328bn in 2008, with GDP per capita up from US$1,490 to US$3,267. Retail sales of consumer goods posted a CAGR of 21.4% from US$719bn to US$1,562bn, while total sportswear revenue recorded a CAGR of 32.2% from US$2.5bn to US$7.7bn.
Per capita expenditure on sportswear lags many developed countries, at just US$7.4 in 2008, much lower than US$20.3-US$232.8 in the U.S., Canada, U.K., Germany, France, Australia, Japan, Korea and Singapore. Total per capita expenditure on sportswear in the PRC is projected to post a CAGR of 31.4% between 2008 and 2013, significantly faster higher than in most developed nations.
Sun Hung Kai Financial 4 20 Nov. 2009
Figure 4: 361 Degrees – Profit and Loss Statement FY06-09 Year ended 30 June, RMBm FY06 FY07 FY08 FY09 CAGR (%) Revenue 262.9 373.3 1,317.1 3,446.6 135.8 COGS (235.9) (296.4) (969.0) (2,252.8) 112.2 Gross profit 27.1 76.9 348.0 1,193.8 253.4 Operating expenses (15.6) (49.2) (146.0) (461.6) 209.0 Other operating income 0.7 1.3 2.1 6.3 109.6 Operating profit 12.1 29.1 204.1 738.5 293.8 Finance expenses (1.3) (3.0) (5.4) (15.8) 132.9 PBT 11.0 26.3 197.2 724.4 304.0 Tax 0.0 (3.4) (18.2) (92.3) N/A Net profit 11.0 22.9 179.0 632.1 285.8 EPS – RMB fen 0.7 1.5 11.9 42.1 291.8 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: 361 Degrees – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 30 June, % FY06 FY07 FY08 FY09 CAGR (%) Revenue N/A 42.0 252.8 161.7 135.8 COGS N/A 25.7 226.9 132.5 112.2 Gross profit N/A 184.3 352.4 243.0 253.4 Operating expenses N/A 214.4 196.9 216.2 209.0 Other operating income N/A 97.9 56.4 197.3 109.6 Operating profit N/A 140.5 601.8 261.8 293.8 Finance expenses N/A 142.1 77.5 194.2 132.9 PBT N/A 139.4 649.6 267.4 304.0 Tax N/A (17,963.2) 436.2 407.1 (1,793.6) Net profit N/A 108.2 681.2 253.2 285.8 EPS N/A 114.3 693.3 253.8 291.8 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: 361 Degrees – Profit and Loss Statement (Common Size) FY06-09 Year ended 30 June, % FY06 FY07 FY08 FY09 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (89.7) (79.4) (73.6) (65.4) (77.0) Gross profit 10.3 20.6 26.4 34.6 23.0 Operating expenses (6.0) (13.2) (11.1) (13.4) (10.9) Other operating income 0.3 0.4 0.2 0.2 0.2 Operating profit 4.6 7.8 15.5 21.4 12.3 Finance expenses (0.5) (0.8) (0.4) (0.5) (0.5) PBT 4.2 7.0 15.0 21.0 11.8 Tax 0.0 (0.9) (1.4) (2.7) (1.2) Net profit 4.2 6.1 13.6 18.3 10.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 5 20 Nov. 2009
Figure 7: 361 Degrees – Balance Sheet FY06-09 As at 30 June, RMB m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 11.8 23.5 108.9 1,983.5 452.4 Accounts receivable 68.7 83.7 537.2 1,413.5 174.0 Inventory 35.2 68.9 181.1 83.6 33.4 Other current assets 133.4 173.8 213.1 265.0 25.7 Total current assets 249.1 350.0 1,040.2 3,745.7 146.8 Net fixed assets 19.3 39.5 112.1 333.2 158.6 Other long-term assets 1.0 1.3 0.0 0.0 N/A Total assets 269.3 390.9 1,152.3 4,078.9 147.4 Short-term debt 101.0 122.5 293.0 587.0 79.8 Accounts payable 69.4 55.1 327.3 662.3 112.1 Other current liabilities 27.2 86.2 210.9 309.9 125.1 Total current liabilities 197.6 263.8 831.1 1,559.1 99.1 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 0.0 3.6 9.5 N/A Total liabilities 197.6 263.8 834.7 1,568.7 99.5 Shareholders equity 71.7 127.1 317.6 2,510.2 227.1 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 269.3 390.9 1,152.3 4,078.9 147.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: 361 Degrees – Balance Sheet (Common Size) FY06-09 As at 30 June, % FY06 FY07 FY08 FY09 Average Total assets Cash and securities 4.4 6.0 9.5 48.6 17.1 Accounts receivable 25.5 21.4 46.6 34.7 32.0 Inventory 13.1 17.6 15.7 2.1 12.1 Other current assets 49.5 44.5 18.5 6.5 29.7 Total current assets 92.5 89.5 90.3 91.8 91.0 Net fixed assets 7.2 10.1 9.7 8.2 8.8 Other long-term assets 0.4 0.3 0.0 0.0 0.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 37.5 31.3 25.4 14.4 27.2 Accounts payable 25.8 14.1 28.4 16.2 21.1 Other current liabilities 10.1 22.0 18.3 7.6 14.5 Total current liabilities 73.4 67.5 72.1 38.2 62.8 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 0.0 0.3 0.2 0.1 Total liabilities 73.4 67.5 72.4 38.5 62.9 Shareholders equity 26.6 32.5 27.6 61.5 37.1 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 6 20 Nov. 2009
Figure 9: 361 Degrees – Key Ratios FY06-09 Year ended 30 June FY06 FY07 FY08 FY09 Average (%) Profitability ratios Gross margin – % 10.3 20.6 26.4 34.6 23.0 Operating margin – % 4.6 7.8 15.5 21.4 12.3 Net margin – % 4.2 6.1 13.6 18.3 10.6 ROAA – % 4.1 6.9 23.2 24.2 14.6 ROAE – % 15.3 23.0 80.5 44.7 40.9
Liquidity ratios Current assets/current liabilities – X 1.3 1.3 1.3 2.4 1.6 Liquid assets/current liabilities – X 0.1 0.1 0.1 1.3 0.4 Cash and securities/current assets – % 4.7 6.7 10.5 53.0 18.7 Cash flow from oper./curr. liabilities – % (20.7) (21.0) (0.0) 34.7 (1.8)
Other ratios Capex/sales – % 0.9 1.8 7.4 4.4 3.6 Capex/depreciation – % 82.9 223.6 1,946.5 1,421.8 1,197.3 Operating expense/sales -% (6.0) (13.2) (11.1) (13.4) (12.6) Net debt/equity (net cash) – % 124.4 77.8 58.0 (55.6) 26.7 Inventory/sales – % 13.4 18.5 13.7 2.4 11.5 Effective tax rate – % (0.2) 12.9 9.2 12.7 11.6 Cash conversion cycle – days N/A 69.8 68.8 40.9 59.8
ROAA component analysis Revenue/average assets – % N/A 113.1 170.7 131.8 138.5 COGS/average assets – % N/A (89.8) (125.6) (86.1) (100.5) Gross profit/average assets – % N/A 23.3 45.1 45.6 38.0 Operating expenses/average assets – % N/A (14.9) (18.9) (17.6) (17.2) Other operating income/average assets – % N/A 0.4 0.3 0.2 0.3 Operating profit/average assets – % N/A 8.8 26.5 28.2 21.2 Finance expenses/average assets – % N/A (0.9) (0.7) (0.6) (0.7) PBT/average assets – % N/A 8.0 25.6 27.7 20.4 Tax/average assets – % N/A (1.0) (2.4) (3.5) (2.3) Net profit/average assets – % N/A 6.9 23.2 24.2 18.1
ROAE component analysis Revenue/average equity – % N/A 375.5 592.3 243.8 403.9 COGS/average equity – % N/A (298.1) (435.8) (159.3) (297.7) Gross profit/average equity – % N/A 77.4 156.5 84.4 106.1 Operating expenses/average equity – % N/A (49.5) (65.7) (32.6) (49.3) Other operating income/average equity – % N/A 1.4 0.9 0.4 0.9 Operating profit/average equity – % N/A 29.3 91.8 52.2 57.8 Finance expenses/average equity – % N/A (3.0) (2.4) (1.1) (2.2) PBT/average equity – % N/A 26.5 88.7 51.2 55.5 Tax/average equity – % N/A (3.4) (8.2) (6.5) (6.0) Net profit/average equity – % N/A 23.0 80.5 44.7 49.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 7 20 Nov. 2009
AMVIG (2300.HK)
Packaging Materials Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Founded in 1998 by former major shareholder Mr. Li Wei Bo, AMVIG is the largest and most profitable cigarette-package printer in China, with a market share of 19% Performance (%) 1m 3m 12m (which should decline to an estimated 12% after the disposal of Brilliance Circle). HSI 2.0 13.5 76.7 The firm is the single largest supplier to seven of the top 10 cigarette brands, but will HSCEI 4.0 19.6 107.6 lose one of these clients, Anhui Tobacco Group (major brands include Huangshan), following the Brilliant Circle disposal. AMVIG – Price vs. HSI, Share Data
AMVIG was previously known as Vision Grande, and listed in Hong Kong in March (HK$) (HK$m) 2004. In May 2007, Vision Grande acquired the remaining interest in World Grand (a 14.0 140 cigarette-package printer for mainly mid-range to high-end products) and changed its 12.0 120 name to AMVIG in November 2007. Upon listing, Mr. Li held a majority interest 10.0 100 8.0 80 (73.6%), but has since been replaced by Amcor as the largest shareholder. 6.0 60 4.0 40 AMVIG acquired Brilliant Circle in mid-2007 for a total consideration of HK$1.56bn 2.0 20 0.0 0 (satisfied by HK$155.5m in cash and HK$1.4bn in shares by issuing 200 million Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 shares at HK$7.00/share). But it has now announced it will sell Brilliant Circle back Turnover Price HSI to founder Mr. Tsoi for a total consideration of HK$2,048m, satisfied by cash of HK$880.3m and 166.8 million shares (at HK$7.00/share). The reason given for the disposal was deteriorating performance, with Brilliant Circle at risk of losing its Price – HK$ 3.74 license on expiry in April 2010. The transferred shares will be cancelled, increasing 52W high/low (HK$) 6.89/2.96 the stake of major shareholder Amcor from 38.95% to 45.99%. Shares in issue – millions 1,089.96 Market cap – HK$m 4,098.25 3M avg. turnover – HK$m 7.52 Including those held under Brilliant Circle, AMVIG has 14 manufacturing facilities. Major shareholders – % All produce cigarette packs, with four plants also producing laminated paper (raw Amcor Ltd 38.95 material for packaging), the majority of which is consumed internally. Sales of Sources: Bloomberg and Sun Hung Kai Financial cigarette packs accounted for 96% of 1H09 turnover.
1H09 results. Net profit fell 14% yoy to HK$202m, with turnover up 15% yoy. Turnover growth was driven by the maiden contribution of Hangzhou Weicheng (acquired in October 2008). Stripping out inorganic growth, 1H09 sales would have been flat. The key reason for the net-profit fall was a decline in associates income, with the contribution from Changde Goldroc (held under Brilliant Circle) down to HK$15m (from HK$52m) over the same period. As a result, it will miss the profit guarantee target per the acquisition agreement. This document is solely based on publicly available information. This Figure 1: Earnings Summary report is intended as information Year ended 31 Dec. FY06 FY07 FY08 FY09E only and not as a recommendation Net profit – HK$m 250.3 353.8 467.3 387.0 for any stock. Sun Hung Kai
Net-profit growth - % Financial does not provide research 38.0 41.3 32.1 (17.2) EPS – HK¢ coverage or ratings for this 34.8 43.4 46.0 34.8 company in this report. EPS growth - % (8.7) 24.7 6.0 (24.3) P/E – X 9.9 7.9 7.5 9.9 DPS – HK¢ 12.8 15.9 13.2 12.5 Dividend yield - % 3.7 4.6 3.8 3.6 BVPS – HK$ 2.8 3.9 4.8 4.1 P/B – X 1.2 0.9 0.7 0.8 Holly Hou Oper cash flow/share – HK¢ 64.9 53.9 51.1 69.0 + (852) 2203 9588 Net debt (net cash) to share price - % (5.5) 23.3 23.6 (17.7) Sources: Bloomberg and Sun Hung Kai Financial. [email protected] Note: Estimates based on Bloomberg consensus
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research reports8 / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: AMVIG – Investment Highlights
Key investment positives Key investment negatives
Well placed to benefit from China tobacco-industry Further EPS dilution and declining ROE. Since listing, AMVIG consolidation. AMVIG currently supplies cigarette packaging to has issued new shares every year, expanding its number of shares most of the top 10 brands in China. Its biggest customers include 144% from 400 million to 1,056 million. In 2006 and 2007, it Hongyun and Guandong Tobacco, which accounted for 45% of issued a total of 504 million shares to raise HK$2.7bn, representing FY07 top-line sales. With the consolidation of the tobacco about 60% of its market cap. More than half these new shares were industry, AMVIG’s market share will likely expand along with its issued as consideration for acquisitions. Further EPS dilution is customers. possible if AMVIG backs its M&A strategy by using consideration shares. Prime beneficiary from printing-supplier consolidation. The applied ‘approved printing suppliers’ system, will give AMVIG, a Smoking ban in public areas, rising health awareness. If the leading printer, an opportunity to capture market share from small government enforces antismoking regulations and awareness of the players. It has a 19% share currently and targets 25% by 2011, dangers of smoking increases, cigarette consumption might fall. which seems a daunting task. But if it achieves this, it would be This could drastically cut cigarette demand and, therefore, large enough to maximize benefits from economies of scale, AMVIG’s sales. However, such a regulation or significant cut in reduce wastage and maximize yields and returns. cigarette consumption does not seem likely in the foreseeable future, as the tobacco industry is a major source of tax revenue and Strategic relations with Amcor. Amcor is the world’s largest employment opportunities for certain provinces, e.g. Yunnan. cigarette-packaging printer and AMVIG’s largest shareholder with a 39% stake. Amcor has 240 plants worldwide and supplies the Heavy reliance on key customers. AMVIG’s success depends world’s top three tobacco companies: Philip Morris, British heavily on its relationships with key customers. Although it seems American Tobacco and Japan Tobacco Industry. This unlikely to lose customers given that it is one of the best-managed AMVIG-Amcor syndicate gives AMVIG an absolute scale cigarette-packaging suppliers in China, and customer service is advantage over its peers and helps it lead consolidation of the given top priority by management, any losses could seriously printing-supplier industry. undermine earnings growth and stability. Major customers include Hongyun and Guandong Tobacco, which accounted for 45% of Close ties with major cigarette companies. AMVIG has formed FY07 sales. close ties with tobacco companies by establishing jointly owned entities with them. This ensures steady orders from customers in Low entry barriers. Although this industry is capital intensive, the long run. there are relatively low entry barriers. However, AMVIG is among the few vertically integrated players, and manufactures its own Integration of resources, costs can be cut. After the disposal, laminated papers. AMVIG may raise its stake in existing subsidiaries (such as Dongguan, Qingdao and Beijing plants). This may help further Pricing power. AMVIG’s customers are large tobacco players and centralization and improve utilization, 86% in FY08. Operating in the past few years have accounted for close to 50% of orders. expenses to revenue fell 1.5 ppts to 13.6% in FY08. The sheer size of its customers and its reliance on them may cut pricing power. High FCF yield: FY07 capex was HK$255m, and declined to HK$175m in FY08. AMVIG decreased capex in FY08 by China’s tobacco industry is highly regulated. Pressures on reallocating printing machinery across its plants to handle different domestic cigarette producers, such as competition from demands in different regions. This improved the FCF yield. international players and changing government policies, may in turn put pressure on AMVIG’s earnings. Any government policies Product differentiation. In the short term, management will focus that affect its customers’ profitability will adversely affect margins on product differentiation to strengthen its customers’ for AMVIG. anti-counterfeiting features. This will help sustain organic growth. In FY08, AMVIG bought a 49% stake in Smart Apex. It is also a Margin pressure. Brilliance Circle has suffered margin pressure minority shareholder of Univacco Technology. These are strategic from 25% higher administrative expenses to maintain market moves to step up the firm’s product development, stay at the share. This partly offset the gross-margin enhancement from forefront of cigarette-packaging technology and differentiate the Hangzhou Weicheng. firm from its competitors. Loss of major contributor. Brilliance Circle made up 43% of Improving product mix. AMVIG has shifted its product mix AMVIG’s earnings in 2008. After the disposal, this revenue will be toward the mid-range (19% of sales in FY07 and 37% in FY08). uncertain. The disposal of Brilliance Circle would also be positive for Lost of market share. After the disposal of BCG, AMVIG’s AMVIG’s product mix, given that Brilliance Circle has a large market share will fall to below 15%. Business relationships with percentage of low-end to mid-range products. This would drive up some top brands might be lost, which would put AMVIG in a the ASP and gross margin. worse position on industry consolidation. It will lose Anhui Tobacco Group (major brands include Huangshan) as a customer. High execution risk. The divestment of Brilliance Circle underlines the high execution risk of AMVIG’s acquisitions-led growth strategy. The tobacco-packaging industry is easily affected by government policy changes. Mild organic growth. In the past few years, AMVIG generated low organic growth of 6%-10% despite rapid tobacco-industry consolidation. This implies it was unable to grab market share, even though it is the largest industry player. Acquisition pace slowing. AMVIG will slow its pace of acquisitions until the packaging industry becomes more stable. M&A has previously greatly contributed to its revenue and market-share increases Higher proportion of short-term debt. Total debt declined 7% hoh to HK$1.55bn in 1H09, but borrowing on demand or payable within one year increased 45.6% hoh to HK$1.25bn. This could be one reason for the quick disposal of Brilliance Circle. Significant goodwill is alarming. Goodwill of HK$3.9bn represents as much as 75% of AMVIG’s book value for 2008. Though significant goodwill boosts net asset value, this could easily become impaired or fail to bring in high earnings growth. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 9 20 Nov. 2009
Figure 3: AMVIG – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Shorter-than-expected integration periods. Longer-than-expected integration periods. Accelerating consolidation among its customers and in the packaging Unfavorable government policies affecting cigarette sales. industry. Hikes in paper prices. Source: Sun Hung Kai Financial
Recent Company News 17 Sep. 2009: Disposal of a major sales contributor AMVIG announced it will sell Brilliance Circle back to its founder, Mr Tsoi, at a total consideration of HK$2,048m, which will be satisfied by cash of HK$880.3m and transferring 166.8 million shares (at HK$7.00/share). SHKF comment. AMVIG acquired Brilliance Circle in mid-2007 and it accounted for as much as 43% of earnings in FY08. The divestment could indicate cash shortages for the company and underlines the high risk involved in its M&A strategy, which has been a large contributor to its revenue and market-share increases.
Industry Dynamics Cigarette packaging in China Cigarette packages in China have a distinct value. Cigarettes are often purchased as gifts, determine a smoker’s status and taste, and indicate the genuineness of a brand. With the proliferation of counterfeit cigarettes, manufacturers are using measures such as holographic designs on their boxes. Entry barriers are low, but lowering the quality of packaging may damage brand reputation. Other barriers include: intensive capital requirements for plants and machinery, strong relationships with tobacco manufacturers, and difficulties in balancing capital requirements and small order sizes (as tobacco manufacturers do not usually have long-term contracts with printers and place small orders to check for quality).
Consolidation in the cigarette-packaging industry China National Tobacco Corporation has applied an “approved printing suppliers” system. This system is aimed to reduce the number of cigarette packaging suppliers in China and encourage those that have high-quality products, are environmentally safe, and take on anti-counterfeit measures. Leading printers will benefit by capturing market share from small players.
Consolidation in China’s tobacco industry Since China joined the WTO in 2001, there have been rising expectations that it will open up its tobacco market. Although this is not likely in the near future, the STMA has prepared leading domestic players to compete with multinationals by pushing for consolidation. The STMA targets to cut the number of tobacco companies to 10 and has restricted new tobacco brands from entering the market. There were 185 cigarette factories in 2001, but this declined to just 31 in 2007. The number of brands fell from around 1,800 in 2001 to just 224 in 2007. The top 10 brands in China have also expanded their total market share to 40% in 2007, up from 37.8% a year earlier. Key suppliers to top 10 brands will likely be the primary beneficiaries and outpace the industry’s average growth of 4%-5% p.a. Brands with annual volume sales of over 1 million master cases numbered 13 in 2007, up from eight in 2006. Recently, Honghe and Hongyun agreed to merge to form the fourth largest tobacco firm in the word (biggest in the mainland).
Sun Hung Kai Financial 10 20 Nov. 2009
Figure 4: AMVIG – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 383.5 1,122.6 2,132.3 3,122.9 75.1 COGS (221.8) (758.4) (1,442.8) (2,091.4) 79.6 Gross profit 161.7 364.2 689.5 1,031.5 67.4 Operating expenses (46.6) (149.1) (333.7) (391.0) 72.8 Other operating income 6.1 23.9 52.5 88.4 169.9 Operating profit 121.1 239.0 408.3 728.9 69.1 Finance expenses (11.6) (14.8) (38.6) (76.6) 69.5 PBT 187.0 297.8 467.9 770.2 59.6 Tax (2.1) (30.4) (68.0) (147.2) 109.0 Net profit 181.4 250.3 353.8 467.3 43.3 EPS – HK¢ 38.1 34.8 43.4 46.0 12.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: AMVIG – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR Revenue 15.4 192.7 89.9 46.5 75.1 COGS 10.4 241.9 90.2 45.0 79.6 Gross profit 23.0 125.3 89.3 49.6 67.4 Operating expenses 6.2 219.7 123.8 17.2 72.8 Other operating income 266.2 292.2 119.1 68.6 169.9 Operating profit 35.7 97.3 70.8 78.5 69.1 Finance expenses 25.4 27.6 159.7 98.7 69.5 PBT 57.6 59.3 57.2 64.6 59.6 Tax (72.3) 1,325.0 123.7 116.3 109.0 Net profit 63.7 38.0 41.3 32.1 43.3 EPS 31.4 (8.7) 24.7 6.0 12.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: AMVIG – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (57.8) (67.6) (67.7) (67.0) (65.0) Gross profit 42.2 32.4 32.3 33.0 35.0 Operating expenses (12.2) (13.3) (15.6) (12.5) (13.4) Other operating income 1.6 2.1 2.5 2.8 2.3 Operating profit 31.6 21.3 19.1 23.3 23.8 Finance expenses (3.0) (1.3) (1.8) (2.5) (2.2) PBT 48.8 26.5 21.9 24.7 30.5 Tax (0.6) (2.7) (3.2) (4.7) (2.8) Net profit 47.3 22.3 16.6 15.0 25.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 11 20 Nov. 2009
Figure 7: AMVIG – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 93.7 337.0 811.0 898.9 61.3 Accounts receivable 205.4 364.4 807.2 754.2 42.8 Inventory 47.6 211.4 316.2 378.7 65.7 Other current assets 133.4 77.2 189.1 277.1 46.5 Total current assets 480.1 990.0 2,123.5 2,308.9 52.7 Net fixed assets 197.4 488.4 1,195.2 1,358.3 75.1 Other long-term assets 261.2 1,345.4 3,465.1 4,690.5 137.7 Total assets 938.7 2,823.8 6,783.8 8,357.7 84.9 Short-term debt 163.4 174.2 501.6 977.2 53.7 Accounts payable 49.0 177.9 343.9 467.8 74.7 Other current liabilities 43.0 143.3 505.2 426.5 39.1 Total current liabilities 255.4 495.5 1,350.7 1,871.5 53.2 Long-term debt 28.8 13.4 1,117.9 815.5 167.3 Other long-term liabilities 0.0 17.7 222.6 95.6 N/A Total liabilities 284.2 526.6 2,691.2 2,782.5 67.3 Shareholders equity 654.6 2,297.2 4,092.6 5,575.2 98.3 Minorities 6.7 122.5 257.2 299.8 214.0 Total equity and liabilities 938.7 2,823.8 6,783.8 8,357.7 84.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: AMVIG – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 10.0 11.9 12.0 10.8 11.2 Accounts receivable 21.9 12.9 11.9 9.0 13.9 Inventory 5.1 7.5 4.7 4.5 5.4 Other current assets 14.2 2.7 2.8 3.3 5.8 Total current assets 51.1 35.1 31.3 27.6 36.3 Net fixed assets 21.0 17.3 17.6 16.3 18.0 Other long-term assets 27.8 47.6 51.1 56.1 45.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 17.4 6.2 7.4 11.7 10.7 Accounts payable 5.2 6.3 5.1 5.6 5.5 Other current liabilities 4.6 5.1 7.4 5.1 5.6 Total current liabilities 27.2 17.5 19.9 22.4 21.8 Long-term debt 3.1 0.5 16.5 9.8 7.4 Other long-term liabilities 0.0 0.6 3.3 1.1 1.3 Total liabilities 30.3 18.6 39.7 33.3 30.5 Shareholders equity 69.7 81.4 60.3 66.7 69.5 Minorities 0.7 4.3 3.8 3.6 3.1 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 12 20 Nov. 2009
Figure 9: AMVIG – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 42.2 32.4 32.3 33.0 35.0 Operating margin – % 31.6 21.3 19.1 23.3 23.8 Net margin – % 47.3 22.3 16.6 15.0 25.3 ROAA – % 21.9 13.3 7.4 6.2 12.2 ROAE – % 35.7 17.0 11.1 9.7 18.4
Liquidity ratios Current assets/current liabilities – X 1.9 2.0 1.6 1.2 1.7 Liquid assets/current liabilities – X 0.4 0.7 0.6 0.5 0.5 Cash and securities/current assets – % 19.5 34.0 38.2 38.9 32.7 Cash flow from oper./curr. liabilities – % 44.1 94.0 32.5 27.7 49.6
Other ratios Capex/sales – % 11.9 3.6 10.0 4.0 7.4 Capex/depreciation – % 242.3 82.9 303.2 92.6 159.6 Operating expense/sales -% (12.2) (13.3) (15.6) (12.5) (13.8) Net debt/equity (net cash) – % 15.1 (6.5) 19.2 16.0 9.5 Inventory/sales – % 12.4 18.8 14.8 12.1 15.3 Effective tax rate – % 1.1 10.2 14.5 19.1 14.6 Cash conversion cycle – days 181.9 110.0 105.5 83.3 99.6
ROAA component analysis Revenue/average assets – % 46.4 59.7 44.4 41.2 47.9 COGS/average assets – % (26.8) (40.3) (30.0) (27.6) (31.2) Gross profit/average assets – % 19.5 19.4 14.4 13.6 16.7 Operating expenses/average assets – % (5.6) (7.9) (6.9) (5.2) (6.4) Other operating income/average assets – % 0.7 1.3 1.1 1.2 1.1 Operating profit/average assets – % 14.6 12.7 8.5 9.6 11.4 Finance expenses/average assets – % (1.4) (0.8) (0.8) (1.0) (1.0) PBT/average assets – % 22.6 15.8 9.7 10.2 14.6 Tax/average assets – % (0.3) (1.6) (1.4) (1.9) (1.3) Net profit/average assets – % 21.9 13.3 7.4 6.2 12.2
ROAE component analysis Revenue/average equity – % 75.6 76.1 66.7 64.6 70.7 COGS/average equity – % (43.7) (51.4) (45.2) (43.3) (45.9) Gross profit/average equity – % 31.9 24.7 21.6 21.3 24.9 Operating expenses/average equity – % (9.2) (10.1) (10.4) (8.1) (9.5) Other operating income/average equity – % 1.2 1.6 1.6 1.8 1.6 Operating profit/average equity – % 23.9 16.2 12.8 15.1 17.0 Finance expenses/average equity – % (2.3) (1.0) (1.2) (1.6) (1.5) PBT/average equity – % 36.8 20.2 14.6 15.9 21.9 Tax/average equity – % (0.4) (2.1) (2.1) (3.0) (1.9) Net profit/average equity – % 35.7 17.0 11.1 9.7 18.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 13 20 Nov. 2009
Anta (2020.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Anta Sports Products is a leading sportswear brand in China, founded in 1994 and listed in Hong Kong on 10 July 2007. The firm designs, develops, manufactures and Performance (%) 1m 3m 12m markets sportswear, including sports footwear, apparel and accessories. These HSI 2.0 13.5 76.7 products are well received by its customers, mostly young people and students in HSCEI 4.0 19.6 107.6 second- and third-tier cities. Anta – Price vs. HSI, Share Data Anta targets the mass market, with average prices of RMB200 affordable for
customers in lower-tier cities. The firm says there has been no major slowdown in (HK$) (HK$m) sales. 14.0 1,200 12.0 1,000 10.0 800 Anta owns one footwear factory and two apparel factories, which means a lower 8.0 600 ROA than asset-light peers such as Li Ning (2331.HK). The group has moved to 6.0 400 optimize its in-house and outsourced production mix, with 35.5% of footwear and 4.0 14.8% of apparel now self-produced. Products are sold through exclusive third-party 2.0 200 0.0 0 distributors, reaching 6,129 Anta stores and 10 flagship shores in China. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Turnover Price HSI With net cash of RMB3.5bn (no bank loans), management is looking for M&A targets, preferring to diversify into relatively upmarket sports brands. On 12 Aug. Price – HK$ 11.00 2009, Anta announced its plan to buy from Belle International (1880.HK) the Fila 52W high/low (HK$) 12.7/2.671 sports brand in China and Hong Kong. The maximum aggregate amount involved Shares in issue – millions 2,491.22 will not exceed HK$600m. Market cap – HK$m 26,755.65 3M avg. turnover – HK$m 113.86 Strong 1H09 results. Turnover increased 27.7% yoy to RMB2.82bn; earnings Major shareholders – % expanded 40% yoy to RMB608m, mainly due to lower-than-expected operating Anta Intl Group Hld 57.48 expenses and a 2.6-ppts rise in gross margin to 41.5%. Source: Bloomberg and Sun Hung Kai Financial
Figure 1: Earnings Summary Year ended 31 Dec. FY06 FY07 FY08 FY09E
Net profit – RMBm 147.4 537.8 894.8 1,132.2 Net-profit growth – % 206.9 264.8 66.4 26.5 EPS – RMB fens 8.2 25.3 35.9 45.4 EPS growth – % 203.7 208.0 42.3 26.3 P/E – X 118.2 38.4 27.0 21.3 DPS – RMB fens N/A 8.0 20.0 22.1 This document is solely based on Dividend yield – % N/A 0.8 2.1 2.3 publicly available information. This BVPS – RMB N/A 1.7 1.8 2.0 report is intended as information only and not as a recommendation P/B – X N/A 5.8 5.4 4.9 for any stock. Sun Hung Kai Operating cash flow per share – RMB fen 8.7 11.2 40.8 40.3 Financial does not provide research
Net debt (net cash)/ price – % N/A (13.4) (14.5) (13.9) coverage or ratings for this Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus company in this report.
Holly Hou + (852) 2203 9588 [email protected]
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Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor14ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Anta – Investment Highlights
Key investment positives Key investment negatives Plenty of room for margin improvement. The company continues to Lower ROA due to operating factories. The company owns one outsource manufacturing and seeks opportunities to cooperate with footwear factory (35.5% self-production) and two apparel factories distributors, which should improve margins. (14.8% self-production). These fixed assets mean a lower ROA Affordable ASPs, limited impact from slowing economy. Anta targets than asset-light peers such as Li Ning (2331.HK). the mass market, with retail prices for footwear and apparel at Higher operating costs. The group had 6,129 retail stores, with RMB230/pair and RMB140/piece – affordable for customers in 1,961 owned by distributors, at end-June 2009. Self-owned stores lower-tier cities. The firm says there has been no major sales slowdown generally mean higher rental and labor costs. for Anta products. Gradually increasing effective tax rate. The effective tax rate has Continuous brand building. Anta’s A&P spending dropped risen from 8.3% a year ago to 14.3%, and will further rise to 25%. significantly in 1H09, but this is temporary and the full-year figure will Difficult conditions in high-end sportswear. Anta has announced likely be 14%-15% of sales. New sponsorship and endorsement deals plans to acquire high-end sportswear brand Fila in Hong Kong and included signing up women tennis players Jelena Jankovic in June and China. But according to Fila management, the operating Zheng Jie in April. environment has been tough because sales of high-end products Expansion plans on schedule. As at end-June 2009, Anta added 462 tend to be hit badly by weak consumer confidence. stores to its network for a total of 6,129 stores and 10 flagship stores in Possible increase in A&P spending in 2H09. Management plans China. Its number of Sports Lifestyle stores increased from 33 as at to stick with its A&P budget for FY09, despite a fall in 1H09 end-2008 to 183, and its kids’ sportswear stores from 81 to 160. spending, so a cost surge seems likely in 2H09, leaving little room M&A plans. With net cash of RMB3.5bn (no bank loans), management for earnings growth. is looking for M&A targets, and has announced plans to buy the Fila sports brand in China and Hong Kong. This should be positive as 1) Fila is a high-end foreign brand, which should improve its brand equity, and 2) Fila’s focuses on fashionable, stylish sportswear. While Anta’s strategy is to focus on functional sportswear, diversification into fashionable sportswear can create a more rounded product portfolio. Expanding production capacity. The firm had 24 production lines as at end-June 2009, in addition to a shoe-sole factory and two apparel-production bases. Management targets 50% footwear self-production and 12%-15% for apparel. Kids and trendy series may be next earnings drivers. The firm launched its kids and fashion series in 4Q08, targeting to open 200 stores in FY09 (160 as at end-June 2009). This segment could be the next earnings driver. Targets mid-range to low-end; no direct competition with international brands. Anta targets the mass market in China with sports shoes at RMB150-RMB200/pair, much cheaper than the RMB600-RMB1,000/pair for international brands that focus on first-tier cities, such as Nike, Adidas and Li Ning. As such, Anta does not directly compete with international brands. 1Q10 order book. Anta just finished its trade fair for 1Q10 orders. It recorded about a 15% yoy increase in value, mainly from volume growth. Source: Sun Hung Kai Financial
Figure 3: Anta – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts SSS growth much higher than market expectations. Lower-than-expected SSS growth. Greater outsourcing for the OEM segment. Better-than-expected integration of the Fila business. Source: Sun Hung Kai Financial
Recent Company News
30 Sep. 2009: Completion of the acquisition of Full Prospect
The company has completed the acquisition of 85% of the issued share capital of Full Prospect and the entire issued share capital of Fila Marketing from Belle International (1880.HK). This gives it the rights to the Fila Sports brand in China and Hong Kong. SHKF comment: The acquisition of the Fila brand extends the firm’s focus to fashionable and stylish products, complementing its functional products. If management can successfully integrate this business, it could be a significant upside share-price catalyst.
Sun Hung Kai Financial 15 20 Nov. 2009
27 Oct. 2009: Placement of 80 million existing shares
Anta has announced that Chairman Ding Shizhong and other controlling shareholders have hired Morgan Stanley to place 80 million existing shares, a 3.2% stake, at HK$10/share. The proceeds will be used to build a charitable fund. SHKF comment: The stock dropped for three straight days after the announcement, but we believe the decline should be temporary given the use of the proceeds and the company’s solid fundamentals. 3Q results were satisfactory, with sales volumes up 25.2% yoy for footwear and 12% yoy for apparel (vs. 26.6% yoy and 22% yoy for 1H09).
Figure 4: Anta – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 670.3 1,250.1 2,988.7 4,626.8 96.3 COGS (544.5) (936.9) (1,988.8) (2,778.2) 79.5 Gross Profit 125.9 313.2 999.9 1,848.6 154.9 Operating expenses (76.2) (167.0) (526.5) (896.6) 106.4 Other operating income 1.0 0.7 9.8 20.0 214.6 Operating profit 50.6 147.0 483.2 972.0 N/A Finance expenses (0.9) (0.3) (1.7) 0.0 N/A PBT 50.2 148.0 604.7 970.2 N/A Tax (2.2) (0.6) (61.3) (67.6) 145.7 Net profit 48.0 147.4 537.8 894.8 N/A EPS – RMB fen 2.7 8.2 25.3 35.9 N/A Sources: The Company and Sun Hung Kai Financial
Figure 5: Anta – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 115.2 86.5 139.1 54.8 96.3 COGS 103.4 72.1 112.3 39.7 79.5 Gross Profit 187.5 148.8 219.2 84.9 154.9 Operating expenses 54.4 119.0 215.4 70.3 106.4 Other operating income 398.5 (30.4) 1,285.5 103.8 214.6 Operating profit N/A 190.2 228.7 101.2 N/A Finance expenses (36.5) (71.9) 573.7 (100.0) (100.0) PBT N/A 194.8 308.5 60.4 N/A Tax 17.6 (72.4) 10,061.2 10.3 145.7 Net profit N/A 206.9 264.8 66.4 N/A EPS – RMB fen N/A 203.7 208.0 42.3 N/A Sources: The Company and Sun Hung Kai Financial
Figure 6: Anta – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (81.2) (74.9) (66.5) (60.0) (70.7) Gross Profit 18.8 25.1 33.5 40.0 29.3 Operating expenses (11.4) (13.4) (17.6) (19.4) (15.4) Other operating income 0.2 0.1 0.3 0.4 0.2 Operating profit 7.6 11.8 16.2 21.0 14.1 Finance expenses (0.1) (0.0) (0.1) 0.0 (0.1) PBT 7.5 11.8 20.2 21.0 15.1 Tax (0.3) (0.0) (2.1) (1.5) (1.0) Net profit 7.2 11.8 18.0 19.3 14.1 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 16 20 Nov. 2009
Figure 7: Anta – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 69.9 176.3 3,231.5 3,271.7 201.2 Accounts receivable 51.4 78.3 184.5 226.5 50.1 Inventory 59.2 154.5 434.8 332.5 89.0 Other current assets 71.3 182.1 285.2 519.3 73.6 Total current assets 251.8 591.2 4,135.9 4,350.0 125.7 Net fixed assets 192.7 261.6 420.1 566.3 45.0 Other long-term assets 1.7 3.6 74.7 26.2 112.2 Total assets 446.1 856.4 4,630.7 4,942.5 101.9 Short-term debt 29.5 92.5 5.3 0.0 N/A Accounts payable 30.0 210.2 327.7 284.6 93.1 Other current liabilities 275.6 315.8 147.0 177.0 19.7 Total current liabilities 335.0 618.4 480.0 461.6 35.6 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 0.0 0.0 0.0 N/A Total liabilities 335.1 618.4 480.0 461.6 35.6 Shareholders equity 111.0 237.9 4,150.7 4,480.9 129.9 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 446.1 856.4 4,630.7 4,942.5 101.9 Sources: The Company and Sun Hung Kai Financial
Figure 8: Li Ning – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 15.7 20.6 69.8 66.2 43.1 Accounts receivable 11.5 9.1 4.0 4.6 7.3 Inventory 13.3 18.0 9.4 6.7 11.9 Other current assets 16.0 21.3 6.2 10.5 13.5 Total current assets 56.4 69.0 89.3 88.0 75.7 Net fixed assets 43.2 30.5 9.1 11.5 23.6 Other long-term assets 0.4 0.4 1.6 0.5 0.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 6.6 10.8 0.1 0.0 4.4 Accounts payable 6.7 24.5 7.1 5.8 11.0 Other current liabilities 61.8 36.9 3.2 3.6 26.4 Total current liabilities 75.1 72.2 10.4 9.3 41.8 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 75.1 72.2 10.4 9.3 41.8 Shareholders equity 24.9 27.8 89.6 90.7 58.2 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 17 20 Nov. 2009
Figure 9: Anta – Key Ratios FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin - % 18.8 25.1 33.5 40.0 29.3 Operating margin – % 7.6 11.8 16.2 21.0 14.1 Net margin – % 7.2 11.8 18.0 19.3 14.1 ROAA – % 12.9 22.6 19.6 18.7 18.5 ROAE – % 35.4 84.5 24.5 20.7 41.3
Liquidity ratios Current assets/current liabilities – X 0.8 1.0 8.6 9.4 4.9 Liquid assets/current liabilities – X 0.4 0.4 7.1 7.6 3.9 Cash and securities/current assets – % 27.8 29.8 78.1 75.2 52.7 Cash flow from oper./curr. liabilities – % 12.0 25.3 49.6 220.1 76.7
Other ratios Capex/sales – % 10.7 6.6 5.3 1.7 6.1 Capex/depreciation – % 824.6 687.1 727.3 216.1 613.8 Operating expenses/sales -% (11.4) (13.4) (17.6) (19.4) (15.4) Net debt/equity – % (36.4) (35.7) (77.7) (78.0) (57.0) Inventory/sales – % 8.8 12.4 14.5 7.2 10.7 Effective tax rate – % 4.3 0.4 10.1 7.0 5.5 Cash conversion cycle - days 38.8 18.1 26.9 24.9 27.2
ROAA component analysis Revenue/average assets – % 180.4 192.0 108.9 96.7 144.5 COGS/average assets - % (146.5) (143.9) (72.5) (58.0) (105.2) Gross profit/average assets - % 33.9 48.1 36.4 38.6 39.3 Operating expenses/average assets – % (20.5) (25.6) (19.2) (18.7) (21.0) Other operating income/average assets – % 0.3 0.1 0.4 0.4 0.3 Operating profit/average assets – % 13.6 22.6 17.6 20.3 18.5 Finance expenses/average assets – % (0.2) (0.0) (0.1) 0.0 (0.1) PBT/average assets – % 13.5 22.7 22.0 20.3 19.6 Tax/average assets – % (0.6) (0.1) (2.2) (1.4) (1.1) Net profit/average assets – % 12.9 22.6 19.6 18.7 18.5
ROAE component analysis Revenue/average equity – % 493.8 716.5 136.2 107.2 363.4 COGS/average equity - % (401.1) (537.0) (90.6) (64.4) (273.3) Gross profit/average equity - % 92.7 179.5 45.6 42.8 90.2 Operating expenses/average equity – % (56.2) (95.7) (24.0) (20.8) (49.2) Other operating income/average equity – % 0.7 0.4 0.4 0.5 0.5 Operating profit/average equity – % 37.3 84.2 22.0 22.5 41.5 Finance expenses/average equity – % (0.7) (0.1) (0.1) 0.0 (0.2) PBT/average equity – % 37.0 84.8 27.6 22.5 43.0 Tax/average equity – % (1.6) (0.3) (2.8) (1.6) (1.6) Net profit/average equity – % 35.4 84.5 24.5 20.7 41.3 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 18 20 Nov. 2009
China Foods (506.HK) Food & Beverage Sector 20 Nov. 2009
Company Background HSI 22,643 China Foods, previously known as COFCO International, is one of the biggest and HSCEI 13,470 most diverse players in mainland F&B. The firm is No.1 or No. 2 in each of its four business segments: 1) wine, 2) beverages, 3) kitchen foods, and 4) confectionery. Performance (%) 1m 3m 12m FY08 sales breakdown: 65% from wine, 35% from beverages, minimal contributions HSI 2.0 13.5 76.7 from edible oil and confectionery. HSCEI 4.0 19.6 107.6
China Foods is majority-owned by parent COFCO Group. After reorganization in China Foods – Price vs. HSI, Share Data 2006, the firm spun off its agriculture-related business into China Agri (606.HK). In
2007, COFCO International changed its name to China Foods and has since become a (HK$) (HK$m) pure F&B company in four main segments: 8.0 250 7.0 200 Beverages. China Foods, through its 65%-owned COFCO Coca-Cola Beverage 6.0 5.0 150 Limited (CBL) subsidiary, holds franchises to bottle Coca-Cola products. In Aug. 4.0 2007, China Foods announced a major restructuring of its beverage business: 1) 3.0 100 2.0 swapping some minority stakes in Coca-Cola bottlers with The Coca-Cola Company 50 1.0 for controlling stakes in the Shandong and Beijing bottlers; 2) CBL purchasing a 21% 0.0 0 stake in still-drinks maker CCBMH in February 2008. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 Wine. China Foods produces, distributes and sells fine wines under its widely Turnover Price HSI recognized Great Wall brand, the No.2 wine brand in China after Changyu. The firm also produces yellow wine and rice wine (under the brands Huang Zhong Huan and Price – HK$ 6.00 Kong Yi Ji). 52W high/low (HK$) 6.35/2.17 Kitchen foods. China Foods ranks No. 2 in consumer-pack edible oil. Its Fortune Shares in issue – millions 2,791.38 brand focuses on high-end products and its Sihai brand on lower-end. Market cap – HK$m 16,608.73 3M avg. turnover – HK$m Confectionary. The firm produces and distributes chocolates, toffee candy and jelly 18.49 candy. Its Le Conte brand is No. 2 by sales in the chocolate market. Major shareholder – % COFCO 74.25 The firm has a strong product mix in each segment, and benefits from ongoing Sources: Bloomberg and Sun Hung Kai Financial capacity expansion. The wine business is the largest sales contributor, followed by beverages. FY08 revenue increased 0.4% yoy to HK$8,191m; net profit increased 24% yoy to HK$301m. The gross margin expanded by 8 ppts to 28.5%. In the wines business, management is aiming to penetrate the high-end market to compensate for sluggish This document is solely based on demand. In beverages, sales growth is expected to remain strong due to capacity publicly available information. This expansion and double-digit organic growth. report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research Year ended 31 Dec. FY06 FY07 FY08 FY09E coverage or ratings for this company in this report. Net profit – HK$ m 990.1 791.7 483.4 691.4 Net-profit growth – % 75.9 (20.0) (38.9) 43.0 EPS – HK¢ 37.3 28.4 17.3 25.1 EPS growth – % 74.7 (23.9) (38.9) 44.9 P/E – X 16.1 21.2 34.6 23.9 DPS – HK¢ 4.5 4.5 6.2 8.4 Dividend yield – % 0.8 0.8 1.0 1.4 BVPS – HK$ 3.5 1.6 1.8 2.1 P/B – X 1.7 3.7 3.3 2.9 Holly Hou Oper cash flow/share – HK¢ 4.4 22.9 34.8 30.6 + (852) 2203 9588 Net debt (net cash) to share price – % 20.6 (6.1) (7.2) (9.3) [email protected] Sources: Bloomberg and Sun Hung Kai Financial Notes: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor19ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: China Foods – Investment Highlights
Key investment positives Key investment negatives Leading brand with diverse portfolio. Wine and beverage margins sensitive to raw-material prices. 1. Great Wall is the No. 2 wine brand in China, with a 27%-30% Although China Foods sources grapes from its own wineries, market share. mitigating the increase in grape prices, it is still affected by prices of 2. A 60%-plus stake in COFCO Coca-Cola Beverages, a JV other raw materials, including sugar, aluminum and PET. A further rise between China Foods and Coca-Cola, and one of only three in oil prices would push up prices and transport expenses for PET mainland bottlers for the soft drink, covering 33% of the bottles, narrowing margins. On top of this, China’s highly competitive population in 2008. Coca-Cola had a leading 19% share of the F&B market makes it difficult to transfer costs to customers. If selling nation’s soft-drinks market in 2006. prices become too high, consumers may switch to beer, spirits or other 3. Le Conte is the No. 2 domestic chocolate brand after Dove, with liquors. a long history in China and high consumer recognition. Beverage bottling constrained by the ability of Coca-Cola. Gross 4. Fortune is the No. 2 consumer-pack edible-oil brand, with a margins are constrained by Coca-Cola’s ability to raise its concentrate 10% market share, up from 7.8% in 2007. prices to squeeze any extraordinary margins that the bottlers might Integrated platform to increase cross-selling for its four segments in enjoy. the medium to long term. The firm targets to sell both wine and Uphill battle in kitchen foods. The No.1 Arawana brand generates Coca-Cola beverages to caterers, and has greater leverage when 3X the sales and enjoys superior brand equity. As an early mover, bargaining with supermarkets in terms of shelf display due to its many Arawana also enjoys lower production and distribution costs due to products. China Foods can also use China Agri-Industries (606HK) the advantageous locations of its plants and facilities. as a supplier for consumer-edible oil. Confectionery division generally weak. Although Le Conte is No. 2 Developing own sales platform means substantial savings from in China’s chocolate market, China Foods’ confectionary business cutting out external distributors, and can also bring about uniformity recorded a 1H08 operating loss of RMB$30m. This was due to high and better execution of sales strategies. selling costs and intensified market competition from more foreign players. The firm sells products aggressively on credit and has Wine Division problems in accounts-receivable collection. Marketing expenses make Winery business the major growth engine. Wine sales are the largest up 46% of division sales, from 35% in 2006. sales contributor, increasing 29% yoy to HK$569m in FY08, and accounting for 94% of FY08 revenue, vs. 22% in FY07. Great Wall stronger after transition. The company consolidated the distribution networks of its three production bases, which were previously run independently. It enhanced brand image and product mix by introducing high-end products and differentiating products by grape species, production region and winemaking method. This helped raise the gross margin from 48.1% in 2006 to 57.3% in 2008. Strong growth potential in wine market. Per capita wine consumption in China is only 10% of the world average. Over 2003-07, wine sales have risen at a 26.5% CAGR, driven by consumers pursuing better lifestyles and increasing appreciation of wine’s health benefits.
Beverage Division Addition of Shandong and Beijing franchises has strengthened the division, making it the second largest profit contributor. The consolidation of the Beijing bottler in 2009 is expected to add HK$1.1bn to the top line, about 23% of 2008 division revenue. Steady sales due to strong Coca-Cola brand. Acquisition of stake in CCBMH to drive growth in still drinks. This aligns the interests of CBL and Coca-Cola, boding well for sales and profit growth for still drinks, which should have better potential than sparkling drinks in China. Rising consumption in areas covered by franchise. Per capita consumption of Coca-Cola products in the regions covered by China Foods’ franchise is only half the national average. Beverage consumption in these markets is expected to grow faster than the national average in coming years.
Kitchen Foods Division Segment recovery. The gross margin increased to 11.9% in 1H09, from 3.6% in 1H08, though sales dropped 37% yoy to HK$2.5bn due to falling soybean-oil prices. This could indicate an upcoming rebound. Packaged edible oil one of the fastest-growing markets in China, posting a 20%-30% CAGR over the past 10 years. An estimated only 20% of Chinese use packaged edible oil. Superior quality and convenience should convince the rest to adopt this product.
Confectionary Division Sector overhauled. The number of products has been halved (RMB400m revenue spread over 200 products); distribution execution has been tightened; and much-needed investment in brand-building has been made. These factors helped sales in the first two months of 2009 to equal those for the first six months of 2008. Strong growth potential in China market, which accounts for only 0.5% of world chocolate consumption. Average market growth of 10%-15% p.a. is expected for the next five years. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 20 20 Nov. 2009
Figure 3: China Foods – Upside/Downside Price Catalysts
Upside price catalyst Downside price catalysts
Earlier-than-expected breakeven for confectionary division. Raw-material costs surging . Government price controls reducing the company’s ability to pass cost increases on to its customers. Economic downturn leading to falling demand for wines. Source: Sun Hung Kai Financial
Figure 4: China Foods – Profit and Loss Statement FY05-08 Year ending 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 19,560.4 6,497.5 9,743.0 14,240.3 (4.0) COGS (17,187.5) (4,507.1) (7,317.7) (10,741.8) (8.7) Gross profit 2,373.0 1,990.3 2,425.3 3,498.5 27.0 Operating expenses (1,856.2) (1,453.4) (2,002.6) (3,009.0) 31.9 Other operating income 97.0 414.9 145.9 103.9 (3.5) Operating profit 613.8 951.9 568.7 593.4 5.9 Finance expenses (171.1) (45.4) (33.1) (31.4) (21.9) PBT 719.0 498.6 933.4 756.3 14.6 Tax (132.2) (105.9) (135.8) (136.3) 9.2 Net profit 562.8 990.1 791.7 483.4 14.0 EPS – HK¢ 21.3 37.3 28.4 17.3 1.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: China Foods – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 16.5 (66.8) 50.0 46.2 (4.0) COGS 11.3 (73.8) 62.4 46.8 (8.7) Gross profit 76.3 (16.1) 21.9 44.2 27.0 Operating expenses 86.7 (21.7) 37.8 50.3 31.9 Other operating income (18.9) 327.5 (64.8) (28.8) (3.5) Operating profit 30.3 55.1 (40.3) 4.3 5.9 Finance expenses 103.1 (73.5) (27.2) (5.1) (21.9) PBT 64.1 (30.7) 87.2 (19.0) 14.6 Tax 37.8 (19.9) 28.3 0.3 9.2 Net profit 96.8 75.9 (20.0) (38.9) 14.0 EPS 30.9 74.7 (23.9) (38.9) 1.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: China Foods – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (87.9) (69.4) (75.1) (75.4) (76.9) Gross profit 12.1 30.6 24.9 24.6 23.1 Operating expenses (9.5) (22.4) (20.6) (21.1) (18.4) Other operating income 0.5 6.4 1.5 0.7 2.3 Operating profit 3.1 14.6 5.8 4.2 6.9 Finance expenses (0.9) (0.7) (0.3) (0.2) (0.5) PBT 3.7 7.7 9.6 5.3 6.6 Tax (0.7) (1.6) (1.4) (1.0) (1.2) Net profit 2.9 15.2 8.1 3.4 7.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 21 20 Nov. 2009
Figure 7: China Foods - Balance Sheet FY05-08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 1,231.2 2,516.0 1,396.6 1,546.7 8.8 Accounts receivable 1,319.9 1,576.7 997.2 884.5 (2.0) Inventory 3,595.1 4,886.9 1,968.3 2,628.9 10.3 Other current assets 1,763.0 2,063.1 540.7 506.5 (16.8) Total current assets 7,909.1 11,042.7 4,902.7 5,566.6 3.3 Net fixed assets 5,420.2 7,302.2 2,259.8 2,660.9 (3.8) Other long-term assets 2,289.7 3,453.5 1,829.9 2,220.4 19.0 Total assets 15,619.0 21,798.3 8,992.5 10,447.9 3.5 Short-term debt 3,629.9 3,898.6 285.0 248.0 (44.3) Accounts payable 1,121.8 1,376.6 815.3 860.9 18.3 Other current liabilities 2,818.9 2,641.4 2,039.6 2,902.1 37.7 Total current liabilities 7,570.6 7,916.5 3,139.9 4,010.9 1.2 Long-term debt 416.3 2,065.1 106.8 95.8 32.0 Other long-term liabilities 157.7 254.5 112.3 16.2 (29.8) Total liabilities 8,144.6 10,236.2 3,359.0 4,122.9 1.2 Shareholders equity 7,474.4 11,562.1 5,633.5 6,325.0 5.1 Minorities 1,644.5 1,807.7 1,074.9 1,232.7 8.8 Total equity and liabilities 15,619.0 21,798.3 8,992.5 10,447.9 3.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: China Foods – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 7.9 11.5 15.5 14.8 12.4 Accounts receivable 8.5 7.2 11.1 8.5 8.8 Inventory 23.0 22.4 21.9 25.2 23.1 Other current assets 11.3 9.5 6.0 4.8 7.9 Total current assets 50.6 50.7 54.5 53.3 52.3 Net fixed assets 34.7 33.5 25.1 25.5 29.7 Other long-term assets 14.7 15.8 20.3 21.3 18.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 23.2 17.9 3.2 2.4 11.7 Accounts payable 7.2 6.3 9.1 8.2 7.7 Other current liabilities 18.0 12.1 22.7 27.8 20.2 Total current liabilities 48.5 36.3 34.9 38.4 39.5 Long-term debt 2.7 9.5 1.2 0.9 3.6 Other long-term liabilities 1.0 1.2 1.2 0.2 0.9 Total liabilities 52.1 47.0 37.4 39.5 44.0 Shareholders equity 47.9 53.0 62.6 60.5 56.0 Minorities 10.5 8.3 12.0 11.8 10.6 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 22 20 Nov. 2009
Figure 9: China Foods – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 12.1 30.6 24.9 24.6 23.1 Operating margin – % 3.1 14.6 5.8 4.2 6.9 Net margin – % 2.9 15.2 8.1 3.4 7.4 ROAA – % 4.6 5.3 5.1 5.0 5.0 ROAE – % 8.9 10.4 9.2 8.1 9.1
Liquidity ratios Current assets/current liabilities – X 1.0 1.4 1.6 1.4 1.3 Liquid assets/current liabilities – X 0.2 0.3 0.4 0.4 0.3 Cash and securities/current assets – % 15.6 22.8 28.5 27.8 23.7 Cash flow from oper./curr. liabilities – % 7.7 1.5 20.4 24.3 13.4
Other ratios Capex/sales – % 4.9 22.7 12.2 3.3 10.8 Capex/depreciation – % 245.1 325.8 493.0 218.9 345.9 Operating expense/sales -% (9.5) (22.4) (20.6) (21.1) (21.4) Net debt/equity (net cash) – % 42.0 29.9 (18.1) (19.2) (2.5) Inventory/sales – % 18.4 75.2 20.2 18.5 38.0 Effective tax rate – % 18.4 21.2 14.5 18.0 17.9 Cash conversion cycle – days 63.3 346.2 128.2 75.6 183.3
ROAA component analysis Revenue/average assets – % 158.2 34.7 63.3 146.5 100.7 COGS/average assets – % (139.0) (24.1) (47.5) (110.5) (80.3) Gross profit/average assets – % 19.2 10.6 15.8 36.0 20.4 Operating expenses/average assets – % (15.0) (7.8) (13.0) (31.0) (16.7) Other operating income/average assets – % 0.8 2.2 0.9 1.1 1.3 Operating profit/average assets – % 5.0 5.1 3.7 6.1 5.0 Finance expenses/average assets – % (1.4) (0.2) (0.2) (0.3) (0.5) PBT/average assets – % 5.8 2.7 6.1 7.8 5.6 Tax/average assets – % (1.1) (0.6) (0.9) (1.4) (1.0) Net profit/average assets – % 4.6 5.3 5.1 5.0 5.0
ROAE component analysis Revenue/average equity – % 308.9 68.3 113.3 238.2 182.2 COGS/average equity – % (271.4) (47.4) (85.1) (179.7) (145.9) Gross profit/average equity – % 37.5 20.9 28.2 58.5 36.3 Operating expenses/average equity – % (29.3) (15.3) (23.3) (50.3) (29.5) Other operating income/average equity – % 1.5 4.4 1.7 1.7 2.3 Operating profit/average equity – % 9.7 10.0 6.6 9.9 9.1 Finance expenses/average equity – % (2.7) (0.5) (0.4) (0.5) (1.0) PBT/average equity – % 11.4 5.2 10.9 12.6 10.0 Tax/average equity – % (2.1) (1.1) (1.6) (2.3) (1.8) Net profit/average equity – % 8.9 10.4 9.2 8.1 9.1 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 23 20 Nov. 2009
China Green (904.HK) Food and Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 China Green is a vertically integrated producer and supplier of fresh fruit and vegetables (26% of FY09 revenue), processed products (40%) and branded F&B Performance (%) 1m 3m 12m (32%). The Xiamen-based company has operated in the green-food industry for HSI 2.0 13.5 76.7 almost 10 years. The founder, Mr. Sun Shao Feng, has been chairman and managing HSCEI 4.0 19.6 107.6 director since the company was established, and holds a 45.88% stake. The firm listed on the Hong Kong stock exchange on 13 Jan. 2004. China Green – Price vs. HSI, Share Data
Expansion relies on its ability to expand and procure optimal cultivation bases, (HK$) (HK$m) while preserving farmland quality. By end-April 2010, the number of cultivation 12.0 140 bases will reach 42, with a total area of about 90,100 mu supporting cultivation 10.0 120 100 capacity of up to 363,200 tons p.a. 8.0 80 6.0 60 4.0 Fresh produce is the main business, with sales to China and overseas. In 2000, the 40 firm began exporting processed vegetable products to Asia, Europe, North America 2.0 20 0.0 0 and South Africa. The top three export customers are in Japan and Germany. The Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 firm launched its own F&B brand in 2005. Turnover Price HSI
China Green operates a sales-driven model where orders are placed a year in Price – HK$ 6.77 advance. This allows it to accurately plan cultivation and processing, avoid high 52W high/low (HK$) 8.92/4.2 inventory levels and fully utilize cultivation bases. Products are either sold fresh or Shares in issue – millions 884.04 used in the company’s processed goods, providing a good product mix and reliable Market cap – HK$m 5,984.92 supply of raw materials for its downstream business. 3M avg. turnover – HK$m 18.58 Major shareholders – % The company’s sales contracts allow it to renegotiate prices when the cost base rises Shaofeng Sun 45.94 over 10%. This means little pressure from raw material hikes and the ability to pass Source: Bloomberg and Sun Hung Kai Financial on higher costs to customers relatively easily.
The government supports agri-business, increasing spending on farming from RMB431.8bn 2007 to RMB595.5bn in 2008 (up 37.9%). Although the firm will not receive direct subsidies, it would benefit directly from price controls on fertilizer and grain, and indirectly from any improvement in water supply and other infrastructure. Recent Reports Date China Green’s debt comprises RMB1bn of CBs (due in October 2010) with a Key Takeaways 18 Nov. 2009 conversion price of HK$11.00/share, representing 10.7% of the issued share capital. Defensive Stock with Growth 3 April 2009
Figure 1: Earnings Summary This document is solely based on Year ending 30 April FY07 FY08 FY09 FY10E publicly available information. This report is intended as information Net profit – RMBm 346.0 471.0 454.9 556.7 only and not as a recommendation Net-profit growth - % 27.5 36.1 (3.4) 22.4 for any stock. Sun Hung Kai EPS – RMB fen 44.8 53.8 51.5 60.7 Financial does not provide research EPS growth - % 20.1 20.1 (4.3) 17.9 coverage or ratings for this P/E – X 14.8 12.3 12.8 10.9 company in this report. DPS – RMB fen 11.1 14.4 12.8 16.6 Dividend yield - % 1.7 2.2 1.9 2.5 Holly Hou BVPS – RMB 2.0 2.5 2.9 3.4 + (852) 2203 9588 P/B – X 3.3 2.6 2.3 1.9 [email protected] Oper. cash flow/share – RMB fen 58.0 67.7 66.7 89.0 Net debt (net cash) to share price - % (17.6) (23.9) (9.2) (14.8) All reports are available at: Sources: Bloomberg and Sun Hung Kai Financial http://www.SHKfg.com Note: Estimates based on Bloomberg consensus http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor24ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: China Green – Investment Highlights.
Key investment positives Key investment negatives Sales-driven model, with orders placed a year in advance. This CB conversion. The company has issued RMB1bn of convertible allows for accurate planning of cultivation and processing, and helps bonds (due October 2010) with a strike price of HK$11.00/share, cut excess inventory and fully utilize cultivation bases. which would equal 10.7% of the issued share capital on conversion. Minimizing cyclicality and waste. Selling processed products Conversion would dilute EPS growth. Management indicates the reduces dependence on sales cycles and minimizes waste of fresh company would have enough internal funds to repay debt if the CB produce. Products can also be stored longer and exported. Fresh and holders do not convert. It has delayed the Shandong noodle factory to processed goods allow for a better product mix and a reliable supply preserve cash for redemption. of raw materials for the downstream business. Effective tax rate increase. The effective tax rate was 8% in FY09 F&B – niche. Competition is fierce in F&B, but the firm focuses on and will probably rise with the end of tax holidays for some niche markets including corn juice, rice milk and non-fried instant subsidiaries. New agricultural tax benefits are still pending the noodles. Peers such as Tingyi, Uni-President and Hualong only outcome of negotiations with local governments. supply fried instant noodles or fruit/vegetable juices.
Tapping new markets for own-brand F&B. There is huge potential, as the firm currently sells only to Fujian, Guangdong and Jiangxi. Switching fresh-produce sales from OEM to own-brand business. This can increase sales given strong demand for quality fresh produce in the PRC on rising awareness of food-quality issues and improving living standards. It can also gain synergies from the new logistics and distribution business. New own-brand F&B products launched, including fruit juices, vegetable juices and mixed-grain beverages in mid-2009. The vertically integrated business and focus on ‘green food’ should help the firm maintain high margins, thanks to solid demand growth. New logistics and distribution business commenced operation in Shanghai in mid-2008. The firm can now send fresh produce and processed products direct to chain restaurants and supermarkets, such as Lianhua Supermarket. This can support other divisions, and help the firm develop a new and more stable customer group, becoming more competitive among it peers. Securing new overseas clients. There is strong demand in Europe and Asia. Revenue from these markets increased 40.8% and 78.3% in FY09 to RMB175m and RMB170m respectively. This can offset slow growth in the more mature Japanese market, the second largest revenue contributor. New catering services supply well-known restaurant and supermarket chains. China Green recently launched catering services to supply fresh and processed products to chain restaurants such as 永和豆漿 and Pizza Hut. It also provides ingredients to canteens at local banks, supermarkets and other companies, which is more stable than the retail market. The scale is still small, but could provide a step into the wholesale business and stable sales growth comparable to retailing. Able to pass cost hikes on to overseas customers, as its sales contracts allow price renegotiation when the cost base rises over 10%. No export duties for the firm’s overseas sales. Greater cultivation in different provinces. The firm targets to increase cultivation area to 90,100 mu by FY10. Management is confident it can rent land by providing a fixed income to farmers. Diversifying cultivation areas to reduce risk from natural disasters. The firm has not disclosed where it aims to rent, but intends to diversify its cultivation areas by region. This could reduce the impact from natural disasters (e.g. the snowstorms in early 2008 had the greatest effect in Guangxi, Shandong, Hubei and Hunan.) Fixed rentals. Most lease terms are 19-25 years, with fixed rentals. This provides stable cultivation capacity and mitigates the effect of rental increases (5.9% of COGS) on margins. Tax benefits. According to management, the firm is set to enjoy some new tax benefits, but details are still pending from local governments. Demand/supply imbalance, food-price hikes to persist. China’s farmland shrank 6.3% over 1997-2007 to 121,736 hectares, as land was used for non-agricultural construction. The population grew 6.9% over the same period. The rapid rise in the use of foodstuffs to generate energy has further unbalanced the demand and supply of food. Food-price rises could be a long-term phenomenon. The government supports agri-business, raising spending on farming from RMB431.8bn 2007 to RMB595.5bn in 2008 (up 37.9%). Although the firm will not receive direct subsidies, it would benefit directly from price controls on fertilizers and grains, and indirectly from improvements in water supply and other infrastructure. Sufficient cash on hand. The company has a strong balance sheet with net cash of RMB447m. This should help it prepare for upcoming CB redemption. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 25 20 Nov. 2009
Figure 3: China Green – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Vertically integrated food companies should outperform during Overseas policy risk. Half of revenue is from overseas, with the top high inflation, as a tightening food supply should improve pricing three customers Japanese and German. Any regulatory changes, such power and buyers become price takers. China Green is one such as import taxes or tariffs for the importing countries, could affect beneficiary. earnings. More orders from overseas. Continues to expand overseas by Export taxes. Fresh vegetables and related processed foods do not participating in food exhibitions, and management expects Europe to attract export duties. This may change if the government decides to become another major market. further stabilize domestic food supplies. Unsystematic risks. Natural disasters such as previous snowstorms could affect harvests, but we expect limited overall impact due to the geographic diversification of China Green’s cultivation areas. Source: Sun Hung Kai Financial
Recent Company News Nil.
Industry Dynamics Despite Chinese government policies to stem the loss of cultivation land, such as restricting the conversion of agricultural land for non-agricultural uses, and heavy taxes for switching agricultural land to other uses, the nation’s farmland shrank 6.3% over 1997-2007 to 121,735.6 hectares. Most of the decline was caused by non-agricultural construction. The mainland’s population increased 6.9% in the same period, while the rapid rise in the use of foodstuffs (e.g. corn) to generate energy further unbalanced demand and supply of food.
The third plenary session of the Communist Party of China (CPC) Central Committee, held on 9-12 Oct. 2008 in Beijing, addressed rural development:
Setting up a “strict and normative” land-management system for the countryside.
Expanding policy support for agriculture.
Establishing a modern rural financial network.
Targeting to double rural disposable incomes from 2008 to 2020.
The CPC promised to invest more government funds in rural public services, including education, health care, employment, housing and pensions.
The CPC can allow farmers to lease their land for agricultural business. This reform removes gray areas, reduces legal and policy risk for agriculture companies, and makes the acquisition of cultivation land easier.
The Minister of Finance has announced the government will spend RMB716.1bn (up 20.3%) on the farming industry in 2009. The authority will focus on:
Support for rural reform.
Subsidies for agricultural products and constructing rural infrastructure.
Support for education, health care and social pensions.
Sun Hung Kai Financial 26 20 Nov. 2009
Figure 4: China Green – Profit and Loss Statement
FY06-09 Year ended 30 April, RMBm FY06 FY07 FY08 FY09 CAGR (%) Revenue 686.6 954.1 1,267.1 1,547.7 34.7 COGS (332.2) (456.2) (590.5) (747.5) 36.4 Gross profit 354.4 497.9 676.6 800.1 33.2 Operating expenses (106.1) (176.5) (207.4) (287.2) 46.6 Other operating income 2.3 0.7 0.9 1.0 329.3 Operating profit 250.6 322.1 470.2 514.0 27.8 Finance expenses (5.7) (14.4) (26.6) (53.7) 918.1 PBT 262.3 345.8 483.7 495.3 24.2 Tax 9.0 0.2 (12.8) (40.4) 13.5 Net profit 271.3 346.0 471.0 454.9 25.5 EPS – RMB fen 37.3 44.8 53.8 51.5 17.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: China Green – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 30 April, % FY06 FY07 FY08 FY09 CAGR (%) Revenue 45.9 39.0 32.8 22.1 34.7 COGS 53.8 37.3 29.4 26.6 36.4 Gross profit 39.2 40.5 35.9 18.2 33.2 Operating expenses 70.7 66.3 17.5 38.5 46.6 Other operating income 75,433.3 (70.8) 34.5 14.6 329.3 Operating profit 30.2 28.5 46.0 9.3 27.8 Finance expenses 114,000.0 152.3 84.8 101.9 918.1 PBT 26.2 31.8 39.9 2.4 24.2 Tax (137.0) (97.3) (5,322.0) 215.9 13.5 Net profit 47.8 27.5 36.1 (3.4) 25.5 EPS 35.6 20.1 20.1 (4.3) 17.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: China Green – Profit and Loss Statement (Common Size) FY06-09 Year ended 30 April, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (48.4) (47.8) (46.6) (48.3) (47.8) Gross profit 51.6 52.2 53.4 51.7 52.2 Operating expenses (15.5) (18.5) (16.4) (18.6) (17.2) Other operating income 0.3 0.1 0.1 0.1 0.1 Operating profit 36.5 33.8 37.1 33.2 35.1 Finance expenses (0.8) (1.5) (2.1) (3.5) (2.0) PBT 38.2 36.2 38.2 32.0 36.2 Tax 1.3 0.0 (1.0) (2.6) (0.6) Net profit 39.5 36.3 37.2 29.4 35.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 27 20 Nov. 2009
Figure 7: China Green – Balance Sheet FY06-09 As at 30 April, RMBm FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 852.9 1,050.5 2,098.0 1,344.3 26.1 Accounts receivable 22.6 11.4 13.7 13.2 9.4 Inventory 7.7 14.3 26.2 21.6 (12.0) Other current assets 101.4 112.5 241.2 220.3 13.4 Total current assets 984.6 1,188.7 2,379.0 1,599.5 22.5 Net fixed assets 468.8 558.4 675.7 1,125.3 52.8 Other long-term assets 65.1 93.8 113.1 856.7 89.5 Total assets 1,518.4 1,841.0 3,167.8 3,581.4 38.1 Short-term debt 0.0 0.0 0.0 0.0 N/A Accounts payable 1.1 1.2 1.8 2.3 8.8 Other current liabilities 82.4 89.6 83.2 91.9 (0.9) Total current liabilities 83.5 90.8 85.0 94.2 (0.7) Long-term debt 301.8 64.6 843.2 896.9 N/A Other long-term liabilities 0.5 0.0 0.0 17.5 46.7 Total liabilities 385.8 155.4 928.2 1,008.6 77.9 Shareholders equity 1,132.6 1,685.5 2,239.6 2,572.8 30.7 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 1,518.4 1,841.0 3,167.8 3,581.4 38.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: China Green – Balance Sheet (Common Size) FY06-09 As at 30 April, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 56.2 57.1 66.2 37.5 54.2 Accounts receivable 1.5 0.6 0.4 0.4 0.7 Inventory 0.5 0.8 0.8 0.6 0.7 Other current assets 6.7 6.1 7.6 6.2 6.6 Total current assets 64.8 64.6 75.1 44.7 62.3 Net fixed assets 30.9 30.3 21.3 31.4 28.5 Other long-term assets 4.3 5.1 3.6 23.9 9.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 0.0 0.0 Accounts payable 0.1 0.1 0.1 0.1 0.1 Other current liabilities 5.4 4.9 2.6 2.6 3.9 Total current liabilities 5.5 4.9 2.7 2.6 3.9 Long-term debt 19.9 3.5 26.6 25.0 18.8 Other long-term liabilities 0.0 0.0 0.0 0.5 0.1 Total liabilities 25.4 8.4 29.3 28.2 22.8 Shareholders equity 74.6 91.6 70.7 71.8 77.2 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 28 20 Nov. 2009
Figure 9: China Green – Key Ratios FY06-09 Year ended 30 April FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 51.6 52.2 53.4 51.7 52.2 Operating margin – % 36.5 33.8 37.1 33.2 35.1 Net margin – % 39.5 36.3 37.2 29.4 35.6 ROAA – % 21.7 20.6 18.8 13.5 18.6 ROAE – % 26.9 24.6 24.0 18.9 23.6
Liquidity ratios Current assets/current liabilities – X 11.8 13.1 28.0 17.0 17.5 Liquid assets/current liabilities – X 10.2 11.6 24.7 14.3 15.2 Cash and securities/current assets – % 86.6 88.4 88.2 84.0 86.8 Cash flow from oper./curr. liabilities – % 377.5 493.3 697.7 625.5 548.5
Other ratios Capex/sales – % 33.4 13.2 13.8 29.8 22.5 Capex/depreciation – % 432.0 178.7 305.6 553.4 345.9 Operating expense/sales -% (15.5) (18.5) (16.4) (18.6) (17.8) Net debt/equity (net cash) – % (48.7) (58.5) (62.2) (20.9) (47.2) Inventory/sales – % 1.1 1.5 2.1 1.4 1.7 Effective tax rate – % (3.4) (0.1) 2.6 8.2 3.6 Cash conversion cycle – days 30.9 14.4 15.2 13.8 14.5
ROAA component analysis Revenue/average assets – % 54.9 56.8 50.6 45.9 52.0 COGS/average assets – % (26.6) (27.2) (23.6) (22.2) (24.9) Gross profit/average assets – % 28.3 29.6 27.0 23.7 27.2 Operating expenses/average assets – % (8.5) (10.5) (8.3) (8.5) (8.9) Other operating income/average assets – % 0.2 0.0 0.0 0.0 0.1 Operating profit/average assets – % 20.0 19.2 18.8 15.2 18.3 Finance expenses/average assets – % (0.5) (0.9) (1.1) (1.6) (1.0) PBT/average assets – % 21.0 20.6 19.3 14.7 18.9 Tax/average assets – % 0.7 0.0 (0.5) (1.2) (0.2) Net profit/average assets – % 21.7 20.6 18.8 13.5 18.6
ROAE component analysis Revenue/average equity – % 68.1 67.7 64.6 64.3 66.2 COGS/average equity – % (33.0) (32.4) (30.1) (31.1) (31.6) Gross profit/average equity – % 35.2 35.3 34.5 33.3 34.6 Operating expenses/average equity – % (10.5) (12.5) (10.6) (11.9) (11.4) Other operating income/average equity – % 0.2 0.0 0.0 0.0 0.1 Operating profit/average equity – % 24.9 22.9 24.0 21.4 23.3 Finance expenses/average equity – % (0.6) (1.0) (1.4) (2.2) (1.3) PBT/average equity – % 26.0 24.5 24.6 20.6 24.0 Tax/average equity – % 0.9 0.0 (0.7) (1.7) (0.4) Net profit/average equity – % 26.9 24.6 24.0 18.9 23.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 29 20 Nov. 2009
China High Speed Transmission (658.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 China High Speed Transmission is the mainland’s leading supplier of mechanical transmission equipment for wind turbines, accounting for 80% of the domestic Performance (%) 1m 3m 12m market in 2008, with a 10% global market share in wind gearboxes. Its products are HSI 2.0 13.5 76.7 used in a wide range of industrial applications, including wind-power generation, HSCEI 4.0 19.6 107.6 marine vessels, rail transport, aerospace, metallurgy, petrochemicals, construction and mining. CHST– Price vs. HSI, Share Data
The firm is China’s fourth largest producer of traditional gearboxes, supplying (HK$) (HK$m) industries including mining, construction, transport and petrochemicals. It expanded 25.0 2,000
20.0 into wind-power gearboxes in FY04. 1,500 15.0 1,000 We see a steady, long-term shift toward renewable energy given increasing 10.0 500 awareness of environmental protection and favorable government policies, which 5.0 should benefit this leading manufacturer of alternative-energy equipment 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
The 1H09 net profit rose just 0.7% to RMB254.4m, on a 50% yoy hike in sales to Turnover Price HSI RMB2,033m. But excluding non-recurring charges from financial derivatives, the net profit would have been RMB333m, up 38% yoy. Price – HK$ 18.00 52W high/low (HK$) 21.00/5.15 Contributions from wind-gear transmission equipment increased to 63%, from 42% Shares in issue – millions 1,245.06 in 1H08, thanks to stellar demand for wind-power plants in China and new product Market cap – HK$m 22,834.48 launches (1.5-MW and 2-MW wind-gear transmission equipment). 3M avg. turnover – HK$m 116.68 Major shareholders – % At last month’s State Council meeting, Premier Wen Jiabao targeted to tighten Fortune Apex Ltd 21.56 investment in wind-power equipment due to signs of overheating. Consolidation in Sources: Bloomberg and Sun Hung Kai Financial the wind-turbine market may cut the currently more than 100 manufacturers to less than 10.
This should not slow industry growth, given the Chinese government’s ambitious targets, but may decrease pricing power for wind-gearbox suppliers. There is currently a supply shortage for turbines, as high industry barriers deter new entrants.
Recent Reports Date Figure 1: Earnings Summary Stronger Upcycle Ahead 17 July 2009
Year ending 31 Dec. FY06 FY07 FY08 FY09E Net profit – RMBm 85.6 306.7 692.4 830.8 Net-profit growth – % 4.8 258.1 125.8 20.0 This document is solely based on EPS – RMB fen 14.0 29.0 56.0 66.0 publicly available information. This report is intended as information EPS growth – % (17.6) 107.1 93.1 17.9 only and not as a recommendation P/E – X 100.7 48.6 25.2 21.4 for any stock. Sun Hung Kai DPS – RMB fen N/A 7.1 22.0 20.4 Financial does not provide research Dividend yield – % N/A 0.5 1.6 1.4 coverage or ratings for this
BVPS – RMB N/A 2.5 3.0 3.5 company in this report. P/B – X N/A 5.7 4.7 4.0 Oper cash flow/share – RMB fen 20.5 31.0 13.2 77.8 Eva Yip, CFA Net debt (net cash) to share price – % N/A (4.3) 7.0 6.2 + (852) 2203 5987 Sources: Bloomberg and Sun Hung Kai Financial [email protected] Note: Estimates based on Bloomberg consensus
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor30ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: China High Speed Transmission – Investment Highlights
Key investment positives Key investment negatives
Sales growth driven by strong global and domestic demand. Relies heavily on major customer GE, accounting for 35%-40% Wind is the most commercially viable renewable energy. Global of wind-gearbox revenue in 2009. installed capacity is set to expand around 30% p.a. over the next 5-10 years, with growth opportunities across the value chain. Long product lifecycles mean lower replacement demand. Ongoing technology advancement reduces wear for gearboxes. China targets wind-power capacity of 100-150 GW by 2020, up from 12 GW in 2008, a 19%-24% 12-year CAGR. Sales mix shifting toward low-margin marine gearboxes. Domestic marine-transmission equipment sales are rising Dominant market position. CHST has a 10% global market share following the shipbuilding recovery due to the government in wind gearboxes, which account for 13% of the total cost of a stimulus package. The marine-gear margin is a company-low 23%, wind turbine, the third largest component. It is also the dominant and these products made up 12% of FY08 sales vs. 7% in FY07. player in the mainland wind market (80% share). Wind gearboxes make up 60%-plus of sales. May take time to penetrate international markets. Despite high-quality products and 25% lower ASPs than international Robust sales growth also driven by new products. New products peers, penetration into new customers is likely to be challenging such as 2.5-MW and 3.0-MW wind-gear transmission equipment due to long qualification times and a short track record in the could stimulate faster replacement (currently 8-10 years). industry. The firm expanded into wind gearboxes in FY04. Strong demand for gearboxes in the construction materials and rolling mills businesses (up 30%-plus to 25% of revenues), driven Component-supply bottleneck may disrupt product delivery. Delivery of large bearings (used in gearboxes and the main shafts) by the government’s infrastructure-led stimulus. can take 16-18 months. The dramatic increase in turbine sizes Strong sales visibility. CHST delivered 2,055 MW of wind means the number of components/parts suppliers that can satisfy gearboxes in 1H09, only 34% of its full-year target of 6,000 MW, demand reliably is reduced considerably. but production is fully booked for next year and the firm is Order delays due to supply-chain disruption. Component maintaining its 9,000 MW delivery target for 2010. suppliers require major investment in machinery, with up to two Moving upstream. The group will invest in producing raw years lead-in time. materials through joint ventures or other channels to lessen its dependence on suppliers. Falling steel costs. Steel-related raw materials accounted for 75% of FY08 COGS. Steel prices have declined 68% from their peak. Minimal ASP pressure for traditional products (36% of sales), despite raw-material cost declines, as these are all tailor-made in small volumes. Lower costs than international peers, higher product quality than domestic peers. CHST has such a dominant position in the Chinese wind-gearbox market that customers prefer its products to imports, which are 20%-30% more expensive. Strong partners maintain technology edge. The firm has tie-ups with global downstream players, for example jointly developing a 2.5-MW gearbox with GE. New products can take two years to develop. Early wind turbines were dogged by fundamental gearbox-design errors, underlining the importance of good wind gearboxes. Orders from major overseas customer GE Wind are set to pick up in FY10, when the U.S. government’s supportive policy takes effect. Major customers locked in. GE Wind is the leading wind-turbine supplier in the U.S. market, accounting for 43% of new installations in FY08. 35%-40% of CHST’s wind-gearbox sales are to GE. High entry barriers. The Chinese gearbox market is difficult to enter due to product complexity. Short cash-conversion cycle (90 days). For key customers, CHST receives 70% of the selling price on delivery, 100% for smaller customers. Source: Sun Hung Kai Financial
Figure 3: China High Speed Transmission – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Increase in international wind business, due to qualification of new Emergence of additional domestic suppliers due to high products at existing customers or gaining new customers. Due to profitability. This may cause market-share loss. the firm’s short track record, it will take time to penetrate large The government withdrawing subsidies for renewable energy, international wind-turbine operators. which have been the main driver for the spike in investment so far. China raising its renewable-energy policy targets. Consolidation of wind turbine market may reduce bargaining power. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 31 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
China is promoting renewable energy to reduce its reliance on less environmentally friendly coal. The authorities require power companies to derive at least 5% of power output from renewable sources by 2010 and 10% by 2020.
IPPs are aggressively building up wind capacity because this is the most viable renewable-energy option (complete within two years vs. five years for a nuclear-power plant) for meeting the government requirements. On cost per kWh, wind and solar are not competitive vs. coal-fired electricity, but wind power in China is much cheaper than solar energy. Wind electricity costs around RMB0.55/kWh, vs. solar energy at RMB3.0/kWh, and only slightly higher than coal-fired at RMB0.40/kWh. Wind power therefore seems a better investment, as renewable-energy tariff subsidies will eventually be phased out. The NDRC targets installed wind-power capacity to increase from 12 GW in 2008 to 100-150 GW by 2020, for a 19%-24% 12-year CAGR. Other countries are also including renewable-energy capex as part of their economic-stimulus plans.
Rapid global demand growth for wind power has driven a sharp increase in demand for wind turbines, which should benefit the whole value chain. Gearboxes account for 13% of the total cost of a wind turbine, the third largest component. CHST is the largest gearbox manufacturer in China, with an 80% market share.
Sun Hung Kai Financial 32 20 Nov. 2009
Figure 4: China High Speed Transmission – Profit and Loss Statement FY06-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR Revenue 946.7 1,184.3 1,904.8 3,439.2 49.5 COGS (672.1) (843.5) (1,351.8) (2,447.1) 49.5 Gross profit 274.6 340.8 553.1 992.2 49.4 Operating expenses (154.7) (206.7) (324.1) (482.6) 41.3 Other operating income 11.1 19.1 18.8 19.0 37.1 Operating profit 131.0 153.1 247.8 528.6 58.6 Finance expenses (21.2) (41.5) (33.0) (28.7) 20.8 PBT 112.7 93.7 324.3 764.5 75.3 Tax (13.3) (3.5) (17.9) (71.8) 138.1 Net profit 81.8 85.6 306.7 692.4 106.9 EPS – RMB fen 17.0 14.0 29.0 56.0 16.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: China High Speed Transmission – Profit and Loss Statement (Year on Year Growth) FY06-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR Revenue 37.4 25.1 60.8 80.6 49.5 COGS 37.3 25.5 60.2 81.0 49.5 Gross profit 37.9 24.1 62.3 79.4 49.4 Operating expenses 27.9 33.6 56.8 48.9 41.3 Other operating income 106.6 71.7 (1.3) 0.8 37.1 Operating profit 56.7 16.9 61.8 113.3 58.6 Finance expenses 57.7 95.6 (20.5) (13.1) 20.8 PBT 39.1 (16.8) 246.0 135.7 75.3 Tax 496.7 (73.6) 409.5 301.2 138.1 Net profit 116.4 4.8 258.1 125.8 106.9 EPS (43.3) (17.6) 107.1 93.1 16.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: China High Speed Transmission – Profit and Loss Statement (Common Size) FY06-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (71.0) (71.2) (71.0) (71.2) (71.1) Gross profit 29.0 28.8 29.0 28.8 28.9 Operating expenses (16.3) (17.5) (17.0) (14.0) (16.2) Other operating income 1.2 1.6 1.0 0.6 1.1 Operating profit 13.8 12.9 13.0 15.4 13.8 Finance expenses (2.2) (3.5) (1.7) (0.8) (2.1) PBT 11.9 7.9 17.0 22.2 14.8 Tax (1.4) (0.3) (0.9) (2.1) (1.2) Net profit 8.6 7.2 16.1 20.1 13.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 33 20 Nov. 2009
Figure 7: China High Speed Transmission – Balance Sheet FY06-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 63.5 196.1 1,516.1 681.6 81.3 Accounts receivable 366.5 479.2 441.4 968.4 60.9 Inventory 229.3 347.5 646.1 1,335.7 46.9 Other current assets 211.8 246.7 431.3 1,875.4 83.4 Total current assets 871.2 1,269.5 3,034.9 4,861.2 64.7 Net fixed assets 545.1 887.1 1,455.3 2,604.2 51.7 Other long-term assets 25.9 65.9 295.5 1,012.5 247.7 Total assets 1,442.1 2,222.6 4,785.6 8,477.9 64.5 Short-term debt 668.5 909.4 734.1 1,865.0 47.0 Accounts payable 156.9 188.7 285.4 562.9 34.7 Other current liabilities 342.1 306.5 573.0 966.8 37.7 Total current liabilities 1,167.5 1,404.6 1,592.4 3,394.8 41.8 Long-term debt 90.0 284.6 73.0 68.3 8.1 Other long-term liabilities 0.7 2.2 12.2 1,280.1 N/A Total liabilities 1,258.2 1,691.4 1,677.7 4,743.2 51.9 Shareholders equity 184.0 531.2 3,107.9 3,734.6 93.0 Minorities 50.2 4.2 3.3 3.6 (55.0) Total equity and liabilities 1,442.1 2,222.6 4,785.6 8,477.9 64.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: China High Speed Transmission – Balance Sheet (Common Size) FY06-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 4.4 8.8 31.7 8.0 13.2 Accounts receivable 25.4 21.6 9.2 11.4 16.9 Inventory 15.9 15.6 13.5 15.8 15.2 Other current assets 14.7 11.1 9.0 22.1 14.2 Total current assets 60.4 57.1 63.4 57.3 59.6 Net fixed assets 37.8 39.9 30.4 30.7 34.7 Other long-term assets 1.8 3.0 6.2 11.9 5.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 46.4 40.9 15.3 22.0 31.2 Accounts payable 10.9 8.5 6.0 6.6 8.0 Other current liabilities 23.7 13.8 12.0 11.4 15.2 Total current liabilities 81.0 63.2 33.3 40.0 54.4 Long-term debt 6.2 12.8 1.5 0.8 5.3 Other long-term liabilities 0.0 0.1 0.3 15.1 3.9 Total liabilities 87.2 76.1 35.1 55.9 63.6 Shareholders equity 12.8 23.9 64.9 44.1 36.4 Minorities 3.5 0.2 0.1 0.0 0.9 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 34 20 Nov. 2009
Figure 9: China High Speed Transmission – Key Ratios FY06-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 29.0 28.8 29.0 28.8 28.9 Operating margin – % 13.8 12.9 13.0 15.4 13.8 Net margin – % 8.6 7.2 16.1 20.1 13.0 ROAA – % 6.3 4.7 8.8 10.4 7.5 ROAE – % 36.1 24.0 16.9 20.2 24.3
Liquidity ratios Current assets/current liabilities – X 0.7 0.9 1.9 1.4 1.2 Liquid assets/current liabilities – X 0.1 0.1 1.0 0.2 0.3 Cash and securities/current assets – % 7.3 15.4 50.0 14.0 21.7 Cash flow from oper./curr. liabilities – % 0.9 8.9 20.7 4.8 8.8
Other ratios Capex/sales – % 10.0 33.7 42.4 32.6 29.7 Capex/depreciation – % 167.5 696.0 950.0 772.0 806.0 Operating expenses/sales -% (16.3) (17.5) (17.0) (14.0) (16.2) Net debt/equity – % 377.7 187.8 (24.2) 33.0 65.5 Inventory/sales – % 24.2 29.3 33.9 38.8 34.0 Effective tax rate – % 11.8 3.7 5.5 9.4 6.2 Cash-conversion cycle – days 141.3 189.5 169.9 173.7 177.7
ROAA component analysis Revenue/average assets – % 72.8 64.6 54.4 51.9 60.9 COGS/average assets – % (51.7) (46.0) (38.6) (36.9) (43.3) Gross profit/average assets – % 21.1 18.6 15.8 15.0 17.6 Operating expenses/average assets – % (11.9) (11.3) (9.2) (7.3) (9.9) Other operating income/average assets – % 0.9 1.0 0.5 0.3 0.7 Operating profit/average assets – % 10.1 8.4 7.1 8.0 8.4 Finance expenses/average assets – % (1.6) (2.3) (0.9) (0.4) (1.3) PBT/average assets – % 8.7 5.1 9.3 11.5 8.6 Tax/average assets – % (1.0) (0.2) (0.5) (1.1) (0.7) Net profit/average assets – % 6.3 4.7 8.8 10.4 7.5
ROAE component analysis Revenue/average equity – % 418.0 331.2 104.7 100.5 238.6 COGS/average equity – % (296.7) (235.9) (74.3) (71.5) (169.6) Gross profit/average equity – % 121.2 95.3 30.4 29.0 69.0 Operating expenses/average equity – % (68.3) (57.8) (17.8) (14.1) (39.5) Other operating income/average equity – % 4.9 5.3 1.0 0.6 3.0 Operating profit/average equity – % 57.8 42.8 13.6 15.4 32.4 Finance expenses/average equity – % (9.4) (11.6) (1.8) (0.8) (5.9) PBT/average equity – % 49.7 26.2 17.8 22.3 29.0 Tax/average equity – % (5.9) (1.0) (1.0) (2.1) (2.5) Net profit/average equity – % 36.1 24.0 16.9 20.2 24.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 35 20 Nov. 2009
China Mengniu (2319.HK) Food and Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 China Mengniu is one of China’s top three dairies; its main competitors are Yili and Bright Dairy. The company manufactures and distributes dairy products, such as Performance (%) 1m 3m 12m UHT milk, milk beverages, yogurt and ice cream under the Mengniu brand in China HSI 2.0 13.5 76.7 and Hong Kong. Liquid milk accounts for 85% of total sales, while ice cream HSCEI 4.0 19.6 107.6 accounts for 13.8%. The group’s major product, UHT milk, saw revenue drop 18.4% yoy in 1H09, the main reason for the 12.8% yoy fall in sales for liquid-milk products. Mengniu – Price vs. HSI, Share Data
Overall revenue fell 11.7% yoy, but increased by 19% hoh to RMB12.1bn; the net (HK$) (HK$m) profit increased 13.6% yoy to RMB662m, gradually recovering to the pre-melanine 25.0 2,000
20.0 scandal levels. Basic EPS increased 3.7% yoy to RMB0.424. No interim dividend 1,500 was declared. 15.0 1,000 10.0 500 The group further expanded production capacity, to an aggregate of 5.74 million tons 5.0 p.a. as at end-June 2009 (5.57 million tons as at end-December 2008). 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Following the melamine scandal, management is now focusing on raising product Turnover Price HSI quality and improving the product mix, in contrast to the previous 10 years when it was aggressively growing product sales and liquid-milk market share. Price – HK$ 23.70 In July 2009, the group secured a capital injection from COFCO Limited, a leading 52W high/low (HK$) 24.85/6.16 oil-and-food enterprise in China, and Hopu Investment Management Co., Ltd, a Shares in issue – millions 1,736.66 well-known private-equity fund. This also brought in industry experience, global Market cap – HK$m 40,724.65 customer networks and a well-established food-safety control system. 3M avg. turnover – HK$m 164.02 Major shareholder – % Food quality and controls are a major concern for the government and consumers; COFCO 20.04 any adverse news could hit customer loyalty and rapidly cut market share, which is Source: Bloomberg and Sun Hung Kai Financial now 40.7%.
The firm had net cash of HK$2,865m as at end-1H09, equal to 8% of its market cap. The stock trades at 27.7x FY09 consensus earnings. This document is solely based on publicly available information. This report is intended as information Figure 1: Earnings Summary only and not as a recommendation for any stock. Sun Hung Kai Year ended 31 Dec. FY06 FY07 FY08 FY09E Financial does not provide research Net profit – RMBm 727.4 935.8 (948.6) 1,266.9 coverage or ratings for this Net-profit growth – % 59.2 28.7 N/A N/A company in this report. EPS – RMB fen 53.2 66.4 (63.9) 75.5 EPS growth – % 45.8 24.8 N/A N/A Name P/E – X 39.3 31.5 N/A 27.7 Analyst DPS – RMB fen 10.9 13.2 0.0 13.9 + (852) Dividend yield – % 0.5 0.6 0.0 0.7
BVPS – RMB 2.2 3.6 2.9 4.5
P/B – X 9.5 5.8 7.3 4.7 Holly Hou Oper. cash flow/share – RMB fen 103.8 149.5 45.6 105.6 + (852) 2203 9588 Net debt (net cash) to share price – % (0.4) (5.5) (2.4) (9.7) Sources: Bloomberg and Sun Hung Kai Financial [email protected] Notes: Estimated based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer Sun HungThis Kaireport Financial / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),36 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Mengniu – Investment Highlights
Key investment positives Key investment negatives The group posted a turnaround from FY08, with a half-on-half The 1H09 gross margin increased 2.6 ppts yoy to 26.7%, but this increase in revenue and year-on-year increase in net profit, was mainly due to low raw-milk costs. This may not be sustainable underlining its ability to quickly recover from the melanine given the changing price cycle or possible government scandal. intervention. The group has secured a capital injection from COFCO and Hopu, Mengniu’s cost structure reflects its high sensitivity to changes in which will also bring in industry experiences, global customer raw-milk prices. Every 1-ppt change in raw-milk costs can move networks and a well-established food-safety control system. the net profit by 8%-9%. It needs government approval for ASP adjustments. The group continues to expand production capacity, which reached an aggregate of 5.74 million tons p.a. as at end-June 2009. This can The 12.8% yoy decline in 1H09 liquid-milk sales was due to the help it meet the sharp increase in retail demand and further product scandal in February this year, which has hurt consumer improve economies of scale. confidence. Peer Yili posted a 12.1% yoy increase in liquid-milk sales plus a 4.8 ppts expansion in liquid-milk gross margin, so The group continues to reinforce R&D for high-end products, Mengniu is probably losing market share. focusing on the female and children’s markets. It has launched various new products in these niche markets to meet the growing To tighten quality controls and improve product mix, management needs of consumers. plans to source more raw milk from larger cattle farms, which can be more expensive than sourcing from individual raw-milk Following last year’s melamine scandal, management has shifted suppliers. its focus to quality control. The group is setting up a long-term and comprehensive regulatory system that covers all processes and Management is now focusing on raising product quality and procedures in production. improving the product mix, rather than aggressively growing product sales and liquid-milk market share. This should cause sales Mengniu still has a good reputation and strong brand name, with a growth to slow in the next several years. dominant 40.7% market share. This means its can increase prices without losing customers in the long term. Scope is limited for product diversification across an extended geographical area, given logistics and cold-transport limitations. The company is shifting its product mix from low-margin, This could make it harder for Mengniu to diversify its product high-raw-milk-content goods such as UHT milk, to high-margin, range compared with smaller regional players. low-raw-milk-content goods such as yogurt and milk beverages. Tighter regulations will further boost consolidation, squeezing smaller players out of the industry. Larger players such as Mengiu will be able to take more market share from smaller players. The industry is growing rapidly due to the robust economy in the past few years and increasing consumption power. Milk sales per capita rose from 3.65 kg in 2001 to 13.27 kg in 2006, for an FY01-FY06 CAGR of 29.5%, as people now are now more health-sensitive. The group can benefit from government policies. The Chinese government will set up some orders to intervene in the market, such as offering subsidies to farmers to raise more milk cows, which will decline raw-milk costs for the company. The company has a strong balance sheet, with net cash of RMB2,865m as at end-June 2009. This can support potential M&A opportunities and help it improve its product mix. Source: Sun Hung Kai Financial
Figure 3: Mengniu – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Faster-than-expected approval for ASP increases reducing the effect of The government can impose price controls for dairy products, which cost hikes and helping to maintain the gross margin. may hurt the company’s gross margin. Small dairy producers are expected to shut down due to high quality Price controls could hurt EPS if the CPI grows too quickly, as the firm requirements, leaving more room for Mengniu to expand market share. will not be able to pass rising costs on to customers. Favorable government policies, such as subsidies for farmers to raise Consumers preferring imported dairy products, especially milk powder, more milk cows. after the melamine scandal last year, which would lead to market-share loss.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 37 20 Nov. 2009
Recent Company News
9 Oct. 2009: Mengniu’s southwest production base has started operations
The new production base in southwest China, with daily production capacity of 800 tons, was launched on 9 Oct. 2009. It can increase annual sales to RMB1.2bn if operating at full capacity. The initial investment was RMB300m.
SHKF Comment: The company is actively seeking opportunities to expand production capacity, which reached an aggregate of 5.74 million tons p.a. as at end-June 2009. According to the National Development and Reform Commission, China’s dairy sector is recovering, with market prices and sales volumes turning around fiollowing declines over the past year. The August ASP and sales volume rose 3.2% and 7% respectively compared with January. Market sales were back to 90% of the level before the melamine scandal. We believe Mengniu expanding its production capacity will help it better capture the recovery in demand.
19 Nov. 2009: Mengniu wins bid for prime-time CCTV advertising slots
Mengniu was one of the biggest spenders at CCTV’s auction of next year’s advertising slots, which raised bids totaling RMB10.97bn, the highest in 16 years and up 18.5% yoy. Mengniu shelled out RMB204m for its ad space.
SHKF comments: Mengniu is recovering from its nadir, and 3Q sales have already returned to 90% of the pre-crisis level, with a further improvement in October. The company’s heavy bidding at the ad-space auction illustrates management’s confidence in the business next year.
Industry Dynamics
After last year’s milk scandal, a series of regulations and measures were introduced by China’s national and local governments to improve the structure of the dairy industry and ensure product safety. These include the Food Safety Law of the People’s Republic of China, the Regulation on the Supervision and Administration of the Quality and Safety of Dairy Products and Outlines of the Rectification and Revival of the Dairy Industry. China’s dairy industry has had to quickly comply with these policies to improve monitoring and testing in 1H09, to provide assurances about product quality and improve consumer confidence.
These efforts have helped the industry recover in 1H09. Future developments will include large-scale breeding, the integration of production and sales, optimization of processing and standardization of the dairy industry.
