Yum Cha 飲 茶 October 7, 2014 CHART OF THE DAY WORLD BANK DOWNGRADES CHINA GROWTH, BUT NOT MUCH INDICES Closing DoD% Hang Seng Index 23,315.0 1.1 HSCEI 10,409.7 0.6 Shanghai COMP 2,363.9 0.3 Shenzhen COMP 1,333.5 0.6 Gold 1,206.0 (0.1) BDIY 1,029.0 (0.8) Crude Oil, WTI(US$/BBL) 90.4 0.0 Crude Oil, BRENT(US$/BBL) 92.8 0.5 HIBOR, 3-M 0.4 (1.9) SHIBOR, 3-M 4.5 (0.1) RMB/USD 6.1 (0.0) HOUSE PRICES CREDIT BREAKDOWN AS SHARE OF GDP EXPORT GROWTH VARIOUS COUNTRIES INVESTMENT vs. CONSUMPTION SHARE OF GDP GROWTH DAILY NOTES FOR THIS WEEK 10/07 HSBC China Services PMI 10/07 HSBC China Composite PMI 10/09 Foreign Reserves 10/09 New Yuan Loans 10/09 Aggregate Financing RMB 10/09 Money Supply M0 YoY 10/09 Money Supply M1 YoY 10/09 Money Supply M2 YoY Source: Bloomberg The World Bank appears to be more bullish on China than the consensus, with growing exports from growth in the US and EU seen as one key to China s outlook in the near term. Exports have contributed around 0.9 percentage points of growth this year, while the contribution from consumption, although much higher (2.4 pps) than exports has declined to its lowest level in five years. Investment remains a key driver for the time being, following the mini-stimulus in Q2 2014. In its latest Economic Update the World Bank projects China s gross domestic product (GDP) growth at 7.4% for 2014, falling to 7.2% in 2015 and 7.1% in 2016. The World Bank expects China s fiscal and monetary policies to stay growth-supportive with investment likely to be focused on affordable housing and related infrastructure. The World Bank is surprisingly sanguine about the property market, noting that the central areas of Tier-1 cities still offer strong fundamentals such as income, employment and population growth. Cities in central and western areas have more oversupply, and weaker fundamentals. Key risk to China is a possible disorderly de-leveraging of local governments, according to the World Bank, which could trigger a sharp slowdown in investment growth and a contraction in certain areas, notably real estate. Quarterly growth is expected to remain volatile (as we have seen this year) as the rebalancing of the economy from investment to consumption-based growth clashes with shortterm demand management measures (i.e. targeted stimulus; monetary easing). The key messages are relatively declining investment vs. growing exports and consumption, with credit the big risk. Not too many surprises there... TALKING POINTS FUFENG GROUP LIMITED [0546.HK; HK$3.81 Not Rated] - One of China s dominant manufacturer of corn-based products such as monosodium glutamate (MSG), glutamic acid and xanthan gum, Fufeng is finally seeing rising MSG prices. The formerly fragmented market has been consolidating for some time, and a key competitor, A-share company Meihua Holding [600873 CH], is negotiating the acquisition of Ningxia Yipin, the third-largest MSG producer in China. If successful, the Meihua acquisition will give Fufeng and Meihua control of 90% of the MSG market. An ability to control upstream corn kernel costs in China due to arbitrage with international corn prices will also help to improve margins. Margins are improving and catalysts include selling prices, outcome of the Meihua deal and also expansion into new products such as amino acids.
