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Uni–President China Holdings Ltd. (220.HK) -Drop in earning for 1H08 due to significant foreign exchange loss

Tuesday, December 2, 2008

5390

Uni–President China Holdings Ltd.(220)

Recommendation on 2 December 2008
Recommendation	BUY
Price on Recommendation Date	$1.770
Target Price	$3.070

Weekly Special - 9618 JD.com

Summary

Beverage segment remains the profit driver of the group.--

For the six months ended 30 June 2008, revenue from juice drinks amounted to RMB 1,232.8 million, and revenue from tea drinks reached RMB 2,159.8 million.

Instant noodles segment still at loss --

Revenue from instant noodles recorded RMB 1,306.6 million in the first half of 2008. We would expect the instant noodles segment start to make profit in next year because of the continuous shift of product portfolio from low end to mid to high-end market.

Better performance ruined by foreign currency loss --

As most of the Group entities` functional currency is RMB, and RMB has strengthened by 6% against USD during the period under review, this has resulted in a net foreign exchange loss of RMB127.8 million for the six months ended 30 June 2008

Improvement in Gross profit margin during rising raw material price

Establishment of Joint venture company in Guilin –

Valuation--

Our DCF-based target price is HK$3.07 Buy.

Beverage segment remains the profit driver of the group

For the six months ended 30 June 2008, revenue from juice drinks amounted to RMB 1,232.8 million (first half of 2007: RMB 1,440.6 million), representing a decrease of 14.4% for the same period in the previous year, accounting for 24.5% of the Group`s total revenue. Revenue decreased in the first half of 2008 largely because sales for larger pack juice drinks products generally peak during the Spring Festival but the largest snowstorm in 50 years had significantly reduced the number of people returning home during the Spring Festival. As a result, consumption of large pack fruit juices decreased, resulting in temporary fall in our results.

The product diversification sales strategy, implemented since 2007, meant that besides focusing on the main product of the ”More” brand of orange juice drink (鮮橙多), the “More” brand of peach juice drink (蜜桃多) also became a new major promoting flavor. After a year of strong promotion, the “More” brand of peach juice drink has secured a leading position in first-and second-tier cities in the PRC. In addition, ready-to-drink quality tomato juice products have been promoted in major coastal cities since 2008 and have been well received by the market, which allows the Group to tap into the healthy consumer diet market.

For the six months ended 30 June 2008, revenue from tea drinks reached RMB 2,159.8 million (first half of 2007: RMB 1,616.8 million), representing an increase of 33.6% from the same period in 2007. To support the increased penetration of the Group`s sales network, Uni-President tea drinks (including its green tea and “Iced” brand) were advertised during primetime on CCTV from March to June 2008 and the awareness of such products increased. Revenue from the “Iced” brand performed well with an increase of 42.1% in the first half of 2008.

Instant noodles segment still at loss

Revenue from instant noodles recorded RMB 1,306.6 million in the first half of 2008, a slight increase from the RMB 1,139.5 million for the same period in 2007, accounting for 25.9% of the Group`s total revenue. In face of the continuing increase in price of raw materials, the Group has insisted on devoting and accelerating the optimization and adjustment of its products mix, and shifting to introducing high value products. During the period under review, the sales portfolio of instant noodles changed significantly. Increase in revenue from the “Gan Cui Mian” (干脆麵), “Lai Yi Tong “ (來一桶) and “Qiao Mian Guan “ (巧麵館) brands has offset the decrease in revenue from the “Good Economy “ (好勁道) brand. The shift in emphasis to sales of mid and high priced brands has helped to alleviate the impact of higher costs of raw materials. After the introduction of the “Qiao Mian Guan “ (巧麵館) brand in Central China at the end of last year, sales for the first half of 2008 was satisfactory. As the sole sponsor of instant noodles for the 2008 Beijing Olympic Games, the Group conducted a series of Olympic related activities in the first half of the year by giving out Olympic Games tickets as gifts for consumers. The focus of such promotional activities was our bowl noodles, with the aim of increasing the proportion of sales of middle to high priced bowl noodle products in order to achieve optimization of our product mix. We would expect the instant noodles segment start to make profit next year as the continuous shift of product portfolio from low end to mid to high-end market.