Sun Hung Kai Financial 38 20 Nov. 2009
Figure 4: Mengniu – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 10,825.0 16,246.4 21,318.1 23,865.0 34.9 COGS (8,411.7) (12,524.6) (16,514.6) (19,195.6) 36.0 Gross profit 2,413.2 3,721.8 4,803.5 4,669.4 30.6 Operating expenses (1,783.4) (2,816.0) (3,766.6) (5,920.0) 49.7 Other operating income 19.2 58.1 48.5 56.8 44.2 Operating profit 649.0 963.9 1,085.3 (1,193.8) N/A Finance expenses (44.0) (63.1) (50.1) (39.4) (0.0) PBT 617.1 942.3 1,130.3 (1,089.3) N/A Tax (61.6) (76.0) (21.7) 161.5 N/A Net profit 456.8 727.4 935.8 (948.6) N/A EPS – RMB fen 36.5 53.2 66.4 (63.9) N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Mengniu – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 50.1 50.1 31.2 11.9 34.9 COGS 50.0 48.9 31.9 16.2 36.0 Gross profit 50.2 54.2 29.1 (2.8) 30.6 Operating expenses 51.1 57.9 33.8 57.2 49.7 Other operating income 46.4 201.9 (16.6) 17.3 44.2 Operating profit 47.6 48.5 12.6 N/A N/A Finance expenses 11.5 43.5 (20.6) (21.3) (0.0) PBT 50.3 52.7 19.9 N/A N/A Tax 233.7 23.4 (71.5) (845.5) N/A Net profit 43.0 59.2 28.7 N/A N/A EPS 2.2 45.8 24.8 N/A N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Mengniu – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (77.7) (77.1) (77.5) (80.4) (78.2) Gross profit 22.3 22.9 22.5 19.6 21.8 Operating expenses (16.5) (17.3) (17.7) (24.8) (19.1) Other operating income 0.2 0.4 0.2 0.2 0.3 Operating profit 6.0 5.9 5.1 (5.0) 3.0 Finance expenses (0.4) (0.4) (0.2) (0.2) (0.3) PBT 5.7 5.8 5.3 (4.6) 3.1 Tax (0.6) (0.5) (0.1) 0.7 (0.1) Net profit 4.2 4.5 4.4 (4.0) 2.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 39 20 Nov. 2009
Figure 7: Mengniu - Balance Sheet FY05-08 As at 31 Dec., RMB m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 1,247.8 1,330.1 2,210.8 2,219.0 21.5 Accounts receivable 256.2 315.1 376.2 348.9 17.1 Inventory 781.0 1,071.5 877.4 824.5 3.6 Other current assets 218.1 225.6 299.1 1,709.2 83.7 Total current assets 2,503.1 2,942.2 3,763.6 5,101.5 25.3 Net fixed assets 3,449.8 4,637.1 5,584.8 5,718.6 22.3 Other long-term assets 134.2 184.4 332.9 495.2 37.3 Total assets 6,087.1 7,763.7 9,681.3 11,315.3 24.2 Short-term debt 389.2 588.8 478.2 1,616.8 34.6 Accounts payable 1,117.0 1,034.7 1,315.4 2,155.3 32.7 Other current liabilities 989.2 1,453.8 1,569.8 1,994.0 27.3 Total current liabilities 2,495.4 3,077.3 3,363.4 5,766.1 31.2 Long-term debt 457.2 641.1 80.0 628.0 25.0 Other long-term liabilities 367.5 412.6 403.2 183.2 (7.9) Total liabilities 3,320.0 4,131.0 3,846.6 6,577.3 27.9 Shareholders equity 2,767.1 3,632.7 5,834.7 4,738.0 19.8 Minorities 436.5 633.8 723.1 273.4 (5.9) Total equity and liabilities 6,087.1 7,763.7 9,681.3 11,315.3 24.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Mengniu – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 20.5 17.1 22.8 19.6 20.0 Accounts receivable 4.2 4.1 3.9 3.1 3.8 Inventory 12.8 13.8 9.1 7.3 10.7 Other current assets 3.6 2.9 3.1 15.1 6.2 Total current assets 41.1 37.9 38.9 45.1 40.7 Net fixed assets 56.7 59.7 57.7 50.5 56.2 Other long-term assets 2.2 2.4 3.4 4.4 3.1 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 6.4 7.6 4.9 14.3 8.3 Accounts payable 18.4 13.3 13.6 19.0 16.1 Other current liabilities 16.3 18.7 16.2 17.6 17.2 Total current liabilities 41.0 39.6 34.7 51.0 41.6 Long-term debt 7.5 8.3 0.8 5.5 5.5 Other long-term liabilities 6.0 5.3 4.2 1.6 4.3 Total liabilities 54.5 53.2 39.7 58.1 51.4 Shareholders equity 45.5 46.8 60.3 41.9 48.6 Minorities 7.2 8.2 7.5 2.4 6.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 40 20 Nov. 2009
Figure 9: Mengniu – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 22.3 22.9 22.5 19.6 21.8 Operating margin – % 6.0 5.9 5.1 (5.0) 3.0 Net margin – % 4.2 4.5 4.4 (4.0) 2.3 ROAA – % 8.4 10.5 10.7 (9.0) 5.2 ROAE – % 18.0 22.7 19.8 (17.9) 10.6
Liquidity ratios Current assets/current liabilities – X 1.0 1.0 1.1 0.9 1.0 Liquid assets/current liabilities – X 0.5 0.4 0.7 0.4 0.5 Cash and securities/current assets – % 49.8 45.2 58.7 43.5 49.3 Cash flow from oper./curr. liabilities – % 53.8 46.2 62.6 11.7 43.6
Other ratios Capex/sales – % 9.6 7.7 6.7 3.4 6.9 Capex/depreciation – % 374.5 308.5 271.0 129.5 236.3 Operating expense/sales -% (16.5) (17.3) (17.7) (24.8) (19.9) Net debt/equity (net cash) – % (14.5) (2.8) (28.3) (16.8) (16.0) Inventory/sales – % 7.2 6.6 4.1 3.5 4.7 Effective tax rate – % 10.0 8.1 1.9 14.8 8.3 Cash conversion cycle – days 0.9 2.8 1.2 (11.4) (2.5)
ROAA component analysis Revenue/average assets – % 199.6 234.6 244.4 227.3 226.5 COGS/average assets – % (155.1) (180.9) (189.3) (182.8) (177.0) Gross profit/average assets – % 44.5 53.7 55.1 44.5 49.4 Operating expenses/average assets – % (32.9) (40.7) (43.2) (56.4) (43.3) Other operating income/average assets – % 0.4 0.8 0.6 0.5 0.6 Operating profit/average assets – % 12.0 13.9 12.4 (11.4) 6.7 Finance expenses/average assets – % (0.8) (0.9) (0.6) (0.4) (0.7) PBT/average assets – % 11.4 13.6 13.0 (10.4) 6.9 Tax/average assets – % (1.1) (1.1) (0.2) 1.5 (0.2) Net profit/average assets – % 8.4 10.5 10.7 (9.0) 5.2
ROAE component analysis Revenue/average equity – % 427.0 507.7 450.3 451.4 459.1 COGS/average equity – % (331.8) (391.4) (348.9) (363.1) (358.8) Gross profit/average equity – % 95.2 116.3 101.5 88.3 100.3 Operating expenses/average equity – % (70.3) (88.0) (79.6) (112.0) (87.5) Other operating income/average equity – % 0.8 1.8 1.0 1.1 1.2 Operating profit/average equity – % 25.6 30.1 22.9 (22.6) 14.0 Finance expenses/average equity – % (1.7) (2.0) (1.1) (0.7) (1.4) PBT/average equity – % 24.3 29.4 23.9 (20.6) 14.3 Tax/average equity – % (2.4) (2.4) (0.5) 3.1 (0.6) Net profit/average equity – % 18.0 22.7 19.8 (17.9) 10.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 41 20 Nov. 2009
China Singyes Solar (750.HK) Alternative Energy Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 China Singyes Solar Technology Holdings Limited (Singyes) is a professional engineering company that fabricates and installs conventional curtain walls (the Performance (%) 1m 3m 12m exterior glass walls seen on many modern commercial buildings). It also designs, Absolute 2.0 13.5 76.7 fabricates and installs Building Integrated Photovoltaic (BIPV) systems, which Relative to HSI integrate photovoltaic technology (converting solar energy into electricity) into 4.0 19.6 107.6
buildings and structures Singyes– Price vs. HSI, Share Data
BIPV increased from 7% of turnover in 1H08 to 20% in 1H09. This segment will be (HK$) (HK$m) the main growth driver in coming years, as target customers overlap with those for 6.0 500 the firm’s curtain-wall business, meaning that Singyes already has a good reputation 5.0 400 4.0 with its prospective BIPV clients. 300 3.0 200 2.0 Downstream solar-power users and installers, like Singyes, are benefiting from a 100 supply glut in photovoltaic (PV) solar-power equipment. This has lowered costs, with 1.0 0.0 0 prices falling 40%-60% across the board. Jan 09 May 09 Sep 09
Turnover Price HSI Furthermore, downstream industry fundamentals are becoming increasingly positive, as the government furthers its support for solar-power-integrated public works, which Price – HK$ 3.67 include mass-transport stations, buildings and schools, amid lower PV-equipment 52W high/low (HK$) 5.197/0.875 costs. Shares in issue – millions 491.00 Market cap – HK$m 1,821.61 China’s downstream solar-power industry will drive the nation’s solar-power 3M avg. turnover – HK$m 24.00 integration program and is expected to continue to outperform upstream equipment Major shareholder – % producers, as these companies must wait for the glut in production capacity to slowly Strong Eagle Holding 39.93 ease. Source: Bloomberg and Sun Hung Kai Financial
Figure 1: Examples of China Singyes’ government projects Recent Reports Curtain wall area Power-generating Date Curtain-wall projects (m²) BIPV projects capacity (kW) Momentum to Pick Up in 27 Aug. 2009 Second Half National Olympics Sports Ganzhou Museum 24,000 8.17 Centre Stadium Update – Sun Still Shining 18 Aug. 2009 Ningqi Railway Yangzhou Solar Powered Uptrend 29 July 2009 35,000 Qingdao Railway Station 103 Station Rising Sun 24 July 2009 Jiangxi Telecom Processing 35,000 Weihai Citizen Plaza 630 Centre ‘110’ Social Linkage and Hohhot East Railway 25,000 100 Command Centre Station This document is solely based on Administration Center of Xi’an BlueStar Terra 19,000 163 publicly available information. This National People’s Congress Photovoltaic Company report is intended as information only Guanyinshan International Shenzhen Vanke Property and not as a recommendation for any 74,000 267 Commercial Operation Center A Holding Ltd. stock. Sun Hung Kai Financial does not Sources: The Company and Sun Hung Kai Financial provide research coverage or ratings for
this company in this report.
Michael Yuk + (852) 2203 9590 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer Sun HungThis Kai rep Financialort / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),42 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Earnings Summary Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – RMBm 50.1 70.3 103.5 149.0 Net-profit growth – % 34.4 40.4 47.2 44.0 EPS – RMB fen N/A N/A 28.1 31.3 EPS growth – % N/A N/A N/A 11.4 P/E – X N/A N/A 11.5 10.3 DPS – RMB fen 0.0 0.0 0.0 9.3 Dividend yield – % 0.0 0.0 0.0 2.8 BVPS – RMB N/A N/A N/A N/A P/B – X N/A N/A N/A N/A Oper cash flow/share – RMB fen N/A N/A 13.1 25.0 Net debt (net cash) to share price – % N/A N/A N/A (20.5) Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus
Figure 3: China Singyes Solar Technology – Investment Highlights
Key investment positives Key investment negatives
Renewable energy policy supportive. The Ministry of Finance Preferential corporate income tax to expire by 2012. Zhuhai has initiated measures to grant subsidies to qualified projects that Singyes currently enjoys a preferential tax rate due to its location apply solar photovoltaic technologies to building i.e. the in the Zhuhai Special Economic Zone. In 2008, its corporate Solar-Powered Rooftops Plan and the Golden Sun Program. A income tax rate was only 9%. However, the preferential tax period special fund has been established to provide subsidies of will gradually lapse by 2012, with preferential tax rates increasing RMB15-RMB20/W for PV systems that are at least 50 kilowatts to 10%, 22%, 24% and 25% over FY09-FY12. (kW) in size and meet required power-conversion efficiencies It is Short BIPV and solar-power product history. Singyes’ BIPV estimated that the new subsidy can cover 50%-60% of the total and solar-power business only started in 2007, and the company cost of an installation, thus boosting demand for BIPV systems. has only completed five BIPV projects. Hence, the company faces Curtain walls and BIPV systems for new railway stations. 548 a certain level of execution risk due to its relative inexperience in new railway stations will be built or developed between 2006 and the BIPV and solar power industry. 2010, based on the State Council’s Mid-to-Long Term Railway Increasing competition. BIPV systems are a fast-growing, Network Development Plan. Singyes will leverage its reputation lucrative industry, in which Singyes posted a 37% gross margin for and proven track record in railway-station projects to win more 1H09. High margins and support from government policy will public-works projects to install curtain walls, and introduce BIPV attract an increasing number of rivals, which will compete with and solar-power products in these stations. Singyes for market share. Large exposure to public works. Public works accounted for Cash-conversion cycle should increase with more public works. 60% of 1H09 turnover. Hence, the company has large exposure to Public projects made up more than 60% of turnover in 1H09 and direct increases in government spending on public projects, such as the company plans to increase this going forward. But this should building schools, mass-transit stations, buildings, etc. increase the cash-conversion cycle from the current 100 days due Higher growth potential in China market. Europe (Germany), to the longer payment periods by government. Japan and the U.S. represent nearly 89% of worldwide Liquidity risk may stifle growth. Although there is little risk of photovoltaic (PV) installed capacity, but these are relatively mature default from Singyes’ government clients, the long CCC could put markets for solar power. However, China’s commitment to pressure on working capital and stifle growth (keeping the alternative energy is expected to result in dramatic growth in solar company from tendering projects with contract values of RMB60m power as production capacity increases from the current 80 MW to or above) if the company cannot finance projects it is awarded. 300 MW in 2010 and 1,800 MW by 2020. Revenue mostly project-based, with little recurring business. BIPV will continue to drive growth. BIPV increased from 7% of Singyes’ business in mainly project based and non-recurring. turnover in 1H08 to 20% in 1H09. This will remain the main Hence, the company has to continuously source new customers and growth driver in coming years, as the target customers for BIPV projects. projects overlap with those for the firm’s curtain-wall business. This means that Singyes already has a good reputation with its Reliance on suppliers for thin-film PV panels. Singyes procures prospective BIPV clients. almost all (99%) of its thin-film PV panels from Weihai China. Supply deficiencies on the part of Weihai China would cause Lower prices for PV equipment. The decrease in conventional project delays for Singyes’ BIPV projects, impacting earnings. energy prices and tighter credit have led to a slowdown in global alternative-energy investment. For example, PV wafers have FX risk. Singyes purchases inverters from European suppliers, declined from RMB47-RMB48/wafer a year ago to as low as priced in Euros. Inverters account for 30%-40% of the total cost of RMB26-RMB30/wafer. a BIPV system. A sharp appreciation in the Euro vs. the RMB, could hit segment profitability. Net cash. As at end-1H09 the company had net cash of RMB84m, enough to cover working capital without taking on heavy debt.
Leveraged to declining labor costs. Subcontracting fees, which comprise 85% of costs for the company’s curtain-wall business, should decline. Labor and raw-material costs are expected to decline as the recovery in the Chinese economy remains fragile.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 43 20 Nov. 2009
Figure 4: China Singyes Solar Technology – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Further Chinese stimulus policies for integrating BIPV and A decline in state-owned and private spending for building solar-power systems into buildings. commercial and industrial buildings could reduce turnover. A Greater subsidies for BIPV-installation projects, which would lower continued economic downturn would adversely affect the commercial costs for installing BIPV in new and old buildings and boost demand and industrial sector for these systems. Differences in raw-material and subcontracting costs due to time-lags A rebound in commercial and high-end residential properties due to a between tender submission and material procurement could lead to rebound in the Chinese economy, leading to an increase in demand for actual costs for completing a project coming in much higher than the BIPV systems. tender price, leading to a decline in or negative gross margins. Acquisitions of PV-panel manufacturers helping the company become The company might have to pay damages if 1) it is unable to meet a fully integrated solar-power player. schedule completion requirements, 2) it is sued by subcontractors due to personal injuries, or 3) defects or errors in project execution lead to litigation. A rebound in PV-equipment prices due to a resurgence in global demand, as well as greater global alternative-energy investment. Source: Sun Hung Kai Financial
Recent Company News Nil.
Industry Dynamics China is the world’s largest producer of photovoltaic cells, but because 98% of sales are exports, when financing became tight worldwide, orders were widely cancelled, particularly from the three largest consumers of Chinese solar power products: Spain, Germany and Japan. Due to contracting overseas demand, China’s PV solar-power equipment industry has experienced a supply glut, causing a steep downturn in global PV solar-power equipment prices. For example, PV wafers have dropped 50% from RMB47-RMB48/wafer to as low as RMB26/wafer. Although this situation creates a difficult business environment for upstream equipment makers, downstream consumers benefit from lower equipment costs. Furthermore, industry fundamentals are becoming increasingly more supportive of downstream solar-power businesses, such as building integrated photovoltaic (BIPV) systems, not only due to lower costs but also increasing governmental support. China promotes green initiatives in its government policies, and solar power is a key industry seen as part of the solution to fossil fuels and pollution. The Chinese government has adopted environment-friendly policies to ensure sustainable development recently including: The Renewable Energy Medium, Long Term Development Plan, which calls for a 22-fold increase (20% CAGR) in total solar-power capacity (from the current 80 MW to 300 MW in 2010 and 1,800 MW by 2020). By 2020, a total of 20,000 PV-equipped rooftops with 1,000 MW total electricity output capacity will be developed. The Interim Measures for the Administration of Government Subsidies of Building Uses of Solar Energy Photovoltaic Power, which provides an RMB15-RMB20/Wp subsidy for integrating PV solar-power facilities of at least 50 kW into buildings. This reduces the installation costs of such systems by about half. The Golden Sun Program, which provides a 50% subsidy for investment in solar-power projects, as well as relevant power-transmission and distribution systems. Various reports have stated that China may further increase its solar-power electrical-production capacity to 10 GW by 2020. Despite current government policies supporting solar power, more is needed to reach this target. The mainland may follow in the path of countries such as Germany in providing further support to develop the solar-power industry, such as Feed-in-tariffs where solar-energy users are paid for the excess solar power they produce. China’s downstream solar-power industry will drive its solar-power integration program, and is expected to continue to outperform upstream equipment producers as they wait for the glut in production capacity to slowly alleviate.
Sun Hung Kai Financial 44 20 Nov. 2009
Figure 5: China Singyes Solar Technology – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 353.7 415.0 604.7 903.3 36.7 COGS (290.5) (344.9) (492.8) (716.3) 35.1 Gross profit 63.2 70.1 111.9 187.0 43.6 Operating expenses (24.1) (18.0) (32.1) (70.5) 42.9 Other operating income 0.1 0.1 0.1 1.0 131.4 Operating profit 39.1 52.2 79.9 117.6 44.3 Finance expenses (1.8) (2.0) (1.4) (0.9) (21.6) PBT 37.4 50.2 78.6 117.1 46.3 Tax (0.0) 0.0 (8.2) (13.5) 1,146.2 Net profit 37.3 50.1 70.3 103.5 40.6 EPS – RMB fen N/A N/A N/A 28.1 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: China Singyes Solar Technology – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue N/A 17.3 45.7 49.4 36.7 COGS N/A 18.7 42.9 45.4 35.1 Gross profit N/A 10.9 59.7 67.1 43.6 Operating expenses N/A (25.6) 78.6 119.7 42.9 Other operating income N/A (21.4) 78.8 782.2 131.4 Operating profit N/A 33.3 53.2 47.1 44.3 Finance expenses N/A 10.8 (29.8) (38.0) (21.6) PBT N/A 34.2 56.7 49.0 46.3 Tax N/A (100.0) N/A 64.3 N/A Net profit N/A 34.4 40.4 47.2 40.6 EPS N/A N/A N/A N/A N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 7: China Singyes Solar Technology – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (82.1) (83.1) (81.5) (79.3) (82.1) Gross profit 17.9 16.9 18.5 20.7 17.9 Operating expenses (6.8) (4.3) (5.3) (7.8) (6.8) Other operating income 0.0 0.0 0.0 0.1 0.0 Operating profit 11.1 12.6 13.2 13.0 11.1 Finance expenses (0.5) (0.5) (0.2) (0.1) (0.5) PBT 10.6 12.1 13.0 13.0 10.6 Tax (0.0) 0.0 (1.4) (1.5) (0.0) Net profit 10.5 12.1 11.6 11.5 10.5 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 45 20 Nov. 2009
Figure 8: China Singyes Solar Technology – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 20.9 28.8 42.6 71.4 50.7 Accounts receivable 140.2 151.8 233.4 315.6 31.1 Inventory 1.4 0.6 0.6 0.9 (11.2) Other current assets 49.9 59.2 96.2 94.7 23.8 Total current assets 212.3 240.3 372.9 482.7 31.5 Net fixed assets 17.7 23.3 41.5 57.4 48.1 Other long-term assets 0.0 0.0 9.5 8.9 N/A Total assets 229.9 263.6 423.9 549.0 33.7 Short-term debt 11.2 12.7 18.0 10.0 (3.8) Accounts payable 28.6 16.8 15.8 36.4 8.4 Other current liabilities 31.2 27.6 55.2 64.2 27.2 Total current liabilities 71.1 57.1 89.0 110.6 15.9 Long-term debt 21.0 17.8 58.4 0.0 N/A Other long-term liabilities 0.0 0.0 0.0 0.0 N/A Total liabilities 92.1 74.9 147.4 110.6 6.3 Shareholders equity 137.9 188.7 276.5 438.4 47.0 Minorities 5.8 5.9 6.0 6.1 1.7 Total equity and liabilities 229.9 263.6 423.9 549.0 33.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 9: China Singyes Solar Technology – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 9.1 10.9 10.1 13.0 10.8 Accounts receivable 61.0 57.6 55.1 57.5 57.8 Inventory 0.6 0.2 0.1 0.2 0.3 Other current assets 21.7 22.4 22.7 17.3 21.0 Total current assets 92.3 91.2 88.0 87.9 89.8 Net fixed assets 7.7 8.8 9.8 10.5 9.2 Other long-term assets 0.0 0.0 2.2 1.6 1.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 4.9 4.8 4.2 1.8 3.9 Accounts payable 12.4 6.4 3.7 6.6 7.3 Other current liabilities 13.6 10.5 13.0 11.7 12.2 Total current liabilities 30.9 21.6 21.0 20.2 23.4 Long-term debt 9.1 6.8 13.8 0.0 7.4 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 40.0 28.4 34.8 20.2 30.8 Shareholders equity 60.0 71.6 65.2 79.8 69.2 Minorities 2.5 2.2 1.4 1.1 1.8 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 46 20 Nov. 2009
Figure 10: China Singyes Solar Technology – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 17.9 16.9 18.5 20.7 18.5 Operating margin – % 11.1 12.6 13.2 13.0 12.5 Net margin – % 10.5 12.1 11.6 11.5 11.4 ROAA – % N/A 20.3 20.4 21.3 20.7 ROAE – % N/A 30.7 30.2 29.0 29.9
Liquidity ratios Current assets/current liabilities – X 3.0 4.2 4.2 4.4 3.9 Liquid assets/current liabilities – X 2.3 3.2 3.1 3.5 3.0 Cash and securities/current assets – % 9.8 12.0 11.4 14.8 12.0 Cash flow from oper./curr. liabilities – % 2.1 28.6 (0.9) 43.7 18.4
Other ratios Capex/sales – % 1.2 2.1 3.4 2.2 2.3 Capex/depreciation – % 390.1 470.6 825.5 486.8 543.2 Operating expense/sales -% (6.8) (4.3) (5.3) (7.8) (6.1) Net debt/equity (net cash) – % 8.3 0.9 12.2 (14.0) 1.8 Inventory/sales – % 0.4 0.1 0.1 0.1 0.2 Effective tax rate – % 0.0 0.0 10.5 11.6 5.5 Cash conversion cycle – days N/A 105.3 104.6 60.5 90.1
ROAA component analysis Revenue/average assets – % N/A 168.1 175.9 185.7 176.6 COGS/average assets – % N/A (139.7) (143.3) (147.2) (143.4) Gross profit/average assets – % N/A 28.4 32.6 38.4 33.1 Operating expenses/average assets – % N/A (7.3) (9.3) (14.5) (10.4) Other operating income/average assets – % N/A 0.0 0.0 0.2 0.1 Operating profit/average assets – % N/A 21.1 23.3 24.2 22.9 Finance expenses/average assets – % N/A (0.8) (0.4) (0.2) (0.5) PBT/average assets – % N/A 20.3 22.9 24.1 22.4 Tax/average assets – % N/A 0.0 (2.4) (2.8) (1.7) Net profit/average assets – % N/A 20.3 20.4 21.3 20.7
ROAE component analysis Revenue/average equity – % N/A 254.1 260.0 252.7 255.6 COGS/average equity – % N/A (211.2) (211.8) (200.4) (207.8) Gross profit/average equity – % N/A 42.9 48.1 52.3 47.8 Operating expenses/average equity – % N/A (11.0) (13.8) (19.7) (14.8) Other operating income/average equity – % N/A 0.0 0.1 0.3 0.1 Operating profit/average equity – % N/A 32.0 34.4 32.9 33.1 Finance expenses/average equity – % N/A (1.2) (0.6) (0.2) (0.7) PBT/average equity – % N/A 30.7 33.8 32.8 32.4 Tax/average equity – % N/A 0.0 (3.5) (3.8) (2.4) Net profit/average equity – % N/A 30.7 30.2 29.0 29.9 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 47 20 Nov. 2009
China WindPower Group Ltd. (182.HK) Alternative Energy 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 China WindPower (formerly Hong Kong Pharmaceutical), was created through a backdoor listing by WindPower Group (WPG) in April 2007, which acquired Hong Performance (%) 1m 3m 12m Kong Pharmaceutical and renamed the company China WindPower. The entire group HSI 2.0 13.5 76.7 is now 100% owned by the listed vehicle China WindPower Group (182.HK). HSCEI 4.0 19.6 107.6
The company has changed its business focus from selling traditional Chinese
medicine, dried seafood and providing medical services under the brand name Nam China WindPower – Price vs. HSI, Share Data Pei Hong, to investing in wind-power plants and manufacturing wind-power equipment in northern China. (HK$) (HK$m) Its main business is constructing and operating wind-power plants in Inner Mongolia, 1.2 1,200 Jilin and Liaoning, while investing in minority equity interests in wind-power 1.0 1,000 projects, with a predetermined dividend payout. Currently, the company has over 7.6 0.8 800 GW of wind resources available, which it can leverage to attract partners to jointly 0.6 600 develop. 0.4 400 0.2 200 Revenue reached HK$379m in FY09, with the company’s wind power equipment 0.0 0 manufacturing and EPC (engineering, procurement, and construction) business Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 accounting for HK$352m (92%) of sales. Furthermore, the company has disposed of Turnover Price HSI its entire heritage Chinese-medicine business, which has crystallized its position as a premier wind-farm developer and operator in the PRC’s growing alternative-energy Price – HK$ 0.94 industry. 52W high/low (HK$) 1.15/0.153 Shares in issue – millions Wind power is capital intensive, and the company has raised net proceeds of 7,278.68 Market cap – HK$m HK$923.8m last year through the placement of new shares to fund this business. 6,769.17 3M avg. turnover – HK$m CWP has over 7 GW of wind-power resources available, requiring US$6bn to fully 54.92 Major shareholders – % develop. The firm will continue to use ⅓ equity to ⅔ debt financing and leverage its Concord Intl Invst Ltd 27.80 vertically integrated business model to attract strategic partners to develop its Source: Bloomberg and Sun Hung Kai Financial wind-farm projects. As at 31 March 2009, the company had HK$23m in convertible notes (about 1 billion shares), which if fully converted would dilute FY09 EPS by 12%. In FY10, the company plans to invest in 13 wind-power plants via joint ventures, adding a further 580 MW of generating capacity by 2011. Recent Reports Date Key Takeaways 13 May 2009 Figure 1: Earnings Summary
Year ending 31 March FY07 FY08 FY09 FY10E Net profit – HK$m 50.1 70.3 103.5 232.8 This document is solely based on Net-profit growth – % 34.4 40.4 47.2 124.9 publicly available information. This EPS – HK¢ N/A N/A 28.1 3.4 report is intended as information EPS growth – % N/A N/A N/A (87.9) only and not as a recommendation for any stock. Sun Hung Kai P/E – X N/A N/A 3.3 27.6 Financial does not provide research DPS – HK¢ 0.0 0.0 0.0 N/A coverage or ratings for this Dividend yield – % 0.0 0.0 0.0 N/A company in this report. BVPS – HK$ N/A N/A N/A 0.5 P/B – X N/A N/A N/A 2.0 Oper cash flow/share – HK¢ N/A N/A 13.1 1.8 Michael Yuk Net debt (net cash) to share price – % N/A N/A N/A N/A Sources: Bloomberg and Sun Hung Kai Financial + (852) 2203 9590 Note: Based on Bloomberg Consensus [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer Sun HungThis Kai report Financial / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),48 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: China WindPower – Investment Highlights
Key investment positives Key investment negatives
Continuing demand for wind-farm design, EPC, maintenance. Minority interest only in wind farms raises earnings risk. To China has budgeted RMB12bn-RMB13bn p.a. for wind-power qualify for Certified Emission Reduction Certificates (carbon credits), capacity expansion to ensure that renewable energy makes up 3% and the company cannot hold a majority stake in any wind-farm projects. 8% of total installed capacity by 2010 and 2020 respectively. Capacity Thus, CWP only receives dividend income from its minority interests. is expected to post an 11.6% CAGR from 2010 to 2020. This will fuel The majority interest holder of a JV can opt not to pay dividends, continued demand for new wind farms. which would negatively affect earnings. Subsidy pool increasing as government continues to show support Two factors affect steady electricity output. The electricity output for alternative energy. End-user electricity tariffs include of wind farms could be negatively affected by two major factors: RMB0.001/kWh to fund the renewable-energy-subsidy pool. In the 1. Periodic fine-tuning for connection with the power grid latest round of electricity tariff hikes in June, the renewable-energy 2. Weather (little wind would drag down average generation). subsidy was further raised to RMB0.002/kWh, signaling the PRC government’s determination to reduce reliance on fossil fuels. Project delays in poor weather. In the ECP business, the average construction period is seven months, including four months of winter. Guaranteed sales by law. According to the Renewable Energy Law, Poor weather poses many challenges for the construction team, and northern and southern power grids are obliged to purchase all power may lead to project delays. output from renewable-energy facilities. This guarantees CWP’s sales and means very low credit risk. Convertible notes may dilute EPS. The company has over HK$23m in convertible notes (approximately 1 billion shares) as of the latest Huge approved reserve capacity. CWP’s total approved capacity is balance sheet, which if fully converted would dilute FY09 EPS by currently 4,150 MW. CWP has already built one wind farm in 12%. Liaoning and will have three more coming online in 2009. The company should have a total of 1,300 MW of power-generating Government subsidy on top of standard tariff will eventually be capacity by end-2009. phased out. On top of standard local tariffs, wind power also receives a renewable-energy subsidy of RMB0.25/kWh. This is paid from the High operating efficiency to capitalize on wind-power renewable-energy subsidy pool, into which all electricity consumers opportunities. CWP’s project completion time averages eight pay RMB0.01 per kWh used. However, in countries where the months, since the company performs the feasibility study, project wind-power market is mature and costs have come down, the subsidy management and ECP (engineering, procurement, and construction) is gradually phased out. China will eventually go down this path, as itself. It took less than six months to construct the first wind farm in the amount of subsidies needed rise along with growing wind-power Liaoning, whereas peers typically take more than a year, perhaps generation. longer for state-owned companies. CWP’s high operating efficiency should thus allow it to capitalize on industry opportunities, as sites for Greater borrowings. The investment for each wind farm is wind farms are by nature limited. RMB450m-RMB500m, of which the company finances one-third with equity and the remainder with bank loans. Although ROE is improved Lower equipment cost due to falling raw-material prices. CWP by additional gearing, under the current economic environment a procures wind-generation equipment from third-party manufacturers freeze or contraction in credit may adversely affect earnings. as well as purchasing raw materials for the fabrication of wind-turbine towers. The decline in raw-material prices, such as steel, has resulted Taxes to increase. CWP paid only HK$3.9m in taxes in FY09 due to in an estimated 10% decline in fabrication costs. tax losses brought forward to offset assessable profits. Furthermore, its subsidiaries were still under a three-year exemption from PRC Experienced management means lower execution risk. The Enterprise Income Tax. This resulted in a net margin of over 30%. The backdoor listing brought in an experienced management team with net margin could come down as available tax losses brought forward expertise in wind-power operation and investment. This should allow run out and the firm’s subsidiaries need to pay taxes. CWP to capitalize on industry opportunities. Share options may cap share price. On 1 April 2008, CWP granted Broader sources of revenue. CWP will set up an 20.4 million share options to it directors at an exercise price of electricity-engineering design company to provide high-value-added HK$0.45/share. 25% of these shares options will be available for services, such as feasibility studies, technical consultancy, engineering redemption on each anniversary of the grant date starting from 1 April design and micro-site selection. This can help broaden the sources of 2009. Hence, share prices may experience downward pressure when revenue. above HK$0.45/share. Expanding its distribution network. The group will continue to expand its distribution network and product mix. Sold Chinese medicine business. CWP sold Nam Pei Hong, it Chinese herbal medicine this in segment wholesales and retails Chinese medicines, health-care products and dried seafood and provides Chinese medical outpatient services. The business turned around this year (from a net loss of HK$2.4m to a net profit of HK$1.0m) by consolidating its retail network, controlling costs and maximizing sales through quality products and services at competitive prices. Source: Sun Hung Kai Financial
Figure 3: ChinaWindPower – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Faster-than-anticipated completion of ongoing wind-farm projects. Majority stakeholders in wind-farm projects may opt not to distribute dividends or reduce the dividend-payout terms, which Higher alternative-energy subsidies to further encourage IPPs to would hit current and future earnings. expand their renewable-energy portfolios. A prolonged credit crisis could restrict expansion due to the high Increase in the VAT rebate for foreign firms with manufacturing receivables-collection risks. Banks may refuse credit or impose operations in China limits. Sale/partial-sale of 100% interest in acquired wind-power projects.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 49 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
China is promoting renewable energy to reduce its reliance on less environmentally friendly coal. The authorities require power companies to derive at least 5% of power output from renewable sources by 2010 and 10% by 2020.
Most recent data shows that the mainland has 2.6 GW of installed wind-power capacity and this is estimated to rise to 8.0 GW by 2010, by which point CWP expects to account for 10% of the market.
According to the National Development and Reform Commission (NDRC), the government is determined to increase the proportion of renewable energy used in China. The Renewable Energy Development Plan, which covers 2006-20, has outlined official support for the development of renewable energy. Renewable energy only accounts for 8% of the country’s current consumption, and Beijing intends to raise this to 10% in 2010 and 15% in 2020.
Wind farms are mainly in northern China, where there are abundant wind resources and substantial energy demand from heavy industry. The focus on the north is also due to shortages of water, which is essential for coal-fired power.
Under current regulations, provincial authorities can only approve individual wind-farm operations of up to 50 MW. Anything greater requires a central-government green light, which could prove much more time consuming.
Looking at pure cost per kWh, wind and solar are not competitive. Average conventional cost is about RMB0.345/kWh. Wind ranges from RMB0.30/kWh to RMB1.30/kWh. Solar is about RMB4.00/kWh and is expected to be competitive with conventional only by 2030 to 2050. Hence subsidies are needed to make alternative energy competitive with conventional energy sources.
Wind-power tariffs are the same as standard local tariffs, but currently a renewable-energy subsidy of RMB0.25/kWh is provided for alternative-energy producers. This subsidy is paid from the renewable-energy subsidy pool, into which all electricity consumers pay RMB0.01 per kWh used.
According to the Renewable Energy Law, northern and southern power grids are obliged to purchase all power output from renewable-energy facilities. This guarantees CWP’s sales and means a very low credit risk.
Sun Hung Kai Financial 50 20 Nov. 2009
Figure 4: China WindPower – Profit and Loss Statement FY06-09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 49.3 59.5 324.9 379.4 56.7 COGS (30.3) (37.0) (162.6) (244.2) 63.2 Gross profit 19.0 22.5 162.4 135.2 47.6 Operating expenses (22.0) (30.8) (63.2) (66.7) 13.1 Other operating income 0.1 0.0 0.0 0.0 N/A Operating profit (3.0) (8.3) 99.1 68.5 N/A Finance expenses (5.9) (1.4) (5.3) (5.5) (6.1) PBT 9.4 33.6 108.1 122.0 N/A Tax 0.0 0.0 0.0 (4.0) 693.9 Net profit 9.4 33.6 100.1 116.8 N/A EPS – HK¢ 6.7 2.7 2.9 2.0 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: China WindPower – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR (%) Revenue (21.6) 20.6 446.3 16.8 56.7 COGS (11.9) 21.9 339.6 50.2 63.2 Gross profit (33.4) 18.5 621.7 (16.7) 47.6 Operating expenses (46.0) 39.9 105.4 5.5 13.1 Other operating income (96.3) (100.0) N/A N/A N/A Operating profit (72.3) 179.7 (1,295.8) (30.9) N/A Finance expenses (16.8) (77.1) 291.1 4.1 (6.1) PBT (352.8) 256.9 221.7 12.9 N/A Tax (100.0) N/A N/A N/A N/A Net profit (352.8) 256.9 197.8 16.7 N/A EPS (348.1) (60.1) 8.6 (31.0) N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: China WindPower – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (61.5) (62.2) (50.0) (64.4) (59.5) Gross profit 38.5 37.8 50.0 35.6 40.5 Operating expenses (44.6) (51.8) (19.5) (17.6) (33.4) Other operating income 0.1 0.0 0.0 0.0 0.0 Operating profit (6.0) (13.9) 30.5 18.1 7.2 Finance expenses (12.0) (2.3) (1.6) (1.5) (4.3) PBT 19.1 56.5 33.3 32.2 35.2 Tax 0.0 0.0 0.0 (1.0) (0.3) Net profit 19.1 56.5 30.8 30.8 34.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 51 20 Nov. 2009
Figure 7: China WindPower – Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 0.8 22.7 335.5 745.1 291.4 Accounts receivable 0.4 2.0 43.3 38.8 134.9 Inventory 5.8 9.1 55.0 63.6 84.5 Other current assets 22.7 6.6 348.3 52.9 85.9 Total current assets 29.6 40.5 782.0 900.3 181.4 Net fixed assets 1.6 1.9 13.5 47.8 139.3 Other long-term assets 0.0 (0.0) 1,400.2 1,696.6 256.9 Total assets 31.2 42.3 2,195.7 2,644.7 216.7 Short-term debt 42.4 0.0 6.6 0.0 (87.3) Accounts payable 9.8 8.1 22.1 65.7 58.2 Other current liabilities 56.5 6.0 85.1 51.9 1.8 Total current liabilities 108.6 14.1 113.8 117.6 1.0 Long-term debt 0.0 10.8 134.1 23.2 1,134.6 Other long-term liabilities 0.3 0.0 0.0 19.3 174.1 Total liabilities 108.9 24.9 247.9 160.2 9.0 Shareholders equity (77.8) 17.5 1,947.8 2,484.6 N/A Minorities 0.0 0 10.5 13.6 N/A Total equity and liabilities 31.2 42.3 2,195.7 2,644.7 216.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: China WindPower – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 2.4 53.5 15.3 28.2 24.8 Accounts receivable 1.2 4.8 2.0 1.5 2.4 Inventory 18.6 21.5 2.5 2.4 11.3 Other current assets 72.8 15.7 15.9 2.0 26.6 Total current assets 95.0 95.6 35.6 34.0 65.1 Net fixed assets 5.0 4.4 0.6 1.8 3.0 Other long-term assets 0.0 (0.0) 63.8 64.1 32.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 136.0 0.0 0.3 0.0 34.1 Accounts payable 31.3 19.1 1.0 2.5 13.5 Other current liabilities 181.1 14.1 3.9 2.0 50.3 Total current liabilities 348.4 33.3 5.2 4.4 97.8 Long-term debt 0.0 25.5 6.1 0.9 8.1 Other long-term liabilities 1.0 0.0 0.0 0.7 0.4 Total liabilities 349.4 58.8 11.3 6.1 106.4 Shareholders equity (249.4) 41.2 88.7 93.9 (6.4) Minorities 0.0 0.0 0.5 0.5 0.2 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 52 20 Nov. 2009
Figure 9: China WindPower – Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 38.5 37.8 50.0 35.6 40.5 Operating margin – % (6.0) (13.9) 30.5 18.1 7.2 Net margin – % 19.1 56.5 30.8 30.8 34.3 ROAA – % 32.8 91.4 8.9 4.8 34.5 ROAE – % (11.4) (111.4) 10.2 5.3 (26.9)
Liquidity ratios Current assets/current liabilities – X 0.3 2.9 6.9 7.7 4.4 Liquid assets/current liabilities – X 0.0 1.8 3.3 6.7 2.9 Cash and securities/current assets – % 2.5 56.0 42.9 82.8 46.1 Cash flow from oper./curr. liabilities – % (18.6) (403.4) (194.3) 106.4 (127.4)
Other ratios Capex/sales – % 1.3 3.1 4.1 11.1 4.9 Capex/depreciation – % 119.0 266.7 593.7 939.8 479.8 Operating expense/sales -% (44.6) (51.8) (19.5) (17.6) (33.4) Net debt/equity (net cash) – % (53.6) (85.9) (10.0) (29.1) (44.6) Inventory/sales – % 11.8 15.3 16.9 16.8 15.2 Effective tax rate – % 0.0 0.0 0.0 3.3 0.8 Cash conversion cycle – days (46.6) 0.1 70.9 64.7 22.3
ROAA component analysis Revenue/average assets – % 171.7 161.8 29.0 15.7 94.6 COGS/average assets – % (105.6) (100.6) (14.5) (10.1) (57.7) Gross profit/average assets – % 66.1 61.2 14.5 5.6 36.9 Operating expenses/average assets – % (76.6) (83.8) (5.7) (2.8) (42.2) Other operating income/average assets – % 0.2 0.0 0.0 0.0 0.0 Operating profit/average assets – % (10.3) (22.6) 8.9 2.8 (5.3) Finance expenses/average assets – % (20.5) (3.7) (0.5) (0.2) (6.2) PBT/average assets – % 32.8 91.4 9.7 5.0 34.7 Tax/average assets – % 0.0 0.0 0.0 (0.2) (0.0) Net profit/average assets – % 32.8 91.4 8.9 4.8 34.5
ROAE component analysis Revenue/average equity – % (59.8) (197.3) 33.1 17.1 (51.7) COGS/average equity – % 36.8 122.7 (16.5) (11.0) 33.0 Gross profit/average equity – % (23.0) (74.6) 16.5 6.1 (18.8) Operating expenses/average equity – % 26.7 102.1 (6.4) (3.0) 29.8 Other operating income/average equity – % (0.1) 0.0 0.0 0.0 (0.0) Operating profit/average equity – % 3.6 27.5 10.1 3.1 11.1 Finance expenses/average equity – % 7.2 4.5 (0.5) (0.2) 2.7 PBT/average equity – % (11.4) (111.4) 11.0 5.5 (26.6) Tax/average equity – % 0.0 0.0 0.0 (0.2) (0.0) Net profit/average equity – % (11.4) (111.4) 10.2 5.3 (26.9) Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 53 20 Nov. 2009
China Yurun (1068.HK) Food & Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Founded in 1993 in Nanjing, China Yurun is one of the top three meat processors in China. By sales, the firm has had the largest market share for low-temperature meat Performance (%) 1m 3m 12m products (LTMPs) with large-scale retailers in China over the past six years. In 2007, HSI 2.0 13.5 76.7 it became the second largest hog slaughterer in China. However, market share HSCEI 4.0 19.6 107.6 remains low at less than 2% due to the highly fragmented market. Yurun sells its products through supermarkets and third-party distributors, targeting its brand at China Yurun – Price vs. HSI, Share Data middle-class consumers who are less sensitive to prices. Brands include Yurun,
Furun, Wangrun and Popular Meat Packing. (HK$) (HK$m) 20.0 4,000 Products range from over 200 types of upstream chilled and frozen pork to about 3,500 1,000 downstream processed meats, including LTMPs and HTMPs (high-temperature 15.0 3,000 2,500 meat products). Chilled pork (75% of upstream turnover) and LTMPs (91% of 10.0 2,000 downstream sales) are the main revenue generators, respectively accounting for about 1,500 61% and 24% of revenue. LTMPs generate higher gross margins, with greater 5.0 1,000 500 potential for expansion. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 On 28 July 2009, the company raised RMB1.675bn in a placement of 130 million new ordinary shares at RMB13.23/share, putting the company in a net-cash position. Turnover Price HSI The capital will mainly be used for capacity expansion, as management expects RMB1.5bn of capex in FY10 to raise upstream production capacity to 30 million Price – HK$ 18.96 tons, up 55% from now, and downstream to 0.35 million tons, up 35%. 52W high/low (HK$) 19.28/8.12 Shares in issue – millions 1,673.17 China’s pork industry is highly fragmented, with the top three players accounting for Market cap – HK$m 32,124.92 less than 5% of the market. When hog prices reach the top of the price cycle, smaller 3M avg. turnover – HK$m 121.14 slaughterhouses are forced to exit, as they are unable to purchase enough pigs and Major shareholders – % lack brand power. Although hog prices are currently not very high at RMB9.98/kg, Yicai Zhu 36.14 they have risen for 11 straight weeks and are expected to continue increasing until at Source: Bloomberg and Sun Hung Kai Financial least 2010. Yurun can take this opportunity to increase market share. In a move to improve food and meat quality, the government has provided the meat industry with favorable tax policies to encourage large-scale meat processors to acquire smaller rivals. 1H09 results. Sales declined 3.5% yoy to RMB5.8bn, while the net profit rose 36.9% yoy to RMB841m. Basic EPS was 0.549 RMB fen, up 36.5% yoy. The stock trades at This document is solely based on 18.8X consensus FY09 earnings. An interim dividend of HK¢15 was declared. publicly available information. This report is intended as information only and not as a recommendation Figure 1: Earnings Summary for any stock. Sun Hung Kai Financial does not provide research Year ending 31 Dec. FY06 FY07 FY08 FY09E coverage or ratings for this Net profit – RMBm 340.8 481.0 859.3 1,137.8 company in this report. Net-profit growth – % 114.2 41.1 78.7 32.4 EPS – RMB fen 32.7 33.1 58.4 74.4 EPS growth – % 87.6 1.3 76.4 27.4 P/E – X 58.1 57.3 32.5 25.5 DPS – RMB fen 6.5 8.4 15.0 19.0 Dividend yield – % 0.3 0.4 0.8 1.0 BVPS – RMB 1.5 1.7 2.7 3.4 P/B – X 12.8 11.2 7.0 5.6 Holly Hou Operating cash flow per share – RMB 25.8 28.8 52.0 79.1 + (852) 2203 9588 Net debt (net cash)/ price – % (3.7) (2.2) (2.4) 3.1 [email protected] Sources: Bloomberg and Sun Hung Kai Financial Note: Estimated based on Bloomberg consensus All reports are available at:
http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor54ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: China Yurun – Investment Highlights
Key investment positives Key investment negatives Well placed to benefit from industry consolidation. Hog prices Raw-material price hikes. Yurun’s primary cost is hogs, will remain high, providing a good opportunity for big players to accounting for 95% of upstream COGS and 50%-62% of gain market share. Stronger government controls on hog downstream COGS. Hog prices are sensitive to supply and prices slaughtering have been effective since August 2008, implying an of corn and other agricultural products used in animal feeds, which increase in the exit rate of small-scale slaughterers with poor are reaching new highs. When hog prices are high, a failure to pass hygiene standards. Yurun’s market share should expand from 1% on cost hikes due to keen competition may hurt margins. to 6% in the next five years. Downstream business-tax rate increasing. The effective tax rate Strategic locations minimize risks from epidemics. Yurun for the company’s downstream business will increase to 25% next locates its upstream production facilities throughout major year, pulling up the overall effective tax rate to almost 15%. pig-farming districts in China. This guarantees ample pig supply Lower earnings. Due to increased acquisition costs for meat and lowers the risk from epidemics. Production capacity at each processors, the company raised a three-year US$12m syndicated slaughterhouse is also limited to prevent neighboring pig farms, if loan in November 2007. Financing costs will decrease Yurun’s contaminated, from severely hitting Yurun’s production. earnings in FY08 and FY09. Gross-margin expansion in both business lines. The overall Greater capex for capacity expansion. Yurun plans to spend gross margin improved 3.1 ppts yoy to 16.7% in 1H09, mainly HK$1.5bn on raising slaughter capacity from 19 million heads at driven by strong volume growth in the upstream segment amid end-1H09 to 30 million in FY10, and increasing processing abundant hog supply and stronger sales of high-end downstream capacity from 258,100 tonnes to 350,000 tonnes. This may drag products The company can further increase the gross margin by free cash flow into negative territory. raising the proportion of high-margin products and cutting its exposure to low-margin products. Exposure to fluctuations in exchange rates. The group is exposed to currency risk on borrowings that are denominated in The upstream business follows a cost-plus model, meaning the USD, while almost all the group’s revenue-generating operations firm can pass hog-price hikes on to its customers. ASPs increase as are transacted in RMB. hog prices increase. Rising hog prices should benefit the upstream top line and gross margin. Hog prices set to increase. Management expects hog prices to increase about 20% yoy in FY09 and another 20% in FY10. For the downstream business, the company secured low-cost raw materials in 1H09 when hog prices had bottomed out. Together with the shift in the sales mix to higher-end products, this should benefit the downstream margin. Booming sales volumes for two core products. 1H09 volumes for chilled meat and low-temperature meat products (LTMP) rose 58.4% yoy and 27.6% yoy respectively, driving the 85% yoy rise in total sales value. Strong capital position can help the firm increase its production capacity to capture strong demand. Yurun raised RMB1.675bn in its July 2009 placement, which can help it continue capacity expansion. Minimal sensitivity to fluctuations in hog prices. Yurun’s business model acts as a natural hedge against fluctuations in hog prices. When hog prices increase, upstream businesses will be benefit and downstream will be hurt, and vice versa. Under such a scenario, volume growth will be the key. Strengthening brand through superior quality control. Consumers are now more sensitive to product quality, so Yurun has implemented stringent internal quality controls, strengthening its brand. This can help it pass hog price increases on to its customers. Focus on R&D to optimize product mix. The firm developed 185 new products in 1H09 in a bid to raise ASPs and gross margins. Nationwide distribution network. The company expanded its distribution channels to southwest China and further strengthened channels in developed cities. It now covers 700 cities compared with last year’s 300. Improving distribution channels. The firm plans to extend distribution to cover a wider market and increase sales. It will focus on higher-margin supermarket and hotel distribution. Inelastic demand for pork. In China, pork is a popular meat staple and accounts for 65% of meat products consumed. Domestic per capita pork consumption doubled from 20 kg in 1996 to 39.6 kg in 2006. Tax benefit. The Chinese government gives tax benefits to the agriculture sector, which include’s Yurun’s upstream business. This will help keep the effective tax rate for the group’s upstream business stable at 8.9% for the coming years. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 55 20 Nov. 2009
Figure 3: China Yurun – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Higher selling prices. Hog price and supply volatility. Further increases in hog supply, such as more government subsidies to Increasing prices for animal feed due to corn price hikes. encourage pig rearing. An inability to manage finance costs.
Discontinuation of government policies (end of low tax rates). Source: Sun Hung Kai Financial
Industry Dynamics Rising demand for pork In China, pork is a popular meat staple and accounts for 65% of meat products consumed. Domestic per capita pork consumption doubled from 20 kg in 1996 to 39.6 kg in 2006. With increasing standards of living, diets in China should become more protein-oriented. Pork is the No.1 consumed meat in China and should see consistent growth on this trend.
Fragmented market: consolidation coming on volatile pig prices and tighter quality control China’s pork industry is highly fragmented, with the top three players accounting for less than 5% of the overall pork market. Yurun has had the largest market share in sales to large-scale retailers among LTMP producers in China for six years and became the second largest hog slaughterer in China in 2007. However, due to the highly fragmented market, its share remains low at less than 2%.
Quality control Following the outbreak of foot-and-mouth disease and the tainted-milk crisis, the government has taken measures to regulate livestock slaughter and better control food safety. The government has given only provincial governments the right to issue slaughterhouse licenses and implemented stricter requirements on slaughterhouse operations. Although Yurun may have to maintain certain technical standards to keep its licenses, many small-scale slaughterhouses with poor disease control will be forced to exit. In view of its high-quality products, Yurun will enjoy an effective tax rate of 8.9% for the upstream business in coming years. Administrative regulations for hog slaughter effective from 1 Aug. 2008 have further increased the threshold for entering the slaughter industry. Further consolidation is inevitable. This market leader may have an easy ride ahead.
Volatile pig prices Although hog prices are at low levels, they have risen for 11 straight weeks and are expected to continue this trend. Smaller slaughterhouses, unable to purchase the number of pigs they used to and lacking branding power, have been forced to exit. The number of unprofitable meat processors increased from 357 in 2003 to 446 in 2008. Yurun can take this opportunity to increase market share. In a move to improve food and meat quality, the government has provided the meat industry with favorable tax policies, which should encourage large-scale meat processors to acquire smaller rivals. The previous surge in hog prices has encouraged farmers to raise pigs. China’s pig and pregnant-pig inventory growth rose 4 ppts to 10.6% yoy in June 2008 (December 2007: 6.5%) and 13.1 ppts to 22.5% yoy in June 2008 (December 2007: 9.4%). Backed by the recovery in supply after a one-year cycle, hog prices dropped to RMB11-RMB12/kg (1Q08: RMB16.7/kg, 2Q08 RMB16.1/kg, 3Q08 RMB13-RMB14/kg). Hog prices may drop further due to high inventory, but this should be limited by the government’s need to give incentives to farmers to raise hogs (to alleviate the supply shortage caused by the surge in prices in the first place).
Sun Hung Kai Financial 56 20 Nov. 2009
Figure 4: Yurun – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 4,228.6 4,621.3 8,635.1 13,023.9 52.0 COGS (3,621.7) (3,910.2) (7,414.8) (11,333.9) 52.7 Gross profit 607.0 711.2 1,220.4 1,690.0 47.6 Operating expenses (250.7) (376.2) (625.9) (755.0) 46.9 Other operating income 20.9 125.3 236.4 133.4 23.8 Operating profit 377.2 460.3 830.9 1,068.4 43.7 Finance expenses (54.0) (13.2) (21.0) (71.6) 13.7 PBT 348.1 485.4 912.0 1,238.5 56.1 Tax (7.3) (5.5) (51.2) (101.4) 19.6 Net profit 340.8 481.0 859.3 1,137.8 63.5 EPS – RMB fen 32.7 33.1 58.4 74.4 43.8 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Yurun – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 73.3 9.3 86.9 50.8 52.0 COGS 73.8 8.0 89.6 52.9 52.7 Gross profit 70.6 17.2 71.6 38.5 47.6 Operating expenses 54.7 50.0 66.4 20.6 46.9 Other operating income (63.1) 498.7 88.7 (43.6) 23.8 Operating profit 50.6 22.0 80.5 28.6 43.7 Finance expenses 25.9 (75.6) 59.7 240.8 13.7 PBT 66.9 39.4 87.9 35.8 56.1 Tax (85.3) (24.6) 830.0 98.2 19.6 Net profit 114.2 41.1 78.7 32.4 63.5 EPS 87.6 1.3 76.4 27.4 43.8 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Yurun – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (85.6) (84.6) (85.9) (87.0) (85.8) Gross profit 14.4 15.4 14.1 13.0 14.2 Operating expenses (5.9) (8.1) (7.2) (5.8) (6.8) Other operating income 0.5 2.7 2.7 1.0 1.7 Operating profit 8.9 10.0 9.6 8.2 9.2 Finance expenses (1.3) (0.3) (0.2) (0.5) (0.6) PBT 8.2 10.5 10.6 9.5 9.7 Tax (0.2) (0.1) (0.6) (0.8) (0.4) Net profit 8.1 10.4 10.0 8.7 9.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 57 20 Nov. 2009
Figure 7: Yurun – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 1,302.4 844.0 1,966.0 1,209.1 50.6 Accounts receivable 313.9 322.8 501.4 445.2 7.7 Inventory 400.8 513.9 681.8 703.5 25.7 Other current assets 138.7 177.2 257.4 898.5 (18.8) Total current assets 2,155.8 1,857.9 3,406.5 3,256.2 2.8 Net fixed assets 565.3 1,154.1 2,721.5 3,691.7 64.1 Other long-term assets 23.6 139.3 249.5 1,373.5 62.9 Total assets 2,744.6 3,151.3 6,377.5 8,321.3 23.1 Short-term debt 20.1 43.5 268.0 1,095.5 (9.5) Accounts payable 140.4 378.0 756.0 902.8 40.8 Other current liabilities 152.2 80.1 19.0 19.8 (62.2) Total current liabilities 312.6 501.5 1,043.0 2,018.2 (8.1) Long-term debt 277.1 187.7 1,003.6 1,011.0 54.7 Other long-term liabilities 1.1 0.9 0.0 57.0 N/A Total liabilities 590.9 690.2 2,046.6 3,086.2 0.7 Shareholders equity 2,153.7 2,461.2 4,330.8 5,235.1 70.8 Minorities 0.0 12.5 191.7 20.1 N/A Total equity and liabilities 2,744.6 3,151.3 6,377.5 8,321.3 23.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Yurun – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 47.5 26.8 30.8 14.5 29.9 Accounts receivable 11.4 10.2 7.9 5.3 8.7 Inventory 14.6 16.3 10.7 8.5 12.5 Other current assets 5.1 5.6 4.0 10.8 6.4 Total current assets 78.5 59.0 53.4 39.1 57.5 Net fixed assets 20.6 36.6 42.7 44.4 36.1 Other long-term assets 0.9 4.4 3.9 16.5 6.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.7 1.4 4.2 13.2 4.9 Accounts payable 5.1 12.0 11.9 10.8 10.0 Other current liabilities 5.5 2.5 0.3 0.2 2.2 Total current liabilities 11.4 15.9 16.4 24.3 17.0 Long-term debt 10.1 6.0 15.7 12.1 11.0 Other long-term liabilities 0.0 0.0 0.0 0.7 0.2 Total liabilities 21.5 21.9 32.1 37.1 28.2 Shareholders equity 78.5 78.1 67.9 62.9 71.8 Minorities 0.0 0.4 3.0 0.2 0.9 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 58 20 Nov. 2009
Figure 9: Yurun – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 14.4 15.4 14.1 13.0 14.2 Operating margin – % 8.9 10.0 9.6 8.2 9.2 Net margin – % 8.1 10.4 10.0 8.7 9.3 ROAA – % 10.7 16.3 18.0 15.5 15.1 ROAE – % 24.6 20.8 25.3 23.8 23.6
Liquidity ratios Current assets/current liabilities – X 6.9 3.7 3.3 1.6 3.9 Liquid assets/current liabilities – X 4.2 1.7 1.9 0.6 2.1 Cash and securities/current assets – % 60.4 45.4 57.7 37.1 50.2 Cash flow from oper./curr. liabilities – % 86.1 83.3 73.2 60.0 75.6
Other ratios Capex/sales – % 2.9 8.8 11.3 12.1 8.8 Capex/depreciation – % 295.2 893.3 1,177.9 1,218.1 1,096.4 Operating expense/sales -% (5.9) (8.1) (7.2) (5.8) (7.1) Net debt/equity (net cash) – % (46.7) (25.0) (16.1) 17.1 (8.0) Inventory/sales – % 9.5 11.1 7.9 5.4 8.1 Effective tax rate – % 2.1 1.1 5.6 8.2 5.0 Cash conversion cycle – days 44.0 44.3 19.6 8.9 24.3
ROAA component analysis Revenue/average assets – % 132.9 156.8 181.2 177.2 162.0 COGS/average assets – % (113.8) (132.6) (155.6) (154.2) (139.1) Gross profit/average assets – % 19.1 24.1 25.6 23.0 23.0 Operating expenses/average assets – % (7.9) (12.8) (13.1) (10.3) (11.0) Other operating income/average assets – 0.7 4.3 5.0 1.8 2.9 Operating profit/average assets – % 11.9 15.6 17.4 14.5 14.9 Finance expenses/average assets – % (1.7) (0.4) (0.4) (1.0) (0.9) PBT/average assets – % 10.9 16.5 19.1 16.9 15.9 Tax/average assets – % (0.2) (0.2) (1.1) (1.4) (0.7) Net profit/average assets – % 10.7 16.3 18.0 15.5 15.1
ROAE component analysis Revenue/average equity – % 305.4 200.3 254.3 272.3 258.1 COGS/average equity – % (261.6) (169.5) (218.3) (237.0) (221.6) Gross profit/average equity – % 43.8 30.8 35.9 35.3 36.5 Operating expenses/average equity – % (18.1) (16.3) (18.4) (15.8) (17.2) Other operating income/average equity – 1.5 5.4 7.0 2.8 4.2 Operating profit/average equity – % 27.2 19.9 24.5 22.3 23.5 Finance expenses/average equity – % (3.9) (0.6) (0.6) (1.5) (1.6) PBT/average equity – % 25.1 21.0 26.9 25.9 24.7 Tax/average equity – % (0.5) (0.2) (1.5) (2.1) (1.1) Net profit/average equity – % 24.6 20.8 25.3 23.8 23.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 59 20 Nov. 2009
Clear Media (100.HK) Media Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Clear Media is the dominant bus-shelter advertising provider in China. This is its core business, contributing 90% of revenue, with the remainder from bus-body Performance (%) 1m 3m 12m advertising. Most shelters are in the central business districts of tier-one cities. The HSI 2.0 13.5 76.7 firm has an estimated 50% domestic market share. HSCEI 4.0 19.6 107.6
Clear Media negotiates with local governments to secure exclusive bus-shelter Clear Media– Price vs. HSI, Share Data concession rights. These give it a monopoly, unlike other outdoor media such as
billboards. Once concessions are granted, the company keeps all revenue generated, (HK$) (HK$m) but pays fixed rental fees and provides cleaning, repair and maintenance for the bus 9.0 30 8.0 25 shelters. Over 90% of concessions have contracts of 10 years or more. 7.0 6.0 20 5.0 15 The firm has a long track record in the bus-shelter advertising and has long 4.0 3.0 10 relationships with local governments. This helps it acquire and renew concession 2.0 5 rights in this expanding industry. Outdoor advertising only accounts for 17% of ad 1.0 0.0 0 spending, and revenues are migrating from mainstream media to other formats. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Turnover Price HSI Clear Media’s extensive bus-shelter advertising network, spanning 30 major cities, gives it pricing power over large corporate customers. It can charge up to a 50% Price – HK$ 3.75 premium over local peers as it can tailor advertising plans for its MNC clients. 52W high/low (HK$) 4.3/0.97 MNCs can find it difficult to promote their brands effectively due to geographic Shares in issue – millions 524.37 dispersion. Market cap – HK$m 1,966.38 3M avg. turnover – HK$m 1.06 The mainland’s media sector is still tightly controlled. For example, during last Major shareholders – % year’s Olympics, advertisements for non-Olympic sponsors could not feature any Clear Channel Communication 51.79 Olympic athletes, referees or officials. Clear Media’s substantial experience in Source: Bloomberg and Sun Hung Kai Financial Chinese media means it can swiftly adapt a new plan for its customer that can avoid missing out on ad spending.
The firm entered bus-body advertising in Shenzhen in early 2007, and accounts for nearly 70% of the market. This can create synergy with its existing business and increase its bargaining powers with customers. The bus-body advertising segment broke even in 2008 (10% of revenue), and margins should expand on rising Recent Reports economies of scale (less than 1% EBITDA margin). Date Next Stop: Pickup in Profit 5 Aug. 2009 Growth
Figure 1: Earnings Summary This document is solely based on Year ending 31 Dec. FY06 FY07 FY08 FY09E publicly available information. This Net profit – HK$m 120.0 141.6 166.1 137.3 report is intended as information Net-profit growth - % 14.2 17.9 17.3 (17.4) only and not as a recommendation for any stock. Sun Hung Kai EPS – HK¢ 23.4 27.0 31.7 25.9 EPS growth - % Financial does not provide research 11.8 15.3 17.2 (18.2) coverage or ratings for this P/E – X 16.0 13.9 11.8 14.5 company in this report. DPS – HK¢ 0.0 0.0 0.0 0.4 Dividend yield - % 0.0 0.0 0.0 0.1 BVPS – HK$ 3.5 4.0 4.6 4.9 Eva Yip, CFA P/B – X 1.1 0.9 0.8 0.8 + (852) 2203 5987 Oper cash flow/share – HK¢ 42.7 61.2 70.9 53.0 [email protected] Net debt (net cash) to share price - % 4.5 (1.6) (7.9) (17.4) Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor60ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Clear Media – Investment Highlights
Key investment positives Key investment negatives Strong industry prospects. 1) Low ad spending per capita. 2) Ad Low earnings visibility. Revenue is volatile, as advertising spending is migrating from mainstream media to new media. 3) budgets are among the first costs cut when the economy heads Domestic ad spending is still growing 5%-8% p.a. south. The firm does not have long-term contracts with customers (usually two weeks to a few months). Low ad spending per capita. Ad spending per capita in China is only 2%-3% of the U.S. level, implying significant upside ASP pressure in mid-tier cities. Local operators have cut prices potential. aggressively due to the weak environment, exerting price pressure in mid-tier cities (ASP down 7%yoy in 1H09). More cost competitive. TV still accounts for 42% of ad spending vs. 17% for outdoor media, but CCTV (90% of population Post-Olympics slowdown. Outdoor advertising in China faces coverage) advertising fees have risen 16% in 2009 despite the challenging times in the short run, following stellar growth for the weak economy. This could increase demand for more Beijing Olympics. Clear Media had high utilization (100% in some cost-effective forms of advertising. periods) and ASP growth (19%) in FY08, which is likely to stay flat but with a 10% ASP decline. Domestic consumption resilient, keen competition forcing firms, especially domestic brands, to invest in brand building. High operating leverage. Half of costs are fixed, such as rentals Total Chinese ad revenue from these industries, including financial and maintenance (23%-24% of revenue) and depreciation and subsidies, reached RMB168bn in 2008, up 21% yoy. Domestic amortization (17% of revenue). There is little room for cost customers now account for more than 50% of revenues (from 42% cutting. previously). Order cancellations may lower occupancy, as the firm reserves Expanding network to increase bargaining power. The firm has spaces for key customers. For example, the tainted-milk scandal over a 50% market share on average, and a unique standardized meant dairy customers canceled all their promotion plans. bus-shelter network that spans 30 PRC major cities. It is dominant in tier-one cities, and has legally granted concession rights. This is Lengthening accounts-receivable period may increase working-capital needs. The accounts-receivable period has difficult for competitors to break through, and monopoly status increased from 150 days to 168 days. The cash-conversion cycle is allows for price hikes with little fear of customer defections. zero, as accounts-payable periods granted to governments in the Benefits from government policy. Shanghai has dismantled all past have been around half a year. outdoor advertising, such as LEDs, leaving only public phones Changes in government policy such as relocating bus shelters booths and bus shelters. The government has also imposed away from central business districts (CBDs) and prohibiting restrictions on mobile-TV ads on public transport. Clear Media can certain advertisements. One reason Clear Media can attract large benefit from lower competition and greater pricing power. customers is its dominance in CBDs. Greater occupancy through launching more new packages, setting up more district sales offices, removing inefficient bus shelters and FY09 results may be hit by one-off concession-rights write off. This is due to the change in display format (from 12 the government cleaning up other forms of outdoor advertising. sheet-equivalent panels to six sheets) enforced by the government The occupancy rate dropped to 55% in 1H09 from 60% in 1H08. in Shanghai. Rising free cash flow. The company has invested heavily to Inefficient capital structure, which lowers ROE (7% in FY08). acquire concession rights in Beijing, Shanghai and Guangzhou The company is net cash, does not have a dividend-payout policy (70%-90% coverage in CBDs). Dominant market share means and funds expansion through internal resources. sustainable free cash flows, as it can attract more MNC customers due to its near monopoly in bus shelters. Capex-light business model generate high free cash flow (29% FCF margin in FY08). Capex is mainly incurred to acquire and build new shelters. The firm has consistently generated positive free cash flow; even after the acquisition of concession rights its FCF margin is still 12%. Synergy from bus-body advertising. The firm has entered bus-body advertising in Shenzhen and targets to expand to other cities. This allows cross selling and/or bundling services. The order book has reached about 75% of the full-year sales target. Debt free. This can back acquisitions of new bus shelters and development of the Beijing bus-body advertising business. As at end-June, it had HK$0.44/share net cash or HK$233m (10% of its market cap). Source: Sun Hung Kai Financial
Sun Hung Kai Financial 61 20 Nov. 2009
Figure 3: Clear Media – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Relaxing controls over the advertising sector. More sectors, such Intensifying market competition. Changes in government policy, as medical services, could be allowed to post advertisements. including deregulating the sector through the public auction of bus-shelter concession rights. Tighter control over outdoor advertising across China. Currently, only Beijing and Shanghai have cleaned up other Stricter control over the advertising sector, including any bans outdoor advertising ahead of major international events. If this on certain sectors from posting advertisements. continues across China this would lower competition. The rollout of new displays for bus shelters across China may Successful rental negotiations with the government. In view of require additional capex and possible write-offs of existing significant capex in preparation for the Shanghai World Expo, a inventory. poor operating environment and close relationships with the government, Clear Media may be able to negotiate lower rental costs this year. Source: Sun Hung Kai Financial
Recent Company News
Nil.
Industry Dynamics
Despite the unclear macro outlook, CCTV, which accounts for 30% of TV ad sales in China and reaches 90% of Chinese population, has raised prices 10% for 2009. This could indicate that advertising is less prone to a post-Olympics slowdown and economic weakness than expected. National ad spending is estimated to reach RMB194bn by 2010, a 17% CAGR over 2007-10 (vs. 14% over 2000-07).
Long-term prospects are positive, as:
Ad spending per capita in China is only 2%-3% of the U.S. level, implying significant upside potential.
Living standards and brand awareness are rising in China, increasing corporate demand for advertising.
More international events, such as the World Expo in 2010 and international sports competitions, are being hosted in China.
However, the number of TV channels has increased in the past decade from less than 100 to 3,000, which may reduce the effectiveness of TV promotion. Despite this, CCTV’s TV ad rates are up 10%-plus this year, which may encourage migration to other formats such as outdoor media.
New media, such as Internet and outdoor advertising, have gained traction at the expense of mainstream media in China. Internet and outdoor advertising together accounted for about 20% of national advertising revenue (up 8 ppts from 2002). TV and newspapers declined 6 ppts and 7 ppts respectively over the same period.
Sun Hung Kai Financial 62 20 Nov. 2009
Figure 4: Clear Media – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 675.4 776.0 997.3 1,260.1 23.7 COGS (387.5) (450.2) (605.5) (743.5) 25.0 Gross profit 287.9 325.8 391.8 516.6 21.9 Operating expenses (141.2) (172.4) (201.7) (257.6) 22.3 Other operating income 9.0 13.6 12.1 3.3 (0.4) Operating profit 155.6 167.0 202.2 262.2 21.1 Finance expenses (17.7) (17.7) (17.6) (14.9) 10.0 PBT 137.9 149.2 184.3 230.7 19.9 Tax (23.9) (20.0) (29.5) (47.8) 36.6 Net profit 105.2 120.0 141.6 166.1 17.3 EPS – HK¢ 21.0 23.4 27.0 31.7 16.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Clear Media – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 25.4 14.9 28.5 26.4 23.7 COGS 27.3 16.2 34.5 22.8 25.0 Gross profit 23.0 13.2 20.3 31.8 21.9 Operating expenses 22.5 22.1 17.0 27.7 22.3 Other operating income 169.9 51.3 (11.4) (72.8) (0.4) Operating profit 27.5 7.3 21.1 29.7 21.1 Finance expenses 74.2 0.1 (0.6) (15.6) 10.0 PBT 23.3 8.2 23.5 25.2 19.9 Tax 74.1 (16.3) 47.5 61.9 36.6 Net profit 19.7 14.2 17.9 17.3 17.3 EPS 19.7 11.8 15.3 17.2 16.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Clear Media – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (57.4) (58.0) (60.7) (59.0) (58.8) Gross profit 42.6 42.0 39.3 41.0 41.2 Operating expenses (20.9) (22.2) (20.2) (20.4) (21.0) Other operating income 1.3 1.8 1.2 0.3 1.1 Operating profit 23.0 21.5 20.3 20.8 21.4 Finance expenses (2.6) (2.3) (1.8) (1.2) (2.0) PBT 20.4 19.2 18.5 18.3 19.1 Tax (3.5) (2.6) (3.0) (3.8) (3.2) Net profit 15.6 15.5 14.2 13.2 14.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 63 20 Nov. 2009
Figure 7: Clear Media – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 302.6 257.4 283.5 209.6 (16.9) Accounts receivable 235.7 282.2 416.0 507.7 27.0 Inventory 0.0 0.0 0.0 0.0 N/A Other current assets 321.3 359.6 278.3 327.9 27.2 Total current assets 859.5 899.1 977.7 1,045.2 8.3 Net fixed assets 70.4 132.0 147.7 24.3 (28.9) Other long-term assets 1,132.8 1,402.4 1,612.6 1,889.6 14.7 Total assets 2,062.7 2,433.6 2,738.0 2,959.1 11.1 Short-term debt 0.0 19.9 151.6 55.0 10.2 Accounts payable 174.6 206.1 291.5 393.0 18.1 Other current liabilities 22.8 22.0 29.3 13.9 2.7 Total current liabilities 197.4 248.0 472.5 461.9 16.4 Long-term debt 0.0 326.6 99.5 0.0 N/A Other long-term liabilities 311.9 5.8 13.6 23.3 (46.8) Total liabilities 509.2 580.4 585.6 485.2 (2.8) Shareholders equity 1,540.4 1,832.1 2,120.9 2,428.2 14.9 Minorities 13.1 21.1 31.4 45.7 72.0 Total equity and liabilities 2,049.6 2,412.5 2,706.5 2,913.4 10.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Clear Media – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 14.7 10.6 10.4 7.1 10.7 Accounts receivable 11.4 11.6 15.2 17.2 13.8 Inventory 0.0 0.0 0.0 0.0 0.0 Other current assets 15.6 14.8 10.2 11.1 12.9 Total current assets 41.7 36.9 35.7 35.3 37.4 Net fixed assets 3.4 5.4 5.4 0.8 3.8 Other long-term assets 54.9 57.6 58.9 63.9 58.8 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.8 5.6 1.9 2.1 Accounts payable 8.5 8.5 10.8 13.5 10.3 Other current liabilities 1.1 0.9 1.1 0.5 0.9 Total current liabilities 9.6 10.3 17.5 15.9 13.3 Long-term debt 0.0 13.5 3.7 0.0 4.3 Other long-term liabilities 15.2 0.2 0.5 0.8 4.2 Total liabilities 24.8 24.1 21.6 16.7 21.8 Shareholders equity 75.2 75.9 78.4 83.3 78.2 Minorities 0.6 0.9 1.2 1.6 1.1 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 64 20 Nov. 2009
Figure9: Clear Media – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 42.6 42.0 39.3 41.0 41.2 Operating margin – % 23.0 21.5 20.3 20.8 21.4 Net margin – % 15.6 15.5 14.2 13.2 14.6 ROAA – % 5.2 5.3 5.5 5.8 5.5 ROAE – % 7.2 7.1 7.2 7.3 7.2
Liquidity ratios Current assets/current liabilities – X 4.4 3.6 2.1 2.3 3.1 Liquid assets/current liabilities – X 1.5 1.0 0.6 0.5 0.9 Cash and securities/current assets – % 35.2 28.6 29.0 20.1 28.2 Cash flow from oper./curr. liabilities – % 110.1 85.2 66.3 79.9 85.4
Other ratios Capex/sales – % 27.1 50.4 22.9 17.8 29.6 Capex/depreciation – % 2,934.5 5,979.1 3,438.0 3,627.7 4,348.3 Operating expense/sales -% (20.9) (22.2) (20.2) (20.4) (21.0) Net debt/equity (net cash) – % (19.6) (13.0) (6.2) (6.4) (8.5) Inventory/sales – % 0.0 0.0 0.0 0.0 0.0 Effective tax rate – % 17.3 13.4 16.0 20.7 16.7 Cash conversion cycle – days N/A N/A N/A N/A N/A
ROAA component analysis Revenue/average assets – % 33.7 34.5 38.6 44.2 37.8 COGS/average assets – % (19.3) (20.0) (23.4) (26.1) (22.2) Gross profit/average assets – % 14.4 14.5 15.2 18.1 15.5 Operating expenses/average assets – % (7.0) (7.7) (7.8) (9.0) (7.9) Other operating income/average assets – % 0.4 0.6 0.5 0.1 0.4 Operating profit/average assets – % 7.8 7.4 7.8 9.2 8.1 Finance expenses/average assets – % (0.9) (0.8) (0.7) (0.5) (0.7) PBT/average assets – % 6.9 6.6 7.1 8.1 7.2 Tax/average assets – % (1.2) (0.9) (1.1) (1.7) (1.2) Net profit/average assets – % 5.2 5.3 5.5 5.8 5.5
ROAE component analysis Revenue/average equity – % 46.0 46.0 50.5 55.4 49.5 COGS/average equity – % (26.4) (26.7) (30.6) (32.7) (29.1) Gross profit/average equity – % 19.6 19.3 19.8 22.7 20.4 Operating expenses/average equity – % (9.6) (10.2) (10.2) (11.3) (10.3) Other operating income/average equity – % 0.6 0.8 0.6 0.1 0.5 Operating profit/average equity – % 10.6 9.9 10.2 11.5 10.6 Finance expenses/average equity – % (1.2) (1.1) (0.9) (0.7) (1.0) PBT/average equity – % 9.4 8.9 9.3 10.1 9.4 Tax/average equity – % (1.6) (1.2) (1.5) (2.1) (1.6) Net profit/average equity – % 7.2 7.1 7.2 7.3 7.2 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 65 20 Nov. 2009
Comba (2342.HK) TMT-Hardware Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Comba is the largest mobile-telecom-coverage system provider in China, supplying
major operators such as China Mobile (56% of FY08 sales) and China Unicom Performance (%) 1m 3m 12m (16%). It has an estimated 25% share of the domestic integrated wireless and HSI 2.0 13.5 76.7 subsystem market. Core products include wireless-enhancement solutions (40% of HSCEI 4.0 19.6 107.6 FY08 sales) and antennas and subsystems (33%). Comba – Price vs. HSI, Share Data The PRC government issued three 3G licenses to three telecom operators in China at
the beginning of 2009. This brings enormous opportunity to spur revenue growth for (HK$) (HK$m) telecom-equipment providers. According to the Ministry of Industry and 10.0 250 Information Technology (MIIT), total investment in 3G networks will reach 8.0 200
RMB400bn for 2009-11, with about RMB150bn for 2009, RMB130bn for 2010 and 6.0 150
RMB120bn for 2011. China Unicom has budgeted RMB100bn in 2009 and 2010 for 4.0 100 its 3G network. Mobile carriers will also increase 2G capex. The mainland’s telecom 2.0 50 sector spent RMB295.4bn on capex in 2008, up nearly 30%. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 The firm reported strong 2008 growth in revenue from both PRC and overseas Turnover Price HSI markets, surging 43% yoy to HK$2,526m. Profits rose 19% yoy to HK$228m. EPS grew 18%, with a final DPS of HK¢7. Price – HK$ 8.14 52W high/low (HK$) 9.06/0.62 The financial position has improved significantly on the recovery of account Shares in issue – millions 1,061.41 receivables. The cash-conversion cycle shortened to 210 days in FY08 from 254 Market cap – HK$m 8,491.30 days, making the company less working-capital intensive. 3M avg. turnover – HK$m 53.05 Major shareholder – % With leading technology and less competition (as new products are not subject to Tung Ling Fok 40.24 central procurement), margins could stabilize amid price cuts for Source: Bloomberg and Sun Hung Kai Financial mature/standardized products.
Figure 1: Earnings Summary Year ending 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m 131.1 191.6 227.5 517.3 Recent Reports Date Net-profit growth - % 59.8 46.1 18.7 127.4 Likely Winner in 3G 18 Feb. 2009 Battleground EPS – HK¢ 13.0 18.6 22.1 48.3 EPS growth - % 59.1 43.7 18.3 119.0 P/E – X 62.8 43.7 36.9 16.9 DPS – HK¢ 3.7 5.0 5.8 12.6 This document is solely based on Dividend yield - % 0.5 0.6 0.7 1.6 publicly available information. This report is intended as information BVPS – HK$ 1.4 1.6 1.9 2.3 only and not as a recommendation P/B – X 5.9 5.0 4.2 3.6 for any stock. Sun Hung Kai
Oper cash flow/share – HK¢ 9.2 (5.3) 19.8 4.3 Financial does not provide research
Net debt (net cash) to share price - % (4.1) (3.4) (5.0) (6.6) coverage or ratings for this Sources: Bloomberg and Sun Hung Kai Financial company in this report. Note: Estimates based on Bloomberg consensus
Eva Yip, CFA + (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest Sun Hung Kai Financial 66 that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Comba – Investment Highlights
Key investment positives Key investment negatives The market is expanding on upbeat industry prospects. Capex could plateau in 2009. Much of the network-equipment 1. 3G opportunities. According to the Ministry of Industry spending was in 1H09, as China Unicom and China Telecom and Information Technology (MIIT), total investment in 3G targeted to launch 3G services in 1H09 to compete on subscriber networks will reach RMB400bn for 2009-11, with about base with China Mobile. RMB150bn for 2009, RMB130bn for 2010 and RMB120bn 2G ASPs and margins to further decline on product maturity. for 2011. 10%-15% of this could be spent on products China Mobile is more price-oriented in procurement and puts related to antennas and subsystems (33% of sales). pricing pressure on 2G products. 2. 2G network upgrades. Mobile operators will continue investing in 2G systems, as ongoing urbanization will lead Product sales are a one-off item. Recurring income makes up to network degradation. only 22% of revenues. Strong sales growth momentum to continue in FY09. Now that Long cash-conversion cycle of about 210 days, from product China’s telecom industry has been restructured, Comba’s earnings order to installation. 50% of revenue is received from customers should benefit from 3G-network rollout (TDSCDMA-related once they confirm delivery (which takes about 100 days after revenue for FY08 accounted for about 5% of total revenue) and installation). 2G-network expansion. Sales growth of 43% in FY08 was due to Credit crisis could hinder overseas sales (c. 18% of FY08 capex delays by PRC telecom operators, and management expects revenue). As banks are refusing to honor letters of credit from 30% growth in FY09. other banks, Comba has to request prepayments to mitigate Less susceptible to economic cycles. Ongoing urbanization means receivable-collection risks when supplying to developing markets greater demand for wireless-enhancement systems (24% of 1H08 such as India. sales) to extend network coverage and sustain high network quality. Strong financial position can support greater working-capital needs through more sales (cash-conversion cycle: 210 days in FY08). Net gearing of 2.5% in 1H08 reversed to net cash of HK$417m or HK$0.49/share. Operating cash flow turned around to an inflow of HK$215m in FY08, from an outflow of HK$53m in FY07. Margins stabilizing on optimal product mix. 3G products generate double-digit margins, while mature/standardized products make single digits, due to more complex technology. Comba’s gross margin has slipped from over 50% five years ago to 37% now due to ASP erosion. But with more and higher-margin new 3G products launching, margins should stabilize. Less pricing pressure than peers. Only 40%-50% of products are under central-procurement programs (vs. its peers’ 80%-90%). Products under central procurement have seen their ASPs drop 5%-30% p.a. (margin dropped from 51% in FY04 to 39% in FY07 due to central procurement). Little pricing pressure on new products, as these are not usually under central procurement. China Unicom’s (16% of sales) new procurement policies restrict keen price competition. China Unicom aims to improve network quality significantly, and only qualified equipment providers can submit tenders, limiting the number of competitors. Competitive advantage in high-growth domestic market. Telecommunications is a politically sensitive sector, and the firm also has much lower costs than its overseas rivals. Comba is No. 1 in the sector and accounts for 20%-plus of the wireless-enhancement and antenna market in China. Strong international sales momentum. International sales soared 122% and accounted for 12% of FY08 revenue. Growth potential of emerging markets is high on continuous capex investment. The firm is well placed to capture overseas orders, due to its lean cost structure, meaning 30%-40% cheaper products. Capacity expansion to ease constraints. The firm has moved up to two shifts, from one shift at end-FY08, and will build a new production plants to commerce operation this year. Greater industry concentration could increase bargaining power against telecom operators. New procurement and time constraints could exert pressure on small- and medium-sized makers, given their small scale and unstable quality. Reducing reliance on single largest customer – China Mobile. Revenue from China Mobile (941 HK) accounted for 56% of total sales in FY08, down from 65% for FY07. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 67 20 Nov. 2009
Figure 3: Comba – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Higher-than-expected telecom capex. Downward revisions in telecom capex. Faster development of LTE networks (4G) than expected. This can Growth may be constrained by capacity and working capital. extend the telecom capex boom into 2009-10. A prolonged credit crisis could restrict overseas sales due to high The financial markets calming down could ease working-capital receivables-collection risks. Banks are refusing to honor letters of constraints. Comba has a long-cash conversion cycle, which means credit from other banks. it needs more working capital. Improving technology could weaken the bargaining power of More stable financial markets could also make banks more vendors against cellular operators, while the entry of new amenable to honoring letters of credit from other banks. This competitors could exacerbate pricing pressure and cause margin would allow Comba to become more confident in taking overseas contraction. orders. Risks of a slowdown in the international market, due to weak A recovery in the international market, could mean telecom subscriber growth amid a global recession. operators spending more on network expansion. Source: Sun Hung Kai Financial
Recent Company News
Nil.
Industry Dynamics China’s State Council issued three 3G licenses in early 2009. Three operators have ramped up 3G investment to expand/defend market share. One way to play the PRC telecom capex boom driven by 2G and 3G spending could be to look upstream, to telecom-services providers. The mainland’s telecom sector spent RMB295.4bn on capex in 2008, nearly a 30% jump.
According to the Ministry of Industry and Information Technology, total 3G investments for 2009 and 2010 will reach RMB280bn (US$41bn), with about RMB150bn to be spent in 2009. The issue of 3G licenses is positive for telecom-equipment makers ZTE (763.HK), as well as infrastructure-services provider China Communications Services (552.HK) and mobile-network enhancement solutions providers Comba Telecom (2342.HK) and Centron (1155.HK). 10%-15% of spending will be on antenna and subsystem products, and the bulk of spending on infrastructure such as network towers.
But 3G beginning is not the end of 2G capex, which is set to soar due to past underinvestment. China Unicom has been unable to capture GSM market share from China Mobile (c. 70% market share) due to its poor network quality. This is due to China Mobile’s estimated 320,000 towers, vs. China Unicom’s 120,000 and China Telecom’s 20,000. China Telecom has announced it will spend RM80bn on capex in the next three years to improve CDMA coverage, as its CDMA network has been underinvested in the past 2-3 years. On the other hand, China Mobile will spend more on 2G, to defend market share.
Sun Hung Kai Financial 68 20 Nov. 2009
Figure 4: Comba – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,170.5 1,550.4 1,768.4 2,525.9 23.3 COGS (696.2) (963.9) (1,087.2) (1,579.9) 31.4 Gross profit 474.3 586.5 681.3 946.0 13.8 Operating expenses (375.2) (434.6) (498.7) (691.7) 20.8 Other operating income 2.7 2.1 9.1 19.1 117.8 Operating profit 101.8 154.1 191.6 246.6 0.7 Finance expenses (12.7) (13.1) (8.0) (13.4) 16.2 PBT 85.8 147.8 197.8 260.0 2.4 Tax (7.3) (16.6) (7.2) (27.5) 46.1 Net profit 82.1 131.1 191.6 227.5 (1.1) EPS – HK¢ 9.9 15.7 22.6 26.7 (1.7) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Comba – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 7.1 32.5 14.1 42.8 23.3 COGS 31.5 38.5 12.8 45.3 31.4 Gross profit (15.8) 23.7 16.1 38.9 13.8 Operating expenses 15.7 15.8 14.8 38.7 20.8 Other operating income 221.5 (21.3) 323.8 109.9 117.8 Operating profit (57.6) 51.4 24.4 28.7 0.7 Finance expenses 73.7 3.1 (39.3) 68.1 16.2 PBT (63.7) 72.3 33.8 31.5 2.4 Tax 21.3 126.4 (56.6) 282.2 46.1 Net profit (65.4) 59.8 46.1 18.7 (1.1) EPS (65.5) 59.1 43.8 18.3 (1.7) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Comba – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (59.5) (62.2) (61.5) (62.5) (61.4) Gross profit 40.5 37.8 38.5 37.5 38.6 Operating expenses (32.1) (28.0) (28.2) (27.4) (28.9) Other operating income 0.2 0.1 0.5 0.8 0.4 Operating profit 8.7 9.9 10.8 9.8 9.8 Finance expenses (1.1) (0.8) (0.5) (0.5) (0.7) PBT 7.3 9.5 11.2 10.3 9.6 Tax (0.6) (1.1) (0.4) (1.1) (0.8) Net profit 7.0 8.5 10.8 9.0 8.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 69 20 Nov. 2009
Figure 7: Comba – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 492.4 493.2 374.5 468.2 (2.4) Accounts receivable 653.9 874.2 1,129.0 1,308.3 25.1 Inventory 572.9 617.8 754.8 1,052.5 19.5 Other current assets 228.1 97.4 85.7 126.0 9.9 Total current assets 1,947.3 2,082.6 2,343.9 2,954.9 15.6 Net fixed assets 185.4 270.9 307.6 359.2 24.6 Other long-term assets 49.5 63.0 107.8 138.3 52.3 Total assets 2,182.2 2,416.6 2,759.3 3,452.4 17.2 Short-term debt 190.9 152.9 88.8 47.5 (26.0) Accounts payable 356.8 500.8 548.5 922.7 33.3 Other current liabilities 439.3 356.0 410.4 483.2 16.1 Total current liabilities 986.9 1,009.7 1,047.6 1,453.4 19.4 Long-term debt 0.0 0.0 0.0 3.8 113.6 Other long-term liabilities 0.0 0.0 6.8 6.2 N/A Total liabilities 986.9 1,009.7 1,054.4 1,463.4 19.6 Shareholders equity 1,195.3 1,406.9 1,705.0 1,989.0 15.6 Minorities 7.7 7.7 6.7 14.5 6.4 Total equity and liabilities 2,182.2 2,416.6 2,759.3 3,452.4 17.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Comba – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 22.6 20.4 13.6 13.6 17.5 Accounts receivable 30.0 36.2 40.9 37.9 36.2 Inventory 26.3 25.6 27.4 30.5 27.4 Other current assets 10.5 4.0 3.1 3.6 5.3 Total current assets 89.2 86.2 84.9 85.6 86.5 Net fixed assets 8.5 11.2 11.1 10.4 10.3 Other long-term assets 2.3 2.6 3.9 4.0 3.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 8.7 6.3 3.2 1.4 4.9 Accounts payable 16.3 20.7 19.9 26.7 20.9 Other current liabilities 20.1 14.7 14.9 14.0 15.9 Total current liabilities 45.2 41.8 38.0 42.1 41.8 Long-term debt 0.0 0.0 0.0 0.1 0.0 Other long-term liabilities 0.0 0.0 0.2 0.2 0.1 Total liabilities 45.2 41.8 38.2 42.4 41.9 Shareholders equity 54.8 58.2 61.8 57.6 58.1 Minorities 0.4 0.3 0.2 0.4 0.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 70 20 Nov. 2009
Figure 9: Comba – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin – % 40.5 37.8 38.5 37.5 38.6 Operating margin – % 8.7 9.9 10.8 9.8 9.8 Net margin – % 7.0 8.5 10.8 9.0 8.8 ROAA – % 4.1 5.7 7.4 7.3 6.1 ROAE – % 7.1 10.1 12.3 12.3 10.5
Liquidity ratios Current assets/current liabilities – X 2.0 2.1 2.2 2.0 2.1 Liquid assets/current liabilities – X 0.5 0.5 0.4 0.3 0.4 Cash and securities/current assets – % 25.3 23.7 16.0 15.8 20.2 Cash flow from oper./curr. liabilities – % 3.0 9.2 (5.2) 14.8 5.4
Other ratios Capex/sales – % 5.5 6.0 2.8 3.8 4.5 Capex/depreciation – % 218.7 272.3 110.3 164.8 191.5 Operating expense/sales -% (32.1) (28.0) (28.2) (27.4) (28.9) Net debt/equity (net cash) – % (25.2) (24.2) (16.8) (21.0) (21.8) Inventory/sales – % 48.9 39.8 42.7 41.7 43.3 Effective tax rate – % 8.5 11.2 3.6 10.6 8.5 Cash conversion cycle – days 313.5 250.2 280.7 210.0 263.6
ROAA component analysis Revenue/average assets – % 58.4 67.4 68.3 81.3 68.9 COGS/average assets – % (34.7) (41.9) (42.0) (50.9) (42.4) Gross profit/average assets – % 23.7 25.5 26.3 30.5 26.5 Operating expenses/average assets – % (18.7) (18.9) (19.3) (22.3) (19.8) Other operating income/average assets – % 0.1 0.1 0.4 0.6 0.3 Operating profit/average assets – % 5.1 6.7 7.4 7.9 6.8 Finance expenses/average assets – % (0.6) (0.6) (0.3) (0.4) (0.5) PBT/average assets – % 4.3 6.4 7.6 8.4 6.7 Tax/average assets – % (0.4) (0.7) (0.3) (0.9) (0.6) Net profit/average assets – % 4.1 5.7 7.4 7.3 6.1
ROAE component analysis Revenue/average equity – % 101.4 119.2 113.7 136.8 117.8 COGS/average equity – % (60.3) (74.1) (69.9) (85.5) (72.5) Gross profit/average equity – % 41.1 45.1 43.8 51.2 45.3 Operating expenses/average equity – % (32.5) (33.4) (32.1) (37.5) (33.9) Other operating income/average equity – % 0.2 0.2 0.6 1.0 0.5 Operating profit/average equity – % 8.8 11.8 12.3 13.4 11.6 Finance expenses/average equity – % (1.1) (1.0) (0.5) (0.7) (0.8) PBT/average equity – % 7.4 11.4 12.7 14.1 11.4 Tax/average equity – % (0.6) (1.3) (0.5) (1.5) (1.0) Net profit/average equity – % 7.1 10.1 12.3 12.3 10.5 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 71 20 Nov. 2009
Coslight Technology Limited (1043.HK) TMT Hardware Sector 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Coslight is the largest sealed-lead-acid (SLA) battery producer in the PRC, with 30% of the domestic market. Large telecom companies, such as China Mobile, China Performance (%) 1m 3m 12m Telecom, and China Netcom use these batteries to power base stations in their HSI 2.0 13.5 76.7 transmission networks. HSCEI 4.0 19.6 107.6
Following China’s recent reforms for 3G mobile technology, huge demand for SLA Coslight – Price vs. HSI, Share Data batteries can be expected in coming months as new wireless-communications players begin spending on capital equipment to boost and enhance their networks. (HK$) (HK$m) The company also manufactures lithium-ion (Li-ion) batteries used in handsets as 20.0 100
80 well as nickel batteries, which are expected to post a CAGR of 30% over 2008-10 in 15.0 a market that has less than 10 suppliers. 60 10.0 The firm has expanded direct exports through supply agreements with Vodafone and 40 5.0 Emerson, plus indirect exports though sales to Huawei. These three customers 20 account for 28% of SLA sales. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 Lead is the main cost driver, accounting for over 60% of production. The acquisition Turnover Price HSI of two lead mines in Russia (Faso Lane and Altai Krai) should help shield the company against rising lead prices when commodity prices begin to rebound. Price – HK$ 12.94 The firm has a 46% interest in Beijing Guangyu Huaxia Technology Corporation, one 52W high/low (HK$) 18.98/3.1 of the top online-games companies in China. Shares in issue – millions 374.18 Market cap – HK$m 4,826.92 The company plans to roll out production of Li-ion batteries for electric bikes in 3M avg. turnover – HK$m 20.89 2009, which have a potential China market of 10 million units p.a. Major shareholder – % Dianquan Song 69.57 Sources: Bloomberg and Sun Hung Kai Financial Figure 1: Earnings Summary Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit - RMBm 144.6 162.3 203.5 268.0 Net-profit growth – % 30.3 12.3 25.4 31.7 EPS – RMB fen 33.4 37.5 49.5 76.0 EPS growth – % 30.3 12.3 32.0 53.7 P/E – X 34.2 30.4 23.0 15.0 Recent Reports Date DPS – RMB fen 5.0 4.5 7.0 9.7 Key Takeaways 23 Feb. 2009 Dividend yield – % 0.4 0.4 0.6 0.9
BVPS – RMB 2.7 3.0 3.3 4.7 P/B – X 4.3 3.8 3.4 2.4 Oper cash flow/share – RMB fen This document is solely based on (4.2) (56.6) 42.5 N/A publicly available information. This Net debt (net cash) to share price – % 12.3 19.2 22.5 N/A Sources: Bloomberg and Sun Hung Kai Financial report is intended as information Note: Based on Bloomberg Consensus only and not as a recommendation for any stock. Sun Hung Kai
Financial does not provide research
coverage or ratings for this company in this report.
Michael Yuk + (852) 2203 9590 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor72ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Coslight – Investment Highlights
Key investment positives Key investment negatives Explosive growth. 3G-license holders China Mobile, China Cash-conversion cycle improving but still long. China Mobile is Telecom, and China Unicom plan to spend RMB170bn in 2009 to the largest customer at about 30% of sales, on long payment periods. enhance and expand their 3G networks. China Mobile had installed This means a long cash-conversion cycle of 188 days. base stations in 28 cities by June this year and China Telecom Use of short-term financing for daily operations. While we view expanded coverage in 100 major cities by end-March. As such there payment defaults from customers as unlikely (since most are large will be large demand for SLA batteries. telecom firms) the long cash-conversion cycle has led Coslight to Stable relationships with large customers. Coslight has a more rely on short-term financing to maintain and expand production than 10-year track record of supplying SLA products to customers levels. Bank borrowings due within one year increased 11% hoh to such as China Mobile, China Telecom and China Netcom. It has also RMB1.1bn by the latest balance-sheet date. The company will most entered an agreement to provide SLA batteries to Vodafone. likely continue to use short-term debt to finance operations until payments are collected from customers. Competition in 3G market will increase sales of mobile phones and batteries. Major mobile service companies such as China Falling dividend payout. The payout ratio has fallen from 24% in Mobile are planning 3G-handset subsidies to encourage handset FY05 to just under 12% based on the latest financial statements. We purchases. Each handset normally comes with at least one Li-ion expect the dividend payout to be the same in FY09, as the long CCC battery, provided by suppliers such as Coslight. discourages increasing the payout ratio. Capitalizing on market dominance. SLA batteries are mature Weaker global demand for handsets. 16% of revenue is from products that may face continued margin pressure. Hence, operating Li-ion batteries and 8% from nickel batteries used in handsets. scale is almost the only way to ensure cost competitiveness. Weaker handset sales will cut into battery sales. Coslight’s domestic market share exceeds 20% and it is aggressively Exposure to foreign markets. As the global supplier to Vodafone tapping the OEM market, so it should be in good shape to increase and Emerson, Coslight will be exposed to the global macroeconomic sales while maintaining its market position. slowdown in the hardest-hit places, such as the U.S. and the U.K., High entry barriers for SLA battery manufacturing. Demand for which could decrease overseas sales. SLAs is mainly from large-cap telecom firms that have stringent Business risks from mining. As a new entrant in mining and quality requirements. New entrants have difficulties reaching the metals, Coslight may be very unfamiliar with the day-to-day reputation and quality levels required by these clients. Certification operations of running a mine. Hence, the business risk is high. and performance records are required to enter this market.
Margins to improve with falling raw-material prices. Lead is the main cost driver, accounting for over 60% of production costs based on the latest financial statements. With lead costs down following the slump in commodities, gross margins are expected to improve 3-5 ppts. Utilization supports organic growth. Utilization is 84% for the SLA division and 50% for the Li-ion segment. This gives ample room to expand operations without incurring intensive capex, leaving ample FCF for dividend payouts. Acquisition of mines will protect against rising lead costs. The two lead mines acquired in Russia (Faso Lane and Altai Krai) are expected to start operation 2011. This will help shield the company against rising lead prices when commodity prices begin to rebound. Lower costs than competitors due to fully integrated operations. Larger operating scale gives Coslight stringent cost controls and greater economies of scale, translating into 10% lower costs (RMB0.10-RMB0.20/KVAH) than its competitors. Strategically located manufacturing facilities in Harbin, Shenyang and Zhuhai (to begin production in 3Q09) will further lower distribution costs. Positive impact from RMB depreciation. The company aims to expand exports, which would benefit from RMB depreciation.
