Small position to follow story. From UOB-Kay Hian
Downgrade to HOLD due to margin risk and weak cash flows
We downgrade Huiyuan Juice (Huiyuan) from BUY to HOLD, due to several reasons:
a) margin pressure from hike in raw material costs,
b) lower investment returns for new facilities, a result of slower-than-expected pick-up in capacity utilisation and
c) weaker projected cash flows and higher working capital requirement.
We cut our target price from HK$7.60 to HK$5.50, based on 10-year DCF valuation (WACC = 10%; terminal growth = 3%).
Cost pressure. We believe Huiyuan would experience heavy cost pressure this year, as the natural disasters including snowstorms, earthquake and floods in southern China, as well as soaring farming costs, have affected fruit plantations in China.
Although the company raised the average selling price (ASP) of non-orange juice drinks by 10%, this would not offset the cost hike. We assume the company’s gross margin would drop from 35.7% in 2007 to 35.2% in 2008, 34.7% in 2009 and 34.2% in 2010.
Capacity utilisation remains low. Due to the seasonality of pure juice and juice drinks sales, the average utilisation rate of Huiyuan’s production facilities remained at a low level (<50%). In order to expand its geographical coverage from northern China to eastern and southern China, the company has built five small plants in Jilin, Liaoning, Shandong, Anhui and Jiangxi since mid-07.
It is going to build a large plant there before end-08. However, the sales pick-up is not fast enough to boost utilisation, resulting in lower investment returns.
Foray into low-concentrate juice market presents short-term risk.
Huiyuan plans to expand further from pure juice and nectar into the low concentrate juice market. This year, the company launched the Kiwi fruit juice drink products, which received positive market acceptance within short period. However, the juice market in China is highly competitive, dominated by such major incumbents such as Tingyi, Uni-President and Coca-Cola.
Huiyuan will have to prove if it can succeed in gaining market share in the segment. Huiyuan’s aggressive foray into a market where it does not have an advantage presents a short-term risk.
Weak cash flow. Despite a 33% growth in core net profit, Huiyuan’s operating cash flow dropped from Rmb293m in FY06 to Rmb10m in FY07, mainly due to a 22-day increase in inventory period to 159 days. Ytd, the company’s cash flow has not improved significantly due to the accumulation of raw materials inventory.
Revise FY08-10 net profit forecasts down by 5-12%. We cut our FY08-10 net profit forecasts for Huiyuan by 5%, 8% and 12% respectively to Rmb356m, Rmb455m and Rmb564m. Our new profit forecasts represent a three-year CAGR of 24%.
Cut target price to HK$5.50. Huiyuan is trading at 17.9x FY08 PE and 14.0x FY09 PE, as opposed to 20x and 18x respectively for other Chinese beverage companies, such as Tingyi. We attribute Huiyuan’s hefty discount to domestic peers to its lower investment returns and weaker cash flow.
Thus, we cut our target price from HK$7.60 to HK$5.50, based on 10-year DCF valuation (WACC = 10%; terminal growth = 3%). Downgrade from BUY to HOLD with an entry price of HK$4.60.