COMPANY NEWS Fufeng Group Limited [0546.HK; HK$3.81 Not Rated] - Major Beneficiary of Industry Consolidation. Market Cap: US$1,025m; Free Float: 42.8%; 3-month Average Daily Turnover: US$1.4m Analyst: Mark Po October 7, 2014 The Company. Fufeng Group (Fufeng) manufactures corn-based bio-chemical products utilizing fermentation technology. Products include glutamic acid and xanthan gum. [Fufeng Group Limited] (HK$) 5 (HK$ million) 80 Downturn of monosodium glutamate (MSG) industry comes to an end. According to management, two key events happened in recent months to indicate a possible end to the downturn in the MSG sector. One of the major MSG producers, with an annual capacity of 100,000 tonnes, filed for bankruptcy in May 2014 due to its high debt burden. Trading of Meihua Holding [600873 CH] (Meihua) shares has been suspended since 23rd Aug 2014 pending the acquisition of a competitor. According to industry sources Meihua will acquire Ningxia Yipin, the third-largest MSG producer in China. After the acquisition Meihua will have annual capacity of 750,000 tonnes. If that acquisition goes smoothly, the combined market share of Fufeng and Meihua will be over 90%. Fufeng s management suggested that Fufeng and Meihua would be the major beneficiaries of industry consolidation. The MSG market price rebounded from the trough at RMB6,200 per tonne in Jun 2014 to RMB6,900 per tonne in Sep 2014. Fufeng has no intention of raising selling prices before the end of 2014 despite improving supply/demand dynamics, as the leading players want to continue squeezing the smaller players further and to soften corn kernel costs. The industry is currently running at a utilization rate of about 60%, and the smaller players are under heavy pressure. Management highlighted that downstream demand for MSG was stabilizing in 3Q 2014, especially from the catering industry. Management believes MSG demand should resume growth in 2015 after two years of stagnant growth in 2013 and 2014. Given the limited new capacity, management believes there is room for selling prices to increase in 2015. Limited new capacity. According to management, the group will only expand capacity through upgrading production processes. Fufeng found that there are limited M&A opportunities in MSG and xanthan gum industry. Unless the group identifies a new business opportunity, the group s major capacity expansion is over, and gearing is expected to come down (from current ~80% debt:equity) starting 2015. Management targets an increased dividend payout ratio in the long run. Stable cost environment. Corn and coal are two of Fufeng s major cost components. Management believes corn kernel costs will fall by 5-8% in 4Q 2014 from the level in Sep 2014. They believe there is a natural cap on any rebound in corn kernel costs given the big price differential between US and local corn prices. Net profit growth in 2H14 and 2015 will be driven by a pick-up in 4 3 2 1 0 Oct13 Dec13 Feb14 Apr14 Jun14 Aug14 Turnover (RHS) Price (LHS) Key Financials (in Rmb m) Source: Bloomberg, Company Data. 2012 2013 2014E 2015E Revenue 11,111.9 11,366.7 11,652.2 12,226.4 Gross Profit 1,637.5 2,099.4 2,219.7 2,475.8 Gross Margin % 14.7 18.5 19.1 20.3 Net Profit 426.6 506.1 707.6 882.0 Net Margin % 3.8 4.5 6.1 7.2 EPS (Basic) 0.23 0.25 0.33 