Source: Sun Hung Kai Financial
Figure 3: Coslight – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
M&A, which would increase the company’s market shares in SLAs Higher lead, lithium and nickel prices, which would outpace the and Li-ion batteries. increase in ASPs for the company’s products. Quicker payments from customers, which would reduce Unexpected increase in expenditure to bring mines into operation. working-capital pressure. Prolonged recession in developed countries leading to lower Increasing reserve valuations of its mine assets due to high reserves handset-replacement demand (⅓ of handset demand is from of copper, zinc and gold. replacement needs in developed countries).
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 73 20 Nov. 2009
Recent Company News
Despite record volumes, revenue from Coslight’s sealed-lead-acid (SLA) battery division dropped RMB44m or 5% yoy in 1H09, as the company’s pricing mechanism brought down the ASP in accordance with falling lead prices.
The Li-ion batteries segment sustained hits to both sales volumes and prices, as the financial situation during the beginning of the year reduced mainland demand.
The online-games division was the only shining light, with sales increasing more than 50% yoy, due to the roll-out of new games 秦始皇, 西遊 Q 記 and 炫舞吧, as well as the continued popularity of domestic online game 問道. However, this was not enough to offset lower revenue from the two other business segments, and total revenue for the period decreased 7% yoy to RMB1.2bn.
Industry Dynamics
The SLA battery industry has seen a spurt and slump in demand over the past decade due to volatile growth in the two main application segments: telecommunications and data communication. China’s large domestic market has become a new growth driver for SLA batteries due to the recent opening of its domestic 3G market.
The mainland’s SLA-battery industry is quite consolidated, with only a few competitors. Jiangsu Shuangdeng generates only half of Coslight’s turnover based on most recent data.
Entry barriers for SLA manufacturing are high, as new entrants need professional certification, solid performance records and strong technology and R&D capabilities before they will be considered by telecom giants.
Opening up of the mainland’s 3G market has triggered huge demand for SLA batteries, and replacement demand will also persist from 2G-network users, as the two systems are set to run concurrently for some years.
The number of mobile-phone users in China is expected to increase to 807 million by 2010, with new handset sales to hit 132 million by 2009 (a CAGR of 11% for 2006-09).
Lead is the main raw material for SLA batteries, and prices increased during the commodities bubble. However, the financial crisis in 2008 and bursting of this bubble have caused prices to drop 45% from the 2008 average, which allows SLA battery manufacturers more breathing room to improve margins.
Sun Hung Kai Financial 74 20 Nov. 2009
Figure 4: Coslight – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,307.4 1,619.7 2,193.6 2,441.8 21.4 COGS (882.5) (1,149.6) (1,712.2) (1,861.6) 25.8 Gross profit 425.0 470.1 481.4 580.3 11.0 Operating expenses (280.0) (288.2) (341.0) (377.8) 15.3 Other operating income 15.6 11.2 10.1 11.5 21.1 Operating profit 160.6 193.1 150.5 214.0 5.4 Finance expenses (38.6) (44.9) (54.6) (77.2) 22.3 PBT 124.6 165.9 178.1 264.3 16.4 Tax (8.6) (14.0) (12.9) (37.0) 35.5 Net profit 110.9 144.6 162.3 203.5 13.6 EPS – RMB fen 25.6 33.4 37.5 49.5 15.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Coslight – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 16.2 23.9 35.4 11.3 21.4 COGS 18.7 30.3 48.9 8.7 25.8 Gross profit 11.3 10.6 2.4 20.5 11.0 Operating expenses 30.9 2.9 18.3 10.8 15.3 Other operating income 189.9 (27.9) (10.3) 14.9 21.1 Operating profit (7.3) 20.3 (22.1) 42.2 5.4 Finance expenses 11.9 16.4 21.6 41.5 22.3 PBT (13.5) 33.1 7.4 48.4 16.4 Tax (21.4) 62.2 (7.9) 186.6 35.5 Net profit (9.1) 30.3 12.3 25.4 13.6 EPS (9.1) 30.3 12.3 32.0 15.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Coslight – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (67.5) (71.0) (78.1) (76.2) (73.2) Gross profit 32.5 29.0 21.9 23.8 26.8 Operating expenses (21.4) (17.8) (15.5) (15.5) (17.6) Other operating income 1.2 0.7 0.5 0.5 0.7 Operating profit 12.3 11.9 6.9 8.8 10.0 Finance expenses (3.0) (2.8) (2.5) (3.2) (2.8) PBT 9.5 10.2 8.1 10.8 9.7 Tax (0.7) (0.9) (0.6) (1.5) (0.9) Net profit 8.5 8.9 7.4 8.3 8.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 75 20 Nov. 2009
Figure 7: Coslight – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 197.3 274.6 362.2 409.2 13.2 Accounts receivable 1,121.4 1,222.6 1,525.8 1,568.1 15.0 Inventory 267.7 336.3 384.6 341.5 11.5 Other current assets 205.0 192.3 320.5 349.9 24.9 Total current assets 1,791.4 2,025.8 2,593.1 2,668.8 15.3 Net fixed assets 540.6 594.5 759.3 886.3 13.6 Other long-term assets 24.2 230.7 249.3 290.1 71.5 Total assets 2,356.2 2,851.0 3,601.7 3,845.3 16.6 Short-term debt 587.3 751.6 1,010.3 1,172.9 20.4 Accounts payable 391.2 395.5 733.7 388.0 15.6 Other current liabilities 262.9 291.0 59.0 508.7 17.4 Total current liabilities 1,241.4 1,438.2 1,803.0 2,069.6 18.7 Long-term debt 0.0 131.0 302.0 251.0 49.5 Other long-term liabilities 3.1 9.2 39.2 39.1 81.3 Total liabilities 1,244.4 1,578.4 2,144.2 2,359.7 21.1 Shareholders equity 1,111.8 1,272.7 1,457.5 1,485.6 11.0 Minorities 94.0 113.4 153.6 167.8 24.1 Total equity and liabilities 2,356.2 2,851.0 3,601.7 3,845.3 16.6 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Coslight– Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 8.4 9.6 10.1 10.6 9.7 Accounts receivable 47.6 42.9 42.4 40.8 43.4 Inventory 11.4 11.8 10.7 8.9 10.7 Other current assets 8.7 6.7 8.9 9.1 8.4 Total current assets 76.0 71.1 72.0 69.4 72.1 Net fixed assets 22.9 20.9 21.1 23.1 22.0 Other long-term assets 1.0 8.1 6.9 7.5 5.9 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 24.9 26.4 28.1 30.5 27.5 Accounts payable 16.6 13.9 20.4 10.1 15.2 Other current liabilities 11.2 10.2 1.6 13.2 9.1 Total current liabilities 52.7 50.4 50.1 53.8 51.8 Long-term debt 0.0 4.6 8.4 6.5 4.9 Other long-term liabilities 0.1 0.3 1.1 1.0 0.6 Total liabilities 52.8 55.4 59.5 61.4 57.3 Shareholders equity 47.2 44.6 40.5 38.6 42.7 Minorities 4.0 4.0 4.3 4.4 4.1 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 76 20 Nov. 2009
Figure 9: Coslight – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 32.5 29.0 21.9 23.8 26.8 Operating margin – % 12.3 11.9 6.9 8.8 10.0 Net margin – % 8.5 8.9 7.4 8.3 8.3 ROAA – % 5.0 5.6 5.0 5.5 5.3 ROAE – % 10.6 12.1 11.9 13.8 12.1
Liquidity ratios Current assets/current liabilities – X 1.4 1.4 1.4 1.3 1.4 Liquid assets/current liabilities – X 0.2 0.2 0.2 0.2 0.2 Cash and securities/current assets – % 11.0 13.6 14.0 15.3 13.5 Cash flow from oper./curr. liabilities – % 10.9 (1.3) (13.6) 8.4 1.1
Other ratios Capex/sales – % 2.8 0.2 9.2 7.8 5.0 Capex/depreciation – % 80.5 6.2 334.1 280.2 206.8 Operating expense/sales -% (21.4) (17.8) (15.5) (15.5) (16.3) Net debt/equity (net cash) – % 35.0 47.8 65.2 68.3 60.4 Inventory/sales – % 20.5 20.8 17.5 14.0 17.4 Effective tax rate – % 6.9 8.5 7.3 14.0 9.9 Cash conversion cycle – days 263.3 242.1 188.4 190.4 207.0
ROAA component analysis Revenue/average assets – % 59.0 62.2 68.0 65.6 63.7 COGS/average assets – % (39.8) (44.2) (53.1) (50.0) (46.8) Gross profit/average assets – % 19.2 18.1 14.9 15.6 16.9 Operating expenses/average assets – % (12.6) (11.1) (10.6) (10.1) (11.1) Other operating income/average assets – % 0.7 0.4 0.3 0.3 0.4 Operating profit/average assets – % 7.2 7.4 4.7 5.7 6.3 Finance expenses/average assets – % (1.7) (1.7) (1.7) (2.1) (1.8) PBT/average assets – % 5.6 6.4 5.5 7.1 6.2 Tax/average assets – % (0.4) (0.5) (0.4) (1.0) (0.6) Net profit/average assets – % 5.0 5.6 5.0 5.5 5.3
ROAE component analysis Revenue/average equity – % 125.0 135.9 160.7 165.9 146.9 COGS/average equity – % (84.4) (96.4) (125.4) (126.5) (108.2) Gross profit/average equity – % 40.6 39.4 35.3 39.4 38.7 Operating expenses/average equity – % (26.8) (24.2) (25.0) (25.7) (25.4) Other operating income/average equity – % 1.5 0.9 0.7 0.8 1.0 Operating profit/average equity – % 15.4 16.2 11.0 14.5 14.3 Finance expenses/average equity – % (3.7) (3.8) (4.0) (5.2) (4.2) PBT/average equity – % 11.9 13.9 13.0 18.0 14.2 Tax/average equity – % (0.8) (1.2) (0.9) (2.5) (1.4) Net profit/average equity – % 10.6 12.1 11.9 13.8 12.1 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 77 20 Nov. 2009
Dachan Food (3999.HK) Food & Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Listed in October 2007, Dachan is the largest integrated chicken-meat processer in China. Majority shareholder Great Wall Enterprise was incorporated in Taiwan in Performance (%) 1m 3m 12m 1960 as a feed and chicken-processing business. In 1990, Dachan entered the China HSI 2.0 13.5 76.7 market and has since replicated its parents’ business model. It was listed in 2007, HSCEI 4.0 19.6 107.6 raising HK$589.1m. Dachan Food – Price vs. HSI, Share Data Its business ranges from chicken-meat processing (51.3% of 1H09 sales), feed production (43.6%), and production of processed foods (5%). It operates 12 feed-manufacturing plants, seven chicken-slaughtering and processing plants, and (HK$) (HK$m) 3.5 90 four processing plants on the mainland. It is the largest supplier for KFC in China and 3.0 80 70 a major supplier to other big names such as McDonald’s in China and Ito Yokado, 2.5 60 and the 7-11 chain in Japan. 2.0 50 1.5 40 30 1.0 Dachan’s vertical integration covers the entire value chain, allowing it to monitor the 20 entire production process and achieve high product quality. The chicken-meat 0.5 10 0.0 0 segment includes three businesses: 1) providing feed to contract farmers, 2) Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 supplying chicks to contract farmer, and 3) producing chilled and frozen chicken. By providing contract farmers with chicken vaccines and technology guidance, the firm Turnover Price HSI can closely monitor the chicken-rearing process. Dachan also sells feed to external customers. Price – HK$ 1.54 52W high/low (HK$) 1.85/0.75 The processed-foods segment produces and distributes pickled, pre-fried and roasted Shares in issue – millions 1,010.66 foods. It has a wide product portfolio, including the new Sister Kitchen brand and a Market cap – HK$m 1,556.42 series of new products, such as teriyaki, instant chicken soup and crepes. About half 3M avg. turnover – HK$m 2.51 of the processed-food sales are booked domestically, with the rest from exports. Major shareholders – % 1H09 results. Turnover dropped 12.4% yoy to US$560.6m, mainly due to the low Great Wall Enterprise 52.32 Sources: Bloomberg and Sun Hung Kai Financial chicken-meat ASP and decline in the feed segment caused by the H1N1 flu scare in 2Q09. The gross margin fell 1.6 ppts yoy to 7.4% and the net profit decreased 57% yoy to US$7m, with basic EPS down 56.9% yoy to US¢0.69. No interim dividend was declared.
Figure 1: Earnings Summary This document is solely based on publicly available information. This Year ending 31 Dec. FY06 FY07 FY08 FY09E report is intended as information Net profit – US$m 13.4 26.2 19.7 15.4 only and not as a recommendation Net-profit growth – % 56.7 96.5 (25.0) (21.6) for any stock. Sun Hung Kai EPS – US¢ 1.8 3.2 2.0 1.6 Financial does not provide research EPS growth – % 56.1 81.5 (39.6) (17.9) coverage or ratings for this P/E – X 11.2 6.2 10.2 12.4 company in this report. DPS – US¢ 0.0 0.0 0.5 0.3 Dividend yield – % 0.0 0.0 2.5 1.5 BVPS – US$ N/A 0.2 0.2 0.2 P/B – X N/A 1.0 0.9 0.9 Operating cash flow per share – US¢ 1.6 2.4 4.9 N/A Net debt (net cash)/ price – % N/A (18.6) (15.5) N/A Sources: Bloomberg and Sun Hung Kai Financial Notes: Estimates based on Bloomberg consensus
Holly Hou + (852) 2203 9588 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor78ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Dachan Food – Investment Highlights
Key investment positives Key investment negatives Expanding geographic coverage. Dachan plans to spend more Thin margins. Dachan’s gross margins have consistently been in than US$40m on replicating its business model elsewhere in China single digits. Profitability is highly sensitive to volatile through acquisitions. It is investing in plants in Tianjin, Shanghai raw-material prices, with direct raw materials accounting for 93% and Vietnam. of COGS. Prices of soybean and corn, two key raw materials in the feed industry, are stable now, but a prolonged increase would Fully integrated business model combines feed production, chick narrow margins. hatching, rearing, slaughtering and processing on one operational platform. Competitors without similar experience will find it very Falling chicken prices. Slower demand and oversupply in the challenging to replicate this model, creating an entry barrier. PRC has led to a decrease in chicken meat ASP, which could eat into margins. Chinese meat prices are usually volatile. Brand recognition, ability to pass on costs. Dachan can promote its products on high quality and safety. This strong brand is an Consumer appetite affected by animal diseases. Recent advantage given China’s rising disposable incomes and rising food-safety scandals, such as poisonous Chinese dumplings in awareness of the heath benefits of white meat, and can help the Japan, have raised concerns about the food sector. In particular, firm pass on raw-material price increases to maintain margins. concerns about avian flu have turned consumers away from chicken. Dachan must maintain its disease-prevention controls to Improving feed-sales mix. The firm is focusing on specially minimize margin pressure. formulated feeds for piglets and sows, which have hlepd imrpvoe the gross margin for each of the six-month periods since the Lower pricing power, subject to government policies. Dachan is beginning of 2008, from 9.6% for 1H08 to 10.4% for FY08 and able to pass rising raw-material costs on to consumers due to its 12.7% for 1H09. These margins may be sustainable, as pricing power, but this may wane. If chicken prices rise very high, soybean-meal and corn prices are steadily declining. the government may intervene. Dachan’s pricing power might also weaken as it confronts downstream retailing giants. Major supplier for well-known customers. Dachan is the largest meat supplier to KFC in China, responsible for about ⅓ of the Vulnerable to chicken-price slumps in its slaughtering chicken used in its restaurants. It is also the largest chicken-meat business. According to Dachan’s contract-farmer business model, supplier to Husi and McKey, main chicken-sourcing agents for the company establishes purchase prices with contract farmers McDonald’s in China. In addition, it exports processed when it allots infant chicks to them. Generally, the purchase price chicken-meat products to Ito Yokada and the 7-11 chain in Japan. is higher than the market price if chick prices fall in the spot market. However, it sells chicken meat at the market price when it Promising industry. Chicken is China’s second most consumed is distributed through retailers. Therefore, Dachan has suffered meat, after pork, but chicken consumption is growing faster. This is from the chicken-price decline. due to lower prices, greater nutritional value and the rising proportion of meat sold via super and hypermarket chains. More High effective tax rate. Dachan will soon be subject to a 25% Chinese consumers are buying ready-made or processed chicken effective tax rate. from supermarkets (50% of Dachan’s sales), rather than whole raw Exchange-rate risk. The group transacts its business mainly in chickens from wet markets. USD, RMB and Vietnamese Dong. The exchange rates of the three Well positioned to capture industry growth. Dachan is the currencies can affect reported revenue. largest integrated chicken-meat processor in PRC and one of the top 10 feed manufacturers in China. According to China Meat Association, Dachan was the largest chicken-meat processor in China by number of chickens slaughtered in 2006 (with the capacity to slaughter 120 million chickens in FY06). Dachan also has 12 feed plants (two in Vietnam and one in Malaysia), and seven chicken-meat plants (four in Liaoning, making it the dominant producer in northeast China), and four processed-food facilities. Government support. The PRC government is supporting large-scale chicken farming to improve farmers’ living standards and the quality of food. This should help with disease prevention product-quality control. New capacity coming onstream. Dachan is on track to attain its chicken-slaughtering capacity target of 300 million chickens p.a. by 2010. Slaughter capacity is forecast to increase to c. 220 million chickens p.a. by 2009. The new Hebei plant (capacity of 40 million chickens p.a.) commenced operation in early 2009. The company is also considering acquisitions of small-scale chicken processors as a cost-efficient way to expand. New brand-building program. Dachan has reconfigured its sales channels and invested in building up its Sisters Kitchen brand. This is supported by an effective product-tracing system in response to growing public concerns about food safety. Turnovers, gross profits and gross margins have subsequently improved. Long-term agreement with KFC, which has signed supply contracts with three chicken-meat suppliers for a total of 280,000 tons over the next three years. This can translate into average annual revenue of RMB556m, equal to 6% of Dachan’s FY08 turnover. Net cash. Dachan should be able to meet the increased capex for its plans to enlarge production capacity, as it now has net cash of US$26.8m. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 79 20 Nov. 2009
Figure 3: Dachan Food – upside/downside price catalysts
Upside price catalysts Downside price catalysts
Higher-than-expected selling prices More-than-expected raw-material price and supply volatility More-than-expected softening in raw-material costs (soybean and corn) More-than-expected increase in hog supply More favorable government policies Discontinuation of government policies (end of low tax rates) Implementation of government price controls Unexpected animal diseases Source: Sun Hung Kai Financial
Industry Dynamics
Chicken is China’s second most consumed meat after pork, but has the highest growth rate. Chicken-meat consumption posted a 5.7% CAGR from 6.2 million tons in 1996 to 10.2 million tons in 2005. Chinese traditionally prefer pork, but chicken consumption is expected to undergo long-term growth, due to:
Chicken consumption remaining below the world average at only 8.0 kg per capita in 2005, vs. the world average of 10.6 kg. Countries with higher chicken consumption include the U.S. at 44.8 kg, the U.K. at 26.4 kg and Japan with 14.8 kg. There is much room for growth.
Lower prices, attributable to the lower feed-to-meat ratio.
Increasing awareness that white meat is healthier.
The rising proportion of meat sales via super and hypermarket chains, with more Chinese are buying ready-made or processed chicken from supermarkets (69% of Dachan’s total sales), rather than whole raw chickens from wet markets.
Government support.
The mainland’s chicken-farming industry remains highly fragmented, with poor disease control. This gives Dachan a competitive edge. Its brand, built around high quality and safety, caters to increasing health awareness among Chinese.
Dachan also improves farmers’ living standards, and enjoys government subsidies and tax benefits due to its large scale and better disease prevention control. In FY07, the government gave Dachan one-off compensation of US$3.4m and subsidies of US$1.2m.
Sun Hung Kai Financial 80 20 Nov. 2009
Figure 4: Dachan – Profit and Loss Statement FY05-08 Year ended 31 Dec., US$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 532.1 637.4 894.5 1,294.0 31.7 COGS (488.6) (583.9) (818.7) (1,198.7) 31.5 Gross profit 43.5 53.5 75.7 95.3 35.1 Operating expenses (31.0) (36.5) (49.4) (69.7) 29.7 Other operating income 0.5 2.6 6.8 3.3 34.7 Operating profit 12.9 19.6 33.2 28.9 55.5 Finance expenses (2.9) (2.7) (4.2) (5.2) 18.3 PBT 10.8 18.7 33.6 27.6 75.4 Tax (1.9) (2.2) (2.4) (5.8) 47.3 Net profit 8.5 13.4 26.2 19.7 65.4 EPS – US¢ 1.1 1.8 3.2 2.0 53.6 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Dachan – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 23.8 19.8 40.3 44.7 31.7 COGS 21.8 19.5 40.2 46.4 31.5 Gross profit 52.1 23.2 41.5 25.8 35.1 Operating expenses 26.0 17.7 35.2 41.2 29.7 Other operating income (51.8) 428.5 167.0 (51.6) 34.7 Operating profit 161.3 51.5 69.8 (13.0) 55.5 Finance expenses 8.6 (4.7) 51.6 24.8 18.3 PBT 269.6 73.0 79.9 (17.7) 75.4 Tax 53.2 15.5 9.6 142.8 47.3 Net profit 223.9 56.7 96.5 (25.0) 65.4 EPS 225.7 56.1 81.5 (39.6) 53.6 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Dachan – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (91.8) (91.6) (91.5) (92.6) (91.9) Gross profit 8.2 8.4 8.5 7.4 8.1 Operating expenses (5.8) (5.7) (5.5) (5.4) (5.6) Other operating income 0.1 0.4 0.8 0.3 0.4 Operating profit 2.4 3.1 3.7 2.2 2.9 Finance expenses (0.5) (0.4) (0.5) (0.4) (0.5) PBT 2.0 2.9 3.8 2.1 2.7 Tax (0.4) (0.3) (0.3) (0.4) (0.4) Net profit 1.6 2.1 2.9 1.5 2.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 81 20 Nov. 2009
Figure 7: Dachan - Balance Sheet FY05-08 As at 31 Dec., US$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 18.4 19.8 97.7 60.5 35.6 Accounts receivable 16.8 21.3 27.9 27.8 13.0 Inventory 43.8 54.4 95.8 73.8 25.0 Other current assets 26.1 32.3 48.5 42.7 17.0 Total current assets 105.2 127.8 269.9 204.8 23.5 Net fixed assets 68.7 73.2 103.9 163.6 24.7 Other long-term assets 4.2 4.0 4.5 0.8 (33.7) Total assets 178.0 205.0 378.3 369.1 23.3 Short-term debt 37.2 43.8 54.4 23.2 (14.7) Accounts payable 37.5 37.2 59.9 52.3 14.9 Other current liabilities 32.2 35.1 45.2 43.2 17.9 Total current liabilities 106.9 116.1 159.5 118.7 5.4 Long-term debt 1.2 0.7 6.0 6.1 29.1 Other long-term liabilities 0.0 0.0 0.0 0.0 (5.0) Total liabilities 108.1 116.9 165.6 124.9 6.1 Shareholders equity 69.9 88.1 212.7 244.3 41.4 Minorities 10.9 14.3 20.1 27.3 27.5 Total equity and liabilities 178.0 205.0 378.3 369.1 23.3 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Dachan – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 10.4 9.6 25.8 16.4 15.6 Accounts receivable 9.4 10.4 7.4 7.5 8.7 Inventory 24.6 26.6 25.3 20.0 24.1 Other current assets 14.7 15.8 12.8 11.6 13.7 Total current assets 59.1 62.4 71.4 55.5 62.1 Net fixed assets 38.6 35.7 27.5 44.3 36.5 Other long-term assets 2.3 1.9 1.2 0.2 1.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 20.9 21.4 14.4 6.3 15.7 Accounts payable 21.1 18.1 15.8 14.2 17.3 Other current liabilities 18.1 17.1 12.0 11.7 14.7 Total current liabilities 60.1 56.7 42.2 32.2 47.8 Long-term debt 0.7 0.3 1.6 1.7 1.1 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 60.7 57.0 43.8 33.8 48.8 Shareholders equity 39.3 43.0 56.2 66.2 51.2 Minorities 6.1 7.0 5.3 7.4 6.4 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 82 20 Nov. 2009
Figure 9: Dachan – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 8.2 8.4 8.5 7.4 8.1 Operating margin – % 2.4 3.1 3.7 2.2 2.9 Net margin – % 1.6 2.1 2.9 1.5 2.0 ROAA – % 5.1 7.0 9.0 5.3 6.6 ROAE – % 13.0 16.9 17.4 8.6 14.0
Liquidity ratios Current assets/current liabilities – X 1.0 1.1 1.7 1.7 1.4 Liquid assets/current liabilities – X 0.2 0.2 0.6 0.5 0.4 Cash and securities/current assets – % 17.5 15.5 36.2 29.5 24.7 Cash flow from oper./curr. liabilities – % 10.7 10.1 12.3 41.4 18.6
Other ratios Capex/sales – % 1.1 1.5 4.4 4.8 3.0 Capex/depreciation – % 87.4 127.8 405.1 504.3 345.7 Operating expense/sales -% (5.8) (5.7) (5.5) (5.4) (5.5) Net debt/equity (net cash) – % 28.5 28.1 (17.5) (12.7) (0.7) Inventory/sales – % 8.2 8.5 10.7 5.7 8.3 Effective tax rate – % 17.4 11.6 7.1 20.9 13.2 Cash conversion cycle – days 14.7 18.7 22.9 16.3 19.3
ROAA component analysis Revenue/average assets – % 315.3 332.9 306.7 346.3 325.3 COGS/average assets – % (289.6) (304.9) (280.8) (320.8) (299.0) Gross profit/average assets – % 25.8 27.9 26.0 25.5 26.3 Operating expenses/average assets – % (18.4) (19.1) (16.9) (18.7) (18.3) Other operating income/average assets – % 0.3 1.3 2.3 0.9 1.2 Operating profit/average assets – % 7.6 10.2 11.4 7.7 9.2 Finance expenses/average assets – % (1.7) (1.4) (1.4) (1.4) (1.5) PBT/average assets – % 6.4 9.7 11.5 7.4 8.8 Tax/average assets – % (1.1) (1.1) (0.8) (1.5) (1.1) Net profit/average assets – % 5.1 7.0 9.0 5.3 6.6
ROAE component analysis Revenue/average equity – % 812.5 807.0 594.8 566.4 695.1 COGS/average equity – % (746.1) (739.2) (544.4) (524.6) (638.6) Gross profit/average equity – % 66.4 67.7 50.4 41.7 56.5 Operating expenses/average equity – % (47.4) (46.2) (32.8) (30.5) (39.2) Other operating income/average equity – % 0.7 3.2 4.5 1.4 2.5 Operating profit/average equity – % 19.7 24.8 22.1 12.6 19.8 Finance expenses/average equity – % (4.4) (3.5) (2.8) (2.3) (3.2) PBT/average equity – % 16.5 23.6 22.3 12.1 18.6 Tax/average equity – % (2.9) (2.7) (1.6) (2.5) (2.4) Net profit/average equity – % 13.0 16.9 17.4 8.6 14.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 83 20 Nov. 2009
Dongxiang (3818.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 Dongxiang is a multi-brand PRC sportswear company, and owns exclusive rights for HSCEI 13,470 Kappa in China, Macau and Japan. 1H09 revenue breakdown: 86.6% from the Kappa brand in the domestic market, 10.2% from Japan, 0.2% from Rukka, and the Performance (%) 1m 3m 12m rest from international sourcing. By product: 73.4% from apparel, 21.9% from HSI 2.0 13.5 76.7 footwear, 4.7% from accessories. The stock listed in Hong Kong in October 2007. HSCEI 4.0 19.6 107.6
The firm generates the highest margins among its peers due to 1) Dongxiang – Price vs. HSI, Share Data higher-than-expected gross margins from Phenix (45%); 2) phasing out less
profitable businesses such as international sourcing and Rukka, and increasing (HK$) (HK$m) contributions from Japan (mid-40% gross margin), and 3) smaller contribution from 7.0 1,800 6.0 1,600 low-margin footwear (24% of FY08 sales vs. 40%-60% for its peers). 1,400 5.0 1,200 Since the Kappa brand focuses on fashion rather than professional or functional 4.0 1,000 3.0 800 sportswear, this helps Dongxiang avoid directly competing with Li Ning. It also has 600 2.0 lower R&D expenses than Li Ning and Anta, but spends more on A&P. Kappa 400 1.0 200 targets the high-end market, with retail prices around 10% lower than the top 0.0 0 international brands Nike and Adidas. This high-end focus may mean harder times Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
during economic slowdowns, as customers trade down. Turnover Price HSI Like its peers, Dongxiang is asset light, relying on around 70 domestic suppliers but only on non-exclusive one-year production agreements, based on each batch of Price – HK$ 5.55 orders. The firm generates only 21.7% ROE and 20.2% ROA, lower than its peers’ 52W high/low (HK$) 5.985/1.787 averages of 31.7% and 21.2%. Shares in issue – millions 5,666.29 Market cap – HK$m 31,051.25 The firm has further broadened its product mix by acquiring a 91% stake in Phenix 3M avg. turnover – HK$m 133.42 in June 2008, entering the ski and outdoor sportswear segment. It has also launched Major shareholder – % Robe Di Kappa, a sub-brand of Kappa, in China, aimed at the higher end, mature Poseidon Sports Ltd. 45.66 end of the casual sportswear-apparel market. Source: Bloomberg and Sun Hung Kai Financial The company formed six joint ventures in 1H09, each 30% held, with key distributors covering Hangzhou, Shanxi, Shenyang, Tianjin, Nanjing, Beijing, Shandong, Shaanxi and Ningxia. This should help it better manage retail expansion in these areas, but the JVs will not contribute to earnings for three years until they are amortized. This document is solely based on Management will continue its multi-brand strategy, and is looking for acquisition publicly available information. This targets at less than RMB5bn, likely focusing on acquiring ownership and operating report is intended as information rights for an international brand in China. The firm had net cash of RMB6.2bn as at only and not as a recommendation end-June 2009, which should be ample for acquisitions. for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this Figure 1: Earnings Summary company in this report. Year ended 31 Dec. FY06 FY07 FY08 FY09E
Net profit – RMBm 306.5 733.6 1,367.7 1,438.9 Net-profit growth – % 710.6 139.4 86.4 5.2 EPS – RMB fen N/A 15.9 24.1 25.5 EPS growth – % N/A N/A 51.8 5.7 P/E – X N/A 30.8 20.3 19.2 DPS – RMB fens N/A 1.1 6.5 12.7 Dividend yield – % N/A 0.2 1.3 2.6 BVPS – RMB N/A 1.0 1.2 1.3 Holly Hou P/B – X N/A 4.7 4.1 3.7 Operating cash flow per share – RMB fen N/A 15.4 16.4 25.8 + (852) 2203 9588 Net debt (net cash)/ price – % N/A (19.9) (21.4) (24.5) [email protected] Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at:
http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor84ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Dongxiang – Investment Highlights
Key investment positives Key investment negatives Superior margins. Dongxiang generates the highest margins Rental subsidies for flagship stores. Dongxiang plan to rent the among its peers. The gross margin increased 1.1 ppts to 62.2% for premises directly from landlords and then sub-lease to the 1H09. distributors at a discount. This is higher risk than operating distribution itself. Lower R&D costs. Dongxiang focuses on fashion rather than functionality, suggesting lower R&D expenses than peers Li Ning Asset-light business. Like its peers, Dongxiang is asset light, and Anta, but more spending on A&P. relying on around 70 domestic suppliers but only on non-exclusive one-year production agreements, based on each batch of orders. Focus on fashion not function. Kappa focuses on fashion rather The firm generates only 21.7% ROE and 20.2% ROA, lower than than professional or functional sportswear, which can help avoid its peers’ averages of 31.7% and 21.2%. direct competition with Li Ning. Uses own resources to run retail business. Directly investing in Becoming a multi-brand sportswear company. The firm its key distributors requires additional investment, and retail acquired a 91% stake in Phenix in June 2008. The deal brings in generates lower returns than wholesale due to higher fixed valuable design expertise from Japan and allows the group to operating costs, such as staff and rentals. expand into the ski and outdoor sportswear segment. Top five customers account for 37% of sales. The top five Direct investments in key distributors increases bargaining customers, including DGJJ, Belle, TD and Pousheng, accounted power. The company formed six JVs in 1H09, each 30% held, for 37% of FY08 sales However, Dongxiang has only secured with six key distributors. This can help increase bargaining power one-year, non-exclusive terms with them to distribute Kappa over distributors. products. It also has not imposed sales/purchase targets. This New brands cater for different consumer groups. The firm has means there is little incentive for distributors not to promote other launched Robe Di Kappa, a sub-brand of Kappa, in China, aimed brands. at the higher end, mature end of the casual sportswear-apparel Targeting high-end market may backfire during economic market. slowdown. Kappa targets the high-end market, with retail prices Still looking for acquisition targets. Management will continue around 10% lower than the top international brands Nike and its multi-brand strategy, and is looking for acquisition targets at Adidas. This high-end focus may mean harder times during less than RMB5bn, likely focusing on acquiring ownership and economic slowdowns, as customers trade down. operating rights for an international brand in China. Longer cash-conversion cycle. The firm has 4.8 months of Net cash equal to 27% of its market cap. The firm had net cash channel inventory, at the high end of the industry range. This is due of RMB6.2bn as at end-June 2009, equivalent to 27% of its market to the consolidation of its Japanese acquisition (these businesses cap, which should be ample for acquisitions. normally have longer cash-conversion cycles). Low order growth. Only limited replenishment orders are coming in for 2H09, despite relatively weak 15% order-book growth. Order growth at the 1Q10 trade fair was 16% yoy, in line with its peers. Source: Sun Hung Kai Financial
Figure 3: Dongxiang – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts SSS growth much higher than the market expectation. Increasing raw-material costs dragging down margins. Better-than-expected gross margin. Uncertain business for new brands. Quicker turnaround for Phenix. Suddenly surge in A&P expenses. Further acquisition of an international brand to accelerate earnings growth. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 85 20 Nov. 2009
Industry Dynamics China’s sportswear market grew from about RMB20bn in 2003 to RMB40.7bn in 2007, for a 19.4% CAGR. Euromonitor estimates a 26.4% CAGR over the next five years to RMB131bn in 2012. Total footwear consumption was about 2.1 million pairs in 2005, only slightly behind the U.S., the world’s largest footwear market, with 2.3 million pairs. But per capita consumption was only 1.6 pairs, well below the U.S.’s 7.6 pairs. The top seven brands accounted for 49% of China’s sportswear market in 2007, with other premium international brands, such as Puma and Reebok, and many smaller local brands, such as Yeli and Eratat, sharing the remainder. Market leader Nike had an 11% share, while the shares of the other six top brands were 3.4%-9.8%. Domestic brands have outpaced international brands for growth, due to their knowledge of local markets, distribution networks and product pricing. Market share for domestic brands jumped from 42% in 2005 to 52% in 2007, and this trend seems likely to continue in coming years. Euromonitor estimates the fashion sportswear market to post a 39% CAGR to RMB35bn over FY07-FY12, outpacing the overall market. Such high growth could attract substantial numbers of new competitors.
Sun Hung Kai Financial 86 20 Nov. 2009
Figure 4: Dongxiang – Profit and Loss Statement FY05-FY08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 147.7 858.9 1,711.0 3,322.2 1,250.1 COGS (81.1) (323.4) (710.5) (1,378.5) 2,089.3 Gross profit 66.6 535.6 1,000.6 1,943.8 1,099.2 Operating expenses (29.4) (159.7) (389.1) (823.0) 785.3 Other operating income 0.1 3.1 20.1 68.8 N/A Operating profit 37.3 378.9 631.6 1,189.5 N/A Finance expenses (1.2) (23.3) (0.1) (0.2) N/A PBT 39.9 372.1 771.3 1,616.1 612.2 Tax (2.1) (65.6) (37.7) (248.3) N/A Net profit 37.8 306.5 733.6 1,367.7 601.1 EPS – RMB fen N/A N/A 15.9 24.1 N/A Sources: The Company and Sun Hung Kai Financial
Figure 5: Dongxiang – Profit and Loss Statement (Year on Year Growth) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 147,612.0 481.5 99.2 94.2 1,250.1 COGS 1,351,583.3 298.7 119.7 94.0 2,089.3 Gross profit 70,762.8 704.0 86.8 94.3 1,099.2 Operating expenses 21,854.5 442.9 143.6 111.5 785.3 Other operating income N/A 2,003.4 555.9 241.4 N/A Operating profit N/A 914.8 66.7 88.3 N/A Finance expenses N/A 1,806.5 (99.4) 65.1 N/A PBT 6,259.2 831.7 107.3 109.5 612.2 Tax N/A 2,980.6 (42.6) 558.8 N/A Net profit 6,579.5 710.6 139.4 86.4 601.1 EPS – RMB fen N/A N/A N/A 51.8 N/A Sources: The Company and Sun Hung Kai Financial
Figure 6: Dongxiang – Profit and Loss Statement (Common Size) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (54.9) (37.6) (41.5) (41.5) (43.9) Gross profit 45.1 62.4 58.5 58.5 56.1 Operating expenses (19.9) (18.6) (22.7) (24.8) (21.5) Other operating income 0.1 0.4 1.2 2.1 0.9 Operating profit 25.3 44.1 36.9 35.8 35.5 Finance expenses (0.8) (2.7) (0.0) (0.0) (0.9) PBT 27.0 43.3 45.1 48.6 41.0 Tax (1.4) (7.6) (2.2) (7.5) (4.7) Net profit 25.6 35.7 42.9 41.2 36.3 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 87 20 Nov. 2009
Figure 7: Dongxiang – Balance Sheet FY05-FY08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 39.1 274.7 5,311.1 5,942.0 1,498.5 Accounts receivable 37.0 84.4 138.3 367.9 N/A Inventory 31.2 87.8 88.2 232.2 N/A Other current assets 11.8 59.1 277.8 208.4 133.4 Total current assets 119.1 506.1 5,815.3 6,750.5 455.1 Net fixed assets 22.4 56.8 124.6 163.3 N/A Other long-term assets 38.9 287.7 283.1 379.6 362.7 Total assets 180.4 850.6 6,223.0 7,293.5 450.5 Short-term debt 13.0 1.8 0.0 0.0 N/A Accounts payable 45.2 112.9 177.6 292.1 N/A Other current liabilities 53.6 123.1 137.6 277.9 N/A Total current liabilities 111.8 237.8 315.2 569.9 208.3 Long-term debt 0.0 298.9 0.0 0.0 N/A Other long-term liabilities 24.8 6.4 5.9 4.2 N/A Total liabilities 136.6 543.1 321.1 574.1 208.8 Shareholders equity 43.9 307.5 5,901.8 6,719.4 701.4 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 180.4 850.6 6,223.0 7,293.5 450.5 Sources: The Company and Sun Hung Kai Financial
Figure 8: Dongxiang – Balance Sheet (Common Size) FY05-FY08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 21.7 32.3 85.3 81.5 55.2 Accounts receivable 20.5 9.9 2.2 5.0 9.4 Inventory 17.3 10.3 1.4 3.2 8.1 Other current assets 6.6 7.0 4.5 2.9 5.2 Total current assets 66.0 59.5 93.4 92.6 77.9 Net fixed assets 12.4 6.7 2.0 2.2 5.8 Other long-term assets 21.6 33.8 4.5 5.2 16.3 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 7.2 0.2 0.0 0.0 1.9 Accounts payable 25.0 13.3 2.9 4.0 11.3 Other current liabilities 29.7 14.5 2.2 3.8 12.6 Total current liabilities 61.9 28.0 5.1 7.8 25.7 Long-term debt 0.0 35.1 0.0 0.0 8.8 Other long-term liabilities 13.7 0.8 0.1 0.1 3.7 Total liabilities 75.7 63.9 5.2 7.9 38.1 Shareholders equity 24.3 36.1 94.8 92.1 61.9 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 88 20 Nov. 2009
Figure 9: Dongxiang – Key Ratios FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin - % 45.1 62.4 58.5 58.5 56.1 Operating margin – % 25.3 44.1 36.9 35.8 35.5 Net margin – % 25.6 35.7 42.9 41.2 36.3 ROAA – % 40.1 59.4 20.7 20.2 35.1 ROAE – % 166.2 174.4 23.6 21.7 96.5
Liquidity ratios Current assets/current liabilities – X 1.1 2.1 18.4 11.8 8.4 Liquid assets/current liabilities – X 0.3 1.2 16.8 10.4 7.2 Cash and securities/current assets – % 32.8 54.3 91.3 88.0 66.6 Cash flow from oper./curr. liabilities – % 64.7 146.3 225.1 163.1 149.8
Other ratios Capex/sales – % 10.0 4.3 3.3 0.4 4.5 Capex/depreciation – % 2,759.7 1,623.9 724.0 139.5 829.1 Operating expenses/sales -% (19.9) (18.6) (22.7) (24.8) (22.0) Net debt/equity – % (59.4) 1.9 (93.4) (88.4) (60.0) Inventory/sales – % 21.1 10.2 5.2 7.0 7.5 Effective tax rate – % 5.3 17.6 4.9 15.4 12.6 Cash conversion cycle - days 42.5 17.1 (5.6) 14.0 8.5
ROAA component analysis Revenue/average assets – % 156.8 166.6 48.4 49.2 105.2 COGS/average assets - % (86.1) (62.7) (20.1) (20.4) (47.3) Gross profit/average assets - % 70.7 103.9 28.3 28.8 57.9 Operating expenses/average assets – % (31.2) (31.0) (11.0) (12.2) (21.3) Other operating income/average assets – % 0.2 0.6 0.6 1.0 0.6 Operating profit/average assets – % 39.6 73.5 17.9 17.6 37.2 Finance expenses/average assets – % (1.3) (4.5) (0.0) (0.0) (1.5) PBT/average assets – % 42.4 72.2 21.8 23.9 40.1 Tax/average assets – % (2.3) (12.7) (1.1) (3.7) (4.9) Net profit/average assets – % 40.1 59.4 20.7 20.2 35.1
ROAE component analysis Revenue/average equity – % 649.3 488.9 55.1 52.6 311.5 COGS/average equity - % (356.5) (184.1) (22.9) (21.8) (146.3) Gross profit/average equity - % 292.8 304.8 32.2 30.8 165.2 Operating expenses/average equity – % (129.3) (90.9) (12.5) (13.0) (61.4) Other operating income/average equity – % 0.6 1.7 0.6 1.1 1.0 Operating profit/average equity – % 164.1 215.7 20.3 18.8 104.7 Finance expenses/average equity – % (5.4) (13.3) (0.0) (0.0) (4.7) PBT/average equity – % 175.5 211.8 24.8 25.6 109.4 Tax/average equity – % (9.4) (37.3) (1.2) (3.9) (13.0) Net profit/average equity – % 166.2 174.4 23.6 21.7 96.5 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 89 20 Nov. 2009
Dynamic Energy (578.HK)
China Coal Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Dynamic Energy is a Henan-based coal-mine operator with a stable base of three major clients, which should ensure steady sales growth. The company switched its Performance (%) 1m 3m 12m focus to coal after disposing of its loss-making electricity business in the first half HSI 2.0 13.5 76.7 of 2007. HSCEI 4.0 19.6 107.6
Dynamic Energy – Price vs. HSI, The company has five mines with a total of 34 million tons of thermal-coal Share Data reserves (no coking coal). Production capacity in FY08 reached 1.7 million tons. It expects maximum production capacity to reach 2.6 million tons p.a., but will not (HK$) (HK$m) meet this target in FY09 after the Henan provincial government ordered the closure 1.2 160 140 1.0 of all mines in 4Q08 (for safety inspections). 120 0.8 100 0.6 80
0.4 60 40 0.2 Reserves as at 31 Dec. 2008 Actual production 20 Dynamic’s mines (million tons) (million tons) 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 Xiaohe (1, 2 & 3) 12 1.1 Turnover Price HSI Xingyun 5 0.24 Xiangyang 17 0.31 Price – HK$ 0.50 Total 34 1.65 52W high/low (HK$) 1.089/0.183 Shares in issue – millions 2,118.13 Market cap – HK$m 1,037.88 The customer base is very narrow, with two major customers making up 90% of 3M avg. turnover – HK$m 5.28 sales: Zhongfu Enterprises (a Shanghai-listed aluminum company, 60% sales) and Major shareholders – % China Resources Power (30%). Dynamic’s close proximity to it clients, which are Dragon Rich Resouce 14.50 no more than 50 km from its production facilities in Dengfeng, has enabled it to Sources: Bloomberg and Sun Hung Kai Financial carve a lucrative niche market for its coal.
The company has stated that it plans to triple reserves to 100 mt by 2011 and has been aggressively bidding for new mines to expand production and increase Recent Reports Date reserves. However, it has not yet been successful in identifying suitable prospects Key Takeaways 30 July 2009 for acquisition. With net debt of HK$195m as at the latest balance-sheet date, the company may need to raise funds to achieve its expansion goals.
Figure 1: Earnings Summary
Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m (82.7) 134.2 283.5 (79.0) Net-profit growth - % N/A N/A 111.3 N/A EPS - HK¢ (9.0) 9.4 18.5 N/A! EPS growth - % N/A N/A 95.6 N/A P/E – X N/A 5.2 2.7 N/A DPS - HK¢ 0.0 0.0 0.0 N/A Dividend yield - % 0.0 0.0 0.0 N/A BVPS – HK$ 0.1 0.2 0.5 N/A P/B - X 3.4 2.1 1.1 N/A Oper cash flow/share - HK¢ 4.3 17.9 10.2 N/A Michael Yuk Net debt (net cash) to share price - % 49.4 26.2 57.0 N/A + (852) 2203 9590 Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus [email protected] All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer Sun Hung ThisKai Financialreport / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),90 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Dynamic Energy – Investment Highlights
Key investment positives Key investment negatives Lucrative niche market. Dynamic’s mining operations, located in Large overhang from CBs issued in FY07 to finance its mine Henan province, are within a 50-km radius from its three main acquisition. As of July 2009, three batches of CBs totaling over customers, which together made up more than 90% of FY08 sales. This HK$375m remained outstanding. The conversion price has been reduced has allowed the company to carve out a lucrative niche market, since from HK$1.00/share to HK$0.88/share, which suggests that the CBs customers can save on expensive transport costs. could be fully converted at any time since they are in the money. Upon full conversion 539 million news shares would be injected into the High profitability and return on equity. Dynamic’s niche market has market. given the company higher margins (net margin: 36%), and low inventory levels (inventory to sales: 3.2%), translating into a high 20% ROA and a Reliant on a very concentrated client base. Any reduction in coal stellar 50% ROE. bought from Dynamic by any of its three major clients would have a significant impact on sales. Rebound in coal demand. Chinese coal demand has rebounded in the wake of rising aluminum and electricity production. Given the Small coal reserves and production. The company’s coal reserves total increasingly sure recovery in China, coal demand and prices should be about 34 million tonnes, with production at around 2 million tonnes per able to sustain a steady uptrend from current levels. year, putting its scale much smaller than its peers. Reopening of mines in June will lead to an eventual recovery in coal More funding needed. With only HK$80m cash on hand, the company production. Overall, coal production is expected to jump 20% yoy to 2 may need to raise more funds in the near future to accommodate its mt, driven by improved production rates from additional machinery expansion plans. deployed during FY08. For FY10, production is expected to reach 2.7 mt as further improvements are made to increase production. Limited downside to coal prices. Coal has declined 40% from a year ago. The trough occurred in November 2008 at US$80/tonne (Qinhuangdao spot). Current prices are around US$90/tonne, hence there is limited downside. Planned JV to acquire mines. The company plans to enter into a JV agreement with Henan Province Coalbed Gas Development and Utilizations Company Limited (an SOE) to buy mines in Henan. The JV would greatly increase the likelihood of mine acquisitions for the company, allowing it to reach or even exceed its goal of 100 mt in coal reserves by 2010. Trading at a deep discount to peers. The stock trades at a 4X 12-month trailing P/E, a deep discount to its peers’ 19X, most likely due to its significantly smaller operations and coal reserves. The company’s plans to expand production and increase reserves could act as a revaluation catalyst.
Source: Sun Hung Kai Financial
Figure 3: Dynamic Energy – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Successful acquisition of coal mines in Henan province boosting Breakdown in talks to finalize the formation of a JV with Henan coal reserves to beyond the 100-mt level. Province Coalbed Gas Development and Utilizations Company Limited. Greater-than-expected coal-production recovery from Dynamic’s recently reopened mines. Expensive acquisition costs for mines. Worsening transport bottlenecks in China resulting in more sales Falling coal-transport costs across China, resulting in less cost for Dynamic. savings from buying coal from Dynamic. Surge in coal prices from current levels due to stimulus spending. Cancellations of orders from any of Dynamic’s three major clients. A suspension in production or closures of mines in Henan province, similar to those in 4Q08. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 91 20 Nov. 2009
Recent Company News
Dynamic Energy posted a 1H09 loss of HK$0.18/share due to a loss of HK$292.7m from the change in fair value of its convertible bonds (CBs). Excluding this change, the operating profit came in 31% lower than a year ago at HK$157m. This was mainly due to the suspension of coal mines in Henan province during the first half of 2009. For 2H09, production levels have returned to the pre-suspension level, selling prices of coal remain stable, and gross margins are expected to remain high.
SHKF Comment: Although the stock trades at just a 3.0X 12-month trailing P/E, we believe the large overhang from its CBs will continue until clearer earnings visibility for FY10 is available.
Industry Dynamics
The IEA predicts the mainland’s total coal consumption to reach 2,050-2,200 million tonnes (mt) by 2020. Power generation will account for 71% of that demand, which will increase by 40 mt p.a. to 1,500 mt p.a. by 2020. This supports thermal-coal producers.
Furthermore, coal-demand growth for power and heat generation is set to be the most stable of the four main industries, with a 3.2% CAGR expected over 2010-20.
Coal prices have stabilized from their 1H09 levels as the recovery in the Chinese economy gains momentum, leading to a revival in industrial production (industry accounts for 70% of power demand, which in turn makes up 71% of coal demand).
The government’s continued efforts to close small mines and coordinated efforts by coal producers to curb production will help prevent a coal glut. Smaller players can take this opportunity to expand their portfolios of coal mines.
Sun Hung Kai Financial 92 20 Nov. 2009
Figure 4: Dynamic Energy – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 0.0 102.6 564.8 790.0 60.6 COGS 0.0 (52.8) (282.6) (308.1) 37.9 Gross profit 0.0 49.8 282.1 481.8 94.7 Operating expenses (8.2) (17.3) (94.4) (118.3) 46.6 Other operating income 1.0 0.1 4.4 13.2 91.1 Operating profit (7.2) 32.6 192.1 376.7 155.3 Finance expenses (0.5) (6.3) (35.6) (74.6) 102.3 PBT (63.0) 25.7 221.4 420.9 110.6 Tax 0.0 (16.2) (71.9) (108.2) 143.8 Net profit (63.0) (82.7) 134.2 283.5 109.6 EPS – HK¢ (9.3) (11.5) 12.0 23.6 81.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Dynamic Energy – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue (100.0) N/A 450.5 39.9 N/A COGS (100.0) N/A 435.5 9.0 N/A Gross profit (100.0) N/A 466.3 70.8 N/A Operating expenses (68.2) 111.7 446.1 25.4 46.6 Other operating income (1.3) (90.4) 4,554.3 201.8 91.1 Operating profit (181.0) (554.4) 488.8 96.1 155.3 Finance expenses (87.9) 1,063.8 469.0 109.3 102.3 PBT (394.5) (140.8) 761.8 90.1 110.6 Tax (100.0) N/A 343.0 50.4 N/A Net profit (528.6) 31.3 (262.3) 111.3 109.6 EPS (529.0) 23.6 (204.6) 95.7 81.5 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Dynamic Energy – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue N/A 100.0 100.0 100.0 100.0 COGS N/A (51.4) (50.0) (39.0) (46.8) Gross profit N/A 48.6 50.0 61.0 53.2 Operating expenses N/A (16.8) (16.7) (15.0) (16.2) Other operating income N/A 0.1 0.8 1.7 0.8 Operating profit N/A 31.8 34.0 47.7 37.8 Finance expenses N/A (6.1) (6.3) (9.4) (7.3) PBT N/A 25.0 39.2 53.3 39.2 Tax N/A (15.8) (12.7) (13.7) (14.1) Net profit N/A (80.6) 23.8 35.9 (7.0) Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 93 20 Nov. 2009
Figure 7: Dynamic Energy - Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 27.2 30.7 115.2 80.1 12.3 Accounts receivable 21.1 58.4 84.1 60.9 27.7 Inventory 34.9 300.9 19.3 25.1 (7.2) Other current assets 8.1 185.4 83.8 246.1 111.1 Total current assets 91.3 575.4 302.4 412.1 36.3 Net fixed assets 294.0 38.8 145.4 207.0 (9.4) Other long-term assets 92.4 293.8 855.7 881.0 57.7 Total assets 477.8 908.0 1,303.4 1,500.2 27.4 Short-term debt 52.5 46.0 83.7 407.9 54.5 Accounts payable 4.8 3.1 14.6 15.2 24.5 Other current liabilities 23.6 277.9 165.7 159.1 51.5 Total current liabilities 80.8 327.0 264.0 582.2 52.3 Long-term debt 60.3 288.4 230.4 105.9 11.3 Other long-term liabilities 26.1 0.0 410.8 47.0 14.9 Total liabilities 167.1 615.4 905.2 735.1 37.7 Shareholders equity 310.6 292.6 398.2 765.1 20.3 Minorities 105.1 110.1 34.7 66.7 (9.5) Total equity and liabilities 477.8 908.0 1,303.4 1,500.2 27.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Dynamic Energy – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 5.7 3.4 8.8 5.3 5.8 Accounts receivable 4.4 6.4 6.5 4.1 5.3 Inventory 7.3 33.1 1.5 1.7 10.9 Other current assets 1.7 20.4 6.4 16.4 11.2 Total current assets 19.1 63.4 23.2 27.5 33.3 Net fixed assets 61.5 4.3 11.2 13.8 22.7 Other long-term assets 19.3 32.4 65.6 58.7 44.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 11.0 5.1 6.4 27.2 12.4 Accounts payable 1.0 0.3 1.1 1.0 0.9 Other current liabilities 4.9 30.6 12.7 10.6 14.7 Total current liabilities 16.9 36.0 20.3 38.8 28.0 Long-term debt 12.6 31.8 17.7 7.1 17.3 Other long-term liabilities 5.5 0.0 31.5 3.1 10.0 Total liabilities 35.0 67.8 69.4 49.0 55.3 Shareholders equity 65.0 32.2 30.6 51.0 44.7 Minorities 22.0 12.1 2.7 4.4 10.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 94 20 Nov. 2009
Figure 9: Dynamic Energy – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % N/A 48.6 50.0 61.0 53.2 Operating margin – % N/A 31.8 34.0 47.7 37.8 Net margin – % N/A (80.6) 23.8 35.9 (7.0) ROAA – % (12.0) (11.9) 12.1 20.2 2.1 ROAE – % (18.6) (27.4) 38.8 48.7 10.4
Liquidity ratios Current assets/current liabilities – X 1.1 1.8 1.1 0.7 1.2 Liquid assets/current liabilities – X 0.6 0.3 0.8 0.2 0.5 Cash and securities/current assets – % 29.8 5.3 38.1 19.4 23.2 Cash flow from oper./curr. liabilities – % 22.8 12.2 96.1 26.9 39.5
Other ratios Capex/sales – % N/A 3.8 10.2 9.4 N/A Capex/depreciation – % 98.1 602.4 740.4 474.2 478.8 Operating expense/sales -% N/A (16.8) (16.7) (15.0) N/A Net debt/equity (net cash) – % 27.4 103.8 50.0 56.7 59.5 Inventory/sales – % N/A 293.3 3.4 3.2 N/A Effective tax rate – % 0.0 63.2 32.5 25.7 30.4 Cash conversion cycle – days N/A N/A N/A 42.6 N/A
ROAA component analysis Revenue/average assets – % 0.0 14.8 51.1 56.4 30.6 COGS/average assets – % 0.0 (7.6) (25.6) (22.0) (13.8) Gross profit/average assets – % 0.0 7.2 25.5 34.4 16.8 Operating expenses/average assets – % (1.6) (2.5) (8.5) (8.4) (5.3) Other operating income/average assets – % 0.2 0.0 0.4 0.9 0.4 Operating profit/average assets – % (1.4) 4.7 17.4 26.9 11.9 Finance expenses/average assets – % (0.1) (0.9) (3.2) (5.3) (2.4) PBT/average assets – % (12.0) 3.7 20.0 30.0 10.4 Tax/average assets – % 0.0 (2.3) (6.5) (7.7) (4.1) Net profit/average assets – % (12.0) (11.9) 12.1 20.2 2.1
ROAE component analysis Revenue/average equity – % 0.0 34.0 163.5 135.8 83.3 COGS/average equity – % 0.0 (17.5) (81.8) (53.0) (38.1) Gross profit/average equity – % 0.0 16.5 81.7 82.8 45.3 Operating expenses/average equity – % (2.4) (5.7) (27.3) (20.3) (13.9) Other operating income/average equity – % 0.3 0.0 1.3 2.3 1.0 Operating profit/average equity – % (2.1) 10.8 55.6 64.8 32.3 Finance expenses/average equity – % (0.2) (2.1) (10.3) (12.8) (6.3) PBT/average equity – % (18.6) 8.5 64.1 72.4 31.6 Tax/average equity – % 0.0 (5.4) (20.8) (18.6) (11.2) Net profit/average equity – % (18.6) (27.4) 38.8 48.7 10.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 95 20 Nov. 2009
Dynasty Fine Wines Group (828.HK) Food & Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Dynasty is one of China’s leading producers and sellers of grape wine, with more
than 50 wine products manufactured under its trademarked brand since it was Performance (%) 1m 3m 12m established as a Sino-French joint venture in 1980 in Tianjin. The company’s HSI 2.0 13.5 76.7 products can broadly be divided into red wines (83% of 1H09 sales), white wines, hscei index 4.0 19.6 107.6 sparkling wines, ice wine and brandy. Its main product, Dynasty Dry Red Wine, accounted for 27% of 1H09 sales. The ASP for red- and white-wine products was Dynasty – Price vs. HSI, Share Data HK$24.70 per bottle (750 ml) in 2008. (HK$) (HK$m) High-end and low-end wines each account for about 10% of sales, with the rest from 4.0 45 3.5 40 mid-range products. The company sells through more than 200 distributors in China, 3.0 35 covering 22 provinces and four municipalities. End customers include hotels, 2.5 30 25 2.0 restaurants and supermarkets. Export markets include Hong Kong, Macau and 20 1.5 15 Europe, which accounted 0.1% of 1H09 sales. 1.0 10 0.5 5 0.0 0 Production quality is highly dependent on sufficient supply of quality grapes and Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 grape juice (38% of 1H09 COGS). Currently the company has more than 10 major Turnover Price HSI grape-juice suppliers, mainly in Tianjin, Shandong, Hebei and Ningxia. The company is catering for growth by enlarging existing vineyards and attracting new suppliers. Price – HK$ 2.26 52W high/low (HK$) 2.66/0.93 Shares in issue – millions 1,245.00 Production capacity is now 50,000 tonnes (about 66.7 million bottles). Plant Market cap – HK$m 2,813.70 utilization is about 95%, and the company plans to expand capacity to 70,000 tonnes 3M avg. turnover – HK$m 3.64 (about 93.3 million bottles) in 2H09 and by a further 30,000 tonnes over 2012-14. Major shareholders – % Tianjin Development 44.82 Dynasty is China’s No. 3 winemaker by market share (11% in 2007), after Yantai Source: Bloomberg and Sun Hung Kai Financial Changyu (21%) and Great Wall (20%). Its main market is eastern China, including Zhejiang, Jiangsu, Shanghai and Tianjin. It has up to a 40% market share in Shanghai, and is No. 1 in Fujian by white-wine sales volume, where Changyu is the market leader.
Sales decreased 5% yoy to HK$687m in 1H09 and net profit decreased 19% yoy to HK$97m. The gross margin declined by 3.6 ppts to 49.8%, due to the lower-than-expected sales growth and higher grape-juice costs since 2H08.
Figure 1: Earnings Summary Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m 114.8 126.3 143.1 151.3 This document is solely based on publicly Net-profit growth – % (35.9) 10.0 13.3 5.8 available information. This report is EPS – HK¢ 9.2 10.1 11.5 12.3 intended as information only and not as a EPS growth – % (37.4) 9.8 13.9 7.0 recommendation for any stock. Sun Hung Kai Financial does not provide research P/E – X 25.9 23.6 20.7 19.3 coverage or ratings for this company in DPS – HK¢ 4.2 4.8 5.4 5.5 this report. Dividend yield – % 1.8 2.0 2.3 2.4 BVPS – HK$ 1.1 1.3 1.4 1.5 Holly Hou P/B – X 2.1 1.9 1.7 1.6 + (852) 2203 9588 Op. cash flow/share – HK¢ 11.4 13.2 21.8 8.0 [email protected] Net debt (net cash)/ price – % (25.8) (28.0) (33.7) N/A
Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor96ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Dynasty – Investment Highlights
Key investment positives Key investment negatives Market-share expansion. Dynasty has improved marketing and Gross margin highly leveraged to grape-juice costs. Grape juice promotion, helping its white wine rank No. 1 by sales volume in accounted for 36%-39% of COGS over 2005-08. The company Fujian, where Yantai Changyu is the market leader, and securing an usually procures enough grape juice for 1-1½ years of production. estimated 40% market share in Shanghai. If the grape-juice costs fluctuate, the gross margin would be affected. Exclusive distributor for imported products. It has become the exclusive distributor for Les Grands Chais de France’s (GCF’s) JP High S&D expenses. Dynasty has set up new distribution Chenet range. This business generates a gross margin of 40%-50%. channels, such as its first wine cellar, to expand market share. It Its partner will also distribute Dynasty products through its also plans to expand to south China and second-tier cities. These distribution channels in Europe, which will help increase brand have raised the S&D expenses to sales ratio to a high level, awareness overseas and boost exports. reaching 27% for 1H09, up 0.2 ppt yoy. Striving for higher export sales. Exports only accounted for 0.2% No track record in new distribution channels. Dynasty’s first of FY08 sales. The company plans to expand its wine sales to wine cellar and its cooperation with financial institutions are not second-tier restaurants through distributors; it currently only only new channels for the company, but also for the sector. Success targets first-tier restaurants in Hong Kong. It aims for exports to is not guaranteed. account for 20% of sales within five years. First wine cellar. Dynasty will open a wine cellar in eastern China with a local partner in 2H09. Wine cellars are still a new idea in China, and Dynasty may benefit from building distribution channels and raising the popularity of its brand. Production capacity expansion. To capture increasing demand in China, Dynasty is building a new production line in Tianjin, scheduled for completion at end-2009. Production capacity will increase to 70,000 tonnes. Recovering business activity. The main markets for Dynasty are restaurants & hotels (70% of 1H09 sales value and 50% of volumes) and retailers. The restaurant trade was adversely affected by the financial crisis, causing Dynasty’s sales to decline. However, now that the PRC economy is recovering, business activity is also up (retail sales to catering services increased to RMB141.1bn in May 2009, from RMB132.3bn in April 2009), which should boost Dynasty’s revenues. Ample cash on hand. Net cash was HK$999m at end-FY08 (with no bank loans), about 35% of the market cap. Given the large cash position, the company has planned capex of HK$80m in FY09 and will continue to look for M&A opportunities. Cooperation with financial institutions. In this new channel, banks organize promotions and distribute two of Dynasty’s red-wine products as premiums. The transaction is for HK$59m, of which HK$47m will be booked in 4Q09 and the remainder in 1Q10. This new channel involves low commissions to middlemen and S&D expenses. Source: Sun Hung Kai Financial
Figure3: Dynasty – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Chinese consumers switching their tastes to grape wines, instead of Ineffective marketing and promotion strategies. traditional Chinese wines. Fierce competition in China’s wine industry (among local and More stable grape-juice costs. foreign competitors). Faster-than-expected economic recovery in China. Unexpected rise in grape-juice costs. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 97 20 Nov. 2009
Industry Dynamics China is the world’s sixth largest grape-wine consumer, according to Asia Bureau, with a 23.8% production CAGR over 2005-07, compared with the average worldwide growth rate is only 1.5%. This has been driven by rising disposable incomes and living standards, changing consumption patterns, and wine’s image as a healthy drink. But the mainland wine market remains in the early stages, with per capita consumption only 6% of the global average. This suggests ample room for further growth. Yantai Changyu, Great Wall and Dynasty are the major local players, accounting for more than 50% of the market in 2007.
Since joining the WTO, China has lowered import tariffs for wine from 65% to 14%. Low tariffs, the strong RMB and high demand for mid-range to high-end wine products have attracted a number of international players to enter the Chinese market. In 2007, imports accounted for only 10% of total consumption, but demand is growing at 30% p.a. China was among the top 10 targets for grape-wine exports from the E.U. over 2006-08.
New wine standards came into effect on 1 Jan. 2008, and should help Chinese producers increase exports by raising product quality to international levels. The authorities are also promoting industry consolidation, which should present M&A opportunities to big players such as Dynasty.
Sun Hung Kai Financial 98 20 Nov. 2009
Figure 4: Dynasty – Profit and Loss Statement FY05-08 Year ending 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 947.5 1,114.1 1,123.3 1,360.9 14.0 COGS (456.9) (546.9) (544.5) (639.1) 14.1 Gross profit 490.6 567.2 578.9 721.7 14.0 Operating expenses (273.0) (447.3) (424.2) (532.8) 26.9 Other operating income 0.0 14.6 15.5 5.7 N/A Operating profit 217.6 134.5 170.1 194.7 (3.1) Finance expenses (0.3) 0.0 0.0 0.0 N/A PBT 229.0 151.4 181.3 217.2 (0.7) Tax (47.6) (37.7) (54.7) (73.3) 6.4 Net profit 179.0 114.8 126.3 143.1 (3.6) EPS – HK cents 14.7 9.2 10.1 11.5 (11.1) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Dynasty – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 17.8 17.6 0.8 21.1 14.0 COGS 21.0 19.7 (0.4) 17.4 14.1 Gross profit 14.9 15.6 2.0 24.7 14.0 Operating expenses 32.7 63.9 (5.2) 25.6 26.9 Other operating income N/A N/A 5.7 (63.0) N/A Operating profit (1.6) (38.2) 26.5 14.4 (3.1) Finance expenses (51.1) (100.0) N/A N/A N/A PBT 2.4 (33.9) 19.7 19.8 (0.7) Tax (16.8) (20.8) 45.0 34.0 6.4 Net profit 7.9 (35.9) 10.0 13.3 (3.6) EPS (20.1) (37.4) 9.8 13.9 (11.1) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Dynasty – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (48.2) (49.1) (48.5) (47.0) (48.2) Gross profit 51.8 50.9 51.5 53.0 51.8 Operating expenses (28.8) (40.2) (37.8) (39.1) (36.5) Other operating income 0.0 1.3 1.4 0.4 0.8 Operating profit 23.0 12.1 15.1 14.3 16.1 Finance expenses (0.0) 0.0 0.0 0.0 (0.0) PBT 24.2 13.6 16.1 16.0 17.5 Tax (5.0) (3.4) (4.9) (5.4) (4.7) Net profit 18.9 10.3 11.2 10.5 12.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 99 20 Nov. 2009
Figure 7: Dynasty - Balance Sheet FY05-08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 763.3 764.4 830.3 999.0 44.7 Accounts receivable 111.7 97.5 106.5 84.1 (5.6) Inventory 354.9 386.0 422.6 462.7 18.5 Other current assets 40.4 42.6 61.4 80.7 34.6 Total current assets 1,270.3 1,290.5 1,420.8 1,626.4 28.7 Net fixed assets 311.4 372.2 423.6 504.1 25.0 Other long-term assets 10.7 10.7 23.3 22.7 107.9 Total assets 1,592.4 1,673.5 1,867.8 2,153.2 28.1 Short-term debt 0.0 0.0 0.0 0.0 N/A Accounts payable 51.0 44.0 44.1 89.0 18.5 Other current liabilities 204.1 199.6 230.4 299.8 (1.5) Total current liabilities 255.1 243.6 274.6 388.8 0.8 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 0.0 0.0 0.0 N/A Total liabilities 255.1 243.6 274.6 388.8 0.8 Shareholders equity 1,337.3 1,429.9 1,593.2 1,764.4 42.9 Minorities 31.1 30.1 32.6 35.5 84.4 Total equity and liabilities 1,592.4 1,673.5 1,867.8 2,153.2 28.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Dynasty – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 47.9 45.7 44.5 46.4 46.1 Accounts receivable 7.0 5.8 5.7 3.9 5.6 Inventory 22.3 23.1 22.6 21.5 22.4 Other current assets 2.5 2.5 3.3 3.7 3.0 Total current assets 79.8 77.1 76.1 75.5 77.1 Net fixed assets 19.6 22.2 22.7 23.4 22.0 Other long-term assets 0.7 0.6 1.2 1.1 0.9 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 0.0 0.0 Accounts payable 3.2 2.6 2.4 4.1 3.1 Other current liabilities 12.8 11.9 12.3 13.9 12.8 Total current liabilities 16.0 14.6 14.7 18.1 15.8 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 16.0 14.6 14.7 18.1 15.8 Shareholders equity 84.0 85.4 85.3 81.9 84.2 Minorities 2.0 1.8 1.7 1.6 1.8 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 100 20 Nov. 2009
Figure 9: Dynasty – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 53.1 51.8 50.9 51.5 53.0 Operating margin – % 27.5 23.0 12.1 15.1 14.3 Net margin – % 20.6 18.9 10.3 11.2 10.5 ROAA – % 21.6 15.0 7.0 7.1 7.1 ROAE – % 37.3 20.3 8.3 8.4 8.5
Liquidity ratios Current assets/current liabilities – X 1.6 5.0 5.3 5.2 4.2 Liquid assets/current liabilities – X 0.6 3.0 3.1 3.0 2.6 Cash and securities/current assets – % 38.4 60.1 59.2 58.4 61.4 Cash flow from oper./curr. liabilities – % 49.3 28.3 58.0 59.8 69.7
Other ratios Capex/sales – % 10.3 8.8 7.1 5.8 7.5 Capex/depreciation – % 501.0 390.4 236.4 171.5 222.2 Operating expense/sales -% (25.6) (28.8) (40.2) (37.8) (39.1) Net debt/equity (net cash) – % (50.5) (57.1) (53.5) (52.1) (56.6) Inventory/sales – % 29.1 37.5 34.6 37.6 34.0 Effective tax rate – % 25.6 20.8 24.9 30.2 33.7 Cash conversion cycle – days 216.5 246.9 251.5 276.5 243.2
ROAA component analysis Revenue/average assets – % 104.9 79.2 68.2 63.4 67.7 COGS/average assets – % (49.3) (38.2) (33.5) (30.7) (31.8) Gross profit/average assets – % 55.7 41.0 34.7 32.7 35.9 Operating expenses/average assets – % (26.8) (22.8) (27.4) (24.0) (26.5) Other operating income/average assets – % 0.0 0.0 0.9 0.9 0.3 Operating profit/average assets – % 28.8 18.2 8.2 9.6 9.7 Finance expenses/average assets – % (0.1) (0.0) 0.0 0.0 0.0 PBT/average assets – % 29.2 19.1 9.3 10.2 10.8 Tax/average assets – % (7.5) (4.0) (2.3) (3.1) (3.6) Net profit/average assets – % 21.6 15.0 7.0 7.1 7.1
ROAE component analysis Revenue/average equity – % 107.6 80.5 74.3 81.1 85.9 COGS/average equity – % (51.9) (39.5) (36.0) (38.1) (41.4) Gross profit/average equity – % 55.7 41.0 38.3 43.0 44.5 Operating expenses/average equity – % (31.0) (32.3) (28.1) (31.7) (30.8) Other operating income/average equity – % 0.0 1.1 1.0 0.3 0.6 Operating profit/average equity – % 24.7 9.7 11.3 11.6 14.3 Finance expenses/average equity – % (0.0) 0.0 0.0 0.0 (0.0) PBT/average equity – % 26.0 10.9 12.0 12.9 15.5 Tax/average equity – % (5.4) (2.7) (3.6) (4.4) (4.0) Net profit/average equity – % 20.3 8.3 8.4 8.5 11.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 101 20 Nov. 2009
Eagle Nice (2368.HK) Textile and Garment Sector 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Eagle Nice is a Guangdong-based sportswear OEM. It is a top five Asia Pacific apparel supplier for Nike, which is also the largest customer, accounting for 60% of Performance (%) 1m 3m 12m sales (the top five customers account for 90%). Yue Yuen (551.HK) acquired a HSI 2.0 13.5 76.7 38.4% stake in 2005, becoming the largest shareholder. HSCEI 4.0 19.6 107.6
Eagle Nice has worked with Nike for more than 10 years and is an approved Eagle Nice – Price vs. HSI, Share Data sportswear manufacturer for the brand – key to its high gross margins of 25% since FY05. The global financial crisis has severely hit consumption, even in China, but Nike’s apparel sales in Asia Pacific still grew 16% yoy for the year ended May 2009 (HK$) (HK$m) 4.0 60 (down from 25% yoy in FY08). We expect PRC sports and recreational goods retail 3.5 50 sales to grow around 15% in 2009, and Nike’s expansion should speed up as the retail 3.0 2.5 40 environment improves. 2.0 30 1.5 20 The company brought in Northface as a client through its acquisition of Wayable in 1.0 10 2007, helping it penetrate the E.U. and U.S. markets. The company is also in talks 0.5 0.0 0 with Kappa and Adidas currently, and in July signed a non-legally-binding letter of Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 intent with an independent third party for a potential acquisition. There might be further upside from gaining business through new brands as well as capacity Turnover Price HSI expansion. Price – HK$ 3.29 Instead of investing heavily in capex to expand capacity, we believe the firm is likely 52W high/low (HK$) 3.57/0.83 to acquire more ready-built factories that already have skilled labor and functioning Shares in issue – millions 499.68 product lines. It has already entered a non-legally-binding letter of intent with an Market cap – HK$m 1,623.96 independent third party on 10 July 2009. 3M avg. turnover – HK$m 4.00 Major shareholders – % Yue Yuen Industrial 38.42 Figure 1: Earnings Summary Sources: Bloomberg and Sun Hung Kai Financial Year ending 31 March FY07 FY08 FY09 FY10E Net profit – HK$m 77.4 77.7 124.7 173.0 Net-profit growth - % (18.4) 0.4 60.4 38.8 EPS – HK¢ 18.1 18.2 26.6 35.0 EPS growth - % (35.6) 0.6 46.2 31.6 Recent Reports P/E – X 18.2 18.1 12.4 9.4 Date DPS – HK¢ 12.0 12.0 17.0 N/A Overlooked Treasure 28 July 2009 Dividend yield - % 3.6 3.6 5.2 N/A More to Come 25 June 2009 BVPS – HK$ 1.2 1.3 1.6 N/A P/B – X 2.6 2.4 2.1 N/A Oper cash flow/share – HK¢ 23.4 23.1 11.1 N/A This document is solely based on Net debt (net cash) to share price - % (15.3) (18.0) (16.7) (23.2) publicly available information. This Sources: Bloomberg and Sun Hung Kai Financial report is intended as information Note: Based on Bloomberg Consensus only and not as a recommendation
for any stock. Sun Hung Kai Financial does not provide research
coverage or ratings for this company in this report.
Eva Yip, CFA + (852) 2203 5987 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor102ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Eagle Nice – Investment Highlights
Key investment positives Key investment negatives Net cash, simple and clear balance sheet. The company has net Hard time in foreign markets. Though there should be no cash of HK$288m (HK$0.58/share) with no outstanding problem on order growth from China, shrinking consumption borrowings as at 31 March 2009. power in overseas markets might mean foreign clients reducing Generous dividend policy. The company has paid a constant orders. dividend of HK$0.06/half year since listing, with a stable payout Lengthening cash-conversion cycle. The cash-conversion cycle ratio of about 65% since 2006. This has increased since the FY07 has stretched significantly to 91.4 days in FY09, from around 60 interim results, with the total DPS at HK$0.17 for FY08 and days over FY04-07, with the receivables period almost doubling to HK$0.24 for FY09. The current stock price implies a yield of 57.5 days during this time. Most of this change should be due to around 10%. Northface, as this client means more business from the U.S. and Strong relationship with Nike. The firm has been cooperating E.U. We believe the current cash-conversion cycle is still healthy with Nike since 1997, and is among the top five of its 15-20 though, but would be cautious if it were to worsen. approved sportswear manufacturers in China. It is difficult to qualify as a Nike’s supplier, given the strict requirements on product quality, delivery time, working environment, workers’ remuneration and environmental protection, etc. The company has an R&D center dedicated to Nike products. Revenue from Nike doubled from HK$316m in FY05 to HK$648m in FY09. High, stable margins. Although an OEM, the gross margin has stayed higher than those of its peers at around 25% since FY05. This is due to its focus on high-end clients such as Nike and Northface, lean manufacturing practices and established supply chain. A new EDI system (Electronic Data Interchange, which merges the company’s database with those of its clients and vendors, eliminating redundant work) was installed in 2008 to boost efficiency in material sourcing and order placing. Furthermore, over 80% of contracts are on a cost-plus basis, helping to stabilize gross margins over the years. Textile quota cancellation by EU and US. The company has been able to penetrate the U.S. and European markets, mainly due to the Wayable acquisition and the cancellation of textile quotas by the E.U. in early 2008. The U.S. and Europe accounted for 19.4% of FY09 sales (FY08: 9.6%, FY07: 0%). The U.S. has also cancelled quotas since 1 Jan. 2009. Chinese apparel manufacturers, especially Eagle Nice, have much more competitive production costs and product quality than their foreign peers. We see little growth in 2009, as consumption in Europe and the U.S. is still weak, but there should be ample upside once a recovery is under way. Slower but still positive growth in China retail sales. Domestic retail-sales growth slowed in the first few months of 2009, but is still in the mid-double digits, about the same as 2007. We don’t expect consumption to shrink as disposable incomes are increasing, and this might benefit retailers as well as manufacturers. Nike is the largest player with the highest product ASPs in Chinese sportswear, and would likely benefit significantly from a recovering economy. Source: Sun Hung Kai Financial
Figure 3: Eagle Nice – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts RMB appreciation. We estimate a 1 % appreciation in the RMB against Possible trade wars. Differences between the U.S. and Chinese the HKD/USD would increase FY09 earnings 1.2%. governments on export policies and protectionism might cause trade wars (tightening of quotas or additional tariffs) and severely affect Eagle Nike’s expansion in Asia Pacific. Even though the financial crisis has Nice’s foreign business. severely hit consumption, Nike’s apparel sales in Asia Pacific still grew 16% yoy to US$1,322m in FY09, from US$1,140m in FY08. Further Changes in arrangement with Nike and Northface. Any negative sales growth is expected once consumption growth returns to normal. change in the firm’s relationship with Nike and Northface would significantly hit business, though this seems unlikely given its currently Reducing reliance on Nike reducing risk. Though orders from Nike solid relationships with these clients. doubled from FY05 to FY09, the company is still keen to add more new brands (e.g. Northface in 2007) to reduce the reliance on Nike. The Potential drop in gross margin. 80% of contracts are cost-plus, which company is currently in talks with Adidas and Kappa, and more high-end means little room for margin expansion if raw-material prices fall. brands/clients would mean a more comprehensive portfolio, while Meanwhile, there is no guarantee on gross margins for any new brands. maintaining a high gross margin. Potential acquisitions might boost capacity and bring in new brands. The company has already entered a non-legally-binding letter of intent with an independent third party on 10 July 2009. Further acquisitions could boost capacity or bring in new brands. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 103 20 Nov. 2009
Recent Company News Nil.
Industry Dynamics Global branded sportswear market
The global branded sportswear market has been recording steady low-single-digit growth in recent years; with U.S. the largest branded sportswear market in the world, followed by Europe. Nike, Adidas and Reebok are the ‘big three,’ followed by Fila, Umbro and Puma. These brands account for about one-fourth of the global sportswear wholesale market.
Asian countries catching up in production and export of sportswear
Historically, global apparel exports have been dominated by developed nations. However, high costs of production, in particular labor, have meant apparels production gradually shifting to developing countries. Asia’s share of global apparel exports grew from 26.8% in 1980 to 38.4% in 2004. China is currently the largest apparel exporter in Asia, with sportswear mainly produced on an OEM basis in a very fragmented industry. Manufacturers are concentrated in Guangdong and Fujian provinces.
China’s sportswear industry
The China sportswear market has grown rapidly, due to rising GDP, increasing in disposable incomes, urbanization and changing consumption patterns. Higher incomes mean people are becoming more fashion-oriented. High-ASP products perform well in first-tier cities and some coastal cities, where per capita consumer spending is higher.
The rising popularity of sports among Chinese has increased demand for sportswear. Domestic sport and recreational retail sales almost doubled from RMB2,837m in 2005 to RMB5,560m in 2H09. The global economic downturn has slowed consumption growth, but signs of an early recovery could bode well for sportswear brands, as well as the OEMs such as Eagle Nice
Sun Hung Kai Financial 104 20 Nov. 2009
Figure 4: Eagle Nice – Profit and Loss Statement FY06-09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 519.3 519.1 860.5 1,071.0 24.1 COGS (393.7) (387.0) (658.1) (797.9) 25.4 Gross profit 125.6 132.1 202.4 273.1 20.7 Operating expenses (39.6) (49.7) (79.1) (90.7) 30.8 Other operating income 0.8 0.3 0.5 1.0 (33.1) Operating profit 86.8 82.7 123.8 183.4 15.6 Finance expenses 0.0 0.0 0.0 0.0 N/A PBT 92.1 86.5 140.7 185.1 15.5 Tax (14.7) (8.8) (16.0) (21.2) 23.3 Net profit 77.4 77.7 124.7 163.8 14.6 EPS – HK¢ 18.1 18.2 26.6 32.8 3.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Eagle Nice – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR (%) Revenue 15.0 (0.0) 65.8 24.5 24.1 COGS 21.9 (1.7) 70.1 21.2 25.4 Gross profit (2.3) 5.1 53.2 34.9 20.7 Operating expenses 28.0 25.4 59.1 14.7 30.8 Other operating income (83.7) (59.9) 56.1 96.4 (33.1) Operating profit (15.3) (4.7) 49.6 48.1 15.6 Finance expenses (100.0) N/A N/A N/A N/A PBT (11.5) (6.1) 62.6 31.6 15.5 Tax 59.5 (40.3) 82.6 32.7 23.3 Net profit (18.4) 0.4 60.4 31.4 14.6 EPS (35.6) 0.6 46.2 23.3 3.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Eagle Nice – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (75.8) (74.6) (76.5) (74.5) (75.3) Gross profit 24.2 25.4 23.5 25.5 24.7 Operating expenses (7.6) (9.6) (9.2) (8.5) (8.7) Other operating income 0.2 0.1 0.1 0.1 0.1 Operating profit 16.7 15.9 14.4 17.1 16.0 Finance expenses 0.0 0.0 0.0 0.0 0.0 PBT 17.7 16.7 16.3 17.3 17.0 Tax (2.8) (1.7) (1.9) (2.0) (2.1) Net profit 14.9 15.0 14.5 15.3 14.9 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 105 20 Nov. 2009
Figure 7: Eagle Nice - Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 215.1 252.6 274.6 285.2 (3.1) Accounts receivable 51.8 58.6 146.6 191.0 49.2 Inventory 31.4 52.0 123.5 133.9 29.4 Other current assets 13.4 11.4 8.5 22.6 17.9 Total current assets 311.8 374.6 553.1 632.7 10.7 Net fixed assets 255.1 269.0 341.3 368.3 45.7 Other long-term assets 12.1 0.9 32.3 28.3 (12.8) Total assets 579.0 644.5 926.8 1,029.3 16.9 Short-term debt 0.0 0.0 0.0 0.0 N/A Accounts payable 13.3 29.7 55.6 55.1 35.8 Other current liabilities 33.6 39.7 78.1 84.8 23.0 Total current liabilities 46.9 69.4 133.7 139.9 27.3 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 1.8 1.3 12.9 16.9 108.4 Total liabilities 48.7 70.6 146.6 156.8 30.5 Shareholders equity 530.3 573.8 780.2 872.5 15.1 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 579.0 644.5 926.8 1,029.3 16.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Eagle Nice – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 37.2 39.2 29.6 27.7 33.4 Accounts receivable 9.0 9.1 15.8 18.6 13.1 Inventory 5.4 8.1 13.3 13.0 10.0 Other current assets 2.3 1.8 0.9 2.2 1.8 Total current assets 53.8 58.1 59.7 61.5 58.3 Net fixed assets 44.1 41.7 36.8 35.8 39.6 Other long-term assets 2.1 0.1 3.5 2.7 2.1 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 0.0 0.0 Accounts payable 2.3 4.6 6.0 5.4 4.6 Other current liabilities 5.8 6.2 8.4 8.2 7.2 Total current liabilities 8.1 10.8 14.4 13.6 11.7 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.3 0.2 1.4 1.6 0.9 Total liabilities 8.4 11.0 15.8 15.2 12.6 Shareholders equity 91.6 89.0 84.2 84.8 87.4 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 106 20 Nov. 2009
Figure 9: Eagle Nice – Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average (%) Profitability ratios Gross margin – % 24.2 25.4 23.5 25.5 24.7 Operating margin – % 16.7 15.9 14.4 17.1 16.0 Net margin – % 14.9 15.0 14.5 15.3 14.9 ROAA – % 13.7 12.7 15.9 16.7 14.8 ROAE – % 15.1 14.1 18.4 19.8 16.8
Liquidity ratios Current assets/current liabilities – X 6.6 5.4 4.1 4.5 5.2 Liquid assets/current liabilities – X 4.6 3.6 2.1 2.0 3.1 Cash and securities/current assets – % 69.0 67.4 49.6 45.1 57.8 Cash flow from oper./curr. liabilities – % 212.8 142.1 38.8 107.4 125.3
Other ratios Capex/sales – % 31.0 3.6 1.9 2.5 9.7 Capex/depreciation – % 731.6 66.1 48.9 73.1 62.7 Operating expense/sales -% (7.6) (9.6) (9.2) (8.5) (9.1) Net debt/equity (net cash) – % (40.6) (44.0) (35.2) (34.1) (37.8) Inventory/sales – % 6.1 10.0 14.4 12.5 12.3 Effective tax rate – % 15.9 10.1 11.4 11.5 11.0 Cash conversion cycle – days 54.2 58.9 71.1 91.4 73.8
ROAA component analysis Revenue/average assets – % 91.9 84.9 109.5 109.5 98.9 COGS/average assets – % (69.6) (63.3) (83.8) (81.6) (74.6) Gross profit/average assets – % 22.2 21.6 25.8 27.9 24.4 Operating expenses/average assets – % (7.0) (8.1) (10.1) (9.3) (8.6) Other operating income/average assets – % 0.1 0.1 0.1 0.1 0.1 Operating profit/average assets – % 15.4 13.5 15.8 18.8 15.8 Finance expenses/average assets – % 0.0 0.0 0.0 0.0 0.0 PBT/average assets – % 16.3 14.1 17.9 18.9 16.8 Tax/average assets – % (2.6) (1.4) (2.0) (2.2) (2.1) Net profit/average assets – % 13.7 12.7 15.9 16.7 14.8
ROAE component analysis Revenue/average equity – % 101.1 94.0 127.1 129.6 113.0 COGS/average equity – % (76.6) (70.1) (97.2) (96.6) (85.1) Gross profit/average equity – % 24.5 23.9 29.9 33.0 27.8 Operating expenses/average equity – % (7.7) (9.0) (11.7) (11.0) (9.8) Other operating income/average equity – % 0.2 0.1 0.1 0.1 0.1 Operating profit/average equity – % 16.9 15.0 18.3 22.2 18.1 Finance expenses/average equity – % 0.0 0.0 0.0 0.0 0.0 PBT/average equity – % 17.9 15.7 20.8 22.4 19.2 Tax/average equity – % (2.9) (1.6) (2.4) (2.6) (2.3) Net profit/average equity – % 15.1 14.1 18.4 19.8 16.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 107 20 Nov. 2009
Fujikon (927.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Fujikon Industrial designs, manufactures, markets and trades electro-acoustic products, accessories and other electronic products. Performance (%) 1m 3m 12m HSI 2.0 13.5 76.7 It manufactures headphones on OEM and ODM bases for tier-one audio-equipment HSCEI 4.0 19.6 107.6 makers (audio products, 28% of FY09 sales), headphones/headsets for mobile
phones (communications products, 31%), supplies headphones/headsets used in Fujikon – Price vs. HSI, Share Data games consoles and computers (multimedia products, 9%), and electronics
accessories (29%). A leading European mobile-phone vendor is a major customer (HK$) (HK$m) for mobile phone headsets. Microsoft was a major customer for headsets used with 4.5 14 its Xbox but Fujikon has opted not to renew these contracts due to falling 4.0 12 3.5 10 profitability. 3.0 2.5 8 2.0 6 1.5 Demand for consumer audio products and headphones remains steady thanks to the 4 1.0 ongoing trend for portable music. Headphones are only low-tech accessories, with 0.5 2 little differentiation between brands. But Fujikon focuses on the niche market of 0.0 0 tier-one customers, which only qualify high-quality manufacturers as suppliers, Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 meaning less competition. Big multinational clients are also consolidating their Turnover Price HSI supplier lists, and Fujikon should be able to keep these customers given its large scale. The firm is estimated to rank among the top five headphone makers in the Price – HK$ 1.58 world by sales, and accounts for one-fifth of China’s headphone exports. 52W high/low (HK$) 1.939/0.713 Shares in issue – millions 399.19 Demand is stable for mobile-phone headphones/headsets. Only 35% of mobile Market cap – HK$m 630.72 phones were bundled with headsets a few years ago, but that is now up to 50% given 3M avg. turnover – HK$m 0.26 the convergence between mobile phones and media players. This may poise a threat Major shareholders – % to sales of headphones for portable handheld devices, but is still an upside catalyst Acoustic Touch Ltd 54.53 for Fujikon since mobile-phone product lifecycles are only 1-2 years, much shorter Sources: Bloomberg and Sun Hung Kai Financial than for portable handheld devices. The firm also partners with mobile-phone vendors to codevelop headphones/headsets for mobile phones, which gives it a higher chance of being selected as a main supplier for a particular model. Bundle headsets can benefit from mass-shipment growth but there is some pricing pressure.
Fujikon’s strategy is to focus on developing innovative products and keeping abreast of the latest trends. This should help it attract new orders given the longer lifecycles for audio products and help stimulate replacement demand. This document is solely based on publicly available information. This report is intended as information
only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research Year ended 31 March FY07 FY08 FY09 FY10E coverage or ratings for this Net profit – HK$ m 159.5 138.2 91.3 133.7 company in this report. Net-profit growth - % 86.0 (13.3) (34.0) 46.4 EPS – HK¢ 42.4 36.3 22.9 34.7 EPS growth - % 84.3 (14.4) (36.9) 51.5 P/E – X 3.7 4.4 6.9 4.6 DPS – HK¢ 8.0 8.0 8.0 10.7 Dividend yield - % 5.1 5.1 5.1 6.8 BVPS – HK$ 1.4 1.8 1.8 2.0 P/B – X 1.1 0.9 0.9 0.8 Oper cash flow/share – HK¢ 50.3 75.0 38.1 35.0 Net debt (net cash) to share price - % (19.5) (56.0) (64.6) (63.7) Sources: Bloomberg and Sun Hung Kai Financial Eva Yip, CFA Note: Estimates based on Bloomberg consensus + (852) 2203 9587
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor108ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Fujikon – Investment Highlights
Key investment positives Key investment negatives
Steady product demand. Fujikon is a major mid-range to Most Fujikon products face competition from other products high-end headphone/headset maker, accounting for around (e.g. headphones for MP3 players) or will become homogenous in one-fifth of PRC exports. Demand for consumer electronics with the next few years (as mobile-phone headsets become standardized video/audio features and for mobile phones remains stable on 1) across different brands of headsets/headphones). the continuing trend for portable music, and 2) music-playing mobile phones. These should drive demand for Convergence between mobile phones and media players headphones/headsets bundled with these devices. trimming demand for headphones.
Growing OEM orders due to shortening mobile-phone Pricing pressure on hands-free headsets, given the rising lifecycles. Mobile phone lifecycles have shortened to 1-2 years, proportion of mobile phones bundled with these products (from compared with 3-4 years for headphones in the past. Tier-one 35%-40% in FY05 to 50%-plus now). handset vendors now usually include headphones/headsets with their mobile phones. Loss of orders from not renewing the Microsoft Xbox contract. The Xbox 360 games console accounted for 18% of FY09 sales. Continued new-product launches. The firm is codeveloping headsets/headphones with customers to help it deliver high-quality, Reliance on only a few communications-product customers. multi-function products and keep abreast of the latest trends. New Leading European handset vendor is Fujikon’s largest customer in products can help stimulate replacement demand. R&D accounts this segment (30% of sales). for 5% of sales, up from 3% a few years ago. It is difficult to penetrate Japanese customers, as they still Working closely with tier-one handset vendors to develop prefer to source from local suppliers. products can increase the chances of securing mass-shipment orders (for headphones/headsets bundled with handsets). Track record of customer acquisitions. Sales growth has been driven by a number of tier-one multinational customers brought in since the firm shifted its focus to this segment 10 years ago. New orders from these customers can reach 50% of last year’s sales. Market-share gains in existing clients. The firm can cross-sell other products from its wide range of electro-acoustic items to help it gain further market share in its major clients. Customers are consolidating their suppliers, favoring large-scale firms such as Fujikon, which should lessen competition. High entry barriers in niche market. It could take 1-2 years for new entrants to qualify as suppliers for top-tier companies. Vertical integration. The firm manufactures over 90% of the components used in headphones, giving it tight control over product quality (a major issue for tier-one customers). Able to quickly ramp up capacity. Customer orders are now less visible as two-months delivery periods have shortened to one month. Compared with close peer Hosiden, Fujikon’s production processes are more manual, which means it can ramp up production capacity quicker. Working-capital light. The cash-conversion cycle is only 64 days. Healthy balance sheet, with net cash of HK$400m or HK$1.00/share as at end-March 2009. Sustainable high dividend yield. The company policy is for an annual dividend of HK¢8, which implies a 5% dividend yield (on a HK$1.27 share price). Source: Sun Hung Kai Financial
Sun Hung Kai Financial 109 20 Nov. 2009
Figure 3: Fujikon – upside/downside price catalysts
Upside price catalysts Downside price catalysts
Faster market-share expansion than its peers by securing more High inflation in China could lead to the authorities raising new, large customers. New customers have driven 40% p.a. sales minimum wages, causing a sharp rise in labor costs. growth in the past. Headsets/headphones becoming interchangeable between all Penetrating Japanese customers’ supply chains. Japan is the one of mobile-phone models. the foremost producers of consumer electronics in the world. Rapid convergence between mobile phones and media players Greater bundling of headphones with other 3G products, such as eliminating demand for handheld media players. notebooks. Source: Sun Hung Kai Financial
Figure 4: Fujikon – Porter’s Five Forces
Threat of substitute products – High Headphones are homogenous and different brands differentiate themselves through quality and design. Some mobile headsets are customized to a particular model. Threat of entry of new competitors – Medium to High There is little technology content in headphone/headset manufacturing. The process is also labor intensive. But it could take 1-2 years to qualify as a supplier for a tier-one handset maker or headphone brand owner. Intensity of competitive rivalry – Low to Medium The firm focuses on tier-one customers, which usually pick large-scale manufacturers as suppliers. Bargaining power of customers – Low to Medium Customers emphasize product quality, which could help the firm pass on rising costs. But pricing pressure for large-volume orders remains. Bargaining power of suppliers – Low 90% of components can be manufactured internally. The five largest suppliers accounted for less than 35% of total purchases. Source: Sun Hung Kai Financial
Recent Company News
19 Oct. 2009 – 1H10 profit warning due to financial crisis.
SHKF Comments: The significant drop in revenue is likely due to losing orders after failing to renew the Microsoft Xbox contract. The Xbox 360 games console accounted for 18% of FY09 sales. Sales of headphones/headsets for mobile phones have been unable to pick up the slack, as the company’s focus on on struggling European handset makers has meant it missing out on much of the handset-market recovery. Its major handset customer has faced difficulties in improving profitability due to price competition in smartphones. This may mean pricing pressure for Fujikon. Meanwhile, it is signing up more new clients, but it has proven difficult to penetrate Japanese customers, as these prefer to source from local suppliers.
Sun Hung Kai Financial 110 20 Nov. 2009
Figure 5: Fujikon – Profit and Loss Statement
FY06-09 Year ending 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 1,089.1 1,678.4 1,616.5 1,265.0 7.9 COGS (837.9) (1,297.9) (1,250.8) (1,009.4) 8.5 Gross profit 251.1 380.5 365.7 255.6 5.9 Operating expenses (146.8) (170.7) (182.8) (156.6) 5.4 Other operating income 0.0 0.0 0.0 10.7 N/A Operating profit 104.3 209.9 182.9 109.6 9.3 Finance expenses (2.5) (6.0) (3.1) (3.4) 30.6 PBT 107.0 209.0 175.9 113.9 9.0 Tax (14.5) (33.6) (24.6) (15.8) 7.1 Net profit 85.8 159.5 138.2 91.3 8.3 EPS – HK cents 23.0 42.4 36.3 22.9 6.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Fujikon – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR Revenue 16.9 54.1 (3.7) (21.7) 7.9 COGS 15.0 54.9 (3.6) (19.3) 8.5 Gross profit 23.4 51.5 (3.9) (30.1) 5.9 Operating expenses 15.9 16.2 7.1 (14.3) 5.4 Other operating income N/A N/A N/A N/A N/A Operating profit 35.9 101.2 (12.8) (40.1) 9.3 Finance expenses 114.7 135.4 (49.0) 12.8 30.6 PBT 32.8 95.2 (15.8) (35.2) 9.0 Tax 21.2 131.1 (26.9) (35.9) 7.1 Net profit 29.4 86.0 (13.3) (34.0) 8.3 EPS 27.8 84.3 (14.4) (36.9) 6.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 7: Fujikon – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 Dec., % FY06 FY07 FY08 FY09 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (76.9) (77.3) (77.4) (79.8) (77.9) Gross profit 23.1 22.7 22.6 20.2 22.1 Operating expenses (13.5) (10.2) (11.3) (12.4) (11.8) Other operating income 0.0 0.0 0.0 0.8 0.2 Operating profit 9.6 12.5 11.3 8.7 10.5 Finance expenses (0.2) (0.4) (0.2) (0.3) (0.3) PBT 9.8 12.5 10.9 9.0 10.5 Tax (1.3) (2.0) (1.5) (1.2) (1.5) Net profit 7.9 9.5 8.6 7.2 8.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 111 20 Nov. 2009
Figure 8: Fujikon – Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 65.4 158.3 325.6 415.8 45.1 Accounts receivable 206.4 258.9 196.5 165.7 3.4 Inventory 211.4 221.2 163.8 104.4 0.0 Other current assets 24.8 43.8 74.8 26.6 29.1 Total current assets 507.9 682.2 760.8 712.5 19.2 Net fixed assets 225.3 250.2 241.4 241.9 6.1 Other long-term assets 20.8 4.1 14.6 2.5 (44.3) Total assets 754.0 936.6 1,016.8 956.9 13.9 Short-term debt 51.1 43.3 30.4 17.0 (18.3) Accounts payable 193.2 185.3 139.9 60.1 (13.1) Other current liabilities 78.0 131.6 133.4 114.7 16.3 Total current liabilities 322.2 360.2 303.8 191.8 (1.8) Long-term debt 10.2 5.9 3.2 0.0 N/A Other long-term liabilities 1.3 1.0 1.1 1.9 (4.0) Total liabilities 333.7 367.1 308.1 193.7 (2.3) Shareholders equity 420.2 569.5 708.7 763.2 21.0 Minorities 20.1 33.3 40.2 44.5 35.1 Total equity and liabilities 754.0 936.6 1,016.8 956.9 13.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 9: Fujikon – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 Average Total assets Cash and securities 8.7 16.9 32.0 43.5 25.3 Accounts receivable 27.4 27.6 19.3 17.3 22.9 Inventory 28.0 23.6 16.1 10.9 19.7 Other current assets 3.3 4.7 7.4 2.8 4.5 Total current assets 67.4 72.8 74.8 74.5 72.4 Net fixed assets 29.9 26.7 23.7 25.3 26.4 Other long-term assets 2.8 0.4 1.4 0.3 1.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 6.8 4.6 3.0 1.8 4.0 Accounts payable 25.6 19.8 13.8 6.3 16.4 Other current liabilities 10.3 14.1 13.1 12.0 12.4 Total current liabilities 42.7 38.5 29.9 20.0 32.8 Long-term debt 1.4 0.6 0.3 0.0 0.6 Other long-term liabilities 0.2 0.1 0.1 0.2 0.1 Total liabilities 44.3 39.2 30.3 20.2 33.5 Shareholders equity 55.7 60.8 69.7 79.8 66.5 Minorities 2.7 3.6 3.9 4.6 3.7 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 112 20 Nov. 2009
Figure 10: Fujikon – Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 23.1 22.7 22.6 20.2 22.1 Operating margin – % 9.6 12.5 11.3 8.7 10.5 Net margin – % 7.9 9.5 8.6 7.2 8.3 ROAA – % 13.0 18.9 14.2 9.3 13.8 ROAE – % 22.1 32.2 21.6 12.4 22.1
Liquidity ratios Current assets/current liabilities – X 1.6 1.9 2.5 3.7 2.4 Liquid assets/current liabilities – X 0.2 0.4 1.1 2.2 1.0 Cash and securities/current assets – % 12.9 23.2 42.8 58.4 34.3 Cash flow from oper./curr. liabilities – % 13.4 52.5 94.0 75.0 58.7
Other ratios Capex/sales – % 5.9 3.2 1.2 2.3 3.2 Capex/depreciation – % 200.7 130.3 42.3 63.4 78.7 Operating expenses/sales -% (13.5) (10.2) (11.3) (12.4) (11.3) Net debt/equity – % (1.0) (20.4) (47.6) (52.3) (40.1) Inventory/sales – % 19.4 13.2 10.1 8.3 10.5 Effective tax rate – % 13.6 16.1 14.0 13.8 14.6 Cash-conversion cycle – days 69.9 58.6 58.0 64.6 60.4
ROAA component analysis Revenue/average assets – % 164.6 198.6 165.5 128.2 164.2 COGS/average assets – % (126.7) (153.5) (128.1) (102.3) (127.6) Gross profit/average assets – % 38.0 45.0 37.4 25.9 36.6 Operating expenses/average assets – % (22.2) (20.2) (18.7) (15.9) (19.2) Other operating income/average assets – % 0.0 0.0 0.0 1.1 0.3 Operating profit/average assets – % 15.8 24.8 18.7 11.1 17.6 Finance expenses/average assets – % (0.4) (0.7) (0.3) (0.3) (0.4) PBT/average assets – % 16.2 24.7 18.0 11.5 17.6 Tax/average assets – % (2.2) (4.0) (2.5) (1.6) (2.6) Net profit/average assets – % 13.0 18.9 14.2 9.3 13.8
ROAE component analysis Revenue/average equity – % 280.4 339.2 252.9 171.9 261.1 COGS/average equity – % (215.7) (262.3) (195.7) (137.2) (202.7) Gross profit/average equity – % 64.7 76.9 57.2 34.7 58.4 Operating expenses/average equity – % (37.8) (34.5) (28.6) (21.3) (30.5) Other operating income/average equity – % 0.0 0.0 0.0 1.4 0.4 Operating profit/average equity – % 26.9 42.4 28.6 14.9 28.2 Finance expenses/average equity – % (0.7) (1.2) (0.5) (0.5) (0.7) PBT/average equity – % 27.6 42.2 27.5 15.5 28.2 Tax/average equity – % (3.7) (6.8) (3.8) (2.1) (4.1) Net profit/average equity – % 22.1 32.2 21.6 12.4 22.1 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 113 20 Nov. 2009
Fushan International Energy Group (639.HK) China Coal Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Fushan International Energy Group was previously a jewelry producer and distributor known as Fu Hui Holdings. Former chairman Wong Lik Ping accumulated a majority Performance (%) 1m 3m 12m stake of 59.6% in 2004 and changed the name to Fushan Energy in mid-2005. HSI 2.0 13.5 76.7 HSCEI 4.0 19.6 107.6 Wong reorganized the company into a coking-coal firm by securing coking-coal resources in Liulin county, in western Shanxi province. In 2007, Fushan Energy Fushan – Price vs. HSI, Share Data raised HK$760m through a Hong Kong IPO.
