Sino Grandness: Proposed issue of RMB100m CBs by its subsidiary (DMG)

(BUY, S$0.42, TP S$0.50)

SFGI announced that its subsidiary Garden Fresh HK (GFHK) has entered into a conditional subscription agreement for issue of RMB100m zero coupon bonds due Oct 2014. While there is no share dilution, we note a minimum RMB133m payback value or 18% p.a. effective interest rate based on our scenario analysis. We revise down our FY11F-FY12F earnings estimates by 4%-9% to RMB162m-RMB172m respectively. We caution that should GFHK fail to generate sufficient cash flow to meet early redemption obligations, SFGI could see claw-backs to its assets as it acts as the guarantor. Given a cautious sentiment towards S-Chips, we lower our target multiple to 4x (old: 6x) FY11F P/E, +0.5SD to its historical mean of 3.5x and derive a lower TP of S$0.50 (old: S$0.76). Maintain BUY.

Rationale. We understand the main intention is for an eventual listing of its fast growing beverage business, which saw a three-fold jump in revenue to RMB178m in 1H11.

Our scenario analysis. Based on the announcement, we identify a best case that leads to an eventual IPO of GFHK by Oct 2014 at 9x RMB250m FY13 earnings. Here, CB holders will likely prefer a 6.7% stake worth RMB150m (vs. redemption at RMB100m principal). However, to support revenue growth to RMB1.3b, we believe GFHK would need more funding for working capital needs, which could lead to a fourth funding exercise under the group since SFGI’s 2009 listing. A worst case scenario would be a non-reply from relevant stock exchange for GFHK’s IPO application, meaning a possible RMB195m repayment or a steep 35% p.a. effective interest cost.

Our base case. Based on our forecasts, we believe the most probable case will be an eventual IPO at ~6.7x FY13 RMB100m earnings estimates, and happens to be one whereby CB holders will be indifferent between conversion and redemption. We assume sufficient internal resources to support growth and haven’t factored in possible fair value gains into our valuation model.

Other details. The CBs can be converted to shares ranging from 6.7% and 19.9% in the subsidiary depending on financial performance. Near term milestone is a minimum RMB80m net profit for FY2012. Net proceeds are estimated at RMB80m, after applying a 13% discount rate to principal sum and deducting RMB7m professional fees. RMB70m will be used for PPE for beverage business, and RMB10m will be used for advertising and promotional activities.