China Minzhong Food Corp - Good-quality S-chip (CIMB)

OUTPERFORM Maintained

S$0.86 @28/09/11

Target: S$1.22

Food & Beverages

• Maintain Outperform and target price of S$1.22. We see value emerging from MINZ’s 31% decline since Dec 10, led by broader concerns over S-chips’ corporate governance. At 3.6x CY11 P/E and 0.8x P/BV, MINZ offers good value, we believe, considering its defensive earnings in this economic climate as well as earnings momentum. We resume coverage with new earnings forecasts, an unchanged Outperform rating and a S$1.22 target price, based on 4.8x CY12 P/E, a 30% premium to the FTSE ST China Index (vs. its average 43% premium this year). We anticipate stock catalysts from continued strong quarterly results and a switch to a Big-4 auditor by FY13.

• Inelastic vegetable demand. MINZ’s earnings grew even during the recession of 2009, as vegetable demand is relatively inelastic. We expect consumer behaviour to be no different in another recession. We project a 3-year earnings CAGR of 32%, powered by farmland expansion. This should be achievable considering its 46% earnings growth in the past recession with less farmland growth.

• Conservatively geared at 0.1x. MINZ had net-cash positions in the past two years. Its cash conversion cycle also shortened from 60 days to 39, comparing well with its competitor China Green’s 101 days. Further, the transparency of its capex plans and full disclosure of farmland assets differentiate it from the other S-chips.

Recession-proof earnings

Sales to increase on the back of inelastic vegetable demand. MINZ is a leading integrated vegetable processor in China, with both vegetable-processing capabilities and its own cultivation bases. Its fresh vegetables are sold domestically while its processed vegetables are exported. An extensive processing platform allows the company to offer more than 100 types of processed vegetables. Global economic uncertainties notwithstanding, vegetable demand should remain strong, backed by: 1) ageing populations in developed markets which would require more fibre intake; and 2) the Chinese government’s pro-farming policies.

MINZ’s sales, in fact, had more than doubled from 2008 to 2010, the period of the global financial crisis. The growth was fuelled by its processed-vegetable exports. We have projected sales growth of 23.3% to Rmb2.4bn for FY12. Our estimates are conservative, given the company’s average sales growth of 45% through the crisis.

Supported by higher number of cultivation bases. MINZ acquired 21,366 mu of vegetable farmland in 2010. This should be ready for cultivation this year. Although the crops will not fully mature until 2013, the land would almost double its total farmland available for cultivation to 58,627 mu. This expansion is motivated by excess demand, with the additional capacity believed to be easily absorbed by the market because of MINZ’s demand-driven business.

We project Rmb703.5m of cultivation sales for FY12 and Rmb1,675m of processed sales, up 38% and 26% yoy respectively. Our projections are based on conservative estimates of Rmb12,000 yields per mu for its cultivation business and the assumption that processed revenue will be 2.4x higher than cultivation sales, using the average sales mix of the past three years. MINZ’s FY11 yields per mu were Rmb14,100.

Gross margins to climb with higher value mix. Increased sales of king oyster mushrooms and black fungi should raise its gross margins as these vegetables have much higher margins than the other vegetables. Gross margins have already improved from 40% to 41% this year with the aid of these vegetables. Production capacity for king oyster mushrooms is expected to increase to 15 tonnes in FY12 from eight tonnes while that for black fungi is expected to increase to 22 tonnes from 15 tonnes.

Assurance of a strong balance sheet

Corporate-governance concerns may continue to hang over S-chips, but we see the following differentiators for MINZ: 1) the transparency of its capex plans. Management discloses committed amounts in each quarter, together with the disbursements made. This data is summarised in Figure 5 below; and 2) full details of its farmland assets:their tenures, land sizes and addresses. In comparison, China Green, its closest competitor, does not disclose details of its farmland assets.

Faster cash collection. MINZ’s cash conversion cycle shortened from 60 to 39 days in FY11, aided by quicker trade receivables and longer trade payables. In comparison, China Green’s cash conversion cycle was 107 days. We like its ability to convert sales to cash much quicker than its competitors, especially given current economic and business uncertainties.

Net gearing of 0.1x. A conservatively geared balance sheet gives us confidence, should another recession occur. Current debt of Rmb327m can be comfortably paid with less than two years of operating cash flows, in our estimation.

Valuation and recommendation

S-chip selldown. We see no fundamental reason for MINZ to shed 31% since Dec 10, particularly as its FY11 earnings had jumped 29.4% yoy, for a 46% CAGR since 2007. Its rock-bottom valuations, we believe, could be linked to the broad sell-off of Chinese companies not owned by the state, which are perceived to be riskier.

Good-quality S-chip! YTD, the FTSE ST China Index has retreated 33%, mirrored by MINZ’s share-price decline. The index is now at 3.7x P/E vs. MINZ’s 3.6x. We argue that MINZ deserves a premium to its S-chip peers for the following reasons: 1) we expect its FY12 EPS to increase to S$0.25 from S$0.20 vs. a 67% decline projected by consensus for its peers; and 2) a more conservative gearing of 0.1x vs. 0.2x for its peers. MINZ has been in net-cash positions for the past two years.

Target price of S$1.22, based on 4.8x CY12 P/E. We observe that MINZ has been trading at a 43% premium on average to the other S-chips. Its earnings outlook for FY12 is expected to be strong and we have conservatively ascribed a 30% premium to S-chips’ current valuations of 3.6x P/E to arrive at our target price at S$1.22 (4.8x CY12 P/E). At current valuations of 3.6x CY11 P/E and 0.8x P/BV, we believe downside is minimal. We see an opportunity to accumulate the stock, anticipating catalysts from continued strong quarterly results and a switch to a Big-4 auditor by FY13.