(HK$) (HK$m) In July 2008, the company announced it had acquired three coking-coal mines in 8.0 3,500 7.0 Liulin from a private coal-mining firm, Fortune Dragon, for a total of HK10.53bn. 3,000 6.0 2,500 5.0 The three mines are held through 100% stakes in three BVI companies, which in turn 2,000 4.0 1,500 own the mines through non-wholly owned PRC subsidiaries. For FY08, the company 3.0 recorded HK$1.9bn in revenue, all of which came from its coal, coking coal, and 2.0 1,000 coke business. 1.0 500 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
The three mines produced a total of 5.3 million tonnes of raw-coal production in Turnover Price HSI 2008, 2.2X the firm’s closest peer Hidili (1393.HK). This makes Fushan Energy the largest Hong Kong-listed coking-coal producer. Price – HK$ 6.85 52W high/low (HK$) 7.19/1.44 Due to the larger size of Fushan Energy’s mines, the company employs advanced Shares in issue – millions 5,001.81 automated long-wall mining, which results in lower production cost of Market cap – HK$m 34,362.40 RMB131/tonne and cash cost of RMB95/tonne. 3M avg. turnover – HK$m 168.98 Major shareholders – % Shougang Group has taken a 22% stake in the company through its Hong Kong Shougang Concord Intl 26.45 affiliates, Shougang Concord International Enterprises Co. Ltd. (697.HK) and Sources: Bloomberg and Sun Hung Kai Financial Shougang Concord Century Holdings Ltd. (103.HK). The company’s new CEO and members of it board are also members of Shougang’s management. In return, Fushan Energy has entered a long-term strategic cooperation with the Shougang Group, where it will supply Shougang with at least 2 million tonnes (39% of FY07 production) of clean coking coal per year at market prices, starting from 2009.
Recent Reports Date Growing Coal Powerhouse 11 June 2009 Figure 1: Earnings Summary Trading Express 18 May 2009
Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m (31.0) (77.9) 567.6 1,602.9
Net-profit growth - % N/A N/A N/A 182.4 This document is solely based on EPS – HK¢ (1.5) (3.4) 16.9 32.6 publicly available information. This EPS growth - % N/A N/A N/A 93.4 report is intended as information
P/E – X N/A N/A 40.6 21.0 only and not as a recommendation
DPS – HK¢ 0.0 0.0 0.0 12.6 for any stock. Sun Hung Kai
Dividend yield - % 0.0 0.0 0.0 1.8 Financial does not provide research
BVPS – HK$ 0.0 0.3 2.4 2.8 coverage or ratings for this company in this report. P/B – X 247.3 22.6 2.9 2.5
Oper cash flow/share – HK¢ (1.3) (1.7) 26.5 42.0 Net debt (net cash) to share price - % 2.5 (1.5) 2.8 (4.5) Michael Yuk Sources: Bloomberg and Sun Hung Kai Financial + (852) 2203 9590 Note: Estimates based on Bloomberg Consensus [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor114ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Fushan International Energy Group – Investment Highlights
Key investment positives Key investment negatives
Major beneficiary of small-mine closures. Fushan’s mines are Coking operations remain weak despite lack of one-time located in Shanxi, where the provincial government targets to write-offs. Despite the lack of one-time write-offs, results from close mines with production less than 900,000 tpa and poor safety the firm’s coking operations should remain weak throughout records. Fushan should benefit as this will reduce the number of FY09, as the price differential between coke and coking coal competitors and leave a large selection of acquisition targets. remains slim. A production loss for each tonne of coke produced by the company’s Yao Zin coke-processing plant is expected, Higher entry barriers. Coal production in Shanxi is highly unless coke prices rise dramatically in 2009. regulated and mine operators must have a proven safety record before a license can be obtained for mining operations. New Liquidity risks persist. Fushan’s current and quick ratios are the green-field mines take 5-6 years to clear all the licensing lowest among coal producers at 0.91 and 0.86 (peer average: requirements. Due to the high entry barriers, Fushan’s share of the current ratio = 2.5, quick ratio = 2.3). The company has over coking-coal market should increase as production from its mines HK$1.5bn in short-term borrowings, while owing over HK$1.8bn ramps up. in coal-mining rights levies, PPE construction costs, and environmental-restoration funds. The company may need to raise Large mines with good reserves. The three acquired mines, funds to meet its short-term obligations. Xingwu, Jinjiazhuang and Zhaiyadi, are large mines with a designed raw coal output capacity of 6.3 mtpa. Furthermore, these Acquisition of smaller inefficient mines and lower coal prices mines have rich coal reserves of over 130 mt. may result in lower margins. Due to the high efficiency of its mining operations and high coal prices throughout 2008, Fushan Faster growth through M&A. Fushan will aggressively expand recorded a gross margin of 66% in FY08. However, the reversion coal production through acquiring these smaller mines in coming in coal prices and acquisition of new mines may result in a decline years. in gross margins and a subsequent slowdown in earnings growth. Potential supply tightness as steel demand picks up and coal Increase in cash-conversion cycle may increase financing mines close. Of the 2,840 coal mines in 2008, more than half will pressure. Fushan hopes 80% of its coal production to will go to be closed, merged or acquired by larger rivals, leaving only about its clientele of medium- to large-sized steel manufacturers. 1,400 mines by 2010. On a national scale, the government’s However, payment terms are usually more generous for these closure of small mines has resulted in a production-capacity companies, resulting in an industry cash-conversion cycle (CCC) decline of about 300 million tons. If demand were to pick up, ranging from 70 to 150 days. As the company’s production supply tightness could occur in areas that have experienced the increase, so will its cost of goods sold. Compounded by a most mine closures, such as Shanxi. lengthier CCC, Fushan’s working capital could shoot up Low-cost advantage. Fushan’s cash cost for production in FY08 dramatically in the coming 1-2 years. averaged RMB95/tonne, one of the lowest among its Steel production and prices are still susceptible to an economic coal-producing peers and second only to China Shenhua. The slowdown. Although there have been signs of an economic company’s mines are larger, allowing automated long-wall recovery in the mainland manufacturing sector, with China’s PMI extraction methods. This results in lower operating costs, better maintaining above the critical 50 point for the past three months, safety and environmental performance, higher capacity and a China’s economic recovery is still fragile and susceptible to generally higher recovery rate. shocks that could derail the increasing demand for steel, and Preferential tax treatment until 2011. The three acquired mines hence coking coal. enjoy preferential tax treatment since their holding companies are Increasing tax rate. Local and provincial taxes make up a large Sino-foreign joint ventures. Hence, they will enjoy a 50% portion of Fushan’s cash cost, at RMB30/tonne of the overall exemption from 2008 to 2010, with a standard tax rate of 25% RMB95/tonne cash cost. Any further increase in taxes would coming into effect in 2011. squeeze earnings. Coking coal and steel stabilizing, with possible rebounds. Coking-coal prices as reflected in McCloskey Xinhua InfoLink Index have stabilized from the trough levels of the past few months. Steel prices, especially for the hot-rolled steel sheets manufactured by Fushan’s clients, are showing signs of a stable price uptrend, signaling that a rebound in coking-coal prices could be around the corner. Diversifying customer base. Fushan is expanding its customer base to include more medium- to large-sized steel manufactures. These tend to maintain long relationships with reliable firms such as Fushan. Hence, the company should enjoy a stable client base and greater economies of scale, resulting in stable sales growth and lower SG&A expenses. Share dilution unlikely with Shougang at the helm. During Fushan’s restructuring and prior to 2009, the company issued over 2 billion shares at an average price of HK$4.50/share to raise funds for coal-mine acquisitions. But Shougang Group now owns a 22% stake in Fushan and its management sits on Fushan’s board. Hence, it seems unlikely that Shougang would allow the dilution of its control and shareholding through the issue of new shares. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 115 20 Nov. 2009
Figure 3: Fushan International Energy Group – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Signing large supply contracts with medium- to large-sized steel M&A risks. Fushan’s plans for acquiring coal mines in Shanxi could mills, which would lock in demand for Fushan’s coking coal, ensuring result in disappointment in the completion of deals and/or stable sales. higher-than-expected costs, which would affect the share price and earnings. Supply tightness for coking coal due to mine closures in Shanxi. Shanxi plans to close and/or merge smaller mines to halve the number Government policy. China has been aggressively trying to curb of operating mines by 2010. Coking-coal supply will decrease as coking-coal exports by reducing and eliminating the export rebate to closed mines need time to be merged and/or acquired by larger rivals coal companies. The government may take further measures to control A supply bottleneck is likely if demand for coking coal sharply rises the supply of coking coal, which may affect coking coal prices in while these mines are closed. China. Price increase in construction steel cascading to other steel Major accidents causing fatalities. China is becoming more products. Domestic steel prices have increased for seven weeks in a conscientious about coal-mine accidents and fatalities. If there were row. Although construction-steel prices have shown the highest rate of an accident at any of Fushan’s mines, suspension of operations would increase, other products such as steel plates, hot-rolled-sheets, and likely affect sales and the company’s image. steel sections should follow. Coking-coal prices, which are highly correlated to steel prices, will eventually follow steel prices. Increase in export rebates for steel. China has already increased the export rebate on certain types of alloy types, profile shapes and structural steels to 9%, starting from 1 June. A further increase in export rebates will encourage larger steel mills to ramp up production, increasing demand for coking coal. Successful M&A of coal mines leading to an increase in reserves and greater market share of the Shanxi coking coal market. Source: Sun Hung Kai Financial
Recent Company News
Two Deals Bring Stake in Western Australian Hematite Iron Ore Deposits
Fushan has purchased from Sky Choice, a wholly owned subsidiary of Shougang International, 154,166,874 shares of Mount Gibson for HK$1.2bn. The acquisition will give Fushan a 14.34% stake in Mount Gibson, which mines hematite-iron-ore deposits in Western Australia.
The company has also agreed to purchase the entire issued share capital of Benefit Rich from Shougang Holding for HK$606m, satisfied by new shares to Shougang Holding. Benefit Rich is an investment-holding company that holds 16.80% of the issued share capital of APAC (1104.HK), which trades and invests in natural resources. APAC also has a 26.03% stake in Mount Gibson.
After completion of both deals, Fushan’s effective stake in Mount Gibson will be 40%.
Interim Results Underline Strong Growth
Fushan turned around to a net profit of HK$920m for 1H09 (from a loss in 1H08), which was 30% higher than the full-year net profit for FY08. Gearing remains low at only 8%, giving the company ample room to expand operations through additional M&A. We believe this underlines the company’s high earnings growth, and maintain our FY10 EPS forecast of HK¢33.2.
Sun Hung Kai Financial 116 20 Nov. 2009
Industry Dynamics
China’s coal industry is very fragmented and plagued by accident-related deaths
China’s coking coal industry is extremely fragmented, with a 1% market share considered large. Furthermore, according to government figures, almost 80% of the nation’s 16,000 coal mines are operating illegally, making it difficult to regulate the industry. Nonetheless, the PRC is in the process of consolidating its mining industry after years of incidents leading to thousands of deaths at small and unsafe coal mines. In 2008 alone, over 3,200 deaths were due to coal-mine accidents.
Safety is the key issue, but coal shortages may result
Safety is the key factor in determining if a coal mine is to be shut down. The State Administration of Work Safety (SAWS) and State Administration of Coal Mine Safety (SACMS) have ordered regional governments to conduct safety inspections of local coal mines and shut down those that fail. As a result, China had shut down over 12,000 coal mines as at end-2008, which reduced annual coal production capacity by about 300 million tons. Hence, China must balance coal-mine closures with the demand for its primary energy source. The country runs the risk of coal shortages if closed mines are not absorbed and reopened by licensed coal-mine operators with good safety records.
Coal companies such as Fushan stand to benefit
Coal companies such as Fushan stand to benefit since they have good safety records, experienced management and sufficient resources to acquire these smaller mines. Once acquired, these small mines can significantly increase their overall coal reserves as well as boost coal output once they are refitted to meet SACMS safety standards. Hence, these coal companies should record faster revenue and earnings growth than their larger state-controlled peers such as China Shenhua and China Coal, where the accretive effects of newly acquired mines would be dwarfed by their current operational levels.
Sun Hung Kai Financial 117 20 Nov. 2009
Figure 4: Fushan International Energy – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 10.2 10.5 15.1 1,896.6 298.0 COGS (9.2) (8.6) (13.2) (659.6) 230.2 Gross profit 1.0 1.9 1.9 1,236.9 397.9 Operating expenses (18.9) (38.3) (59.6) (238.1) 94.4 Other operating income 0.0 0.0 0.0 26.6 121.6 Operating profit (17.9) (36.4) (57.7) 1,025.5 N/A Finance expenses (0.2) (9.0) (22.5) (91.3) 438.0 PBT (14.0) (45.1) (86.1) 933.1 N/A Tax 0.0 0.0 0.0 (226.5) N/A Net profit (14.0) (31.0) (77.9) 567.6 N/A EPS – HK¢ (0.7) (1.5) (3.4) 16.9 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Fushan International Energy – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 35.3 3.0 42.9 12,496.8 298.0 COGS 66.7 (7.0) 53.5 4,895.0 230.2 Gross profit (51.0) 96.1 (4.3) 66,761.2 397.9 Operating expenses 13.4 102.5 55.5 299.7 94.4 Other operating income (96.4) (100.0) N/A N/A N/A Operating profit 31.9 103.3 58.7 (1,876.8) N/A Finance expenses 85.3 4,369.3 149.0 306.3 438.0 PBT (25.4) 221.8 90.8 (1,183.9) N/A Tax N/A N/A N/A N/A N/A Net profit (4.9) 121.0 151.5 (828.2) N/A EPS (5.6) 122.4 129.5 (593.0) N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Fushan International Energy – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (90.4) (81.6) (87.7) (34.8) (73.6) Gross profit 9.6 18.4 12.3 65.2 26.4 Operating expenses (184.8) (363.5) (395.6) (12.6) (239.1) Other operating income 0.4 0.0 0.0 1.4 0.4 Operating profit (174.8) (345.1) (383.3) 54.1 (212.3) Finance expenses (2.0) (85.7) (149.3) (4.8) (60.5) PBT (137.0) (428.2) (571.8) 49.2 (272.0) Tax 0.0 0.0 0.0 (11.9) (3.0) Net profit (137.0) (294.1) (517.7) 29.9 (229.7) Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 118 20 Nov. 2009
Figure 7: Fushan International Energy – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 10.6 10.6 460.5 760.2 121.4 Accounts receivable 6.9 0.0 7.2 999.4 568.0 Inventory 0.0 0.0 0.0 187.5 N/A Other current assets 5.6 6.2 20.4 2,044.6 275.0 Total current assets 23.0 16.7 488.2 3,991.6 211.4 Net fixed assets 240.2 272.4 394.1 2,124.4 129.8 Other long-term assets 120.6 227.9 412.7 13,136.3 246.2 Total assets 383.8 517.1 1,295.1 19,252.3 209.4 Short-term debt 24.5 139.8 184.6 1,603.2 148.1 Accounts payable 6.3 0.0 2.3 380.8 326.4 Other current liabilities 26.3 41.8 248.4 2,417.2 201.8 Total current liabilities 57.1 181.7 435.3 4,401.3 179.0 Long-term debt 189.2 229.2 34.0 35.2 39.1 Other long-term liabilities 10.0 6.6 33.8 2,366.8 N/A Total liabilities 256.3 417.5 503.1 6,803.3 201.8 Shareholders equity 127.5 99.6 792.0 12,449.0 214.0 Minorities 54.3 42.0 58.3 1,627.3 149.4 Total equity and liabilities 383.8 517.1 1,295.1 19,252.3 209.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Fushan International Group – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 2.8 2.0 35.6 3.9 11.1 Accounts receivable 1.8 0.0 0.6 5.2 1.9 Inventory 0.0 0.0 0.0 1.0 0.2 Other current assets 1.5 1.2 1.6 10.6 3.7 Total current assets 6.0 3.2 37.7 20.7 16.9 Net fixed assets 62.6 52.7 30.4 11.0 39.2 Other long-term assets 31.4 44.1 31.9 68.2 43.9 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 6.4 27.0 14.3 8.3 14.0 Accounts payable 1.6 0.0 0.2 2.0 1.0 Other current liabilities 6.8 8.1 19.2 12.6 11.7 Total current liabilities 14.9 35.1 33.6 22.9 26.6 Long-term debt 49.3 44.3 2.6 0.2 24.1 Other long-term liabilities 2.6 1.3 2.6 12.3 4.7 Total liabilities 66.8 80.7 38.8 35.3 55.4 Shareholders equity 33.2 19.3 61.2 64.7 44.6 Minorities 14.1 8.1 4.5 8.5 8.8 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 119 20 Nov. 2009
Figure 9: Fushan International Group – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 9.6 18.4 12.3 65.2 26.4 Operating margin – % (174.8) (345.1) (383.3) 54.1 (212.3) Net margin – % (137.0) (294.1) (517.7) 29.9 (229.7) ROAA – % (4.7) (6.9) (8.6) 5.5 (3.7) ROAE – % (11.0) (27.3) (17.5) 8.6 (11.8)
Liquidity ratios Current assets/current liabilities – X 0.4 0.1 1.1 0.9 0.6 Liquid assets/current liabilities – X 0.3 0.1 1.1 0.4 0.5 Cash and securities/current assets – % 46.0 63.2 94.3 19.0 55.6 Cash flow from oper./curr. liabilities – % (30.8) (14.4) (8.8) 20.3 (8.5)
Other ratios Capex/sales – % 529.7 122.4 383.5 31.7 266.8 Capex/depreciation – % 1,869.6 487.8 1,801.5 944.3 1,275.8 Operating expense/sales -% (184.8) (363.5) (395.6) (12.6) (239.1) Net debt/equity (net cash) – % 159.4 360.0 (30.5) 7.1 124.0 Inventory/sales – % 0.0 0.0 0.0 9.9 2.5 Effective tax rate – % 0.0 0.0 0.0 24.3 6.1 Cash conversion cycle – days N/A N/A N/A 66.4 66.4
ROAA component analysis Revenue/average assets – % 3.4 2.3 1.7 18.5 6.5 COGS/average assets – % (3.1) (1.9) (1.5) (6.4) (3.2) Gross profit/average assets – % 0.3 0.4 0.2 12.0 3.3 Operating expenses/average assets – % (6.4) (8.5) (6.6) (2.3) (5.9) Other operating income/average assets – % 0.0 0.0 0.0 0.3 0.1 Operating profit/average assets – % (6.0) (8.1) (6.4) 10.0 (2.6) Finance expenses/average assets – % (0.1) (2.0) (2.5) (0.9) (1.4) PBT/average assets – % (4.7) (10.0) (9.5) 9.1 (3.8) Tax/average assets – % 0.0 0.0 0.0 (2.2) (0.6) Net profit/average assets – % (4.7) (6.9) (8.6) 5.5 (3.7)
ROAE component analysis Revenue/average equity – % 8.0 9.3 3.4 28.6 12.3 COGS/average equity – % (7.2) (7.6) (3.0) (10.0) (6.9) Gross profit/average equity – % 0.8 1.7 0.4 18.7 5.4 Operating expenses/average equity – % (14.8) (33.7) (13.4) (3.6) (16.4) Other operating income/average equity – % 0.0 0.0 0.0 0.4 0.1 Operating profit/average equity – % (14.0) (32.0) (12.9) 15.5 (10.9) Finance expenses/average equity – % (0.2) (8.0) (5.0) (1.4) (3.6) PBT/average equity – % (11.0) (39.7) (19.3) 14.1 (14.0) Tax/average equity – % 0.0 0.0 0.0 (3.4) (0.9) Net profit/average equity – % (11.0) (27.3) (17.5) 8.6 (11.8) Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 120 20 Nov. 2009
Genesis Energy (702.HK) Oil & Gas 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Genesis Energy is an upstream oil exploration and exploitation company. Through joint ventures and equity interests, it has oil & gas exploration & exploitation Performance (%) 1m 3m 12m operations in the U.S., China and Australia. The company recently diversified into HSI 2.0 13.5 76.7 waste-incineration power, which it hopes will drive a turnaround to profitability in HSCEI 4.0 19.6 107.6 FY09.
Hong Chang Group (HCG) acquired the company in 2005 after buying out China Genesis Energy – Price vs. HSI, Share Data GeoMaxima, which held a controlling 54.85% of Genesis Energy (then known as GeoMaxima Energy). The current management paid about HK$49m for this stake and has since slowly disposed of unprofitable businesses to refocus on upstream oil (HK$) (HK$m) 0.5 400 exploration and production. 0.4 350 0.4 300 0.3 250 Shareholder equity was HK$378m at end-FY04, before the change in management. 0.3 200 Over FY06-FY07, the company issued a further 778.25 million shares, raising 0.2 0.2 150 shareholder equity by HK$179m. However, it continued to make losses of more than 0.1 100 HK470m from FY05 to FY08 (mainly on the disposal of assets), driving shareholder 0.1 50 0.0 0 equity down 75% during this period. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
To increase its revenue base, the company has spent around RMB150m on a 30% Turnover Price HSI equity interest in a waste-incineration power plant in Datong. It expects this plus the current upstream oil operations to drive a turnaround to profit in FY09. Price – HK$ 0.22 52W high/low (HK$) Genesis has formed a strategic alliance with Frankfurt-listed waste-disposal expert 0.445/0.042 Shares in issue – millions ZhongDe Waste Technology, which designs, manufactures and installs pyrolytic, 4,386.15 Market cap – HK$m grate and rotary-kiln waste incinerators for the disposal of solid medical, municipal 969.34 3M avg. turnover – HK$m and industrial waste. 2.53 Major shareholders – % Through the partnership, the company has signed a non-legally binding Letter of Xiao Jing Xing 38.69 Intent with the Jilin government for the possible building and operation of Source: Bloomberg and Sun Hung Kai Financial waste-incineration and biomass-renewable-energy projects for electricity in the province. The indicative plan is to build an initial four waste-incineration power plants by 2011, with investment up to RMB5bn over the next five years.
Figure 1: Earnings Summary Recent Reports Date Year ending 31 Dec. FY06 FY07 FY08 FY09E Key Takeaways 23 April 2009 Net profit – RMBm (87.4) (7.7) (125.1) N/A Net-profit growth - % N/A N/A N/A N/A EPS – RMB fen (2.8) (0.2) (3.0) N/A This document is solely based on EPS growth - % N/A N/A N/A N/A publicly available information. This P/E – X N/A N/A N/A N/A report is intended as information DPS – RMB fen 0.0 0.0 0.0 N/A only and not as a recommendation Dividend yield - % 0.0 0.0 0.0 N/A for any stock. Sun Hung Kai
BVPS – RMB 0.0 0.1 0.0 N/A Financial does not provide research coverage or ratings for this P/B – X 7.0 3.5 7.4 N/A company in this report. Oper cash flow/share – RMB fen 0.2 (0.1) (0.3) N/A
Net debt (net cash) to share price - % 56.4 (12.0) (2.0) N/A Sources: Bloomberg and Sun Hung Kai Financial Note: Based on Bloomberg Consensus Michael Yuk + (852) 2203 9590
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor121ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Genesis Energy – Investment Highlights
Key investment positives Key investment negatives Possible turnaround in FY09. The company has made losses since Additional funds will be needed to support new projects. As at FY03 due to restructuring and continued disposal of legacy end-2008, cash on hand was only HK$19.6m, so the company will businesses, including its oil-transport business and natural-gas likely need additional funding for its expansion plans. For example, an pipelines. The company completed its disposals in FY08 and may turn estimated RMB220m will be needed to complete the additional wells profitable in FY09. for drilling the Xun Yi Oilfield project. Large oil reserves. Through joint ventures and equity interests, the New shares issued to purchase a 30% stake in Datong firm has access to over 940 million barrels of proven oil reserves in waste-incineration plant. The company issued 377 million new the U.S., China and Australia. shares at HK$0.45/share to purchase a 30% stake in the Datong waste plant in February 2009. Hence, selling pressure is likely to increase as Chinese government’s push for clean waste disposal. Genesis’s the share price nears HK$0.45. recent JV with Germany’s ZhongDe to provide waste-incineration projects in Jilin province brings exposure to the government’s drive Greater operating risk from expansion into waste-to-energy. The for environmentally cleaner waste disposal. If successful, more Datong venture will be Genesis’ first waste-incineration project. It has projects may be in the pipeline. no experience in building and operating waste-to-energy power facilities. Hence, operating risk is high. The company must continue Guaranteed profit from waste incineration. The company has to rely on partners and other stakeholders more experienced in this bought a 30% stake in the Datong waste-incineration project. The industry, such as Germany’s ZhongDe Waste Energy Technology AG vendor guarantees the project will net a profit of RMB70m during the Industry, for guidance on future waste-incineration projects. first 12 months (expected to start in July 2009). Genesis’s share of this would be about RMB21m. Genesis may consider increasing its stake Poor earnings record. The company has not been profitable since in the incineration power plant if returns are promising. FY03. The company has lost over 75% of its shareholder equity, even after new management took over in FY05. Liu Luo Yu Oilfield to pay back in five years. Genesis has acquired a 90% interest in Liu Luo Yu Oilfield for HK$59.9m. The company No track record of consistent sales growth. Genesis’ revenue is has the right to operate the oilfield for seven years (expiry in 2015), mainly derived from sales of natural gas and LPG at its refilling with oil produced sold at a fixed contract price of RMB3,300/ton. stations, which makes turnover susceptible to crude oil and natural gas Payback period for the project is about five years. prices fluctuations. With crude oil prices falling over 50% from one-year ago, Genesis’ revenue from its filling stations should decline Increasing oil production from Grassy Trails oilfield. The company in FY09. is reworking this oilfield in Utah, U.S. Oil production from this field may increase to 2.6 million barrels of oil (about US$117.3m @ Capital-intensive operations. Genesis’ operations are very capital US$45/bbl in revenue) upon completion of all rework and horizontal intensive. Capital expenditure equaled more that 65% of sales in drilling. FY08. The company will continue to spend heavily to expand its upstream oil & gas production and waste-to-power production Projects with good oil-producing potential. The company has a 50% businesses. interest in a JV project in Australia (Tasmania Project), which is currently in the drilling stage. The oil project has between 535 million No dividend. The company has never paid a dividend. Even if it were and 2.29 billion barrels of potential petroleum resources. to turn profitable in FY09, it may want to retain as much cash as possible for working capital or project expansion. Hence, a dividend payout is not foreseeable in the short to medium term. Source: Sun Hung Kai Financial
Figure 3: Genesis Energy – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Better-than-expected income from the Datong incineration plant in the Oil production from existing oilfields coming in less than planned, first 12 months of operation, thus exceeding the guaranteed profit of resulting in lower turnover from the oil & gas segment. RMB70m. A sharp decline in crude prices, which would affect revenue. Signing agreements with the Jilin provincial government to build the Equipment breakdowns or startup delays at the waste-incineration four planned waste-incineration plants currently under discussion. plant in Datong.
New environmental legislation that regulates the use of incineration for municipal waste.
Source: Sun Hung Kai Financial
Recent Company News Nil.
Sun Hung Kai Financial 122 20 Nov. 2009
Industry Dynamics Oil & gas production
China’s oil industry is very consolidated, comprising three stated-owned oil majors: PetroChina, Sinopec and CNOOC. PetroChina and Sinopec have a duopoly of oil and gas resources on land, while CNOOC has a monopoly on these resources off the coast of China.
Other smaller petroleum production players (or oil minors) can only produce oil in China through
Production sharing contracts (PSCs);
Providing services (such as drilling or EOR) to the oil giants, which include a stake of the oil produced, and/or
Signing cooperation agreements, where specific terms are stated for the production company to ultimately sell the oil and gas produced to the oil major.
Opportunities for smaller players arise if they can produce oil more economically from new or existing fields than the cumbersome oil giants. Furthermore, oil minors can develop, in collaboration with oil majors, concessions that are considered non-strategic to the big state oil companies.
To produce at lower costs than the oil majors, smaller companies might require special technology for which the majors do not yet have a firm grasp, such as deep-sea drilling and various enhanced oil recovery (EOR) techniques and/or technology.
Waste incineration
Waste is a huge problem for China. Regulated waste management is only available in cities, and waste is usually dumped on agricultural land in rural areas.
Municipal waste has grown dramatically with rapid urbanization. In major cities such as Beijing, Shanghai and Shenyang, waste volumes are rising 10%-20% p.a., with the national municipal total doubling to over 149 million tons over the past 10 years. Since municipal waste correlates with economic development, the waste problem will persist in coming years.
Most municipal waste is dumped as landfill, which is a burden on the environment. With some municipal authorities already having great difficulty in finding landfill sites, more are turning to incineration as an alternative.
China has 19 municipal incinerators with total capacity of 7,000 tonnes, based on the latest available data. Yet these plants only process 1.8% of all municipal solid waste. Hence, China is a vast potential market for new incineration plants.
However, waste-incineration growth has been stifled in developed nations such as the U.S., due to concerns about the toxic gases these facilities can produce and the view that waste incineration can be a disincentive for more environmentally friendly alternatives such as ‘clean waste’ or recycling.
Sun Hung Kai Financial 123 20 Nov. 2009
Figure 4: Genesis Energy – Profit and Loss Statement FY05-08 Year ended 31 Dec, RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 10.2 10.5 15.1 1,896.6 298.0 COGS (9.2) (8.6) (13.2) (659.6) 230.2 Gross Profit 1.0 1.9 1.9 1,236.9 397.9 Operating expenses (18.9) (38.3) (59.6) (238.1) 94.4 Other operating income 0.0 0.0 0.0 26.6 121.6 Operating profit (17.9) (36.4) (57.7) 1,025.5 N/A Finance expense (0.2) (9.0) (22.5) (91.3) 438.0 PBT (19.7) (45.1) (86.1) 933.1 N/A Tax 0.0 0.0 0.0 (226.5) N/A Net profit (14.0) (31.0) (77.9) 567.6 N/A EPS – RMB fen (0.7) (1.5) (3.4) 16.9 N/A Sources: The Company and Sun Hung Kai Financial
Figure 5: Genesis Energy – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec , % FY05 FY06 FY07 FY08 CAGR (%) Revenue 35.3 3.0 42.9 12,496.8 298.0 COGS 66.7 (7.0) 53.5 4,895.0 230.2 Gross Profit (51.0) 96.1 (4.3) 66,761.2 397.9 Operating expenses 13.4 102.5 55.5 299.7 94.4 Other operating income (96.4) (100.0) N/A N/A N/A Operating profit N/A N/A N/A N/A N/A Finance expense 85.3 4,369.3 149.0 306.3 438.0 PBT N/A N/A N/A N/A N/A Tax N/A N/A N/A N/A N/A Net profit N/A N/A N/A N/A N/A EPS N/A N/A N/A N/A N/A Sources: The Company and Sun Hung Kai Financial
Figure 6: Genesis Energy – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (90.4) (81.6) (87.7) (34.8) (73.6) Gross Profit 9.6 18.4 12.3 65.2 26.4 Operating expenses (184.8) (363.5) (395.6) (12.6) (239.1) Other operating income 0.4 0.0 0.0 1.4 0.4 Operating profit (174.8) (345.1) (383.3) 54.1 (212.3) Finance expense (2.0) (85.7) (149.3) (4.8) (60.5) PBT (192.3) (428.2) (571.8) 49.2 (285.8) Tax 0.0 0.0 0.0 (11.9) (3.0) Net profit (137.0) (294.1) (517.7) 29.9 (229.7) Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 124 20 Nov. 2009
Figure 7: Genesis Energy – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 10.6 10.6 460.5 760.2 121.4 Accounts receivable 6.9 0.0 7.2 999.4 568.0 Inventory 0.0 0.0 0.0 187.5 N/A Other current assets 5.6 6.2 20.4 2,044.6 275.0 Total current assets 23.0 16.7 488.2 3,991.6 211.4 Net fixed assets 240.2 272.4 394.1 2,124.4 129.8 Other long-term assets 120.6 227.9 412.7 13,136.3 246.2 Total assets 383.8 517.1 1,295.1 19,252.3 209.4 Short-term debt 24.5 139.8 184.6 1,603.2 148.1 Accounts payable 6.3 0.0 2.3 380.8 326.4 Other current liabilities 26.3 41.8 248.4 2,417.2 201.8 Total current liabilities 57.1 181.7 435.3 4,401.3 179.0 Long-term debt 189.2 229.2 34.0 35.2 39.1 Other long-term liabilities 10.0 6.6 33.8 2,366.8 N/A Total liabilities 256.3 417.5 503.1 6,803.3 201.8 Shareholders equity 127.5 99.6 792.0 12,449.0 214.0 Minorities 54.3 42.0 58.3 1,627.3 149.4 Total equity and liabilities 383.8 517.1 1,295.1 19,252.3 209.4 Sources: The Company and Sun Hung Kai Financial
Figure 8: Genesis Energy– Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 2.8 2.0 35.6 3.9 11.1 Accounts receivable 1.8 0.0 0.6 5.2 1.9 Inventory 0.0 0.0 0.0 1.0 0.2 Other current assets 1.5 1.2 1.6 10.6 3.7 Total current assets 6.0 3.2 37.7 20.7 16.9 Net fixed assets 62.6 52.7 30.4 11.0 39.2 Other long-term assets 31.4 44.1 31.9 68.2 43.9 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 6.4 27.0 14.3 8.3 14.0 Accounts payable 1.6 0.0 0.2 2.0 1.0 Other current liabilities 6.8 8.1 19.2 12.6 11.7 Total current liabilities 14.9 35.1 33.6 22.9 26.6 Long-term debt 49.3 44.3 2.6 0.2 24.1 Other long-term liabilities 2.6 1.3 2.6 12.3 4.7 Total liabilities 66.8 80.7 38.8 35.3 55.4 Shareholders equity 33.2 19.3 61.2 64.7 44.6 Minorities 14.1 8.1 4.5 8.5 8.8 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 125 20 Nov. 2009
Figuer 9: Genesis Energy – Key Ratios FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 9.6 18.4 12.3 65.2 26.4 Operating margin – % (174.8) (345.1) (383.3) 54.1 (212.3) Net margin – % (137.0) (294.1) (517.7) 29.9 (229.7) ROAA – % (4.7) (6.9) (8.6) 5.5 (3.7) ROAE – % (11.0) (27.3) (17.5) 8.6 (11.8)
Liquidity ratios Current assets/current liabilities – X 0.4 0.1 1.1 0.9 0.6 Liquid assets/current liabilities – X 0.2 0.1 1.1 0.2 0.4 Cash and securities/current assets – % 46.0 63.2 94.3 19.0 55.6 Cash flow from oper./curr. liabilities – % (30.8) (14.4) (8.8) 20.3 (8.5)
Other ratios Capex/sales – % 529.7 122.4 383.5 31.7 266.8 Capex/depreciation – % 1,869.6 487.8 1,801.5 944.3 1,077.8 Operating expenses/sales -% (184.8) (363.5) (395.6) (12.6) (257.2) Net debt (cash)/equity – % 159.4 360.0 (30.5) 7.1 112.2 Inventory/sales – % 0.0 0.0 0.0 9.9 3.3 Effective tax rate – % 0.0 0.0 0.0 24.3 8.1 Cash conversion cycle - days N/A N/A N/A 66.4 66.4
ROAA component analysis Revenue/average assets – % 3.4 2.3 1.7 18.5 6.5 COGS/average assets – % (3.1) (1.9) (1.5) (6.4) (3.2) Gross Profit/average assets – % 0.3 0.4 0.2 12.0 3.3 Operating expenses/average assets – % (6.4) (8.5) (6.6) (2.3) (5.9) Other operating income/average assets – % 0.0 0.0 0.0 0.3 0.1 Operating profit/average assets – % (6.0) (8.1) (6.4) 10.0 (2.6) Finance expenses/average assets – % (0.1) (2.0) (2.5) (0.9) (1.4) PBT/average assets – % (6.6) (10.0) (9.5) 9.1 (4.3) Tax/average assets – % 0.0 0.0 0.0 (2.2) (0.6) Net profit/average assets – % (4.7) (6.9) (8.6) 5.5 (3.7)
ROAE component analysis Revenue/average equity – % 8.0 9.3 3.4 28.6 12.3 COGS/average equity – % (7.2) (7.6) (3.0) (10.0) (6.9) Gross Profit/average equity – % 0.8 1.7 0.4 18.7 5.4 Operating expenses/average equity – % (14.8) (33.7) (13.4) (3.6) (16.4) Other operating income/average equity – % 0.0 0.0 0.0 0.4 0.1 Operating profit/average equity – % (14.0) (32.0) (12.9) 15.5 (10.9) Finance expenses/average equity – % (0.2) (8.0) (5.0) (1.4) (3.6) PBT/average equity – % (15.4) (39.7) (19.3) 14.1 (15.1) Tax/average equity – % 0.0 0.0 0.0 (3.4) (0.9) Net profit/average equity – % (11.0) (27.3) (17.5) 8.6 (11.8) Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 126 20 Nov. 2009
Hopefluent (733.HK)
China Realty Sector 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Hopefluent is a real estate agency mainly operating in mainland China. Commissions from primary and secondary real estate agency services made up 86% of 2008 Performance (%) 1m 3m 12m revenue, property management 9%, marketing and planning consultancy 4% and HSI 2.0 13.5 76.7 conveyance services 1%. The firm has more than 20 offices in major markets HSCEI 4.0 19.6 107.6 including Guangzhou, Dongguan, Foshan, Tianjin, Shanghai, Anhui, Hubei, Hunan and Shandong. Hopefluent – Price vs. HSI, Share Data
The company works closely with major property developers and has secured (HK$) (HK$m) exclusive agency rights for a number of projects. Over 2005-08, it was the sole agent 8.0 70 for well-known mainland developers including Vanke, Gemdale, KWG Property, 7.0 60 6.0 50 Sino-Ocean Land, China Everbright, Poly, Evergrande Real Estate and China 5.0 40 4.0 Merchants Property Development. It is also an agent for projects by Hong Kong 30 3.0 developers such as Sun Hung Kai Properties and China Overseas. 2.0 20 1.0 10 0.0 0 FY08 was not a good year, due to government tightening policies aimed at the Oct 07 Feb 08 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 property market and a slump in asset prices. Though the number of primary-market Turnover Price HSI projects reached a new high of 250, poor market sentiment and dropping prices cut total transaction value to HK$30.2bn, from FY07’s HK$32bn. Due to high operating leverage and aggressive expansion in Shanghai, the company had made a loss of Price – HK$ 2.13 HK$75.2m for the year, compared with a HK$110m profit in FY07. 52W high/low (HK$) 2.85/0.48 Shares in issue – millions 296.00 Market cap – HK$m 630.48 The mainland property market is currently volatile, with many uncertainties ahead, 3M avg. turnover – HK$m 3.03 but consumer confidence is starting to pick up and the government has introduced Major shareholders – % measures to boost the economy. Hopefluent aims to control costs and trim operating Fu’s Family Ltd. 35.76 expenses to help it survive the industry adjustment. For primary property agency, the Sources: Bloomberg and Sun Hung Kai Financial firm plans to secure more exclusive agency rights, and consolidate underperforming to boost economies of scale. It will slow down expansion in Shanghai, including cutting advertising expenses and the number of staff (from 4,600 to 2,500 for the secondary market).
This document is solely based on Figure 1: Earnings Summary publicly available information. This report is intended as information Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$ m 73.5 109.8 (75.2) 84.6 only and not as a recommendation Net-profit growth - % 25.7 49.5 N/A N/A for any stock. Sun Hung Kai EPS – HK¢ 32.9 44.5 (30.0) 29.0 Financial does not provide research EPS growth - % 11.9 35.3 N/A N/A coverage or ratings for this P/E - X 6.5 4.8 N/A 7.3 company in this report. DPS - HK¢ 11.5 14.5 0.0 8.0 Dividend yield - % 5.4 6.8 0.0 3.8 BVPS – HK$ 1.7 2.1 1.6 1.8 P/B - X 1.2 1.0 1.3 1.2 Oper cash flow/share - HK¢ 35.3 43.6 (15.2) 30.0 Net debt (net cash) to share price - % (46.6) (38.5) (14.0) N/A Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus
Eva Yip, CFA + (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor127ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Hopefluent – Investment Highlights
Key investment positives Key investment negatives
Strong network and brand in southern cities. Hopefluent has Primary-market sales depend on developers’ supply. operated in Guangdong for more than 10 years. It is currently the Primary-market sales provide more stable income due to greater exclusive agent for 180 property projects and has a ⅔ market share visibility of supply and prices from developers. However, this is in the provinces primary property market. It has solid brand in under the control of developers, which may opt to stop launching southern cities such as Foshan, Dongguan, Changsha and Hefei. new projects during property-price declines. Developers using more agents for primary property sales. In Business concentrated in Guangzhou. Despite moves to the past, developers have hired and trained additional staff for diversify the business, half of FY08 revenue was still from primary property sales, but this might not prove cost efficient Guangzhou in FY08. This increases the risks from any unfavorable going forward, especially after the introduction of the new labor policy moves by the provincial government. law. Marketing for primary projects incurs additional expenses, Low entry barriers. Apart from brand, licensed staff and capital, and is not a core skill for developers, hence the trend for there are few barriers to opening a new property agency. developers to use professional agencies rather than keeping this function in-house. Secondary commission rate trending down. The company charges 0.8%-3.0% commission for secondary transactions, which Over 300 primary market projects on hand. The company has could decline as the market matures. built up strong relationships with developers and has been growing very rapidly. The number of primary market projects increased to Unstable margins. Given the high operating margin, a decline in over 300 in 1H09, from less than 50 when it listed in 2004. sales would severely affect earnings. Comprehensive services. Hopefluent’s peers focus either on the primary or secondary markets, whereas the company provides a wide range of services, from the property development stage (site and development consultancy, marketing and promotion) to property management. These services supplement each other, and help the company get information more quickly about developers and potential clients. Expanding outside Guangzhou to avoid over-concentration. Revenue from outside Guangzhou made up 50% of FY08 sales, vs. 9% in FY01. High operating leverage in secondary-market business. The initial fixed cost of opening a new branch is HK$1m-HK$2m (varying by city) and running costs are HK$50,000-HK$150,000 per month (depending on branch size). High fixed costs compared with variable costs such as commission (several thousand dollars per deal) mean high operating leverage. This could mean benefits from a growing secondary property market and rising prices. Net cash. The company had net cash of HK$88m (HK$0.30/share) as at end-FY08. More prudent expansion plans, following the property slump in 2008. The number of branches was cut from 423 in 1H08 to 260 in 2H08 and almost half of staff were cut. Source: Sun Hung Kai Financial
Figure 3: Hopefluent – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Property price surge. Hopefluent’s high operating leverage makes Unexpected government interference in the property market. it a good play on a surge in property prices. Increases in mortgage lending rates, down-payment requirements or property-transaction taxes would increase purchasing costs for property. Harvest in northern cities. Hopefluent posted rapid expansion in 2007, when it initiated the primary-market business (mainly consultancy and marketing) in other northern cities. It usually takes 3-5 years for a business to mature, and earnings could surge if it can build up solid brand in these cities. Primary-property supply bottlenecks. The government’s tightening policies in 2008 caused many developers to delay projects, and this may cause a supply bottleneck. This would likely push up property prices and quicken the development of the secondary market. Both scenarios would benefit Hopefluent. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 128 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
Real estate agents in China
In Hong Kong, real estate agencies mainly match buyers and sellers, but in Guangzhou they provide a wider scope of services, including those for property-development projects. These include feasibility studies, architectural and development planning, promotion, marketing and sales. This means Guangzhou real estate agents derive revenue not only from sales commissions, but also from such ancillary services received during various phases of development projects.
Operating environment
Real estate agents rely heavily on commission income, which is driven by transactions in the primary and secondary markets. Property prices and floor area have increased steadily in Guangzhou since 1998, benefiting property agents substantially due to their high operating leverage. However, the uptrend reversed in late 2008, following tightening measures for the property market by the Chinese government. Prices in Guangzhou are currently at about the same levels as early 2007.
There are two main approaches to cooperation between agents and developers, with agents usually bidding to become exclusive agents for a property (unlike Hong Kong, where different agents can compete at the same site).
The underwriting method requires the agent to place guarantee deposits on property projects, but usually means a higher commission split once transaction value reaches a certain level, as the agent needs to guarantee an agreed amount of sales. Shanghai-based property agency E-house (EJ. US) uses this method.
The pure-agent method is more simple, with agents receiving fixed commissions on a property project. Most projects use this approach, which is considered more conservative.
Licensing requirements
Real estate agencies in China must obtain business licenses from the relevant administrative bureaus to conduct real estate agency services. A property agency should be an independent entity with its own organizational structure, a fixed place of business and possess the minimum required assets and capital.
There are three grades of licenses in Guangzhou, based on capital, number of staff and track record requirements. In 2008, there were 1,033 accredited agents, but only a small number, including GZ Hopefluent RP Consultancy, a subsidiary of Hopefluent, qualified in the first grade.
Sun Hung Kai Financial 129 20 Nov. 2009
Figure 4: Hopefluent – Profit and Loss Statement FY04-08 Year ending 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Revenue 310.2 452.2 773.7 683.9 43.3 COGS N/A N/A N/A N/A N/A Gross Profit N/A N/A N/A N/A N/A Operating expense (223.2) (348.2) (625.3) (726.3) 62.8 Operating profit 0.5 1.6 6.8 5.7 87.3 Finance expense 87.5 105.6 155.2 (36.7) N/A PBT (0.5) (0.4) (0.4) (2.7) 23.9 Tax 88.3 106.5 159.0 (61.4) N/A Net profit (19.4) (27.4) (41.1) (17.8) 6.4 EPS – HK¢ 58.4 73.5 109.8 (75.2) N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Hopefluent – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 91.2 45.8 71.1 (11.6) 43.3 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses 115.6 55.9 79.6 16.2 62.8 Other operating income 11.8 211.7 318.1 (15.5) 87.3 Operating profit 47.8 20.8 46.9 N/A N/A Finance expenses (51.6) (25.5) 5.6 517.8 23.9 PBT 48.9 20.7 49.2 N/A N/A Tax 40.2 41.3 50.0 (56.8) 6.4 Net profit 53.9 25.7 49.5 N/A N/A EPS 13.5 11.9 35.3 N/A N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Hopefluent – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (72.0) (77.0) (80.8) (106.2) (84.0) Other operating income 0.2 0.4 0.9 0.8 0.6 Operating profit 28.2 23.4 20.1 (5.4) 16.6 Finance expenses (0.2) (0.1) (0.1) (0.4) (0.2) PBT 28.5 23.6 20.6 (9.0) 15.9 Tax (6.3) (6.1) (5.3) (2.6) (5.1) Net profit 18.8 16.2 14.2 (11.0) 9.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 130 20 Nov. 2009
Figure 7: Hopefluent - Balance Sheet FY05-08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 173.3 253.4 210.4 155.9 6.9 Accounts receivable 93.9 148.3 212.0 196.4 44.3 Inventory 0.0 0.0 0.0 0.0 N/A Other current assets 28.6 33.1 57.7 38.5 40.9 Total current assets 295.8 434.8 480.1 390.9 22.3 Net fixed assets 121.3 152.1 227.5 268.6 38.8 Other long-term assets 2.4 5.5 15.4 15.5 37.7 Total assets 419.5 592.5 722.9 675.0 28.0 Short-term debt 7.6 7.8 7.8 36.7 49.3 Accounts payable 56.3 79.4 0.0 0.0 N/A Other current liabilities 16.9 25.0 151.8 93.1 70.1 Total current liabilities 80.8 112.3 159.6 129.8 28.3 Long-term debt 1.2 0.4 0.0 31.3 100.0 Other long-term liabilities 12.7 16.4 15.8 20.3 14.9 Total liabilities 94.7 129.1 175.4 181.3 31.0 Shareholders equity 324.8 463.4 547.5 493.7 27.0 Minorities 31.7 36.1 26.6 22.2 12.4 Total equity and liabilities 419.5 592.5 722.9 675.0 28.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Hopefluent – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 41.3 42.8 29.1 23.1 34.1 Accounts receivable 22.4 25.0 29.3 29.1 26.5 Inventory 0.0 0.0 0.0 0.0 0.0 Other current assets 6.8 5.6 8.0 5.7 6.5 Total current assets 70.5 73.4 66.4 57.9 67.1 Net fixed assets 28.9 25.7 31.5 39.8 31.5 Other long-term assets 0.6 0.9 2.1 2.3 1.5 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 1.8 1.3 1.1 5.4 2.4 Accounts payable 13.4 13.4 0.0 0.0 6.7 Other current liabilities 4.0 4.2 21.0 13.8 10.8 Total current liabilities 19.3 19.0 22.1 19.2 19.9 Long-term debt 0.3 0.1 0.0 4.6 1.2 Other long-term liabilities 3.0 2.8 2.2 3.0 2.7 Total liabilities 22.6 21.8 24.3 26.9 23.9 Shareholders equity 77.4 78.2 75.7 73.1 76.1 Minorities 7.5 6.1 3.7 3.3 5.2 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 131 20 Nov. 2009
Figure 9: Hopefluent – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin – % N/A N/A N/A N/A N/A Operating margin – % 28.2 23.4 20.1 (5.4) 16.6 Net margin – % 18.8 16.2 14.2 (11.0) 9.6 ROAA – % 17.4 14.5 16.7 (10.8) 9.5 ROAE – % 22.7 18.6 21.7 (14.4) 12.2
Liquidity ratios Current assets/current liabilities – X 3.7 3.9 3.0 3.0 3.4 Liquid assets/current liabilities – X 2.1 2.3 1.3 1.2 1.7 Cash and securities/current assets – % 58.6 58.3 43.8 39.9 50.1 Cash flow from oper./curr. liabilities – % 69.2 70.2 67.4 (29.4) 44.4
Other ratios Capex/sales – % 20.5 12.3 13.9 14.2 15.2 Capex/depreciation – % 353.3 227.1 280.8 236.4 248.1 Operating expense/sales -% (72.0) (77.0) (80.8) (106.2) (88.0) Net debt/equity (net cash) – % (50.6) (52.9) (37.0) (17.8) (35.9) Inventory/sales – % 0.0 0.0 0.0 0.0 0.0 Effective tax rate – % 22.0 25.7 25.9 (28.9) 7.6 Cash conversion cycle – days N/A N/A N/A N/A N/A
ROAA component analysis Revenue/average assets – % 92.5 89.4 117.6 97.8 99.3 COGS/average assets – % N/A N/A N/A N/A N/A Gross profit/average assets – % N/A N/A N/A N/A N/A Operating expenses/average assets – % (66.6) (68.8) (95.1) (103.9) (83.6) Other operating income/average assets – % 0.2 0.3 1.0 0.8 0.6 Operating profit/average assets – % 26.1 20.9 23.6 (5.2) 16.3 Finance expenses/average assets – % (0.2) (0.1) (0.1) (0.4) (0.2) PBT/average assets – % 26.3 21.1 24.2 (8.8) 15.7 Tax/average assets – % (5.8) (5.4) (6.3) (2.5) (5.0) Net profit/average assets – % 17.4 14.5 16.7 (10.8) 9.5
ROAE component analysis Revenue/average equity – % 120.6 114.7 153.1 131.4 129.9 COGS/average equity – % N/A N/A N/A N/A N/A Gross profit/average equity – % N/A N/A N/A N/A N/A Operating expenses/average equity – % (86.8) (88.3) (123.7) (139.5) (109.6) Other operating income/average equity – % 0.2 0.4 1.3 1.1 0.8 Operating profit/average equity – % 34.0 26.8 30.7 (7.0) 21.1 Finance expenses/average equity – % (0.2) (0.1) (0.1) (0.5) (0.2) PBT/average equity – % 34.3 27.0 31.5 (11.8) 20.3 Tax/average equity – % (7.5) (7.0) (8.1) (3.4) (6.5) Net profit/average equity – % 22.7 18.6 21.7 (14.4) 12.2 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 132 20 Nov. 2009
Huabao (336.HK) Flavors & Fragrances Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Huabao is the leading flavor and fragrance producer in China by sales and the largest listed company in the Asia Pacific food and fragrances industry. Its main businesses Performance (%) 1m 3m 12m are R&D, production and sales for tobacco flavors (used in cigarettes), food flavors HSI 1.2 5.6 67.4 (beverages, dairy, instant foods and other processed/packaged foods), and fine HSCEI 4.0 4.0 115.4 fragrances (cosmetics and household products). Huabao is unusual in that it has two well-known China-registered trademarks: Kongque (food flavors) and Xideng (the Huabao – Price vs. HSI, Share Data leading tobacco flavor by market share).
Huabao, along with its subsidiaries, has 16 production plants and two R&D centers. It (HK$) (HK$m) 10.0 1,600 has the strongest R&D capability in China, with the only state-recognized technical 1,400 8.0 center, and has a patented partition and purification technology for producing raw 1,200 6.0 1,000 materials. As at 31 March 2009, production capacity totaled 26,600 tons and is 800 increasing as the firm undertakes aggressive M&A. Recent acquisitions include 4.0 600 400 100% of Wealth King Investment Group, 51% of Amber and the Group had entered 2.0 200 into a strategic cooperation agreement with Hongta Tobacco Group. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 Tobacco. Huabao is by far the market leader in tobacco flavorings, with a 35-40% market share by revenue. This is attributable to not only Huabao’s ‘Big Customer, Turnover Price HSI Big Brand’ development strategy, but also to being the core supplier for eight of the top 10 tobacco brands in China. Huabao is best placed to benefit from the current Price – HK$ 8.73 consolidation in a tobacco industry that represents ⅓ of global cigarette consumption. 52W high/low (HK$) 9.185/4.413 Shares in issue – millions 3,108.97 Food. Customers include well-known F&B brands such as Yurun and Master. Direct Market cap – HK$m 26,395.17 sales contribute 25% of revenues, up from 20% last year, and distributor sales 75%. 3M avg. turnover – HK$m 68.89 This segment is closely tied to a consumer F&B market characterized by 1) high Major shareholders – % fragmentation, 2) rapidly growing consumption and 3) increasing demand for Chu Lam Yiu 51.20 customized flavors. Source: Bloomberg and Sun Hung Kai Financial FY09 results. Net profit grew 29.3% yoy to HK$1.1bn and turnover rose 36.6% yoy. 20.4% of this increase was organic growth, and rest driven by M&A. The overall gross margin increased 0.5 ppt yoy to 75.4%. Tobacco-flavoring sales surged 33.4% yoy to HK$1,654m (85.3% of total sales) and have been climbing at a CAGR of 34.3% in the past three years. Food-flavors sales increased 28.1% yoy to HK$219m.
Recent Reports Date Figure 1: Earnings Summary Growth Prospect Sill Smoking 29 Sep 2009 Year ended 31 March FY07 FY08 FY09 FY10E Net profit – HK$m 567.0 862.1 1,114.7 1,320.8
Net-profit growth - % 100.3 52.0 29.3 18.5 This document is solely based on publicly available information. This EPS – HK¢ 19.9 28.1 36.2 42.4 report is intended as information EPS growth - % 73.6 41.3 28.8 17.1 only and not as a recommendation P/E – X 43.8 31.0 24.1 20.6 for any stock. Sun Hung Kai DPS – HK¢ 5.6 8.3 10.8 12.8 Financial does not provide research
Dividend yield - % 0.6 1.0 1.2 1.5 coverage or ratings for this company in this report. BVPS – HK$ 0.4 0.6 0.9 1.2
P/B – X 24.8 13.7 9.5 7.2
Oper cash flow/share – HK¢ 22.4 28.9 36.9 42.0
Net debt (net cash) to share price - % (3.2) (3.6) (3.1) (6.2) Sources: Bloomberg and Sun Hung Kai Financial. Eva Yip, CFA Note: Based on Bloomberg Consensus + (852) 2203 9587
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor133ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Huabao – Investment Highlights
Key investment positives Key investment negatives Few competitive threats. Due to the high standard of skilled Rising effective tax rate. Huabao’s effective tax rate rose to 6.8% researchers, chemists and flavorists needed, Huabao faces little from 3.8% in FY08. Management guides it to further rise to challenge in defending its market share. Clients have high 12%-13% in FY10E and 15%-16% in FY11E. The operating switching costs for suppliers. Since flavorings are tailor-made to margin could be under pressure. customers’ products, it is hard for them to switch flavorings without risking a change in taste. Largely depends on the performance of its major cigarette customers. Huabao already has a 35%-40% market share in the Highly defensive against slowdown and competitors. Its tobacco flavor industry and with the top 10 brands all current flavoring business is highly defensive. Packaged foods and daily customers, we expect further market-share gains will slow. chemicals should stay in demand regardless of economic Prospects to a large extent depend on the performance of the top performance. Smokers will continue to smoke. China accounts for cigarette brands. ⅓ of the global smoking population, giving Huabao the biggest Acquisition achieved little revenue growth. Wealth King, the share of the world’s smokiest market. Earnings visibility is high. It tobacco flavor company Huabao acquired last July, reported a also faces very little threat from new entrants. Flavors and substantial improvement in FY09 margins, but little growth in fragrances need professional flavorists with specialized techniques turnover. If this continues, it may be difficult for Huabao to and there is very high customer stickiness. Tobacco companies are achieve its revenue-growth targets. highly unlikely to risk the flavor of their cigarettes by changing suppliers. This gives great bargaining power. Margins of over 70% Limited room for gross-margin expansion. Huabao is speeding are sustainable. up its development in the food segment, which commands much lower margins than tobacco. Integration with an acquired company Healthy organic growth. Huabao recorded 36.6% revenue growth that commands much lower margins should also be noted. SG&A yoy, with organic revenue growth at 20.4%. expenses rose to 15.5% of group sales from 15.1% in FY08. Also Strong net cash. Huabao has no bank debt and its operating cash with RMB appreciation and the effective tax rate increasing, improved to HK$1.1bn in FY09 from HK$871m last year. margins may peak in 1-2 years. Inventory days were up by 33 to 135, but the impact on working Reliance on one business. Tobacco flavoring contributes 87% of capital was offset by the improvement of 9 days in accounts total turnover. Although Huabao is diversifying into food flavors receivable to 74. Net cash rose to HK$1.1bn, from HK$971m at and fine fragrances, its reliance on tobacco flavorings means heavy end 2008. exposure to any unfavorable policy changes. Tobacco producers Tobacco-flavoring margins immune from raw-material cost are 100% state-owned and highly subject to policy changes. hikes. Despite previous inflationary concerns, input costs have Rising monopoly, difficult to increase market share. been stable. This was due to high integration and cost reductions Acquisitions are the major sales-growth driver for tobacco from internal raw-material production capacity provided by the fragrances, and the company’s rising monopoly means a widening four plants of Wuxi Huahai. In FY09, the segmental gross margin gap over the operating scale of its acquisition targets. Greater remained stable at 75%. organic growth or more acquisitions may be needed to further Margins immune from price pressure. Huabao’s advantageous increase market shares and sales. relationships with strong tobacco brands relieve price pressure and Rising health awareness. Although not expected to happen in the help sustain a high gross margin of 75%. Strong tobacco brands are next 15 years or so, rising health awareness in China may lead to less sensitive to price, especially since fragrances cost only a lower demand for cigarettes or more regulations. marginal 2% of total tobacco-production costs. Leading player, best positioned to benefit from industry trends. Cigarettes with more than 15 mg of tar/stick have been prohibited in China. Tar content in domestic cigarettes has dropped to an average of 13.5 mg/stick and the government targets an average tar content of 12 mg/stick. Lowered tar levels require more flavoring to maintain taste. Research has shown that an increase of 10%-20% in tar fragrance will be needed if tar levels decrease to 12 mg/stick. On top of that, consumers have been trading up to higher-end brands. Huabao will benefit from this as tobacco flavors play a crucial role in high-end cigarettes. Defensive against low-margin food flavorings. To defend against a surge in raw-material costs due to inflation and lower margins in food flavoring, the firm has increased direct sales. With a 9-ppts higher margin than distributional sales, Huabao increased its direct sales from 20% in FY07 to 25% in FY08 and 28% in FY09. In addition, it is also offering tailor-made value-added products, launching 82 new types of products last year. Its product mix, comprising mainly sweet products, is moving towards localized, savory products through its establishment of Guangzhou Huabao in June 2008. Increasing selling prices is still an option if costs rise. Strong M&A potential and efficient integration. It is the best-positioned to benefit from the sector’s high fragmentation (more than 600 players, with only 20 generating revenues more than RMB100m). Huabao’s financial position (net cash of HK$1bn as at 30 Sep. 2008) and leading position mean plentiful M&A opportunities, a key growth driver. Apart from Amber, Huabao acquired Wealth King in 1H09, a major tobacco-flavors supplier in China with sales of over RMB100m. It contributed 13.3% of the tobacco-flavors revenue growth in FY09. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 134 20 Nov. 2009
Figure 3: Huabao – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Better-than-expected results from food flavors. Higher-than-expected raw-material price hikes for food flavors. Successful acquisitions of food and fine-fragrance clients. Sooner-than-expected peak in tobacco flavors. Better-than expected results from entering fine fragrances. Worse-than-expected performance of newly acquired companies. Softening raw-material costs. Higher-than-expected margins and sales growth for tobacco flavors. Source: Sun Hung Kai Financial
Recent Company News
8 Oct. 2009: Placing of existing shares by chairman
Huabao announced that its chairman Ms. Chu has hired J P Morgan to place a total of 150 million shares held by her wholly owned company Mogul Enterprises at HK$7.75/share.
SHKF comment: Investors were cautious about the placement, and the stock dropped more than 5% the day of the announcement. This was the second time Ms. Chu has sold down the company’s shares this year, following the previous placement 190.5 million shares in April. We still see Huabao’s fundamentals as good, and growth momentum should remain strong.
Industry Dynamics
China’s flavors and fragrance industry remains relatively dispersed, with over 600 companies. This sector offers prospects for consolidation, especially in tobacco flavors. Favorable trends in China’s tobacco industry include:
Consolidation
Since China joined the WTO in 2001, there have been rising expectations that it will open up its tobacco market. Although this is not likely in the near future, the STMA has prepared leading domestic players to compete with multinationals by pushing for consolidation. The STMA targets to cut the number of tobacco companies to 10 and has restricted new tobacco brands from entering the market. There were 185 cigarette factories in 2001, but this declined to just 31 in 2007. The number of brands fell from around 1,800 in 2001 to just 224 in 2007. The top 10 brands in China have also expanded their total market share to 40% in 2007, up from 37.8% a year earlier.
As a key supplier to eight of the top 10 brands, Huabao will likely continue to outpace the industry’s average growth of 4%-5% p.a. (its tobacco-flavor sales have posted over a 30% CAGR in the past three years). Brands with annual volume sales of over 1 million master cases numbered 13 in 2007, up from eight in 2006. Recently, Honghe and Hongyun agreed to merge to form the fourth largest tobacco firm in the word (biggest in the mainland).
Falling tar content in cigarettes
The government has prohibited cigarettes with more than 15 mg of tar/stick in China and targets an average tar content of 12 mg/stick. Tar content in domestic cigarettes has dropped to an average of 13.5 mg/stick from 14.3 mg/stick in 2003 and is continuing to downtrend. The lower the tar levels, the more flavoring a cigarette needs to maintain its taste. Research has shown that 10%-20% more tar fragrance will be needed if tar levels decrease to 12 mg/stick.
Sun Hung Kai Financial 135 20 Nov. 2009
Tobacco industry trending toward higher-end products
Production volumes of low-end tobacco products decreased 7.6% to c. 700 billion in 2007. Zhonghua and Furongwang, two typical high-end brands, recorded rapid sales growth. Huabao will benefit from this, as tobacco flavor plays a crucial role in high-end cigarettes.
Figure 4: Huabao – Profit and Loss Statement FY06-FY09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 779.0 1,013.2 1,419.1 1,938.4 197.6 COGS (410.5) (309.1) (356.0) (477.5) 114.4 Gross profit 368.5 704.1 1,063.1 1,461.0 414.1 Operating expenses (80.5) (144.5) (214.3) (300.8) 230.7 Other operating income 16.1 4.0 7.5 22.4 829.3 Operating profit 304.1 563.7 856.3 1,182.5 N/A Finance expenses (6.5) (2.4) 0.0 (7.9) 7.5 PBT 300.0 578.7 904.0 1,211.9 N/A Tax (10.0) (1.4) (34.4) (82.2) 513.5 Net profit 283.1 567.0 862.1 1,114.7 N/A EPS – HK¢ 11.5 19.9 28.1 36.2 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Huabao – Profit and Loss Statement (Year on Year Growth) FY06-FY09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR Revenue 3,053.5 30.1 40.1 36.6 197.6 COGS 1,715.6 (24.7) 15.2 34.1 114.4 Gross profit 17,513.9 91.1 51.0 37.4 414.1 Operating expenses 3,103.3 79.4 48.3 40.4 230.7 Other operating income 537,100.0 (75.0) 85.2 199.8 829.3 Operating profit N/A 85.4 51.9 38.1 N/A Finance expenses 8.7 (62.3) (100.0) N/A N/A PBT N/A 92.9 56.2 34.1 N/A Tax 17,086.2 (85.6) 2,296.1 138.9 513.5 Net profit N/A 100.3 52.0 29.3 N/A EPS N/A 73.6 41.3 28.8 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Huabao – Profit and Loss Statement (Common Size) FY06-FY09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (52.7) (30.5) (25.1) (24.6) (33.2) Gross profit 47.3 69.5 74.9 75.4 66.8 Operating expenses (10.3) (14.3) (15.1) (15.5) (13.8) Other operating income 2.1 0.4 0.5 1.2 1.0 Operating profit 39.0 55.6 60.3 61.0 54.0 Finance expenses (0.8) (0.2) 0.0 (0.4) (0.4) PBT 38.5 57.1 63.7 62.5 55.5 Tax (1.3) (0.1) (2.4) (4.2) (2.0) Net profit 36.3 56.0 60.8 57.5 52.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 136 20 Nov. 2009
Figure 7: Huabao – Balance Sheet FY06-FY09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 180.9 858.5 971.6 1,125.2 232.2 Accounts receivable 354.4 319.5 415.9 493.1 410.3 Inventory 124.7 61.9 136.9 215.7 N/A Other current assets 38.6 11.6 13.3 33.2 251.4 Total current assets 698.5 1,251.5 1,537.6 1,867.2 268.0 Net fixed assets 159.2 169.5 223.8 336.9 988.5 Other long-term assets 18.0 42.0 716.0 1,547.4 N/A Total assets 875.7 1,463.0 2,477.4 3,751.6 337.9 Short-term debt 0.0 0.0 0.0 299.1 N/A Accounts payable 157.3 80.3 162.3 160.8 133.4 Other current liabilities 218.0 241.8 262.4 263.7 273.5 Total current liabilities 375.3 322.1 424.7 723.6 221.5 Long-term debt 48.6 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 0.0 30.7 93.8 N/A Total liabilities 423.8 322.1 455.4 817.4 231.5 Shareholders equity 451.9 1,140.9 2,022.0 2,934.2 440.7 Minorities 54.2 60.9 69.7 93.8 N/A Total equity and liabilities 875.7 1,463.0 2,477.4 3,751.6 337.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Huabao – Balance Sheet (Common Size) FY06-FY09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 20.7 58.7 39.2 30.0 37.1 Accounts receivable 40.5 21.8 16.8 13.1 23.1 Inventory 14.2 4.2 5.5 5.7 7.4 Other current assets 4.4 0.8 0.5 0.9 1.7 Total current assets 79.8 85.5 62.1 49.8 69.3 Net fixed assets 18.2 11.6 9.0 9.0 11.9 Other long-term assets 2.1 2.9 28.9 41.2 18.8 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 8.0 2.0 Accounts payable 18.0 5.5 6.6 4.3 8.6 Other current liabilities 24.9 16.5 10.6 7.0 14.8 Total current liabilities 42.9 22.0 17.1 19.3 25.3 Long-term debt 5.5 0.0 0.0 0.0 1.4 Other long-term liabilities 0.0 0.0 1.2 2.5 0.9 Total liabilities 48.4 22.0 18.4 21.8 27.6 Shareholders equity 51.6 78.0 81.6 78.2 72.4 Minorities 6.2 4.2 2.8 2.5 3.9 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 137 20 Nov. 2009
Figure 9: Huabao – Key Ratios FY06-FY09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 47.3 69.5 74.9 75.4 66.8 Operating margin – % 39.0 55.6 60.3 61.0 54.0 Net margin – % 36.3 56.0 60.8 57.5 52.6 ROAA – % 63.9 48.5 43.8 35.8 48.0 ROAE – % 124.3 71.2 54.5 45.0 73.8
Liquidity ratios Current assets/current liabilities – X 1.9 3.9 3.6 2.6 3.0 Liquid assets/current liabilities – X 0.5 2.7 2.3 1.6 1.7 Cash and securities/current assets – % 25.9 68.6 63.2 60.3 54.5 Cash flow from oper./curr. liabilities – % 85.9 198.5 208.7 156.8 162.5
Other ratios Capex/sales – % 6.6 1.7 2.1 4.6 3.8 Capex/depreciation – % 656.1 172.5 191.2 306.4 223.4 Operating expense/sales -% (10.3) (14.3) (15.1) (15.5) (15.0) Net debt/equity (net cash) – % (35.7) (75.2) (48.1) (28.2) (50.5) Inventory/sales – % 16.0 6.1 9.6 11.1 9.0 Effective tax rate – % 3.3 0.2 3.8 6.8 3.6 Cash conversion cycle – days 83.1 55.5 94.0 114.3 87.9
ROAA component analysis Revenue/average assets – % 175.9 86.6 72.0 62.2 99.2 COGS/average assets – % (92.7) (26.4) (18.1) (15.3) (38.1) Gross profit/average assets – % 83.2 60.2 54.0 46.9 61.1 Operating expenses/average assets – % (18.2) (12.4) (10.9) (9.7) (12.8) Other operating income/average assets – % 3.6 0.3 0.4 0.7 1.3 Operating profit/average assets – % 68.6 48.2 43.5 38.0 49.6 Finance expenses/average assets – % (1.5) (0.2) 0.0 (0.3) (0.5) PBT/average assets – % 67.7 49.5 45.9 38.9 50.5 Tax/average assets – % (2.3) (0.1) (1.7) (2.6) (1.7) Net profit/average assets – % 63.9 48.5 43.8 35.8 48.0
ROAE component analysis Revenue/average equity – % 342.1 127.2 89.7 78.2 159.3 COGS/average equity – % (180.3) (38.8) (22.5) (19.3) (65.2) Gross profit/average equity – % 161.8 88.4 67.2 59.0 94.1 Operating expenses/average equity – % (35.4) (18.1) (13.5) (12.1) (19.8) Other operating income/average equity – % 7.1 0.5 0.5 0.9 2.2 Operating profit/average equity – % 133.5 70.8 54.1 47.7 76.5 Finance expenses/average equity – % (2.8) (0.3) 0.0 (0.3) (0.9) PBT/average equity – % 131.8 72.7 57.2 48.9 77.6 Tax/average equity – % (4.4) (0.2) (2.2) (3.3) (2.5) Net profit/average equity – % 124.3 71.2 54.5 45.0 73.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 138 20 Nov. 2009
Inspur International (596.HK) Software Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Inspur is one of the top three ERP software providers in China, with more than a 20% market share in high-end ERP software. It develops enterprise/ERP solutions and Performance (%) 1m 3m 12m software outsourcing for private and government organizations. It listed in 2004, with HSI 2.0 13.5 76.7 low margins of 3%-4% due to the inclusion of an IT-products distribution business. HSCEI 4.0 19.6 107.6 The firm switched to IT services and software outsourcing in 2006 after acquiring this business from its parent. Many clients are large SOEs such as China Mobile and Inspur International– Price vs. HSI, Share China Telecom and government bodies such as tax authorities. Data Sales increased 30% p.a. on average over 2005-08, and growth should stay high on rising product demand, market-share expansion, overseas expansion and potential (HK$) (HK$m) 2.0 700 asset injections. 600 1.5 500 Market share should expand; many SOEs need to invest in IT to improve operating 400 1.0 efficiency and strengthen internal controls, and the central government is also 300 encouraging the use of homegrown solutions providers. The firm added Sinopec, 0.5 200 China Railway Engineering Corporation, First Automotive Group Corporation and 100 0.0 0 China Grain Reserves Corporation as new customers last year. Strong government Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 links should help Inspur secure further government contracts. Turnover Price HSI ERP use in the private sector is still in its infancy, but companies increasingly recognize its usefulness in improving long-term efficiency, which should improve Price – HK$ 1.07 adoption. Inspur should benefit from prospective industry growth. 52W high/low (HK$) 1.67/0.44 Shares in issue – millions Microsoft holds convertible preference shares and would have a 27% stake on 3,770.12 Market cap – HK$m conversion. Inspur is the largest outsourcing provider to Microsoft in China and will 4,034.03 3M avg. turnover – HK$m outsource US$80m of orders (equivalent to about 25% of FY08 sales) from June 44.38 Major shareholders – % 2008 to 2011. The firm can leverage the technology of its strategic partner to enrich Inspur Electronic Ltd 35.92 its products and cater for government departments’ demand for differentiated Source: Bloomberg and Sun Hung Kai Financial back-office software. This should also help maintain its competitive edge in customizing localized solutions for government projects.
This document is solely based on Figure 1: Earnings Summary publicly available information. This Year ending 31 Dec. FY07 FY08 FY09E FY10E report is intended as information Net profit – HK$m 25.2 38.8 311.6 386.5 only and not as a recommendation Net-profit growth – % 3.9 54.2 703.2 24.0 for any stock. Sun Hung Kai EPS – HK¢ 1.0 1.5 10.2 8.3 Financial does not provide research EPS growth – % (7.5) 49.5 590.5 (18.8) coverage or ratings for this P/E – X 108.1 72.3 10.5 12.9 company in this report. DPS – HK¢ 0.3 0.0 2.0 2.4 Dividend yield – % 0.3 0.0 1.9 2.2
BVPS – HK 0.1 0.1 0.3 0.4
P/B – X 17.4 11.4 4.2 2.6
Operating cash flow per share – HK¢ (3.2) 0.1 13.0 12.0 Net debt (net cash)/ price – % 1.1 0.5 (9.1) (25.0) Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus
Eva Yip, CFA + (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor139ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Inspur also offers software-outsourcing services to European, U.S. and Japanese companies. This segment generates the highest margins (gross margin 40% vs. the average of 28%). The firm has ranked in Fortune’s Global Outsourcing 100 for three consecutive years, and was No. 38 in 2008. Outsourcing only makes up c. 10% of sales, but growth potential is enormous and contributions are likely to pick up. China’s know-how is now comparable to India, the current global IT-services outsourcing center, but labor costs are 30%-40% lower. Microsoft’s investment in Inspur strengthens the brand and should help bring in more international business opportunities. Inspur is negotiating deals with new overseas customers; these should help raise the proportion of overseas income (less than 3% in FY08). The net margin soared from 3% in FY05 to 17% in FY08, and could expand further due to rising economies of scale. Most costs are front-loaded, meaning minimal capex for current projects. Free cash flows are expected to remain steady (HK¢9 in FY08) due to maintenance fees from existing projects and little capex. Possible asset injections from the parent company are another growth area. The parent, Inspur Group, with annual sales of RMB20bn, holds a high-margin software-outsourcing business. Inspur, as the listed flagship of the group, could see further injections of valuable assets at attractive valuations. At end-April, it acquired a stake in a high-growth solutions provider (103% sales growth in FY08) at just 5X earnings. The firm had net cash of HK$600m, or HK¢20 per share, as at end-2008. Outstanding options for employees equaled 13% of outstanding shares as at end-2008. Although this should eventually dilute EPS, such incentives are usually needed to retain key talents, especially in China where the supply of IT professionals is limited.
Recent Company News
4 Sep.: Acquires digital-media unit from parent for HK$30m. The acquisition was priced at a 5.0X 2009E P/E, based on the guaranteed-earnings agreement. The newly acquired business unit mainly provides IT solutions to digital-cable TV systems and video-on-demand (IPTV) for provincial cable operators, including the migration of existing analog TV to digital. SHKF comment. This is the second parent asset acquisition since the share placement in May. There should be only a minimal contribution of 2%-3% to earnings this year. However, the deal may help strengthen the firm’s focus on IPTV, which is still in its infancy in China. Demand for IPTV solutions could be significant over a longer timescale. Only 2 million households currently subscribe to IPTV in China. Though the acquisition was at 5X forecast earnings, vs. the firm’s own 10X, it is unclear whether this is cheap as it is difficult to price a software company using P/E. While there is a profit guarantee, a lack of new customers or project upgrades could cause future earnings to decline substantially.
Sun Hung Kai Financial 140 20 Nov. 2009
Figure 2: Inspur International– Investment Highlights
Key investment positives Key investment negatives Rapid transformation. Leading developer of high-end software EPS and ROE dilution from potential share placements. Inspur and solutions in China. Through parent asset injections in the past has previously funded acquisitions of assets from its parent and two years, it has transformed from a low-margin trader into a retained key management through issuing consideration shares and high-margin software development and solutions firm. options. The number of outstanding shares increased 10% p.a. from FY06 to FY08. Track record of sales growth (20% CAGR in FY05-08) set to continue, due to 1) new customers, 2) new products and 3) greater Hard to determine whether the parent asset injection is cheap. customer penetration. Inspur signed deals with Sinopec, Sinograin, The parent has injected soft assets, with revenues likely on a China Railway Engineering, First Automobile Works, China one-off basis (despite the profit guarantee). Historical P/E may not Communication Construction and China State Construction value the acquisition accurately. This may leave the impression Engineering in 2008. It also launched upgraded ERP-GS5.0 that the parent is taking advantage of the listed company by products that have been applied by customers in various fields. placing shares at a historical high to acquire assets from the parent. Continued growth in corporate software. Enterprise applications Loss of management credibility could take a long time recover. and ERP software in China are still in their infancy; growth should The 1H09 results (only 12% yoy revenue growth) damaged exceed overall software spending (30% in 2008). 27% of IT management credibility, as it guided for 30%-plus growth in May. spending is on software in China vs. 61% globally. It did not provide a segment breakdown, which means investors cannot reconcile the difference. Also, the firm made a stock Government stimulus policy spurs demand. Corporate buyers of placement at the share-price peak of HK$1.60. software are entitled to tax refunds and increasing subsidies, while business-tax waivers encourage domestic software firms. M&A may not be realized due to demanding valuations and smaller peers getting more funding channels. With the gradual Growing software-outsourcing market in China. India accounts recovery in the domestic economy, valuations of acquisition targets for 70% of global outsourcing of enterprise solutions and 90% of have risen. While the reopening of A-share IPOs allows for more customized solutions in Europe and the U.S. China has just as small peers to get funding, it makes it harder to conduct M&A, a much talent as India, but with 30%-50% lower costs. key growth driver. More asset injections. Inspur Group, the largest SOE IT services No confirmation on tax-collection machine contracts, despite provider, is restructuring and will inject existing projects into the winning nine of the 11 provincial and municipal tenders. listed company so it can become the flagship IT-services arm. Lack of earnings visibility for investors. The firm only reveals Strong in IT outsourcing services. Inspur had been listed in new clients’ names, but no further details, such as order size or Fortune’s Global Outsourcing 100 for three straight years and is time frame of projects. the largest domestic software outsourcer for Microsoft. Delays by provincial governments in installing enterprise Strong links with government compared with peers. Inspur is solutions. There may be political resistance by SOEs and local government owned. The central government encourages local governments against upgrading their IT systems, as this would authorities and SOEs to improve information systems by increase transparency, accountability and fraud detection. purchasing more homegrown ERP. Over 50% of revenues are from government or related bodies. Shift in government policy. The government might foster another state-owned IT company, which may result in market-share loss. Enormous potential in tax-industry IT services To strengthen tax collection, the central government will mandate the use of Technology advancement by peers. government-approved tax-control cashiers in businesses such as ROE dilution from asset acquisitions. Given the firm’s already stores and restaurants by 2012 (estimated cumulative market size high ROE (58% in FY08), acquisitions may lower ROE. of RMB60bn-RMB100bn over the next few years and product life cycle of 4-5 years, vs. sales of RMB184m in 1H09). Inspur is the ERP products for SMEs lack differentiation. Inspur lacks market leader and has a solid position due to 1) having the only expertise in the SME market. domestic 32-bit SOC chip certified by State Tax Bureau (68% cheaper than imports) and 2) lower unit-production costs due to Lacks distribution network for SME ERP products. Indirect large economies of scale. It has a 25% market share in China. sales channels such as product distributors generate higher margins (80% vs. 60% from direct sales). Strong partnership with Microsoft, which would hold a 27% stake on conversion of its convertible preferred shares. Microsoft has outsourced US$80m of orders to Inspur for FY09-FY10 (equal to 25% of FY08 sales). Rising profitability. The net margin has risen from 3% in FY06 to 17% in FY08, as R&D costs have been gradually amortized. High ROA on asset-light business model. Most assets are intangible, with low inventory and account receivables. The FY08 ROA was 29%. Free-cash-flow generating business. Customers generate maintenance fees over a long period, with only minimal capex for services. Strong brand name. The parent has a track record of providing IT services to SOEs. Brand awareness is an increasingly important factor for outsourcing contracts. Substantial revenues from tailored enterprise solutions, which give greater control over proprietary intellectual property and high customer stickiness, as it is not economical to frequently redevelop new systems.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 141 20 Nov. 2009
Figure 3: Inspur International– Upside/Downside Price Catalysts
Upside price catalysts Negative price catalysts Corporate IT-software budgets are increasing, driving system Shrinking corporate IT budgets from the economic slowdown demand. delaying IT upgrades. Retaining technicians (personnel are key for software companies). Weak economy could put pricing pressure on More government support for the electronics and information Improving technology reducing switching costs. industry spurring demand. Potential clients may develop systems internally to reduce reliance Faster-than-expected homegrown technology replacement. on third parties. Faster-than-expected penetration in SME market. Price cuts by overseas ERP vendors that encourage the replacement of domestic software. Not being able to retain technicians. Growing domestic competition, with rivals catching up in providing customized solutions for government and related bodies. Source: Sun Hung Kai Financial
Industry Dynamics
Long-term earnings-growth prospects for China’s enterprise solutions/ERP software industry are excellent. Key catalysts include:
Rising penetration
Corporate clients will continue to implement solutions that raise efficiency. Software solutions can automate tasks such as accounting and improve customer relationships. High total labor costs encourage the use of software solutions to increase productivity by minimizing time-consuming tasks such as managing personnel, salaries, attendance, performance, training, recruitment and budgeting. This can help management in its decision making.
In mature economies, spending on software and ERP solutions is highly cyclical. For example, IT spending makes up 3.7% of GDP in the U.S., where many corporations see software/enterprise system upgrades as discretionary spending that can be deferred in tough times. But in China, IT spending is still low, at only 1.3% of GDP, and the software industry exhibits the characteristics of a growth sector.
According to the Ministry of Information Industry, China’s spending on software and ERP solutions increased fivefold from 2002 to 2007 to RMB580bn, and will grow a further 20% p.a. to RMB1tn from 2007 to 2010. Software sales including enterprise solutions, rose 30% to RMB757bn in 2008. Despite tough economic conditions, sales growth still accelerated by 8.3 ppts from 2007.
ERP use in China is still in its infancy and more companies are realizing its usefulness in making long-term efficiency gains. Mainland ERP sales were estimated at RMB6bn last year, with only 10%-plus of corporations adopting ERP vs. 60%-70% in the U.S. and Europe. Sales could reach RMB35bn if penetration rises to this level.
Government support
The government has designated electronics and IT as a pillar industry as part of its move up the economic value chain. Government support measures introduced in this economic downturn include:
Sun Hung Kai Financial 142 20 Nov. 2009
increasing state-enterprise investments in domestic software;
tax refunds for corporate buyers of software;
providing bank credit support to software companies and raising tax rebates on software exports; and
encouraging homegrown firms to go abroad for R&D, production and sales by raising export-tax rebates and subsidies for R&D investment.
The government targets the electronics and IT sector to contribute at least 0.7 ppt to GDP growth over 2009-11. Last year, the sector made up 0.8 ppt of GDP growth.
Domestic replacement trend
Large enterprises that are already using enterprise solutions/ERP software are switching to domestic providers, as these are more able to customize for domestic operational intricacies and accounting and legal standards.
Market-share gains for large players as industry consolidates
The government is encouraging M&A in this industry as part of the move up the economic value chain. Bank credit is easier to come by for acquisitions. Top players like Kingdee and Inspur are growing through M&A, which could be the fastest way to expand given the high switching costs for ERP users. This can also broaden a company’s product range quicker.
Overseas expansion
India supplies 70% of the world’s outsourced enterprise solutions and 90% of outsourced enterprise solutions in Europe and the U.S. China has just as much talent as India, but 30%-50% lower costs, and is increasingly sought as a supplier of enterprise solutions/ERP software. It exported US$14bn of software in 2008, up 40%, including US$1.6bn of customized solutions, up 55%. The government is encouraging homegrown firms to go abroad for R&D and sales by raising export-tax rebates and offering subsidies for R&D investment.
Strategic partnerships
Firms that have strategic partnerships with overseas corporations are better poised to grow sales domestically and abroad. Kingdee works with IBM in China for cross-customer referrals and technology exchange. IBM holds 3.9% of Kingdee. Inspur works with Microsoft, which will own 27.5% of Inspur on conversion of its preference shares.
Sun Hung Kai Financial 143 20 Nov. 2009
Figure 4: Inspur – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 729.6 870.6 922.2 1,841.6 30.5 COGS (697.2) (820.7) (829.5) (1,327.4) 22.1 Gross profit 32.4 49.9 92.7 514.2 91.0 Operating expenses (8.9) (16.6) (46.8) (180.2) 100.0 Other operating income 3.6 4.0 3.7 72.8 392.2 Operating profit 27.1 37.3 49.5 406.8 96.1 Finance expenses (0.4) (12.0) (14.3) (15.4) N/A PBT 29.2 27.9 42.8 373.7 92.0 Tax (4.9) (2.8) (2.6) (40.1) 71.2 Net profit 24.2 25.1 40.3 333.5 95.5 EPS – HK¢ 1.0 1.0 1.5 10.2 69.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Inspur – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR Revenue 14.7 19.3 5.9 99.7 30.5 COGS 16.7 17.7 1.1 60.0 22.1 Gross profit (16.2) 54.1 85.6 454.9 91.0 Operating expenses (21.2) 87.3 181.4 285.1 100.0 Other operating income 2,824.2 9.6 (8.0) 1,890.3 392.2 Operating profit 17.9 28.7 37.9 706.4 102.7 Finance expenses 2,625.0 2,648.6 19.4 7.4 456.7 PBT 30.6 (4.3) 53.5 772.0 102.3 Tax 5.9 (44.0) (7.7) 1,469.1 71.2 Net profit 37.1 3.9 54.2 703.2 105.0 EPS 11.5 (7.5) 49.5 590.5 80.6 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Inspur – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR Revenue 100.0 100.0 100.0 100.0 100.0 COGS (95.6) (94.3) (90.0) (72.1) (88.0) Gross profit 4.4 5.7 10.0 27.9 12.0 Operating expenses (1.2) (1.9) (5.1) (9.8) (4.5) Other operating income 0.5 0.5 0.4 4.0 1.3 Operating profit 3.7 4.3 5.4 22.1 8.9 Finance expenses (0.1) (1.4) (1.6) (0.8) (1.0) PBT 4.0 3.2 4.6 20.3 8.0 Tax (0.7) (0.3) (0.3) (2.2) (0.9) Net profit 3.3 2.9 4.4 18.1 7.2 Sources: Bloomberg and Sun Hung Kai Financial
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Figure 7: Inspur – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 165.4 148.2 167.2 606.9 106.2 Accounts receivable 3.0 13.8 59.4 125.8 61.5 Inventory 88.1 45.3 56.3 63.2 8.8 Other current assets 10.2 165.8 342.9 320.7 150.1 Total current assets 266.7 373.1 625.9 1,116.6 80.4 Net fixed assets 0.6 1.8 3.8 58.3 173.7 Other long-term assets 21.6 58.5 114.0 244.4 N/A Total assets 288.9 433.3 743.7 1,419.3 91.1 Short-term debt 0.0 0.0 0.0 67.4 N/A Accounts payable 64.3 61.3 122.3 94.1 27.2 Other current liabilities 7.8 28.0 152.8 186.4 148.8 Total current liabilities 72.1 89.2 275.1 347.9 70.9 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 179.3 184.9 271.4 N/A Total liabilities 72.1 268.5 460.1 619.3 97.3 Shareholders equity 121.7 158.1 274.7 787.1 86.1 Minorities 0.0 6.7 8.9 12.9 N/A Total equity and liabilities 193.8 426.6 734.7 1,406.4 90.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Inspur – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 CAGR Total assets Cash and securities 57.2 34.2 22.5 42.8 39.2 Accounts receivable 1.0 3.2 8.0 8.9 5.3 Inventory 30.5 10.5 7.6 4.5 13.2 Other current assets 3.5 38.3 46.1 22.6 27.6 Total current assets 92.3 86.1 84.2 78.7 85.3 Net fixed assets 0.2 0.4 0.5 4.1 1.3 Other long-term assets 7.5 13.5 15.3 17.2 13.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 4.8 1.2 Accounts payable 33.2 14.4 16.7 6.7 17.7 Other current liabilities 4.0 6.6 20.8 13.3 11.2 Total current liabilities 37.2 20.9 37.4 24.7 30.1 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 42.0 25.2 19.3 21.6 Total liabilities 37.2 62.9 62.6 44.0 51.7 Shareholders equity 62.8 37.1 37.4 56.0 48.3 Minorities 0.0 1.6 1.2 0.9 0.9 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 145 20 Nov. 2009
Figure 9: Inspur – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 4.4 5.7 10.0 27.9 12.0 Operating margin – % 3.7 4.3 5.4 22.1 8.9 Net margin – % 3.3 2.9 4.4 18.1 7.2 ROAA – % 12.2 7.0 6.8 30.8 14.2 ROAE – % 25.9 18.0 18.6 62.8 31.3
Liquidity ratios Current assets/current liabilities – X 3.7 4.2 2.3 3.2 3.3 Liquid assets/current liabilities – X 2.3 1.7 0.6 1.7 1.6 Cash and securities/current assets – % 62.0 39.7 26.7 54.4 45.7 Cash flow from oper./curr. liabilities – % 33.0 (94.7) 8.0 115.7 15.5
Other ratios Capex/sales – % 0.0 4.8 7.5 7.3 4.9 Operating expense/sales -% (1.2) (1.9) (5.1) (9.8) (5.6) Net debt/equity (net cash) – % (135.9) (93.7) (60.9) (68.5) (74.4) Inventory/sales – % 12.1 5.2 6.1 3.4 4.9 Effective tax rate – % 17.0 9.9 6.0 10.7 8.9 Cash conversion cycle – days (31.6) (32.0) (30.3) (25.0) (29.1)
ROAA component analysis Revenue/average assets – % 369.1 241.1 156.7 170.3 234.3 COGS/average assets – % (352.7) (227.3) (141.0) (122.7) (210.9) Gross profit/average assets – % 16.4 13.8 15.7 47.5 23.4 Operating expenses/average assets – % (4.5) (4.6) (8.0) (16.7) (8.4) Other operating income/average assets – % 1.8 1.1 0.6 6.7 2.6 Operating profit/average assets – % 13.7 10.3 8.4 37.6 17.5 Finance expenses/average assets – % (0.2) (3.3) (2.4) (1.4) (1.8) PBT/average assets – % 14.8 7.7 7.3 34.5 16.1 Tax/average assets – % (2.5) (0.8) (0.4) (3.7) (1.9) Net profit/average assets – % 12.2 7.0 6.8 30.8 14.2
ROAE component analysis Revenue/average equity – % 779.0 622.2 426.2 346.9 543.6 COGS/average equity – % (744.4) (586.6) (383.3) (250.0) (491.1) Gross profit/average equity – % 34.6 35.7 42.8 96.9 52.5 Operating expenses/average equity – % (9.5) (11.9) (21.6) (33.9) (19.2) Other operating income/average equity – % 3.9 2.8 1.7 13.7 5.5 Operating profit/average equity – % 29.0 26.6 22.9 76.6 38.8 Finance expenses/average equity – % (0.5) (8.6) (6.6) (2.9) (4.6) PBT/average equity – % 31.1 20.0 19.8 70.4 35.3 Tax/average equity – % (5.3) (2.0) (1.2) (7.6) (4.0) Net profit/average equity – % 25.9 18.0 18.6 62.8 31.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 146 20 Nov. 2009
Jinheng Automotive (872.HK) Auto and Auto Parts Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Jinheng Automotive manufactures and sells auto-safety airbag systems (78% of sales) and safety-system components. Performance (%) 1m 3m 12m HSI 2.0 13.5 76.7 The firm produces mechanical and electronic airbags, licensing its HSCEI 4.0 19.6 107.6 mechanical-airbag technology from major global airbag player Key Safety Systems (KSS), and developing its own technology for electronic airbags. This proprietary Jinheng Automotive – Price vs. HSI, technology is a substantial barrier to potential new entrants, and global airbag Share Data leaders are unlikely to license their technology to newcomers. (HK$) (HK$m The global airbag-systems market is dominated by three players, Autoliv, TRW and 1.6 7 1.4 6 Takata, which together account for an 80% global market share. Jinheng has only a 1.2 5 1.0 small global market share, but c. 10% by number of vehicles in China. It has plenty 4 0.8 3 of room to expand if it can penetrate tier-one customers that mainly source from the 0.6 global big three. 0.4 2 0.2 1 0.0 0 Lower costs mean Jinheng can offer 30% lower prices, while its testing lab also Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
provides short lead times for design and testing (12-18 months vs. 18-24 months for Turnover Price HSI its peers). Price – HK$ 0.95 The firm has only a 10-year track record in safety products, but it is able to secure 52W high/low (HK$) 1.12/0.28 sales due to close ties with domestic-brand automakers. It has formed JVs with Shares in issue – millions 443.50 Hefei Motor and Brilliance Jinbei, which accounts for 10% of sales and can help Market cap – HK$m 412.46 further expand its customer base. In turn, this should help attract more new 3M avg. turnover – HK$m 0.35 customers. Major shareholder – % Applaud Group Ltd 51.55 Sources: Bloomberg and Sun Hung Kai Financial Figure 1: Earnings Summary Year ending 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$ m 45.6 66.6 38.7 35.7 Net-profit growth - % 42.5 46.1 (41.9) (7.9) EPS – HK¢ 11.9 16.4 8.8 0.1 Recent Reports Date EPS growth - % 41.2 38.4 (46.6) (98.9) Clear Road Ahead 2 Oct 2009 P/E – X 8.0 5.8 10.8 950.0 Buckle Up for an Upturn 31 July 2009 DPS – HK¢ 3.5 3.6 1.5 1.5 Dividend yield - % 3.7 3.8 1.6 1.6 BVPS – HK$ 0.7 0.9 1.0 1.0 P/B – X 1.5 1.0 1.0 1.0 This document is solely based on Oper cash flow/share – HK¢ publicly available information. This 7.8 (5.3) 13.6 19.0 report is intended as information Net debt (net cash) to share price - % 33.7 70.1 83.7 N/A only and not as a recommendation Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this company in this report.
Eva Yip, CFA + (852) 2203 5987 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor147ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Jinheng Automotive – Investment Highlights
Key investment positives Key investment negatives China auto sector supported by government policy, including Short track record in product safety. The firm only started up in subsidies for rural residents to buy new cars and replace old autos. 1997. Its short track record compared with global peers could Jinheng has a 10% share (by number of vehicles) in China’s hinder its attempts to penetrate U.S./European tier-one automakers. airbag-systems market. Liquidity risk may stifle growth. Although there is little risk of Rising penetration of airbags. More automakers are including default from its domestic-brand automaker clients, some of which high-value-added accessories such as airbags to attract customers. are state-owned, the long CCC could exert pressure on working Currently, only 50% of vehicles sold are equipped with airbags, as capital and stifle growth. Short-term bank borrowings are these are not compulsory. equivalent to its market cap (net gearing of 58% as at end-FY08), which may cap its ability to borrow funds. The CCC is almost half Rising market share of domestic-brand cars (around 30% a year, as the firm offers 90 days of credit and keeps three months currently), as more domestic firms launch their own brands. This of inventory. can benefit Jinheng, as it is a key supplier for domestic-brand automakers due to its low prices. Funding needs from possible early redemption of two outstanding CBs. The firm has HK$77m of CBs outstanding, which can be Engine-management systems (EMSs) could drive growth (c. redeemed between 2009 and 2011. 10% of revenues). Currently, EMSs are mainly imported, but automakers are moving to increase content localization and cut Customer default risk. Most customers are local-brand costs. This can benefit Jinheng, which is one of the few local firms automakers, some small-scale and some SOEs. Financial capable of producing EMSs, at 30% lower prices than imports. difficulties among small-scale manufacturers could result in payment defaults. Low costs. The firm has a testing center in China, charging only one-seventh the testing fees of its overseas suppliers, with 30% Potential liability claims. Any product failure could result in lower product prices. liability claims from customers. Shorter lead times than small peers. Having its own testing lab EPS dilution from CB conversion. Full CB conversion would cut and partnerships with domestic automakers means the firm can EPS 16%. shorten lead times and react rapidly to changes in the auto industry. Proprietary airbag technology. The firm has secured mechanical-airbag technology from KSS and developed its own electronic airbags, creating a high barrier to new entrants. This has helped keep airbag profitability at 25%-30%. High customer stickiness. Once the company has received a customer tender for a product, it is not cost effective for the customer to switch a new supplier. EMS segment reaching breakeven. Economies of scale will kick in once commercial production starts, as customers launch new auto models. The firm is currently testing a few new products, and will start shipments soon. Product lifecycles shortening due to frequent new auto-model launches in China. Airbag and engine lifecycles are around 10 years. Mainland automakers are launching new models frequently to drive sales growth. Greater component localization to improve profitability. The firm’s electronic airbags use 40% local components, which is set to rise as it develops components internally. Source: Sun Hung Kai Financial
Figure 3: Jinheng Automotive – upside/downside price catalysts
Upside price catalysts Downside price catalysts
Airbags currently are not mandatory for passenger cars sold in Proprietary technology leakage, which may increase market China. Any positive change in regulation could bring substantial competition. Even so, rivals would need five years plus to build upside. Current penetration is 50%-60% comparable scale and a solid customer base. Carmakers could increase the number of airbags per car to meet Forced redemption of bonds. The firm has only HK$56m cash on stricter safety standards. Most countries require two airbags, but hand vs. outstanding CBs of HK$77m. automakers such as Honda are launching models with airbags for the back seats. Securing OEM outsourcing orders from global airbag makers can help the firm penetrate tier-one automaker customers. It is currently an OEM airbag supplier for KSS (6% global market share). KSS auto clients include Audi, DaimlerChrysler, Fiat, Ford, General Motors, Hyundai, Suzuki, Toyota and Volkswagen. Source: Sun Hung Kai Financial
Recent Company News Nil.