Better performance ruined by foreign currency loss

For the six months ended 30 June 2008, the Group recorded revenue of RMB 5,036.7 million, representing growth of 13.1% from RMB 4,453.2 million for the same period in 2007. Revenue from our instant noodles and beverage products amounted to RMB 1,306.6 million and RMB 3,713.9 million respectively, representing an increase of 14.7% and 13.0% respectively, as compared with the same period in 2007 and accounting for 25.9% and 73.7% respectively of the Group`s total revenue. However, as most of the Group entities` functional currency is RMB, and RMB has strengthened by 6% against USD during the period under review, this has resulted in a net foreign exchange loss of RMB127.8 million for the six months ended 30 June 2008 (compared to first half of 2007 where net foreign exchange gain was RMB5.7 million) from recognized assets of the Group denominated in USD and HKD, such as cash and cash equivalent and other current financial assets. As a result, profit attributable to equity holders of the Company decreased by 18.4% to RMB212.2 million (RMB260.1 million for the same period in 2007). Management has undertaken a variety of measures to mitigate foreign currency risk, including but not limited to import of equipment and raw materials from overseas market directly and lending foreign currency funds to domestic subsidiaries. During the period under review, earnings per share were RMB5.90 cents (first half of 2007: RMB8.67 cents). Excluding the foreign exchange losses, the Group has had a strong performance during the period under review.

Improvement in Gross profit margin during rising raw material price

During the period under review, gross profit increased by 16.4% to RMB 1,729.8 million and gross profit margin rose to 34.3% from 33.4% for the same period in 2007.

Growth of revenue for the period reflects significant increase in tea drinks operation and market share of the Group, success of the Group`s strategy in focusing on the development of the beverage business, which generally supports higher margins, and successful implementation of effective cost control measures, offsetting rising raw material prices, resulting in increase in overall gross profit.

Establishment of Joint venture company in Guilin

The Group has agreed to, through a wholly owned subsidiary, establish a joint venture company (the “Joint Venture Company”) in Guilin, the PRC, with Shanghai Ziquan Beverage Co. Ltd. (“Shanghai Ziquan”) to engage in the production of PET bottled beverage products for the Company. Upon establishment, the joint venture company will be owned 45% by the group and be owned 55% by Shanghai Ziquan. The Company and Shanghai Ziquan will each contribute US$4.05 million and US$4.95 million respectively, to the registered capital of the Joint Venture Company. Shanghai Ziquan is a joint venture enterprise established in the PRC and is a subsidiary of Shanghai Zijiang Enterprise Group Co. Ltd., a company whose shares are listed on the Shanghai Stock Exchange. The main business of Shanghai Ziquan is the research and development of hot-filling beverage products.

We would take positively towards the group to establish the joint venture company for the production of PET bottled beverage products for the group. We would expect the gross profit margin of beverage segment could be easier to maintained or improved.

Risk factors

--Fierce competition in Beverage Market

--Uncertainty in raw material price

--Heavily reliance on beverage segment to generate profit for the Group

Valuation

Our DCF-based target price is HK$3.07 with assumption of 3% terminal growth rate and 20.4%WACC is also assumed. We lowered our target price due to the expected decreasing revenue growth. At our DCF-based target price, which suggests a potential 73.4% upside, Uni-President would trade at a 2008E P/E of 11x, 2009E P/E of 8x and 2010E P/E of 6x.

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Author

Uni–President China Holdings Ltd. (220.HK) -Drop in earning for 1H08 due to significant foreign exchange loss

Summary

Beverage segment remains the profit driver of the group.--

Instant noodles segment still at loss --

Better performance ruined by foreign currency loss --

Improvement in Gross profit margin during rising raw material price

Establishment of Joint venture company in Guilin –

Valuation--

Beverage segment remains the profit driver of the group

Instant noodles segment still at loss

Better performance ruined by foreign currency loss

Improvement in Gross profit margin during rising raw material price

Establishment of Joint venture company in Guilin

Risk factors

--Fierce competition in Beverage Market

--Uncertainty in raw material price

--Heavily reliance on beverage segment to generate profit for the Group

Valuation

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