China Animal Healthcare Ltd - Waiting for a Gem to Sparkle (AmFraser)

LAST CLOSE: S$0.225

BUY FAIR VALUE: S$0.345

FY2011 Q2 results below expectations. China Animal Healthcare (“CAH”) announced FY2011Q2 revenue and NPAT of RMB214.1m (up 55% YoY) and RMB66.3m (up 64% YoY) respectively. Excluding the gain in fair value of derivative financial instruments and amortised interest expense relating to the convertible bonds, the adjusted net profit attributable to shareholders for Q2 is RMB59.0m (up 55% YoY). The overall results fell short of our expectations mainly due to the lacklustre performance of the vaccine segment.

Powdered drugs power ahead. Revenue for CAH’s core segment grew strongly by 20.3% YoY to RMB122.7m. This exceeded our expectations. If history is a good guide, H2FY2011 should see stronger sales figure by about 40-50% as farmers continue to ramp up breeding activities in preparation for the next Chinese New Year. Moreover, with poultry prices remaining high, we believe farmers will continue to ‘insure’ their precious livestock against diseases.

Vaccines sparkle, except for one. The biological drug business saw YoY growth of 188% to RMB84.1m. The Swine Fever and PRRS vaccines accounted for RMB70.2m. Based on indicative orders from February’s bidding of RMB30m and RMB60m respectively, there should be ~RMB20m of orders to be delivered in Q3. The animal FMD vaccine, on the other hand, continues to disappoint with only RMB4.9m of sales in the current quarter. Losses from this business is likely a main drag to the segment margins. Management stated that they are exploring opportunities to export the FMD vaccines overseas. We will have further clarity after their coming August bidding.

Lower margins overall. Overall gross margins were reduced due to the introduction of 2 new taxes in Nov 2010 in the PRC: the City Construction Tax (“CCT”) and Education Supplementary Tax (“EST”). CCT and EST are computed based on 7% and 3% of Value Added Tax respectively and are included in cost of sales. These new taxes amounted to about RMB4.8 million for 2H2011.

Lower FV to 34.5 SG cents and maintain BUY. We drastically reduced our sales forecast for the vaccine segment from RMB419m to RMB278m due to the lacklustre performance of the animal FMD vaccine business. GP margin for the whole vaccine segment is also reduced from 75% to 70%. For the powdered drug segment, we raised our revenue expectation to RMB481m from the original RMB428m. Our earnings model arrived at an FV of 34.5 SG cents, down from the previous 47 SG cents. As this is still a 53% premium over the last close price of 22.5 SG cents, we maintain our BUY recommendation.