Sun Hung Kai Financial 148 20 Nov. 2009
Figure 4: Jinheng Automotive – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 195.7 352.5 666.9 647.5 37.3 COGS (133.1) (253.0) (502.6) (500.5) 45.7 Gross profit 62.5 99.5 164.3 147.0 19.9 Operating expenses (25.3) (43.1) (81.6) (117.7) 74.0 Other operating income 0.8 3.7 4.6 17.3 120.6 Operating profit 35.5 57.4 79.2 61.4 2.5 Finance expenses (2.8) (7.8) (17.9) (24.6) 62.8 PBT 32.5 53.3 66.5 41.1 (5.5) Tax (0.4) (5.5) (7.7) (8.8) 268.2 Net profit 32.0 45.6 66.6 38.7 (6.8) EPS – HK¢ 8.4 11.9 16.4 8.8 (15.1) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Jinheng Automotive – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 7.3 80.2 89.2 (2.9) 37.3 COGS 19.7 90.0 98.7 (0.4) 45.7 Gross profit (12.0) 59.2 65.1 (10.6) 19.9 Operating expenses 97.4 70.2 89.0 44.3 74.0 Other operating income 12.0 350.5 25.4 274.3 120.6 Operating profit (36.2) 61.5 38.0 (22.5) 2.5 Finance expenses (20.2) 177.9 130.5 37.2 62.8 PBT (36.9) 64.1 24.8 (38.2) (5.5) Tax 835.4 1,136.8 39.8 13.7 268.2 Net profit (37.8) 42.5 46.1 (41.9) (6.8) EPS (50.2) 41.2 38.4 (46.6) (15.1) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Jinheng Automotive – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (68.0) (71.8) (75.4) (77.3) (73.1) Gross profit 32.0 28.2 24.6 22.7 26.9 Operating expenses (13.0) (12.2) (12.2) (18.2) (13.9) Other operating income 0.4 1.0 0.7 2.7 1.2 Operating profit 18.2 16.3 11.9 9.5 13.9 Finance expenses (1.4) (2.2) (2.7) (3.8) (2.5) PBT 16.6 15.1 10.0 6.3 12.0 Tax (0.2) (1.6) (1.2) (1.4) (1.1) Net profit 16.4 12.9 10.0 6.0 11.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 149 20 Nov. 2009
Figure 7: Jinheng Automotive – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 44.4 65.7 56.2 56.9 (11.5) Accounts receivable 110.9 235.1 414.1 474.6 65.9 Inventory 41.1 78.7 108.3 142.1 38.0 Other current assets 52.9 1.2 30.0 28.1 58.1 Total current assets 249.3 380.7 608.4 701.7 37.0 Net fixed assets 73.8 118.6 186.9 284.4 62.3 Other long-term assets 44.8 128.5 234.6 328.1 62.1 Total assets 367.9 627.7 1,029.9 1,314.2 46.2 Short-term debt 43.0 93.9 228.6 305.8 72.2 Accounts payable 34.5 152.9 248.9 316.4 88.0 Other current liabilities 24.5 0.0 20.9 169.0 608.7 Total current liabilities 102.0 246.9 498.5 791.2 90.4 Long-term debt 26.9 24.0 0.0 0.0 N/A Other long-term liabilities 0.5 75.5 86.3 31.7 N/A Total liabilities 129.4 346.4 584.8 822.9 68.6 Shareholders equity 199.3 250.9 392.2 429.8 24.3 Minorities 10.6 30.4 52.9 61.5 168.3 Total equity and liabilities 328.8 597.3 977.1 1,252.8 45.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Jinheng Automotive – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 12.1 10.5 5.5 4.3 8.1 Accounts receivable 30.1 37.4 40.2 36.1 36.0 Inventory 11.2 12.5 10.5 10.8 11.3 Other current assets 14.4 0.2 2.9 2.1 4.9 Total current assets 67.8 60.6 59.1 53.4 60.2 Net fixed assets 20.1 18.9 18.1 21.6 19.7 Other long-term assets 12.2 20.5 22.8 25.0 20.1 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 13.1 15.7 23.4 24.4 19.2 Accounts payable 10.5 25.6 25.5 25.3 21.7 Other current liabilities 7.4 0.0 2.1 13.5 5.8 Total current liabilities 31.0 41.3 51.0 63.2 46.6 Long-term debt 8.2 4.0 0.0 0.0 3.1 Other long-term liabilities 0.1 12.6 8.8 2.5 6.0 Total liabilities 39.4 58.0 59.9 65.7 55.7 Shareholders equity 60.6 42.0 40.1 34.3 44.3 Minorities 3.2 5.1 5.4 4.9 4.7 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 150 20 Nov. 2009
Figure 9: Jinheng Automotive– Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 32.0 28.2 24.6 22.7 26.9 Operating margin – % 18.2 16.3 11.9 9.5 13.9 Net margin – % 16.4 12.9 10.0 6.0 11.3 ROAA – % 9.8 9.2 8.0 3.3 7.6 ROAE – % 16.9 20.3 20.7 9.4 16.8
Liquidity ratios Current assets/current liabilities – X 2.4 1.5 1.2 0.9 1.5 Liquid assets/current liabilities – X 0.4 0.3 0.1 0.1 0.2 Cash and securities/current assets – % 17.8 17.3 9.2 8.1 13.1 Cash flow from oper./curr. liabilities – % 8.7 13.6 (4.6) 10.7 7.1
Other ratios Capex/sales – % 14.3 35.2 18.6 27.5 23.9 Capex/depreciation – % 484.4 1,322.7 767.5 667.2 919.1 Operating expenses/sales -% (13.0) (12.2) (12.2) (18.2) (14.2) Net debt/equity – % 12.8 20.8 44.0 57.9 40.9 Inventory/sales – % 21.0 22.3 16.2 21.9 20.2 Effective tax rate – % 1.4 10.4 11.6 21.3 14.4 Cash-conversion cycle – days 154.7 105.9 82.9 114.9 101.2
ROAA component analysis Revenue/average assets – % 59.7 70.8 80.5 55.2 66.6 COGS/average assets – % (40.6) (50.8) (60.6) (42.7) (48.7) Gross profit/average assets – % 19.1 20.0 19.8 12.5 17.9 Operating expenses/average assets – % (7.7) (8.7) (9.8) (10.0) (9.1) Other operating income/average assets – % 0.2 0.7 0.6 1.5 0.8 Operating profit/average assets – % 10.8 11.5 9.6 5.2 9.3 Finance expenses/average assets – % (0.9) (1.6) (2.2) (2.1) (1.7) PBT/average assets – % 9.9 10.7 8.0 3.5 8.0 Tax/average assets – % (0.1) (1.1) (0.9) (0.7) (0.7) Net profit/average assets – % 9.8 9.2 8.0 3.3 7.6
ROAE component analysis Revenue/average equity – % 103.1 156.6 207.4 157.5 156.2 COGS/average equity – % (70.2) (112.4) (156.3) (121.8) (115.1) Gross profit/average equity – % 33.0 44.2 51.1 35.8 41.0 Operating expenses/average equity – % (13.4) (19.2) (25.4) (28.6) (21.6) Other operating income/average equity – % 0.4 1.6 1.4 4.2 1.9 Operating profit/average equity – % 18.7 25.5 24.6 14.9 20.9 Finance expenses/average equity – % (1.5) (3.5) (5.6) (6.0) (4.1) PBT/average equity – % 17.1 23.7 20.7 10.0 17.9 Tax/average equity – % (0.2) (2.5) (2.4) (2.1) (1.8) Net profit/average equity – % 16.9 20.3 20.7 9.4 16.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 151 20 Nov. 2009
Johnson Electric (179.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Johnson Electric is one of the world’s largest providers of motion solutions for the automotive, industrial, consumer and medical markets. Customers are mostly U.S. Performance (%) 1m 3m 12m and European automakers and auto-component suppliers. The company acquired HSI 2.0 13.5 76.7 Saia-Burgess and Parlex in November 2006, transforming from a pure HSCEI 4.0 19.6 107.6 auto-components maker into a systems-solutions maker. The acquisitions have strengthened the firm’s development capabilities, and the extra capacity helps it Johnson Electric – Price vs. HSI, Share develop customized solutions for clients. Data
It is a prime turnaround candidate: (HK$) (HK$m) Transformation complete. It completed a four-year transformation from pure 5.0 300 auto-parts maker into a systems-solutions manufacturer. Acquisitions of 4.0 250 200 Saia-Burgess and Parlex in 2005 strengthened ability to develop customized 3.0 150 solutions, helping it compete with leading global suppliers of motion/automation 2.0 equipment such as Bosch, Emerson, Nidec and Denso. 100 1.0 50 Signs of bottom for U.S. automakers. Thanks to the cash-for-clunkers program, 0.0 0 July auto sales rose above 10 million units and Ford reported positive sales, the Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 first year-on-year gain since end-2007. Around 11% of sales are from US Turnover Price HSI market. Price – HK$ Gaining traction in high-growth China market. China’s vehicle ownership is at 3.50 52W high/low (HK$) 30 vehicles per 1,000 people, vs. world average of 120. Recently banks have 3.92/1.03 Shares in issue – millions been lending more to auto financing and automakers have set up auto-financing 3,673.79 Market cap – HK$m arms, which can help drive sales in middle-income segment. In mature markets 12,748.05 3M avg. turnover – HK$m 60%-80% of transactions are done with financing, but in China, auto-financing 32.46 Major shareholders – % only accounts for less than 7% car sales. New government policies favoring 58.98 more environmentally friendly cars, such as tax breaks and improved Yik Chun Wang Koo Sources: Bloomberg and Sun Hung Kai Financial infrastructure, could also trigger new auto sales It has exposure to China market. China car industry accounts for only 25% of Johnson’s auto-motor business and is expected contribution to rise on more sales to domestic car makers. It can also benefit from rising local component sourcing by Chinese manufacturers. Recent Reports Date Leaner cost structure to improve profit margins. In the U.S. and Europe, it has More Encouraging Signs of a 14 Aug. 2009 Bottoming out in Micromotor trimmed operations in high-cost areas and laid off staff, reducing headcount Sales 29% in the six months to March 2009. Sales growth could ramp up given Turnaround Play 10 Aug. 2009 underutilized capacity.
Figure 1: Earnings Summary This document is solely based on Year ending 31 March FY07 FY08 FY09 FY10E publicly available information. This report is intended as information Net profit – US$m 109.7 130.8 2.6 20.1 only and not as a recommendation Net-profit growth - % 16.7 19.3 (98.0) 675.8 for any stock. Sun Hung Kai EPS – US¢ 3.0 3.6 0.1 0.5 Financial does not provide research EPS growth - % 16.8 19.4 (98.0) 614.3 coverage or ratings for this company in this report. P/E – X 15.1 12.7 645.2 90.3 DPS – US¢ 1.7 1.8 0.0 0.0 Dividend yield - % 3.7 4.1 0.0 0.0 Eva Yip, CFA BVPS – US$ 0.3 0.3 0.3 0.3 + (852) 2203 9587 P/B – X 1.8 1.5 1.7 1.6 [email protected] Oper cash flow/share – US¢ 4.6 7.4 5.8 N/A Net debt (net cash) to share price - % 26.0 17.9 13.7 19.9 All reports are available at: Sources: Bloomberg and Sun Hung Kai Financial. http://www.SHKfg.com Note: Based on Bloomberg Consensus http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor152ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Johnson Electric – Investment Highlights
Key investment positives Key investment negatives
Move up value chain differentiates the firm from low-cost Financial difficulties for US automakers may disrupt the supply manufacturers. It transformed from a pure motormaker into a chain and hurt sales. There could be a risks to receivables collection. motion-systems provider after acquiring electronic-module maker Micromotors and other components are commodity items, which Saia-Burgess and PCB maker Parlex in FY06. could cap the firm’s ability to pass on rising steel and copper prices Benefits from global auto recovery. 50% of sales are from the (45%-50% of COGS) given keen competition. automotive sector. The U.S. and European auto markets may have Continued restructuring could cause asset impairments and erode bottomed out given government stimulus packages such as the Cash BV. for Clunkers program (11% of sales are to U.S. and 30% to Europe). The U.S. and European auto markets could take longer to fully Gaining traction in high-growth China market. Johnson is selling recover, as rising saving rates reduce demand for larger or higher-end more to mainland OEMs and auto-component producers, which now cars. make up 25% of automotive sales. PRC market prospects are bright given the low auto penetration, rising use of auto financing and Weak sales of industrial products (36% of FY09 revenue). Major supportive government policy. end-markets, including home appliances, power tools and business and industrial equipment, are still weak due to the depressed housing Steady product demand. Motion technology is becoming more and construction markets and lower consumer spending. common, used in autos, business machines (ATMs and vending machines) and DSCs. No dividend payout in the near future. The company aims to use internal cash flows to repay bank loans (24% of net gearing at Continuing outsourcing by automakers. Johnson Electric is the end-March 2009). Continued R&D for new products may also cap the market leader in precision-motor and motion-system solutions. dividend payout. The company did not distribute a dividend in FY09, Margin improvement. The firm has trimmed its factories in in order to conserve cash. high-cost areas such as Europe and the U.S., reduced headcount 30%, and used in-house component production to ramp up utilization. Rising EUR and other currencies against the USD. 42% of sales are from Europe. Global footprint to provide comprehensive customer support. Reliable products. The firm has a strong R&D team that can deliver products and services to exacting standards of quality and reliability. Source: Sun Hung Kai Financial
Figure 3: Johnson Electric – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Sharper-than-expected economic could lead to a full recovery in Worsening U.S./European economies depressing auto demand. the global auto market. Abrupt increases in copper and steel prices. Rapid rises in copper Rapid penetration into new customers for its automotive systems. price, possibly from speculation in the commodity markets. Rapid rise in China auto demand, such as from more new policies Slower penetration into new customers than expected, perhaps due to increase demand. to resistance from labor unions. Decline in copper and steel prices. Source: Sun Hung Kai Financial
Recent Company News
Nil.
Sun Hung Kai Financial 153 20 Nov. 2009
Figure 4: Johnson Electric – Profit and Loss Statement FY06-09 Year ended 31 March, US$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 1,526.3 2,086.6 2,220.8 1,828.2 12.4 COGS (1,149.2) (1,574.4) (1,656.5) (1,402.5) 15.2 Gross profit 377.1 512.2 564.3 425.7 5.2 Operating expenses (243.3) (348.4) (358.3) (306.9) 13.6 Other operating income 0.1 0.0 0.0 0.0 N/A Operating profit 133.9 163.8 206.0 118.8 (7.7) Finance expenses (7.6) (27.9) (26.1) (15.7) 167.2 PBT 116.3 135.9 170.2 37.4 (30.1) Tax (21.9) (22.9) (31.9) 0.4 N/A Net profit 94.0 109.7 130.8 2.6 (63.2) EPS – US¢ 2.6 3.0 3.6 0.1 (63.3) Sources: The Company and Sun Hung Kai Financial
Figure 5: Johnson Electric – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR (%) Revenue 33.4 36.7 6.4 (17.7) 12.4 COGS 44.4 37.0 5.2 (15.3) 15.2 Gross profit 8.3 35.8 10.2 (24.6) 5.2 Operating expenses 31.8 43.2 2.9 (14.3) 13.6 Other operating income 21.3 (100.0) N/A N/A N/A Operating profit (18.2) 22.4 25.7 (42.4) (7.7) Finance expenses 2,373.4 266.3 (6.4) (39.9) 167.2 PBT (25.7) 16.9 25.2 (78.0) (30.1) Tax 44.0 4.8 39.3 (101.4) N/A Net profit (33.4) 16.7 19.3 (98.0) (63.2) EPS (33.3) 16.8 19.4 (98.0) (63.3) Sources: The Company and Sun Hung Kai Financial
Figure 6: Johnson Electric – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (75.3) (75.5) (74.6) (76.7) (75.5) Gross profit 24.7 24.5 25.4 23.3 24.5 Operating expenses (15.9) (16.7) (16.1) (16.8) (16.4) Other operating income 0.0 0.0 0.0 0.0 0.0 Operating profit 8.8 7.9 9.3 6.5 8.1 Finance expenses (0.5) (1.3) (1.2) (0.9) (1.0) PBT 7.6 6.5 7.7 2.0 6.0 Tax (1.4) (1.1) (1.4) 0.0 (1.0) Net profit 6.2 5.3 5.9 0.1 4.4 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 154 20 Nov. 2009
Figure 7: Johnson Electric – Balance Sheet FY06-09 As at 31 March, US$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 238.5 149.3 268.0 302.0 14.4 Accounts receivable 366.9 398.7 430.7 223.4 (0.8) Inventory 233.4 251.2 269.9 202.8 6.0 Other current assets 65.6 72.4 94.1 80.7 (8.5) Total current assets 904.5 871.6 1,062.8 808.8 4.3 Net fixed assets 421.1 439.0 471.3 391.3 8.7 Other long-term assets 688.5 709.7 820.6 749.8 66.2 Total assets 2,014.0 2,020.3 2,354.7 1,949.9 16.4 Short-term debt 184.9 20.9 37.8 1.1 (46.3) Accounts payable 194.9 183.0 227.4 120.0 (1.7) Other current liabilities 124.2 155.3 205.5 155.1 27.7 Total current liabilities 504.1 359.1 470.7 276.1 8.5 Long-term debt 523.2 560.7 526.7 527.8 263.7 Other long-term liabilities 131.0 137.1 224.4 147.8 38.7 Total liabilities 1,158.2 1,056.9 1,221.7 951.8 40.8 Shareholders equity 855.8 963.4 1,132.9 998.1 5.1 Minorities 10.3 22.7 31.0 33.7 134.9 Total equity and liabilities 2,014.0 2,020.3 2,354.7 1,949.9 16.4 Sources: The Company and Sun Hung Kai Financial
Figure 8: Johnson Electric – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 11.8 7.4 11.4 15.5 11.5 Accounts receivable 18.2 19.7 18.3 11.5 16.9 Inventory 11.6 12.4 11.5 10.4 11.5 Other current assets 3.3 3.6 4.0 4.1 3.7 Total current assets 44.9 43.1 45.1 41.5 43.7 Net fixed assets 20.9 21.7 20.0 20.1 20.7 Other long-term assets 34.2 35.1 34.9 38.5 35.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 9.2 1.0 1.6 0.1 3.0 Accounts payable 9.7 9.1 9.7 6.2 8.6 Other current liabilities 6.2 7.7 8.7 8.0 7.6 Total current liabilities 25.0 17.8 20.0 14.2 19.2 Long-term debt 26.0 27.8 22.4 27.1 25.8 Other long-term liabilities 6.5 6.8 9.5 7.6 7.6 Total liabilities 57.5 52.3 51.9 48.8 52.6 Shareholders equity 42.5 47.7 48.1 51.2 47.4 Minorities 0.5 1.1 1.3 1.7 1.2 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 155 20 Nov. 2009
Figure 9: Johnson Electric – Key Ratios FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average (%) Profitability ratios Gross margin – % 24.7 24.5 25.4 23.3 24.5 Operating margin – % 8.8 7.9 9.3 6.5 8.1 Net margin – % 6.2 5.3 5.9 0.1 4.4 ROAA – % 6.1 5.4 6.0 0.1 4.4 ROAE – % 11.2 12.1 12.5 0.2 9.0
Liquidity ratios Current assets/current liabilities – X 1.8 2.4 2.3 2.9 2.4 Liquid assets/current liabilities – X 0.5 0.4 0.6 1.1 0.6 Cash and securities/current assets – % 26.4 17.1 25.2 37.3 26.5 Cash flow from oper./curr. liabilities – % 32.8 47.5 57.4 76.4 53.5
Other ratios Capex/sales – % 4.2 3.6 4.4 3.4 3.9 Capex/depreciation – % 117.2 107.2 133.7 88.8 109.9 Operating expenses/sales -% (15.9) (16.7) (16.1) (16.8) (16.5) Net debt/equity – % 54.6 44.8 26.2 22.7 31.2 Inventory/sales – % 15.3 12.0 12.2 11.1 11.8 Effective tax rate – % 18.8 16.9 18.8 (1.2) 11.5 Cash-conversion cycle – days 85.8 79.8 81.1 79.3 80.1
ROAA component analysis Revenue/average assets – % 99.2 103.4 101.5 84.9 97.3 COGS/average assets – % (74.7) (78.0) (75.7) (65.2) (73.4) Gross profit/average assets – % 24.5 25.4 25.8 19.8 23.9 Operating expenses/average assets – % (15.8) (17.3) (16.4) (14.3) (15.9) Other operating income/average assets – % 0.0 0.0 0.0 0.0 0.0 Operating profit/average assets – % 8.7 8.1 9.4 5.5 7.9 Finance expenses/average assets – % (0.5) (1.4) (1.2) (0.7) (1.0) PBT/average assets – % 7.6 6.7 7.8 1.7 6.0 Tax/average assets – % (1.4) (1.1) (1.5) 0.0 (1.0) Net profit/average assets – % 6.1 5.4 6.0 0.1 4.4
ROAE component analysis Revenue/average equity – % 182.2 229.4 211.9 171.6 198.8 COGS/average equity – % (137.2) (173.1) (158.0) (131.6) (150.0) Gross profit/average equity – % 45.0 56.3 53.8 40.0 48.8 Operating expenses/average equity – % (29.0) (38.3) (34.2) (28.8) (32.6) Other operating income/average equity – % 0.0 0.0 0.0 0.0 0.0 Operating profit/average equity – % 16.0 18.0 19.7 11.1 16.2 Finance expenses/average equity – % (0.9) (3.1) (2.5) (1.5) (2.0) PBT/average equity – % 13.9 14.9 16.2 3.5 12.1 Tax/average equity – % (2.6) (2.5) (3.0) 0.0 (2.0) Net profit/average equity – % 11.2 12.1 12.5 0.2 9.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 156 20 Nov. 2009
Ju Teng (3336.HK) Computer and Peripherals Sector 20 Nov. 2009
HSI 22,643 Company background HSCEI 13,470
Ju Teng was formed in 2000, and manufactures and sells notebook-computer casings. Performance (%) 1m 3m 12m It is the largest maker of plastic notebook casings in the world, with a 30% market HSI 1.2 5.6 67.4 share by shipments, up from 28% in 2007. It serves most Taiwan notebook HSCEI 4.0 4.0 115.4 OEM/ODMs, including Arima, ASUS, Compal, FIC, Wistron and Quanta which in turn serving leading international brands like Dell, HP, Toshiba and Lenovo. It makes Ju Teng – Price vs. HSI, Share Data semi-finished consumer goods and delivers these to its customers’ PRC production
plants for further processing, before marketing and sale to end users. Ju Teng’s main (HK$) (HK$m) competitors are Hon Hai and Huan Hsin (combined with 39% of market share). 8.0 140 7.0 120 6.0 100 5.0 The notebook-casing business is growing rapidly, driven by soaring demand for 80 4.0 60 notebooks against a backdrop of desktop-to-notebook replacement, the increasing 3.0 popularity of netbooks and Microsoft launching a new OS. 2.0 40 1.0 20 0.0 0 Ju Teng is also set to gain more market share at the expense of the No. 2 and No. 3 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
players. Hon Hai will expand from PC ODM into NB ODM/OEM, becoming a rival Turnover Price HSI for its NB-OEM customers. Such clients may reallocate orders to due to this conflict of interests. The third largest casemaker, Huan Hsin, is lossmaking and still lags Ju Price – HK$ Teng in high-end products. Large OEMs continue to prefer to source from vendors 5.99 52W high/low (HK$) with solid financial positions, making the firm an ideal supplier. 6.95/1.12 Shares in issue – millions 1,117.90 Market cap – HK$m 6,685.03 Ju Teng has a technological edge as it can continuously roll out new products, a key 3M avg. turnover – HK$m 28.98 to defying ASP erosion. ASPs are being cut for old models due to falling notebook Major shareholders – % prices putting pressure on the supply chain, even though cases only account for 2% of Cheng Family Trust 24.47 NB selling prices. Sources: Bloomberg and Sun Hung Kai Financial
To diversify its product mix, the firm has acquired 53.4% of WY, a magnesium-alloy NB-casing company, from Compal. The acquisition not only broadens Ju Teng’s product mix, it also strengthens ties with Compal, which makes up 10% of Ju Teng’s sales and sources 15% of casings from Ju Teng. Recent Reports Date Further Re-rating on 21 Oct. 2009 Blockbuster Industry Results Figure 1: Earnings Summary
Year ending 31 Dec. FY06 FY07 FY08F FY09E Net profit – HK$ m 206.9 410.0 658.3 738.7
Net-profit growth – % 7.7 98.1 60.6 12.2 EPS – HK¢ 20.3 41.0 65.8 68.5
EPS growth – % (17.5) 102.0 60.5 4.1 P/E – X 29.5 14.6 9.1 8.7 DPS – HK¢ 0.0 0.0 5.0 6.2 This document is solely based on Dividend yield – % 0.0 0.0 0.8 1.0 publicly available information. This BVPS – HK$ 1.6 2.1 2.8 3.6 report is intended as information P/B – X 3.9 2.8 2.1 1.7 only and not as a recommendation for any stock. Sun Hung Kai Op. cash flow/share – HK¢ 47.3 41.6 (21.4) 69.0 Net debt (net cash)/ price – % 12.4 5.9 23.8 4.6 Financial does not provide research
Sources: Bloomberg and Sun Hung Kai Financial coverage or ratings for this Note: Estimates based on Bloomberg consensus company in this report
Eva Yip, CFA
+ (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor157ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Ju Teng last year acquired a factory that makes desktop-computer casings, hard disks and printers, and has converted this into an LCD-TV casing plant, aiming for mass production by 2H09. Though product lifecycles are much shorter than for PCs, LCD-TV casings still have strong prospects, with global LCD-TV shipments estimated to reach 133 million units in 2010, a 20% CAGR for 2007-10, based on DisplaySearch findings. There is also an increasing trend for outsourcing LCD-TV assembly, due to competition intensifying and increasing price pressure for TV makers.
Ju Teng faces little risk in expanding into LCD-TV casings due to its strong relationship with Wistron, which lists world No. 2 LCD-TV firm Sony as a customer. The new LCD-TV casing plants are close to Wistron’s LCD-TV plant in Zhongshan, and Ju Teng already makes casings for Sony notebooks. Diversifying into other applications can reduce reliance on the notebook market, which currently makes up almost all revenue.
Risks
Ju Teng has a concentrated customer base, with the three largest customers, Quanta, Wistron and Compal, making up c. 70% of sales. Any customer loss could have a significant impact on sales, such as possible move by Hon Hai to acquire its customers to quickly expand into notebook OEM/ODM. This may result in customer losses as Hon Hai can supply notebook casings internally.
A spike in the RMB is also a key concern, given that 100% of sales are in USD and 50%-60% of costs are in RMB. Not being able to adjust ASPs to ease RMB appreciation could cut margins. We estimate a 1% rise in the RMB would cut margins by 44 bps and EPS 4.5%.
Industry Dynamics
In the PC market, we are witnessing a few significant trends: 1) the switch to consumer PCs from corporate PCs, 2) the replacement of desktops by notebooks, and 3) the increasing popularity of netbooks. These factors have driven PC demand, in particular for notebooks.
Corporate customers continue to account for around 70% of global PC demand, but cooling global business activity should mean a fall in corporate PC demand. However, PCs are now seen as essential consumer items, driving demand for consumer PCs.
NB retail prices are falling an estimated 7% p.a. thanks to rapid technology evolution keeping component prices down, sparking the trend for desktops to be replaced by notebooks (due to a narrowing price premium), bringing further demand.
The increasing popularity of netbooks since 2008 has added pressure to ASPs, though it has increased unit growth. Netbook selling prices are usually 50% lower than for traditional notebooks.
The global PC market is still limping along, with second-quarter shipments falling 5% yoy according to Gartner. But earnings visibility for the sector has improved significantly on a recovery in consumer-electronics spending in 2H. PC brands are aggressively launching new models such as slimmer and lighter notebooks or netbooks to drive sales. The launching of a new Microsoft OS and new CPUs may bring further upside to the notebook market by triggering upgrading demand.
Sun Hung Kai Financial 158 20 Nov. 2009
Figure 2: Ju Teng – Investment Highlights
Key investment positives Key investment negatives Promising prospects in the notebook market due to Gradual increase in tax rates will lower profitability. Tax desktop-to-notebook replacement, the increasing popularity of holidays for some production will expire and lift the effective tax netbooks, new CPUs and OS stimulating upgrade demand, and the rate from 16% in FY08 to 18% in FY09. launch of lighter and more durable notebooks. RMB appreciation could hurt profits. 100% of sales are in USD Ongoing desktop-to-notebook replacement should bring solid vs. 50%-60% of costs in RMB. We estimate a 1% rise in the RMB demand for notebooks and in turn notebook casings. According to could cut the gross margin by 44 bps and EPS 4.5%. IDC, global notebook shipments are expected grow 15% and 22% growth in 2010 and 2011, following only 7% growth this year. The A widening pricing premium between notebooks and desktops. Persistent notebook-component shortages could raise production firm has a 30% market share in notebook casings. costs. Increasing popularity of netbooks. Notebook makers are Much longer product lifecycles for LCD-TV casings, but aggressively launching new netbooks to capture market share. Ju comparable margins and ASPs to notebook casings. Teng has a 40% market share in netbook casings.
Market-share expansion. Ju Teng’s technology leadership, customers reallocating orders and stronger ties with customers can help it capture more market share. Hon Hai will expand into notebook OEM/ODMs, which may raise conflicts of interest with customers and cause them to reallocate orders to Ju Teng. Strengthening ties with customers. In recent years, the firm has formed notebook-casing JVs with customers Winstron and Compal, securing a captive customer base. Ju Teng offers one-stop services, including plastic-injection molding, dust-free spray painting, metal tooling and stamping and assembly of notebook-computer casings. This vertically integrates a lengthy and complex production processes, lowering production costs and times. Comprehensive product portfolios. The firm will start production of metal casings this year. Margins improving. The gross margin rose to 17.8% in 1H09, from 15.1% for FY07 and could further improve on 1) the product mix shifting to higher-margin models (such as IMD and metal casings), 2) the launch of more new models and more netbook casings (light, slimmer casings are more complicated and generate higher margins). Limited impact from notebook ASP erosion due to cannibalization from netbooks, as casing prices make up less than 3% of product prices. Expansion into high-growth LCD-TV casings. Global LCD-TV shipments are estimated to reach 133 million in 2010, with a 20% CAGR for FY07-FY10. Outsourcing is increasing, as LCD-TV competition is intensifying and pricing pressure forces TV makers to outsource. Ample growth in TV outsourcing, as outsourcing by major Japanese and Korean manufacturers remains low. Low risk from expanding into LCD-TV casings, due to strong relationship with Wistron (Ju Teng has a 70/30 JV with Wistron), which lists the world’s No. 2 LCD-TV firm Sony as a customer. Ju Teng’s LCD-TV casing plants are close to Wistron’s LCD-TV plant in Zhongshan, and it already makes casings for Sony notebooks. High entry barriers. High production yields are difficult to achieve (90%-95% for Ju Teng). No imminent threat from EMS firms, as these are likely to continue to outsource parts and play to their strengths in supply-chain management. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 159 20 Nov. 2009
Figure 3: Ju Teng – Upside/Downside Price Catalysts
Upside price catalysts Dowside price catalysts Sharp economic recovery leading to an increase in consumer purchasing Tight supply in other components leading to high prices for notebooks power. and less notebook upgrading. Faster-than-expected desktop replacement on rapid notebook price Market-share loss from losing competitive edge, such as manufacturing erosion. becoming easier due to technology improvement. Faster-than-expected market-share expansion at the expense of its rival. Market-share loss due to its customers losing market share to Hon Hai if Increasing notebook component supply from easing bottleneck problems Hon Hai takes an aggressive pricing strategy. The top five world (from falling entry barriers) may lead to notebook prices falling and notebook makers (70% of global market share) are all customers of the triggering more demand. firm. Customer losses from potential M&A by its rival. Hon Hai may consider acquisitions to expand its notebook ODM strategy. Value destruction from low-price netbooks offsetting the impact from shipment/unit growth. A prolonged recession leading to a freeze in consumer-electronics spending. Source: Sun Hung Kai Financial
Figure 4: Ju Teng - Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 2,671.8 3,558.3 5,275.8 7,249.2 46.8 COGS (2,229.7) (3,053.2) (4,479.7) (6,036.2) 51.1 Gross profit 442.1 505.1 796.2 1,213.0 31.8 Operating expenses (218.0) (262.8) (305.8) (401.5) 29.5 Other operating income 1.7 5.8 46.9 85.9 43.0 Operating profit 225.7 248.1 537.3 897.5 33.8 Finance expenses (59.9) (99.1) (99.9) (75.1) 56.4 PBT 209.1 231.8 484.2 818.9 32.9 Tax (17.0) (30.7) (57.3) (130.3) 57.1 Net profit 192.1 206.9 410.0 658.3 28.5 EPS – HK cents 24.6 20.3 41.0 65.8 19.2 Sources: The Company and Sun Hung Kai Financial
Figure 5: Ju Teng - Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 71.1 33.2 48.3 37.4 46.8 COGS 92.3 36.9 46.7 34.7 51.1 Gross profit 10.0 14.3 57.6 52.4 31.8 Operating expenses 52.7 20.5 16.4 31.3 29.5 Other operating income (92.0) 249.7 709.9 83.4 43.0 Operating profit (19.3) 9.9 116.6 67.0 33.8 Finance expenses 377.3 65.3 0.9 (24.8) 56.4 PBT (20.4) 10.9 108.9 69.1 32.9 Tax (20.6) 80.5 86.9 127.2 57.1 Net profit (20.4) 7.7 98.1 60.6 28.5 EPS (24.5) (17.5) 102.0 60.5 19.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Ju Teng - Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (83.5) (85.8) (84.9) (83.3) (84.4) Gross profit 16.5 14.2 15.1 16.7 15.6 Operating expenses (8.2) (7.4) (5.8) (5.5) (6.7) Other operating income 0.1 0.2 0.9 1.2 0.6 Operating profit 8.4 7.0 10.2 12.4 9.5 Finance expenses (2.2) (2.8) (1.9) (1.0) (2.0) PBT 7.8 6.5 9.2 11.3 8.7 Tax (0.6) (0.9) (1.1) (1.8) (1.1) Net profit 7.2 5.8 7.8 9.1 7.5 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 160 20 Nov. 2009
Figure 7: Ju Teng - Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 226.7 179.5 406.0 450.5 32.7 Accounts receivable 1,299.6 1,316.5 2,026.2 2,937.4 40.8 Inventory 765.0 654.6 727.8 821.9 18.6 Other current assets 99.9 391.9 248.0 349.6 30.6 Total current assets 2,391.1 2,542.5 3,408.0 4,559.4 33.7 Net fixed assets 1,175.7 1,501.4 1,688.0 2,345.4 28.8 Other long-term assets 37.4 31.1 128.3 239.7 42.8 Total assets 3,604.2 4,075.0 5,224.3 7,144.5 32.2 Short-term debt 343.1 838.0 757.2 947.3 5.3 Accounts payable 630.0 819.8 1,398.4 1,530.1 37.1 Other current liabilities 865.3 830.4 858.7 746.5 30.5 Total current liabilities 1,838.4 2,488.3 3,014.3 3,223.9 21.9 Long-term debt 526.3 2.1 0.0 930.1 51.7 Other long-term liabilities 0.0 0.0 25.6 9.1 N/A Total liabilities 2,364.7 2,490.3 3,039.9 4,163.0 26.3 Shareholders equity 1,239.5 1,584.7 2,184.4 2,981.4 43.5 Minorities 0.0 33.7 73.2 161.1 N/A Total equity and liabilities 3,604.2 4,075.0 5,224.3 7,144.5 32.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Ju Teng - Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 6.3 4.4 7.8 6.3 6.2 Accounts receivable 36.1 32.3 38.8 41.1 37.1 Inventory 21.2 16.1 13.9 11.5 15.7 Other current assets 2.8 9.6 4.7 4.9 5.5 Total current assets 66.3 62.4 65.2 63.8 64.4 Net fixed assets 32.6 36.8 32.3 32.8 33.7 Other long-term assets 1.0 0.8 2.5 3.4 1.9 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 9.5 20.6 14.5 13.3 14.5 Accounts payable 17.5 20.1 26.8 21.4 21.4 Other current liabilities 24.0 20.4 16.4 10.4 17.8 Total current liabilities 51.0 61.1 57.7 45.1 53.7 Long-term debt 14.6 0.1 0.0 13.0 6.9 Other long-term liabilities 0.0 0.0 0.5 0.1 0.2 Total liabilities 65.6 61.1 58.2 58.3 60.8 Shareholders equity 34.4 38.9 41.8 41.7 39.2 Minorities 0.0 0.8 1.4 2.3 1.1 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 161 20 Nov. 2009
Figure 9: Ju Teng - Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 16.5 14.2 15.1 16.7 15.6 Operating margin – % 8.4 7.0 10.2 12.4 9.5 Net margin – % 7.2 5.8 7.8 9.1 7.5 ROAA – % 6.5 5.4 8.8 10.6 7.8 ROAE – % 19.8 14.7 21.8 25.5 20.4
Liquidity ratios Current assets/current liabilities – X 1.3 1.0 1.1 1.4 1.2 Liquid assets/current liabilities – X 0.1 0.1 0.1 0.1 0.1 Cash and securities/current assets – % 9.5 7.1 11.9 9.9 9.6 Cash flow from oper./curr. liabilities – % 9.6 19.0 13.8 (6.6) 9.0
Other ratios Capex/sales – % 13.0 10.6 4.1 8.0 8.9 Capex/depreciation – % 376.8 288.5 128.8 280.8 232.7 Operating expenses/sales -% (8.2) (7.4) (5.8) (5.5) (6.2) Net debt/equity – % 54.4 46.9 16.1 47.9 36.9 Inventory/sales – % 28.6 18.4 13.8 11.3 14.5 Effective tax rate – % 8.1 13.2 11.8 15.9 13.7 Cash-conversion cycle – days 161.2 129.1 83.0 84.9 99.0
ROAA component analysis Revenue/average assets – % 89.9 92.7 113.5 117.2 103.3 COGS/average assets – % (75.0) (79.5) (96.3) (97.6) (87.1) Gross profit/average assets – % 14.9 13.2 17.1 19.6 16.2 Operating expenses/average assets – % (7.3) (6.8) (6.6) (6.5) (6.8) Other operating income/average assets – % 0.1 0.2 1.0 1.4 0.7 Operating profit/average assets – % 7.6 6.5 11.6 14.5 10.0 Finance expenses/average assets – % (2.0) (2.6) (2.1) (1.2) (2.0) PBT/average assets – % 7.0 6.0 10.4 13.2 9.2 Tax/average assets – % (0.6) (0.8) (1.2) (2.1) (1.2) Net profit/average assets – % 6.5 5.4 8.8 10.6 7.8
ROAE component analysis Revenue/average equity – % 275.1 252.0 280.0 280.7 271.9 COGS/average equity – % (229.6) (216.2) (237.7) (233.7) (229.3) Gross profit/average equity – % 45.5 35.8 42.2 47.0 42.6 Operating expenses/average equity – % (22.5) (18.6) (16.2) (15.5) (18.2) Other operating income/average equity – % 0.2 0.4 2.5 3.3 1.6 Operating profit/average equity – % 23.2 17.6 28.5 34.7 26.0 Finance expenses/average equity – % (6.2) (7.0) (5.3) (2.9) (5.3) PBT/average equity – % 21.5 16.4 25.7 31.7 23.8 Tax/average equity – % (1.7) (2.2) (3.0) (5.0) (3.0) Net profit/average equity – % 19.8 14.7 21.8 25.5 20.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 162 20 Nov. 2009
Kenford (464.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 Kenford designs, manufactures and sells electrical hair-care products (96% of HSCEI 13,470 turnover), health-care products and other small household appliances. It operates on an OEM/ODM basis for electrical-appliance brand owners, chain-store retailers and Performance (%) 1m 3m 12m wholesalers and exporters. The firm is one of the five key global OEM/ODM HSI 2.0 13.5 76.7 suppliers for major hair-care brands. HSCEI 4.0 19.6 107.6
The company has been in this industry for 20 years and is a dedicated hair-care Kenford Group Holdings– Price vs. HSI, product maker. This should help it keep abreast of the latest market trends and Share Data develop innovative, fashionable products to stimulate replacement demand. Around
20% of sales are from new products, which are the key sales-growth driver. The firm (HK$) (HK$m) aims to compete through providing more value-added-products. 0.8 25 0.7 20 Most products are exported to the U.S. and Europe, as consumers in these regions 0.6 0.5 15 prefer to style their hair at home. Overseas demand for hair-styling products is hence 0.4 much higher than in the China, but a trend toward self-hairstyling in the mainland 0.3 10 0.2 could become an upside catalyst for the company. 50% of sales volume is for 5 0.1 hairstyling products, which generate higher ASPs and margins as they are more 0.0 0 value-added than regular hair-care products. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 The overall gross margin has risen from 11.6% in FY06 to 20.6% in FY08, but fell Turnover Price HSI to 17.3% in FY09 due to rising raw-material costs such as for copper and lead. Price – HK$ 0.53 Kenford is expanding in the PRC market by supplying products to major mainland 52W high/low (HK$) 0.735/0.094 electrical-appliance manufacturers. The Chinese hair-care-product market is Shares in issue – millions 433.34 dominated by overseas brands and smaller manufacturers. Domestic brands are Market cap – HK$m 221.00 widening their product ranges to strengthen their local presence. Kenford supplies a 3M avg. turnover – HK$m 0.53 number of these firms, and is the sole supplier of hair-care products to Midea. Major shareholders – % Chinese firms could snap up further market share due to their strong brands, which Beaute 47.08 should benefit Kenford given its focus on up-market and high-quality products. Sources: Bloomberg and Sun Hung Kai Financial The operating environment is improving due to falling raw-material costs (metals are down 30%-40% from their peaks) and labor costs (¼ of sales) staying low. The firm can also expand market share on industry consolidation. Small manufacturers are exiting the industry due to declining exports and rising demand for higher-quality products. Key risks: 1) Reliance on key customers, as the top five clients make up 78% of This document is solely based on sales but the firm only accounts for 20% of its customers’ supply; 2) Difficulty in publicly available information. This developing new products could hinder sales growth, as the hair-care-product market report is intended as information is maturing and the replacement cycle is 10 years. only and not as a recommendation for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this Figure 1: Earnings Summary company in this report. Year ended 31 March FY07 FY08 FY09 FY10E Net profit – HK$m 46.3 17.7 51.0 N/A Net-profit growth - % 1,016.8 (61.8) 188.0 N/A EPS – HK¢ 11.6 4.3 11.8 N/A EPS growth - % 962.4 (62.5) 171.0 N/A P/E – X 4.6 12.2 4.5 N/A DPS – HK¢ 3.5 3.8 4.0 N/A Dividend yield - % 6.6 7.2 7.5 N/A BVPS – HK$ 0.4 0.5 0.5 N/A P/B – X 1.3 1.1 1.0 N/A Eva Yip, CFA Oper. Cash flow/share – HK¢ 12.2 9.3 13.1 N/A Net debt (net cash) to share price - % 6.2 (2.7) (7.0) N/A + (852) 2203 9587 Sources: Bloomberg and Sun Hung Kai Financial [email protected] Note: Estimates based on Bloomberg consensus
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor163ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Kenford – Investment Highlights
Key investment positives Key investment negatives Steady overseas demand. Europeans and Americans prefer to Low entry barriers. Entry barriers are low, as little technology is style their hair at home, resulting in steady demand. required to manufacture hairdryers and hair straighteners. New product launches to drive sales. Lifecycles are long for Long product lifecycle. Hairdryers (c. 50% of sales) are mature hairdryers and hairstyling products, so the company needs to products, with lifecycles of more than 10 years. develop new products with more functions to stimulate Reliance on key customers. The top five customers made up 78% replacement demand (20% of sales are of new products). Kenford of FY09 sales. budgets 1%-2% of sales for R&D. New products helped drive FY09 sales growth to 39%, the highest rate since FY06. Reliance on European/U.S. markets (75% of sales). Europeans and Americans prefer to style their hair at home, leading to steady Better operating environment can help increase market share. demand for hair-care and styling products (50% of sales). Weaker players are exiting the industry due to consolidation and outsourcers are trimming their numbers of suppliers. Kenford can Highly seasonal production. Most orders are from Europe and benefit, as it is a competent player with strong ODM capacity. North and South America, aimed at serving Christmas-period demand. Tighter standards. Kenford has the equipment and technology to manufacture products that comply with international standards, e.g. the REACH regulations. New E.U. regulations took effect on 1 June 2009, and smaller peers could find it harder to secure overseas orders. Customer market-share expansion. The firm only has around a 10% market share in some new customers, but this could rise to 20%-25%. Securing major Chinese brands as new customers. Chinese brands such as Midea and Haier are expanding their product offerings to compete with overseas brands that currently dominate the domestic hair-care-product segment. They select top hair-care-product OEMs that can develop products and have a wide product range. China made up 12% of sales in FY09. Dedicated hair-care-product manufacturer. Unlike its key competitors, the firm concentrates on a single type of product. This means it can devote more resources to developing new products and improving its product portfolio. Rising economies of scale. The new plant in Dongguan commenced production in March 2009, and can help the company achieve economies of scale. The new plant will boost overall production capacity 30%, increasing annual production from 8 million units to 11 million units. Softening raw-material prices. Raw material and commodity prices have stabilized since 4Q08, while RMB appreciation has slowed. Solid finances. As at 31 March 2009, the firm had net cash of HK¢2.5/share even after its final-dividend distribution. This could be used to raise the payout ratio (43% in FY09). Rising free cash flow on falling capex. The firm completed its capacity expansion in FY09, and capex could fall in FY10. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 164 20 Nov. 2009
Figure 3: Kenford – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Market-share expansion from securing more new customers. The Sharp rises in metal prices. firm typically makes up 10% of supply for new customers, rising Slow progress in gaining new customers, especially among China on average to 20% once it establishes a long-term relationship. electrical-appliance makers, due to rising competition. Demand for hair-styling products increasing if there is a trend for Market-share loss if its peers can launch more new products. self-styling.
Expansion of customer base, especially as a prime supplier for Chinese electrical-appliance makers. Rapid declines in metal prices. Market-share gains from peers from launching more new products. Source: Sun Hung Kai Financial
Figure 4: Kenford – Porter’s Five Forces
Threat of substitute products – Low
Hair-care products are highly differentiated by function.
Threat of entry of new competitors – High
Little technology is needed, so entry barriers are very low.
Intensity of competitive rivalry – Low to Medium
Only 4-5 manufacturers serve the top brands. Competition is not so intense in the mid-range to high-end market.
Bargaining power of customers –Low to Medium
Hair-care products are a mature segment, with little significant innovation; pricing pressure is low. However, each customer makes up c. 20% of sales, so there is still some pricing pressure given the reliance on key customers.
Bargaining power of suppliers –Low
The main components are heaters and plastics, for which there is a range of suppliers in China. The top five suppliers account for 28% of purchases. Source: Sun Hung Kai Financial
Recent Company News
Nil.
Sun Hung Kai Financial 165 20 Nov. 2009
Figure 5: Kenford – Profit and Loss Statement FY06-09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 403.6 537.3 552.9 769.3 13.4 COGS (356.9) (436.4) (439.0) (636.2) 14.5 Gross profit 46.7 100.9 113.9 133.1 9.0 Operating expenses (43.4) (49.7) (56.8) (79.3) 20.0 Other operating income 7.4 6.1 6.3 8.1 (9.6) Operating profit 10.6 57.2 63.3 61.9 (2.4) Finance expenses (5.7) (7.9) (6.7) (4.4) 3.2 PBT 4.7 50.5 17.9 57.4 (2.2) Tax (0.6) (4.2) (0.2) (6.5) 4.9 Net profit 4.1 46.3 17.7 51.0 (2.9) EPS – HK¢ 1.1 11.6 4.3 11.8 (11.5) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Kenford – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR Revenue (13.2) 33.1 2.9 39.1 13.4 COGS (3.7) 22.3 0.6 44.9 14.5 Gross profit (50.4) 116.1 12.9 16.9 9.0 Operating expenses 13.7 14.5 14.3 39.5 20.0 Other operating income (39.0) (17.9) 3.8 28.3 (9.6) Operating profit (84.4) 438.8 10.7 (2.3) (2.4) Finance expenses 46.4 38.2 (14.9) (34.2) 3.2 PBT (92.4) 963.8 (64.5) 220.4 (2.2) Tax (88.8) 597.7 (94.4) 2,656.6 4.9 Net profit (92.8) 1,016.8 (61.8) 188.0 (2.9) EPS (94.3) 962.4 (62.5) 171.0 (11.5) Sources: Bloomberg and Sun Hung Kai Financial
Figure 7: Kenford – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (88.4) (81.2) (79.4) (82.7) (82.9) Gross profit 11.6 18.8 20.6 17.3 17.1 Operating expenses (10.8) (9.3) (10.3) (10.3) (10.2) Other operating income 1.8 1.1 1.1 1.0 1.3 Operating profit 2.6 10.6 11.5 8.0 8.2 Finance expenses (1.4) (1.5) (1.2) (0.6) (1.2) PBT 1.2 9.4 3.2 7.5 5.3 Tax (0.1) (0.8) (0.0) (0.8) (0.5) Net profit 1.0 8.6 3.2 6.6 4.9 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 166 20 Nov. 2009
Figure 8: Kenford – Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 63.3 116.8 126.7 116.3 10.8 Accounts receivable 69.4 94.7 86.3 105.1 22.4 Inventory 54.2 55.9 72.4 62.0 0.5 Other current assets 10.3 7.9 9.2 9.5 (15.5) Total current assets 197.2 275.4 294.6 292.9 9.5 Net fixed assets 94.7 99.4 134.1 142.9 15.0 Other long-term assets 1.4 1.4 1.4 1.4 (0.0) Total assets 293.4 376.2 430.1 437.2 11.1 Short-term debt 69.7 118.2 86.8 72.3 (5.6) Accounts payable 46.3 55.4 70.1 59.4 1.8 Other current liabilities 34.0 19.3 29.2 34.2 (9.3) Total current liabilities 150.0 192.9 186.0 166.0 (4.2) Long-term debt 11.8 11.9 33.6 27.8 35.7 Other long-term liabilities 6.1 6.4 9.6 9.3 34.6 Total liabilities 167.9 211.2 229.3 203.1 (0.6) Shareholders equity 125.5 164.9 200.8 234.1 31.4 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 293.4 376.2 430.1 437.2 11.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 9: Kenford – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 21.6 31.1 29.5 26.6 27.2 Accounts receivable 23.6 25.2 20.1 24.0 23.2 Inventory 18.5 14.8 16.8 14.2 16.1 Other current assets 3.5 2.1 2.1 2.2 2.5 Total current assets 67.2 73.2 68.5 67.0 69.0 Net fixed assets 32.3 26.4 31.2 32.7 30.6 Other long-term assets 0.5 0.4 0.3 0.3 0.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 23.7 31.4 20.2 16.5 23.0 Accounts payable 15.8 14.7 16.3 13.6 15.1 Other current liabilities 11.6 5.1 6.8 7.8 7.8 Total current liabilities 51.1 51.3 43.2 38.0 45.9 Long-term debt 4.0 3.2 7.8 6.4 5.3 Other long-term liabilities 2.1 1.7 2.2 2.1 2.0 Total liabilities 57.2 56.2 53.3 46.5 53.3 Shareholders equity 42.8 43.8 46.7 53.5 46.7 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 167 20 Nov. 2009
Figure 10: Kenford– Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 11.6 18.8 20.6 17.3 17.1 Operating margin – % 2.6 10.6 11.5 8.0 8.2 Net margin – % 1.0 8.6 3.2 6.6 4.9 ROAA – % 1.4 13.8 4.4 11.8 7.9 ROAE – % 4.1 31.9 9.7 23.4 17.3
Liquidity ratios Current assets/current liabilities – X 1.3 1.4 1.6 1.8 1.5 Liquid assets/current liabilities – X 0.4 0.6 0.7 0.7 0.6 Cash and securities/current assets – % 32.1 42.4 43.0 39.7 39.3 Cash flow from oper./curr. liabilities – % (5.0) 25.3 20.4 34.3 18.7
Other ratios Capex/sales – % 3.3 2.3 3.9 N/A 3.2 Capex/depreciation – % 107.9 91.3 154.9 N/A 123.1 Operating expenses/sales -% (10.8) (9.3) (10.3) (10.3) (9.9) Net debt/equity – % 14.4 8.0 (3.1) (6.9) (0.7) Inventory/sales – % 13.4 10.4 13.1 8.1 10.5 Effective tax rate – % 12.7 8.3 1.3 11.3 7.0 Cash-conversion cycle – days 58.5 59.4 63.0 46.2 56.2
ROAA component analysis Revenue/average assets – % 139.2 160.5 137.1 177.4 153.6 COGS/average assets – % (123.1) (130.4) (108.9) (146.7) (127.3) Gross profit/average assets – % 16.1 30.1 28.2 30.7 26.3 Operating expenses/average assets – % (15.0) (14.9) (14.1) (18.3) (15.6) Other operating income/average assets – % 2.5 1.8 1.6 1.9 1.9 Operating profit/average assets – % 3.7 17.1 15.7 14.3 12.7 Finance expenses/average assets – % (2.0) (2.4) (1.7) (1.0) (1.8) PBT/average assets – % 1.6 15.1 4.4 13.2 8.6 Tax/average assets – % (0.2) (1.3) (0.1) (1.5) (0.8) Net profit/average assets – % 1.4 13.8 4.4 11.8 7.9
ROAE component analysis Revenue/average equity – % 395.4 370.0 302.3 353.8 355.4 COGS/average equity – % (349.7) (300.5) (240.0) (292.5) (295.7) Gross profit/average equity – % 45.7 69.5 62.3 61.2 59.7 Operating expenses/average equity – % (42.6) (34.3) (31.1) (36.5) (36.1) Other operating income/average equity – % 7.2 4.2 3.4 3.7 4.6 Operating profit/average equity – % 10.4 39.4 34.6 28.4 28.2 Finance expenses/average equity – % (5.6) (5.5) (3.7) (2.0) (4.2) PBT/average equity – % 4.7 34.8 9.8 26.4 18.9 Tax/average equity – % (0.6) (2.9) (0.1) (3.0) (1.6) Net profit/average equity – % 4.1 31.9 9.7 23.4 17.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 168 20 Nov. 2009
Kingboad Laminates (1888.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Kingboard Laminates is the largest laminates producer in the world by revenue (14% global market share). It produces three types of laminates: glass-epoxy laminates, Performance (%) 1m 3m 12m paper laminates and composite-epoxy-material laminates. Laminates are used to HSI 2.0 13.5 76.7 produce PCBs, which are in turn used in a wide variety of electronic products like HSCEI 4.0 19.6 107.6 computers and mobile phones. 90% of sales are to the domestic market. KBL – Price vs. HSI, Share Data The stellar volume-shipment growth of 16% p.a. over 2003-07 seems unlikely to return soon, with low single digits more likely on steady shipment growth in (HK$) (HK$m) electronic products. The sales-growth driver will be ASP hikes and market-share 0.8 25 0.7 20 expansion. 0.6 0.5 15 The ASP grew 13% p.a. over 2004-07 on raw-material cost hikes such as for copper 0.4 and wood pulp. Laminate makers have strong bargaining power over customers (PCB 0.3 10 0.2 5 makers) as the market is highly concentrated (50% by the top five makers) vs. the top 0.1 10 China PCB makers having c. 30% market share. This makes it easy to pass 0.0 0 through raw-material price hikes. However, the ASP declined 17% in 1H09 on a Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 sharp fall in raw-material costs. Turnover Price HSI Market share is set to expand from acquiring more customers and due to industry Price – HK$ consolidation. The top five makers account for a 53% global market share (2005: 5.01 52W high/low (HK$) 40%). Customers are now less willing to wait for inventory, so the firm’s ability for 5.82/1.5 Shares in issue – millions deliver shipments quickly (thanks to backward integration to ease raw-material 3,000.00 Market cap – HK$m bottlenecks) can differentiate it from peers that supply commoditized products. 14,880.00 3M avg. turnover – HK$m Market share rose from 10% in 2005 to 14% in 2008. 25.35 Major shareholders – % The firm has expanded its product range to include high-end laminates (used in Kingboard Chemical 70.00 multi-layer PCBs) to cater for rising demand for high-end products in the domestic Source: Bloomberg and Sun Hung Kai Financial market. Overseas electronics plants are being shut down to cut costs, with production shifting to the mainland or high-end PCBs being sourced in this market. Some Japanese rivals have shut down laminate plants in the past year due to declining demand. A vertically integrated supply chain and large scale (twice the production volume of Recent Reports Date its closest peer) offer higher profitability, with an average gross margin of 26% and a Investment Daily Note 31 Aug. 2009 high ROE of 28% in the past four years vs. sector averages of 19% and 22%. The firm generates significant savings by producing upstream component materials. This makes it more leveraged to an upturn. It is self-sufficient in copper foil and glass epoxy, another factor in its fast shipment deliveries. This document is solely based on publicly available information. This report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research coverage or ratings for this
Year ended 31 Dec. FY06 FY07 FY08 FY09E company in this report. Net profit – HK$m 1,638.1 1,813.3 1,203.8 1,285.7 Net-profit growth – % 51.9 10.7 (33.6) 6.8 EPS – HK¢ 57.3 60.4 40.1 47.8
EPS growth – % 45.1 5.4 (33.6) 19.2 P/E – X 8.7 8.3 12.5 10.5 DPS – HK¢ 0.0 30.0 22.0 28.3 Dividend yield – % 0.0 6.0 4.4 5.7 Eva Yip, CFA BVPS – HK¢ 1.6 2.2 2.4 1.6 P/B – X 3.0 2.2 2.1 3.2 + (852) 2203 9587 Op. cash flow/share – HK¢ 76.7 50.4 86.5 64.0 [email protected] Net debt (net cash)/price – % 12.7 15.6 8.6 (2.4) Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com
http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor169ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
KBL established its first laminate-manufacturing facility in 1989. Most production capacity has been in operation a long time, with minimal maintenance capex needed. This means strong FCF generation. Capex was cut from HK$854m to HK$400m this year, which should boost FCF to HK$0.45/share this year. The company had cut debt 33% and had reached 2% net gearing as at end-June, and is expected to turn to net cash.
The strengthening financial position provides room for higher dividend payouts. The latest 55% dividend payout, up from 50% the previous year, reflects management confidence in the improving financial health. Indeed, the company is the cash cow for parent Kingboard Chemical, which received a HK$800m dividend last year.
Figure 2: Kingboard Laminates – Investment Highlights
Key investment positives Key investment negatives The rural electrical-appliances subsidy program and auto-sector Sales-growth has peaked. Organic growth hinges on volume stimulus have revived PCB demand, and hence laminate demand. growth and ASP increases. The firm now operates a cost-plus 2Q09 shipments have doubled compared with 4Q08. model, where ASPs fall due to passing through declines in raw-material costs. Profit has rebounded due to a fall in copper and wood-pulp prices (60% of COGS), high operating leverage and rising utilization Earnings growth could be threatened by technology changes. There (85% in 2Q09, from 60% in 1Q09). The net margin jumped 8 ppts has been a shift toward the use of flexible PCBs in consumer from end-2008 to 20% in 1H09. electronics. KBL currently only produces rigid laminates and does not service the flexible-PCB market. Market-share expansion (14% globally) from acquiring more customers (40%-50% lower prices than Japanese peers) and Not being able to find lucrative investment opportunities to industry consolidation (production plants have been shut down by enhance ROE. It is not easy to find M&A targets or new businesses some Japanese rivals due to low profitability). that generate ROEs higher than its own (average of 28% for 2004-08). Vertically integrated supply and large scale (2X the production volume of its closest peer) mean higher profitability – average gross margin of 26% and ROE of 28% in the past four years vs. sector averages of 19% and 22%. The firm generates significant savings by self-producing upstream component materials. Broadening product portfolio to strengthen profitability. KBL will invest in high-end laminate production to maintain its competitive edge. Demand for high-end laminates is rising due to increasing outsourcing to China and technology migration increasing the use of higher-layer-count PCB products (as electronic products become more multifunctional). Operations are less likely to be disrupted, as the firm has sufficient upstream materials due to in-house production. Glass-yarn shortages are a bottleneck for the industry. Largest customer E&E (18%-20% of sales) is locked in, as it is 70%-owned by parent Kingboard Chemicals. E&E is the second largest producer of rigid PCBs in China. Close proximity to customers. KBL’s production plants are in east and south China, close to key PCB production plants, lowering logistics costs and allowing for fast delivery. The firm is set to turn net cash due to stronger operating cash flows, while capex is falling (HK$1.8bn in FY08 to HK$400m in FY09). Rising FCF offers room for higher dividend payouts (55% in FY08). Good inventory management. The firm can manage its finished goods inventory level to c. one week of sales. This reduces the risk of inventory write downs. Close peer Guangdong Shengyi’s FY08 profit plunged 71% due to inventory write-offs. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 170 20 Nov. 2009
Figure 3: Kingboard Laminates – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Increase in electronics demand from booming economy. Sharp rise in copper prices led by speculation and supply disruptions from strikes, which could erode profitability if the firm Resumption in corporate IT capex, which could boost computer is slow in passing through price hikes. demand (corporate makes up 70% of total demand). A global economic slowdown and hence weak demand for electronic products and laminates; c. 60% of end users are export-oriented and could be vulnerable to market weakness. RMB rising faster than expected, which could erode its price advantage. Running at full utilization may mean the firm cannot capitalize on a further pickup in sales orders. It has stopped production capacity expansion since end-2008. Source: Sun Hung Kai Financial
Figure 4: Kingboard Laminates– Porter’s Five Forces
Threat of substitute products – Low to Medium
There are no substitutes for laminate products. Laminates are a commodity product with no differentiation between makers.
Threat of entry of new competitors – Medium to High
Laminates production is capital intensive. The firm has budgeted HK$100m to set up a new plant.
Intensity of competitive rivalry –Low
The top 10 makers account for a 70% market share.
Bargaining power of customers – High
Strong bargaining power due to the concentrated market means the firm can pass through rising raw-material costs to its customers.
Bargaining power of suppliers – Low to Medium
Highly self-sufficient; able to meet all its glass-epoxy and copper-foil supply. There is a wide range of wood-pulp suppliers, though the company is still a price taker. Source: Sun Hung Kai Financial
Recent Company News
4 Nov. 2009: Subsidiary posts strong net profit growth
62%-owned Kingboard Copper Foil, which accounted for ⅓ of KBL’s sales, recorded a 98% yoy surge in 9M09 net profit thanks to lower raw-material costs, despite a 12% yoy dip in revenues due to lower ASPs.
SHKF comment: These results highlight that KBL’s recovery is on track, as more than 80% of sales are to its group companies. Kingboard Copper Foil expects demand for electronic products to remain robust in emerging markets, which should be positive to KBL since it is the leading laminate maker in China; putting it in a good position to capture business opportunities.
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Sun Hung Kai Financial 171 20 Nov. 2009
Figure 5: Kingboard Laminates – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 6,131.2 8,472.4 10,426.8 10,127.8 21.4 COGS (4,397.5) (6,058.4) (7,671.5) (8,149.9) 27.1 Gross profit 1,733.7 2,414.0 2,755.2 1,977.9 6.4 Operating expenses (474.6) (532.0) (601.9) (615.9) 15.8 Other operating income 75.0 77.5 69.6 75.2 17.2 Operating profit 1,334.2 1,959.6 2,223.0 1,437.2 3.8 Finance expenses (100.3) (73.1) (168.1) (116.1) 4.2 PBT 1,233.1 1,887.3 2,054.8 1,321.1 3.7 Tax (91.0) (145.8) (129.2) (70.5) 3.8 Net profit 1,078.2 1,638.1 1,813.3 1,203.8 3.8 EPS – HK¢ 39.5 57.3 60.4 40.1 (0.9) Sources: The Company and Sun Hung Kai Financial
Figure 6: Kingboard Laminates–Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR Revenue 31.6 38.2 23.1 (2.9) 21.4 COGS 41.0 37.8 26.6 6.2 27.1 Gross profit 12.5 39.2 14.1 (28.2) 6.4 Operating expenses 38.8 12.1 13.1 2.3 15.8 Other operating income 88.2 3.3 (10.2) 8.0 17.2 Operating profit 7.7 46.9 13.4 (35.3) 3.8 Finance expenses 1.8 (27.2) 130.1 (31.0) 4.2 PBT 8.1 53.1 8.9 (35.7) 3.7 Tax 50.0 60.2 (11.4) (45.5) 3.8 Net profit 4.0 51.9 10.7 (33.6) 3.8 EPS (5.1) 45.1 5.4 (33.6) (0.9) Sources: The Company and Sun Hung Kai Financial
Figure 7: Kingboard Laminates – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (71.7) (71.5) (73.6) (80.5) (74.3) Gross profit 28.3 28.5 26.4 19.5 25.7 Operating expenses (7.7) (6.3) (5.8) (6.1) (6.5) Other operating income 1.2 0.9 0.7 0.7 0.9 Operating profit 21.8 23.1 21.3 14.2 20.1 Finance expenses (1.6) (0.9) (1.6) (1.1) (1.3) PBT 20.1 22.3 19.7 13.0 18.8 Tax (1.5) (1.7) (1.2) (0.7) (1.3) Net profit 17.6 19.3 17.4 11.9 16.5 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 172 20 Nov. 2009
Figure 8: Kingboard Laminates – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 685.0 1,713.3 1,471.7 2,237.5 45.5 Accounts receivable 2,372.5 2,710.3 3,510.0 2,380.9 8.2 Inventory 889.8 1,339.5 1,510.6 1,668.9 15.6 Other current assets 4,964.1 181.2 409.7 197.2 (52.2) Total current assets 8,911.5 5,944.2 6,902.1 6,484.6 (1.7) Net fixed assets 3,995.1 4,105.5 5,192.7 5,949.8 12.5 Other long-term assets 335.4 196.1 436.4 370.0 (3.6) Total assets 13,242.0 10,245.9 12,531.2 12,804.4 3.6 Short-term debt 1,008.8 540.7 636.6 1,078.4 20.7 Accounts payable 647.5 729.9 892.3 837.7 8.2 Other current liabilities 6,163.9 800.7 834.4 564.5 (41.7) Total current liabilities 7,820.1 2,071.2 2,363.3 2,480.6 (19.8) Long-term debt 360.9 2,535.0 2,573.5 2,130.0 24.9 Other long-term liabilities 12.7 0.5 0.0 35.6 (30.7) Total liabilities 8,193.7 4,606.8 4,936.8 4,646.2 (9.9) Shareholders equity 5,048.2 5,639.1 7,594.4 8,158.1 19.1 Minorities 600.3 700.9 854.7 889.2 12.7 Total equity and liabilities 13,242.0 10,245.9 12,531.2 12,804.4 3.6 Sources: The Company and Sun Hung Kai Financial
Figure 9: Kingboard Laminates– Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 5.2 16.7 11.7 17.5 12.8 Accounts receivable 17.9 26.5 28.0 18.6 22.7 Inventory 6.7 13.1 12.1 13.0 11.2 Other current assets 37.5 1.8 3.3 1.5 11.0 Total current assets 67.3 58.0 55.1 50.6 57.8 Net fixed assets 30.2 40.1 41.4 46.5 39.5 Other long-term assets 2.5 1.9 3.5 2.9 2.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 7.6 5.3 5.1 8.4 6.6 Accounts payable 4.9 7.1 7.1 6.5 6.4 Other current liabilities 46.5 7.8 6.7 4.4 16.4 Total current liabilities 59.1 20.2 18.9 19.4 29.4 Long-term debt 2.7 24.7 20.5 16.6 16.2 Other long-term liabilities 0.1 0.0 0.0 0.3 0.1 Total liabilities 61.9 45.0 39.4 36.3 45.6 Shareholders equity 38.1 55.0 60.6 63.7 54.4 Minorities 4.5 6.8 6.8 6.9 6.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 173 20 Nov. 2009
Figure 10: Kingboard Laminates– Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin - % 28.3 28.5 26.4 19.5 25.7 Operating margin – % 21.8 23.1 21.3 14.2 20.1 Net margin – % 17.6 19.3 17.4 11.9 16.5 ROAA – % 8.9 13.9 15.9 9.5 12.1 ROAE – % 23.7 30.7 27.4 15.3 24.3
Liquidity ratios Current assets/current liabilities – X 1.1 2.9 2.9 2.6 2.4 Liquid assets/current liabilities – X 0.1 0.8 0.6 0.9 0.6 Cash and securities/current assets – % 7.7 28.8 21.3 34.5 23.1 Cash flow from oper./curr. liabilities – % 11.4 108.0 69.8 108.2 74.4
Other ratios Capex/sales – % 10.6 8.6 12.7 9.9 10.4 Capex/depreciation – % 170.8 159.1 234.7 139.1 175.9 Operating expenses/sales -% (7.7) (6.3) (5.8) (6.1) (6.5) Net debt/equity – % 13.6 24.2 22.9 11.9 18.1 Inventory/sales – % 14.5 15.8 14.5 16.5 15.3 Effective tax rate – % 7.4 7.7 6.3 5.3 6.7 Cash conversion cycle –days 145.8 135.1 138.1 102.6 130.4
ROAA component analysis Revenue/average assets – % 50.4 72.1 91.6 79.9 73.5 COGS/average assets – % (36.1) (51.6) (67.4) (64.3) (54.9) Gross profit/average assets – % 14.2 20.6 24.2 15.6 18.7 Operating expenses/average assets – % (3.9) (4.5) (5.3) (4.9) (4.6) Other operating income/average assets – % 0.6 0.7 0.6 0.6 0.6 Operating profit/average assets – % 11.0 16.7 19.5 11.3 14.6 Finance expenses/average assets – % (0.8) (0.6) (1.5) (0.9) (1.0) PBT/average assets – % 10.1 16.1 18.0 10.4 13.7 Tax/average assets – % (0.7) (1.2) (1.1) (0.6) (0.9) Net profit/average assets – % 8.9 13.9 15.9 9.5 12.1
ROAE component analysis Revenue/average equity – % 134.6 158.6 157.6 128.6 144.8 COGS/average equity – % (96.6) (113.4) (115.9) (103.5) (107.3) Gross profit/average equity – % 38.1 45.2 41.6 25.1 37.5 Operating expenses/average equity – % (10.4) (10.0) (9.1) (7.8) (9.3) Other operating income/average equity – % 1.6 1.5 1.1 1.0 1.3 Operating profit/average equity – % 29.3 36.7 33.6 18.2 29.5 Finance expenses/average equity – % (2.2) (1.4) (2.5) (1.5) (1.9) PBT/average equity – % 27.1 35.3 31.1 16.8 27.6 Tax/average equity – % (2.0) (2.7) (2.0) (0.9) (1.9) Net profit/average equity – % 23.7 30.7 27.4 15.3 24.3 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 174 20 Nov. 2009
Lee & Man Paper (2314.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 Lee & Man Paper is the second largest containerboard manufacturer in China, with a HSCEI 13,470 15%-plus market share in China based on production capacity of 3.76 mtpa as at end-March 2009. It is run by the Lee family, which also makes handbags through Performance (%) 1m 3m 12m Lee & Man Holding (746.HK) and diversified into containerboard in 1994. HSI 2.0 13.5 76.7 Containerboard production is in Dongguan, Changshu and Chongqing. HSCEI 4.0 19.6 107.6
Products include paper and pulp, and the firm also collects and recycles Lee & Man Paper – Price vs. HSI, Share Data corrugated-cardboard containers. Containerboard is used to make boxes for most products, both consumer and industrial. Based on company estimates, more than 80% of demand is now for boxes used for domestic consumption (up from 50% in (HK$) (HK$m) 40.0 600 2007). Strong retail sales in China should keep demand robust, while a recovery in 35.0 500 PRC exports should help stimulate demand in FY10. 30.0 25.0 400 20.0 300 Due to aggressive capacity expansion to cater for booming China exports and a move 15.0 200 10.0 100 upstream into wood-pulp production, net gearing rose to 81% in FY09 from 31% in 5.0 FY07. The company is reducing debt to lower insolvency risk, and aims to pay back 0.0 0 HK$1bn in bank loans p.a. to reduce gearing to 70% by next year and 55% in FY11. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Turnover Price HSI Better working-capital management helped increase operating cash flow to HK$1.6bn last year (vs. an outflow of HK$317m in FY08), and positive Price – HK$ 20.40 free-cash-flow generation in FY10 should improve finances. The firm slashed capex 52W high/low (HK$) 22.3/2.28 to HK$300m-HK$400m for 2010, from HK$1.2bn in FY09, and has ruled out major Shares in issue – millions investments over the next two years. 1,137.38 Market cap – HK$m 22,724.86 Lee & Man expects a turnaround after net profit fell 79% in FY09. Weak China 3M avg. turnover – HK$m 64.44 exports meant a market contraction, which in turn led to a decline in customer orders Major shareholders – % and drop in sale prices. It posted a record quarterly loss in 3Q09, which contributed Gold Best Hldgs Ltd 63.03 to the sharp fall in net profit. But EPS growth should be strong going forward due to: Sources: Bloomberg and Sun Hung Kai Financial 1) the low base in FY09 and rising market demand for containboard; 2) profitability recovering to an average of HK$300/tonne in 1H10, vs. a loss of over HK$600/tonne in 3Q09, and 3) an improving sales mix.
Figure 1: Earnings Summary Recent Reports Date Year ending 31 March FY07 FY08 FY09 FY10E Upbeat Signal from Market 17 Sep.2009 Net profit – HK$m 1,010.2 1,441.3 302.1 1,562.9 Leader Net-profit growth - % 68.4 42.7 (79.0) 417.3 EPS – HK¢ 100.7 127.2 26.6 137.8 EPS growth - % 61.8 26.3 (79.1) 418.8 P/E – X 20.3 16.0 76.8 14.8 This document is solely based on publicly available information. This DPS – HK¢ 36.0 26.0 5.0 36.2 Dividend yield - % report is intended as information 1.8 1.3 0.2 1.8 only and not as a recommendation BVPS – HK$ 5.9 7.1 7.4 8.6 for any stock. Sun Hung Kai P/B – X 3.5 2.9 2.7 2.4 Financial does not provide research Oper cash flow/share – HK¢ 70.1 (27.4) 148.6 180.8 coverage or ratings for this Net debt (net cash) to share price - % 9.1 29.2 29.7 25.5 company in this report. Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus Eva Yip, CFA + (852) 2203 9587
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor175ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Lee & Man Paper – Investment Highlights
Key investment positives Key investment negatives
Turnaround story. EPS growth should be strong, driven by: 1) High gearing restricts capex. Management still considers debt the low base in FY09 and strong demand (due to margin repayment more important than aggressive capacity expansion. contraction from the depletion of high-cost inventories at low Net debt was HK$6.9bn as at end-FY09. The group plans to selling prices); 2) profitability recovering to an average of repay HK$1bn debt p.a. over the next two years, to bring net HK$300/tonne in 1H10, vs. a loss of over HK$600/tonne in gearing down to 50%. 3Q09, and 3) an improving sales mix. May not meet rising market demand on capacity bottlneck. Strong demand for containerboards. Increasingly demand is The company’s very conservative slow-growth strategy means it being driven by domestic consumer demand and a recovery in may lose market share to larger rival ND Paper, which has very China exports. The company estimates more than 80% of sales is aggressive capacity expansion plans despite its high financial now for boxes used for domestic consumption (up from 50% in leverage. 2007). Strong retail sales in China should lead to higher demand for cardboard boxes to ship the likes of foodstuffs, drinks, and Volatile raw-material costs. Lee & Man depends heavily on personal consumer products. imported OCC.Old corrugated cardboard (OCC) makes up 40-45% of the total production cost for containerboards Rising efficiency. The company aims through machine optimization to lift FY10 capacity 11.2%, to 4.18 million tonnes. May adopt aggressive pricing to secure orders to generate This could help it meet rising domestic demand while keeping cash for debt repayment. This may cap profitability. capex low. Continued RMB appreciation would lower demand for China Improving sales mix. Lower-margin products will be gradually exports and hence related packaging materials. replaced by higher-margin products; e.g. corrugated medium is down from 20% of sales to less than 10%, with rising volumes for the likes of white top liner and fine paper.
Market leader regaining pricing power. The two large players, Nine Dragons (2689.HK) and Lee & Man, account for 35%-40% of the domestic market. The industry will become more of an oligopoly, as smaller firms find it increasingly difficult to expand in the short term due to 1) tight credit in 4Q08 (it takes 1-2 years to set up a new production line) nd 2) rising production-plant set-up costs from stricter requirements. Smaller rivals account for ⅓ of the domestic market.
Greater domestic sourcing of raw materials. Lee & Man plans to increase sourcing of recovered paper from China to 40% in FY11, from the current 10%-plus. Domestic costs are usually c. 10% lower than for imports.
Benefits from industry consolidation. The firm can expand market share at the expense of smaller rivals and further increase sales exposure to the resilient PRC end-user market (from 79% of sales to a target 85%).
Improving finances due to lower capex, which is expected to fall to HK$300m this year (FY09: HK$1.2bn).
Better working-capital management to improve operating cash flows. FY09 operating cash flows surged to HK$1.7bn, from an outflow of HK$317m in FY08, due to more efficient working-capital management.
Source: Sun Hung Kai Financial
Figure 3: Lee & Man Paper – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Strong than expected China retail sales leading to higher demand from If banks unexpectedly recall their loans, the company may face liquidity domestic retailers for containerboard. problems. China exports recovering faster than expected due to a more certain Rising prices for wood pulp and recovered paper, and not being able to economic environment, increasing exports of mainland-made goods. pass these costs on due to the fragmented market. Falling prices for wood pulp and recovered paper. Sharp rise in crude prices would make imported OCC more expensive than domestic OCC. This gives a cost advantage to local players vs. Faster-than-expected domestic consolidation raising the bargaining larger operators and could cut Lee & Man’s market share. power of large players. Slower-than-expected domestic consolidation, if the government eases Greater sourcing of raw materials in the domestic market, lowering restrictions for smaller players so they can stay afloat. COGS. China exports recovering slower than expected. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 176 20 Nov. 2009
Figure 4: Lee & Man Paper – Profit and Loss Statement FY06-09 Year ended 31 Dec., HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 3,778.1 5,160.6 8,996.1 9,649.4 36.6 COGS (2,903.9) (3,799.1) (6,843.5) (8,606.3) 40.7 Gross profit 874.2 1,361.5 2,152.6 1,043.0 16.1 Operating expenses (332.5) (461.1) (610.5) (656.1) 42.4 Other operating income 93.2 143.2 118.1 98.8 38.0 Operating profit 634.9 1,043.5 1,660.3 485.7 2.4 Finance expenses (69.2) (80.1) (86.4) (218.8) 109.3 PBT 625.6 1,041.0 1,499.1 337.5 (5.5) Tax (25.6) (30.9) (68.0) (37.1) 59.8 Net profit 600.0 1,010.2 1,441.3 302.1 (7.8) EPS – HK¢ 62.2 100.7 127.2 26.6 (11.6) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Lee & Man Paper – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 Dec., % FY06 FY07 FY08 FY09 CAGR (%) Revenue 36.3 36.6 74.3 7.3 36.6 COGS 32.1 30.8 80.1 25.8 40.7 Gross profit 52.4 55.7 58.1 (51.5) 16.1 Operating expenses 108.5 38.7 32.4 7.5 42.4 Other operating income 242.7 53.6 (17.5) (16.4) 38.0 Operating profit 43.9 64.4 59.1 (70.7) 2.4 Finance expenses 506.4 15.7 7.9 153.3 109.3 PBT 47.7 66.4 44.0 (77.5) (5.5) Tax 348.9 20.9 120.2 (45.4) 59.8 Net profit 43.6 68.4 42.7 (79.0) (7.8) EPS 42.9 61.8 26.3 (79.1) (11.6) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Lee & Man Paper – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 Dec., % FY06 FY07 FY08 FY09 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (76.9) (73.6) (76.1) (89.2) (78.9) Gross profit 23.1 26.4 23.9 10.8 21.1 Operating expenses (8.8) (8.9) (6.8) (6.8) (7.8) Other operating income 2.5 2.8 1.3 1.0 1.9 Operating profit 16.8 20.2 18.5 5.0 15.1 Finance expenses (1.8) (1.6) (1.0) (2.3) (1.7) PBT 16.6 20.2 16.7 3.5 14.2 Tax (0.7) (0.6) (0.8) (0.4) (0.6) Net profit 15.9 19.6 16.0 3.1 13.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 177 20 Nov. 2009
Figure 7: Lee & Man Paper – Balance Sheet FY06-09 As at 31 Dec., HK$ m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 110.3 215.0 318.2 1,659.4 112.4 Accounts receivable 807.1 1,080.6 2,234.8 1,387.5 23.3 Inventory 774.3 1,379.2 2,499.2 1,635.9 31.4 Other current assets 154.7 365.1 684.3 1,064.1 65.1 Total current assets 1,846.4 3,039.8 5,736.5 5,747.0 43.0 Net fixed assets 3,751.4 5,841.5 10,329.2 12,559.4 48.5 Other long-term assets 176.2 963.9 949.4 370.2 23.6 Total assets 5,774.0 9,845.2 17,015.0 18,676.6 46.0 Short-term debt 782.6 824.8 2,781.3 4,738.4 66.4 Accounts payable 169.7 510.5 747.7 338.2 36.4 Other current liabilities 196.0 412.9 841.9 613.8 33.1 Total current liabilities 1,148.3 1,748.1 4,371.0 5,690.4 58.0 Long-term debt 1,001.0 1,461.0 4,319.5 3,803.3 124.1 Other long-term liabilities 47.7 65.5 290.2 716.0 197.4 Total liabilities 2,197.0 3,274.5 8,980.7 10,209.7 75.7 Shareholders equity 3,577.0 6,570.7 8,034.3 8,466.8 29.2 Minorities 0.0 (0.1) (10.3) 0.0 N/A Total equity and liabilities 5,774.0 9,845.2 17,015.0 18,676.6 46.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Lee & Man Paper – Balance Sheet (Common Size) FY06-09 As at 31 Dec., % FY06 FY07 FY08 FY09 Average Total assets Cash and securities 1.9 2.2 1.9 8.9 3.7 Accounts receivable 14.0 11.0 13.1 7.4 11.4 Inventory 13.4 14.0 14.7 8.8 12.7 Other current assets 2.7 3.7 4.0 5.7 4.0 Total current assets 32.0 30.9 33.7 30.8 31.8 Net fixed assets 65.0 59.3 60.7 67.2 63.1 Other long-term assets 3.1 9.8 5.6 2.0 5.1 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 13.6 8.4 16.3 25.4 15.9 Accounts payable 2.9 5.2 4.4 1.8 3.6 Other current liabilities 3.4 4.2 4.9 3.3 4.0 Total current liabilities 19.9 17.8 25.7 30.5 23.4 Long-term debt 17.3 14.8 25.4 20.4 19.5 Other long-term liabilities 0.8 0.7 1.7 3.8 1.8 Total liabilities 38.0 33.3 52.8 54.7 44.7 Shareholders equity 62.0 66.7 47.2 45.3 55.3 Minorities 0.0 (0.0) (0.1) 0.0 (0.0) Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 178 20 Nov. 2009
Figure 9: Lee & Man Paper – Key Ratios FY06-09 Year ended 31 Dec. FY06 FY07 FY08 FY09 Average (%) Profitability ratios Gross margin – % 23.1 26.4 23.9 10.8 21.1 Operating margin – % 16.8 20.2 18.5 5.0 15.1 Net margin – % 15.9 19.6 16.0 3.1 13.7 ROAA – % 12.1 12.9 10.7 1.7 9.4 ROAE – % 18.1 19.9 19.7 3.7 15.4
Liquidity ratios Current assets/current liabilities – X 1.6 1.7 1.3 1.0 1.4 Liquid assets/current liabilities – X 0.1 0.1 0.1 0.3 0.1 Cash and securities/current assets – % 6.0 7.1 5.5 28.9 11.9 Cash flow from oper./curr. liabilities – % 26.9 40.2 (7.1) 29.7 22.4
Other ratios Capex/sales – % 27.8 37.7 36.9 14.8 29.3 Capex/depreciation – % 1,032.9 1,256.2 1,156.1 333.7 915.3 Operating expense/sales -% (8.8) (8.9) (6.8) (6.8) (7.5) Net debt/equity (net cash) – % 46.8 31.5 84.4 81.3 65.7 Inventory/sales – % 20.5 26.7 27.8 17.0 23.8 Effective tax rate – % 4.1 3.0 4.5 11.0 6.2 Cash conversion cycle – days 135.5 142.0 142.2 130.6 138.3
ROAA component analysis Revenue/average assets – % 76.4 66.1 67.0 54.1 65.9 COGS/average assets – % (58.7) (48.6) (51.0) (48.2) (51.6) Gross profit/average assets – % 17.7 17.4 16.0 5.8 14.2 Operating expenses/average assets – % (6.7) (5.9) (4.5) (3.7) (5.2) Other operating income/average assets – % 1.9 1.8 0.9 0.6 1.3 Operating profit/average assets – % 12.8 13.4 12.4 2.7 10.3 Finance expenses/average assets – % (1.4) (1.0) (0.6) (1.2) (1.1) PBT/average assets – % 12.7 13.3 11.2 1.9 9.8 Tax/average assets – % (0.5) (0.4) (0.5) (0.2) (0.4) Net profit/average assets – % 12.1 12.9 10.7 1.7 9.4
ROAE component analysis Revenue/average equity – % 114.2 101.7 123.2 117.0 114.0 COGS/average equity – % (87.8) (74.9) (93.7) (104.3) (90.2) Gross profit/average equity – % 26.4 26.8 29.5 12.6 23.8 Operating expenses/average equity – % (10.0) (9.1) (8.4) (8.0) (8.9) Other operating income/average equity – % 2.8 2.8 1.6 1.2 2.1 Operating profit/average equity – % 19.2 20.6 22.7 5.9 17.1 Finance expenses/average equity – % (2.1) (1.6) (1.2) (2.7) (1.9) PBT/average equity – % 18.9 20.5 20.5 4.1 16.0 Tax/average equity – % (0.8) (0.6) (0.9) (0.4) (0.7) Net profit/average equity – % 18.1 19.9 19.7 3.7 15.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 179 20 Nov. 2009
Li Ning (2331.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 Li Ning is a leading sports apparel and footwear retailer and brand manager in HSCEI 13,470 China. It focuses on marketing and R&D, and outsources all its manufacturing and retailing. It has strategic marketing partnerships with the NBA, ATP, Olympic teams Performance (%) 1m 3m 12m and individual NBA athletes. With over 6,000 outlets, it is the largest domestic HSI 2.0 13.5 76.7 apparel and footwear retailer in the PRC, ranking in the top-three in the athletics HSCEI 4.0 19.6 107.6 market by sales and No. 1 by volume. The company had an 11% market share of the sportswear market in 2008. Li Ning – Price vs. HSI, Share Data
Manufacturing is 100% outsourced, which means a relatively asset-light business (HK$) (HK$m) model, and most retail stores are franchised (5,935 as at end-2008), meaning cost 35.0 900 30.0 800 efficiency in terms of rental fees and sales-force labor. This drove an average 17% 700 25.0 ROA and average 27% ROE in FY05-FY08. Since the firm is already cost efficient 600 20.0 500 in its upstream (manufacturing outsourcing) and downstream (franchised retail 15.0 400 300 stores) businesses, further savings might be difficult. This could mean more 10.0 200 gross-margin downside risk. 5.0 100 0.0 0 Due to the high year-on-year comparable base, advance orders for 1Q10 rose just Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
11.6% yoy, mainly thanks to a poor performance in the footwear sector, up 5% only. Turnover Price HSI Growth was slower than for peer Anta. The company generates the highest ASPs among its Hong Kong-listed peers as it Price – HK$ 24.60 targets the mid-range to high-end market. However, this makes its products more 52W high/low (HK$) 27/8.98 income elastic, which could be unfavorable given the macro headwinds. SSS growth Shares in issue – millions 1,045.77 was flat in 1H09. Market cap – HK$m 26,039.59 3M avg. turnover – HK$m 102.54 Products are mainly sold under the flagship Li Ning brand, which contributed 92% Major shareholders – % of 1H09 turnover. The firm is expanding into new categories/segments. In July Victory Mind Assets 16.58 2008, it acquired a 57.7% stake in Double Happiness, and in August 2008 signed an Source: Bloomberg and Sun Hung Kai Financial exclusive 20-year license to manufacture and sell the Lotto brand in the PRC. It has also acquired Kason Sports, allowing it to enter the badminton market, which could be the next growth driver. 1H09 revenue rose 32.4% yoy to RMB4bn, while net profit increased 42% yoy to RMB473m. The operating margin improved due to a lower advertising and marketing expense ratio, which declined 3.3 ppts to 15.4%. The firm plans to increase its number of stores to 7,100 by end-2009 and 10,000 by 2013. It set up its first flagship store in Singapore, to expand into the badminton This document is solely based on market in Southeast Asia, with further moves overseas planned in the long run. publicly available information. This report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research Year ending 31 Dec. FY06 FY07 FY08 FY09E coverage or ratings for this Net profit – RMBm 294.8 473.6 721.3 897.0 company in this report. Net-profit growth – % 57.8 60.6 52.3 24.4 EPS – RMB fen 28.7 45.8 69.6 86.4 EPS growth – % 57.0 60.0 51.9 24.1 P/E – X 75.7 47.3 31.1 25.1 DPS – RMB fens 11.4 13.7 20.8 40.2 Dividend yield – % 0.5 0.6 1.0 1.8 Holly Hou BVPS – RMB 1.4 1.7 1.8 2.3 + (852) 2203 9588 P/B – X 16.0 12.9 11.8 9.3 [email protected] Operating cash flow per share – RMB fen 30.2 38.6 64.8 93.3 All reports are available at: Net debt (net cash)/ share price – % (3.8) (3.4) (0.8) (2.0) http://www.SHKfg.com Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus http://www.im.knowledge.reuter.com http://www.tfibcm.com
http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor180ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Li Ning – Investment Highlights
Key investment positives Key investment negatives Asset light. Manufacturing is 100% outsourced, which means a Little room for margin improvement. Since the firm is already relatively asset-light business model. cost efficient in its upstream (manufacturing outsourcing) and downstream (franchised retail stores) businesses, further savings Cost efficiency. Most of the company’s retail stores are franchised might be difficult. The overall gross margin dropped 0.6 ppt yoy to (5,935 by end-2008), meaning cost efficiency in terms of rental 47.8% in 1H09, mainly due to margin dilution from new brands fees and sales-force labor. such as Lotto (gross margin –2.9%) and Double Happiness Fast expansion. The number of stores increased to 6,809 under (40.8%), compared with the Li Ning core brand at 48.7%. the Li Ning brand and 741 under other brands as at end-June 2009, Distributor discounts could make profitability targets tough to up 633 overall year on year. 82% of newly opened Li Ning stores reach. Li Ning is reluctant to cut ASPs, unlike some of its peers, as were in second- and third-tier cities. it looks to protect brand equity. The firm targets to keep the gross Consumption likely to rise. High savings rates and positive margin at 46%-48%, but this could be tough since it may have to government measures to stimulate rural spending have resulted in offer more discounts to distributors (an estimated 0.3-0.5 ppts). greater consumption, benefiting retailers. Competition from other brands. The company allows Capitalizing on stronger brand. An improving brand image can non-exclusive distribution of its products, which could mean help raise ASPs. Li Ning now has the highest distributor selling competition from other brands within the same store. prices among its peers, meaning a high gross margin. Order growth down sharply. Due to the high year-on-year Largest local player in the sector. The company had an 11% comparison base, advance orders for 1Q10 have risen just 11.6% share of the sportswear market in 2008. yoy, mainly due to poor footwear performance, up only 5% yoy. Growth was slower than for peer Anta. Horizontal expansion. The company has acquired Double Happiness and Kason, and secured an exclusive 20-year license to Growth may not be sustainable. The company generates the manufacture and sell Lotto products in the PRC. This has helped it highest ASPs among its Hong Kong-listed peers, as it targets the to expand into new categories and segments, allowing it to reach mid-range to high-end markets. This makes its products more different customer groups. income elastic, which could be unfavorable given the macro headwinds. SSS growth is flat, and lower than its peers’. Guidance for a least a 30% payout ratio. Management guides for a dividend-payout ratio of at least 30% for FY09. Lowest net margin. Li Ning has quite a high gross margin at 47.8%, but the lowest net margin among its peers, at 11.7% for Focus on China, preparing for international markets. 1H09. This is mainly because of higher operating costs as a Management says it will focus on China over the next five years, percentage of total turnover, more than 25% for 1H09. but is preparing for internationalization in the long run. It plans to expand its sales channels to 10,000 Li Ning stores by 2013 to capture rapidly expanding PRC demand, but has also opened its first flagship store in Singapore to explore Southeast Asia. Source: Sun Hung Kai Financial
Figure 3: Li Ning – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts SSS growth much higher than the market expects. More competition from local and foreign players, due to over-expansion of sports-brand retail networks ahead of the Olympics. Synergy from acquisitions resulting in faster margin expansion. Not being as successful in penetrating overseas markets, as global peers Nike, Adidas, Li Ning, Anta and Reebok had a dominant 40% combined such as Nike, Reebok, Adidas are well established brands with leading market share in 2005, which increased to 50% in 2008. worldwide positions. Faster-than-expected market consolidation could drive further growth. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 181 20 Nov. 2009
Figure 4: Li Ning – Profit and Loss Statement FY05-FY08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 2,450.5 3,180.5 4,348.7 6,690.1 37.4 COGS (1,324.3) (1,672.0) (2,265.9) (3,469.7) 36.3 Gross profit 1,126.2 1,508.6 2,082.8 3,220.4 38.6 Operating expenses (887.3) (1,135.6) (1,517.9) (2,336.7) 34.7 Other operating income 29.5 24.6 31.0 64.9 39.0 Operating profit 268.4 397.5 596.0 948.5 51.4 Finance expenses (1.1) 0.0 (0.3) (33.9) 66.9 PBT 273.5 401.2 618.5 929.2 50.5 Tax (85.1) (106.1) (144.5) (201.9) 36.9 Net profit 186.8 294.8 473.6 721.3 55.8 EPS – RMB fen 18.3 28.7 45.8 69.6 49.9 Sources: The Company and Sun Hung Kai Financial
Figure 5: Li Ning – Profit and Loss Statement (Year on Year Growth) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 30.5 29.8 36.7 53.8 37.4 COGS 31.8 26.3 35.5 53.1 36.3 Gross profit 28.9 34.0 38.1 54.6 38.6 Operating expenses 24.9 28.0 33.7 53.9 34.7 Other operating income 69.8 (16.7) 26.0 109.4 39.0 Operating profit 48.8 48.1 49.9 59.2 51.4 Finance expenses (74.8) (100.0) N/A 10,273.4 N/A PBT 50.9 46.7 54.2 50.2 50.5 Tax 48.0 24.7 36.2 39.7 36.9 Net profit 52.6 57.8 60.6 52.3 55.8 EPS – RMB fen 32.4 57.0 60.0 51.9 49.9 Sources: The Company and Sun Hung Kai Financial
Figure 6: Li Ning – Profit and Loss Statement (Common Size) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (54.0) (52.6) (52.1) (51.9) (52.6) Gross profit 46.0 47.4 47.9 48.1 47.4 Operating expenses (36.2) (35.7) (34.9) (34.9) (35.4) Other operating income 1.2 0.8 0.7 1.0 0.9 Operating profit 11.0 12.5 13.7 14.2 12.8 Finance expenses (0.0) 0.0 (0.0) (0.5) (0.1) PBT 11.2 12.6 14.2 13.9 13.0 Tax (3.5) (3.3) (3.3) (3.0) (3.3) Net profit 7.6 9.3 10.9 10.8 9.6 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 182 20 Nov. 2009
Figure 7: Li Ning – Balance Sheet FY05-FY08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 378.4 838.9 849.9 788.0 25.0 Accounts receivable 373.2 579.1 684.7 1,090.6 49.6 Inventory 290.6 350.5 513.9 650.7 19.6 Other current assets 421.0 120.3 125.2 288.6 (13.7) Total current assets 1,463.2 1,888.8 2,173.8 2,817.9 19.6 Net fixed assets 99.7 182.5 365.0 954.1 78.7 Other long-term assets 20.0 94.0 242.0 564.9 178.7 Total assets 1,582.8 2,165.3 2,780.9 4,336.9 30.8 Short-term debt 0.0 0.0 100.0 607.5 97.4 Accounts payable 214.2 424.5 490.4 863.5 34.9 Other current liabilities 190.4 264.0 387.0 615.9 41.6 Total current liabilities 404.5 688.5 977.4 2,086.8 46.4 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 59.8 58.8 161.1 N/A Total liabilities 404.5 748.2 1,036.3 2,248.0 49.2 Shareholders equity 1,178.3 1,417.1 1,744.6 2,088.9 19.4 Minorities 17.4 17.6 0.0 192.5 82.9 Total equity and liabilities 1,582.8 2,165.3 2,780.9 4,336.9 30.8 Sources: The Company and Sun Hung Kai Financial
Figure 8: Li Ning – Balance Sheet (Common Size) FY05-FY08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 23.9 38.7 30.6 18.2 27.8 Accounts receivable 23.6 26.7 24.6 25.1 25.0 Inventory 18.4 16.2 18.5 15.0 17.0 Other current assets 26.6 5.6 4.5 6.7 10.8 Total current assets 92.4 87.2 78.2 65.0 80.7 Net fixed assets 6.3 8.4 13.1 22.0 12.5 Other long-term assets 1.3 4.3 8.7 13.0 6.8 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 3.6 14.0 4.4 Accounts payable 13.5 19.6 17.6 19.9 17.7 Other current liabilities 12.0 12.2 13.9 14.2 13.1 Total current liabilities 25.6 31.8 35.1 48.1 35.2 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 2.8 2.1 3.7 2.1 Total liabilities 25.6 34.6 37.3 51.8 37.3 Shareholders equity 74.4 65.4 62.7 48.2 62.7 Minorities 1.1 0.8 0.0 4.4 1.6 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 183 20 Nov. 2009
Figure 9: Li Ning – Key Ratios FY05-FY08 CAGR/ Year ended 31 Dec., % FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin - % 46.0 47.4 47.9 48.1 47.4 Operating margin – % 11.0 12.5 13.7 14.2 12.8 Net margin – % 7.6 9.3 10.9 10.8 9.6 ROAA – % 12.2 15.7 19.2 20.3 16.8 ROAE – % 16.9 22.7 30.0 37.6 26.8
Liquidity ratios Current assets/current liabilities – X 3.6 2.7 2.2 1.4 2.5 Liquid assets/current liabilities – X 0.9 1.2 0.9 0.4 0.9 Cash and securities/current assets – % 25.9 44.4 39.1 28.0 34.3 Cash flow from oper./curr. liabilities – % 37.2 45.2 40.8 32.2 38.8
Other ratios Capex/sales – % 1.6 3.1 5.1 3.3 3.3 Capex/depreciation – % 171.8 354.9 424.0 284.6 354.5 Operating expenses/sales -% (36.2) (35.7) (34.9) (34.9) (35.2) Net debt/equity – % (62.1) (59.9) (43.6) (8.6) (37.4) Inventory/sales – % 11.9 11.0 11.8 9.7 10.9 Effective tax rate – % 31.1 26.4 23.4 21.7 23.8 Cash conversion cycle - days 61.0 57.3 53.9 41.3 50.9
ROAA component analysis Revenue/average assets – % 159.9 169.7 175.8 188.0 173.4 COGS/average assets - % (86.4) (89.2) (91.6) (97.5) (91.2) Gross profit/average assets - % 73.5 80.5 84.2 90.5 82.2 Operating expenses/average assets – % (57.9) (60.6) (61.4) (65.7) (61.4) Other operating income/average assets – % 1.9 1.3 1.3 1.8 1.6 Operating profit/average assets – % 17.5 21.2 24.1 26.7 22.4 Finance expenses/average assets – % (0.1) 0.0 (0.0) (1.0) (0.3) PBT/average assets – % 17.8 21.4 25.0 26.1 22.6 Tax/average assets – % (5.6) (5.7) (5.8) (5.7) (5.7) Net profit/average assets – % 12.2 15.7 19.2 20.3 16.8
ROAE component analysis Revenue/average equity – % 222.2 245.1 275.1 349.0 272.9 COGS/average equity - % (120.1) (128.8) (143.3) (181.0) (143.3) Gross profit/average equity - % 102.1 116.2 131.8 168.0 129.5 Operating expenses/average equity – % (80.5) (87.5) (96.0) (121.9) (96.5) Other operating income/average equity – % 2.7 1.9 2.0 3.4 2.5 Operating profit/average equity – % 24.3 30.6 37.7 49.5 35.5 Finance expenses/average equity – % (0.1) 0.0 (0.0) (1.8) (0.5) PBT/average equity – % 24.8 30.9 39.1 48.5 35.8 Tax/average equity – % (7.7) (8.2) (9.1) (10.5) (8.9) Net profit/average equity – % 16.9 22.7 30.0 37.6 26.8 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 184 20 Nov. 2009
Little Sheep (968.HK) Food and Beverage Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Little Sheep is the one of the largest restaurant-chain operators in China. It specializes in Mongolian-style hot-pot cuisine, with a signature menu characterized Performance (%) 1m 3m 12m by aromatic soup bases and Mongolian lamb. It operates restaurants in China and HSI 2.0 13.5 76.7 overseas under the Little Sheep brand, and also processes and sells lamb and HSCEI 4.0 19.6 107.6 soup-base products and wholesales fresh and dried food. 83% of revenue is from restaurants, with the remainder from selling food products to franchised restaurants Little Sheep – Price vs. HSI, Share Data and customers, franchise income and management-service fees. As at end-June 2009,
the firm had 146 self-owned restaurants and 276 franchise restaurants (owned and (HK$) (HK$m) operated by third parties) in Hong Kong and China. The stock listed in Hong Kong 5.0 800 700 on 12 June 2008. 4.0 600 3.0 500 The firm owns and operates two lamb-processing facilities in Inner Mongolia that 400 meet 40%-50% of its lamb requirements, with the rest from third-party facilities. It 2.0 300 200 also owns and operates a production facility in Baotou, Inner Mongolia, which 1.0 100 produces the hot-pot soup base served in its restaurants and sold through its 0.0 0 wholesale operations. Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 Top-line growth could be driven by a shift in Chinese consumption toward dining Turnover Price HSI out. The firm is also switching to a new franchise structure. The old scheme collected fixed fees up front or prior to the start of the franchise term, with revenues from sales Price – HK$ 4.32 of lamb and other food to the franchisees. The new scheme ties franchise fees to 52W high/low (HK$) 4.69/1.41 annual revenues at franchise restaurants. Shares in issue – millions 1,027.67 Market cap – HK$m 4,449.79 Prospects are bright, with top-line growth driven by a shift in Chinese consumption 3M avg. turnover – HK$m 4.20 toward more dining out and ongoing restaurant-network expansion. This may already Major shareholders – % be factored into the stock price though, and downside risks include: Possible Way Intl Ltd 30.00 Consumers could opt to cut down on discretionary spending such as dining out Sources: Bloomberg and Sun Hung Kai Financial during the economic downturn, which would be negative to Little Sheep even though it focuses on the mass market. SSS growth in 1H09 slowed to 1.3% yoy with a 6.6% yoy decline for the overseas market. It will be difficult to achieve the 5% SSS-growth target for 2009.