0.43 ROE (%) 11.8 11.8 12.6 15.9 Dividend Yield (%) - 1.50 2.92 3.71 PER (x) 14.27 12.58 9.30 7.06 PBR (x) 1.61 1.37 1.20 1.04 the MSG segment gross margin through average selling price (ASP) hikes and a more favourable cost environment. Despite the potential decline in gross margin for xanthan gum in 2015, the blended gross margin is expected to improve given the improvement in the MSG segment. Catalysts: Newsflow on Meihua s acquisition, average selling price hike and 2014 results announcement; all share-price catalysts. Fufeng is one of the major beneficiaries of probable industry consolidation, given its leading market position and strong pricing power. Fufeng s long-term growth will be supported by MSG industry recovery and increasing contribution from new business such as amino acids. 60 40 20 0
Figure 1: Fufeng Turnover Breakdown User Figure 2: Fufeng Gross Margin Trend Xanthan Gum MSG 14,000.0 12,000.0 10,000.0 8,000.0 6,000.0 4,000.0 2,000.0 0.0 2009 2010 2011 2012 2013 2014F 2015F 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2009 2010 2011 2012 2013 2014F 2015F Figure 3: Figure 7: Peer Comparisons Maket --------------PE------------- ---------EV/EBITDA-------- -------------P/B------------- ------ROE------ ------ROA------ ----Div yield--- Ticker Company Price Cap 2014 2015F 2016F 2014F 2015F 2016F 2013 2014F 2013 2014F 2013 2014F 2013 2014F (Lcy) (US$m) (x) (x) (x) (x) (x) (x) (x) (x) (%) (%) (%) (%) (%) (%) 546 HK Fufeng 3.81 1,025 9.1 7.0 6.5 5.8 4.9 4.8 1.3 1.2 11.8 12.6 4.4 5.0 1.8 3.0 2317 HK Vedan 0.45 87 n.a. n.a. n.a. n.a. n.a. n.a. 0.3 n.a. 0.5 n.a. 0.4 n.a. 1.8 n.a. 809 HK Global Bio-Chem 0.30 124 n.a. n.a. n.a. n.a. n.a. n.a. 0.2 n.a. -87.4 n.a. -29.2 n.a. 0.0 n.a. 43. HK CPP 0.89 2,762 11.5 11.5 11.5 7.4 6.4 8.0 2.3 2.3 18.4 21.2 8.1 8.2 4.0 4.4 606 HK China Agri 3.06 2,071 191.3 12.8 9.3 26.6 12.2 10.5 0.6 0.6 5.4-0.2 0.7-0.7 1.3 0.5 829 HK Shenguan 2.67 1,144 9.8 9.4 8.9 7.7 7.3 6.9 2.7 2.4 30.9 26.0 23.9 21.9 4.3 7.0 1006 HK Changshouhua 6.35 470 9.3 7.1 5.3 5.0 3.9 3.1 1.4 1.3 15.5 14.3 10.6 11.9 2.4 2.2 3838 HK China Starch 0.20 155 n.a. n.a. n.a. n.a. n.a. n.a. 0.5 n.a. 6.4 n.a. 3.2 n.a. 3.4 n.a. 2341 HK Ecogreen 2.30 146 5.2 4.1 3.4 2.8 2.2 1.8 0.7 0.6 12.0 n.a. 7.1 n.a. 3.8 3.9 336 HK Huabao 6.00 2,400 9.0 8.5 8.0 6.1 5.8 5.5 2.1 1.9 25.2 22.9 20.5 18.9 3.2 4.9 288 HK Wh Group 6.4 12,086 13.3 11.6 9.8 9.2 8.4 7.5 3.1 2.3-12.9 22.0 n.a. 7.9 n.a. 2.2 Average 35.6 9.3 8.0 9.3 6.6 6.2 1.4 1.6 1.4 17.7 5.0 11.4 2.7 3.6 600873 CH Meihua 5.55 2,809 29.2 16.1 11.1 11.1 9.0 7.3 2.2 2.0 6.0 8.9 1.6 3.1 n.a. 0.9 600186 CH Henan Lotus 3.89 673 n.a. n.a. n.a. n.a. n.a. n.a. 7.9 n.a. -43.7 n.a. -10.6 n.a. n.a. n.a. 2802 JP Ajinomoto 1861.00 10,112 24.6 20.3 17.7 10.1 9.1 8.5 1.8 1.7 7.8 7.1 3.9 5.2 n.a. 1.2 Average 26.9 18.2 14.4 10.6 9.1 7.9 4.0 1.9-10.0 8.0-1.7 4.2 n.a. 1.0
