Sino Grandness Food Industry Group Ltd (POEMS)

BUY (Maintained)
Closing Price S$0.455
Target Price S$0.75 (+64.8%)

• Concerns over DEHP tainted products in Taiwan and drought in China
• Management says operations unaffected
• Maintained Buy

Share price has weakened almost 20% since our last report on 12 May 2011. Although overall market weakness may be partly the cause, however we feel that there might be concerns over the 2 mentioned factors. We have sought clarifications from the management on the impacts and nothing adverse has been seen yet.

DEHP

In recent weeks, the F&B scene got another scare when DEHP tainted products were discovered in Taiwan. DEHP (Bis(2-ethylhexyl)phthalate) is an organic compound widely used as a plasticizer. The reason why it found its way into F&B products is that it is being used to substitute natural vegetable oil in the manufacturing of clouding agent. Clouding agents or emulsifiers are used to mix otherwise immiscible contents in beverages such as juices or sports drinks and act as emulsifiers to give products a more appealing appearance. As opposed to clouding agents made with natural vegetable oil, DEHP clouding agents have a longer shelf live and give a more pleasing look to the finished product. Besides, cheaper cost could also be a reason manufacturers resort to using chemical substitutes.

As an F&B company selling bottled juices, we believe there are concerns in Sino Grandness being affected. We had checked with the company and were informed that the ingredients are all stated on the bottle packaging and it does not use clouding agent. Juice concentration ranges from 30% to 100%. Currently the company has one OEM manufacturer and in order to ensure production quality, one staff is stationed at the OEM site to monitor the process. Furthermore, the company has started construction of a new plant for the production of bottled juices. This will ensure better control over product quality. Point of sales has expanded rapidly from convenience stores to large scale supermarkets and includes Walmart, Carrefour, Jusco and Tesco. As such, the company stresses product quality and industrial qualifications are all stated on the bottle packaging.

China Drought
Interestingly, newspaper article had termed this as the worst drought to hit China in 50 years. The prolong drought which started in April has depleted much of the lower reaches of the Yangtze River, a rich source of irrigation for nearby farmland. According to a news article on Chinadaily.com, affected areas include Hubei, Hunan, Jiangxi, Anhui, Jiangsu and Zhejiang provinces. Last we check, the China Meteorological Administration says heavy rainfall is expected soon over these areas.

For Sino Grandness, the April-June period marks the planting and harvesting season of Asparagus which the plantation areas are in Shanxi and Shandong. Management says there is no disruption to the planting and harvesting. Asparagus is one of the main products and accounted for 32% of revenue in FY2010.

Comparatively, second half of the year will record higher sales from the export segment. At the price of $0.455, the stock is trading at slightly over 4x forward earnings. We are maintaining our Buy recommendation with a target price of $0.75, peg to 7x earnings.