Surging operating costs from a substantial rise in staff costs and A&P costs This document is solely based on caused the 1H09 net profit to drop 7.2% yoy. There should be plenty of room to publicly available information. This enhance efficiency, though higher A&P costs could be explained as being report is intended as information preparation for the upcoming peak season, i.e. staff costs for better staff welfare only and not as a recommendation and more permanent staff numbers. for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this Figure 1: Earnings Summary company in this report. Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – RMBm 79.6 91.2 128.7 150.6 Net-profit growth - % 32.4 14.6 41.2 17.0 EPS – RMB fen 9.3 10.7 13.6 14.7 EPS growth - % 32.5 14.6 26.8 8.5 P/E - X 40.8 35.6 28.1 25.9 DPS – RMB fen 0.0 0.0 6.7 6.1 Dividend yield - % 0.0 0.0 1.8 1.6 Holly Hou BVPS – RMB N/A N/A 0.9 1.0 + (852) 2203 9588 P/B - X N/A N/A 4.2 3.8 [email protected] Oper cash flow/share – RMB fen 15.8 10.7 14.7 17.0
Net debt (net cash) to share price - % N/A N/A (10.8) (9.2) Sources: Bloomberg and Sun Hung Kai Financial All reports are available at: Note: Estimates based on Bloomberg consensus http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor185ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Little Sheep – Investment Highlights
Key investment positives Key investment negatives
Long-term change in Chinese consumption patterns. Rising Despite targeting the mass market, consumers could prefer to incomes could increase dining out. stay at home and cut discretionary spending during the economic downturn. SSS grew 4.2% yoy in 2Q09, offsetting the 0.8% yoy Increasing store coverage. In 1H09, 19 new company-owned decline in 1Q, for overall SSS growth of 1.3% yoy for 1H09. But restaurants and 28 new franchise restaurants were opened. The the firm may still miss its target of 5% SSS growth for FY09. firm should be on track to meet its target of 40 new restaurants in 2009. No short-term synergy from Yum’s stake acquisition. Yum operates western-style food chains and is unfamiliar with the hot Lower barriers to rapid network expansion. Entry barriers for pot segment cross-regional expansion are high, as non-standardized Chinese cuisine involves complex kitchen work and relies on skilled chefs. Though the gross margin may stabilize, overall profitability Little Sheep can expand quickly and efficiently into new markets faces downward pressure. Operating margins are under pressure and maintain consistent quality, as its cuisine involves less kitchen from high operating leverage but low SSS growth (10% in FY08 preparation and customers do most of the cooking. vs. 1.3% in 1H09), given the fixed rental structure and longer-than-expected breakeven periods for self-owned restaurants New franchise system increases quality and stability of (usually 2-3 years). franchise income. The turnover-based system offers more upside potential for franchise contributions (90 franchise restaurants had Profitability could continue to worsen on aggressive applied this new arrangement by end-June 2009). promotions to improve SSS. This would increase SG&A costs and could hit operating margins. Gross margin could stabilize at 60%-plus given the firm’s ability to pass on cost hikes. It updates the menu on a quarterly Surging operating expenses from rising staff costs. This increase basis with new high-margin products. The gross margin has been should be permanent, i.e. better staff welfare and more staff stable at around 60% in the past three years. numbers. Strong ability to pass on cost hikes. High demand and limited Keen competition. The restaurant industry is fragmented, and supply have driven up lamb prices since 2007. Management competition is intensifying due to the many promotions launched anticipates a 10% hike this year and the trend to continue. But the by competitors such as McDonald’s, which have cut prices to lift company can pass on cast fluctuations to customers, underlined by SSS. its stable gross margin. Lamb purchases make up 35% of COGS. Rapid changes in consumer tastes mean little customer loyalty. Strong brand. Food-safety scandals in 2008 have raised consumer Hot pot is seasonal in nature, and more popular in winter, while concerns. The middle classes tend to opt for restaurants with restaurant sales tend to be higher between September and February. trusted brands and large scale.
New store types and products launched. The company opened its first shopping-mall unit in Beijing in 1H09. It also launched a new hot pot type, Qing Liang Guo. Continued innovation can help attract a wider range of customers and increase sales in non-peak seasons. Solid balance sheet. As at end-June 2009, the firm had net cash of RMB310m (HK$0.30/share). Food wholesale (14% of FY08 revenues) can improve blended utilization of production facilities and diversify revenues. Hot pot meals are suitable for all customer groups. Source: Sun Hung Kai Financial
Figure 3: Little Sheep – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Market consolidation, such as the closure of small-scale Rising food prices but an inability to adjust menu prices in time. restaurants. Not being able to update menus to cater for changing consumer Increasing the restaurant network could help raise entry barriers for tastes. new rivals. Failure to detect any outbreaks of food-borne diseases might hit The new franchise system could offer better returns. food quality and damage the brand. An economic recovery would encourage more dining out. Not being able to monitor franchisee performance may affect the strong brand. Not being able to attract franchisees could slow network expansion across China. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 186 20 Nov. 2009
Recent Company News
22 Oct. 2009: Management sells 7.3% stake to Yum!
The six executive directors and the senior management team sold a combined 7.3% interest in the company to YUM! on 20 Oct. 2009 at HK$4.00/ share. New York-listed YUM! operates various restaurant brands, including KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W All-American Food Restaurants, and is the second largest shareholder in Little Sheep.
SHKF comment. YUM! already had a 20% stake in Little Sheep, which has now risen to 27.3%. YUM! has alrerady sent two teams to help Little Sheep conduct an internal review. YUM!’s expertise in fast-food catering can help accelerate Little Sheep’s development.
Figure 4: Little Sheep – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 513.1 702.7 949.2 1,271.5 35.3 COGS (205.4) (277.4) (377.1) (524.4) 36.6 Gross profit 307.8 425.3 572.1 747.1 34.4 Operating expenses (180.0) (242.2) (331.2) (432.6) 33.9 Other operating income 10.6 7.1 7.8 30.0 41.5 Operating profit 138.3 190.2 248.7 344.5 35.5 Finance expenses (3.8) (11.0) (20.6) (6.6) 20.3 PBT 82.8 102.3 129.4 165.3 25.9 Tax (20.1) (22.0) (34.3) (30.8) 15.3 Net profit 60.1 79.6 91.2 128.7 28.9 EPS – RMB fen 7.0 9.3 10.7 13.6 24.4 Sources: The Company and Sun Hung Kai Financial
Figure 5: Little Sheep – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. - % FY04 FY05 FY06 FY07 CAGR (%) Revenue N/A 36.9 35.1 34.0 35.3 COGS N/A 35.1 35.9 39.1 36.6 Gross profit N/A 38.2 34.5 30.6 34.4 Operating expenses N/A 34.6 36.7 30.6 33.9 Other operating income N/A (32.9) 9.8 285.2 41.5 Operating profit N/A 37.5 30.8 38.5 35.5 Finance expenses N/A 191.4 86.8 (68.0) 20.3 PBT N/A 23.5 26.5 27.8 25.9 Tax N/A 9.5 56.3 (10.3) 15.3 Net profit N/A 32.4 14.6 41.2 28.9 EPS N/A 32.5 14.6 26.8 24.4 Sources: The Company and Sun Hung Kai Financial
Figure 6: Little Sheep – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. - % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (40.0) (39.5) (39.7) (41.2) (40.1) Gross profit 60.0 60.5 60.3 58.8 59.9 Operating expenses (35.1) (34.5) (34.9) (34.0) (34.5) Other operating income 2.1 1.0 0.8 2.4 1.4 Operating profit 27.0 27.1 26.2 27.1 26.8 Finance expenses (0.7) (1.6) (2.2) (0.5) (1.4) PBT 16.1 14.6 13.6 13.0 13.7 Tax (3.9) (3.1) (3.6) (2.4) (3.1) Net profit 11.7 11.3 9.6 10.1 10.3 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 187 20 Nov. 2009
Figure 7: Little Sheep – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 96.3 168.7 204.1 424.0 63.9 Accounts receivable 5.5 5.2 5.4 12.2 30.5 Inventory 68.2 61.4 144.1 179.4 38.0 Other current assets 44.2 53.5 55.3 65.9 14.2 Total current assets 214.1 288.9 408.9 681.5 47.0 Net fixed assets 133.4 164.7 193.8 459.7 51.0 Other long-term assets 14.9 104.1 172.3 22.6 14.9 Total assets 362.4 557.8 775.0 1,163.8 47.5 Short-term debt 60.5 0.0 98.0 0.5 (79.3) Accounts payable 25.5 26.5 37.4 40.8 17.0 Other current liabilities 69.4 111.5 138.3 165.3 33.5 Total current liabilities 155.4 138.0 273.8 206.7 10.0 Long-term debt 4.0 193.2 191.9 0.4 (54.5) Other long-term liabilities 6.6 6.8 5.1 6.9 1.4 Total liabilities 166.0 338.0 470.7 213.9 8.8 Shareholders equity 196.5 219.8 304.3 949.9 69.0 Minorities 5.2 8.2 16.4 8.3 16.9 Total equity and liabilities 362.4 557.8 775.0 1,163.8 47.5 Sources: The Company and Sun Hung Kai Financial
Figure 8: Little Sheep – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 26.6 30.2 26.3 36.4 31.0 Accounts receivable 1.5 0.9 0.7 1.0 0.9 Inventory 18.8 11.0 18.6 15.4 15.0 Other current assets 12.2 9.6 7.1 5.7 7.5 Total current assets 59.1 51.8 52.8 58.6 54.4 Net fixed assets 36.8 29.5 25.0 39.5 31.3 Other long-term assets 4.1 18.7 22.2 1.9 14.3 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 16.7 0.0 12.6 0.0 4.2 Accounts payable 7.0 4.7 4.8 3.5 4.4 Other current liabilities 19.1 20.0 17.9 14.2 17.3 Total current liabilities 42.9 24.7 35.3 17.8 25.9 Long-term debt 1.1 34.6 24.8 0.0 19.8 Other long-term liabilities 1.8 1.2 0.7 0.6 0.8 Total liabilities 45.8 60.6 60.7 18.4 46.6 Shareholders equity 54.2 39.4 39.3 81.6 53.4 Minorities 1.4 1.5 2.1 0.7 1.4 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 188 20 Nov. 2009
Figure 9: Little Sheep – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 60.0 60.5 60.3 58.8 59.9 Operating margin – % 27.0 27.1 26.2 27.1 26.8 Net margin – % 11.7 11.3 9.6 10.1 10.3 ROAA – % 16.6 17.3 13.7 13.3 14.7 ROAE – % 30.6 38.2 34.8 20.5 31.2
Liquidity ratios Current assets/current liabilities – X 1.4 2.1 1.5 3.3 2.3 Liquid assets/current liabilities – X 0.6 1.2 0.7 2.1 1.3 Cash and securities/current assets – % 44.9 58.4 49.9 62.2 56.8 Cash flow from oper./curr. liabilities – % 47.8 97.9 33.3 68.8 66.7
Other ratios Capex/sales – % 12.6 7.7 6.2 12.2 8.7 Capex/depreciation – % 276.7 182.3 182.7 380.9 248.6 Operating expenses/sales -% (35.1) (34.5) (34.9) (34.0) (34.5) Net debt/equity – % (18.2) 11.1 28.2 (44.5) (1.7) Inventory/sales – % 13.3 8.7 15.2 14.1 12.7 Effective tax rate – % 24.2 21.5 26.5 18.6 22.2 Cash-conversion cycle – days N/A 53.1 76.2 87.9 72.4
ROAA component analysis Revenue/average assets – % 141.6 152.7 142.4 131.2 142.1 COGS/average assets – % (56.7) (60.3) (56.6) (54.1) (57.0) Gross profit/average assets – % 84.9 92.4 85.8 77.1 85.1 Operating expenses/average assets – % (49.7) (52.6) (49.7) (44.6) (49.0) Other operating income/average assets – % 2.9 1.5 1.2 3.1 1.9 Operating profit/average assets – % 38.2 41.3 37.3 35.5 38.1 Finance expenses/average assets – % (1.0) (2.4) (3.1) (0.7) (2.1) PBT/average assets – % 22.8 22.2 19.4 17.1 19.6 Tax/average assets – % (5.5) (4.8) (5.1) (3.2) (4.4) Net profit/average assets – % 16.6 17.3 13.7 13.3 14.7
ROAE component analysis Revenue/average equity – % 261.2 337.6 362.2 202.8 300.9 COGS/average equity – % (104.5) (133.3) (143.9) (83.6) (120.3) Gross profit/average equity – % 156.6 204.3 218.3 119.1 180.6 Operating expenses/average equity – % (91.6) (116.4) (126.4) (69.0) (103.9) Other operating income/average equity – % 5.4 3.4 3.0 4.8 3.7 Operating profit/average equity – % 70.4 91.4 94.9 54.9 80.4 Finance expenses/average equity – % (1.9) (5.3) (7.9) (1.1) (4.7) PBT/average equity – % 42.1 49.2 49.4 26.4 41.6 Tax/average equity – % (10.2) (10.6) (13.1) (4.9) (9.5) Net profit/average equity – % 30.6 38.2 34.8 20.5 31.2 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 189 20 Nov. 2009
Meadville (3313.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Meadville ranks third in China’s PCB market by sales, up from fifth in 2007. Its PCB products are mainly for high-end applications such as communications products and Performance (%) 1m 3m 12m cell phones (55% of sales). Its top five customers are Huawei, Apple, ZTE, Sony HSI 2.0 13.5 76.7 Ericsson and Nokia. HSCEI 4.0 19.6 107.6
Telecom-industry restructuring and 3G rollout in China means domestic carriers have Meadville – Price vs. HSI, Share Data to increase capex to upgrade their networks. This can drive contract sales from Meadville’s key customers, such as Huawei and ZTE. The Ministry of Industry and Information Technology has said the PRC will invest RMB280bn in 3G in 2009 and (HK$) (HK$m) 3.0 80 2010 and 80% of this is estimated for telecom equipment. However, given the 70 2.5 uncertain environment, the company aims to preserve more cash to lower its financial 60 2.0 50 leverage, putting capacity expansion on hold. This could constrain sales growth. 1.5 40 1.0 30 China’s low-end to mid-range PCB producers have little pricing power and are highly 20 0.5 competitive, and demand for their products is cyclical. But Meadville is focusing on 10 0.0 0 niche markets such as serving big-name customers like Apple and IBM and the Oct 07 Feb 08 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 aerospace industry, which small/mid-sized peers find trickier to penetrate. It is also one of the few manufacturers able to produce high-end PCBs (40 layers or above), so Turnover Price HSI competition is not keen and ASPs can be maintained. The firm even has a history of passing on cost increases to customers. Price – HK$ 2.84 52W high/low (HK$) 3.18/0.63 A previous key concern had been high net gearing (93% in FY08). But the long Shares in issue – millions 1,964.00 loan-maturity profile (24% of bank borrowings are short-term loans) means there is Market cap – HK$m 5,675.96 not much need for short-term refinancing. The short cash-conversion cycle means the 3M avg. turnover – HK$m 11.16 firm can use internal resources to support greater working capital. Major shareholders – % Hsiang Chien Tang 72.18 Sources: Bloomberg and Sun Hung Kai Financial Figure 1: Earnings Summary Year ending 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m 320.0 341.6 402.5 311.6 Net-profit growth - % 51.8 6.8 17.8 (22.6) EPS – HK¢ 21.0 17.0 20.0 16.2 Recent Reports EPS growth - % N/A (19.0) 17.6 (19.0) Date Sacrificing Growth for Less 19 Aug. 2009 P/E – X 13.5 16.7 14.2 17.5 Leverage DPS – HK¢ 0.0 6.0 4.2 4.4 Dividend yield - % 0.0 2.1 1.5 1.5 BVPS – HK$ 0.5 1.2 1.4 1.6 This document is solely based on P/B – X 5.8 2.3 2.0 1.7 publicly available information. This Oper cash flow/share – HK¢ 28.5 61.5 58.1 42.8 report is intended as information Net debt (net cash) to share price - % 36.7 44.8 51.9 48.3 only and not as a recommendation
Sources: Bloomberg and Sun Hung Kai Financial. for any stock. Sun Hung Kai Note: Based on Bloomberg Consensus Financial does not provide research coverage or ratings for this company in this report.
Eva Yip, CFA + (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor190ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Meadville – Investment Highlights
Key investment positives Key investment negatives Sales growth is underpinned by a unique sales mix and exposure to Global electronics manufacturing is in a downturn. End-user a high-growth segment. The telecom sector contributes 40% of demand for electronics goods has fallen sharply since 2008 due to sales (up 11% yoy in 1H09) and has high growth potential. The the economic downturn. Ministry of Industry and Information Technology has said China Poor capacity management meant missing opportunities from 3G will invest RMB280bn in 3G in 2009 and 2010 and is estimated capex kicking off. The firm was unable to ramp up capacity, 80% of theses spending on telecom equipment. leading to order losses. The firm has secure order flows from key telecom-equipment Order pullbacks from Nokia (5% of sales). Due to weak handset providers. It supplies PCBs to Huawei, ZTE and Sony Ericsson for demand, Nokia has allocated PCB orders to other EMS firms to network infrastructure, providing up to 40%-50% of their demand. compensate for assembly-order losses. Benefits from continued high-layer PCB outsourcing. Its large Needs continued R&D to maintain competitiveness. Not coping scale and superior product quality can attract orders from these big with rapid technology change to meet customer requirements could names. The U.S. and European market for high-layer PCBs is hurt the business. worth US$10bn (around 65% of China’s total PCB production). Expansion into new business segments. The company plans to China is moving toward higher-value-added electronic products, invest in used in aerospace products. Opportunities are remote leading to greater high-end PCB demand. The high-end business is though, as China will need 10-15 years to fully compete with expected to outpace the low-end market. Meadville is the one of Airbus and Boeing. few companies that can produce high-end PCBs in China. These made up 38% of 1H09 sales. RMB appreciation could cut cost competitiveness by causing electronics plants to shift to other Asian countries, cutting into Greater sales of higher-value-added products like HDIs, IC PCB demand. substrates and multilayer PCBs will also help improve margins.
Less pricing pressure vs. low-end PCB makers. The lack of high-end PCB suppliers in China means Meadville does not have to face cutthroat price competition. The company does not compete on cost and volume, but rather in terms of technology. High customer loyalty. It is not easy for small peers to capture market share. Most customers are reputable, large OEMs such as Huawei and ZTE. It could take 2-3 years for small peers to qualify as suppliers. Aerospace could also be trickier for mid-sized peers to penetrate. High financial leverage but an improving debt-maturity profile. 84% of loans only have to be paid off by 2011. The firm has also revised down its FY09 capex budget from HK$1.4bn to HK$400m-HK$500m. Net gearing is estimated to fall from 68% in FY08 to 93% in 1H09. Source: Sun Hung Kai Financial
Figure 3: Meadville – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Sharper-than-expected U.S. recovery leading to strong Prolonged U.S. recession could lead to significant downturn in consumer-electronics demand. consumer electronics and hit selling prices. Faster-than-expected PCB-industry consolidation could Lower utilization due to lower orders, squeezing profitability. concentrate the market and raise the bargaining power of PCB Delays in telecom-network expansion. makers over suppliers (laminate producers) and customers (electronics market). Abrupt increases in copper prices, possibly from market speculation. Rapid penetration into new customers Sharp fall in copper prices from depressed demand. Faster-than-expected growth in Chinese aerospace development Source: Sun Hung Kai Financial
Recent Company News
Nil.
Sun Hung Kai Financial 191 20 Nov. 2009
Figure 4: Meadville – Profit and Loss Statement
FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 2,216.9 3,140.4 4,490.3 5,626.5 36.0 COGS (1,792.6) (2,486.6) (3,430.2) (4,546.0) 37.3 Gross profit 424.3 653.8 1,060.0 1,080.4 31.2 Operating expenses (232.6) (280.8) (485.3) (562.0) 28.5 Other operating income 62.6 97.1 177.1 172.5 84.8 Operating profit 254.3 417.9 497.3 679.3 40.7 Finance expenses (56.9) (88.2) (109.7) (132.0) 41.0 PBT 258.2 433.6 522.7 585.9 30.1 Tax (18.3) (48.7) (72.1) (77.4) 40.4 Net profit 210.8 320.0 341.6 402.5 23.9 EPS – HK¢ N/A 21.0 17.0 20.0 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Meadville – Profit and Loss Statement (Year on Year Growth)
FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 34.9 41.7 43.0 25.3 36.0 COGS 40.1 38.7 38.0 32.5 37.3 Gross profit 16.4 54.1 62.1 1.9 31.2 Operating expenses 12.9 20.7 72.8 15.8 28.5 Other operating income 323.5 55.2 82.3 (2.6) 84.8 Operating profit 46.7 64.3 19.0 36.6 40.7 Finance expenses 70.6 54.9 24.5 20.3 41.0 PBT 26.4 67.9 20.5 12.1 30.1 Tax (7.9) 165.6 48.0 7.3 40.4 Net profit 23.4 51.8 6.8 17.8 23.9 EPS N/A N/A (19.0) 17.6 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Meadville – Profit and Loss Statement (Common Size)
FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (80.9) (79.2) (76.4) (80.8) (79.3) Gross profit 19.1 20.8 23.6 19.2 20.7 Operating expenses (10.5) (8.9) (10.8) (10.0) (10.1) Other operating income 2.8 3.1 3.9 3.1 3.2 Operating profit 11.5 13.3 11.1 12.1 12.0 Finance expenses (2.6) (2.8) (2.4) (2.3) (2.5) PBT 11.6 13.8 11.6 10.4 11.9 Tax (0.8) (1.6) (1.6) (1.4) (1.3) Net profit 9.5 10.2 7.6 7.2 8.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 192 20 Nov. 2009
Figure 7: Meadville – Balance Sheet
FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 174.3 211.2 418.2 889.8 71.3 Accounts receivable 974.9 1,241.7 1,597.0 1,243.0 19.2 Inventory 259.2 373.5 498.0 544.9 25.5 Other current assets 36.2 2.2 45.1 21.8 (11.7) Total current assets 1,444.5 1,828.5 2,558.4 2,699.5 29.0 Net fixed assets 1,536.0 2,030.8 4,121.4 5,290.3 45.7 Other long-term assets 496.9 578.5 938.1 874.5 20.0 Total assets 3,477.4 4,437.8 7,617.8 8,864.3 36.3 Short-term debt 863.3 1,026.2 961.1 858.5 0.9 Accounts payable 600.4 800.0 1,428.3 1,467.1 33.0 Other current liabilities 188.0 910.6 206.0 217.3 34.0 Total current liabilities 1,651.7 2,736.8 2,595.4 2,543.0 16.8 Long-term debt 532.8 749.1 1,738.1 2,777.1 144.3 Other long-term liabilities 13.6 14.2 461.5 340.3 148.5 Total liabilities 2,198.1 3,500.1 4,795.0 5,660.4 40.5 Shareholders equity 1,126.8 733.8 2,463.5 2,778.8 30.0 Minorities 152.5 203.9 359.3 425.2 30.8 Total equity and liabilities 3,324.9 4,233.9 7,258.5 8,439.1 36.6 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Meadville – Balance Sheet (Common Size)
FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 5.0 4.8 5.5 10.0 6.3 Accounts receivable 28.0 28.0 21.0 14.0 22.8 Inventory 7.5 8.4 6.5 6.1 7.1 Other current assets 1.0 0.1 0.6 0.2 0.5 Total current assets 41.5 41.2 33.6 30.5 36.7 Net fixed assets 44.2 45.8 54.1 59.7 50.9 Other long-term assets 14.3 13.0 12.3 9.9 12.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 26.0 24.2 13.2 10.2 18.4 Accounts payable 18.1 18.9 19.7 17.4 18.5 Other current liabilities 5.7 21.5 2.8 2.6 8.1 Total current liabilities 49.7 64.6 35.8 30.1 45.1 Long-term debt 16.0 17.7 23.9 32.9 22.6 Other long-term liabilities 0.4 0.3 6.4 4.0 2.8 Total liabilities 66.1 82.7 66.1 67.1 70.5 Shareholders equity 33.9 17.3 33.9 32.9 29.5 Minorities 4.6 4.8 4.9 5.0 4.8 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 193 20 Nov. 2009
Figure 9: Meadville – Key Ratios
FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 19.1 20.8 23.6 19.2 20.7 Operating margin – % 11.5 13.3 11.1 12.1 12.0 Net margin – % 9.5 10.2 7.6 7.2 8.6 ROAA – % 7.0 8.1 5.7 4.9 6.4 ROAE – % 20.1 34.4 21.4 15.4 22.8
Liquidity ratios Current assets/current liabilities – X 0.9 0.7 1.0 1.1 0.9 Liquid assets/current liabilities – X 0.1 0.1 0.2 0.3 0.2 Cash and securities/current assets – % 12.1 11.5 16.3 33.0 18.2 Cash flow from oper./curr. liabilities – % 12.0 14.1 45.4 44.3 28.9
Other ratios Capex/sales – % 23.8 21.8 30.9 25.0 25.4 Capex/depreciation – % 331.1 328.2 475.5 319.0 374.3 Operating expenses/sales -% (10.5) (8.9) (10.8) (10.0) (9.9) Net debt/equity – % 108.4 213.2 92.6 98.8 134.9 Inventory/sales – % 11.7 11.9 11.1 9.7 10.9 Effective tax rate – % 7.1 11.2 13.8 13.2 12.7 Cash-conversion cycle – days 70.9 72.5 43.2 67.7 61.1
ROAA component analysis Revenue/average assets – % 73.3 79.4 74.5 68.3 73.9 COGS/average assets – % (59.3) (62.8) (56.9) (55.2) (58.5) Gross profit/average assets – % 14.0 16.5 17.6 13.1 15.3 Operating expenses/average assets – % (7.7) (7.1) (8.1) (6.8) (7.4) Other operating income/average assets – % 2.1 2.5 2.9 2.1 2.4 Operating profit/average assets – % 8.4 10.6 8.2 8.2 8.9 Finance expenses/average assets – % (1.9) (2.2) (1.8) (1.6) (1.9) PBT/average assets – % 8.5 11.0 8.7 7.1 8.8 Tax/average assets – % (0.6) (1.2) (1.2) (0.9) (1.0) Net profit/average assets – % 7.0 8.1 5.7 4.9 6.4
ROAE component analysis Revenue/average equity – % 211.1 337.6 280.9 214.7 261.1 COGS/average equity – % (170.7) (267.3) (214.6) (173.4) (206.5) Gross profit/average equity – % 40.4 70.3 66.3 41.2 54.6 Operating expenses/average equity – % (22.1) (30.2) (30.4) (21.4) (26.0) Other operating income/average equity – % 6.0 10.4 11.1 6.6 8.5 Operating profit/average equity – % 24.2 44.9 31.1 25.9 31.5 Finance expenses/average equity – % (5.4) (9.5) (6.9) (5.0) (6.7) PBT/average equity – % 24.6 46.6 32.7 22.4 31.6 Tax/average equity – % (1.7) (5.2) (4.5) (3.0) (3.6) Net profit/average equity – % 20.1 34.4 21.4 15.4 22.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 194 20 Nov. 2009
Natural Beauty (157.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 Natural Beauty is the largest spa operator in Taiwan (441 spas) and the PRC (1,329 HSCEI 13,470 spas) and also manufactures own-brand skin-care products in these two markets. The company was established in 1976 and listed in Hong Kong on 28 March 2002. Performance (%) 1m 3m 12m HSI 2.0 13.5 76.7 By segment, 97.4% of revenue is from product sales, 2.5% from services and the HSCEI 4.0 19.6 107.6
rest from entrustment income. By region, 74.8% of revenue is from mainland China,
23.4% from Taiwan and the rest from other Asian markets such as Hong Kong and Natural Beauty – Price vs. HSI, Share Data Malaysia.
(HK$) (HK$m) Natural Beauty has a vertically integrated business, from R&D and in-house 3.0 200
production to sales through franchise stores in the PRC and Taiwan. Factory 2.5 150 utilization is currently around 80% in Taiwan and China. 2.0
1.5 100 1.0 The franchise model allows the company to open spas faster, as it does not need to 50 use internal resources. Operating costs such as staff and rentals are paid by the 0.5 franchisees, which means a high operating margin over 40% for the company. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Referral sales from existing customers bringing in friends and family have led to Turnover Price HSI advertising and promotion expenses to sales dropping from 9.6% in 1H08 to 6.9% in 1H09. Management expects this to be about 10% of sales in FY09. Price – HK$ 1.29 52W high/low (HK$) 1.48/0.84 The firm launched high-margin nutrition supplements in FY07, and has since Shares in issue – millions 2,002.10 aggressively promoted these products (average 80% gross margin). This segment Market cap – HK$m 2,562.69 accounted for 13.9% of 1H09. Management targets to launch 11 health supplements 3M avg. turnover – HK$m 2.39 this year (vs. 29 in FY08). We see this business as the next growth driver. Major shareholders – % Yen Yu Tsai 65.52 Source: Bloomberg and Sun Hung Kai Financial The balance sheet remains strong, with net cash equal to ¼ of the market cap (with no bank loans). The dividend-payout ratio has been over 70% in the past five years and management expects to keep this at 60%-70% going forward. We see this as sustainable, as the franchise model means an asset-light business.
Turnover in the PRC and Taiwan market fell by 18.9% and 21.3% respectively for 1H09. This was mainly due to decreases in product sales and the services sector Recent Reports Date following the global financial crisis from 3Q08. Nutrition Supplements the 20 April 2009 Next Growth Driver
Figure 1: Earnings Summary Year ending 31 Dec. FY06 FY07 FY08 FY09E This document is solely based on publicly available information. This Net profit – HK$m 123.2 178.7 238.5 218.0 Net-profit growth - % report is intended as information 51.9 45.1 33.4 (8.6) only and not as a recommendation EPS – HK¢ 6.2 8.9 11.9 10.5 for any stock. Sun Hung Kai EPS growth - % 51.2 43.5 33.7 (11.8) Financial does not provide research P/E - X 20.8 14.5 10.8 12.3 coverage or ratings for this company in this report. DPS – HK¢ 4.4 7.2 8.4 7.8 Dividend yield - % 3.4 5.6 6.5 6.1 BVPS – HK$ 0.4 0.5 0.4 0.5 Holly Hou P/B - X 2.9 2.8 3.0 2.7 + (852) 2203 9588 Oper cash flow/share – HK¢ 5.5 14.0 13.8 11.0 [email protected] Net debt (net cash) to share price - % (14.9) (22.8) (21.2) N/A! Sources: Bloomberg and Sun Hung Kai Financial。 Note: Estimates based on Bloomberg consensus. All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research reports195 / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Natural Beauty – Investment Highlights
Key investment positives Key investment negatives Margins still high. Although turnover and net profit decreased Declining EPS. The consumer sector has been deeply affected by 19.1% yoy and 27.3% yoy in 1H09, the overall gross margin the global financial turmoil. EPS declined 28% yoy in 1H09 to stayed high at 81.7% and the product gross margin (97.4% of HK¢5.4, from HK¢7.5 in 1H08. sales) was stable at 87.5%. Poor performance of Fonperi. Fonperi is a retail product for the Market bottoming out. The PRC market should be more resilient Taiwan market only launched in April 2007. Turnover declined and is expected to outperform other countries, despite the over 70% yoy to HK$2.2m and the number of retail outlets also challenging overall market environment. The Taiwan market has decreased from 3,628 as at end-2008 to 3,351. The overall gross rebounded as a result of the tourism industry opening up to PRC and operating margins in Taiwan dropped from 86.7% and 29.5% visitors. to 85.7% and 25.3% respectively. Under the current economic condition, the Group will move focus away from it. Solid performances of main products. The mid-price skin-care range NB-1 was launched in 2007. In 1H09, over 114, 000 The cash-conversion cycle lengthened by 41 days in FY08 to 327 sets/bottles of NB-1 products were sold, with turnover of days due to inventory turnover increasing 48 days, offsetting the HK$84m, accounting for over a third of product sales. This improvement in receivable collections. We believe management underlines the effectiveness of the firm’s R&D. will focus on inventory control given weak consumer spending. New products launched. 32 new products entered the market in 1H09, of which 11 were health supplements. This can increase sales, as the new products target more customer groups. Establishment of new store format. A new store format will be established to enhance brand awareness and strengthen the franchisee network. This format should foster faster network expansion, particularly in second-tier cities, and requires lower initial investment from franchisees. This could further increase the gross margin. Health food/supplements. This new product segment delivered 69.5% revenue growth to HK$34.6m, accounting for 13.9% of sales. This is seen as a new growth driver. Benefits from referral sales. The group reduced media exposure and introduced products offering through client referrals, which led to advertising and promotion expenses falling to 6.9% of turnover, from 9.6% in 1H08, greatly increasing cost effectiveness. Increasing turnover in Hong Kong, Macau and Malaysia. Due to the financial downturn, the PRC and Taiwan businesses declined significantly. Other markets posted a 5.3% yoy turnover increase, but only account for 1.8% of sales. Net cash. The group had net cash of HK$593.5m as at end-1H09, compared with HK$546.2m at end-2008, with no bank borrowing. This should mean sufficient financial resources to finance commitments and meet working-capital requirements. Steady dividend policy. The payout ratio was over 70% in the past five years, and is still 64% for the proposed interim dividend. Low capex. Since there are no M&A targets, management has budgeted only around HK$28m for capex this year. The franchise model allows the company to open spas faster, as it does not need to use internal resources. High operating margin. Operating costs such as staff and rentals are paid by the franchisees, which means a high operating margin of over 40%. Improving consumer confidence. Greater focus on sales and product-knowledge training for franchisees to improve consumer confidence. Source: Sun Hung Kai Financial
Figure 3: Natural Beauty – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts New nutrition supplements will be the next earnings driver. Execution risks in getting and keeping franchisees. Faster than expected franchise spa openings. A downturn in the PRC economy would hurt sales. M&A activities. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 196 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
Annual beauty-industry sales of RMB200bn to double in five years
According to 中國美容經濟年度報告, in 2004 there were 15.4 million beauty shops, while 673 companies in China provided training courses and examining centers in conjunction with the Ministry of Labor.
In 2006, beauty-industry sales had reached RMB200bn and are forecast to double in the next five years. This puts the mainland beauty business just behind property, autos, telecommunication equipment and tourism in terms of sales. China’s per capita spending on beauty is now RMB118.30, No. 8 in the world and just behind Japan in Asia.
Cosmetics sales still strong in China, sales focused on urban areas
According to government statistics, cosmetics sales grew 21.2% yoy in 1H08 and 31.8% yoy in July. Year-to-date sales have reached RMB33.1bn, up 22.5% yoy. Spending is focused on urban areas and coastal cities, with six provinces contributing around 55% of national cosmetics sales (Shanghai 12%, Beijing 11%, Jiangsu 9%, Guangdong 9%, Zhejiang and Shandong 14%).
Nutrition-supplement sales estimated to grow 8% p.a.
According to Zhongguo Yigao Bao (中國醫藥報), national sales of nutrition supplements reached RMB30bn in 2003, with sales growth sharply increasing on greater health awareness, especially after the SARS outbreak. In 2006 sales rose 66.7% to RMB50bn, and are expected to post 8% growth p.a. hereon.
Chinese spend only 0.07% of outgoings on nutrition supplements, vs. 2% in the west
Nutrition supplements only account for 1.5% of national retail sales, with average spending per capita of only RMB31 per year, only 5.9% of the U.S. figure and 8.3% of Japanese spending. Chinese only spend 0.07% of outgoings on nutrition supplements, lagging the west’s 2%. We see strong growth potential given rising national incomes and health awareness.
Traditional nutrition supplements dominate with 44.3% of the market
Traditional nutrition supplements dominated with 44.3% of the market, followed by western supplements (36.8%) and functional supplements (15%).
The elderly are the major end consumers of traditional nutrition supplements
In the traditional nutrition-supplement market, the elderly account for 55% of end consumers, women 25%, young people 10% and others 10%. Four companies, Wanji Jiankang Bavjianping Co., Ltd, Yaodu Jin Ri, Hong Fu Loi and Joincare Pharmaceutical, account for around 30% of the market.
Sun Hung Kai Financial 197 20 Nov. 2009
Figure 4: Natural Beauty – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 357.9 363.7 450.1 592.7 13.4 COGS (73.3) (68.7) (77.6) (86.1) 1.1 Gross profit 284.6 295.0 372.6 506.6 16.4 Operating expenses (207.8) (165.7) (197.4) (253.1) 7.0 Other operating income 31.3 13.7 1.3 1.8 (44.5) Operating profit 108.0 143.0 176.5 255.3 25.6 Finance expenses 0.0 0.0 0.0 0.0 N/A PBT 119.8 174.5 208.0 308.5 32.8 Tax (38.8) (51.6) (29.2) (69.9) 17.8 Net profit 81.1 123.2 178.7 238.5 39.3 EPS – HK¢ 4.1 6.2 8.9 11.9 38.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Natural Beauty – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue (0.1) 1.6 23.8 31.7 13.4 COGS (10.9) (6.3) 12.9 11.0 1.1 Gross profit 3.2 3.7 26.3 36.0 16.4 Operating expenses 7.8 (20.3) 19.1 28.2 7.0 Other operating income 61.1 (56.2) (90.6) 43.6 (44.5) Operating profit 5.4 32.4 23.4 44.7 25.6 Finance expenses N/A N/A N/A N/A N/A PBT 21.0 45.6 19.2 48.3 32.8 Tax 6.9 33.0 (43.4) 139.0 17.8 Net profit 28.2 51.9 45.1 33.4 39.3 EPS 28.1 51.2 43.5 33.7 38.9 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Natural Beauty – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (20.5) (18.9) (17.2) (14.5) (17.8) Gross profit 79.5 81.1 82.8 85.5 82.2 Operating expenses (58.1) (45.5) (43.9) (42.7) (47.5) Other operating income 8.7 3.8 0.3 0.3 3.3 Operating profit 30.2 39.3 39.2 43.1 37.9 Finance expenses 0.0 0.0 0.0 0.0 0.0 PBT 33.5 48.0 46.2 52.0 44.9 Tax (10.9) (14.2) (6.5) (11.8) (10.8) Net profit 22.7 33.9 39.7 40.2 34.1 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 198 20 Nov. 2009
Figure 7: Natural Beauty – Balance Sheet FY05-08 As at 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 338.7 356.2 588.7 546.2 23.4 Accounts receivable 77.9 86.0 59.4 65.3 2.4 Inventory 56.5 63.6 71.0 100.9 16.0 Other current assets 90.1 106.9 39.9 28.1 (35.2) Total current assets 563.2 612.7 759.0 740.5 9.7 Net fixed assets 338.4 344.8 232.1 240.4 (8.6) Other long-term assets 35.9 40.2 41.2 45.3 (0.1) Total assets 937.5 997.7 1,032.3 1,026.2 3.3 Short-term debt 0.0 0.0 0.0 0.0 N/A Accounts payable 16.6 16.6 21.8 14.0 8.5 Other current liabilities 89.7 90.6 83.0 143.5 17.5 Total current liabilities 106.3 107.2 104.8 157.6 16.5 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 10.9 11.3 11.9 12.3 4.8 Total liabilities 117.2 118.5 116.7 169.8 15.4 Shareholders equity 820.3 879.2 915.7 856.4 1.6 Minorities 6.8 0.4 6.0 6.4 (9.6) Total equity and liabilities 937.5 997.7 1,032.3 1,026.2 3.3 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Natural Beauty – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 36.1 35.7 57.0 53.2 45.5 Accounts receivable 8.3 8.6 5.7 6.4 7.3 Inventory 6.0 6.4 6.9 9.8 7.3 Other current assets 9.6 10.7 3.9 2.7 6.7 Total current assets 60.1 61.4 73.5 72.2 66.8 Net fixed assets 36.1 34.6 22.5 23.4 29.1 Other long-term assets 3.8 4.0 4.0 4.4 4.1 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 0.0 0.0 Accounts payable 1.8 1.7 2.1 1.4 1.7 Other current liabilities 9.6 9.1 8.0 14.0 10.2 Total current liabilities 11.3 10.7 10.1 15.4 11.9 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 1.2 1.1 1.2 1.2 1.2 Total liabilities 12.5 11.9 11.3 16.5 13.1 Shareholders equity 87.5 88.1 88.7 83.5 86.9 Minorities 0.7 0.0 0.6 0.6 0.5 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 199 20 Nov. 2009
Figure 9: Natural Beauty – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 79.5 81.1 82.8 85.5 82.2 Operating margin – % 30.2 39.3 39.2 43.1 37.9 Net margin – % 22.7 33.9 39.7 40.2 34.1 ROAA – % 8.8 12.7 17.6 23.2 15.6 ROAE – % 10.0 14.5 19.9 26.9 17.8
Liquidity ratios Current assets/current liabilities – X 5.3 5.7 7.2 4.7 5.7 Liquid assets/current liabilities – X 3.2 3.3 5.6 3.5 3.9 Cash and securities/current assets – % 60.1 58.1 77.6 73.8 67.4 Cash flow from oper./curr. liabilities – % 108.2 103.1 268.2 175.1 163.6
Other ratios Capex/sales – % 7.0 3.1 11.9 6.0 7.0 Capex/depreciation – % 100.9 53.5 302.6 203.5 186.5 Operating expense/sales -% (58.1) (45.5) (43.9) (42.7) (44.0) Net debt/equity (net cash) – % (44.5) (43.7) (64.3) (63.8) (57.2) Inventory/sales – % 15.8 17.5 15.8 17.0 16.8 Effective tax rate – % 32.4 29.6 14.1 22.7 22.1 Cash conversion cycle – days 283.4 321.1 293.1 347.2 320.5
ROAA component analysis Revenue/average assets – % 39.0 37.6 44.4 57.6 44.6 COGS/average assets – % (8.0) (7.1) (7.6) (8.4) (7.8) Gross profit/average assets – % 31.0 30.5 36.7 49.2 36.8 Operating expenses/average assets – % (22.6) (17.1) (19.4) (24.6) (20.9) Other operating income/average assets – % 3.4 1.4 0.1 0.2 1.3 Operating profit/average assets – % 11.8 14.8 17.4 24.8 17.2 Finance expenses/average assets – % 0.0 0.0 0.0 0.0 0.0 PBT/average assets – % 13.0 18.0 20.5 30.0 20.4 Tax/average assets – % (4.2) (5.3) (2.9) (6.8) (4.8) Net profit/average assets – % 8.8 12.7 17.6 23.2 15.6
ROAE component analysis Revenue/average equity – % 44.1 42.8 50.2 66.9 51.0 COGS/average equity – % (9.0) (8.1) (8.6) (9.7) (8.9) Gross profit/average equity – % 35.0 34.7 41.5 57.2 42.1 Operating expenses/average equity – % (25.6) (19.5) (22.0) (28.6) (23.9) Other operating income/average equity – % 3.8 1.6 0.1 0.2 1.5 Operating profit/average equity – % 13.3 16.8 19.7 28.8 19.7 Finance expenses/average equity – % 0.0 0.0 0.0 0.0 0.0 PBT/average equity – % 14.8 20.5 23.2 34.8 23.3 Tax/average equity – % (4.8) (6.1) (3.3) (7.9) (5.5) Net profit/average equity – % 10.0 14.5 19.9 26.9 17.8 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 200 20 Nov. 2009
NewOcean Energy Holdings (342.HK) China Gas Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 NewOcean Energy Holdings Limited is an importer, trader and seller (wholesale and
of LPG products. In 2003, it purchased a class 1 LPG sea terminal on Gaolan Island, Performance (%) 1m 3m 12m Zhuhai, which can handle VLGCs (very large gas carriers) of 50,000 million tons HSI 2.0 13.5 76.7 (MT). It is one of only five LPG terminals within a 250-km radius, and is the storage HSCEI 4.0 19.6 107.6 and logistics center for the group. This vital asset has allowed the company to establish a strong LPG retail and wholesale business. NewOcean Evergy– Price vs. HSI, Share Data The firm is a leader in the Guangdong LPG market. It ranks No. 1 by total sales, supplying about 18% of the LPG in the province, and is also No.1 in LPG wholesale (HK$) (HK$m) volumes and LPG imports and exports. 1.4 350 1.2 300 Figure 1: NewOcean – major LPG player in Guangdong 1.0 250 0.8 200 Market share in Guangdong Rank 0.6 150 LPG supply 18% #1 0.4 100 LPG retail volume 6% #3 0.2 50 0.0 0 LPG wholesale volume 12% #1 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
LPG import volume 37% #1 Turnover Price HSI LPG export volume 64% #1 Source: The Company Price – HK$ 1.15 52W high/low (HK$) 1.18/0.209 It has an LPG distribution network of 14 bottling plants, distributing LPG cylinders Shares in issue – millions 963.35 in nine cities in Guangdong and Guangxi, including Guilin, Lipu, Cangwu, Wuzhou, Market cap – HK$m 1,059.69 Qingyuan, and Huadu. The company also imports, distributes and re-exports LPG. 3M avg. turnover – HK$m 6.39 The firm’s sea terminal ranks No. 1 in the PRC by throughput volume. Major shareholders – % Uniocean Investment 50.94 NewOcean also sells electronic products, with operations in Guangdong and Source: Bloomberg and Sun Hung Kai Financial Guangxi. Figure 2: Earnings Summary Year ended 31 Dec. FY06 FY07 FY08 FY09E Net profit – HK$m 44.1 50.5 52.9 90.3 Net-profit growth – % 23.6 14.3 4.9 70.7 EPS – HK¢ 8.0 9.2 8.5 9.4 EPS growth – % 23.8 14.2 (7.4) 10.8 Recent Reports Date P/E – X 14.3 12.6 13.6 12.2 Expanding Gas Giant 6 Nov. 2009 DPS – HK¢ 1.1 1.0 0.3 1.1 Dividend yield – % 0.9 0.8 0.3 1.0 BVPS – HK$ 0.8 0.9 0.7 0.8 This document is solely based on P/B – X 1.4 1.2 1.5 1.4 publicly available information. This Op. cash flow/share – HK¢ 38.6 (35.6) (24.4) 21.0 report is intended as information only Net debt (net cash)/ price – % 94.7 194.9 131.4 N/A and not as a recommendation for any Sources: Bloomberg and Sun Hung Kai Financial stock. Sun Hung Kai Financial does Note: Estimates based on Bloomberg consensus not provide research coverage or ratings for this company in this report.
Michael Yuk + (852) 3761 1400 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor201ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 3: NewOcean Energy– Investment Highlights
Key investment positives Key investment negatives Robust volume growth. Sales volume posted a 23% two-year Vulnerable to rising crude-oil prices. Purchase prices for LPG CAGR for FY06-FY08, while 1H09 volume increased 26% yoy. are based on crude-oil prices. Sharp increases in crude prices would cut the spread between the discount on LPG purchased (X) Pricing mechanism reduces inventory risk. The company and the premium added to selling price (Y), lowering gross purchases its LPG and feed-in products at a fixed discount to the margins. monthly average price. Yet it sells LPG at a fixed premium based on the same pricing benchmark. Hence, the company has a natural Low net margins, but growth is driven by volume. The net hedge against sharp declines in LPG price, which reduces margin is low at around 1.5%. Earnings growth has been driven by inventory risk. increases in the volume of LPG sold. However, the company is implementing measures such as direct sales to customers to boost Strong market share in Guangdong. The LPG market in China is its gross margins, which will be reflected in future results. very fragmented, and even a 10% share is considered significant. The firm ranks No. 3 in Guangdong for LPG cylinder bottles (6% Foreign-exchange risk. The firm imports butane and propane on market share), No. 1 for LPG (12%), and No. 1 for LPG imports the international market in USD, while sales are in RMB. If the (37%). It is also No. 1 overall for China in LPG imports. USD were to appreciate strongly vs. the RMB, the cost of its imported LPG would increase and margins would be squeezed. Own fleet of LPG-tank trucks and cylinder wagons to sell LPG directly to end users, thereby cutting out middlemen, allowing for Higher interest rates would increase cash-flow problems. higher margins than the industry. Currently the company enjoys low interest rates of about 2.5% p.a. But increasing interest rates would raise the company’s financial Expanding into Autogas. The company is expanding into Autogas burden. in Zhuhai, which should help shorten the cash-conversion cycle and tap a lucrative market with gross margins of 18%. Operating risk from expanding into the Hong Kong and Macau LPG market. The company plans to use its low-cost Lack of LPG substitutes in Guangdong. LPG is widely used in production base in Zhuhai to ship and sell LPG in Hong Kong, Guangdong for domestic, industrial, commercial and vehicle where prices are on average 300% higher than in Guangdong. But purposes. Due to the population being spread across the province, there is operating risk, as the LPG market is very saturated by the laying gas pipelines would be expensive and mean difficult inroads oil majors already operating in Hong Kong. to replace current LPG usage. Needs funds for expansion. The company’s plans to 1) expand the The only privately operated LPG export terminal in terminal facilities cater to increasing export demand of LPG; 2) to Guangdong. Although most LPG terminals can import LPG, they enter the Zhuhai Autogas market and 3) to break into the Hong cannot export. The company has the only bonded LPG terminal in Kong & Macau’s retail LPG market. All of which capital Zhuhai, which allows it to export LPG to other regions, including investment. Total capex is estimated at HK$250m, which Hong Kong, the Philippines, Taiwan and Vietnam. HK$100m has already been sourced through a capital injection Only terminal with butane & propane mixing facilities. The from Provisional Talent for a 25% stake in subsidiary NewOcean company imports butane and propane and has the only facilities in Development Ltd. Hence, the company still needs to secure a Guangdong that can mix butane propane proportions to meet further HK130m to fund expansion, which may be sourced through customer specifications. equity financing, which may dilute earnings or through bank loans, which would increases interest expense. JV with to operate-oil storage terminal. The company is establishing a JV with Caltex (a member of the Chevron group) to End of tax holiday. Subsidiary NewOcean Energy (Zhuhai) Co. build an oil-storage terminal adjacent to its LPG terminal in Zhuhai Ltd. is entitled to 50% relief on PRC enterprise tax. However, that at end FY09. The company will not only share in the equity profit tax rate will progressively increase from 18% to 22% over of the JV, but will also be paid a throughput fee for utilization of its FY08-FY10. jetties and pipelines connected to the oil storage. Benefits from RMB appreciation. The company’s business is in mainland China, where sales are in RMB, while the cost of purchasing LPG is in USD. Hence, the company would benefit from an appreciation in the RMB vs. the dollar.
Source: Sun Hung Kai Financial
Figure 4: NewOcean Energy – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Approval from the Zhuhai municipal government to roll out Inability to obtain government approval for the introduction of Autogas in Zhuhai. Autogas into the Zhuhai market and/or failure to get approval for the distribution of LPG cylinders in Hong Kong and Macau retail Successful entry into the Hong Kong LPG market. market. Wide adoption of LPG for transport, such as for buses and taxis Consolidation of the LPG market in Guangdong by national oil throughout Guangdong. majors. A spin-off of the electronics division, which would crystallize the Widespread adoption of CNG or LNG, which would reduce company’s focus on LPG. demand for LPG. A relapse of the credit crisis experienced during 1Q09, which would restrict sales due to high receivables-collection risks. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 202 20 Nov. 2009
Industry Dynamics LPG applications are mainly split into two categories: 1) household, and 2) industrial & commercial, including vehicle use. Household LPG is mainly used for cooking and heating water, so therefore has no specific requirements for the ratio between Butane and Propane (the main ingredients in LPG) for vapor pressure. Conversely, industrial and vehicle applications often require certain specifications, which refineries in China often cannot produce economically or at consistent quality. Hence, LPG from domestic refineries is mainly supplied to households, while industrial LPG is generally imported.
Demand for retail LPG is very price inelastic, as it is mainly used for cooking and heating. Suppliers also often try to lock in customers by providing valves that can only be attached to their own cylinders. Furthermore, suppliers are often restricted to a certain area in a city to minimize price gouging and price wars.
Guangdong province is the largest consumer of LPG and has already implemented LPG use for vehicles, which have been shown to release 20% less nitrogen oxide and 60% less carbon monoxide than gasoline vehicles.
LPG is preferred to compressed natural gas (CNG) in sparsely populated areas, where building an expensive CNG pipeline would be uneconomical. It is also preferred as an alternative fuel, since less equipment needs to be installed at retail stations and in vehicles.
LPG also has a higher calorific value than CNG, meaning it generates similar engine performance to gasoline or diesel, with less initial investment than CNG since Autogas storage cylinders are lighter than those for CNG.
Figure 5: Head to head – LPG vs. natural gas Fuel type LPG Natural gas Remarks Calorific value Gasoline: 43,124 kJ/kg; 50,241 38,979 (kJ/kg) Diesel: 42,705 kJ/kg Carbon emission 17.2 15.5 Gasoline: 18.9; Diesel: 20.2 factor Natural gas must be refrigerated for liquefaction, Vaporization –50 to 4 –162 hence very heavy temperature (ºC) infrastructure is need for production and transport. Easily and cheaply stored in Stored in heavy steel Storage Great vapor pressure. cylinders or bulk gas tanks cylinders. LPG can be dispensed using a As natural gas is highly wide variety of storage pressurized, it must be Portability cylinders, making it very transported via fixed pipeline portable. networks. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 203 20 Nov. 2009
Figure 6: NewOcean Energy – Profit and Loss Statement FY05-08 Year ending 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,615.5 2,384.8 3,890.2 6,158.6 56.6 COGS (1,533.4) (2,261.6) (3,719.2) (5,931.2) 58.3 Gross profit 82.1 123.3 171.0 227.4 29.9 Operating expenses (62.1) (75.3) (132.3) (202.8) 46.2 Other operating income 1.6 3.8 9.4 3.7 26.6 Operating profit 21.5 51.8 48.1 28.3 (6.4) Finance expenses (9.5) (37.3) (53.7) (108.0) 143.4 PBT 30.2 38.2 52.6 54.1 19.9 Tax 3.7 0.2 (2.1) (1.2) (33.6) Net profit 35.7 44.1 50.5 52.9 27.3 EPS – HK¢ 6.5 8.0 9.2 8.5 22.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 7: NewOcean Energy – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 57.8 47.6 63.1 58.3 56.6 COGS 62.4 47.5 64.5 59.5 58.3 Gross profit 2.9 50.2 38.7 33.0 29.9 Operating expenses 40.0 21.2 75.8 53.3 46.2 Other operating income 7.5 142.8 147.3 (60.1) 26.6 Operating profit (41.7) 141.0 (7.2) (41.1) (6.4) Finance expenses 208.1 292.9 44.0 101.2 143.4 PBT 15.6 26.4 37.5 3.0 19.9 Tax (159.0) (95.1) (1,276.0) (42.5) (33.6) Net profit 76.9 23.6 14.3 4.9 27.3 EPS 69.2 23.8 14.2 (7.4) 22.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: NewOcean Energy – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (94.9) (94.8) (95.6) (96.3) (95.4) Gross profit 5.1 5.2 4.4 3.7 4.6 Operating expenses (3.8) (3.2) (3.4) (3.3) (3.4) Other operating income 0.1 0.2 0.2 0.1 0.1 Operating profit 1.3 2.2 1.2 0.5 1.3 Finance expenses (0.6) (1.6) (1.4) (1.8) (1.3) PBT 1.9 1.6 1.4 0.9 1.4 Tax 0.2 0.0 (0.1) (0.0) 0.0 Net profit 2.2 1.9 1.3 0.9 1.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 204 20 Nov. 2009
Figure 9: NewOcean Energy - Balance Sheet FY05-08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 57.5 151.0 106.0 143.8 26.6 Accounts receivable 50.3 139.3 430.9 447.7 55.0 Inventory 40.2 58.0 126.9 137.7 170.2 Other current assets 313.9 446.2 919.3 1,148.2 133.3 Total current assets 462.0 794.6 1,583.1 1,877.3 81.0 Net fixed assets 275.4 502.6 566.8 638.6 25.0 Other long-term assets 95.3 164.7 169.7 184.3 24.2 Total assets 832.6 1,461.8 2,319.5 2,700.3 51.4 Short-term debt 375.7 528.1 1,134.4 1,489.7 93.6 Accounts payable 21.9 158.1 312.4 141.5 98.3 Other current liabilities 35.0 96.7 122.5 226.3 66.1 Total current liabilities 432.7 782.9 1,569.4 1,857.4 89.2 Long-term debt 0.0 222.2 205.4 110.3 N/A Other long-term liabilities 9.5 9.2 20.9 15.0 11.1 Total liabilities 442.2 1,014.3 1,795.7 1,982.7 89.2 Shareholders equity 390.5 447.5 523.8 717.6 18.9 Minorities 1.5 1.5 10.7 1.5 (24.5) Total equity and liabilities 832.6 1,461.8 2,319.5 2,700.3 51.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 10: NewOcean Energy– Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 6.9 10.3 4.6 5.3 6.8 Accounts receivable 6.0 9.5 18.6 16.6 12.7 Inventory 4.8 4.0 5.5 5.1 4.8 Other current assets 37.7 30.5 39.6 42.5 37.6 Total current assets 55.5 54.4 68.2 69.5 61.9 Net fixed assets 33.1 34.4 24.4 23.7 28.9 Other long-term assets 11.4 11.3 7.3 6.8 9.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 45.1 36.1 48.9 55.2 46.3 Accounts payable 2.6 10.8 13.5 5.2 8.0 Other current liabilities 4.2 6.6 5.3 8.4 6.1 Total current liabilities 52.0 53.6 67.7 68.8 60.5 Long-term debt 0.0 15.2 8.9 4.1 7.0 Other long-term liabilities 1.1 0.6 0.9 0.6 0.8 Total liabilities 53.1 69.4 77.4 73.4 68.3 Shareholders equity 46.9 30.6 22.6 26.6 31.7 Minorities 0.2 0.1 0.5 0.1 0.2 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 205 20 Nov. 2009
Figure 11: NewOcean Energy – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 5.1 5.2 4.4 3.7 4.6 Operating margin – % 1.3 2.2 1.2 0.5 1.3 Net margin – % 2.2 1.9 1.3 0.9 1.6 ROAA – % 5.3 3.8 2.7 2.1 3.5 ROAE – % 9.5 10.5 10.4 8.5 9.7
Liquidity ratios Current assets/current liabilities – X 1.1 1.0 1.0 1.0 1.0 Liquid assets/current liabilities – X 0.1 0.2 0.1 0.1 0.1 Cash and securities/current assets – % 12.4 19.0 6.7 7.7 11.5 Cash flow from oper./curr. liabilities – % 1.2 27.1 (12.5) (8.2) 1.9
Other ratios Capex/sales – % 1.6 10.4 3.8 1.3 4.3 Capex/depreciation – % 142.3 1,430.7 577.9 201.2 736.6 Operating expense/sales -% (3.8) (3.2) (3.4) (3.3) (3.3) Net debt/equity (net cash) – % 81.5 133.9 235.5 202.9 190.8 Inventory/sales – % 2.5 2.4 3.3 2.2 2.6 Effective tax rate – % (12.1) (0.5) 4.0 2.2 1.9 Cash conversion cycle – days 15.9 8.0 13.2 20.3 13.8
ROAA component analysis Revenue/average assets – % 239.9 207.9 205.8 245.4 224.7 COGS/average assets – % (227.7) (197.1) (196.7) (236.3) (214.5) Gross profit/average assets – % 12.2 10.7 9.0 9.1 10.3 Operating expenses/average assets – % (9.2) (6.6) (7.0) (8.1) (7.7) Other operating income/average assets – % 0.2 0.3 0.5 0.1 0.3 Operating profit/average assets – % 3.2 4.5 2.5 1.1 2.8 Finance expenses/average assets – % (1.4) (3.2) (2.8) (4.3) (3.0) PBT/average assets – % 4.5 3.3 2.8 2.2 3.2 Tax/average assets – % 0.5 0.0 (0.1) (0.0) 0.1 Net profit/average assets – % 5.3 3.8 2.7 2.1 3.5
ROAE component analysis Revenue/average equity – % 430.9 569.2 801.0 992.2 698.3 COGS/average equity – % (409.0) (539.8) (765.8) (955.5) (667.5) Gross profit/average equity – % 21.9 29.4 35.2 36.6 30.8 Operating expenses/average equity – % (16.6) (18.0) (27.2) (32.7) (23.6) Other operating income/average equity – % 0.4 0.9 1.9 0.6 1.0 Operating profit/average equity – % 5.7 12.4 9.9 4.6 8.1 Finance expenses/average equity – % (2.5) (8.9) (11.1) (17.4) (10.0) PBT/average equity – % 8.1 9.1 10.8 8.7 9.2 Tax/average equity – % 1.0 0.0 (0.4) (0.2) 0.1 Net profit/average equity – % 9.5 10.5 10.4 8.5 9.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 206 20 Nov. 2009
NWDS (825.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 New World Department Store was established in 1993 and wholly owned by New World Development. NWDS listed in Hong Kong on 12 July 2007, and the parent Performance (%) 1m 3m 12m
still holds a 72.3% stake. It operates a national store network of 22 self-owned stores HSI 2.0 13.5 76.7 and 11 managed stores in 17 regions in the PRC. 26 stores are under the New World HSCEI 4.0 19.6 107.6 brand and seven under Ba Li Chun Tian. Most stores are in the northeast and east of China and in the Shanghai region. NWDS – Price vs. HSI, Share Data
The company has a balanced strategy, focusing more on profitability. Rather than (HK$) (HK$m) aggressive discounts to boost sales, which would hurt margins, NWDS has 12.0 140 implemented a rebranding program and more VIP activities. This has resulted in 10.0 120 100 slow SSS growth of 5% in FY09 (vs. 10.9% for 1H09), but stable commission rates 8.0 80 6.0 at 20.3% in FY09 (vs. 21% in FY08). 60 4.0 40 The nationwide rebranding program has introduced the new Fashion Gallery and 2.0 20 0.0 0 Living Gallery concepts in phases at its department stores, with Shenyang as the Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 launch city in September 2009. Turnover Price HSI
The company stands out among its department-store peers as it can leverage a strong Price – HK$ 7.84 parent company, New World Development, to purchase properties and secure prime 52W high/low (HK$) 8.29/2.3 locations. This could provide a strategic advantage over its peers and help lower Shares in issue – millions 1,686.15 rental costs and improve margins in the long term. Market cap – HK$m 13,067.62 3M avg. turnover – HK$m 14.56 NWDS also has priority to acquire stores that it manages. This is less risky than Major shareholders – % opening new stores, which need 1-1½ years to break even, and can boost New World Development 72.29 medium-term growth. The company acquired its Kunming Store and Ningbo Trendy Source: Bloomberg and Sun Hung Kai Financial Store in FY09, while one more managed store was opened in Beijing.
The firm has a strong balance sheet, with net cash equal to 26.8% of its market cap and no debts.
FY09 results. Net income rose 14.8% to HK$547m, but recurring net profit only grew 7.7%. Revenue increased 15.6% to HK$1,489m, driven by SSS growth of 5% and total GFA expansion of 10.5%. Commission income from concessionaires was still the largest contributor, at 67.6% of total revenue.
Figure 1: Earnings Summary Year ending 30 June FY07 FY08 FY09 FY10E
Net profit – HK$m 302.8 476.6 547.3 582.2 Recent Reports Date
Net-profit growth – % 91.7 57.4 14.8 6.4 Investment Daily Note 7 Oct. 2009 EPS – HK¢ 25.0 29.0 32.0 34.3
EPS growth – % N/A 16.0 10.3 7.2 P/E – X 31.4 27.0 24.5 22.9 DPS – HK¢ 0.0 9.0 15.0 15.4 This document is solely based on publicly available information. This Dividend yield – % 0.0 1.1 1.9 2.0 BVPS – HK$ report is intended as information 14.1 2.4 2.6 2.8 Holly Hou P/B – X 0.6 3.2 3.0 2.8 only and not as a recommendation + (852) 2203 9588 Oper. cash flow/share – HK¢ 53.2 40.8 12.1 54.7 for any stock. Sun Hung Kai [email protected] Net debt (net cash)/price – % (202.5) (23.7) (22.1) (22.1) Financial does not provide research Sources: Bloomberg and Sun Hung Kai Financial coverage or ratings for this Note: Estimates based on Bloomberg consensus Allcompany reports are in available this report. at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer Sun HungThis Kai rep Financialort / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),207 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: NWDS – Investment Highlights
Key investment positives Key investment negatives Top five department store operator. According to Euromonitor, Poor operating efficiency. The company’s focus on profitability has NWDS was among the top five owners and operators of department meant lower SSS growth than its peers, at 5% in FY09 (vs. 10.9% for stores in the PRC by sales (excluding sales tax) in 2006. 1H09). It kept commission rates stable at about the 20% level, but most peers also little change in commission rates. Satisfactory results from rebranding. The firm introduced two new concepts in September 2009: 1) Fashion Gallery at smaller department Margins under pressure in the short term. The firm has the highest stores, targeting younger, trendy consumers with exclusive brands and rental costs among its peers, so operating margins may be under designer labels, but with lower ASPs, and 2) Living Gallery at larger pressure. Rental costs to sales stayed at 18.8% for FY09, as rental costs stores, with 30% of GFA set aside for dining, leisure and are almost fixed under 15-25 year leases. Since sales growth is slowing, complementary services for all age groups. Management guides that fixed rental costs could put operating margins under pressure. traffic has increased 30%-40% and that conversion rates have improved at the launch store.
Sufficient funds for capex. There should be little financial pressure, given the HK$2,924 net cash, with no funding needs expected in the next 2-3 years. Less risk from acquiring managed stores than opening new stores. The company currently manages 11 stores, and has priority rights to acquire these stores. This should entail lower operating risks than opening a new stores. Geographically diverse revenue contributions. NWDS has 22 self-owned stores and 11 managed stores across 17 regions in the PRC. This nationwide footprint can help diversify geographical risk. Strong parent can help secure prime location. NWDS stands out among listed department-store plays through its ability to pick out good store locations by leveraging NWD’s strong presence in the China property market. NWDS expects to open three new stores in FY10, one in Beijing and two in Shanghai. The openings of self-owned greenfield stores in Zhengzhou and Shenyang have been delayed until FY11. Lower inventory risk, due to less inventory on hand (direct sales account for 15% of revenue) compared with apparel retailers. Receives cash from customers, but only pays concession counters 1-2 months later. This results in strong cash flows. Improving commission rates. The company has a balanced strategy, focusing more on profitability. Rather than aggressive discounts to boost sales, which would hurt margins, NWDS has implemented a rebranding program and more VIP activities. This has resulted in stable commission rates at 20.3% in FY09 (vs. 21% in FY08). Source: Sun Hung Kai Financial
Figure 3: NWDS – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Can acquire property during the weak property market, which would Failure of rebranding program. reduce rental costs in the long run. Further deferring new-store openings. Small players may close, allowing the company to capture more market Further decrease in SSS growth. share. Losing management rights for managed stores. Better-than-expected results for rebranding program. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 208 20 Nov. 2009
Industry Dynamics
China’s real retail sales grew a solid 15.7% yoy in 2008, reflecting the current tough environment, including negative export growth, manufacturers shutting down, increasing unemployment, weak consumer confidence and the negative wealth effect.
However, consumers seem to believe the worst is over, and sentiment is improving. Retail sales for the eight-day Golden Week celebration in 2009 reached some US$83bn, up 18% yoy, according to the Ministry of Commerce.
Urban consumer incomes are more closely tied to the external environment, such as exports and finance. Weak global consumption is dragging down orders from around the world, and there have been many news reports of manufacturers shutting down or closing part of their production lines. The plunging stock market and weak property market have also dragged down consumer confidence in first-tier cities.
Given the economic slowdown and job insecurity, we expect urban income growth to fall and see urban consumers becoming more cautious on spending. As such, retailers with predominantly first-tier-city footprints may be hit hard by the slowdown in exports and manufacturing.
However, consumption in second- and third-tier cities should be less affected by the stock- and property-market woes, while government policies are set to benefit those cities by boosting incomes.
The government aims to increase rural incomes to narrow the gap between cities and the countryside. It has announced favorable polices such as cheaper home appliances for rural buyers, minimum pricing for farm produce and agriculture subsidies.
Cities still account for over 70% of consumption, so even if rural incomes grow faster than urban incomes, the increase in rural spending may not compensate for a sharply fall in urban spending. Even so, retailers with a nationwide sales network can benefit from a more diverse geographic risk.
Retailers will likely have to conduct more promotion activities and offer big discounts to stimulate sales, which may eat into earnings. This could hit the balance sheets of companies with longer cash-conversion cycles or less efficient working capital. Companies with higher gearing could face cash-flow problems, as it may be difficult to clear inventory; this could lead to bankruptcy.
Retailers are now scaling down expansion plans, and we expect longer breakeven periods for new stores.
Compared with other retail operators, department stores have lower risk as:
They have lower or even no inventory on hand compared with apparel retailers.
They have lease terms of 15-25 years, with annual rentals predetermined and fixed; other retailers face rental hikes every 2-3 years.
It is easy to replace underperforming brands to maintain sales growth.
Cash is received from customers first, but only paid to concession counters 1-2 months later.
Sun Hung Kai Financial 209 20 Nov. 2009
Figure 4: NWDS – Profit and Loss Statement FY06-FY09 Year ended 30 June, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 749.9 1,046.9 1,489.3 1,721.2 30.5 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (658.5) (780.3) (1,018.2) (1,193.3) 22.6 Other operating income 71.5 20.5 25.1 32.3 (15.5) Operating profit 162.9 287.1 496.3 560.2 44.3 Finance expenses 0.0 0.0 0.0 0.0 N/A PBT 182.6 356.1 600.2 693.0 52.5 Tax (24.7) (53.3) (123.6) (145.7) 51.9 Net profit 157.9 302.8 476.6 547.3 52.7 EPS – HK¢ N/A 25.0 29.0 32.0 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: NWDS – Profit and Loss Statement (Year on Year Growth) FY06-FY09 Year ended 30 June, % FY06 FY07 FY08 FY09 CAGR (%) Revenue 26.2 39.6 42.3 15.6 30.5 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses 24.7 18.5 30.5 17.2 22.6 Other operating income 13.1 (71.4) 22.7 28.5 (15.5) Operating profit 26.0 76.2 72.9 12.9 44.3 Finance expenses N/A N/A N/A N/A N/A PBT 42.6 95.0 68.5 15.5 52.5 Tax (9.7) 116.0 131.8 17.8 51.9 Net profit 56.8 91.7 57.4 14.8 52.7 EPS N/A N/A 16.0 10.3 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: NWDS – Profit and Loss Statement (Common Size) FY06-FY09 Year ended 30 June, % FY06 FY07 FY08 FY09 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (87.8) (74.5) (68.4) (69.3) (75.0) Other operating income 9.5 2.0 1.7 1.9 3.8 Operating profit 21.7 27.4 33.3 32.5 28.8 Finance expenses 0.0 0.0 0.0 0.0 0.0 PBT 24.4 34.0 40.3 40.3 34.7 Tax (3.3) (5.1) (8.3) (8.5) (6.3) Net profit 21.1 28.9 32.0 31.8 28.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 210 20 Nov. 2009
Figure 7: NWDS – Balance Sheet FY06-FY09 As at 30 June, HK$ m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 488.7 967.5 2,336.7 2,186.0 60.8 Accounts receivable 8.0 19.2 25.7 14.4 16.9 Inventory 15.7 29.7 57.5 53.4 36.8 Other current assets 301.7 240.7 1,109.2 1,255.1 88.3 Total current assets 814.2 1,257.2 3,529.1 3,508.9 67.1 Net fixed assets 738.7 732.2 1,934.5 1,990.9 34.7 Other long-term assets 70.4 68.6 296.9 799.1 82.5 Total assets 1,623.3 2,058.0 5,760.4 6,298.9 53.8 Short-term debt 0.0 0.0 0.0 0.0 N/A Accounts payable 569.6 663.9 858.4 800.1 20.9 Other current liabilities 727.2 363.1 410.0 631.8 (0.1) Total current liabilities 1,296.8 1,026.9 1,268.4 1,431.9 9.1 Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 138.0 173.8 385.3 437.6 52.1 Total liabilities 1,434.8 1,200.7 1,653.7 1,869.5 14.4 Shareholders equity 188.4 857.2 4,106.7 4,429.4 234.3 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 1,623.3 2,058.0 5,760.4 6,298.9 53.8 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: NWDS – Balance Sheet (Common Size) FY06-FY09 As at 30 June, % FY06 FY07 FY08 FY09 Average Total assets Cash and securities 30.1 47.0 40.6 34.7 38.1 Accounts receivable 0.5 0.9 0.4 0.2 0.5 Inventory 1.0 1.4 1.0 0.8 1.1 Other current assets 18.6 11.7 19.3 19.9 17.4 Total current assets 50.2 61.1 61.3 55.7 57.1 Net fixed assets 45.5 35.6 33.6 31.6 36.6 Other long-term assets 4.3 3.3 5.2 12.7 6.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 0.0 0.0 0.0 Accounts payable 35.1 32.3 14.9 12.7 23.7 Other current liabilities 44.8 17.6 7.1 10.0 19.9 Total current liabilities 79.9 49.9 22.0 22.7 43.6 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 8.5 8.4 6.7 6.9 7.6 Total liabilities 88.4 58.3 28.7 29.7 51.3 Shareholders equity 11.6 41.7 71.3 70.3 48.7 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 211 20 Nov. 2009
Figure 9: NWDS – Key Ratios FY06-FY09 Year ended 30 June FY06 FY07 FY08 FY09 Average (%) Profitability ratios Gross margin – % N/A N/A N/A N/A N/A Operating margin – % 21.7 27.4 33.3 32.5 28.8 Net margin – % 21.1 28.9 32.0 31.8 28.4 ROAA – % 11.5 16.4 12.2 9.1 12.3 ROAE – % 141.1 57.9 19.2 12.8 57.7
Liquidity ratios Current assets/current liabilities – X 0.6 1.2 2.8 2.5 1.8 Liquid assets/current liabilities – X 0.4 0.9 1.8 1.5 1.2 Cash and securities/current assets – % 60.0 77.0 66.2 62.3 66.4 Cash flow from oper./curr. liabilities – % 29.6 63.2 53.7 14.2 40.2
Other ratios Capex/sales – % 27.5 9.5 16.4 11.8 16.3 Capex/depreciation – % 268.7 107.5 210.0 137.1 151.5 Operating expense/sales -% (87.8) (74.5) (68.4) (69.3) (70.7) Net debt/equity (net cash) – % (259.3) (112.9) (76.2) (66.0) (85.0) Inventory/sales – % 2.1 2.8 3.9 3.1 3.3 Effective tax rate – % 13.5 15.0 20.6 21.0 18.9 Cash conversion cycle – days N/A N/A N/A N/A N/A
ROAA component analysis Revenue/average assets – % 54.5 56.9 38.1 28.5 44.5 COGS/average assets – % N/A N/A N/A N/A N/A Gross profit/average assets – % N/A N/A N/A N/A N/A Operating expenses/average assets – % (47.9) (42.4) (26.0) (19.8) (34.0) Other operating income/average assets – % 5.2 1.1 0.6 0.5 1.9 Operating profit/average assets – % 11.9 15.6 12.7 9.3 12.4 Finance expenses/average assets – % 0.0 0.0 0.0 0.0 0.0 PBT/average assets – % 13.3 19.3 15.4 11.5 14.9 Tax/average assets – % (1.8) (2.9) (3.2) (2.4) (2.6) Net profit/average assets – % 11.5 16.4 12.2 9.1 12.3
ROAE component analysis Revenue/average equity – % 669.8 200.2 60.0 40.3 242.6 COGS/average equity – % N/A N/A N/A N/A N/A Gross profit/average equity – % N/A N/A N/A N/A N/A Operating expenses/average equity – % (588.1) (149.2) (41.0) (28.0) (201.6) Other operating income/average equity – % 63.9 3.9 1.0 0.8 17.4 Operating profit/average equity – % 145.5 54.9 20.0 13.1 58.4 Finance expenses/average equity – % 0.0 0.0 0.0 0.0 0.0 PBT/average equity – % 163.1 68.1 24.2 16.2 67.9 Tax/average equity – % (22.0) (10.2) (5.0) (3.4) (10.2) Net profit/average equity – % 141.1 57.9 19.2 12.8 57.7 Sources: Bloomberg and Sun Hung Kai Financi
Sun Hung Kai Financial 212 20 Nov. 2009
Parkson (3368.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 Parkson Retail is a foreign-owned department-store chain in China. It operates a HSCEI 13,470
network of 32 self-owned and 10 managed stores across 26 PRC cities, with only a Performance (%) 1m 3m 12m 2% domestic market share, according to management estimates. It listed in Hong HSI 2.0 13.5 76.7 Kong on 30 Nov. 2005; Malaysian-listed parent Parkson Holdings still holds a HSCEI 4.0 19.6 107.6 53.7% stake. Parkson – Price vs. HSI, Share Data The company generates revenue from concessionaire commission (50.2%), direct sales (33.3%), rental income (4%) and other sources, including consultancy and (HK$) (HK$m) management fees (12.5%). 20.0 900 800 15.0 700 The firm aims to open 5-6 new stores p.a. (expanding operating area 15% p.a.) and 600 500 reach 80 stores in the next five years. Its strategy to accelerate breakeven is to pick 10.0 400 locations where: 1) the population is over 1 million; 2) GDP per capita is US$3,000 300 or more; and 3) retail sales are over RMB10bn. 5.0 200 100 0.0 0 The weak property market provides opportunities to rent or acquire prime locations, Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
and the company plans: 1) to open three new stores, in Shijiazhuang, Lanzhou and Turnover Price HSI Changshu, and 2) look out for M&A opportunities. Price – HK$ 12.34 The company has reduced its reliance on Beijing and Shanghai, shifting the focus to 52W high/low (HK$) 14.8/5.58 second-tier cities that can offer stable profits. Only five Parkson stores are in Beijing Shares in issue – millions 2,806.43 and Shanghai, and the two flagship stores only accounted for 23.5% of gross sales Market cap – HK$m 35,248.78 proceeds in 1H09, from 47.9% in 2005. 3M avg. turnover – HK$m 63.71 Major shareholders – % The 1H09 net profit came in at RMB462m, up 12% yoy, on merchandise sales of Heng Jum Cheng 51.55 RMB5.8bn, up 17% yoy. The company cut the interim dividend by RMB0.01 to Source: Bloomberg and Sun Hung Kai Financial RMB0.05/share.
Both the commission rate from concessionaire sales and the direct-sales margin dropped by 0.9 ppt yoy to 19.1% and 16.7% respectively, due to heavy sales promotions and discounts offered in 1Q09 to boost sales.
Rental costs to revenue increased from 9.2% in FY05 to 13.4% in 1H09, as the number of self-owned stores increased from 23 to 32. New stores usually charge Recent Reports Date lower commission rates and sell lower-value merchandise than mature stores. The Discounts Ahead for Most 8 Jan. 2009 breakeven period may be longer than the company’s previous record of only 1 to 1½ Expensive Retailer years during the boom years. Surging rental costs may reduce operating leverage and become a short-term concern. This document is solely based on
publicly available information. This report is intended as information Figure 1: Earnings Summary only and not as a recommendation for any stock. Sun Hung Kai
Year ending 31 Dec FY06 FY07 FY08 FY09E Financial does not provide research
Net profit- RMBm 460.8 676.0 841.1 973.0 coverage or ratings for this Net-profit growth – % 85.8 46.7 24.4 15.7 company in this report. EPS – RMB fen 16.6 24.4 30.2 34.4 EPS growth – % 50.9 47.0 23.8 13.9 P/E – X 65.5 44.6 36.0 31.6 Holly Hou DPS – RMB fen 8.4 12.0 14.5 16.6 + (852) 2203 9588 Dividend yield – % 0.8 1.1 1.3 1.5 BVPS – RMB 0.8 1.0 1.2 1.4 [email protected] P/B – X 13.5 10.9 8.8 7.7 Operating cash flow per share – RMB fen 34.1 37.4 44.2 39.7 All reports are available at: http://www.SHKfg.com Net debt (net cash)/ price – % (0.2) 2.9 1.6 1.8 Sources: Bloomberg and Sun Hung Kai Financial http://www.im.knowledge.reuter.com Note: Estimates based on Bloomberg consensus http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor213ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Parkson – Investment Highlights
Key investment positives Key investment negatives The largest department-store network in China, with 42 department Parkson maintains its store-expansion plans but breakeven periods stores (32 self-owned and 10 managed stores) covering 26 major may be longer than the company’s previous record of only 1-1½ years cities. International brands favor department stores with nationwide during the boom years. coverage, strong brand names and prime locations. Latecomers and Rental costs to revenue increased from 9.2% in FY05 to 13.4% in mere regional players face execution risk when expanding across 1H09, as the number of self-owned stores increased from 23 to 32. regions and may find it hard to catch up with Parkson’s store portfolio New stores usually charge lower commission rates and sell in the next 4-5 years. lower-value merchandise than mature stores. Surging rental costs may Small department-store players charge lower concessionaire reduce operating leverage and become a short-term concern. commission rates at new stores due to their limited nationwide Accounts payable declined to RMB1.07bn from RMB1.33bn in 1H08 coverage and lower brand awareness. Parkson can charge even though overall revenue surged; the payables period therefore fell commissions in the high to mid-teen percentages at its new sores, sharply. This is an industry-wide phenomenon and has been higher than Intime’s 11.4%-15.7%. Given their aggressive expansion deliberately pursued to bolster concession rates. plans, commission rates for small department-store operators may deteriorate.
The average lease term for Parkson’s stores is 13 years, with predetermined rent increases of only 3%-5% every 3-5 years. Under straight-line amortization of rental expenses, rentals-to-revenue could decline further in the long term. The weak property market provides opportunities to rent or acquire prime locations, and the company maintains its plan to expand operating area 15% p.a. through: 1) opening three new stores, in Shijiazhuang, Lanzhou and Changshu, and 2) M&A. Lower rental costs could improve operating leverage in the long term. Management plans to open 5-6 new stores per year and achieve 80 stores in the next five years, adding not less than 15% to floor space p.a. through new openings. To accelerate breakeven time, Parkson picks store locations where: 1) the population is over 1 million; 2) GDP per capita is US$3,000 or more; and 3) retail sales are over RMB10bn. Positives from buying out remaining store stakes from minority shareholders: 1) fewer uncertainties compared with opening new stores; 2) attractive acquisition valuations; 3) more efficient operations through full control. Management indicates that it will only make acquisitions at low-to-mid-teen P/Es. Little or no inventory on hand compared with apparel retailers. Does not suffer from raw-material inflation, as it has no OEM segment, unlike retailers such as Li Ning, Prime Success or Esprit. Staff costs decreased 6% yoy to RMB137m in 1H09, helping the EBIT margin rise slightly to 39.4%, despite a lower merchandise gross margin. SSS growth was 6.9% for 1H09 and 9% for 1Q09, slowing as less promotions and sales were offered in 2Q09 in a bid to improve the gross margin. Management targets high-single-digit growth for FY09, as consumer sentiment and traffic have recovered. Source: Sun Hung Kai Financial
Figure 3: Parkson – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Larger department stores can charge higher commission rates, attract International concessionaire brands may opt to set up standalone more famous brands and pick prime locations. stores or flagship shops rather than operate in department stores. If Parkson fails to attract international brands, this may make its stores The top five department stores account for less than 10% of the less attractive, lowering customer traffic and per ticket sales. market by sales, while Parkson accounts for 2%. This suggests plenty of room for consolidation. Greater competition may lead Parkson to cut its commission rates for concession counters, lowering EPS growth. More meaningful earnings-accretive acquisitions.
Better-than-expected cost controls to boost the bottom-line margin. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 214 20 Nov. 2009
Industry Dynamics
China’s government intends to stimulate domestic consumption to ease the nation’s current overdependence on exports. But slowing income growth and deteriorating employment conditions will be a tough test of consumers’ willingness to spend.
Urban consumer incomes are closely tied to the external environment. Global consumption is dragging down orders from around the world and there have been many news reports of manufacturers shutting down or closing part of their production lines in the Pearl River Delta and Yangtze River Delta. The plunging stock market and weak property market have also dragged down consumer confidence in first-tier cities.
Given the economic slowdown and job insecurity, we expect urban income growth to fall and see consumers becoming more cautious. As such, retailers with predominantly first-tier-city footprints may be hit hard.
The government aims to increase rural incomes to narrow the gap between cities and the countryside. It has announced favorable polices such as home-appliance subsidies for rural buyers, minimum pricing for farm produce and agriculture subsidies.
Cities account for over 70% of consumption, so even if rural incomes grow faster than urban incomes, the increase in rural spending may not compensate for a sharp fall in urban spending. Even so, retailers with nationwide sales networks can benefit by diversifying their geographic risk.
Retailers will likely have to conduct more promotion activities and offer big discounts to stimulate sales, which may erode earnings. This could hit the balance sheets of companies with longer cash-conversion cycles or less efficient working capital. Companies with higher gearing could face cash-flow problems, as it may be difficult to clear inventory.
Retailers are now scaling down expansion plans, and breakeven periods may lengthen for new stores.
Sun Hung Kai Financial 215 20 Nov. 2009
Figure 4: Parkson – Profit and Loss Statement FY05-FY08 Year ended 31 Dec., RMB m FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,131.9 1,942.0 2,727.0 3,137.4 43.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (888.4) (1,536.9) (2,293.1) (2,322.3) 44.1 Other operating income 82.8 242.0 332.7 399.5 83.2 Operating profit 326.3 647.1 766.6 1,214.6 48.8 Finance expenses (4.6) (51.5) (327.0) (331.8) 261.3 PBT 406.2 732.0 943.3 1,126.1 45.3 Tax (131.8) (218.8) (215.5) (247.8) 28.5 Net profit 248.0 460.8 676.0 841.1 53.2 EPS – RMB fen 11.0 16.6 24.4 30.2 44.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Parkson – Profit and Loss Statement (Year on Year Growth) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 50.9 71.6 40.4 15.1 43.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses 65.2 73.0 49.2 1.3 44.1 Other operating income 133.1 192.4 37.5 20.1 83.2 Operating profit 31.7 98.4 18.5 58.4 48.8 Finance expenses 137.1 1,016.4 534.8 1.5 261.3 PBT 60.6 80.2 28.9 19.4 45.3 Tax 44.9 66.0 (1.5) 15.0 28.5 Net profit 62.3 85.8 46.7 24.4 53.2 EPS 57.1 50.9 47.0 23.8 44.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Parkson – Profit and Loss Statement (Common Size) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (78.5) (79.1) (84.1) (74.0) (78.9) Other operating income 7.3 12.5 12.2 12.7 11.2 Operating profit 28.8 33.3 28.1 38.7 32.2 Finance expenses (0.4) (2.7) (12.0) (10.6) (6.4) PBT 35.9 37.7 34.6 35.9 36.0 Tax (11.6) (11.3) (7.9) (7.9) (9.7) Net profit 21.9 23.7 24.8 26.8 24.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 216 20 Nov. 2009
Figure 7: Parkson - Balance Sheet FY05-FY08 As at 31 Dec., RMB m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 2,080.4 3,271.4 2,860.2 3,031.5 65.0 Accounts receivable 16.7 18.5 19.0 21.0 (3.2) Inventory 80.9 109.9 143.9 187.9 50.2 Other current assets 235.1 259.5 1,156.3 1,042.1 25.4 Total current assets 2,413.2 3,659.3 4,179.4 4,282.4 48.1 Net fixed assets 648.0 1,408.8 1,461.3 1,715.4 29.3 Other long-term assets 189.7 2,406.4 3,348.8 3,836.3 252.5 Total assets 3,250.9 7,474.5 8,989.5 9,834.1 59.3 Short-term debt 154.9 83.9 0.0 0.0 N/A Accounts payable 569.0 871.6 1,144.7 1,325.8 52.4 Other current liabilities 450.1 724.6 858.8 1,082.6 28.7 Total current liabilities 1,173.9 1,680.1 2,003.6 2,408.4 36.2 Long-term debt 79.4 3,133.8 3,749.3 3,523.9 N/A Other long-term liabilities 124.2 341.0 368.5 374.5 37.0 Total liabilities 1,377.6 5,155.0 6,121.4 6,306.8 67.2 Shareholders equity 1,873.3 2,319.5 2,868.1 3,527.3 48.7 Minorities 92.4 91.9 79.0 80.6 5.0 Total equity and liabilities 3,250.9 7,474.5 8,989.5 9,834.1 59.3 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Parkson – Balance Sheet (Common Size) FY05-FY08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 64.0 43.8 31.8 30.8 42.6 Accounts receivable 0.5 0.2 0.2 0.2 0.3 Inventory 2.5 1.5 1.6 1.9 1.9 Other current assets 7.2 3.5 12.9 10.6 8.5 Total current assets 74.2 49.0 46.5 43.5 53.3 Net fixed assets 19.9 18.8 16.3 17.4 18.1 Other long-term assets 5.8 32.2 37.3 39.0 28.6 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 4.8 1.1 0.0 0.0 1.5 Accounts payable 17.5 11.7 12.7 13.5 13.8 Other current liabilities 13.8 9.7 9.6 11.0 11.0 Total current liabilities 36.1 22.5 22.3 24.5 26.3 Long-term debt 2.4 41.9 41.7 35.8 30.5 Other long-term liabilities 3.8 4.6 4.1 3.8 4.1 Total liabilities 42.4 69.0 68.1 64.1 60.9 Shareholders equity 57.6 31.0 31.9 35.9 39.1 Minorities 2.8 1.2 0.9 0.8 1.4 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 217 20 Nov. 2009
Figure 9: Parkson – Key Ratios FY05-FY08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % N/A N/A N/A N/A N/A Operating margin – % 28.8 33.3 28.1 38.7 32.2 Net margin – % 21.9 23.7 24.8 26.8 24.3 ROAA – % 10.4 8.6 8.2 8.9 9.0 ROAE – % 19.1 22.0 26.1 26.3 23.4
Liquidity ratios Current assets/current liabilities – X 2.1 2.2 2.1 1.8 2.0 Liquid assets/current liabilities – X 1.8 1.9 1.4 1.3 1.6 Cash and securities/current assets – % 86.2 89.4 68.4 70.8 78.7 Cash flow from oper./curr. liabilities – % 45.7 56.0 51.7 51.2 51.2
Other ratios Capex/sales – % N/A N/A N/A N/A N/A Capex/depreciation – % N/A N/A N/A N/A N/A Operating expense/sales -% (78.5) (79.1) (84.1) (74.0) (79.1) Net debt/equity (net cash) – % (98.6) (2.3) 31.0 14.0 14.2 Inventory/sales – % 7.2 5.7 5.3 6.0 5.6 Effective tax rate – % 32.5 29.9 22.8 22.0 24.9 Cash conversion cycle – days N/A N/A N/A N/A N/A
ROAA component analysis Revenue/average assets – % 47.4 36.2 33.1 33.3 37.5 COGS/average assets – % N/A N/A N/A N/A N/A Gross profit/average assets – % N/A N/A N/A N/A N/A Operating expenses/average assets – % (37.2) (28.7) (27.9) (24.7) (29.6) Other operating income/average assets – % 3.5 4.5 4.0 4.2 4.1 Operating profit/average assets – % 13.7 12.1 9.3 12.9 12.0 Finance expenses/average assets – % (0.2) (1.0) (4.0) (3.5) (2.2) PBT/average assets – % 17.0 13.6 11.5 12.0 13.5 Tax/average assets – % (5.5) (4.1) (2.6) (2.6) (3.7) Net profit/average assets – % 10.4 8.6 8.2 8.9 9.0
ROAE component analysis Revenue/average equity – % 87.2 92.6 105.1 98.1 95.8 COGS/average equity – % N/A N/A N/A N/A N/A Gross profit/average equity – % N/A N/A N/A N/A N/A Operating expenses/average equity – % (68.5) (73.3) (88.4) (72.6) (75.7) Other operating income/average equity – % 6.4 11.5 12.8 12.5 10.8 Operating profit/average equity – % 25.1 30.9 29.6 38.0 30.9 Finance expenses/average equity – % (0.4) (2.5) (12.6) (10.4) (6.4) PBT/average equity – % 31.3 34.9 36.4 35.2 34.4 Tax/average equity – % (10.2) (10.4) (8.3) (7.7) (9.2) Net profit/average equity – % 19.1 22.0 26.1 26.3 23.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 218 20 Nov. 2009
Solargiga (757.HK) Alternative Energy 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Solargiga makes monocrystalline silicon ingots and wafers, key components for producing solar-power photovoltaic (PV) cells. It is the PRC’s second largest Performance (%) 1m 3m 12m manufacturer of monocrystalline silicon ingots by output and sales (according to HSI 1.2 5.6 67.4 China Electronics Material Industry Association). Sales are mainly to solar-wafer or HSCEI 4.0 4.0 115.4 cell manufacturers or traders, which include Isofoton, Sharp, Sumitomo and Suntech. Solargiga – Price vs. HSI, Share Data FY08 sales increased 47% yoy to RMB1,492.9m, split among three business
segments: (HK$) (HK$m) 7.0 250 6.0 Sales from manufacturing and selling monocrystalline ingots and wagers 200 5.0 increased 42.1% to RMB1,229.0m. 4.0 150
3.0 100 2.0 Revenue from processing solar ingots and wafers (ingots and wafers are 50 1.0 processed into light-processing ingots and wafers capable of power production) 0.0 0 increased only 3.3% to RMB113.3m processing volume for ingots and wafers Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
decreased. Turnover Price HSI
Sales from polysilicon reclamation and trading (scrap polysilicon is reused Price – HK$ and/or upgraded) increased 285.5% to RMB150.6m. 2.30 52W high/low (HK$) 3.44/1.05 Growth is driven by the global focus on renewable and environmentally friendly Shares in issue - m 1,707.10 sources of power in Europe (mainly Germany) and Japan, i.e. clean energy. Market cap - HK$m 3,909.25 3M avg. turnover - HK$m 14.38 Although the PRC accounts for 74.8% of sales, these are mainly to downstream Major shareholders – % solar-power-equipment manufacturers that in turn sell their products to markets in Wenhua Tan 29.90 Recent Reports Date Europe. This makes Europe the ultimate destination for more than half of Solargiga’s Sources: Bloomberg and Sun Hung Kai Financial Key Takeaways products. 27 April 2009
Japan is another key market. Solargiga has appointed Sumitomo as its exclusive distributor in Japan, which made up 9.9% of sales in FY08
This document is solely based on Figure 1: Earnings Summary publicly available information. This report is intended as information Year ending 31 Dec. FY06 FY07 FY08 FY09E only and not as a recommendation Net profit – RMBm 109.7 292.2 83.4 (92.6) for any stock. Sun Hung Kai Net-profit growth - % 165.5 166.5 (71.5) N/A Financial does not provide research EPS – RMB fen 21.9 58.2 5.1 (3.5) coverage or ratings for this
EPS growth - % 164.5 166.5 (91.2) N/A company in this report. P/E – X 9.3 3.5 39.6 N/A DPS – RMB fen 0.0 5.2 1.5 0.3 Dividend yield - % 0.0 2.6 0.7 0.1
BVPS – RMB N/A N/A 0.7 0.7
P/B – X N/A N/A 2.7 2.9
Oper cash flow/share – RMB fen 23.1 79.3 (22.5) 10.2 Net debt (net cash) to share price - % N/A N/A (0.8) (5.8) Michael Yuk Sources: Bloomberg and Sun Hung Kai Financial + (852) 2203 9590 Note: Estimates based on Bloomberg consensus [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor219ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Polysilicon makes up 60% of COGS. Although polysilicon has plummeted from its high of US$450/kg to the current US$160/kg, so have Solargiga’s product prices (solar wafers are down 40% from RMB47-RMB8/wafer to RMB26-RMB30/wafer). Hence the benefits of lower raw-material prices have been offset by lower product prices, with demand still unclear due to the seasonal effect in Europe and continued tight credit lines.
Solargiga prides itself on high operational efficiency. Its silicone reclaiming and upgrading facilities (throughput of over 2,400 tonnes of reclaimable polysilicon) give it cost advantages to produce solar ingots at better margins than rivals that lack reclaiming facilities.
The company has embarked on massive capacity expansion using proceeds from its IPO. By 2009, management wants to increase ingot-pulling capacity fourfold (from 1,000 tons to 4,000 tons) and wafer-production capacity eightfold (from 17 million pieces to 150 million pieces) from 2007 levels.
Solargiga is the result of a series of mergers, acquisitions, and corporate restructurings that began with a Sino-Japan JV between Xinhua Quartz Glass Co. Ltd. and Space Energy Corporation (SEC) of Japan and later included Wafer Works of Taiwan. As a result, Solargiga has a unique shareholder base that gives it a strong distribution network in Asia.