Key Financials Income Statement (Rmbm) FY2011 FY2012 FY2013 Cash Flow Statement (Rmb m) FY2011 FY2012 FY2013 Revenue 8,399 11,112 11,367 Net Income 842 719 994 Growth yoy% 30.9% 32.3% 2.3% Depreciation & Amort. 366 529 690 Gross Profit 1,520 1,637 2,099 Change in Working Capital (750) (104) (176) Growth yoy% (2.9%) 7.8% 28.2% Cash from Ops. 458 1,144 1,508 Selling General & Admin Exp. (795) (1,011) (1,252) Capital Expenditure (2,318) (1,756) (1,031) Others Operating Expenses/Items 118 92 146 Sale of Property, Plant, and Equipment - - - Operating Income 842 719 994 Change in Investing Acitivities 184 52 (269) Growth yoy% (22.8%) (14.6%) 38.2% Cash from Investing (2,134) (1,704) (1,300) Interest Expense (135.9) (251.3) (367.2) Net increase in bank borrowings 2,050 836 119 Interest and Invest. Income 10.1 6.4 6.9 Income/(Loss) from Affiliates 0 0 0 Issuance of Common Stock 0 41 493 Other Non-Operating Inc. (Exp.) 0 0 0 Common Dividends Paid (358) (42) (33) Impairment of Goodwill - - - Special Dividend Paid - - - Gain (Loss) On Sale Of Invest. - - - Other Financing Activities (199) (378) (463) Gain (Loss) On Sale Of Assets - - - Cash from Financing 1,492 457 116 Income Tax Expense (112) (64) (129) Minority Int. in Earnings 0 0 0 Net Change in Cash (184) (103) 325 Net Income 604 411 505 Growth yoy% (37.5%) (32.0%) 23.0% Balance Sheet (Rmb m) FY2011 FY2012 FY2013 Ratios FY2011 FY2012 FY2013 ASSETS Profitability Cash And Equivalents 584 481 806 Return on Assets % 7.3% 3.8% 4.1% Receivables 1,739 2,340 2,069 Return on Capital % 12.7% 8.7% 9.9% Inventory 1,180 1,415 1,517 Return on Equity % 18.4% 11.4% 11.7% Other Current Assets 30 69 56 Total Current Assets 3,533 4,305 4,449 Margin Analysis Net Property, Plant & Equipment 6,032 7,259 7,576 Gross Margin % 18.1% 14.7% 18.5% Long-term Investments 0 0 0 SG&A Margin % 9.5% 9.1% 11.0% Other Intangibles 294 407 595 EBIT Margin % 10.1% 6.5% 8.8% Deferred Tax Assets, LT - - - EBITDA Margin % 14.5% 11.3% 14.9% Other Long-Term Assets 0 0 0 Net Income Margin % 7.2% 3.7% 4.4% Goodwill 0 0 0 Accounts Receivable Long-Term 0 0 0 Asset Turnover Total Long Term Assets 6,327 7,666 8,171 Total Asset Turnover 0.9x 0.9x 0.9x Total Assets 9,859 11,971 12,619 Fixed Asset Turnover 1.3x 1.4x 1.4x Accounts Receivable Turnover 6.6x 5.4x 5.2x LIABILITIES & EQUITY Inventory Turnover 7.1x 7.9x 7.5x Accounts Payable 2,631 3,304 2,891 Accrued Exp. - - - Liquidity Short-term Borrowings 704 2,408 1,168 Current Ratio 1.0x 0.7x 1.1x Curr. Port. of LT Debt - - - Quick Ratio 0.7x 0.5x 0.7x Curr. Income Taxes Payable - - - Avg. Days Sales Out. 75.6 76.9 66.4 Unearned Revenue, Current - - - Avg. Days Inventory Out. 51.3 46.5 48.7 Other Current Liabilities 54 47 52 Avg. Days Payable Out. 118.6 114.3 122.0 Total Current Liabilities 3,388 5,759 4,111 Avg. Cash Conversion Cycle 23.8 22.8 33.4 Long-Term Debt 2,844 2,045 3,309 Net Debt to Equity 87% 105% 76% Def. Tax Liability, Non-Curr. 20 20 20 Other Non-Current Liabilities 200 352 360 Growth Over Prior Year Total Liabilities 6,453 8,176 7,800 Total Revenue 30.9% 32.3% 2.3% Common Stock 174 176 204 Net Income (37.5%) (32.0%) 23.0% Additional Paid In Capital - - - Payout Ratio % 9% 0% 12% Retained Earnings 3,233 3,619 4,615 Treasury Stock - - - Comprehensive Inc. and Other - - - Minority Interest 0 0 0 Total Equity 3,407 3,795 4,819 Total Liabilities And Equity 9,859 11,971 12,619 Source: Company Data
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Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >20% within 12 months in absolute terms share price will decrease by >20% within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 Room 3501-3507, 35/F, Cosco Tower, Grand Millennium Plaza, 183 Queen s Road Central, Sheung Wan, Hong Kong. General line: 3698-6888.