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China Corn Oil Company Limited (1006.HK) - Fast Growing Consumption Ahead

Monday, December 7, 2009

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China Corn Oil Company Limited(1006)

Recommendation on 7 December 2009
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Target Price	$4.470

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Summary

China Corn Oil Company is the largest edible corn oil manufacturer in the PRC during 2006 to 2008 in terms of production volume according to CCOA (Oil & Fats Division), representing 32.4% and 30.6% of total production volume of edible corn oil in the PRC in 2007 and 2008 respectively.

Revenue in 1H09 was down 0.04% yea-on-year, because of the drop in average selling price of branded corn oil and non-branded corn oil in bulk by approx. 40.8% and 46.6% respectively. Yet the net profit decreased by approx. 20% in 1H09, because of the decrease in export sales that has higher profit margin and the full exemption of enterprise income tax no long effective from 2009 onwards.

We think the outlook of corn oil market in the PRC is very bullish in next few years, considering the penetration rate of edible corn oil in PRC versus US as well as the growing size of middle-to-upper class population in the PRC.

12-month target price is HK$ 4.47 and the upside potential will be 16.1% from the upper end of the price range.

Company Description

The company is principally engaged in the manufacture of edible corn oil products for domestic or export bulk sales mainly to other companies engaging in the sale of edible corn oil under their own brands, and domestic sales under their own brand – Longevity Flower in the PRC. Longevity Flower is one of the top three edible corn oil brands in the PRC that contributed for not less than 10% of the total sales volume of all packaged edible corn oil in the PRC in 2008.

As of 1H09, corn oil including bulk sales and branded products accounted for the highest proportion of turnover of 85.2%, followed by corn meal that is commonly used as animals feeds.

The company has put more focus on PRC sales, as the selling price of the products in the export market in 2009 became less appealing than that in the domestic market after the cancellation of the export sales value-added tax refund policy in Jun 2008. We expect the situation will not change in foreseeable future, and actually this will benefit the company since PRC economy is expected to recover at a fastest pace in 2010 compared with other nations. Export sales of total turnover dropped significantly from 30% in 2008 to 1% in 1H09.

Financial Highlights

Revenue in 1H09 was down 0.04% yea-on-year, because of the drop in average selling price of branded corn oil and non-branded corn oil in bulk by approx. 40.8% and 46.6% respectively. Such drop was primarily due to the adverse impact of the financial crisis in late 2008, decrease in consumption demand, and drop in the raw materials prices like corn embryo and crude corn oil.

Yet the net profit decreased by approx. 20% in 1H09, because of the decrease in export sales that has higher profit margin and the full exemption of enterprise income tax no long effective from 2009 onwards.

The indebtedness and liquidity is healthy that its net gearing ratio was substantially dropped from 97.6% in 2006 to 0.1% in 1H09.

Fast Growing Consumption Ahead

US the world's largest edible corn oil producer with production volume accounted for 52.3% of the total global production volume of edible corn oil in 2007, whereas China has become the world's second largest edible corn oil producer with production volume accounted for 9.2%. Edible vegetable oil contains less saturated fats, compared with animal oil. In particular, corn oil that is one of vegetable oil generally has higher polyunsaturated fats or lower saturated fats. Though proportion of corn oil production increased from 0.36% in 2003 to 1.27% in 2007, this ratio was still far less than that in the US of 9.7%. With growing urbanization and rising disposable income in the PRC, we think more consumers will change their diet habits from edible animal oil to healthier edible vegetable oil, similar to what happens in the US. The CAGR of production volume of edible corn oil in the PRC between 2003 and 2007 recorded 43% growth.

Also, China has abundant supply of corn embryos for the development of edible corn oil production which is similar to the US. This help the development of edible corn oil in the PRC as this can stabilize the market price of corn embryos in the PRC and lessen corn oil manufacturers` reliance on the import of corn embryos which in turn lower the procurement costs.

Peers Comparison

Valuation

We estimate 2009E and 2010E EPS to be HK$ 0.22 and HK$ 0.34 respectively. With respect to the indicative price range, this implies 7.47x – 11.2x times 2010E earnings per share. By referencing similar peers in the food sector, we set the reasonable 2010E P/E to be 13x. 12-month target price is HK$ 4.47 and the upside potential will be 16.1% from the upper end of the price range.

Risk

1) Fluctuation in prices and the availability of raw materials

2) Reliance on suppliers to acquire corn embryo

3) Reliance on Shandong Mingda which has been supplying steam and electricity to the company during the track record period

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