Figure 2: Solargiga – Investment Highlights
Key investment positives Key investment negatives Strong government support. In the 11th Five Year Plan, China Increasing competition. Due to the maturity of the wafer production expects to install 300 MW of solar power by 2010 and 1.8 GW by industry, new rivals can easily enter the business, especially for 2020 to lower emissions and reduce dependence on coal-fired mono-crystalline wafers, since these furnaces can be manufactured generation. Solar power will experience enormous growth as capex domestically. However, it would take time to establish a mature for alternative energy shifts from wind power to solar in the coming distribution network for the finished products. years. More inventory write-offs expected. Solargiga wrote off Cost of polysilicon to drop in 2009. Prices for polysilicon, the main RMB220.2m in inventory in 4Q08 due to falling polysilicon prices feedstock for silicon wafers and hence PV cells, are expected to drop (the main raw material for solar wafers), which hit the FY08 results. in 2009 after prices peaked earlier this year at US$450/kg. The The polysilicon inventory on Solargiga’s books is estimated at average spot price for polysilicon is expected to decline dramatically US$280/kg, and as at 31 Dec. 2008 the company had RMB395.5m in during 2009, falling to as little as US$160/kg. inventory. All things being equal, with polysilicon prices averaging around US$160/kg, a further RMB169m in write-offs can be expected Expansion in line to capture increasing demand. Revenue is if polysilicon prices do not rebound by end-2Q09. expected to increase threefold with production bottlenecks removed. For 2009, this should expand ingot production capacity fourfold (from At risk from RMB depreciation. China is heavily reliant on imports 1,000 tons to 4,000 tons) and wafer production capacity eightfold of polysilicon, which are sold in USD. The industry hence faces (from 17 million pieces to 150 million pieces). increasing costs for feedstock when the RMB depreciates. Overseas sales are less affected as a whole, as these sales are usually Growing domestic sales. China accounted for 74.8% of FY08 sales denominated in either USD or Euros. and this is expected to grow further due the government’s policy of increasing the proportion of alternative energy in its power industry. IPPs may hold off alternative-energy expansion due to the slowing economy. Conventional IPPs have been the main investors in Increasing profitability from focusing more on wafer segment. alternative energy, as they move to meet government regulations Instead of selling ingots, which fetch a lower selling price, Solargiga about the amount of alternative power in their power mix. However, is now growing ASPs by focusing on wafers, which account for 66% the economic slowdown could deter IPPs from investing as of its business. This has increased the gross margin to 40.4%, vs. aggressively in alternative power as they did before. 28.9% a year ago. Short-term slowdown in alternative-energy investment while oil Advantage in raw-material procurement. Solargiga excels at prices remain low. Interest and investment in alternative energy recycling scrap polysilicon, which lowers raw-material costs. declines as oil prices drop, so there is less incentive to invest in alternative energy in the short term.
Drop in cash from capacity expansion. The company had net cash of RMB544m in 1H08. However, the rapid pace of expansion has left the company with a net position of only RMB55m. The company may need to raise more capital or take on more debt to continue expansion. Unclear demand for monocrystalline solar-grade silicon. Crude-oil prices and energy demand have fallen recently, due to the slowing global economy. As such, demand for monocrystalline solar-grade silicon remains unclear, as government support and subsidies are needed to make solar power a viable alternative to conventional energy sources.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 220 20 Nov. 2009
Figure 3: Solargiga – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Abrupt increase in crude-oil prices. An abrupt increase in crude oil Delay in new production of polysilicon. Recent falls in oil prices would re-spark interest in alternative energy. may reduce the need for polysilicon, forcing producers to cut production and new projects to stabilize prices. The expected decline Stricter government policies on pollution. A global effort to reduce in polysilicon may therefore come later than expected. greenhouse gases will spark added demand for alternative energy, thus boosting demand for solar grade ingots and wafers. Reduced investment in solar power by China IPPs. If the economic slowdown persists, IPPs will cut spending and investment in U.S. green energy policy. The Obama administration has continually alternative energy. Sales of silicon wafers would hence decline. expressed the need to wean the U.S off conventional energies such as oil. The U.S. push for alternative energy would result in an increase in Persistent write-offs in inventory. The company may need to again demand for all types of solar products. write off inventory if raw-material and product prices continue to decrease. This would affect gross margins and earnings. Source: Sun Hung Kai Financial
Recent Company News
Nil.
Industry Dynamics
China is still promoting green initiatives in its government policies, and solar power is a key industry seen as part of the solution to fossil fuels and pollution. The Chinese government has adopted environment-friendly policies to ensure sustainable development in recent years. The Renewable Energy Medium, Long Term Development Plan calls for a 22-fold increase (20% CAGR) in total solar-power capacity (from the current 80 MW to 300 MW in 2010 and 1,800 MW by 2020). By 2020, a total of 20,000 PV-equipped rooftops with 1,000 MW total electricity output capacity will be developed.
But despite the bright outlook in the enormous China market, currently the bulk of PV solar-power demand comes from Europe (Germany), Japan, and the U.S., who represent nearly 89% of the world-wide photovoltaic (PV) installed capacity. The PV growth in Germany is the fastest with over 1.3 GWp of PV installed according to the most recent data available (2007).
Solargiga has a record of steady sales to its mainland downstream customer who sell to the U.S. and European markets, however, with the global economic crisis, Solargiga’s downstream customers would cut back inventory and wait for winter to end before increasing orders.
Solargiga’s recent production-capacity upgrades make it better positioned than its competitors to capture a larger share of the Chinese market, when mainland policy measures begin bearing fruit in the form of increased sale orders. But until then the company must still rely on the European and Japan markets as the main driver for growth.
Sun Hung Kai Financial 221 20 Nov. 2009
Figure 4: Solargiga – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 173.7 413.3 1,015.5 1,492.9 125.6 COGS (104.8) (244.2) (692.4) (1,267.4) 127.7 Gross profit 68.9 169.1 323.1 225.5 115.1 Operating expenses (8.2) (17.3) (51.6) (108.4) 143.2 Other operating income 2.4 4.9 4.5 11.1 111.7 Operating profit 63.1 156.6 276.1 120.7 97.1 Finance expenses (2.4) (3.9) (7.6) (3.3) 45.6 PBT 60.4 152.2 337.1 117.4 100.6 Tax (3.4) (4.0) (20.6) (34.0) 219.8 Net profit 41.3 109.7 292.2 83.4 102.7 EPS – RMB fen 8.3 21.9 58.2 5.1 50.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Solargiga – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR Revenue 201.3 137.9 145.7 47.0 125.6 COGS 122.4 133.1 183.5 83.0 127.7 Gross profit 553.5 145.4 91.1 (30.2) 115.1 Operating expenses 165.5 110.4 198.0 110.0 143.2 Other operating income 342.0 99.1 (6.6) 144.3 111.7 Operating profit 689.2 148.1 76.3 (56.3) 97.1 Finance expenses 230.4 60.0 95.6 (56.6) 45.6 PBT 732.8 151.8 121.6 (65.2) 100.6 Tax 951.4 18.1 410.8 65.0 219.8 Net profit 735.9 165.5 166.5 (71.5) 102.7 EPS 734.3 164.5 166.5 (91.2) 50.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Solargiga – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (60.3) (59.1) (68.2) (84.9) (68.1) Gross profit 39.7 40.9 31.8 15.1 31.9 Operating expenses (4.7) (4.2) (5.1) (7.3) (5.3) Other operating income 1.4 1.2 0.4 0.7 0.9 Operating profit 36.3 37.9 27.2 8.1 27.4 Finance expenses (1.4) (0.9) (0.7) (0.2) (0.8) PBT 34.8 36.8 33.2 7.9 28.2 Tax (2.0) (1.0) (2.0) (2.3) (1.8) Net profit 23.8 26.5 28.8 5.6 21.2 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 222 20 Nov. 2009
Figure 7: Solargiga - Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 35.6 46.7 349.0 270.4 91.0 Accounts receivable 38.9 68.3 77.8 493.8 237.6 Inventory 15.5 127.6 137.8 395.5 178.3 Other current assets 45.3 22.3 109.4 26.9 0.0 Total current assets 135.3 264.9 674.0 1,186.7 113.0 Net fixed assets 101.2 123.0 223.9 442.2 130.6 Other long-term assets 8.3 11.5 54.0 146.6 181.4 Total assets 244.8 399.4 951.9 1,775.4 120.1 Short-term debt 61.4 40.0 127.0 214.6 80.0 Accounts payable 9.5 58.4 38.4 252.4 222.8 Other current liabilities 4.7 30.9 124.2 4.3 (2.7) Total current liabilities 75.5 129.3 289.5 471.3 103.3 Long-term debt 1.9 2.8 2.9 3.0 N/A Other long-term liabilities 13.1 12.6 26.7 37.6 297.8 Total liabilities 90.5 144.6 319.2 511.9 107.3 Shareholders equity 154.3 254.8 632.7 1,263.5 126.7 Minorities 40.5 66.0 0.0 0.0 N/A Total equity and liabilities 244.8 399.4 951.9 1,775.4 120.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Solargiga – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 14.5 11.7 36.7 15.2 19.5 Accounts receivable 15.9 17.1 8.2 27.8 17.3 Inventory 6.3 31.9 14.5 22.3 18.8 Other current assets 18.5 5.6 11.5 1.5 9.3 Total current assets 55.3 66.3 70.8 66.8 64.8 Net fixed assets 41.3 30.8 23.5 24.9 30.1 Other long-term assets 3.4 2.9 5.7 8.3 5.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 25.1 10.0 13.3 12.1 15.1 Accounts payable 3.9 14.6 4.0 14.2 9.2 Other current liabilities 1.9 7.7 13.0 0.2 5.7 Total current liabilities 30.9 32.4 30.4 26.5 30.0 Long-term debt 0.8 0.7 0.3 0.2 0.5 Other long-term liabilities 5.3 3.1 2.8 2.1 3.4 Total liabilities 37.0 36.2 33.5 28.8 33.9 Shareholders equity 63.0 63.8 66.5 71.2 66.1 Minorities 16.5 16.5 0.0 0.0 8.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 223 20 Nov. 2009
Figure 9: Solargiga – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 39.7 40.9 31.8 15.1 31.9 Operating margin – % 36.3 37.9 27.2 8.1 27.4 Net margin – % 23.8 26.5 28.8 5.6 21.2 ROAA – % 25.8 34.0 43.3 6.1 27.3 ROAE – % 40.9 53.6 65.9 8.8 42.3
Liquidity ratios Current assets/current liabilities – X 1.8 2.0 2.3 2.5 2.2 Liquid assets/current liabilities – X 1.0 0.9 1.5 1.6 1.2 Cash and securities/current assets – % 26.3 17.6 51.8 22.8 29.6 Cash flow from oper./curr. liabilities – % 10.3 89.5 137.4 80.6 79.5
Other ratios Capex/sales – % 54.0 7.9 12.9 18.8 23.4 Capex/depreciation – % 3,723.9 437.1 1,114.6 1,351.1 1,656.7 Operating expense/sales -% (4.7) (4.2) (5.1) (7.3) (5.3) Net debt/equity (net cash) – % 18.0 (1.5) (34.6) (4.2) (5.6) Inventory/sales – % 8.9 30.9 13.6 26.5 20.0 Effective tax rate – % 5.7 2.7 6.1 29.0 10.8 Cash conversion cycle – days 64.4 119.5 71.1 111.9 91.7
ROAA component analysis Revenue/average assets – % 108.4 128.3 150.3 109.5 124.1 COGS/average assets – % (65.4) (75.8) (102.5) (92.9) (84.2) Gross profit/average assets – % 43.0 52.5 47.8 16.5 40.0 Operating expenses/average assets – % (5.1) (5.4) (7.6) (7.9) (6.5) Other operating income/average assets – % 1.5 1.5 0.7 0.8 1.1 Operating profit/average assets – % 39.4 48.6 40.9 8.8 34.4 Finance expenses/average assets – % (1.5) (1.2) (1.1) (0.2) (1.0) PBT/average assets – % 37.7 47.2 49.9 8.6 35.9 Tax/average assets – % (2.1) (1.3) (3.0) (2.5) (2.2) Net profit/average assets – % 25.8 34.0 43.3 6.1 27.3
ROAE component analysis Revenue/average equity – % 171.9 202.1 228.8 157.5 190.1 COGS/average equity – % (103.7) (119.4) (156.0) (133.7) (128.2) Gross profit/average equity – % 68.2 82.7 72.8 23.8 61.9 Operating expenses/average equity – % (8.1) (8.5) (11.6) (11.4) (9.9) Other operating income/average equity – % 2.4 2.4 1.0 1.2 1.7 Operating profit/average equity – % 62.5 76.6 62.2 12.7 53.5 Finance expenses/average equity – % (2.4) (1.9) (1.7) (0.3) (1.6) PBT/average equity – % 59.8 74.4 76.0 12.4 55.6 Tax/average equity – % (3.4) (2.0) (4.6) (3.6) (3.4) Net profit/average equity – % 40.9 53.6 65.9 8.8 42.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 224 20 Nov. 2009
SCUD Group (1399.HK) Handset & Peripherals Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 1,466 SCUD generates 71% of revenue from own-brand SCUD rechargeable battery packs
for mobile phones, with the remainder from supplying OEM rechargeable batteries Performance (%) 1m 3m 12m for domestic mobile, laptop and charger suppliers. Clients include Lenovo, Huawei, HSI 1.2 5.6 67.4 ZTE, UT Starcom, Shngfei, Hisense and Haier. HSCEI 4.0 4.0 115.4
SCUD has acquired a 70% stake in rival Shenzhen Chaolitong Electronics, a leading SCUD – Price vs. HSI, Share Data brand in rural areas and second- and third-tier cities. Its national market share has increased from 12% to 20%, well ahead of its peers, and strengthening its leadership position in urban and rural areas. Management targets over a 30% national market (HK$) (HK$m) 2.5 70 share in the next three years. 60 2.0 The government’s Communication Projects in Rural Areas scheme is expected to 50 1.5 40
boost demand for mobile phones in secondary, tertiary and rural areas, driving 1.0 30 demand for mobile-phone rechargeable batteries. SCUD’s acquisition of Shenzhen 20 0.5 Chaolitong should help it ride this trend. 10 0.0 0 Now that 3G mobiles have come to market, demand for replacement batteries could Oct 07 Feb 08 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 increase further. 3G mobiles consume more power than regular handsets, as they Turnover Price HSI need to support video and data functions. OEM sales slumped 30% yoy in 1H09, while the segment gross margin slipped 7 Price – HK$ 0.91 ppts to 15.2% yoy due to intense competition, as the technology is mature and entry 52W high/low (HK$) 1.28/0.5 barriers are low, giving customers substantial bargaining power over suppliers. Shares in issue – millions 1,032.00 Market cap – HK$m 928.80 To strengthen its brand, SCUD has entered 2-3 year commitments with 6,000 retail 3M avg. turnover – HK$m 4.39 outlets to exclusively sell its products, offering RMB15,000 to redecorate each store Major shareholders – % with the SCUD brand (distributors probably are not keen to order large quantities Jin Fang 38.95 given the high obsolescence risk in this fast-evolving industry). Sources: Bloomberg and Sun Hung Kai Financial
The firm aims to improve profitability by building its own battery-cell plants to better control manufacturing costs. It is also seeking opportunities to enter related industries. SCUD has secured preferential income-tax rates for three further years, at an effective rate of 10% for 2007-10. The rate will gradually increase to 25% after 2010.
Net cash of HK$300m is equivalent to 35% of the market cap, which should support Recent Reports setting up its own plants. The stock trades at 5.7X FY08 earnings and 5.8X FY09E Date Key Takeaways consensus earnings (3.8X ex-cash). 2 Sep. 2009
Figure 1: Earnings Summary This document is solely based on publicly available information. This Year ended 31 Dec. FY06 FY07 FY08 FY09E report is intended as information only and not as a recommendation Net profit - RMBm 160.2 15.5 132.0 135.0 for any stock. Sun Hung Kai Net-profit growth - % 85.5 (90.3) 750.6 2.3 Financial does not provide research EPS - RMB fen 26.4 1.6 13.2 13.0 coverage or ratings for this EPS growth - % 83.1 (94.0) 734.2 (1.4) company in this report. P/E - X 3.0 50.7 6.1 6.2 DPS - RMB fen 0.0 3.7 1.8 2.0 Holly Hou Dividend yield - % 0.0 4.7 2.2 2.5 + (852) 2203 9588 BVPS - RMB 1.0 1.0 1.1 1.3 [email protected]
P/B - X 0.8 0.8 0.7 0.6 All reports are available at: Oper cash flow/share - RMB fen 10.3 3.2 26.2 N/A http://www.SHKfg.com Net debt (net cash) to share price - % (48.0) (51.5) (25.5) N/A http://www.im.knowledge.reuter.com Sources: Bloomberg and Sun Hung Kai Financial http://www.tfibcm.com Note: Estimated based on Bloomberg consensus http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor225ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: SCUD Group – Investment Highlights
Key investment positives Key investment negatives After acquiring a 70% stake in rival Shenzhen Chaolitong, the OEM sales slumped 30% yoy in 1H09, while the segment gross firm’s national market share has increased from 12.0% to 20.3%. margin slipped 7 ppts to 15.2% yoy due to intense competition, as Most other rechargeable-battery producers have market shares of the technology is mature and entry barriers are low, giving 5% or less. Management targets over a 30% national market share customers substantial bargaining power over suppliers. in the next three years. The ASP for own-brand products is falling in the long term from a The government’s Communication Projects in Rural Areas scheme combination of phone-price declines and the company entering the is expected to boost demand for mobile phones in secondary, rural market. Margin pressure is already evident, with the own-brand tertiary and rural areas, driving demand for mobile-phone gross margin slipping 5 ppts yoy to 20.4% in 1H09. rechargeable batteries. This should further strengthen SCUD’s Failure to renew the exclusive two-year distributor contracts may leadership in urban and rural areas. hurt sales. Chaolitong has a leading brand in rural areas and second- and Distributors are probably not keen to order large quantities given the third-tier cities. This should help SCUD further benefit from rising high obsolescence risk in this fast-evolving industry demand for mobile phones and mobile-phone rechargeable batteries due to the Communication Projects in Rural Areas scheme. The company has a long-term supply agreement with Sanyo Corporation of Japan, sourcing bare lithium batteries to produce The acquisition can bring synergy as: 1) SCUD focuses on the high- notebook-computer batteries (around 8% of revenue). Yen and mid-end markets and Chaolitong targets the mid- to low-end appreciation may hurt margins. market, allowing brand differentiation and separate markets; 2) central procurement can reduce costs and inventories, and 3) market SCUD has extended its preferential income-tax rate for three more share could increase in urban and rural areas. years and will pay an effective rate of 10% over 2007-10. Tax will gradually increase to 25% after 2010. Now that 3G mobiles have come to market, demand for replacement batteries could increase further. 3G mobiles consume Not receiving OEM orders could mean SCUD falling behind in more power than regular handsets, as they need to support video technology. and data functions. To strengthen its brand, SCUD has entered 2-3 year commitments with 6,000 retail outlets to exclusively sell its products, offering RMB15, 000 to redecorate each store with the SCUD brand. This control over distributors helps maintain quality and enhance loyalty and reliability. The firm has signed a long-term supply agreement with a subsidiary of Sanyo Corporation, the largest lithium-battery manufacturer in the world. Sanyo will support the supply of lithium bare battery cells to SCUD to produce notebook batteries. Management believes notebook-computer batteries will be the next earnings driver; currently this business contributes 11% of revenue. SCUD can import technology from its major OEM customers, such as Lenovo, Huawei, ZTE, UT Starcom, Hisense, Haier and Sangfei, to improve product quality for its own brands. SCUD is the only domestic producer of Li-ion rechargeable batteries that has been awarded the Certification of Exemption from Government Inspection. This highlights SCUD’s high product quality, which allows it to charge a premium over less well-known brands. SCUD targets to penetrate China’s southwest, which management believes has great potential. The company targets to capture over a 30% national market share in the next three years. Aims to improve profitability by building its own battery-cell plants to better control manufacturing costs, while seeking opportunities to enter related industries The firm had net cash of RMB350m as at end-1H09, equal to 35% of its market cap. This should support the acquisition of smaller players and building its own plants. Source: Sun Hung Kai Financial
Figure 3: SCUD Group – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Further M&A can enhance market share. Loss of OEM business from major customers. Greater-than-expected numbers of 3G phone users. Weak market sentiment may hurt sales of mobile phones and notebook computers. Greater-than-expected use of data, video and mobile games.
Source: Sun Hung Kai Financial
Sun Hung Kai Financial 226 20 Nov. 2009
Industry Dynamics Mobile phones According to the Ministry of Information Industry’s (MOI’s) Statistic Report on the Development of the Telecommunication Industry in the PRC in 2007, the number of mobile-phone users in the PRC rose 20% in 2007 to around 540 million, and increased further to 623 million by end-October 2008. The authority estimated the number of mobile-phone users to reach 738 million in 2010. China remains the largest mobile-phone market in the world. Given the population of 1.3 billion, there is still room for expansion. According to MOI, telecommunication fees fell 13.6% in 2007. In February 2008, MOI and the National Development and Reform Commission (NDRC) cut prices for mobile-roaming services 54%-73% depending on locality. The new policy should increase mobile-phone usage and demand for rechargeable batteries. The government’s Communication Projects in Rural Areas scheme is expected to boost demand for mobile phones in secondary, tertiary and rural areas, driving demand for mobile-phone rechargeable batteries. Continuous improvement in the multimedia functions of mobile phones has increased power consumption, and hence demand for spare rechargeable batteries. According to IDC’s 2008 Analysis Report on Consumer Behavior in China’s Mobile Phone Gaming Market, 67.2% of users play games as a primary function for their mobile phones, followed by voice calls and short messages. 54.9% of users claim they play 10-30 minutes each time and 18% play 30-60 minutes. Games consume plenty of power, so demand for replacement batteries should increase. The market is highly fragmented, with SCUD’s own-brand Li-ion batteries making up 12% of the market and Shenzhen Chaolitong Electronics taking 7%. Most other rechargeable-battery producers in China have market shares of 5% or less. Well-capitalized and well-known major players can dominate the market through acquisitions; market consolidation may drive smaller manufacturers out of the industry.
Notebook computers Notebook computers are becoming smaller and lighter and increasingly convenient. They are also becoming cheaper, and low-cost netbooks have also recently emerged, retailing at as little as US$300. These factors should stimulate the desktop-to-notebook replacement trend. According to the Ministry of Industry and Information Technology’s Completion of Major Targets in the Electronic Information Industry from January to June 2008, 48 million notebook computers were produced in 1H08, up 33% yoy, while desktop production grew only 3% yoy.
Sun Hung Kai Financial 227 20 Nov. 2009
Figure 4: SCUD Group – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 707.0 936.3 960.9 1,252.7 24.8 COGS (559.7) (695.8) (717.4) (988.9) 24.7 Gross profit 147.3 240.5 243.5 263.8 25.4 Operating expenses (35.0) (85.8) (89.2) (139.9) 40.9 Other operating income 4.4 6.8 1.8 4.9 9.9 Operating profit 116.7 161.5 156.1 128.9 14.6 Finance expenses (4.5) (8.4) (2.4) (0.4) (45.0) PBT 111.7 174.9 15.9 142.4 19.4 Tax (8.3) (14.7) (0.4) (0.1) (64.9) Net profit 86.3 160.2 15.5 132.0 32.8 EPS – RMB fen 14.4 26.4 1.6 13.2 16.8 Sources: The Company and Sun Hung Kai Financial
Figure5: SCUD Group – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue 37.1 32.4 2.6 30.4 24.8 COGS 36.9 24.3 3.1 37.8 24.7 Gross profit 37.8 63.3 1.3 8.3 25.4 Operating expenses (1.5) 145.1 4.0 56.8 40.9 Other operating income 30.5 54.2 (73.5) 173.0 9.9 Operating profit 56.2 38.4 (3.4) (17.4) 14.6 Finance expenses (7.5) 86.9 (71.0) (81.8) (45.0) PBT 59.6 56.6 (90.9) 792.7 19.4 Tax 75.3 76.3 (97.1) (83.2) (64.9) Net profit 103.7 85.5 (90.3) 750.6 32.8 EPS – RMB fen 103.5 83.1 (94.0) 734.2 16.8 Sources: The Company and Sun Hung Kai Financial
Figure 6: SCUD Group – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (79.2) (74.3) (74.7) (78.9) (76.8) Gross profit 20.8 25.7 25.3 21.1 23.2 Operating expenses (4.9) (9.2) (9.3) (11.2) (8.6) Other operating income 0.6 0.7 0.2 0.4 0.5 Operating profit 16.5 17.3 16.2 10.3 15.1 Finance expenses (0.6) (0.9) (0.3) (0.0) (0.5) PBT 15.8 18.7 1.7 11.4 11.9 Tax (1.2) (1.6) (0.0) (0.0) (0.7) Net profit 12.2 17.1 1.6 10.5 10.4 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 228 20 Nov. 2009
Figure 7: SCUD Group – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 14.8 486.9 468.5 351.2 136.3 Accounts receivable 167.1 227.6 191.5 318.8 37.2 Inventory 63.3 94.9 149.1 178.0 32.9 Other current assets 47.6 251.7 158.8 175.1 44.9 Total current assets 292.8 1,061.1 967.8 1,023.0 50.8 Net fixed assets 57.4 91.6 180.4 288.2 65.1 Other long-term assets 1.9 4.1 4.8 226.7 244.2 Total assets 352.1 1,156.8 1,153.1 1,537.9 59.4 Short-term debt 99.3 154.8 57.8 141.8 10.2 Accounts payable 15.4 69.5 89.0 123.1 60.5 Other current liabilities 35.2 95.5 33.0 51.7 19.5 Total current liabilities 149.9 319.7 179.8 316.7 22.6 Long-term debt 0.0 1.4 1.0 0.5 N/A Other long-term liabilities 0.0 0.0 0.0 0.0 N/A Total liabilities 149.9 321.1 180.8 317.2 22.7 Shareholders equity 202.2 835.7 972.3 1,220.7 87.6 Minorities 0.0 0.0 0.0 82.8 24.5 Total equity and liabilities 352.1 1,156.8 1,153.1 1,537.9 59.4 Sources: The Company and Sun Hung Kai Financial
Figure 8: SCUD Group – Balance Sheet (Common Size) FY05-08 As at 31 Dec, % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 4.2 42.1 40.6 22.8 27.4 Accounts receivable 47.5 19.7 16.6 20.7 26.1 Inventory 18.0 8.2 12.9 11.6 12.7 Other current assets 13.5 21.8 13.8 11.4 15.1 Total current assets 83.1 91.7 83.9 66.5 81.3 Net fixed assets 16.3 7.9 15.6 18.7 14.7 Other long-term assets 0.5 0.4 0.4 14.7 4.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 28.2 13.4 5.0 9.2 14.0 Accounts payable 4.4 6.0 7.7 8.0 6.5 Other current liabilities 10.0 8.3 2.9 3.4 6.1 Total current liabilities 42.6 27.6 15.6 20.6 26.6 Long-term debt 0.0 0.1 0.1 0.0 0.1 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 42.6 27.8 15.7 20.6 26.7 Shareholders equity 57.4 72.2 84.3 79.4 73.3 Minorities 0.0 0.0 0.0 5.4 1.3 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 229 20 Nov. 2009
Figure 9: SCUD Group – Key Ratios FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin – % 20.8 25.7 25.3 21.1 23.2 Operating margin – % 16.5 17.3 16.2 10.3 15.1 Net margin – % 12.2 17.1 1.6 10.5 10.4 ROAA – % 29.2 21.2 1.3 9.8 15.4 ROAE – % 57.4 30.9 1.7 12.0 25.5
Liquidity ratios Current assets/current liabilities – X 2.0 3.3 5.4 3.2 3.5 Liquid assets/current liabilities – X 0.1 1.5 2.6 1.1 1.3 Cash and securities/current assets – % 5.1 45.9 48.4 34.3 33.4 Cash flow from operations/current liabilities 4.5 19.6 17.2 82.7 31.0
Other ratios Capex/sales – % 3.9 3.4 12.6 12.2 8.0 Capex/depreciation – % 374.9 220.6 643.5 326.4 396.8 Operating expenses/sales -% (4.9) (9.2) (9.3) (11.2) (9.9) Net debt (net cash)/equity – % 41.8 (39.6) (42.1) (17.1) (32.9) Inventory/sales – % 8.9 10.1 15.5 14.2 13.3 Effective tax rate – % 7.5 8.4 2.7 0.1 3.7 Cash-conversion cycle – days 94.7 97.1 104.2 96.9 99.4
ROAA component analysis Revenue/average assets – % 239.4 124.1 83.2 93.1 135.0 COGS/average assets – % (189.6) (92.2) (62.1) (73.5) (104.4) Gross profit/average assets – % 49.9 31.9 21.1 19.6 30.6 Operating expenses/average assets – % (11.8) (11.4) (7.7) (10.4) (10.3) Other operating income/average assets – % 1.5 0.9 0.2 0.4 0.7 Operating profit/average assets – % 39.5 21.4 13.5 9.6 21.0 Finance expenses/average assets – % (1.5) (1.1) (0.2) (0.0) (0.7) PBT/average assets – % 37.8 23.2 1.4 10.6 18.2 Tax/average assets – % (2.8) (1.9) (0.0) (0.0) (1.2) Net profit/average assets – % 29.2 21.2 1.3 9.8 15.4
ROAE component analysis Revenue/average equity – % 470.3 180.4 106.3 114.2 217.8 COGS/average equity – % (372.3) (134.1) (79.4) (90.2) (169.0) Gross profit/average equity – % 98.0 46.3 26.9 24.1 48.8 Operating expenses/average equity – % (23.3) (16.5) (9.9) (12.8) (15.6) Other operating income/average equity – % 2.9 1.3 0.2 0.4 1.2 Operating profit/average equity – % 77.6 31.1 17.3 11.8 34.4 Finance expenses/average equity – % (3.0) (1.6) (0.3) (0.0) (1.2) PBT/average equity – % 74.3 33.7 1.8 13.0 30.7 Tax/average equity – % (5.6) (2.8) (0.0) (0.0) (2.1) Net profit/average equity – % 57.4 30.9 1.7 12.0 25.5 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 230 20 Nov. 2009
Varitronix Int’l (710.HK) China Industrials Sector 20 Nov. 2009
Company Background HSI 21,264 HSCEI 12,466 Varitronix Int’l designs, manufactures and sells LCDs and related products, ranging from high-end automotive and industrial displays to consumer-grade mobile-phone Performance (%) 1m 3m 12m displays. 43% of 1H09 sales were to China and Hong Kong, 31% to Europe and 19% HSI 2.0 13.5 76.7 to Korea. It has a 20% share of the global auto-display market. HSCEI 4.0 19.6 107.6
In the past decade, Varitronix has transformed from a producer of low-end LCD Varitronix – Price vs. HSI, Share Data displays for mobile phones to a manufacturer of higher-end LCD products, such as
dashboard displays for autos. The firm is running both business lines concurrently to (HK$) (HK$m) generate steady cash flows from mobile-phone displays and benefit in the long term 8.0 25 7.0 20 from higher-margin auto displays. Lead times for auto displays are much longer than 6.0 for mobile phones (at least a year for domestic brands and two years for foreign 5.0 15 brands), but once the firm has agreed supply contracts with clients this business can 4.0 3.0 10 also generate steady cash flows. 2.0 5 1.0 0.0 0 FY08 results were hit badly by the global financial crisis, with earnings slumping Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 93.4% yoy to HK$16.7m, following a 50% yoy growth in FY07. This was due to a Turnover Price HSI sharp dip in global auto demand. The firm will continue its two-pronged product strategy, with the high-potential Asian auto market making up for sluggish sales in Europe and America. Price – HK$ 2.59 52W high/low (HK$) 3.05/1.42 Shares in issue – millions 323.42 The company plans to continue R&D investments (currently 3% of sales) to improve Market cap – HK$m 831.20 the design and performance of its high-end displays. It has also expanded its LCD 3M avg. turnover – HK$m 1.41 production line and strengthening assembly facilities at its Heyuan plant in 2008. Major shareholders – % This should make its products more competitive and help improve margins. Chun Shun Ko 15.02 Sources: Bloomberg and Sun Hung Kai Financial The company has recently used acquisitions to increase its vertical integration. In 2008, the firm acquired South Korean TFT-panel manufacturer Hydis Technology, securing a stable source of high-quality TFT panels for its automotive and high-end displays. The company has also acquired a 20% stake in longtime client Data Modul Aktiengesellschaft, which develops, produces and sells display components for ship navigation, medical and rugged industrial applications. This move expanded Varitronix’s distribution capacity in Europe.
Figure 1: Earnings Summary
Year ended 31 Dec. FY06 FY07 FY08 FY09E This document is solely based on Net profit – HK$ m 173.2 260.4 15.0 40.8 publicly available information. This Net-profit growth - % N/A 50.3 (94.2) 171.1 report is intended as information EPS – HK¢ 54.0 80.5 4.7 13.0 only and not as a recommendation EPS growth - % N/A 49.1 (94.2) 176.6 for any stock. Sun Hung Kai P/E - X 4.8 3.2 55.1 19.9 Financial does not provide research DPS - HK¢ 33.0 38.0 13.0 6.0 coverage or ratings for this
Dividend yield - % 12.7 14.7 5.0 2.3 company in this report. BVPS – HK$ 4.1 4.7 4.3 4.4 P/B - X 0.6 0.6 0.6 0.6
Oper cash flow/share - HK¢ 60.4 72.6 121.8 N/A Net debt (net cash) to share price - % (73.7) (62.4) (32.2) (32.8) Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus Eva Yip, CFA + (852) 2203 9587
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor231ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Varitronix Int’l – Investment Highlights
Key investment positives Key investment negatives
Stable growth in South Korea despite financial tsunami. Extremely tough operating environment in the U.S. and Revenue has dropped in China, the U.S. and Europe, but sales to Europe. The firm is heavily leveraged to auto sales in western South Korea increased 14% yoy in 1H09 to HK$179m, markets. But unemployment in these regions is still high and contributing 19% of total revenue. This was due to strong sales by consumption remains low. Sales of discretionary items such as its client Hyundai, a leading auto brand. autos will likely remain uncertain at least for 2009. Cutting prices would not likely be effective in driving demand, as auto displays High entry barriers in auto-display business. Very high levels of account for only a small portion of the cost of a vehicle. quality and accuracy are required, since the display panel is among the first things a prospective car owner looks at and is hence very Huge investment losses in FY08. The company lost HK$120.8m important for an auto brand. There are also country-specific on its trading portfolio, equity linked notes and derivative financial requirements, such as tolerance to extreme temperatures. assets in FY08. Excluding these losses, it would have made a net Therefore, high levels of technology and manufacturing quality are profit of HK$16.7m. Some of these products have not reached necessary. Long lead times for display products (at least a year, and maturity, and continue to provide expose to market risk. sometimes two years for foreign brands) mean heavy initial capital Low entry barriers to mobile-display business. The investments. mobile-display business is very competitive, suppressing margins, Strong brand, with a 20% global market share in 2008. due to the low technology requirements. Rapid growth in PRC vehicle production. The Chinese Rising currency risk. The company is expanding in South Korea, government is keen to boost domestic demand, and has focused on which will increase its exposure to the Korean Won, which tends the auto industry by introducing subsidies for passenger-vehicle to depreciate against the USD when market sentiment turns purchases. Sales of passenger vehicles surged 48% yoy in June bearish. 2009 to 872,900 units. Less uncertainty from smaller investment portfolio. The company does not plan to renew its ELIs and will reduce its securities-trading portfolio. Investment volatility should therefore decline. Restructuring and acquisitions to drive growth. FY09 will be tough as the company undergoes restructuring and acquisitions to help expand market share ahead of an economic recovery. The company streamlined its structure and cut its staff 21% to 4,464 as at end-FY08. It also acquired an 11% stake in supplier Hydis Technology to secure supplies, and a 20% stake in client Data Modul to broaden its sales channels. Net cash of HK$101m (HK$0.31/share) as at end-1H09. Source: Sun Hung Kai Financial
Figure 3: Varitronix Int’l – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Better-than-expected market-share gains. A number of smaller Prolonged economic recovery. Varitronix would be severely hurt by a and weaker players have exited the auto-display market, and prolonged recovery, as discretionary-goods sales are highly sensitive to Varitronix could gain their market shares. Consolidation could the economy. drive strong earnings growth in coming years, as auto-display makers would gain greater pricing power. Bullish market bringing investment profits. The company generated investment income of HK$71m in FY07 (28% of net income), but a loss of HK$69m (more than 4X net income) in FY08. Therefore, global financial-market movements are a major driver of net income. Investment income could spring an upside surprise in the bullish trend continues. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 232 20 Nov. 2009
Recent Company News Nil.
Industry Dynamics The auto-display market has evolved rapidly in recent decades, from mechanical boards to VFDs (vacuum fluorescent displays) to LCDs (liquid crystal displays). Japanese firms dominate supply due to their innovative products and advanced technology, but their market share is diminishing due to high operating costs. The auto-display market is heavily dependent on the auto market, with demand mainly from Europe and Japan, though China is catching up.
Automakers around the world are focusing on the high-potential China market, where auto sales are set to grow 17% yoy in 2009 to 11 million units, following 7% growth in 2008. Vehicle ownership remains low at about 30 vehicles per 1,000 people, vs. the world average of about 120.
In turn, the PRC auto-display sector has posted a rapid 25%-30% CAGR in recent years. This market is dominated by foreign JVs, as they have more advanced technology.
The development of an auto-financing market can also help drive auto sales. In a mature auto market, auto financing covers 60%-80% of total transactions. However, less than 7% of mainland car sales last year were through loans. If auto financing takes hold, this could help unlock the middle-income consumer group.
New government policies favoring more environmentally friendly cars, such as tax breaks and improved infrastructure, could trigger a new auto boom.
Sun Hung Kai Financial 233 20 Nov. 2009
Figure 4: Varitronix Int’l – Profit and Loss Statement FY05-08 Year ended 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,979.8 1,867.1 2,618.2 2,411.9 4.7 COGS N/A N/A N/A N/A N/A Gross Profit N/A N/A N/A N/A N/A Operating expense (1,868.9) (1,741.7) (2,396.4) (2,305.9) 6.5 Other operating income 3.4 23.2 12.7 20.5 70.7 Operating profit 114.3 148.5 234.4 126.5 (12.4) Finance expense (6.8) (3.3) (3.4) (9.3) 15.3 PBT (173.3) 196.7 281.8 27.4 (42.1) Tax (31.0) (33.4) (27.3) (10.7) (21.4) Net profit (179.0) 173.2 260.4 15.0 (47.1) EPS- cents (56.0) 54.0 80.5 4.7 (47.5) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Varitronix Int’l – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue (1.3) (5.7) 40.2 (7.9) 4.7 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses 4.2 (6.8) 37.6 (3.8) 6.5 Other operating income 40.9 580.5 (45.4) 62.1 70.7 Operating profit (46.8) 29.9 57.8 (46.0) (12.4) Finance expenses 29.4 (51.4) 3.8 171.1 15.3 PBT N/A N/A 43.3 (90.3) N/A Tax 10.3 7.6 (18.1) (60.8) (21.4) Net profit N/A N/A 50.3 (94.2) N/A EPS N/A N/A 49.1 (94.2) N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Varitronix Int’l – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS N/A N/A N/A N/A N/A Gross profit N/A N/A N/A N/A N/A Operating expenses (94.4) (93.3) (91.5) (95.6) (93.7) Other operating income 0.2 1.2 0.5 0.9 0.7 Operating profit 5.8 8.0 9.0 5.2 7.0 Finance expenses (0.3) (0.2) (0.1) (0.4) (0.3) PBT (8.8) 10.5 10.8 1.1 3.4 Tax (1.6) (1.8) (1.0) (0.4) (1.2) Net profit (9.0) 9.3 9.9 0.6 2.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 234 20 Nov. 2009
Figure 7: Varitronix Int’l – Balance Sheet FY05-08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 415.8 498.7 545.0 514.2 (6.4) Accounts receivable 384.3 464.7 336.6 325.1 (10.3) Inventory 233.6 337.1 545.3 300.3 (1.0) Other current assets 222.9 165.1 333.6 301.5 23.2 Total current assets 1,256.7 1,465.6 1,760.5 1,441.0 (2.8) Net fixed assets 359.0 335.6 413.1 464.2 3.0 Other long-term assets 204.7 78.5 163.4 439.5 39.1 Total assets 1,820.4 1,879.7 2,337.0 2,344.7 2.3 Short-term debt 98.5 45.1 149.2 208.1 20.5 Accounts payable 241.5 478.0 472.7 438.5 14.7 Other current liabilities 125.9 14.2 191.7 136.7 (1.7) Total current liabilities 465.9 537.4 813.6 783.3 12.0 Long-term debt 30.1 0.0 0.0 152.7 48.7 Other long-term liabilities 1.4 0.2 0.2 0.1 (67.1) Total liabilities 497.4 537.6 813.8 936.0 14.9 Shareholders equity 1,322.9 1,342.1 1,523.2 1,408.7 (3.2) Minorities 33.8 19.6 13.7 14.6 (28.5) Total equity and liabilities 1,820.4 1,879.7 2,337.0 2,344.7 2.3 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Varitronix Int’l – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 22.8 26.5 23.3 21.9 23.7 Accounts receivable 21.1 24.7 14.4 13.9 18.5 Inventory 12.8 17.9 23.3 12.8 16.7 Other current assets 12.2 8.8 14.3 12.9 12.0 Total current assets 69.0 78.0 75.3 61.5 70.9 Net fixed assets 19.7 17.9 17.7 19.8 18.8 Other long-term assets 11.2 4.2 7.0 18.7 10.3 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 5.4 2.4 6.4 8.9 5.8 Accounts payable 13.3 25.4 20.2 18.7 19.4 Other current liabilities 6.9 0.8 8.2 5.8 5.4 Total current liabilities 25.6 28.6 34.8 33.4 30.6 Long-term debt 1.7 0.0 0.0 6.5 2.0 Other long-term liabilities 0.1 0.0 0.0 0.0 0.0 Total liabilities 27.3 28.6 34.8 39.9 32.7 Shareholders equity 72.7 71.4 65.2 60.1 67.3 Minorities 1.9 1.0 0.6 0.6 1.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 235 20 Nov. 2009
Figure 9: Varitronix Int’l – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 average (%) Profitability ratios Gross margin – % N/A N/A N/A N/A N/A Operating margin – % 5.8 8.0 9.0 5.2 7.0 Net margin – % (9.0) 9.3 9.9 0.6 2.7 ROAA – % (9.0) 9.4 12.3 0.6 3.3 ROAE – % (12.2) 13.0 18.2 1.0 5.0
Liquidity ratios Current assets/current liabilities – X 2.7 2.7 2.2 1.8 2.4 Liquid assets/current liabilities – X 0.9 0.9 0.7 0.7 0.8 Cash and securities/current assets – % 33.1 34.0 31.0 35.7 33.4 Cash flow from oper./curr. liabilities – % 54.4 36.3 28.9 50.3 42.5
Other ratios Capex/sales – % 5.8 2.7 5.6 8.1 5.6 Capex/depreciation – % 155.8 62.6 176.8 232.8 157.4 Operating expense/sales -% (94.4) (93.3) (91.5) (95.6) (93.5) Net debt/equity (net cash) – % (36.3) (46.0) (34.3) (19.2) (33.2) Inventory/sales – % 11.8 18.1 20.8 12.4 17.1 Effective tax rate – % (17.9) 17.0 9.7 39.1 21.9 Cash conversion cycle – days N/A N/A N/A N/A N/A
ROAA component analysis Revenue/average assets – % 99.9 100.9 124.2 103.0 107.0 COGS/average assets – % N/A N/A N/A N/A N/A Gross profit/average assets – % N/A N/A N/A N/A N/A Operating expenses/average assets – % (94.3) (94.1) (113.7) (98.5) (100.2) Other operating income/average assets – % 0.2 1.3 0.6 0.9 0.7 Operating profit/average assets – % 5.8 8.0 11.1 5.4 7.6 Finance expenses/average assets – % (0.3) (0.2) (0.2) (0.4) (0.3) PBT/average assets – % (8.7) 10.6 13.4 1.2 4.1 Tax/average assets – % (1.6) (1.8) (1.3) (0.5) (1.3) Net profit/average assets – % (9.0) 9.4 12.3 0.6 3.3
ROAE component analysis Revenue/average equity – % 135.1 140.1 182.8 164.5 155.6 COGS/average equity – % N/A N/A N/A N/A N/A Gross profit/average equity – % N/A N/A N/A N/A N/A Operating expenses/average equity – % (127.6) (130.7) (167.3) (157.3) (145.7) Other operating income/average equity – % 0.2 1.7 0.9 1.4 1.1 Operating profit/average equity – % 7.8 11.1 16.4 8.6 11.0 Finance expenses/average equity – % (0.5) (0.2) (0.2) (0.6) (0.4) PBT/average equity – % (11.8) 14.8 19.7 1.9 6.1 Tax/average equity – % (2.1) (2.5) (1.9) (0.7) (1.8) Net profit/average equity – % (12.2) 13.0 18.2 1.0 5.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 236 20 Nov. 2009
Vinda International (3331.HK) Consumer Product 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Vinda manufactures and sells household consumable paper. It should benefit from diverging demand and supply factors, as 1) Rising living standards in urban and rural Performance (%) 1m 3m 12m areas has increased demand for mid-range to high-end tissue-paper products, but 2) HSI 2.0 13.5 76.7 smaller, less efficient production plants are being phased out due to government HSCEI 4.0 19.6 107.6 environmental-protection policies. Vinda International – Price vs. HSI, Share As such, the group has steadily increased output to meet expanding demand. It has Data production bases in Beijing, Guangdong, Hubei, Jiangmen, Sichuan and Zhejiang, with total tissue-paper capacity of 320,000 tonnes p.a. as at end-1H09, from 300,000 (HK$) (HK$m) tonnes p.a. as at end-2008, and 240,000 tonnes p.a. as at end-2007. Utilization was 7.0 180 6.0 160 over 90% in 1H09. 140 5.0 120 4.0 100 The firm plans to increase capacity to 340,000 tonnes p.a. by end-2010 by building a 3.0 80 60 2.0 new production plant in Liaoning and relocating 10,000 tons p.a. of existing capacity 40 1.0 20 there from October 2010. It will also add a new production line at an existing plant in 0.0 0 Hubei in 2010 or 2011, with estimated capacity of 40,000 tonnes p.a. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Turnover Price HSI 1H09 net profit jumped 191.7% yoy to HK$180m, on a 13.6% yoy rise in turnover. Sales of low-margin products increased substantially, and the toilet-roll segment Price – HK$ remains the major contributor at 63.4% of sales (18.5% yoy sales growth). Soft 5.38 envelope facial tissues sales grew 32.2% yoy. The strong results were driven by 1) 52W high/low (HK$) 6/1.49 sticky demand for necessities, even during an economic slowdown, and 2) entering Shares in issue – millions 904.24 and expanding market share in second- and third-tier cities. Market cap – HK$m 4,801.52 3M avg. turnover – HK$m 32.72 But the performance in premium products was not good. Paper handkerchiefs, boxed Major shareholder – % facial tissue paper and paper napkins registered slower growth at 5.8% yoy, –4.7% HSBC International Trustee 31.49 yoy and 4.1% yoy respectively. High-margin products accounted for only 31.5% of Sources: Bloomberg and Sun Hung Kai Financial 1H09 sales, mainly due to their discretionary nature.
Wood pulp is the main raw material, at 57.7% of 1H09 COGS (64.1% in 1H08). Pulp prices slumped from mid-2008, helping the gross margin expand 13.1 ppts to 31.8% for 1H09. But with prices rebounding about 10% since April 2009, management has adopted a more aggressive procurement strategy, accumulating 150,000 tonnes of pulp at US$500/tonne for use through 1Q10, to mitigate rising prices.
This document is solely based on Figure 1: Earnings Summary publicly available information. This Year ended 31 Dec. FY06 FY07 FY08 FY09E report is intended as information Net profit – HK$ m 106.8 78.4 165.9 339.9 only and not as a recommendation Name Net-profit growth – % 83.0 (26.6) 111.7 104.8 for any stock. Sun Hung Kai EPS – HK¢ N/A 10.3 18.4 39.6 AnalystFinancial does not provide research EPS growth – % N/A N/A 78.6 115.2 +coverage (852) 3761 [email protected] ratings for this P/E – X N/A 52.2 29.2 13.6 company in this report. DPS – HK¢ 48.0 2.2 4.6 10.0 Dividend yield – % 8.9 0.4 0.9 1.9 BVPS – HK$ N/A 1.6 1.9 2.2 Holly Hou P/B – X N/A 3.3 2.8 2.5 + (852) 2203 9588 Oper cash flow/share – HK¢ N/A (6.2) 41.1 40.8 Net debt (net cash) to share price – % N/A 8.3 11.8 8.8 [email protected] Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor237ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Vinda International – Investment Highlights
Key investment positives Key investment negatives Falling material costs. Wood-pulp prices declined in 1H09, helping the Fluctuating wood-pulp prices remain the major uncertainty, given gross margin rise 13.1 ppts to 31.8%. Pulp accounted for 57.7% of 1H09 Vinda’s high sensitivity to this raw material (57.7% of 1H09 COGS). COGS. Any price surges would hit bottom-line growth. Shielded against wood-pulp price hikes. Pulp has rebounded about High marketing costs and administrative expenses. Competition in 10% since April 2009, and to defend against rising prices management the tissue industry is keen, so aggressive promotions by competitors has adopted a more aggressive procurement strategy, accumulating could cut into Vinda’s market share. In 1H09, Vinda put more effort into 150,000 tonnes of pulp at US$500/tonne for use through 1Q10. it is also boosting sales volume and its competitive position in the industry. in talks with distributors about potential price hikes, which could come Selling and marketing costs accounted for 7.3% of sales, while as early as 4Q09. administrative expenses accounted for 6.2% (increasing mainly due to one-off stock-option costs of HK$25m). Improving finances. Net gearing fell to 26.6% as at end-June 2009 (vs. 33.5% as at end-2008), and about 60% of bank borrowings are medium Discretionary nature of premium products. Paper handkerchiefs, to long term. Interest coverage has expanded to 21.4X (vs. 12.5X in boxed facial tissue paper and paper napkins registered slower growth 1H08). than low-end items in 1H09, at 5.8% yoy, –4.7% yoy and 4.1% yoy respectively. High-end tissues are not yet seen as necessities in China, so Rapid expansion of production capacity. Production capacity has any mainland economic slowdown could result in disappointing sales. expanded to 320,000 tonnes p.a. as at end-1H09, from 300,000 tonnes p.a. as at end-2008 The firm plans to increase capacity to 340,000 tonnes p.a. by end-2010 by building a new production plant in Liaoning and relocating 10,000 tons p.a. of existing capacity there from October 2010. Relatively inelastic demand for lower margin products. Sales of low-margin products increased substantially, with toilet-roll sales up 18.5% yoy in 1H09 and soft envelope facial tissues up 32.2% yoy. This was driven by sticky demand for necessities, even during an economic slowdown. Launching high-margin products. Vinda recently entered the wet-tissue market, which should help improve profitability when this business matures, as segment gross margins are over 40%. Entering second- and third-tier cities. Vinda has two main strategies to enter more second- and third-tier cities: 1) dual brand, and 2) 10,000 stores in more than 100 cities. This market offers huge growth potential and market scale.
Source: Sun Hung Kai Financial
Figure 3: Vinda International – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Higher demand for high-margin tissues in China would benefit Vinda, Heavy market competition would cut margins. due to its strong nationwide brand and high quality. Unexpected rise in interest rates would hurt the bottom line. Falling pulp prices would ease cost pressure and improve margins. Higher-than-expected selling prices. Faster-than-expected installation and ramp-up of new paper machines, which would increase revenue growth. Source: Sun Hung Kai Financial
Recent Company News
19 Nov. 2009: Signed a three-year supply deal with Svenska Cellulosa Aktiebolaget (SCA) Vinda has entered an agreement to supply substantial shareholder SCA with tissue-paper products, with an initial three-year term. The processing fee per box payable by SCA is about US$2. Vinda will only bear manufacturing costs (excluding raw materials). The quantity of products to be manufactured by Vinda and sold to SCA is estimated at 3,000 tonnes for 2010, 5,000 tonnes for 2011 and 6,000 tonnes for 2012. SHKF comment: The supply agreement is equivalent to less than 2% of Vinda’s 1H09 production capacity and sales, so we do not expect a significant impact on its business. But SCA is not only Vinda’s second largest shareholder, but also its main business partner, purchasing paper tissue from and selling packaging materials to Vinda. From that perspective, we think ongoing good relationships with SCA would be beneficial.
Sun Hung Kai Financial 238 20 Nov. 2009
Figure 4: Vinda International – Profit and Loss Statement FY05-FY08 Year ending 31 Dec., HK$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 925.9 1,358.2 1,777.7 2,424.0 35.2 COGS (677.5) (1,018.0) (1,411.8) (1,910.9) 38.1 Gross profit 248.4 340.2 365.9 513.1 26.4 Operating expenses (156.4) (194.9) (276.5) (288.0) 24.0 Other operating income 9.1 3.5 14.7 12.8 25.2 Operating profit 101.1 148.8 104.2 238.0 29.7 Finance expenses (29.4) (47.9) (59.2) (40.9) 23.0 PBT 70.5 113.7 94.9 194.8 32.6 Tax (12.1) (6.9) (16.5) (28.9) 12.7 Net profit 58.4 106.8 78.4 165.9 38.4 EPS – HK¢ N/A N/A 10.3 18.4 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Vinda International – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 27.5 46.7 30.9 36.4 35.2 COGS 29.0 50.3 38.7 35.4 38.1 Gross profit 23.8 36.9 7.6 40.2 26.4 Operating expenses 28.3 24.6 41.9 4.1 24.0 Other operating income 73.2 (61.0) 318.1 (13.0) 25.2 Operating profit 20.2 47.2 (30.0) 128.4 29.7 Finance expenses 64.3 63.2 23.4 (30.8) 23.0 PBT 11.7 61.4 (16.5) 105.3 32.6 Tax (32.4) (43.1) 140.4 74.7 12.7 Net profit 29.2 83.0 (26.6) 111.7 38.4 EPS N/A N/A N/A 78.6 N/A Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Vinda International – Profit and Loss Statement (Common Size) FY05-FY08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (73.2) (75.0) (79.4) (78.8) (76.6) Gross profit 26.8 25.0 20.6 21.2 23.4 Operating expenses (16.9) (14.3) (15.6) (11.9) (14.7) Other operating income 1.0 0.3 0.8 0.5 0.6 Operating profit 10.9 11.0 5.9 9.8 9.4 Finance expenses (3.2) (3.5) (3.3) (1.7) (2.9) PBT 7.6 8.4 5.3 8.0 7.3 Tax (1.3) (0.5) (0.9) (1.2) (1.0) Net profit 6.3 7.9 4.4 6.8 6.4 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 239 20 Nov. 2009
Figure 7: Vinda International - Balance Sheet FY05-FY08 As at 31 Dec., HK$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 48.6 61.6 252.1 172.2 13.8 Accounts receivable 101.1 150.1 195.1 213.4 24.2 Inventory 236.0 330.2 501.3 491.8 47.9 Other current assets 51.0 98.1 61.6 52.4 (8.2) Total current assets 436.7 640.0 1,010.0 929.8 26.0 Net fixed assets 814.0 1,069.1 1,486.6 1,969.7 38.0 Other long-term assets 12.6 26.2 34.6 48.3 44.7 Total assets 1,263.3 1,735.3 2,531.1 2,947.7 33.7 Short-term debt 578.7 737.9 345.5 279.1 (6.3) Accounts payable 129.1 141.4 146.9 208.6 44.1 Other current liabilities 145.6 172.6 234.3 250.4 23.1 Total current liabilities 853.5 1,051.8 726.8 738.1 9.2 Long-term debt 59.1 192.4 308.6 465.9 55.1 Other long-term liabilities 9.8 28.0 29.1 34.7 40.2 Total liabilities 922.3 1,272.2 1,064.5 1,238.6 19.4 Shareholders equity 341.0 463.1 1,466.6 1,709.1 52.7 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 1,263.3 1,735.3 2,531.1 2,947.7 33.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Vinda International – Balance Sheet (Common Size) FY05-FY08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 3.8 3.5 10.0 5.8 5.8 Accounts receivable 8.0 8.7 7.7 7.2 7.9 Inventory 18.7 19.0 19.8 16.7 18.5 Other current assets 4.0 5.7 2.4 1.8 3.5 Total current assets 34.6 36.9 39.9 31.5 35.7 Net fixed assets 64.4 61.6 58.7 66.8 62.9 Other long-term assets 1.0 1.5 1.4 1.6 1.4 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 45.8 42.5 13.7 9.5 27.9 Accounts payable 10.2 8.1 5.8 7.1 7.8 Other current liabilities 11.5 9.9 9.3 8.5 9.8 Total current liabilities 67.6 60.6 28.7 25.0 45.5 Long-term debt 4.7 11.1 12.2 15.8 10.9 Other long-term liabilities 0.8 1.6 1.1 1.2 1.2 Total liabilities 73.0 73.3 42.1 42.0 57.6 Shareholders equity 27.0 26.7 57.9 58.0 42.4 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 240 20 Nov. 2009
Figure 9: Vinda International – Key Ratios FY05-FY08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 26.8 25.0 20.6 21.2 23.4 Operating margin – % 10.9 11.0 5.9 9.8 9.4 Net margin – % 6.3 7.9 4.4 6.8 6.4 ROAA – % 5.3 7.1 3.7 6.1 5.5 ROAE – % 17.8 26.6 8.1 10.4 15.7
Liquidity ratios Current assets/current liabilities – X 0.5 0.6 1.4 1.3 0.9 Liquid assets/current liabilities – X 0.1 0.1 0.3 0.2 0.2 Cash and securities/current assets – % 11.1 9.6 25.0 18.5 16.1 Cash flow from oper./curr. liabilities – % 8.9 (2.2) (6.5) 50.3 12.6
Other ratios Capex/sales – % 31.6 21.3 20.1 21.2 23.5 Capex/depreciation – % 701.8 482.6 524.2 524.2 510.3 Operating expense/sales -% (16.9) (14.3) (15.6) (11.9) (13.9) Net debt/equity (net cash) – % 172.8 187.6 27.4 33.5 82.8 Inventory/sales – % 25.5 24.3 28.2 20.3 24.3 Effective tax rate – % 17.2 6.1 17.4 14.8 12.8 Cash conversion cycle – days 88.9 90.9 109.7 91.7 97.4
ROAA component analysis Revenue/average assets – % 84.7 90.6 83.3 88.5 86.8 COGS/average assets – % (62.0) (67.9) (66.2) (69.8) (66.4) Gross profit/average assets – % 22.7 22.7 17.2 18.7 20.3 Operating expenses/average assets – % (14.3) (13.0) (13.0) (10.5) (12.7) Other operating income/average assets – % 0.8 0.2 0.7 0.5 0.6 Operating profit/average assets – % 9.2 9.9 4.9 8.7 8.2 Finance expenses/average assets – % (2.7) (3.2) (2.8) (1.5) (2.5) PBT/average assets – % 6.4 7.6 4.4 7.1 6.4 Tax/average assets – % (1.1) (0.5) (0.8) (1.1) (0.8) Net profit/average assets – % 5.3 7.1 3.7 6.1 5.5
ROAE component analysis Revenue/average equity – % 282.4 337.8 184.2 152.7 239.3 COGS/average equity – % (206.6) (253.2) (146.3) (120.3) (181.6) Gross profit/average equity – % 75.8 84.6 37.9 32.3 57.7 Operating expenses/average equity – % (47.7) (48.5) (28.7) (18.1) (35.7) Other operating income/average equity – % 2.8 0.9 1.5 0.8 1.5 Operating profit/average equity – % 30.8 37.0 10.8 15.0 23.4 Finance expenses/average equity – % (9.0) (11.9) (6.1) (2.6) (7.4) PBT/average equity – % 21.5 28.3 9.8 12.3 18.0 Tax/average equity – % (3.7) (1.7) (1.7) (1.8) (2.2) Net profit/average equity – % 17.8 26.6 8.1 10.4 15.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 241 20 Nov. 2009
VST Holdings (856.HK) China IT Sector 20 Nov. 2009
Company Background HSI 21,264 HSCEI 12,466
VST Holdings is a leading distributor of IT products and components in Hong Kong Performance (%) 1m 3m 12m and China. It listed on the Stock Exchange of Hong Kong in 2002. The company has a wide range of distributorships and longstanding relationships with HSI 2.0 13.5 76.7 HSCEI 4.0 19.6 107.6 world-renowned brands including Hewlett-Packard, Apple, Intel, AMD, Seagate, Western Digital, Lenovo, IBM, Sun Micro Systems, Microsoft, Oracle, Cisco, BenQ VST– Price vs. HSI, Share Data and Hitachi, to name just a few. It has also secured PRC distributorships for A-DATA Technology Co., Taiwan’s largest and the world’s second largest DRAM-module provider, and for the Lenovo ThinkPad notebook series. (HK$) (HK$m) 3.0 60 2.5 50 The company’s success is well recognized by its vendors. It has won the 2.0 40 ‘Outstanding Achievement: Personal Storage – Seagate FY2007’ award, plus many 1.5 30 other accolades. 1.0 20 0.5 10 The group acquired ECS, a leading distributor of IT products in Singapore, in FY08. 0.0 0 Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 This expanded and strengthened its network in China, Thailand, Malaysia, Singapore, Indonesia and the Philippines. The company has extended it business Turnover Price HSI from distribution of IT products to providing enterprise-system tools for IT infrastructure, IT-infrastructure design and implementation, training, maintenance Price – HK$ 1.92 and support services. 52W high/low (HK$) 1.96/0.355 Shares in issue – millions 1,258.89 VST will continue to extend its distribution network, expand its range of products Market cap – HK$m 2,417.07 and services and increase its penetration into different Asian markets. 3M avg. turnover – HK$m 8.30 Major shareholders – % Jialin Li 36.75 Source: Bloomberg and Sun Hung Kai Financial
Figure 1: Earnings Summary
Year ended 31 March FY07 FY08 FY09 FY10E Net profit – HK$ m 161.3 244.7 231.6 309.0 Net-profit growth - % 44.3 51.7 (5.4) 33.4 EPS – HK ¢ 18.1 24.0 20.9 25.0
EPS growth - % 35.8 32.8 (13.1) 19.9 P/E - X 10.6 8.0 9.2 7.7 Recent Reports DPS - HK ¢ 7.8 0.0 3.8 9.3 Date Dividend yield - % 4.1 0.0 2.0 4.8 Digital Bridge to China 1 Sep. 2009 BVPS – HK$ 0.4 1.0 1.0 1.1 Investment Daily Note 28 Sep. 2009 P/B - X 4.3 1.9 1.8 1.8 Oper cash flow/share - HK ¢ (2.9) (7.4) 57.6 N/A Net debt (net cash) to share price - % (6.4) 79.5 42.9 27.8 Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus This document is solely based on publicly available information. This
report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this company in this report.
Michael Yuk + (852) 2203 9590 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor242ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: VST – Porter’s Five Forces
Threat of substitute products – Low IT equipment is at the core of a digitized society and cannot be substituted. Threat of entry of new competitors – Low Net margins in the industry are thin and only a few can survive due to their well developed, cost-efficient distribution networks, which take years to establish. Equipment suppliers discriminate again small and new entrants that do not have a strong sales record that can indicate the ability to move large equipment quantities in a relatively short time. Intensity of competitive rivalry – Low The China market is dominated by four major distributors that cannot expand market share without cannibalizing profitability. Bargaining power of customers – Low IT equipment is commoditized and prices quickly adjust to market demands, leaving little negotiating power with customers. Bargaining power of suppliers – Low Suppliers must deal with distributors, which have the largest distribution networks if they are to cost-effectively sell large volumes through these vast and diverse channels. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 243 20 Nov. 2009
Figure 3: VST Holdings – Investment Highlights
Key investment positives Key investment negatives
Government support. The Home Electronics to the Countryside Low net margins leads to large earning swings. VST’s net policy, Home Appliances Trade-In policy and the removal of price margins, along with China’s IT distribution sector, are low. The caps for subsidies support an increase in PC demand, which would company’s net margin, since listing in 2002, has ranged from only result in more hardware imports through VST. 0.8% to 3.8%. Hence, small changes in net margins can translate into huge earnings swings. Distribution oligopoly. Distribution of imported IT equipment in China is controlled by 3-4 companies that cannot aggressively High inventory. VST had inventory of HK$21bn as at the latest expand market share without cannibalizing profitability, due to low balance-sheet date. net margins (c. 2%),. Interest-rate sensitive. Interest rates for VST’s remaining Price protection to hedge against rapid price reductions. VST’s HK$330m loan, for the acquisition of ECS, are based on HIBOR, supplier contracts incorporate a price-protection clause. If any which is at its lowest levels since 2004 and with little room for product does not sell according to plan, VST will be compensated downside. either by direct reimbursement or through rebates for the price FX risk. Since VST’s sales are mainly in SGD and RMB, difference. depreciations in either currency vs. the USD/HKD would translate Net income to surge after refinancing the bridge loan into a into lower revenues. long-term facility. The lower interest rates should increase the net Unable to expand market share without M&A. Due to the thin margin from 1.0% in FY09 to 1.5% in FY10. net margins in the industry, VST and it competitors are unable to Strong distribution network of over 20,000 channel partners in aggressively compete for market share, e.g. price cuts, without China (over 8,000), Thailand, Malaysia, Singapore, Indonesia and cannibalizing profitability. Hence, expanding market share is the Philippines. dependant on acquiring competitors or their sub-distributors. Strong operating cash flows. VST’s operating cash flows Possible further share placements. VST entered two subscription increased fourfold in FY09 as the company fully enjoyed the agreements for the issue of 223 million shares to Eternal Asia (HK) integration and synergies from its acquisition of ECS. Ltd. in September 2008. To date, only 50% of the shares have been subscribed. The remaining 111 million shares, which account for Fast inventory turnover. The latest reported inventory turnover is 10% of the total shares outstanding could be sold during the later 20 days, lower than the industry average. Turnover days have part of this year. shortened as the firm continues to streamline its operations while keeping minimum levels of stock. Quick cash-conversion cycle. The cash-conversion cycle for the previous financial year was only 7 days, lower than its peers and underlining the firm’s efficiency and low working-capital needs. Share buybacks. VST has bought back over 26 million shares since end-2008. It may buy back more shares to increase investor returns. Malaysia spin-off to bring one-off gain in FY10. VST is proposing spinning off its Malaysian arm, ECS ICT BHD, on the main board of Bursa Malaysia Securities Berhad. The firm will still hold 60% after the listing. A one-off gain of HK$20.4m is expected in FY10. Source: Sun Hung Kai Financial
Figure 4: VST Holdings – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
More spin-offs of its distribution subsidiaries resulting in more Slowdown or cancellation of supportive policies that bolster one-off gains. electronics and computer sales. Winning rights to distribute more well-known IT products and Sanctions against exporting CPUs and other digital equipment into equipment, e.g. iPhone distribution in China. China by the U.S. Depreciation of the USD/HKD vs. the RMB and SGD. Rapid increase in the HIBOR, which would increase VST’s interest costs. A stronger-than-expected rebound in IT spending in China leading to a surge in IT imports. Appreciation of the USD/HKD vs. the RMB and SGD. Net-margin expansion due to increased contributions from the Increase in impairment provisions for trade receivables. enterprise-systems business. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 244 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
IT is one of the fastest-growing industries in China due to the mainland market opening up to foreign competitors and the government’s 11th Five Year Plan moving the nation into the digital age. Yet China still lacks the manufacturing technology to produce equipment such as CPUs and hard drives that can compete with international brands such as Intel, AMD and Seagate. Hence, Chinese imports of IT equipment have shown durable, stable growth regardless of cyclical downturns.
These imports are channeled through VST and a handful of other companies (including Digital China, Synnex Corp and Ingram Mirco). The industry itself is tough as product lifecycles are short and net margins are thin. Furthermore, suppliers do not sign exclusive distribution agreements with the few distributors that they have, creating a low-price environment. Yet competition between distributors is mild, as aggressive measures to expand market share would increase costs and cannibalize profitability. This leaves the Chinese IT distribution industry with few players, high industry barriers and low, but stable, margins.
China’s demand for IT equipment will continue to grow as new measures such as the Home Electronics to the Countryside policy, the Home Appliances Trade-In policy and the removal of price ceilings for electronics subsidies bolster demand for PCs in China, where penetration is only 22% vs. 80% in the U.S.
Sun Hung Kai Financial 245 20 Nov. 2009
Figure 5: VST – Profit and Loss Statement FY06-09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 3,705.6 4,236.8 12,350.5 22,091.3 67.6 COGS (3,534.5) (3,980.8) (11,681.1) (21,041.8) 66.5 Gross profit 171.1 256.0 669.4 1,049.5 102.3 Operating expenses (30.9) (57.8) (322.4) (655.6) 116.2 Other operating income 0.0 0.0 7.3 3.7 N/A Operating profit 140.2 198.3 354.3 397.5 86.9 Finance expenses (5.7) (5.3) (44.6) (93.1) 136.3 PBT 135.9 195.6 329.3 318.4 75.5 Tax (24.1) (34.3) (69.7) (56.6) 74.3 Net profit 111.8 161.3 244.7 231.6 70.5 EPS – HK¢ 13.3 18.1 24.0 20.9 54.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: VST – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR Revenue 32.3 14.3 191.5 78.9 67.6 COGS 29.1 12.6 193.4 80.1 66.5 Gross profit 173.2 49.6 161.4 56.8 102.3 Operating expenses 3.0 86.7 458.1 103.4 116.2 Other operating income N/A N/A N/A (49.7) N/A Operating profit 330.1 41.4 78.7 12.2 86.9 Finance expenses 89.8 (7.3) 748.3 108.8 136.3 PBT 304.9 44.0 68.3 (3.3) 75.5 Tax 293.0 42.2 103.5 (18.8) 74.3 Net profit 307.6 44.3 51.7 (5.4) 70.5 EPS 258.8 35.8 32.8 (13.1) 54.0 Sources: Bloomberg and Sun Hung Kai Financial
Figure 7: VST – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (95.4) (94.0) (94.6) (95.2) (94.8) Gross profit 4.6 6.0 5.4 4.8 5.2 Operating expenses (0.8) (1.4) (2.6) (3.0) (1.9) Other operating income 0.0 0.0 0.1 0.0 0.0 Operating profit 3.8 4.7 2.9 1.8 3.3 Finance expenses (0.2) (0.1) (0.4) (0.4) (0.3) PBT 3.7 4.6 2.7 1.4 3.1 Tax (0.7) (0.8) (0.6) (0.3) (0.6) Net profit 3.0 3.8 2.0 1.0 2.5 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 246 20 Nov. 2009
Figure 8: VST – Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 219.1 113.9 312.8 303.6 59.5 Accounts receivable 159.1 346.4 2,554.8 2,371.3 82.9 Inventory 163.4 287.7 1,407.1 1,146.6 59.1 Other current assets 1.7 13.6 372.4 510.0 123.2 Total current assets 543.4 761.6 4,647.1 4,331.4 75.3 Net fixed assets 2.7 2.8 58.8 58.3 112.4 Other long-term assets 10.0 9.5 389.8 365.3 N/A Total assets 556.0 773.9 5,095.7 4,755.0 79.2 Short-term debt 0.0 0.0 1,666.9 653.4 64.3 Accounts payable 213.2 333.2 1,543.0 1,770.3 71.6 Other current liabilities 20.9 21.4 336.0 420.1 202.2 Total current liabilities 234.1 354.6 3,546.0 2,843.8 75.6 Long-term debt 63.5 0.0 351.5 550.0 N/A Other long-term liabilities 0.2 0.2 8.6 9.9 176.1 Total liabilities 297.9 354.8 3,906.1 3,403.7 83.6 Shareholders equity 258.1 419.1 1,189.6 1,351.3 70.0 Minorities 0.0 0.0 83.7 214.6 N/A Total equity and liabilities 556.0 773.9 5,095.7 4,755.0 79.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 9: VST – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 39.4 14.7 6.1 6.4 16.7 Accounts receivable 28.6 44.8 50.1 49.9 43.3 Inventory 29.4 37.2 27.6 24.1 29.6 Other current assets 0.3 1.8 7.3 10.7 5.0 Total current assets 97.7 98.4 91.2 91.1 94.6 Net fixed assets 0.5 0.4 1.2 1.2 0.8 Other long-term assets 1.8 1.2 7.6 7.7 4.6 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.0 32.7 13.7 11.6 Accounts payable 38.3 43.1 30.3 37.2 37.2 Other current liabilities 3.8 2.8 6.6 8.8 5.5 Total current liabilities 42.1 45.8 69.6 59.8 54.3 Long-term debt 11.4 0.0 6.9 11.6 7.5 Other long-term liabilities 0.0 0.0 0.2 0.2 0.1 Total liabilities 53.6 45.8 76.7 71.6 61.9 Shareholders equity 46.4 54.2 23.3 28.4 38.1 Minorities 0.0 0.0 1.6 4.5 1.5 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 247 20 Nov. 2009
Figure 10: VST – Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 4.6 6.0 5.4 4.8 5.2 Operating margin – % 3.8 4.7 2.9 1.8 3.3 Net margin – % 3.0 3.8 2.0 1.0 2.5 ROAA – % 22.0 24.3 8.3 4.7 14.8 ROAE – % 53.2 47.6 30.4 18.2 37.4
Liquidity ratios Current assets/current liabilities – X 2.3 2.1 1.3 1.5 1.8 Liquid assets/current liabilities – X 0.9 0.3 0.1 0.1 0.4 Cash and securities/current assets – % 40.3 15.0 6.7 7.0 17.3 Cash flow from oper./curr. liabilities – % 88.9 (7.2) (2.1) 22.5 25.5
Other ratios Capex/sales – % 0.0 0.0 0.1 0.1 0.1 Capex/depreciation – % 79.8 140.7 87.7 133.0 120.5 Operating expense/sales -% (0.8) (1.4) (2.6) (3.0) (2.3) Net debt/equity (net cash) – % (60.3) (27.2) 143.4 66.6 60.9 Inventory/sales – % 4.4 6.8 11.4 5.2 7.8 Effective tax rate – % 17.7 17.5 21.2 17.8 18.8 Cash conversion cycle – days 14.3 18.2 42.7 33.7 31.5
ROAA component analysis Revenue/average assets – % 728.6 637.2 420.8 448.5 558.8 COGS/average assets – % (694.9) (598.7) (398.0) (427.2) (529.7) Gross profit/average assets – % 33.6 38.5 22.8 21.3 29.1 Operating expenses/average assets – % (6.1) (8.7) (11.0) (13.3) (9.8) Other operating income/average assets – % 0.0 0.0 0.2 0.1 0.1 Operating profit/average assets – % 27.6 29.8 12.1 8.1 19.4 Finance expenses/average assets – % (1.1) (0.8) (1.5) (1.9) (1.3) PBT/average assets – % 26.7 29.4 11.2 6.5 18.5 Tax/average assets – % (4.7) (5.2) (2.4) (1.1) (3.4) Net profit/average assets – % 22.0 24.3 8.3 4.7 14.8
ROAE component analysis Revenue/average equity – % 1,764.6 1,251.3 1,535.5 1,738.9 1,572.6 COGS/average equity – % (1,683.1) (1,175.7) (1,452.3) (1,656.3) (1,491.8) Gross profit/average equity – % 81.5 75.6 83.2 82.6 80.7 Operating expenses/average equity – % (14.7) (17.1) (40.1) (51.6) (30.9) Other operating income/average equity – % 0.0 0.0 0.9 0.3 0.3 Operating profit/average equity – % 66.8 58.6 44.0 31.3 50.2 Finance expenses/average equity – % (2.7) (1.6) (5.5) (7.3) (4.3) PBT/average equity – % 64.7 57.8 40.9 25.1 47.1 Tax/average equity – % (11.5) (10.1) (8.7) (4.5) (8.7) Net profit/average equity – % 53.2 47.6 30.4 18.2 37.4 Sources: Bloomberg and Sun Hung Kai Financial
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Want Want (151.HK) Food & Beverage Sector 20 Nov. 2009
Company Background HSI 22,643 Want Want is a leading F&B manufacturer in China, mainly producing beverages and HSCEI 13,470 snacks. It is the only F&B firm that is the market leader for all its key products. Want Want dominates the rice-cracker market and is No. 1 in flavored milk and soft candy. Performance (%) 1m 3m 12m The firm also produces ball cakes, popsicles and jellies, and beans and nuts. Its HSI 2.0 13.5 76.7 multi-brand strategy includes two core brands, Want Want and Hot Kid, and two HSCEI 4.0 19.6 107.6 sub-brands, Yappy and Mitailang. The firm was founded in Taiwan in 1962, entered China in 1992, and has since become one of the most recognized brands in F&B. Want Want – Price vs. HSI, Share Data
Want Want listed on the Hong Kong stock exchange on 26 March 2008, raising (HK$) (HK$m) HK$1,353m. It plans to use the net proceeds to expand production, establish more 6.0 2,500
sales offices and continue marketing efforts. 5.0 2,000 4.0 1,500 China’s consumption growth remains strong, help by the government policies to 3.0 1,000 create jobs and raise household incomes. China also has the largest pool of young 2.0
people in the world, and so the largest pool of potential snackers. 1.0 500
0.0 0 The three key product segments, rice crackers, dairy products and beverages and Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 snack foods accounted for 21.3%, 48.1% and 30.1% respectively of our total revenue. Rice cracker business had a poor performance during the period, it decreased by 25% Turnover Price HSI yoy to US$170.3m, while revenue of dairy products and beverages grew by 57.6% yoy to US$384.1m at 1H09. Snack foods had a stable performance. Price – HK$ 5.66 52W high/low (HK$) Although China’s F&B industry is highly competitive, Want Want has many 5.75/2.73 advantages. The firm’s multi-brand strategy widens its customer base and fends off Shares in issue – millions 13,208.55 competitors, while its diverse portfolio mix shields it from cost pressures. It also has Market cap – HK$m 73,967.88 numbers of production bases factories throughout China, reducing reliance on any 3M avg. turnover – HK$m 81.47 single facility. Finally, Want Want’s strong brand recognition allows it to raise Major shareholders – % product prices with ease. Eng-Meng Tsai 48.76 Want Want generates less sales than Tingyi and Uni-President China, but is the most Source: Bloomberg and Sun Hung Kai Financial profitable company in its peer group. 1H09 results. Sales grew 12.5% yoy to US$798m, while earnings dropped 6.4% yoy to US$120m. The poor results were mainly due to the rice-cracker segment. Recurring profit rose 13.1% yoy. In view of the poor interim results, management This document is solely based on trimmed its full-year sales-growth forecast from 20% to 15%-18%. publicly available information. This report is intended as information Figure 1: Earnings Summary only and not as a recommendation Year ending 31 Dec. FY06 FY07 FY08 FY09E for any stock. Sun Hung Kai Financial does not provide research Net profit – US$m 126.8 176.7 262.7 295.2 coverage or ratings for this Net-profit growth – % 14.5 39.4 48.6 12.4 company in this report. EPS – US¢ 9.8 1.4 2.0 2.2
EPS growth – % 14.0 (85.9) 44.9 10.0
P/E – X 7.5 52.9 36.5 33.2
DPS – US¢ N/A 0.9 1.4 1.2
Dividend yield – % N/A 1.2 1.9 1.7 BVPS – US¢ N/A 0.5 0.1 0.1 P/B – X N/A 1.4 10.4 9.2 Op. cash flow/share – US¢ 11.6 1.9 1.4 2.8 Holly Hou Net debt (net cash)/price – % N/A (9.4) (1.2) (2.4) + (852) 2203 9588 Sources: Bloomberg and Sun Hung Kai Financial [email protected] Note: Estimates based on Bloomberg consensus
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Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor249ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Want Want – Investment Highlights
Key investment positives Key investment negatives
Market leader in all key segments, main beneficiary of growth in Raw-material price fluctuations, margin volatility. Want Want’s rice crackers and flavored milk. Want Want is the only F&B firm main costs are direct materials, about 80% of COGS. Raw materials that is the market leader for all its key products. include rice, milk powder, sugar, palm oil, potato starch, and flour. Although Want Want’s wide product portfolio and domestic Multi-branding strategy widens customer base and fends off sourcing can help mitigate the effect of raw-material price changes, competitors. In addition to two core brands, the firm has two margins are still potentially volatile. However, China is almost low-priced sub-brands, Yappy and Mitailang, to target the mass self-sufficient in rice and rice prices are regulated by the market, and gift packs for the Chinese festival and holiday market. government, so rice is less likely to surge than other raw materials. Diverse product mix. Want Want supplies a broad range of Intensifying competition. China’s F&B market has relatively low products, including: rice crackers, flavored milk, gummy sweets, entry barriers and remains highly competitive. A steady flow of local milk candy, popsicles, jellies, and nuts and beans. It also has a wide and international peers has entered the market, attracted by China’s variety of flavors and packaging. The balanced product portfolio growth potential. Their products may overlap with Want Want’s, and will mitigate some of the effect of raw-material price changes, the firm may have to spend more on promotions or lose market which account for about 80% of COGS. share and pricing power. Strong brand recognition, ability to raise ASPs. The Want Want Risks of consumer tastes changing. Want Want has a strong history brand with the Hot Kid logo is the most recognized F&B brand in of developing successful new products, but there is always a risk. China. Its promotion strategy targets young consumers to build a An inability to anticipate, identify and react to changes in consumer long-term customer base. Hot Kid milk and ball cakes are unique behavior would hurt growth. products designed especially for children. Under China’s one-child policy, children’s purchasing power is strong, with parents’ willing Poor execution by third parties. With 90 factories across the to spend on their only child. Want Want’s products are also popular country, Want Want relies on third-party distributors and logistics for Chinese festivals, allowing the firm to continuously raise prices. companies for distribution and transport. This subjects the firm to the risk of delays or operational inefficiencies by these third parties. Extensive distribution network, swift response to market. Apart Poor execution by these third parties may reflect badly on Want from selling to more than 15,000 wholesalers (76% of sales), Want Want’s reputation and hit sales. Want also sells directly to supermarkets, hypermarkets, chain stores, and convenience stores. Its products are sold in almost every Higher tax rates. Want Want had an effective tax rate of only province in China. 10.5% in 2007, vs. the current maximum enterprise income tax rate of 25%. It currently entitled to exemptions or reductions from the Not a target for government price controls. None of the current standard income tax rate for a fixed term, but after that, the company government price-control policies affect Want Want’s products. The will face a much higher effective tax rate. risk of government intervention is much lower for Want Want than its F&B peers because the government usually targets daily EBIT margin erosion. This was mainly a result of the substantial necessities rather than snack foods. increase in selling and distribution expenses, mainly due to advertising and promotional expenses for new-product launches Benefits from milk scandal. Impressive beverage sales growth of (pocket juices) as well as sales-force rationalization in relation to the 57.6%, mainly thanks to consumers’ switching to melamine-free group’s “Delivering Want Want to Villages” campaigns that began in brands and new product launches. 4Q07. New product launches to stimulate sales growth. The company Deep structural issues. Management’s explanation for the will launch non-fried rice-based instant noodles in late 2009. slower-than-expected sales of rice crackers was the 20% ASP hikes Management is upbeat on this and guides a 30%-40% gross margin in 2H08 and an inventory pile-up in its distribution network in (vs. Tingyi’s about 30%). It may be the next growth driver, anticipation of the 2009 Chinese New Year. But if this sales decline particular with the health-oriented and niche market focus, which turns out to be due to deeper structural problems rather than a series can stand out from the majority flour-based instant-noodle players. of one-off issues, it could indicate substantial further problems. Changing procurement strategy. The company had to import milk Management decreased its sales-growth target for FY09, from powder (the raw material for dairy products) at relatively high costs around 20% to 15%-18% because of the poor performance of its for nine months following the milk scandal. It has since reverted its rice-cracker segment. procurement strategy to normal for the past four months. It will start to use low-cost milk from 4Q09 and COGS will decrease in FY09 Possible gross-margin decline because of new instant noodles. and FY10. Given the market margins for instant noodles, expanding into this new product line will likely drag down Want Want’s overall gross Consolidating sales team. Overstocking in 4Q08 was attributed to margin, currently 38%. Want Want’s loose supervision of its sales term after overexpansion in 2008. Management has consolidated its sales team to 10,500 sales Working capital increasing. Most consumer plays enjoy negative representatives, from 14,000 at end-2008. The team is now stable working capital, but Want Want operates with positive working and more disciplined. capital, which increased in 1H09 as it developed its product distribution network. It will worsen further if product sales cannot Restructuring distribution channels. Want Want restructured its meet targets. distributor channels from July to September 2009, mainly in second-tier cities. It now operates one core distributor in a given area, supported by a number of sub-distributors. This system could help better control its product pricing and launch new products more quickly. Gross margins could increase for rice crackers. Rice cracker ASPs rose 10% yoy in 1H09, but that only led to a 5.8 ppts improvement in segment gross margin due to falling of sales volumes. If the company can improve volumes, it can raise margins. Favorable demographics. China has the largest pool of young people in the world (some 350 million between the ages of 2 and 18), and so the world’s largest pool of potential snackers. Children wield enormous purchasing power, both directly and indirectly. Consumption growth in China. Consumption growth in China should remain strong, helped by government policies to create jobs and raise household incomes. Growth potential in China appears intact in the long run. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 250 20 Nov. 2009
Figure 3: Want Want – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Higher ASPs. Raw-material price hikes. Softening raw-material costs. Changes in consumer tastes. Discontinuation of preferential tax rates. Source: Sun Hung Kai Financial
Industry Dynamics
Rising disposable incomes Personal incomes in China have increased along with economic growth in recent years. According to NBSC, urban per capita disposable incomes increased from RMB7,702.8 to RMB13,785.8 over 2002-07, for a CAGR of 12.4%. The rural figure rose from RMB2,713.0 to RMB4,958.4, for a CAGR of 12.8%.
Growth in consumption Rising personal incomes have driven growth in consumption and retail sales. Urban per capita consumption expenditure increased from RMB6,030 to RMB 9,997.5 over 2002-07, for a CAGR of 10.6%. The rural figure rose from RMB1,703 to RMB 4,533.1, for a CAGR of 13.2%.
F&B consumption F&B has been the single largest category of per capita consumption expenditure, exceeding other essential items such as housing and clothing. In 2007, F&B made up 36.3% of urban per capita consumption expenditure and 27% in rural areas. Food consumption has grown along with overall consumption. Urban food-consumption expenditure per capita increased from RMB2,271 to RMB 3,628 over 2002-07, for a CAGR of 9.8%. The rural figure increased from RMB848.4 to RMB1,389, for a CAGR of 10.4%.
Increase in urban population and disposable incomes Economic development and growing affluence have increased consumer spending power and driven demand for F&B products in China. Urban consumers, due to busier lifestyles and greater average incomes, have increased their consumption of convenience foods. (Urban disposable incomes have risen at a 12.3% five-year CAGR, while rural cash incomes have increased at a 12.8% five-year CAGR.)
Increased penetration of organized chains The rapid development and increased penetration of modern chain stores in China have made F&B products more accessible to the mass market and consumption more convenient and affordable. The development of organized chains has also promoted brand products. The increasing prevalence of chain stores is expected to further drive F&B consumption.
Dynamic consumer preferences Consumers of different age groups and socioeconomic backgrounds have different tastes and product preferences. Within the same consumer segment, consumer tastes may also differ due to differences in locations and climates in the PRC. In addition, consumer preferences may change in response to seasonal factors. Packaging is generally considered an important factor in consumer preferences. Attractive, bright packaging and professional designs are more likely to attract consumers.
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Innovative products F&B manufacturers have generally realized the importance of developing new product categories. Through continuous investment in R&D and technical cooperation with foreign investors, Chinese companies have launched various products containing innovative ingredients and flavors to help expand their customer bases and strengthen brand loyalty.
Increasing food-safety awareness According to Euromonitor, consumers in China are increasingly concerned about food safety. With growing demand for safe food, consumers are expected to pay more attention to product quality and branding, rather than unit price, as their main selection criteria. The Chinese government is also beginning to focus on food safety, and legislation on food is expected to tighten. These factors are likely to result in strong growth for large players, especially those entering markets in less developed regions.
Crispy snacks According to ACNielsen, China’s consumption of crispy snack foods posted a volume CAGR of 7.5% over 2H04-1H07, reaching 232.95 million kg in 2006, and a value CAGR of 8.4%, reaching RMB7.3bn. Want Want is the market leader in rice snacks, with market share by sales increasing from 59.3% for 2005 to 68.6% for 1H07. Its nearest competitor had a 3.2% share for 1H07. The aggregate market share of the next four largest brands increased from 9.1% to 9.8% over the period. Want Want is also the market leader for extruded pellets (including ball cakes, potato twists and crispy bites), with a market share by sales of 22.9% for 1H07, up from 12.2% in 2005. Its nearest competitor has steadily lost market share.
Sugar confectionery According to Euromonitor, rising sales of sugar confectionary in China can be mainly attributed to greater consumer purchasing power. Consumers can afford to buy more and are willing to upgrade to more expensive premium products. According to ACNielsen, sugar-confectionary consumption by volume rose 7.4% per half on average over 2005-1H07, reaching 79.9 billion kg in 2006. By value, consumption rose 10.5% per half on average, reaching RMB2.8bn. Euromonitor estimates sugar-confectionery value to post a 5% CAGR over 2006-11. Soft candy sales accounted for 54.0% of sugar-confectionary sales in 2006 and hard candy 46.0%. Soft-candy sales rose 15.9% per half on average over 2005-1H06 and hard candy 4.9%. For 2006 and 1H07, Want Want was the market leader in soft candy with market shares of 29.0% and 28.5% respectively. Its closest competitor had about half its market share in 1H07 and the remaining three of the top five brands had market shares of less than 5% each.
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Figure 4: Want Want – Profit and Loss Statement FY05-08 Year ended 31 Dec., US$m FY05 FY06 FY07 FY08 CAGR (%) Revenue 681.9 861.7 1,094.5 1,553.9 31.6 COGS (419.3) (534.3) (658.1) (957.4) 31.8 Gross profit 262.6 327.3 436.5 596.5 31.3 Operating expenses (155.4) (209.6) (241.4) (329.4) 26.0 Other operating income 11.8 24.8 19.1 21.5 28.9 Operating profit 119.0 142.5 214.2 288.6 38.7 Finance expenses (4.4) (12.5) (4.6) (3.8) 26.8 PBT 122.3 139.5 225.7 309.9 39.6 Tax (12.5) (15.9) (23.8) (46.9) 48.5 Net profit 110.8 126.8 176.7 262.7 37.9 EPS – US¢ 8.6 9.8 1.4 2.0 (23.0) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Want Want – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 31.5 26.4 27.0 42.0 31.6 COGS 32.0 27.4 23.2 45.5 31.8 Gross profit 30.7 24.7 33.3 36.7 31.3 Operating expenses 18.7 34.9 15.2 36.5 26.0 Other operating income 51.7 109.4 (23.0) 12.8 28.9 Operating profit 52.8 19.7 50.3 34.7 38.7 Finance expenses 203.2 183.0 (63.6) (17.1) 26.8 PBT 50.0 14.1 61.7 37.3 39.6 Tax 29.9 26.9 49.5 97.3 48.5 Net profit 52.5 14.5 39.4 48.6 37.9 EPS 50.9 14.0 (85.9) 44.9 (23.0) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Want Want – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (61.5) (62.0) (60.1) (61.6) (61.3) Gross profit 38.5 38.0 39.9 38.4 38.7 Operating expenses (22.8) (24.3) (22.1) (21.2) (22.6) Other operating income 1.7 2.9 1.7 1.4 1.9 Operating profit 17.5 16.5 19.6 18.6 18.0 Finance expenses (0.6) (1.5) (0.4) (0.2) (0.7) PBT 17.9 16.2 20.6 19.9 18.7 Tax (1.8) (1.8) (2.2) (3.0) (2.2) Net profit 16.2 14.7 16.1 16.9 16.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 253 20 Nov. 2009
Figure 7: Want Want - Balance Sheet FY05-08 As at 31 Dec., US$ m FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 163.4 185.1 270.5 284.2 18.5 Accounts receivable 49.4 55.0 67.2 98.4 22.5 Inventory 196.9 281.2 227.6 345.9 33.1 Other current assets 40.9 56.7 72.8 89.6 9.0 Total current assets 450.6 578.0 638.1 818.1 22.6 Net fixed assets 526.8 622.8 493.4 599.8 13.5 Other long-term assets 9.5 9.5 4.0 7.2 24.4 Total assets 986.9 1,210.3 1,135.4 1,425.1 18.4 Short-term debt 27.6 189.4 15.3 1.5 (47.5) Accounts payable 71.6 94.0 79.0 87.8 25.5 Other current liabilities 98.3 104.1 177.6 235.0 40.2 Total current liabilities 197.5 387.5 271.9 324.2 29.3 Long-term debt 145.8 56.4 168.0 165.0 31.6 Other long-term liabilities 8.2 7.7 0.0 0.0 N/A Total liabilities 351.5 451.6 439.9 489.2 30.0 Shareholders equity 635.4 758.7 695.5 935.9 14.0 Minorities 8.7 7.0 4.5 4.5 (18.7) Total equity and liabilities 986.9 1,210.3 1,135.4 1,425.1 18.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Want Want – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 16.6 15.3 23.8 19.9 18.9 Accounts receivable 5.0 4.5 5.9 6.9 5.6 Inventory 19.9 23.2 20.0 24.3 21.9 Other current assets 4.1 4.7 6.4 6.3 5.4 Total current assets 45.7 47.8 56.2 57.4 51.8 Net fixed assets 53.4 51.5 43.5 42.1 47.6 Other long-term assets 1.0 0.8 0.3 0.5 0.6 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 2.8 15.6 1.3 0.1 5.0 Accounts payable 7.3 7.8 7.0 6.2 7.0 Other current liabilities 10.0 8.6 15.6 16.5 12.7 Total current liabilities 20.0 32.0 23.9 22.8 24.7 Long-term debt 14.8 4.7 14.8 11.6 11.5 Other long-term liabilities 0.8 0.6 0.0 0.0 0.4 Total liabilities 35.6 37.3 38.7 34.3 36.5 Shareholders equity 64.4 62.7 61.3 65.7 63.5 Minorities 0.9 0.6 0.4 0.3 0.5 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 254 20 Nov. 2009
Figure 9: Want Want – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 38.5 38.0 39.9 38.4 38.7 Operating margin – % 17.5 16.5 19.6 18.6 18.0 Net margin – % 16.2 14.7 16.1 16.9 16.0 ROAA – % 12.9 11.5 15.1 20.5 15.0 ROAE – % 18.6 18.2 24.3 32.2 23.3
Liquidity ratios Current assets/current liabilities – X 2.3 1.5 2.3 2.5 2.2 Liquid assets/current liabilities – X 0.8 0.5 1.0 0.9 0.8 Cash and securities/current assets – % 36.3 32.0 42.4 34.7 36.4 Cash flow from oper./curr. liabilities – % 84.1 38.6 87.8 56.2 66.7
Other ratios Capex/sales – % 23.5 17.5 8.0 8.1 14.3 Capex/depreciation – % 397.5 317.9 171.3 278.0 255.7 Operating expense/sales -% (22.8) (24.3) (22.1) (21.2) (22.5) Net debt/equity (net cash) – % 1.4 7.9 (12.6) (12.6) (5.8) Inventory/sales – % 28.9 32.6 20.8 22.3 25.2 Effective tax rate – % 10.2 11.4 10.5 15.1 12.3 Cash conversion cycle – days 120.0 136.5 109.2 100.8 115.5
ROAA component analysis Revenue/average assets – % 79.6 78.4 93.3 121.4 93.2 COGS/average assets – % (49.0) (48.6) (56.1) (74.8) (57.1) Gross profit/average assets – % 30.7 29.8 37.2 46.6 36.1 Operating expenses/average assets – % (18.1) (19.1) (20.6) (25.7) (20.9) Other operating income/average assets – % 1.4 2.3 1.6 1.7 1.7 Operating profit/average assets – % 13.9 13.0 18.3 22.5 16.9 Finance expenses/average assets – % (0.5) (1.1) (0.4) (0.3) (0.6) PBT/average assets – % 14.3 12.7 19.2 24.2 17.6 Tax/average assets – % (1.5) (1.4) (2.0) (3.7) (2.1) Net profit/average assets – % 12.9 11.5 15.1 20.5 15.0
ROAE component analysis Revenue/average equity – % 114.6 123.6 150.5 190.5 144.8 COGS/average equity – % (70.5) (76.7) (90.5) (117.4) (88.8) Gross profit/average equity – % 44.1 47.0 60.0 73.1 56.1 Operating expenses/average equity – % (26.1) (30.1) (33.2) (40.4) (32.4) Other operating income/average equity – % 2.0 3.6 2.6 2.6 2.7 Operating profit/average equity – % 20.0 20.4 29.5 35.4 26.3 Finance expenses/average equity – % (0.7) (1.8) (0.6) (0.5) (0.9) PBT/average equity – % 20.6 20.0 31.0 38.0 27.4 Tax/average equity – % (2.1) (2.3) (3.3) (5.7) (3.3) Net profit/average equity – % 18.6 18.2 24.3 32.2 23.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 255 20 Nov. 2009
Wasion (3393.HK) Manufacturing Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Wasion is a leader in China’s electronic-power-meter market, with a 25% share in
three-phase electronic power meters (51% of sales), 5% in single-phase electronic Performance (%) 1m 3m 12m power meters (24%) and 25% in data-collection terminals and power-management HSI 2.0 13.5 76.7 system (20%). It also sells water, gas and heat meters (5%). The company listed in HSCEI 4.0 19.6 107.6 Hong Kong in December 2005. Wasion– Price vs. HSI, Share Data The major customers are State Grid Corporation of China (SGCC) and China
Southern Power Grid (CSG), which account for 77% of revenue. SGCC is (HK$) (HK$m) responsible for the northern 26 provinces and CSG the other five. These core 9.0 1,000 8.0 state-owned enterprises are closely related to national energy security and the 7.0 800 6.0 economy. They are responsible for building and operating power grids to provide a 600 5.0 4.0 secure and reliable power supply. 400 3.0 2.0 200 Having acquired water-, gas- and heat-meter companies, Wasion has transformed 1.0 0.0 0 into an integrated meter and data-collection system provider. Non-power-grid clients Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 include PetroChina, CHALCO and Dongfeng Motor. Turnover Price HSI
The company is set to benefit from grid companies’ increasing budgets. An Price – HK$ 6.59 estimated RMB60bn-RMB80bn will be allocated to purchase power meters and 52W high/low (HK$) 8.35/1.08 automated power-measurement systems and terminals (90% of Wasion’s products) Shares in issue – millions 928.96 in the next 3-5 years. Market cap – HK$m 6,093.96 3M avg. turnover – HK$m 23.46 The domestic electronic-power-meter market is expected to continue growing in the Major shareholders – % next five years given the government’s commitment to ‘one family, one meter’ and Wei Ji 50.25 power-saving projects. Wasion can benefit from growth in single-phase power Sources: Bloomberg and Sun Hung Kai Financial meters.
