BUY (Unchanged) FAIR VALUE: S$0.61
LAST CLOSE: S$0.405
Previous: S$0.88
Raising funds via zero-coupon CB. We met the Management of Sino Grandness (“Grandness”) to understand more about their recent fundraising exercise. The structure of the RMB100m zero-coupon convertible bond appears risky at first glance due to the high interest ‘penalties’ and ambitious valuation and conversion targets. We do not dispute that. However, further research and insights from Management allow us to better put things in perspective.
Beverage business recap and updates. Grandness introduced a range of mixed vegetable/fruit juices under their “Xian Lü Yuan” brand in Q2FY2010. Sales of the beverage grew strongly to hit RMB177.8m in FY2011H1. We estimate the net profit margin for this business to average 22%, translating to a net profit of RMB39m for the half-year. To date, the Company has successfully pushed their beverages into major supermarkets (e.g. Carrefour, Tesco, Jusco, Parkson, etc.) and other distribution channels like convenience stores, restaurants, etc. We understand they have about 9000 retail points currently and Management is keen to open more channels. They aim to commission a production facility at their existing site in Sichuan by end- FY2011 to double the ~40,000 tonnes of beverages per annum capacity they currently have via their OEMs. RMB70m of the sum raised would then contribute towards a new facility at their site in Hubei that, when completed in mid-2012, will add another 40,000 tonnes of capacity.
Likely Scenario. Our discussion with Management led us to increase our forecast of GFHK’s NPAT for FY11, FY12 and FY13 to RMB80m, RMB125m and RMB175m (previous: FY11:RMB80m; FY12:RMB100m; FY13:RMB125m) respectively. Conversion conditions will then fall into Scenario 5 in Exhibit 1. We further analyse the peers in the nonalcoholic F&B sector listed on the Hong Kong, Shenzhen, Korea and Taiwan Stock Exchanges (see exhibit 1). From the table, the average PER of peers are 19.5x, 31.9x, 23.5x and 21.3x respectively. Taking the HKEx’s 19.5x as a base-case, we believe it is possible for GFHK to list at 9x FY2013 NPAT. The CB holders would need to be diluted >45% during listing before they would prefer to redeem the CBs.
Lower FV to 61 SG c and maintain BUY. Despite our relatively bullish analysis above, we cannot ignore the fact that this is an exercise in advanced forecasting based on current assumptions. In reality, uncertainties abound that are largely beyond the Management’s control, e.g. changes in listing regulation, financial market downturns, deterioration in business climate, etc. Failure to list in FY2013 brings about a hefty interest expense. However, at this juncture, we have only included the interest expense of RMB13m (amortised into FY11-14) and professional expenses of RMB7m into our earnings model. To take into account the increased risk, we are ascribing a 5x PER (previous: 7x) to FY11 estimated EPS of RMB 0.645. This reduces our FV to 61 SG c from 88 SG c. We believe the last close price of 40.5 SG c has priced in much of this uncertainty and hence, we maintain our BUY recommendation.
SALIENT TERMS OF CONVERTIBLE BONDS
• RMB100m zero-coupon rate convertible bonds (“CBs”) issued by indirect wholly-owned Hong Kong subsidiary, Garden Fresh (HK) (“GFHK”), to be subscribed at 87% and due on 19 Oct 2014. Grandness will guarantee the repayment.
• Deducting professional expenses of RMB7m, RMB70m out of the net proceeds of RMB80m will be used as capex in the beverage business. The remainder will be used for advertising and promotional activities.
• Conversion or redemption is at the option of the bondholders at maturity date or at IPO (conversion only). Bondholders have right to extend the maturity date to 30 Jun 2015;
• Conversion ratio is dependent on the projected or actual net profit of GFHK in FY2011, FY12 and FY13;
• Interest rate upon redemption is revised upwards if GFHK does not manage to list on an approved stock exchange before maturity or fails to list at a price-earnings ratio of more than 9 times;
• An event of default is declared if FY2012 NPAT is less than RMB80m. This leads to a 23.9% annualised interest cost.
Advantages to Grandness.
• Avoids dilution at listed-company (i.e. “Grandness”) level while getting the funds to the division with the expansion plans; and
• Defers and minimises dilution at GFHK until 2013/14 when the division has grown its NPAT.
Risks to Grandness.
• Potentially expensive cost of funds (i.e. from 18.5% to 34.7% per annum depending on situation) if best-case scenario of listing at more than 9 times FY2013 P/E not met.
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