Production is running near capacity, but this should ease once new plants start operation this year, which will double annual capacity for three-phase electronic power meters from 600,000 units in FY07 to 1.2 million units, and single-phase meters from 2 million units to 4 million units. This should help Wasion cater for industry growth. Recent Reports Date Explosive Momentum 27 May 2009 Sound 1H09 results: Wasion’s 1H09 net profit grew 10% yoy to RMB73m, with revenue from all sectors up, except a slight decline for data-collection terminals and Powering Up 25 May 2009 power-management systems. The results were less exciting due to seasonal factors. Normally, the second half of the year is the peak season when power-grid customers place huge orders. This document is solely based on Figure 1: Earnings Summary publicly available information. This report is intended as information Year ending 31 Dec. FY06 FY07 FY08 FY09E only and not as a recommendation Net profit - RMBm 151.7 212.9 261.5 304.4 for any stock. Sun Hung Kai Net-profit growth - % 30.8 40.3 22.8 16.4 Financial does not provide research EPS - RMB fen 22.0 29.0 32.0 36.4 coverage or ratings for this EPS growth - % (8.3) 31.8 10.3 13.8 company in this report. P/E - X 26.4 20.0 18.1 16.0 DPS - RMB fen 7.0 8.0 9.7 10.6 Holly Hou Dividend yield - % 1.2 1.4 1.7 1.8 + (852) 2203 9588 BVPS - RMB 0.8 1.5 1.7 2.3 [email protected] P/B - X 7.0 3.9 3.4 2.6 Oper cash flow/share - RMB fen 5.5 13.7 38.2 29.5 All reports are available at: Net debt (net cash) to share price - % 1.3 (5.4) 0.3 (0.5) http://www.SHKfg.com Sources: Bloomberg and Sun Hung Kai Financial http://www.im.knowledge.reuter.com Note: Based on Bloomberg Consensus http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor256ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Wasion – Investment Highlights
Key investment positives Key investment negatives 25% national market share. The company has a 25% national Long cash-conversion cycle. The cash-conversion cycle remained market share in three-phase power meters (industrial use) and a 5% long at about 150 days in FY08 (though down from 178 days in share in single-phase power meters (individual use). FY07), due to late payments by two major customers, SGCC and CSG. Still, there should be little risk of bankruptcy, though we don’t Rising investment by state-owned grids. State Grid has set see many signs of improvement in the short term unless the firm can timeframes for smart grid construction, with R&D and standard pilot continue diversifying its customer base beyond grid companies. testing in 2009-10, main construction in 2011-15, and upgrades fine-tuning in 2016-20. The Grid has earmarked RMB4.5tn in capex Increasing tax rate. The effective tax rate increased from 4.2% in over 2009-20 to upgrade China’s grid system. Large orders for FY06 to 7.5% in FY08; management expects 9% for FY09. The AMRs (smart meters) will be placed, which should drive strong company is recognized as a high-tech enterprise and is entitled to a sales growth for Wasion’s single-phase carrier-wave power meter. preferential tax rate of 15% (the effective rate is gradually increasing to this level). The entitlement is subject to annual review; ‘One family, one meter’ policy. The government has various if the company loses this rate it will be charged at the normal tax construction projects to improve the country’s power network, with rate of 25%. policies including new socialism villages, power saving and ‘one family, one meter.’ These plus the establishment of more urban Demand heavily affected by economic downturn. The financial residential areas are expected to increase demand for electronic crisis has had a substantial impact on power-intensive enterprises in power meters in the next five years, in particular for single-phase the PRC, increasing the incentive to invest in energy-saving and power meters. pollutant-reducing projects. Expanding capacity to cater for growth. Production is running near capacity, but this should ease once new plants start operation this year, which will double annual capacity for three-phase electronic power meters from 600,000 units in FY07 to 1.2 million units, and single-phase meters from 2 million units to 4 million units. This should help Wasion cater for industry growth. Extending product range to water and gas meters. To diversify its product range, Wasion acquired water- and gas-meter firm Hunan Weiming Technology for RMB150m in May 2008. Management expects public utilities to demand more energy-saving solutions. Large corporations and medium-sized enterprises have already started replacing their water, electricity and gas meters. Diversifying customer base. Wasion is expanding into non-power customers such as steel factories. It already has an RMB100m order from PetroChina for integrated meter systems, to be delivered this year. Expanding overseas. Wasion has penetrated the Middle East, Africa and Southeast Asia, and is now marketing to developed markets such as the U.S. and Europe. Exports account for less than 10% of total sales, but management expects this to pick up in the next 2-3 years. Advanced technology, ability to innovate. Wasion’s R&D department accounts for 20% of its staff. The company was granted 16 product patents during the period, including six for three-phase meters, two for single-phase meters, and eight for data-collection terminals and power-management systems. Partnership with CEPRI can help gain market share. Wasion is one of two winners (out of 24 bids) of the project tender to jointly develop electronic power meters with China Electric Power Research Institute (CEPRI), which is controlled by SGCC. Management expects to announce details in 2H09. The deal highlights the firm’s leading brand name, R&D capability and product quality. CEPRI targets to a 30% market share in power meters and data-collection systems from SGCC, which can help Wasion increase its own market shares. Preparing for new generation of smart meters. Wasion started an AMI project with U.S firm ESCO in 2007, which will end in 2009-10 and is now at the certification stage. The high gross margin of over 40% has been sustained by: 1. The company’s in-house R&D department, which has secured 68 patents, underlining its innovation and advanced technology. 2. Under the Metrology Law of the PRC, meter makers must have a License for Manufacturing Measuring Instruments and a License for Repairing Measuring Instruments. This takes 2-3 years to process, so smaller players with weak finances or latecomers will find it hard to fund initial R&D costs without any income. 3. Grid companies’ preference for quality, stability and technology when choosing meters, rather than price (when meters break down, the grids lose money). 4. Grid companies’ tendency to maintain long relationships with reliable meter suppliers like Wasion. 5. Heavy working-capital requirements. SGCC and SGC only settle bills after 6-7 months, so small firms with weak finances are forced out of the industry. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 257 20 Nov. 2009
Figure 3: Wasion – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts Projects starting for smart meters and smart grids in China. Capacity expanding faster than demand. More favorable government policy. Not reacting to a rapid change in technology. Capturing more market share. Expanding to more countries. Source: Sun Hung Kai Financial
Recent Company News Nil.
Industry Dynamics Three-stage electronic power meters The 11th Five Year Plan aims to cut power consumption per unit of GDP by 20% and the volume of major pollutants discharged by 10% by 2010, to satisfy increasing demand for energy management from all levels of local governments and power consuming units. The Plan factors in 9% p.a. growth in power demand, and over RMB1,000bn to construct power grids, with 6%-8% (RMB60bn-RMB80bn) allocated to buy power meters and automated power-measurement systems and terminals. Wasion should benefit. Power-automation products are mainly used for automatic meter reading, but can also measure power, charge and load control. Applications could extend to monitoring power distribution and transformation. More comprehensive information could increase quality control over power management.
Data-collection terminals and power-management systems The State Power Grid has issued the Guidance for the Acceleration of Modernized Construction with respect to Power Sales, which requires power grids at all levels to 1) establish a power-collection platform for users consuming more than 315 kVA prior to 2007, 2) establish demand-side power-management system, and 3) establish a power collection and monitoring platform for terminals with 50 kVA or above prior to 2010. Based on the number of heavy power users and transformers of 50 kVA, the market for power-management systems over the next five years is estimated at about RMB8bn, with great potential for development. Including Wasion, there are only 10 or so companies that produce power-usage automation.
Single-phase electronic power meters The government has various construction projects to improve the power network, with policies including new socialism villages, power saving and ‘one family, one meter.’ These plus establishing more urban residential areas are expected to increase demand for electronic power meters in the next five years, in particular single-phase power meters.
Smart meters and smart grid Smart grids deliver electricity from suppliers to consumers using digital technology to save energy, reduce cost and increase reliability. Many governments are promoting this as a way to improve energy independence and address global warming. Smart meters make it possible for energy suppliers to charge variable electric rates to reflect the large cost differences in generating electricity during peak or off-peak periods. This would allow the use of energy-intensive devices such as water heaters when electricity is cheaper to produce. Communications and metering technologies can inform smart devices in homes and businesses when demand is high, track how much electricity is used and when it is used. Prices can be increased during high periods and cut during low periods, shifting consumption habits and, in theory, increasing efficiency.
Sun Hung Kai Financial 258 20 Nov. 2009
Figure 4: Wasion – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 445.6 600.4 804.0 1,059.4 34.8 COGS (210.5) (323.2) (425.1) (561.8) 36.3 Gross profit 235.2 277.3 378.9 497.6 33.1 Operating expenses (101.3) (116.5) (156.9) (215.2) 36.9 Other operating income 2.7 7.2 28.6 23.1 147.7 Operating profit 136.6 167.9 250.6 305.5 32.9 Finance expenses (12.2) (9.5) (17.2) (19.6) 18.8 PBT 124.3 158.4 233.4 282.9 33.9 Tax (8.4) (6.7) (20.5) (21.3) 36.8 Net profit 116.0 151.7 212.9 261.5 33.5 EPS – RMB fen 24.0 21.0 28.0 31.0 16.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Wasion – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR Revenue 38.8 34.7 33.9 31.8 34.8 COGS 29.4 53.5 31.6 32.1 36.3 Gross profit 48.4 17.9 36.6 31.3 33.1 Operating expenses 65.6 15.0 34.6 37.2 36.9 Other operating income 344.0 163.3 298.0 (19.2) 147.7 Operating profit 39.5 23.0 49.2 21.9 32.9 Finance expenses 24.0 (22.2) 80.9 14.1 18.8 PBT 41.2 27.4 47.3 21.2 33.9 Tax 37.2 (19.9) 205.9 4.0 36.8 Net profit 40.7 30.8 40.3 22.8 33.5 EPS 41.2 (12.5) 33.3 10.7 16.2 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Wasion – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (47.2) (53.8) (52.9) (53.0) (51.7) Gross profit 52.8 46.2 47.1 47.0 48.3 Operating expenses (22.7) (19.4) (19.5) (20.3) (20.5) Other operating income 0.6 1.2 3.6 2.2 1.9 Operating profit 30.6 28.0 31.2 28.8 29.7 Finance expenses (2.7) (1.6) (2.1) (1.9) (2.1) PBT 27.9 26.4 29.0 26.7 27.5 Tax (1.9) (1.1) (2.5) (2.0) (1.9) Net profit 26.0 25.3 26.5 24.7 25.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 259 20 Nov. 2009
Figure 7: Wasion – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 206.4 158.2 508.7 439.2 102.8 Accounts receivable 247.1 393.6 604.0 766.6 51.9 Inventory 85.4 106.6 149.9 255.6 33.6 Other current assets 52.1 71.5 162.6 186.4 45.2 Total current assets 591.1 729.8 1,425.3 1,647.7 54.1 Net fixed assets 88.9 101.5 185.4 437.3 54.8 Other long-term assets 64.1 98.3 304.8 458.8 60.7 Total assets 744.2 929.6 1,915.6 2,543.8 55.3 Short-term debt 39.7 163.7 208.8 234.1 14.4 Accounts payable 151.9 174.6 277.2 472.1 38.4 Other current liabilities 5.9 4.8 142.4 201.3 192.0 Total current liabilities 197.6 343.1 628.4 907.5 35.7 Long-term debt 75.0 0.0 42.0 220.0 N/A Other long-term liabilities 0.0 0.7 21.9 31.2 N/A Total liabilities 272.6 343.7 692.3 1,158.7 44.2 Shareholders equity 471.6 585.9 1,223.3 1,385.1 69.2 Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 744.2 929.6 1,915.6 2,543.8 55.3 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Wasion – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 27.7 17.0 26.6 17.3 22.1 Accounts receivable 33.2 42.3 31.5 30.1 34.3 Inventory 11.5 11.5 7.8 10.0 10.2 Other current assets 7.0 7.7 8.5 7.3 7.6 Total current assets 79.4 78.5 74.4 64.8 74.3 Net fixed assets 12.0 10.9 9.7 17.2 12.4 Other long-term assets 8.6 10.6 15.9 18.0 13.3 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 5.3 17.6 10.9 9.2 10.8 Accounts payable 20.4 18.8 14.5 18.6 18.1 Other current liabilities 0.8 0.5 7.4 7.9 4.2 Total current liabilities 26.6 36.9 32.8 35.7 33.0 Long-term debt 10.1 0.0 2.2 8.6 5.2 Other long-term liabilities 0.0 0.1 1.1 1.2 0.6 Total liabilities 36.6 37.0 36.1 45.6 38.8 Shareholders equity 63.4 63.0 63.9 54.4 61.2 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 260 20 Nov. 2009
Figure 9: Wasion – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 52.8 46.2 47.1 47.0 48.3 Operating margin – % 30.6 28.0 31.2 28.8 29.7 Net margin – % 26.0 25.3 26.5 24.7 25.6 ROAA – % 19.6 18.1 15.0 11.7 16.1 ROAE – % 36.2 28.7 23.5 20.1 27.1
Liquidity ratios Current assets/current liabilities – X 3.0 2.1 2.3 1.8 2.3 Liquid assets/current liabilities – X 2.3 1.6 1.8 1.3 1.8 Cash and securities/current assets – % 34.9 21.7 35.7 26.7 29.7 Cash flow from oper./curr. liabilities – % 30.8 12.7 14.9 33.9 23.1
Other ratios Capex/sales – % 3.4 3.8 11.1 20.5 9.7 Operating expense/sales -% 193.4 225.6 674.0 1,244.5 584.4 Net debt/equity (net cash) – % (22.7) (19.4) (19.5) (20.3) (20.5) Inventory/sales – % (19.4) 0.9 (21.1) 1.1 (9.6) Effective tax rate – % 19.2 17.8 18.6 24.1 19.9 Cash conversion cycle – days 6.7 4.2 8.8 7.5 6.8 204.1 192.0 168.9 148.5 178.4 ROAA component analysis Revenue/average assets – % COGS/average assets – % 75.5 71.7 56.5 47.5 62.8 Gross profit/average assets – % (35.6) (38.6) (29.9) (25.2) (32.3) Operating expenses/average assets – % 39.8 33.1 26.6 22.3 30.5 Other operating income/average assets – % (17.2) (13.9) (11.0) (9.7) (12.9) Operating profit/average assets – % 0.5 0.9 2.0 1.0 1.1 Finance expenses/average assets – % 23.1 20.1 17.6 13.7 18.6 PBT/average assets – % (2.1) (1.1) (1.2) (0.9) (1.3) Tax/average assets – % 21.1 18.9 16.4 12.7 17.3 Net profit/average assets – % (1.4) (0.8) (1.4) (1.0) (1.2) 19.6 18.1 15.0 11.7 16.1 ROAE component analysis Revenue/average equity – % COGS/average equity – % 139.1 113.6 88.9 81.2 105.7 Gross profit/average equity – % (65.7) (61.1) (47.0) (43.1) (54.2) Operating expenses/average equity – % 73.4 52.4 41.9 38.2 51.5 Other operating income/average equity – % (31.6) (22.0) (17.3) (16.5) (21.9) Operating profit/average equity – % 0.9 1.4 3.2 1.8 1.8 Finance expenses/average equity – % 42.6 31.8 27.7 23.4 31.4 PBT/average equity – % (3.8) (1.8) (1.9) (1.5) (2.3) Tax/average equity – % 38.8 30.0 25.8 21.7 29.1 Net profit/average equity – % (2.6) (1.3) (2.3) (1.6) (1.9) Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 261 20 Nov. 2009
Xingda International (1899.HK) Auto and Peripherals Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Xingda, through its subsidiary (a 69.5% interest in Jiangsu Xingda), manufactures
and distributes tire cords and bead wires, which are the principal skeleton materials of Performance (%) 1m 3m 12m radial tires. It is the second largest PRC-based producer of radial tire cords in China HSI 2.0 13.5 76.7 by volume, with around 35% market share, up from only 15% in 2003. HSCEI 4.0 19.6 107.6 Higher-margin radial tire cords for trucks make up 79% of revenue, radial tire cords for passenger cars 14%, and bead wire 8%. Radial tire cords are used to strengthen Xingda – Price vs. HSI, Share Data the supporting walls of a radial tire, while bead wires are used to support a tire where
it attaches to the rim of a wheel. (HK$) (HK$m) 4.5 140 4.0 120 Following a price war launched by small players in 2006, the radial tire cord market 3.5 100 has improved, and demand and supply are becoming more balanced. During the price 3.0 2.5 80 war, Xingda cut its ASP 8% p.a. over 2005-08 to protect its a 30% market share and 2.0 60 1.5 40 limit opportunities for second-tier manufacturers to expand. The top two players now 1.0 account for 65% of the market and smaller peers only 10% (annual production 0.5 20 0.0 0 capacity of 10,000 tonnes vs. Xingda’s 315,000 tonnes). This has given Xingda much Oct 07 Feb 08 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 stronger bargaining power now that smaller peers have been squeezed out, since the end market remains highly fragmented (the top customer only accounts for 5% of the Turnover Price HSI domestic market). This means Xingda should easily be able to pass on any rise in steel costs (50% of COGS). Price – HK$ 3.80 52W high/low (HK$) 4.09/0.69 The company is an approved supplier for U.S. tiremakers such as Michelin and Shares in issue – millions 1,386.18 Goodyear, underlining its product quality. It focuses on tier-one tiremakers, for which Market cap – HK$m 5,114.99 entry barriers are substantial due to the long time needed to qualify as a supplier. 3M avg. turnover – HK$m 13.82 Major shareholders – % Jinlan Liu 18.29 As one of the PRC’s leading manufacturers of radial tire cords, Xingda should benefit Sources: Bloomberg and Sun Hung Kai Financial from the expected recovery in the global auto market, particularly in domestic commercial vehicles. It is more economical to use radial tires despite the higher price, as they can help save energy.
1H09 net profit including CB revaluations dropped 16% yoy to RMB201m, as CB revaluations switched from an RMB19m gain in 1H08 to an RMB1m loss in 1H09. Xingda redeemed all its outstanding CBs in May, so there should be no more CB revaluation expenses going forward. Recent Reports Date Riding on Commercial Vehicle 15 Oct 2009 Revival
A Pure Technical Play 13 May 2009
Figure 1: Earnings Summary Year ending 31 Dec. FY06 FY07 FY08 FY09E This document is solely based on Net profit – RMBm 194.2 345.4 418.2 515.3 publicly available information. This Net-profit growth - % 67.2 77.8 21.1 23.2 report is intended as information EPS – RMB fen 21.3 26.0 30.2 34.0 only and not as a recommendation EPS growth - % 65.1 21.9 16.2 12.7 for any stock. Sun Hung Kai P/E – X Financial does not provide research 15.7 12.9 11.1 9.8 DPS – RMB fen coverage or ratings for this 4.0 5.3 7.0 7.0 company in this report. Dividend yield - % 1.2 1.6 2.1 2.2 BVPS – RMB 1.5 1.9 2.1 3.6 Eva Yip, CFA P/B – X 2.3 1.8 1.6 0.9 + (852) 2203 9587 Oper cash flow/share – RMB fen 19.2 34.3 38.7 62.0 [email protected] Net debt (net cash) to share price - % 17.2 5.6 15.4 8.7 Sources: Bloomberg and Sun Hung Kai Financial Note: Based on Bloomberg Consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com
http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor262ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Xingda – Investment Highlights
Key investment positives Key investment negatives
Increasing demand for radial truck tires on commercial-vehicle Low rubber prices may reduce demand for radial tires. During recovery. China’s heavy-duty and medium-duty truck sales are the crude-price peak, demand for truck-tire cords was strong, being driven by rising infrastructure spending. An export recovery driven by faster radialization. This was because high rubber prices can also improve demand for logistics. 79% of sales are from narrowed the price gap between bias and radial tires, prompting radial tire cords used for trucks and 14% from passenger-car tire truckers to switch to radial tires. Bias tires consume more rubber cords. than radial tires. A recovery in China’s freight and passenger traffic can also help Working-capital constraints. The cash-conversion cycle is stimulate sales by increasing replacement demand. 150-160 days. Not being able to secure adequate financing for working capital could cap sales growth. Ongoing radialization. In addition, rising gasoline prices have helped speed up radialization (currently only 70%-plus in China Rising effective tax rates on change in government tax policy. vs. nearly 100% in developed nations). Mainland radialization has The firm has received government grants every year since listing, been low due to poor infrastructure, as radial tires are more keeping the effective tax rate below 15% in the past few years. suitable for use on smooth roads. Liberalization of gasoline prices An end to favorable auto taxes could worsen auto consumption in China can also help drive usage, as radial tire cords can help and cut replacement demand. save fuel compared with traditional tires. Strong bargaining power over customers. The radial-cord market is highly concentrated, with the top two players (including Xingda) accounting for 65% of the market, whereas the biggest client only accounts 5% of demand in China. Gross margins can be sustained at 25%-30%, as it is not likely that there will be a price war similar to that for traditional tires in 2007, which was triggered by smaller players. Passenger-car tire-cord exports could increase after the U.S. increased import tariffs for Chinese passenger cars and light trucks. U.S. passenger-car and light-truck tire production could rise to fill the gap, which might accelerate tire-cord imports. Xingda’s passenger-car tire cords are ⅓ cheaper than their U.S equivalents. Continued replacement demand. Lifecycles for radial cord tires are 3-6 months, ensuring replacement demand. Around 70% of products are sold to the after-sales market. Lower raw-material prices. Steel-wire rods are the major raw material, accounting for 50% of COGS. The company will benefit from lower spot prices, as overcapacity in China’s steel sector could cap price hikes for steel cords. China’s major steel millers have cut prices recently, indicated the market is worsening.
Source: Sun Hung Kai Financial
Figure 3: Xingda – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Faster-than-expected client-base expansion. Crude-price hikes may dampen auto sales. Global economic recovery leading to more tire exports and Low rubber prices causing less use of radial tires, as this would demand for trucks. give substitute bias tires a price advantage. China’s auto-parts import policy changing, weakening the competitiveness of domestic auto parts. Steel prices rising faster than ASP adjustments. Consolidation in tire market may increase bargaining power of customers Source: Sun Hung Kai Financial
Recent Company News
On 11 Sep. the U.S. announced it would impose higher tariffs on China passenger-car and light-truck tire imports, effective from 26 Sep. The current import tariff of 4% would be supplemented by additional levies of 35%, 30% and 25% in years one, two and three. The new duties do not affect Chinese truck-tire imports. Though this could reduce Chinese exports of passenger-car and light-truck tires to the U.S., there should be limited impact on Xingda, which has little exposure to this market. In fact, the new policy may raise U.S. demand for Chinese radial tire cords (20%-plus share of the American market), as these remain much cheaper than their alternatives.
Sun Hung Kai Financial 263 20 Nov. 2009
Industry Dynamics
China’s auto sector has become the main focus for automakers around the world. Domestic auto sales are set to grow 17% yoy in 2009 to 11 million units, following 7% growth in 2008. However, vehicle ownership remains low at about 30 vehicles per 1,000 people, vs. the world average of about 120.
The development of an auto-financing market can also help drive auto sales. In a mature auto market, financing covers 60%-80% of transactions. However, less than 7% of mainland car sales last year were through loans. If auto financing takes hold, this could help unlock the middle-income consumer group.
New government policies favoring more environmentally friendly cars, such as tax breaks and improved infrastructure, could trigger a new auto boom.
Rather than focus on PRC automakers, we see auto-parts suppliers as a better play on this high-growth industry. As more global automakers enter China, domestic automakers will face intensified competition. While auto players fight for a bigger slice of the mainland market, brand building should become their top priority and marketing expenses should surge. The trend for carmakers to source auto parts from Chinese manufacturers should increase.
Sun Hung Kai Financial 264 20 Nov. 2009
Figure 4: Xingda – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR Revenue 2,357.4 2,516.2 2,778.1 3,488.5 20.0 COGS (1,648.1) (1,784.3) (2,076.1) (2,567.8) 26.0 Gross profit 709.3 731.9 701.9 920.8 8.6 Operating expenses (217.8) (222.9) (258.4) (332.2) 20.1 Other operating income 80.0 15.4 61.9 115.1 10.8 Operating profit 571.5 524.3 505.4 703.6 5.0 Finance expenses (84.8) (72.3) (69.0) (90.0) 6.1 PBT 320.6 345.3 513.4 628.4 5.1 Tax 1.5 (0.5) (64.6) (86.0) (7.6) Net profit 116.2 194.2 345.4 418.2 22.5 EPS – RMB fen 12.9 21.3 26.0 30.2 1.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Xingda – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR Revenue 40.1 6.7 10.4 25.6 20.0 COGS 61.6 8.3 16.4 23.7 26.0 Gross profit 7.0 3.2 (4.1) 31.2 8.6 Operating expenses 36.5 2.3 15.9 28.6 20.1 Other operating income 5.0 (80.8) 302.9 86.0 10.8 Operating profit (1.4) (8.3) (3.6) 39.2 5.0 Finance expenses 19.5 (14.7) (4.5) 30.3 6.1 PBT (37.8) 7.7 48.7 22.4 5.1 Tax (101.3) (131.3) 13,413.2 33.1 (7.6) Net profit (37.5) 67.2 77.8 21.1 22.5 EPS (54.7) 65.1 21.9 16.2 1.4 Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Xingda – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (69.9) (70.9) (74.7) (73.6) (72.3) Gross profit 30.1 29.1 25.3 26.4 27.7 Operating expenses (9.2) (8.9) (9.3) (9.5) (9.2) Other operating income 3.4 0.6 2.2 3.3 2.4 Operating profit 24.2 20.8 18.2 20.2 20.9 Finance expenses (3.6) (2.9) (2.5) (2.6) (2.9) PBT 13.6 13.7 18.5 18.0 16.0 Tax 0.1 (0.0) (2.3) (2.5) (1.2) Net profit 4.9 7.7 12.4 12.0 9.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 265 20 Nov. 2009
Figure 7: Xingda – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 294.3 1,370.2 947.4 446.0 11.2 Accounts receivable 882.2 1,573.9 1,429.3 1,384.2 19.1 Inventory 303.1 226.0 288.7 511.0 36.4 Other current assets 111.4 2.5 258.5 219.2 27.1 Total current assets 1,591.0 3,172.7 2,923.8 2,560.3 20.6 Net fixed assets 1,791.0 1,996.8 2,189.5 2,755.0 23.1 Other long-term assets 2.3 1.5 190.8 123.1 39.6 Total assets 3,384.3 5,171.0 5,304.1 5,438.4 22.1 Short-term debt 1,083.4 1,167.5 1,201.7 1,159.3 5.3 Accounts payable 155.4 454.1 184.5 229.0 14.3 Other current liabilities 377.7 34.5 604.0 292.9 (15.0) Total current liabilities 1,616.4 1,656.1 1,990.3 1,681.1 0.6 Long-term debt 608.3 941.8 0.0 0.0 N/A Other long-term liabilities 7.5 15.0 24.9 0.0 N/A Total liabilities 2,232.2 2,612.8 2,015.2 1,681.1 (0.3) Shareholders equity 1,152.0 2,558.1 3,289.0 3,757.3 50.0 Minorities 509.9 652.3 747.5 871.7 21.2 Total equity and liabilities 3,384.3 5,171.0 5,304.1 5,438.4 22.1 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Xingda – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 8.7 26.5 17.9 8.2 15.3 Accounts receivable 26.1 30.4 26.9 25.5 27.2 Inventory 9.0 4.4 5.4 9.4 7.0 Other current assets 3.3 0.0 4.9 4.0 3.1 Total current assets 47.0 61.4 55.1 47.1 52.6 Net fixed assets 52.9 38.6 41.3 50.7 45.9 Other long-term assets 0.1 0.0 3.6 2.3 1.5 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 32.0 22.6 22.7 21.3 24.6 Accounts payable 4.6 8.8 3.5 4.2 5.3 Other current liabilities 11.2 0.7 11.4 5.4 7.1 Total current liabilities 47.8 32.0 37.5 30.9 37.1 Long-term debt 18.0 18.2 0.0 0.0 9.0 Other long-term liabilities 0.2 0.3 0.5 0.0 0.2 Total liabilities 66.0 50.5 38.0 30.9 46.3 Shareholders equity 34.0 49.5 62.0 69.1 53.7 Minorities 15.1 12.6 14.1 16.0 14.5 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 266 20 Nov. 2009
Figure 9: Xingda – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 30.1 29.1 25.3 26.4 27.7 Operating margin – % 24.2 20.8 18.2 20.2 20.9 Net margin – % 4.9 7.7 12.4 12.0 9.3 ROAA – % 4.0 4.5 6.6 7.8 5.7 ROAE – % 12.3 10.5 11.8 11.9 11.6
Liquidity ratios Current assets/current liabilities – X 1.0 1.9 1.5 1.5 1.5 Liquid assets/current liabilities – X 0.2 0.8 0.5 0.3 0.4 Cash and securities/current assets – % 18.5 43.2 32.4 17.4 27.9 Cash flow from oper./curr. liabilities – % 13.7 10.6 22.9 31.9 19.8
Other ratios Capex/sales – % 26.2 16.2 20.2 18.4 20.2 Capex/depreciation – % 497.8 268.1 309.6 281.4 286.4 Operating expenses/sales -% (9.2) (8.9) (9.3) (9.5) (9.2) Net debt/equity – % 121.3 28.9 7.7 19.0 18.5 Inventory/sales – % 12.9 9.0 10.4 14.6 11.3 Effective tax rate – % (0.5) 0.1 12.6 13.7 8.8 Cash-conversion cycle – days 142.2 167.1 188.0 177.5 177.5
ROAA component analysis Revenue/average assets – % 80.9 58.8 53.0 64.9 64.4 COGS/average assets – % (56.5) (41.7) (39.6) (47.8) (46.4) Gross profit/average assets – % 24.3 17.1 13.4 17.1 18.0 Operating expenses/average assets – % (7.5) (5.2) (4.9) (6.2) (6.0) Other operating income/average assets – % 2.7 0.4 1.2 2.1 1.6 Operating profit/average assets – % 19.6 12.3 9.6 13.1 13.7 Finance expenses/average assets – % (2.9) (1.7) (1.3) (1.7) (1.9) PBT/average assets – % 11.0 8.1 9.8 11.7 10.1 Tax/average assets – % 0.1 (0.0) (1.2) (1.6) (0.7) Net profit/average assets – % 4.0 4.5 6.6 7.8 5.7
ROAE component analysis Revenue/average equity – % 249.0 135.6 95.0 99.0 144.7 COGS/average equity – % (174.1) (96.2) (71.0) (72.9) (103.5) Gross profit/average equity – % 74.9 39.5 24.0 26.1 41.1 Operating expenses/average equity – % (23.0) (12.0) (8.8) (9.4) (13.3) Other operating income/average equity – % 8.4 0.8 2.1 3.3 3.7 Operating profit/average equity – % 60.4 28.3 17.3 20.0 31.5 Finance expenses/average equity – % (9.0) (3.9) (2.4) (2.6) (4.4) PBT/average equity – % 33.9 18.6 17.6 17.8 22.0 Tax/average equity – % 0.2 (0.0) (2.2) (2.4) (1.1) Net profit/average equity – % 12.3 10.5 11.8 11.9 11.6 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 267 20 Nov. 2009
Xinhua Winshare (811.HK) Logistics Sector 20 Nov. 2009
Company background HSI 22,643 HSCEI 13,470 Xinhua Winshare is the sole distributor of non-government-subsidized and government-subsidized textbooks for primary and secondary schools in Sichuan. It Performance (%) 1m 3m 12m has also established the Zhongpan network, an intermediary that provides marketing HSI 2.0 13.5 76.7 and delivery services to small- and medium-sized publishers throughout China as HSCEI 4.0 19.6 107.6 well as sourcing and storage services to independent retailers and smaller wholesalers. 48.1% of 1H09 sales were from subscription business, 32.4% from Xinhua Winshare– Price vs. HSI, Share Zhongpan and 10% from retail. The Zhongpan and retail segments both reported Data operating losses.
(HK$) (HK$m) Xinhua Winshare listed in Hong Kong in May 2007, issuing 369.4 million H-shares 7.0 120 and raising net proceeds of RMB2.1bn. These have not been fully used yet, with 6.0 100 5.0 80 RMB2.2bn remaining in cash and short-term deposits at commercial banks as at 4.0 60 end-June 2009. As a result, ROE was only 4.5% for 1H09. 3.0 40 2.0 1.0 20 Operationally, the firm takes orders from schools before placing orders with its 0.0 0 suppliers. Textbook prices are determined each school term by the local education Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 authorities and the local Price Bureau, and textbooks are sold at their prescribed Turnover Price HSI prices. Suppliers are mainly publishers, and the firm’s parent Sichuan Publication Group is its main supplier of textbooks and supplementary materials. Price – HK$ 3.14 52W high/low (HK$) 3.48/1.261 For textbook distribution, customers are mainly primary and secondary schools, or Shares in issue – millions 441.94 indirectly all students in Sichuan. Customers for supplementary materials are mainly Market cap – HK$m 3,564.71 students, and to a lesser extent universities, libraries and other educational 3M avg. turnover – HK$m 8.40 institutions. Customers for ancillary support and services are primarily book Major shareholders – % publishers. Social Security Fund 9.09 Source: Bloomberg and Sun Hung Kai Financial The Sichuan government has designated the company as the exclusive distributor for government-subsidized textbooks to primary and lower-secondary schools. The PRC government purchases required textbooks from suppliers at a more favorable price than non-government entities can, and distributes them at no charge to students at primary and lower-secondary schools. Sichuan Province Finance Bureau makes direct payments to the company from a specific fund of the PRC government. The Sichuan government also grants the firm exclusive rights to distribute non-government-subsidized textbooks to upper-secondary schools, again making Xinhua the sole distributor in the province. This implies the core This document is solely based on textbook-distribution business is risk free, but growth potential is weakening because publicly available information. This of the decreased number of students. report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Financial does not provide research coverage or ratings for this Figure 1: Earnings Summary company in this report. Year ending 31 Dec. FY06 FY07 FY08 FY09E
Net profit – RMBm 302.8 388.8 338.0 380.8
Net-profit growth – % 10.6 28.4 (13.1) 12.7
EPS – RMB fen 41.0 40.0 30.0 34.8 EPS growth – % 2.5 (2.4) (25.0) 16.0 P/E – X 6.7 6.9 9.2 7.9 Holly Hou DPS – RMB fen N/A 30.0 8.0 19.5 + (852) 2203 9588 Dividend yield – % N/A 10.8 2.9 7.0 [email protected] BVPS – RMB 1.7 3.2 3.2 3.4 P/B – X 1.6 0.9 0.9 0.8 All reports are available at: Operating cash flow per share – RMB fen 52.0 27.3 47.9 39.0 http://www.SHKfg.com Net debt (net cash)/ price – % (42.3) (86.7) (88.4) (40.7) http://www.im.knowledge.reuter.com Sources: Bloomberg and Sun Hung Kai Financial http://www.tfibcm.com Note: Estimates based on Bloomberg consensus http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor268ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
In addition to textbooks, the firm distributes supplementary materials, mainly to school students in Sichuan. It has more than an 80% share of the province’s supplementary-materials market. Students are free to choose their supplementary materials and where to buy them. Textbook distribution generates a 36% gross margin, lower than the 52% for supplementary materials, but market entry barriers are lower than for textbooks. Demand for supplementary materials should be solid, as parents are highly willing to spend on education given the one-child policy.
The company is actively expanding into areas related to its core businesses, as there are few opportunities for market-share expansion in textbook distribution and supplementary materials. One such move is the acquisition of a 24.3% equity interest in Chengdu Institute Sichuan International Studies University.
As at end-1H09, the company had net cash of RMB1.90/share, equal to 68% of its share price. Based on consensus figures, the stock trades at a 6.9X FY09 P/E.
Figure 2: Xinhua Winshare – Investment Highlights
Key investment positives Key investment negatives The firm is the government-designated exclusive distributor of Xinhua lacks growth potential. Although textbook selling is almost textbooks and has a more than 80% market share in supplementary risk-free, demand has declined due to fewer students. Also, the an materials in Sichuan. The textbook business is almost risk-free. inefficient capital structure lowers ROE. The government has subsided all textbooks for over 95% of Xinhua’s business is highly dependent on government policy. students in primary and secondary schools from the autumn term of 2008. For the government-subsidized textbook business, the local government makes direct payments for orders. As the local Expanded student recruitment by tertiary institutions and government has greater bargaining power than the firm, payment vocational schools has swelled demand for textbooks in these times can be unclear. markets. The retail business is only breaking even. Despite the company Merging with Sichuan Publishing Group gives the company full owning some of its shops, most of which are in prime locations in publishing rights for supplementary materials and means it does Sichuan, its books and audio-visual-product retail made an not have to rely on third-party publishers. 33% of 1H09 sales and operating loss in 1H09. 36% of the gross profit was from supplementary materials. This also benefits its Zhongpan business, as it has sole distributor rights The Zhongpan gross margin further dropped to 8.6% in 1H09, for its publications. from 9.5% in 1H08 and 14.9% in FY07. This is because Zhongpan is still at the startup stage and the set-up costs are quite high. M&A is encouraged by the government, which aims to have only a few giant book-publishing and distribution companies. Competition is intense in supplementary education materials distribution. There are no exclusive distribution rights for The company is searching for expansion opportunities in areas suppliers, though the business is highly profitable (52% gross related to its core business, and aims to develop into a major margin). cultural enterprise in China. One such move is the acquisition of a 24.3% equity interest in Chengdu Institute Sichuan International Studies University, which will distribute 8%-12% of its profits to Xinhua over the next three years. The agreement has a buy-back mechanism, so if the institute meets its profit target, Xinhua would
be paid back for its investment.
Xinhua is exploring the ‘cultural malls’ business model to make its retail shops more competitive. This helped trigger growth in both sales volumes and revenues for books in 1H09, the first time both have increased. The firm plans to expand into study-related items. The company is developing its media business, and is now one of the top 10 media-business suppliers in the PRC. This could bring synergy to its core businesses. The firm had RMB1.90 net cash/share as at end-1H09. Entry barriers are high due to political sensitivity. China’s cultural sector is unlikely to open up excessively to foreign companies. The government is relaxing controls on cross-province and cross-platform integrations in this sector, which could help Xinhua’s expansion across China. Already, the Zhongpan network covers 25 provinces and accounted for 32.4% of 1H09 sales, vs. 6% in 1H08. Full exemption of profit tax is set to continue until 2013. As an incentive for cultural enterprises to reform, the government is also rebating all value-added tax. Supportive policy by parent company. Xinhua is charged lower rental fees from its parent company for retail stores, narrowing its losses from this segment. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 269 20 Nov. 2009
Figure 3: Xinhua Winshare – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
M&A can help secure publishing rights and strengthen the firm’s Reduced education spending if the government’s finances weaken. competitiveness by providing more quality products. Deregulation of the cultural sector, increasing the number of Prolonged restrictions for foreign enterprises to enter the industry. suppliers and raising market competition. Relaxations on distribution rights for subsidized or non-subsidized textbooks. Loss of distribution rights for subsidized or non-subsidized textbooks. Source: Sun Hung Kai Financial
Recent Company News Nil.
Industry Dynamics Education and related sectors should be resilient to the economic downturn, as these are regarded as necessities. School textbooks and supplementary materials account for c. 55% of the total volume of books published in the PRC.
As the government has increased spending on education, the number of graduating colleague students has increased from 1.3 million in 2002 to 4.5 million in 2007, for 35% CAGR over 2002-07. The number of school-aged children of migrant workers entitled to compulsory education is also estimated to rises by 1.5 million every year due to poverty, so the Chinese government is expected to further increase spending to guarantee education for school-age children. In 2007, central-government spending on health care and education soared 297% and 76% respectively. The government targets education spending to reach 4% of GDP by 2009 (3.8% in 2007).
China is stimulating domestic consumption and adjusting its economic structure, in accelerating the development of the cultural sector, the focus is on cross-regional, cross-industrial mergers and restructuring, the promotion of key cultural enterprises and further reforms to the press/publishing system.
Due to the nation’s one-child policy, parents are investing even more in their children’s education, and the sector should indirectly benefit from growing household incomes in the long run.
For educational, cultural and recreational products, industry growth prospects hinge on literacy levels, where there is room for improvement. Secondary-school enrollments have risen on greater government subsidies and this should also lift the literate reading rate (the percentage of the literate population that has read at least one book in the past year). Higher literacy levels should lead to greater demand for reading material. Literacy in urban areas has reached c. 60%, with the average literate individual reading 6.4 books per year.
Education is subject to more government regulation than many other industries, as this could be an important vehicle to enforce ideological unity. So in the short term, government arms could be in a favorable position to secure distribution rights..
Sun Hung Kai Financial 270 20 Nov. 2009
Figure 4: Xinhua Winshare – Profit and Loss Statement
FY05-08 Year ending 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 2,262.6 2,217.6 2,309.5 2,736.9 7.0 COGS (1,442.2) (1,367.6) (1,383.5) (1,630.4) 5.9 Gross profit 820.4 850.1 926.0 1,106.5 8.8 Operating expenses (556.0) (590.9) (707.2) (857.6) 12.6 Other operating income 76.2 36.1 74.2 62.1 9.4 Operating profit 340.6 295.3 292.9 311.0 0.9 Finance expenses (0.7) (0.4) (0.8) (0.8) (43.8) PBT 345.1 305.9 388.8 341.2 3.6 Tax (71.1) (3.4) (1.8) (3.1) (57.6) Net profit 273.7 302.8 388.8 338.0 13.7 EPS – RMB fen 40.0 41.0 40.0 30.0 (1.6) Sources: The Company and Sun Hung Kai Financial
Figure 5: Xinhua Winshare – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. - % FY05 FY06 FY07 FY08 CAGR Revenue 8.5 (2.0) 4.1 18.5 7.0 COGS 11.4 (5.2) 1.2 17.8 5.9 Gross profit 3.8 3.6 8.9 19.5 8.8 Operating expenses 4.2 6.3 19.7 21.3 12.6 Other operating income 75.7 (52.6) 105.5 (16.3) 9.4 Operating profit 13.4 (13.3) (0.8) 6.2 0.9 Finance expenses (90.7) (42.5) 90.0 (1.8) (43.8) PBT 16.7 (11.4) 27.1 (12.2) 3.6 Tax (25.1) (95.2) (48.4) 73.3 (57.6) Net profit 35.3 10.6 28.4 (13.1) 13.7 EPS 25.0 2.5 (2.4) (25.0) (1.6) Sources: The Company and Sun Hung Kai Financial
Figure 6: Xinhua Winshare – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. - % FY05 FY06 FY07 FY08 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (63.7) (61.7) (59.9) (59.6) (61.2) Gross profit 36.3 38.3 40.1 40.4 38.8 Operating expenses (24.6) (26.6) (30.6) (31.3) (28.3) Other operating income 3.4 1.6 3.2 2.3 2.6 Operating profit 15.1 13.3 12.7 11.4 13.1 Finance expenses (0.0) (0.0) (0.0) (0.0) (0.0) PBT 15.3 13.8 16.8 12.5 14.6 Tax (3.1) (0.2) (0.1) (0.1) (0.9) Net profit 12.1 13.7 16.8 12.3 13.7 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 271 20 Nov. 2009
Figure 7: Xinhua Winshare – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 592.2 873.0 1,536.4 2,610.7 1,403.1 Accounts receivable 225.2 321.2 289.7 309.9 286.5 Inventory 499.3 338.9 576.2 827.0 560.3 Other current assets 116.1 130.3 1,364.5 347.8 489.7 Total current assets 1,432.7 1,663.3 3,766.9 4,095.5 2,739.6 Net fixed assets 574.9 607.2 698.3 733.7 653.5 Other long-term assets 137.4 136.1 470.1 558.4 325.5 Total assets 2,145.0 2,406.7 4,935.3 5,387.6 3,718.6 Short-term debt 0.0 15.4 0.0 9.6 6.2 Accounts payable 938.6 869.3 1,021.0 1,172.9 1,000.5 Other current liabilities 176.1 208.9 177.1 466.0 257.0 Total current liabilities 1,114.6 1,093.6 1,198.1 1,648.5 1,263.7 Long-term debt 0.0 0.0 13.1 3.5 4.2 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 1,114.6 1,093.6 1,211.3 1,652.0 1,267.9 Shareholders equity 1,030.4 1,313.0 3,724.0 9,735.5 3,950.7 Minorities 7.1 47.2 45.4 61.6 40.3 Total equity and liabilities 2,145.0 2,406.7 4,935.3 11,387.6 5,218.6 Sources: The Company and Sun Hung Kai Financial
Figure 8: Xinhua Winshare – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 average Total assets Cash and securities 27.6 36.3 31.1 48.5 35.9 Accounts receivable 10.5 13.3 5.9 5.8 8.9 Inventory 23.3 14.1 11.7 15.4 16.1 Other current assets 5.4 5.4 27.6 6.5 11.2 Total current assets 66.8 69.1 76.3 76.0 72.1 Net fixed assets 26.8 25.2 14.1 13.6 19.9 Other long-term assets 6.4 5.7 9.5 10.4 8.0 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 0.0 0.6 0.0 0.1 0.2 Accounts payable 43.8 36.1 20.7 10.3 27.7 Other current liabilities 8.2 8.7 3.6 4.1 6.1 Total current liabilities 52.0 45.4 24.3 14.5 34.0 Long-term debt 0.0 0.0 0.3 0.0 0.1 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 52.0 45.4 24.5 14.5 34.1 Shareholders equity 48.0 54.6 75.5 85.5 65.9 Minorities 0.3 2.0 0.9 0.5 0.9 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 272 20 Nov. 2009
Figure 9: Xinhua Winshare – Key Ratios FY05-08 Year ended 31 Dec. FY05 FY06 FY07 FY08 average Profitability ratios Gross margin – % 36.3 38.3 40.1 40.4 38.8 Operating margin – % 15.1 13.3 12.7 10.3 12.8 Net margin – % 12.1 13.7 16.8 12.3 13.7 ROAA – % 15.2 13.3 10.6 6.5 11.4 ROAE – % 33.4 25.8 15.4 9.1 20.9
Liquidity ratios Current assets/current liabilities – X 1.3 1.5 3.1 2.5 2.1 Liquid assets/current liabilities – X 0.5 0.8 1.3 1.5 1.0 Cash and securities/current assets – % 41.3 52.5 40.8 61.9 49.1 Cash flow from oper./curr. liabilities – % 34.6 34.9 22.1 33.0 31.1
Other ratios Capex/sales – % 5.8 3.9 3.6 2.9 4.1 Capex/depreciation – % 491.5 228.5 236.3 183.0 216.0 Operating expenses/sales -% (24.6) (26.6) (30.6) (31.3) (29.5) Net debt/equity – % (57.5) (65.3) (73.1) (74.4) (70.9) Inventory/sales – % 22.1 15.3 25.0 30.2 23.5 Effective tax rate – % 20.6 1.1 0.5 0.9 0.8 Cash-conversion cycle – days (41.1) (116.5) (43.8) (15.8) (58.7)
ROAA component analysis Revenue/average assets – % 125.9 97.4 62.9 53.0 84.8 COGS/average assets – % (80.2) (60.1) (37.7) (31.6) (52.4) Gross profit/average assets – % 45.6 37.4 25.2 21.4 32.4 Operating expenses/average assets – % (30.9) (26.0) (19.3) (16.6) (23.2) Other operating income/average assets – % 4.2 1.6 2.0 0.6 2.1 Operating profit/average assets – % 18.9 13.0 8.0 5.5 11.3 Finance expenses/average assets – % (0.0) (0.0) (0.0) (0.0) (0.0) PBT/average assets – % 19.2 13.4 10.6 6.6 12.5 Tax/average assets – % (4.0) (0.2) (0.0) (0.1) (1.1) Net profit/average assets – % 15.2 13.3 10.6 6.5 11.4
ROAE component analysis Revenue/average equity – % 275.7 189.3 91.7 73.4 157.5 COGS/average equity – % (175.8) (116.7) (54.9) (43.7) (97.8) Gross profit/average equity – % 100.0 72.5 36.8 29.7 59.7 Operating expenses/average equity – % (67.8) (50.4) (28.1) (22.9) (42.3) Other operating income/average equity – % 9.3 3.1 2.9 0.8 4.0 Operating profit/average equity – % 41.5 25.2 11.6 7.5 21.5 Finance expenses/average equity – % (0.1) (0.0) (0.0) (0.0) (0.0) PBT/average equity – % 42.1 26.1 15.4 9.1 23.2 Tax/average equity – % (8.7) (0.3) (0.1) (0.1) (2.3) Net profit/average equity – % 33.4 25.8 15.4 9.1 20.9 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 273 20 Nov. 2009
Xiwang Sugar (2088.HK) Food and Beverage Sector 20 Nov. 2009
Company Background HSI 22,643 HSCEI 13,470 Shandong-based Xiwang Sugar refines corn into sweeteners and co-products used in F&B, animal feed and other consumer and industrial products. It is one of China’s Performance (%) 1m 3m 12m largest corn processors, with processing capacity of 1.5 million tonnes p.a. HSI 2.0 13.5 76.7 HSCEI 4.0 19.6 107.6 Products include crystalline glucose (42% of 1H09 revenue), corn germ (10%), animal feed (9%), corn gluten meal (10%), cornstarch paste (17%) and sodium Xiwang Sugar – Price vs. HSI, Share gluconate (7%). The firm is the largest domestic producer of crystalline glucose Data (800,000 tonnes capacity p.a.) and crystalline fructose (50,000 tonnes). Overall, 89% of processed products are sold in the domestic market and 11% overseas. (HK$) (HK$m) 4.5 80 4.0 70 Xiwang is the domestic leader in crystalline glucose, with a 30% market share. This 3.5 60 3.0 50 is a major earnings contributor, but high fixed costs mean it is important to maximize 2.5 40 market share and factory utilization. The firm raised utilization to 70%-75% in 2008, 2.0 1.5 30 from less than 60% in 2007, but a shift to higher-grade products such as 1.0 20 0.5 10 pharmaceutical crystalline glucose (high-end F&B and medical use) cut 1H09 0.0 0 utilization to 45%. This should return to normal after it has upgraded production. Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09
Turnover Price HSI A new 50,000-tonne crystalline-fructose plant will likely start production in 3Q09, but earnings contributions might not come until FY10. In the long run, this should be Price – HK$ positive for gross margins, as crystalline-fructose ASPs are 1.86 RMB8,000-RMB9,000/tonne including VAT vs. RMB2,500-RMB3,000/tonne for 52W high/low (HK$) 2.55/0.83 crystalline glucose including VAT. Shares in issue – millions 847.38 Market cap – HK$m 1,576.12 1H09 earnings were severely hit by the melamine scandal and the global financial 3M avg. turnover – HK$m 9.62 crisis, slumping 99% to RMB1m. Major shareholders – % Xiwang Holdings Ltd 62.97 To diversify geographical risk, the company plans to selectively develop international Sources: Bloomberg and Sun Hung Kai Financial markets, with Korea as the initial target. It aims to increase exports from 11% of sales in 1H09 to 20% by FY10.
Figure 1: Earnings Summary Recent Reports Date Year ending 31 Dec. FY06 FY07 FY08 FY09E Key Takeaways 4 Sep. 2009
Net profit - RMBm 290.2 360.9 63.8 97.7 Net-profit growth - % 38.3 24.4 (82.3) 53.1 This document is solely based on EPS - RMB fen 35.6 43.5 7.7 11.8 publicly available information. This EPS growth - % (2.5) 22.2 (82.3) 53.2 report is intended as information P/E - X 4.6 3.8 21.3 13.9 only and not as a recommendation Namefor any stock. Sun Hung Kai DPS - RMB fen 14.0 15.0 2.7 2.6 AnalystFinancial does not provide research Dividend yield - % 8.5 9.2 1.6 1.6 + (852)covera 3761ge [email protected] or rating s for this BVPS - RMB 1.4 1.7 1.6 1.7 company in this report.
P/B - X 1.2 1.0 1.0 1.0 Oper cash flow/share - RMB fen 30.5 (14.3) 33.3 (6.0) Net debt (net cash) to share price - % 15.4 50.5 45.7 59.8 Eva Yip, CFA Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus + (852) 2203 9587 [email protected]
All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer This report / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”), and together with its associates and subsidiaries “Sun Hung Kai Financial” or Sun Hung“SHKF”). Kai Financial SHKF does and seeks to do business with companies covered in its research repor274ts / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Xiwang Sugar – Investment Highlights
Key investment positives Key investment negatives Crystalline-glucose leader, with 50% of the market’s capacity at Gross margin slumped in 1H09. Apart from syrups, gross margins for 800,000 tonnes p.a., 4X larger than the No. 2 player. all sweeteners and corn co-products slumped 9%-23% in 1H09 compared with FY08. This was due to poor sales caused by the Moving into higher-margin products, including crystalline fructose melamine scandal and the global financial crisis. and pharmaceutical-grade glucose, to avoid price competition in low-margin corn co-products. Net debt (RMB759m as at end-1H09) and high gearing. All of the 1. Crystalline fructose to drive earnings from 2010. A new 50,000 RMB1.6bn borrowings are current liabilities, though there should be tonnes p.a. factory for crystalline fructose is set to start production little refinancing risk given that the company was able to secure loans in 3Q09, with contributions likely from 2010. Full-scale operation even during the financial crisis. However, debt/equity has surged from is expected in 2H10, which should improve margins as 97% as at end-2H08 to 148% as at end-1H09 (vs. Hong Kong-listed peer crystalline-fructose ASPs are RMB8,000-RMB9,000/tonne vs. Global Sweetener’s 77% as at end-FY08), which could raise liquidity production costs of about RMB6,500/tonne. concerns. Furthermore, interest expenses on this heavy debt will hit the bottom line (finance costs equaled 17X the 1H09 net profit). 2. The firm switched 80,000 tonnes of crystalline-glucose capacity to glucose monohydrate (pharmaceutical products) in No or little exchange gains for the foreseeable future. Before 1H08, 1H09, which generates higher margins than industrial-use glucose. debt was mainly in USD, so the firm has benefited from RMB This business is expected to contribute from 2H09. appreciation in recent years (the exchange gain was RMB57m in 1H08, about 25% of net profit). However, foreign financial institutions have More stable corn prices. The Chinese government is trying to stabilize called back loans during the financial crisis and the company’s debt is corn prices to ease the burden on the agricultural population, and has currently denominated in RMB, so there should not be substantial thus been more active in the corn market in recent years (accounting for exchange income in the foreseeable future. about 25% of the total corn harvest, compared with 10%-12% in the past). Though heavy buying to boost national corn reserves might raise Won’t benefit from the recent government subsidy program. The corn prices slightly in the short term, greater government control should government announced in August 2009 that corn refineries based in mean more stable corn prices in the long term. eastern provinces (Jilin, Heilongjiang and Liaoning) and Inner Mongolia would enjoy a RMB150/tonne rebate. Xiwang Sugar is based in Successful switch to sodium gluconate. The company ceased Shandong, and is therefore not eligible for the program. production of semi-alcohol products in 2008 and switched its fermentation plant to higher-margin sodium gluconate from the Still relies heavily on low-margin products in the short term. We do beginning of 2009. Planned infrastructure and reconstruction in China not expect significant contributions from crystalline fructose and should also support strong demand growth. pharmaceutical-grade glucose products before FY10. Leveraged to sales rebound. High fixed costs mean high operating leverage, so Xiwang’s priority has been to increase market share and factory utilization rather than maximizing prices. Utilization dropped to 45% in 1H09 due to plant upgrades and falling sales, but upgrades are now complete and the current economic recovery should be favorable for a sales rebound. Industrial demand (75% of crystalline-glucose revenue) less sensitive to sugarcane prices. F&B accounted for 25% of crystalline-glucose sales in 2008, and industrials (fermentation, chemicals and pharmaceuticals) 75%. Rising sugarcane prices should be positive for Xiwang, as crystallized glucose is a substitute product, while a drop in prices should not affect sales much due to the cushion from industrial demand. To diversify geographical risk, the company plans to selectively develop international markets, with Korea as the initial target. It targets to increase exports from 11% of sales in 1H09 to 20% by FY10. Source: Sun Hung Kai Financial
Figure 3: Xiwang Sugar – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts
Potential injection of pharmaceutical enterprise from Xiwang’s Slump in domestic sugar prices. Cane-sugar price might weaken after parent company. the peak Mid-Autumn Festival season, which could bring pressure to crystalline-glucose prices and affect ASPs. Extension of government’s subsidy program to Shandong province. The company’s average cost of corn would fall 10% (cutting total COGS Slower-than-expected progress in sales of crystalline fructose and 7.5%) if the government applies the RMB150/tonne corn subsidy in pharmaceutical-grade glucose. Shandong. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 275 20 Nov. 2009
Recent Company News
Nil.
Industry Dynamics
Corn co-products include corn germ, which is a raw material for corn oil, while corn gluten products are used as poultry feed and pet food. Cornstarch can be used to make sweeteners, including syrup and crystalline products, used in F&B and pharmaceuticals. Refinery/crystallization by-products can be used in fermented products and alcoholic beverages.
Cane sugar and sweeteners (crystalline glucose, crystalline fructose and other syrup products) are widely used in F&B. Cane sugar is the main product, with demand at 14 1 million tonnes p.a. Sweeteners are a substitute, but the market is only /10 the size. Therefore, cane-sugar price movements directly affect sweetener prices but not vice versa, because cane sugar is a much bigger market.
The crystalline-products market is concentrated compared with corn co-products as more advanced technology is required. There are around 15 sizable enterprises (annual capacity over 100,000 tonnes) in China for crystalline glucose, but only 3-4 in the world for crystalline fructose (Xiwang Sugar is the only Chinese enterprise that has the technology to produce crystalline fructose).
Corn-price movements (raw materials) are a critical factor for corn-refinery earnings, due to heavy capital investment (high fixed costs) and oversupply turning crystalline glucose and animal feed into buyers’ markets in recent years. Meanwhile, government restrictions on biofuel projects have increased sugar supply and suppressed crystalline-glucose prices. However, domestic sugar prices have risen since January 2009 due to worse-than-expected harvests and declining inventories. This is a positive for sweetener prices.
The operating environment was severely hit by the melamine scandal and the global financial crisis in 2H08. However, the industry has improved since April 2009, illustrated by continued rises in ASPs and sales volumes. Corn-refiner earnings could continue their rebound on increasing demand in an economic recovery and government controls leading to stable corn and poultry prices.
Sun Hung Kai Financial 276 20 Nov. 2009
Figure 4: Xiwang Sugar – Profit and Loss Statement FY05-08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 1,037.7 1,384.9 2,062.3 2,544.4 43.3 COGS (776.5) (1,019.9) (1,598.0) (2,324.6) 48.0 Gross Profit 261.2 365.0 464.3 219.8 16.7 Operating expense (37.0) (59.1) (73.7) (163.0) 59.8 Other operating income 2.9 5.3 8.1 11.5 (8.5) Operating profit 227.1 311.3 398.7 68.3 (11.2) Finance expense (18.1) (26.6) (64.1) (53.4) 35.2 PBT 209.8 290.2 382.0 60.8 (10.4) Tax 0.0 0.0 (21.1) 2.9 N/A Net profit 209.8 290.2 360.9 63.8 (5.2) EPS- RMB fen 36.5 35.6 43.5 7.7 (14.0) Sources: Bloomberg and Sun Hung Kai Financial
Figure 5: Xiwang Sugar – Profit and Loss Statement (Year on Year Growth) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 CAGR (%) Revenue 72.2 33.5 48.9 23.4 43.3 COGS 60.3 31.4 56.7 45.5 48.0 Gross profit 120.5 39.7 27.2 (52.7) 16.7 Operating expenses 48.0 59.6 24.7 121.2 59.8 Other operating income (82.5) 85.6 51.7 42.6 (8.5) Operating profit 106.7 37.1 28.1 (82.9) (11.2) Finance expenses 13.4 46.3 141.5 (16.7) 35.2 PBT 122.1 38.3 31.6 (84.1) (10.4) Tax (100.0) N/A N/A (113.6) N/A Net profit 166.2 38.3 24.4 (82.3) (5.2) EPS 158.9 (2.5) 22.2 (82.3) (14.0) Sources: Bloomberg and Sun Hung Kai Financial
Figure 6: Xiwang Sugar – Profit and Loss Statement (Common Size) FY05-08 Year ended 31 Dec. – % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (74.8) (73.6) (77.5) (91.4) (79.3) Gross profit 25.2 26.4 22.5 8.6 20.7 Operating expenses (3.6) (4.3) (3.6) (6.4) (4.5) Other operating income 0.3 0.4 0.4 0.5 0.4 Operating profit 21.9 22.5 19.3 2.7 16.6 Finance expenses (1.7) (1.9) (3.1) (2.1) (2.2) PBT 20.2 21.0 18.5 2.4 15.5 Tax 0.0 0.0 (1.0) 0.1 (0.2) Net profit 20.2 21.0 17.5 2.5 15.3 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 277 20 Nov. 2009
Figure 7: Xiwang Sugar – Balance Sheet FY05-08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 502.0 662.6 343.1 248.2 47.1 Accounts receivable 42.9 85.3 411.8 341.8 86.9 Inventory 78.2 135.9 330.0 326.5 66.7 Other current assets 68.1 26.3 186.3 125.0 (10.5) Total current assets 691.2 910.0 1,271.1 1,041.4 34.5 Net fixed assets 636.0 1,285.5 1,507.4 1,648.5 47.2 Other long-term assets 60.3 0.0 0.0 7.1 N/A Total assets 1,387.5 2,195.5 2,778.5 2,696.9 41.7 Short-term debt 110.0 206.8 182.6 869.4 87.7 Accounts payable 39.6 17.2 143.6 200.6 133.8 Other current liabilities 162.3 135.8 181.1 258.7 17.5 Total current liabilities 311.9 359.8 507.3 1,328.7 58.1 Long-term debt 234.7 664.3 846.8 0.0 N/A Other long-term liabilities 0.0 0.0 0.0 0.0 N/A Total liabilities 546.6 1,024.1 1,354.1 1,328.7 35.2 Shareholders equity 841.0 1,171.4 1,424.5 1,368.2 49.8 Minorities 0.0 0.0 0.0 0.5 N/A Total equity and liabilities 1,387.5 2,195.5 2,778.5 2,696.9 41.7 Sources: Bloomberg and Sun Hung Kai Financial
Figure 8: Xiwang Sugar – Balance Sheet (Common Size) FY05-08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 36.2 30.2 12.3 9.2 22.0 Accounts receivable 3.1 3.9 14.8 12.7 8.6 Inventory 5.6 6.2 11.9 12.1 9.0 Other current assets 4.9 1.2 6.7 4.6 4.4 Total current assets 49.8 41.5 45.7 38.6 43.9 Net fixed assets 45.8 58.5 54.3 61.1 54.9 Other long-term assets 4.3 0.0 0.0 0.3 1.2 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 7.9 9.4 6.6 32.2 14.0 Accounts payable 2.9 0.8 5.2 7.4 4.1 Other current liabilities 11.7 6.2 6.5 9.6 8.5 Total current liabilities 22.5 16.4 18.3 49.3 26.6 Long-term debt 16.9 30.3 30.5 0.0 19.4 Other long-term liabilities 0.0 0.0 0.0 0.0 0.0 Total liabilities 39.4 46.6 48.7 49.3 46.0 Shareholders equity 60.6 53.4 51.3 50.7 54.0 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 278 20 Nov. 2009
Figure 9: Xiwang Sugar – Key Ratios FY05-08 Year ending 31 Dec. FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin – % 25.2 26.4 22.5 8.6 20.7 Operating margin – % 21.9 22.5 19.3 2.7 16.6 Net margin – % 20.2 21.0 17.5 2.5 15.3 ROAA – % 20.4 16.2 14.5 2.3 13.4 ROAE – % 37.7 28.8 27.8 4.6 24.7
Liquidity ratios Current assets/current liabilities – X 2.2 2.5 2.5 0.8 2.0 Liquid assets/current liabilities – X 1.6 1.8 0.7 0.2 1.1 Cash and securities/current assets – % 72.6 72.8 27.0 23.8 49.1 Cash flow from oper./curr. liabilities – % 74.4 69.1 (23.4) 20.8 35.2
Other ratios Capex/sales – % 25.2 46.8 13.7 5.7 22.9 Capex/depreciation – % 1,111.4 2,751.1 413.7 180.4 1,115.1 Operating expense/sales -% (3.6) (4.3) (3.6) (6.4) (4.7) Net debt/equity (net cash) – % (18.7) 17.8 48.2 45.4 37.1 Inventory/sales – % 7.5 9.8 16.0 12.8 12.9 Effective tax rate – % 0.0 0.0 5.5 (4.7) 0.3 Cash conversion cycle – days 30.4 45.6 80.8 78.7 68.4
ROAA component analysis Revenue/average assets – % 100.9 77.3 82.9 92.9 88.5 COGS/average assets – % (75.5) (56.9) (64.3) (84.9) (70.4) Gross profit/average assets – % 25.4 20.4 18.7 8.0 18.1 Operating expenses/average assets – % (3.6) (3.3) (3.0) (6.0) (4.0) Other operating income/average assets – % 0.3 0.3 0.3 0.4 0.3 Operating profit/average assets – % 22.1 17.4 16.0 2.5 14.5 Finance expenses/average assets – % (1.8) (1.5) (2.6) (2.0) (1.9) PBT/average assets – % 20.4 16.2 15.4 2.2 13.5 Tax/average assets – % 0.0 0.0 (0.8) 0.1 (0.2) Net profit/average assets – % 20.4 16.2 14.5 2.3 13.4
ROAE component analysis Revenue/average equity – % 186.5 137.6 158.9 182.2 166.3 COGS/average equity – % (139.5) (101.4) (123.1) (166.5) (132.6) Gross profit/average equity – % 46.9 36.3 35.8 15.7 33.7 Operating expenses/average equity – % (6.7) (5.9) (5.7) (11.7) (7.5) Other operating income/average equity – % 0.5 0.5 0.6 0.8 0.6 Operating profit/average equity – % 40.8 30.9 30.7 4.9 26.8 Finance expenses/average equity – % (3.3) (2.6) (4.9) (3.8) (3.7) PBT/average equity – % 37.7 28.8 29.4 4.4 25.1 Tax/average equity – % 0.0 0.0 (1.6) 0.2 (0.4) Net profit/average equity – % 37.7 28.8 27.8 4.6 24.7 Sources: Bloomberg and Sun Hung Kai Financial
Sun Hung Kai Financial 279 20 Nov. 2009
Xtep (1368.HK) Consumer Sector 20 Nov. 2009
Company background HSI 22,643 Xtep was founded in 1999 as an OEM sportswear manufacturer. In 2002, it HSCEI 13,470 established its Xtep own brand, and in 2007 added the Disney Sport licensed brand and Koling, another own brand. Xtep produces more fashion-based products and is Performance (%) 1m 3m 12m now one of the top five domestic sportswear producers in China, with a 4.9% market HSI 2.0 13.5 76.7 share in 2008. The firm listed in Hong Kong in June 2008 and now has 5,869 outlets HSCEI 4.0 19.6 107.6 across the mainland. Xtep – Price vs. HSI, Share Data Xtep has 12 footwear and 14 apparel production lines, but rapid demand growth has
outpaced its production growth, leading it to outsource 90% of apparel products and (HK$) (HK$m) around half of footwear products in 1H09. Outsourcing increased to 50.3% of 5.0 700 600 COGS, from 43.1% in FY08. This led to higher ROE and ROA than its peers’ 4.0 average. More outsourcing also means less investment in manufacturing, and this 500 3.0 asset-light business can free more resources to expand the retail network. 400 2.0 300 200 The firm targets the mass market and has the lowest ASP among its peers, making 1.0 100 its products more affordable in lower-tier cities. Purchasing power is growing faster 0.0 0 in rural areas than urban, due to more subsidies from the government and these areas Jun 08 Oct 08 Feb 09 Jun 09 Oct 09
being less affected by the global economic slowdown. Xtep’s order-book value grew Turnover Price HSI 22% yoy in 1Q10, the fastest among its peers. The company has more than 5,800 retail outlets across the nation, operated by Price – HK$ 4.04 distributors and third-party retailers. This model helps it expand its nationwide 52W high/low (HK$) 4.44/1.353 network faster without using its own resources. Shares in issue – millions 2,173.65 Market cap – HK$m 8,585.90 However, Xtep has no long-term agreements with suppliers, and only place orders 3M avg. turnover – HK$m 14.56 on a case-by-case basis. There is no guarantee that it can renew its supplier Major shareholders – % contracts, and if the company cannot find replacement suppliers, operations may be Group Success Investment 65.24 affected. Source: Bloomberg and Sun Hung Kai Financial Xtep now has three brands: 1) self-owned Xtep, 2) Disney Sport (under license from Disney Shanghai), targeting the youth mass market, and 3) Koling, targeting the mature high-end market. Expanding its brand portfolio can enhance competitiveness by appealing to more age groups and fashions. Revenue from the newer brands increased 35.4% yoy in 1H09, but still only accounted for less than 10% of total revenue. 1H09 turnover increased 19% yoy to RMB1,677m; the net profit grew 21% yoy. The gross margin increased 1.8 ppts to 38.6%, while the net margin was flat at 18.3% due to much higher advertising and promotion expenses. Net cash was This document is solely based on RMB2.1bn as at end-1H09, equal to 24% of its market cap; the market view is that it publicly available information. This is well placed to acquire new brands with little financial pressure. report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research Year ended 31 Dec. FY06 FY07 FY08 FY09E coverage or ratings for this Net profit – RMB m 50.1 221.9 508.2 606.9 company in this report. Net-profit growth – % 509.8 343.1 129.0 19.4
EPS – RMB fens 3.4 15.1 26.8 27.8 EPS growth – % 508.9 343.1 77.6 3.6 P/E – X 104.4 23.6 13.3 12.8 DPS – RMB fen 0.0 N/A 11.4 15.0 Dividend yield – % 0.0 N/A 3.2 4.3 BVPS – RMB N/A N/A 1.2 1.3 Holly Hou P/B – X N/A N/A 2.9 2.7 Operating cash flow per share – RMB fen (4.3) 0.9 26.5 24.6 + (852) 2203 9588 Net debt (net cash)/share price – % N/A N/A (25.6) (25.5) [email protected] Sources: Bloomberg and Sun Hung Kai Financial Note: Estimates based on Bloomberg consensus All reports are available at: http://www.SHKfg.com http://www.im.knowledge.reuter.com http://www.tfibcm.com http://www.securities.com Bloomberg Code:
Disclaimer SunThis Hung report Kai Financial/ note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),280 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Xtep – Investment Highlights
Key investment positives Key investment negatives
Top five domestic sportswear producer in China. Xtep had a No contracts with suppliers; replacing suppliers at short notice 4.9% market share in 2008, and its product range focuses on the is a key risk. The firm’s top five suppliers accounted 17.4% of its low-end markets, which should put it in a good position to expand total purchases, but it does not have any long-term supply along with Chinese economic growth. agreements, instead placing orders on case-by-case basis. There is no guarantee that suppliers will renew their contracts, and if the Low ASP helps move into second- and third- tier cities. Xtep is company cannot find replacement suppliers, operations may be targeting the mass market with the lowest ASP among its peers. affected. Retail prices for footwear and apparel are RMB80.40/pair and RMB46.10/piece, affordable for customers in lower-tier cities. Keen competition in the Chinese sportswear market, from both Rural purchasing power is also growing faster than urban, as these domestic and overseas producers, leads to high advertising and areas have been affected less by the global economic slowdown promotion expenses. The firm spent 14% of revenue on A&P and receive more subsidies from the government. expenses in 1H09, from just 8% in 1H08. Strongest order growth among its peers in 1Q10. Xtep recorded 22% yoy order-value growth at the 1Q10 trade fairs, the strongest growth rate among its sportswear peers. Substantial outsourcing means few assets. Rapid demand growth has outpaced the firm’s production-capacity growth, leading it to outsource 90% of apparel products and around half of footwear products in 1H09. Outsourcing increased to 50.3% of COGS, from 43.1% in FY08. More outsourcing also means less investment in manufacturing, and this asset-light business can free more resources to expand the retail network, as well as resulting in higher ROE and ROA. Margin expansion. The gross margin increased by 1.8 ppts to 38.6% in 1H09. It is expected to further expand, as the firm has cut its footwear discounts to distributors by 1% for 2010. Retail outlets operated by distributors allow faster growth without using own resources. The company has more than 5,800 retail outlets across the nation, operated by distributors and third-party retailers. This model helps it expand its nationwide network faster without using its own resources. It targets 400 more outlets under the Xtep brand by end-2009. Multi-brand strategy caters for many markets. Xtep now has three brands: 1) self-owned Xtep, established in 2002, 2) Disney Sport (under license from Disney Shanghai), launched in 2007 to target the youth mass market, and 3) Koling, also launched in 2007 and targeting the mature high-end market. Expanding its brand portfolio can enhance competitiveness by appealing to more age groups and fashions. Quarterly fashion fairs help the firm keep up with trends. Xtep operates quarterly sales fairs, compared with every six months for other sportswear operators. More frequent sales fairs help it keep up better with the fashion trends demanded by consumers. Potential new brand acquisitions. With net cash of RMB2.1bn as at end-1H09, the market sees Xtep as well placed to acquire new brands at lower valuations. Unique brand position. Management plans to differentiate the brand by producing fashionable and functional sports apparel, a unique strategy among sportswear producers. Better inventory management. As at 30 June 2009, 70% of stores operated by Xtep’s distributors had installed a DRP (distribution requirement planning) system (vs. 50% in 2008). This enhances the management of distributors and improves the analysis of inventory. Source: Sun Hung Kai Financial
Figure 3: Xtep – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts SSS growth much higher than market expectations. Increasing raw-material costs dragging down margins. Faster-than-expected economic growth and urbanization. Less synergy from newly opened outlets. Not being able to renew the license for Disney Sport. Strong growth may not be sustained. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 281 20 Nov. 2009
Figure 4: Xtep – Profit and Loss Statement FY05-FY08 Year ended 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Revenue 297.4 483.6 1,364.9 2,867.2 N/A COGS (237.7) (347.5) (921.8) (1,802.9) N/A Gross profit 59.7 136.1 443.1 1,064.3 N/A Operating expenses (45.8) (80.0) (176.3) (478.8) N/A Other operating income 0.3 0.3 1.8 4.6 N/A Operating profit 14.2 56.4 268.6 590.1 N/A Finance expenses (5.3) (6.9) (14.2) (12.7) N/A PBT 9.1 50.1 255.2 577.4 N/A Tax (0.9) (0.0) (33.3) (69.2) N/A Net profit 8.2 50.1 221.9 508.2 N/A EPS – RMB fen 0.6 3.4 15.1 26.8 N/A Sources: The Company and Sun Hung Kai Financial
Figure 5: Xtep – Profit and Loss Statement (Year on Year Growth) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 CAGR (%) Revenue N/A 62.6 182.3 110.1 N/A COGS N/A 46.2 165.3 95.6 N/A Gross profit N/A 127.9 225.6 140.2 N/A Operating expenses N/A 74.8 120.3 171.6 N/A Other operating income N/A 10.5 408.3 157.6 N/A Operating profit N/A 296.2 376.2 119.7 N/A Finance expenses N/A 31.8 104.1 (10.2) N/A PBT N/A 451.0 409.6 126.3 N/A Tax N/A (99.7) N/A 107.9 N/A Net profit N/A 509.8 343.1 129.0 N/A EPS N/A 508.9 343.1 77.6 N/A Sources: The Company and Sun Hung Kai Financial
Figure 6: Xtep – Profit and Loss Statement (Common Size) FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (79.9) (71.9) (67.5) (62.9) (70.5) Gross profit 20.1 28.1 32.5 37.1 29.5 Operating expenses (15.4) (16.6) (12.9) (16.7) (15.4) Other operating income 0.1 0.1 0.1 0.2 0.1 Operating profit 4.8 11.7 19.7 20.6 14.2 Finance expenses (1.8) (1.4) (1.0) (0.4) (1.2) PBT 3.1 10.4 18.7 20.1 13.1 Tax (0.3) (0.0) (2.4) (2.4) (1.3) Net profit 2.8 10.4 16.3 17.7 11.8 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 282 20 Nov. 2009
Figure 7: Xtep – Balance Sheet FY05-FY08 As at 31 Dec., RMBm FY05 FY06 FY07 FY08 CAGR (%) Cash and securities 14.4 22.2 215.0 2,136.9 N/A Accounts receivable 101.5 188.0 234.4 526.9 N/A Inventory 102.4 151.4 193.5 288.3 N/A Other current assets 15.7 53.4 132.0 127.7 N/A Total current assets 234.0 414.9 774.9 3,079.9 N/A Net fixed assets 75.7 97.1 118.3 137.2 N/A Other long-term assets 6.2 10.4 10.3 61.2 N/A Total assets 315.9 522.4 903.5 3,278.2 N/A Short-term debt 89.3 223.9 116.0 154.0 N/A Accounts payable 44.5 68.7 55.9 348.0 N/A Other current liabilities 50.1 42.5 233.9 135.6 N/A Total current liabilities 183.8 335.0 405.8 637.6 N/A Long-term debt 0.0 0.0 0.0 0.0 N/A Other long-term liabilities 0.0 0.0 217.9 2.8 N/A Total liabilities 183.8 335.0 623.7 640.4 N/A Shareholders equity 132.1 187.4 279.8 2,637.8 N/A Minorities 0.0 0.0 0.0 0.0 N/A Total equity and liabilities 315.9 522.4 903.5 3,278.2 N/A Sources: The Company and Sun Hung Kai Financial
Figure 8: Xtep – Balance Sheet (Common Size) FY05-FY08 As at 31 Dec., % FY05 FY06 FY07 FY08 Average Total assets Cash and securities 4.6 4.3 23.8 65.2 24.4 Accounts receivable 32.1 36.0 25.9 16.1 27.5 Inventory 32.4 29.0 21.4 8.8 22.9 Other current assets 5.0 10.2 14.6 3.9 8.4 Total current assets 74.1 79.4 85.8 93.9 83.3 Net fixed assets 24.0 18.6 13.1 4.2 15.0 Other long-term assets 2.0 2.0 1.1 1.9 1.7 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 28.2 42.9 12.8 4.7 22.2 Accounts payable 14.1 13.1 6.2 10.6 11.0 Other current liabilities 15.8 8.1 25.9 4.1 13.5 Total current liabilities 58.2 64.1 44.9 19.5 46.7 Long-term debt 0.0 0.0 0.0 0.0 0.0 Other long-term liabilities 0.0 0.0 24.1 0.1 6.1 Total liabilities 58.2 64.1 69.0 19.5 52.7 Shareholders equity 41.8 35.9 31.0 80.5 47.3 Minorities 0.0 0.0 0.0 0.0 0.0 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 283 20 Nov. 2009
Figure 9: Xtep – Key Ratios FY05-FY08 Year ended 31 Dec., % FY05 FY06 FY07 FY08 Average (%) Profitability ratios Gross margin - % 20.1 28.1 32.5 37.1 29.5 Operating margin – % 4.8 11.7 19.7 20.6 14.2 Net margin – % 2.8 10.4 16.3 17.7 11.8 ROAA – % 2.6 11.9 31.1 24.3 17.5 ROAE – % 6.2 31.3 95.0 34.8 41.8
Liquidity ratios Current assets/current liabilities – X 1.3 1.2 1.9 4.8 2.3 Liquid assets/current liabilities – X 0.1 0.1 0.5 3.4 1.0 Cash and securities/current assets – % 6.2 5.4 27.7 69.4 27.2 Cash flow from oper./curr. liabilities – % (7.4) (18.8) 3.2 78.8 13.9
Other ratios Capex/sales – % 9.4 5.7 2.4 2.5 5.0 Capex/depreciation – % 550.0 443.8 390.2 579.4 471.2 Operating expenses/sales -% (15.4) (16.6) (12.9) (16.7) (15.4) Net debt/equity – % 56.6 107.6 (35.4) (75.2) (1.0) Inventory/sales – % 34.4 31.3 14.2 10.1 18.5 Effective tax rate – % 9.7 0.0 13.1 12.0 8.4 Cash conversion cycle - days N/A 190.4 101.2 58.5 116.7
ROAA component analysis Revenue/average assets – % N/A 115.4 191.4 137.1 148.0 COGS/average assets - % N/A (82.9) (129.3) (86.2) (99.5) Gross profit/average assets - % N/A 32.5 62.2 50.9 48.5 Operating expenses/average assets – % N/A (19.1) (24.7) (22.9) (22.2) Other operating income/average assets – % N/A 0.1 0.2 0.2 0.2 Operating profit/average assets – % N/A 13.5 37.7 28.2 26.5 Finance expenses/average assets – % N/A (1.7) (2.0) (0.6) (1.4) PBT/average assets – % N/A 11.9 35.8 27.6 25.1 Tax/average assets – % N/A (0.0) (4.7) (3.3) (2.7) Net profit/average assets – % N/A 11.9 31.1 24.3 22.5
ROAE component analysis Revenue/average equity – % N/A 302.7 584.4 196.5 361.2 COGS/average equity - % N/A (217.5) (394.6) (123.6) (245.2) Gross profit/average equity - % N/A 85.2 189.7 73.0 116.0 Operating expenses/average equity – % N/A (50.1) (75.5) (32.8) (52.8) Other operating income/average equity – % N/A 0.2 0.8 0.3 0.4 Operating profit/average equity – % N/A 35.3 115.0 40.5 63.6 Finance expenses/average equity – % N/A (4.3) (6.1) (0.9) (3.8) PBT/average equity – % N/A 31.3 109.3 39.6 60.1 Tax/average equity – % N/A (0.0) (14.3) (4.7) (6.3) Net profit/average equity – % N/A 31.3 95.0 34.8 53.7 Sources: The Company and Sun Hung Kai Financial
Sun Hung Kai Financial 284 20 Nov. 2009
Yip’s Chemical (408.HK)
Chemical Sector 20 Nov. 2009
Company background HSI 22,643
HSCEI 13,470 Yip’s Chemical has three business units: solvents (57% of revenue), coatings (36%)
and lubricants. It is the third largest solvents maker in the world and largest in Performance (%) 1m 3m 12m China, with a 60% market share in the Pearl River Delta. HSI 2.0 13.5 76.7 HSCEI 4.0 19.6 107.6 Solvent quality is mainly differentiated through water content (the lower the better). Yip’s high-quality solvents mean it can charge 3%-5% higher ASPs than its peers. It Yip’s Chemical – Price vs. HSI, Share
is also the main customer of supplier Celanese, and sources around 70% of its acetic Data
acid from this company. This gives Yip’s strong bargaining power and it is therefore able to negotiate bulk discounts. Yip’s products are almost homogenous, but the firm (HK$) (HK$m) has cost advantages from economies of scale – its production capacity is 3X larger 7.0 350 than the No. 2 solvents maker. 6.0 300 5.0 250 4.0 200 Solvents are the raw materials for coatings, so the operating performances of these 3.0 150 segments are related. When raw-material prices change for solvents, these are 2.0 100 1.0 50 immediately reflected in prices for finished solvents. Coatings selling prices react a 0.0 0 few months later. Therefore, when raw-material prices increase, the solvents Nov 07 Mar 08 Jul 08 Nov 08 Mar 09 Jul 09 Nov 09 business benefits and the coating segment suffers, and vice versa. This provides a Turnover Price HSI hedge to reduce the impact of raw-material price volatility on operating margins. But during downturns in selling prices for both solvents and coatings, even though Price – HK$ the company can maintain operating margins, the bottom line may be hurt. 5.62 52W high/low (HK$) 5.72/1.9 Shares in issue – millions 538.66
Given the tougher economy, Yip’s may lower its solvents prices to: 1) sustain/protect Market cap – HK$m 2,968.04 its customer base; 2) put pressure on competitors and increase market share. 3M avg. turnover – HK$m 1.76 Major shareholders – % The coatings market is highly competitive, with over 2,000 coatings companies in Chi Shing Ip 34.78 China and the top 20 accounting for only 20% of the national market. Yip’s focuses Source: Bloomberg and Sun Hung Kai Financial on second- and third-tier cities, as the first-tier cities are dominated by Nippon and Dupont, which can spend heavily on advertising. Yip’s faces intense competition.
In the long run, Yip’s plans to expand its solvents and coatings businesses to east and north China, following its clients. But recently many manufacturers have shut Recent Reports down in the Pearl River Delta and Yangtze River Delta, which could also hurt Yip’s. Date Painting an Unclear Future 11 March 2009
Management says the firm has been net cash since October, with the cash position improving due to tighter inventory and credit controls. No M&A activities are planned this year and capex has been cut to keep more cash. This document is solely based on publicly available information. This report is intended as information only and not as a recommendation for any stock. Sun Hung Kai Figure 1: Earnings Summary Financial does not provide research Year ending 31 March FY07 FY08 FY09 FY10E coverage or ratings for this
Net profit – HK$m 223.6 275.2 224.2 247.0 company in this report.
Net-profit growth - % 32.8 23.0 (18.5) 10.2
EPS – HK¢ 46.6 56.7 41.9 45.0
EPS growth - % 31.3 21.7 (26.1) 7.4
P/E – X 12.1 9.9 13.4 12.5
DPS – HK¢ 15.0 25.0 25.0 20.0 Holly Hou Dividend yield - % + (852) 2203 9588 2.7 4.4 4.4 3.6 [email protected] BVPS – HK$ 2.3 3.0 3.4 N/A
P/B – X 2.5 1.9 1.6 N/A All reports are available at: Oper cash flow/share – HK¢ 55.4 61.0 103.0 60.0 http://www.SHKfg.com Net debt (net cash) to share price - % 5.8 5.7 (12.3) (15.1) http://www.im.knowledge.reuter.com Sources: Bloomberg and Sun Hung Kai Financial. http://www.tfibcm.com Note: Estimates based on Bloomberg consensus http://www.securities.com Bloomberg Code:
Disclaimer Sun HungThis Kai report Financial / note has been prepared by Sun Hung Kai Investment Services Limited (“SHKIS”),285 and together with its associates and subsidiaries “Sun Hung Kai Financial” or “SHKF”). SHKF does and seeks to do business with companies covered in its research reports / notes. At a result, investors should be aware that SHKF may have a conflict of interest that could affect the objectivity of this report / note. Investors should consider this report / note as only a single factor in making their investment decisions. For analyst certification and other disclosures, refer to the Disclosure Section at the end of the report / note.
20 Nov. 2009
Figure 2: Yip’s Chemical – Investment Highlights
Key investment positives Key investment negatives China’s economy is bottoming out. Multiple economic indicators Volatile raw-material and finished-product prices. Solvents raw show the PRC economy is reviving. The PMI has stayed above 50 materials account for 88% of COGS, but prices tumbled in 4Q08 with since March, and residential construction and light industry sales Butanol down 39% qoq, ethanol down 20% qoq and acetic acid down have both stopped slowing down. Yip’s is set to enjoy this tailwind as 33% qoq. Chemical prices collapsed in 4Q08 along with the plunge in domestic sales constitute 90% of revenue. crude oil and other raw materials, which squeezed the solvents Prudent financial management during financial crisis. The operating margin due to inventory losses. cash-conversion cycle was shortened by 22 days due to stricter Raw-material cost drops could hit long-run earnings. Coatings control over debtors and inventories, and cutting capex from benefit from raw-material cost declines due to the 3-9 months time lag HK$215m in FY08 to HK$161m. This left Yip’s with net cash of before selling prices decline. But like solvents, even though the HK$350m. We believe this offers a good shelter in the financial storm company can maintain margins, bottom-line earnings may fall in the and can help it expand when the outlook improves. long run. Natural hedging mechanism between solvents and coating reduces Bad-debt risk. Even though the company has tightened its credit volatility and protects earnings, as lower solvent prices will enhance policy, the risk of bad debt would increase if its customers collapse. margins for coatings. Smart Union (2700.HK) folded in October 2008, but the firm’s Less competition as smaller competitors close down. exposure to this client was less than 0.1% of sales. Benefits from RMB appreciation. Revenue is in RMB while raw Weak overseas market. Slowing export growth will hit Yip’s, as materials are priced in USD. around 10% of its customers manufacture products for overseas market. Given reported closures of manufacturing businesses in the High dividend yield. Management targets to maintain its Pearl River Delta, we believe the company’s business risk will dividend-payout ratio at 40%-60%. The stock generates a historical increase. dividend yield of 5.7%. Pricing power may weaken. Given the tougher economic conditions, Solvents (57% of revenue) Yip’s may have to slightly lower solvent prices to: 1) sustain/protect its customer base; 2) exert pressure on competitors and increase Dominant 20% national market share, third largest solvent market share. producer in the world. Yip’s has a dominant over 60% market share in Guangdong and 20% nationwide, with a production capacity of Highly competitive coatings market. The coatings market is highly over 330,000 tons. It is the largest solvents producers in China and competitive, with over 2,000 coatings companies in China and the top the third largest in the world. 20 accounting for only 20% of the national market. Yip’s focuses on second- and third-tier cities, as the first-tier cities are dominated by Selling prices 3%-5% higher than peers. Solvent quality is mainly Nippon and Dupont, which can spend heavily on advertising. Yip’s differentiated through water content (the lower the better). Yip’s faces intense competition. high-quality solvents mean it charges 3%-5% higher ASPs than peers. Cost advantages from large production capacity. Yip’s products are almost homogenous, but the firm has cost advantages from economies of scale. According to management, the No. 2 player has less than 100,000 tons of production capacity, making it hard to compete on production costs. Discounts on bulk purchases. Yip’s is the main customer of U.S. supplier Celanese, the largest acetate-solvent maker in the world. This gives Yip’s strong bargaining power and it is therefore able to negotiate bulk discounts. The firm sources around 70% of its acetic acid from Celanese. Following manufacturing customers to east and north China. Yip’s is building an acetate solvents production line with a capacity of 120,000 tons p.a. at its Taixing chemical plant (in Jiangsu province), making it the world’s largest acetate solvent maker after completion late this year. The project can help Yip’s enter the solvents market in east and north China and enjoy vertical integration from the existing ethanol plant.
Coatings (36% of revenue) Brand enhancement and distribution network expansion. Bauhinia paint, Yip’s biggest brand, has changed its logo to a more modern design with large-scale marketing campaign to expand into the household market. At the same time, Yip’s has further penetrated its distribution network into secondary and tertiary cities and towns. Expanding range to high-end coatings. In April 2008, Yip’s acquired Guangdong-based Pak Lam Chemical, a specialist in electronics-casing coatings and a supplier to the likes of VTech, Sony, ZTE, Lenovo, Samsung and Foxconn. The RMB33m consideration implies a 6X FY07 P/E (including working capital). Yip’s management believes Pak Lam’s large production scale and advanced coatings technology will bring synergy by raising the quality of its electronics-casing coatings, and eventually help raise market share. Qualified vendor to international brands. The toys sector accounts for 10% of revenue, and Yip’s is a qualified vendor for international manufacturers such as Mattel, McDonald’s and Sony, giving it a significant competitive advantage over rivals. We believe the toxic-toys scandal will help bring steady growth to this segment, as more manufacturers shift from lower-quality coatings to Yip’s higher-quality products. Expanding to east China. New plants in Tungxiang and Zhejiang started operation in early 2009, and serve as a platform to develop digital-electronics casings and furniture coatings in east China. As with the solvents business, this will follow the migration of its customers to new locations. Source: Sun Hung Kai Financial
Sun Hung Kai Financial 286 20 Nov. 2009
Figure 3: Yip’s Chemical – Upside/Downside Price Catalysts
Upside price catalysts Downside price catalysts RMB appreciation against the USD, as raw-material costs are settled More manufacturers shutting down. in USD and sales are in RMB. Any change in environmental regulations, which may mean more Smaller peers shutting down, helping the firm increase market share. capex. Celanese may expand into downstream products in China, such as solvents. Source: Sun Hung Kai Financial
Recent Company News Nil.
Industry Dynamics Solvents Raw solvents include ethyl acetate, butyl acetates (normal butyl acetate, mixed butyl acetate and iso-butyl acetate). These are used in coatings, inks, pharmaceuticals, adhesive and cosmetics. The biggest producers are BP Amoco, Yip’s and Celanese. Raw solvents are produced via chemical processes between acetic acid and either ethanol or butanol. Raw solvents are like commodities, and are traded internationally. Prices are subject to global supply and demand. Solvent quality is mainly differentiated through water content (the lower the better). Larger players can enjoy cost advantages via economies of scale. According to China Chemical Reporter, the coatings (35%), pharmaceutical (30%) and adhesive industries (20%) account for about 85% of the mainland’s ethyl acetate consumption, mainly concentrated in east, central south, north and northeast China. Global demand for ethyl acetate is forecast to rise 3%-4% p.a. up to 2010, and 6% in China from 2006 to 2011.
Coatings China is the world’s second largest producer and consumer of coatings, and No. 4 for ink, accounting for 6% of world production. Coatings are broadly split into four segments: paints, inks, varnishes and resins. There are over 2,000 coating manufacturers in China and competition is intense, with the top 20 firms account for only 20% of sales. Paint products can be subdivided into architectural and industrial paints. Architectural paints include water-based emulsion paints and oil-based paints. Industrial paints include paints for toys, furniture, electrical and electronic equipment, corrosion-protection coatings for ships and aircraft, etc. Paint companies are mainly located in the Bohai Sea Delta, the Yangtze River Delta and the Pearl River Delta. Nippon Paint has the highest brand awareness at over 50%, much higher than ICI’s 20% and Huarun’s 20% due to heavy advertising in China. Yip’s Bauhinia is No. 4 with 3% brand awareness. Carpoly, Master and Ivy have less than 1%. Guangdong toy exports rose only 3.6% yoy in 2008, following a 19-ppts fall in export growth the previous year, according to Guangdong Huangpu Customs. The number of toy factories declined from 3,089 to 2,167, of which SMEs with export turnover under RMB1m fell from 2,272 to 1,382. Since U.S. and E.U. consumption continues to slump, demand for industrial paints will likely be low this year. Inks are mainly used to print packaging materials for consumer products, plastic bags and printed matter, including newspapers and magazines. China is the fourth largest ink producer in the world, and posted a CAGR of 15.5% over 2005-07, which is expected to sustain through 2008-10. China produced 400,000 tons of ink in 2007, with 600,000 tons forecast for 2010. Given increasing health concerns, environmentally friendly inks such as aromatic-free and water-based inks are expected to become more popular.
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Figure 4: Yip’s Chemical – Profit and Loss Statement FY06-09 Year ended 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Revenue 3,329.7 3,913.8 4,648.4 5,089.9 17.4 COGS (2,667.2) (3,121.2) (3,788.2) (4,146.1) 18.1 Gross profit 662.5 792.6 860.2 943.8 14.7 Operating expenses (446.8) (484.5) (585.7) (696.8) 16.3 Other operating income 16.2 26.4 97.3 78.1 68.1 Operating profit 231.9 334.5 371.7 325.1 16.7 Finance expenses (21.5) (26.3) (30.2) (29.4) 58.8 PBT 218.4 321.7 382.8 346.2 17.9 Tax (21.7) (52.0) (63.4) (82.1) 57.3 Net profit 168.4 223.6 275.2 224.2 16.2 EPS – HK¢ 35.5 46.6 56.7 41.9 12.3 Sources: The Company and Sun Hung Kai Financial
Figure 5: Yip’s Chemical – Profit and Loss Statement (Year on Year Growth) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 CAGR (%) Revenue 24.4 17.5 18.8 9.5 17.4 COGS 25.1 17.0 21.4 9.4 18.1 Gross profit 21.3 19.6 8.5 9.7 14.7 Operating expenses 17.4 8.5 20.9 19.0 16.3 Other operating income 66.0 62.7 268.1 (19.7) 68.1 Operating profit 32.2 44.2 11.1 (12.5) 16.7 Finance expenses 365.6 21.9 15.1 (2.6) 58.8 PBT 21.9 47.3 19.0 (9.6) 17.9 Tax 61.8 139.8 21.9 29.7 57.3 Net profit 36.7 32.8 23.0 (18.5) 16.2 EPS – RMB fen 35.0 31.3 21.7 (26.1) 12.3 Sources: The Company and Sun Hung Kai Financial
Figure 6: Yip’s Chemical – Profit and Loss Statement (Common Size) FY06-09 Year ended 31 March, % FY06 FY07 FY08 FY09 average Revenue 100.0 100.0 100.0 100.0 100.0 COGS (80.1) (79.7) (81.5) (81.5) (80.7) Gross profit 19.9 20.3 18.5 18.5 19.3 Operating expenses (13.4) (12.4) (12.6) (13.7) (13.0) Other operating income 0.5 0.7 2.1 1.5 1.2 Operating profit 7.0 8.5 8.0 6.4 7.5 Finance expenses (0.6) (0.7) (0.7) (0.6) (0.6) PBT 6.6 8.2 8.2 6.8 7.5 Tax (0.7) (1.3) (1.4) (1.6) (1.2) Net profit 5.1 5.7 5.9 4.4 5.3 Sources: The Company and Sun Hung Kai Financial
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Figure 7: Yip’s Chemical – Balance Sheet FY06-09 As at 31 March, HK$m FY06 FY07 FY08 FY09 CAGR (%) Cash and securities 237.1 234.1 455.8 729.5 45.4 Accounts receivable 610.8 751.3 961.6 833.0 10.6 Inventory 341.7 417.8 487.0 386.9 7.0 Other current assets 114.9 196.5 396.6 275.9 29.7 Total current assets 1,304.6 1,599.6 2,300.9 2,225.2 18.9 Net fixed assets 528.4 592.1 782.8 887.2 16.5 Other long-term assets 43.4 71.5 119.4 127.3 46.6 Total assets 1,876.3 2,263.2 3,203.1 3,239.8 18.9 Short-term debt 347.6 428.6 738.8 449.5 12.3 Accounts payable 221.9 487.2 388.5 343.2 6.9 Other current liabilities 155.9 56.2 297.2 346.7 27.5 Total current liabilities 725.4 972.0 1,424.5 1,139.3 13.9 Long-term debt 165.9 55.6 136.9 67.4 (14.5) Other long-term liabilities 1.8 1.9 12.7 7.2 40.7 Total liabilities 893.1 1,029.5 1,574.1 1,213.9 10.8 Shareholders equity 983.2 1,233.7 1,629.0 2,025.9 25.6 Minorities 89.3 129.9 180.2 195.5 37.1 Total equity and liabilities 1,876.3 2,263.2 3,203.1 3,239.8 18.9 Sources: The Company and Sun Hung Kai Financial
Figure 8: Yip’s Chemical – Balance Sheet (Common Size) FY06-09 As at 31 March, % FY06 FY07 FY08 FY09 average Total assets Cash and securities 12.6 10.3 14.2 22.5 14.9 Accounts receivable 32.6 33.2 30.0 25.7 30.4 Inventory 18.2 18.5 15.2 11.9 16.0 Other current assets 6.1 8.7 12.4 8.5 8.9 Total current assets 69.5 70.7 71.8 68.7 70.2 Net fixed assets 28.2 26.2 24.4 27.4 26.5 Other long-term assets 2.3 3.2 3.7 3.9 3.3 Total assets 100.0 100.0 100.0 100.0 100.0
Total equity and liabilities Short-term debt 18.5 18.9 23.1 13.9 18.6 Accounts payable 11.8 21.5 12.1 10.6 14.0 Other current liabilities 8.3 2.5 9.3 10.7 7.7 Total current liabilities 38.7 42.9 44.5 35.2 40.3 Long-term debt 8.8 2.5 4.3 2.1 4.4 Other long-term liabilities 0.1 0.1 0.4 0.2 0.2 Total liabilities 47.6 45.5 49.1 37.5 44.9 Shareholders equity 52.4 54.5 50.9 62.5 55.1 Minorities 4.8 5.7 5.6 6.0 5.5 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0 Sources: The Company and Sun Hung Kai Financial
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Figure 9: Yip’s Chemical – Key Ratios FY06-09 Year ended 31 March FY06 FY07 FY08 FY09 average Profitability ratios Gross margin – % 19.9 20.3 18.5 18.5 19.3 Operating margin – % 7.0 8.5 8.0 6.4 7.5 Net margin – % 5.1 5.7 5.9 4.4 5.3 ROAA – % 9.6 10.8 10.1 7.0 9.4 ROAE – % 18.7 20.2 19.2 12.3 17.6
Liquidity ratios Current assets/current liabilities – X 1.8 1.6 1.6 2.0 1.8 Liquid assets/current liabilities – X 0.3 0.2 0.3 0.6 0.4 Cash and securities/current assets – % 18.2 14.6 19.8 32.8 21.4 Cash flow from oper./curr. liabilities – % 18.1 27.3 20.8 48.4 28.7
Other ratios Capex/sales – % 2.7 2.0 2.0 2.7 2.4 Capex/depreciation – % 3,921.5 3,589.2 3,912.9 222.0 2,574.7 Operating expenses/sales -% (13.4) (12.4) (12.6) (13.7) (12.9) Net debt/equity – % 25.4 12.6 9.6 (18.2) 1.3 Inventory/sales – % 10.3 10.7 10.5 7.6 9.6 Effective tax rate – % 9.9 16.2 16.6 23.7 18.8 Cash-conversion cycle – days 74.9 67.4 69.6 69.8 68.9
ROAA component analysis Revenue/average assets – % 190.5 189.1 170.1 158.0 176.9 COGS/average assets – % (152.6) (150.8) (138.6) (128.7) (142.7) Gross profit/average assets – % 37.9 38.3 31.5 29.3 34.2 Operating expenses/average assets – % (25.6) (23.4) (21.4) (21.6) (23.0) Other operating income/average assets – % 0.9 1.3 3.6 2.4 2.0 Operating profit/average assets – % 13.3 16.2 13.6 10.1 13.3 Finance expenses/average assets – % (1.2) (1.3) (1.1) (0.9) (1.1) PBT/average assets – % 12.5 15.5 14.0 10.7 13.2 Tax/average assets – % (1.2) (2.5) (2.3) (2.5) (2.2) Net profit/average assets – % 9.6 10.8 10.1 7.0 9.4
ROAE component analysis Revenue/average equity – % 370.3 353.1 324.8 278.5 331.7 COGS/average equity – % (296.6) (281.6) (264.7) (226.9) (267.4) Gross profit/average equity – % 73.7 71.5 60.1 51.6 64.2 Operating expenses/average equity – % (49.7) (43.7) (40.9) (38.1) (43.1) Other operating income/average equity – % 1.8 2.4 6.8 4.3 3.8 Operating profit/average equity – % 25.8 30.2 26.0 17.8 24.9 Finance expenses/average equity – % (2.4) (2.4) (2.1) (1.6) (2.1) PBT/average equity – % 24.3 29.0 26.7 18.9 24.8 Tax/average equity – % (2.4) (4.7) (4.4) (4.5) (4.0) Net profit/average equity – % 18.7 20.2 19.2 12.3 17.6 Sources: The Company and Sun Hung Kai Financial
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Address: 12/F, CITIC Tower, 1 Tim Mei Avenue, Central, Hong Kong
Phone : (852) 3920 2888 Fax : (852) 3920 2789 Web : http://www.SHKFG.com
Research Team Head of Research Alvin Chong
Investment Analysts Holly Hou Eva Yip, CFA Michael Yuk
Securities Analyst Tammy Leung
Gold and FX Analyst Kenix Lai
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Definitions SHKIS means Sun Hung Kai Investment Services Limited, and together with its associates and subsidiaries, Sun Hung Kai Financial or SHKF.
Disclosure Section Analyst Certification I / We Eva Yip, CFA, Holly Hou and Michael Yuk hereby certify that all of the views expressed in this report / note accurately reflect my / our personal views about the subject company or companies and its or their securities. I / We also certify that no part of my / our compensation was / were, is / are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note. Analyst as Officer or Director: SHKF’s policy prohibits its analysts, persons reporting to analysts or members of their households from serving as an officer, director, advisory board member or employee of any company in the analyst’s area of coverage. Analyst compensation: Analysts are paid in part based on the profitability of SHKF, which includes investment banking revenues.
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