China Hongxing - Changed Fron Usual Optimism To Caution

While 4Q ‘08 sales of RMB857.3mln (+28% yoy and +23% Due to the weak global economic environment which qoq) did not disappoint, gross margin fell a disappointing will likely negatively impact consumer demand, 2% point yoy and 4% point qoq due to bigger than expected management has turned from their usual optimistic product discounts given to their distributors and retailers.

outlook to one of caution and warns that the near term market condition is expected to be challenging. 4Q ‘08 pretax profit was also hit by an unexpected big forex loss of RMB23.653mln, up 265% yoy and offsetting At the results briefing this morning, management said that first 9 months of forex gain of RMB11.906mln. Due to same store sales growth in 4Q ‘08 averaged only 17% in the expiry of tax exemption status of certain subsidiaries, 4Q08 versus the usual 25-30% and recovered slightly to tax rate rose from 14.3% a quarter ago and 6% a year 20% in Jan ’09, but growth have since declined sharply to ago to 17.8%.

only 10% in Feb ’09, reflecting the very cautious consumer sentiment in China. And with 4 months worth of As a result, 4Q ‘08 net profit (-30% yoy but up 4% qoq to inventories, management would be monitoring the sales RMB110mln) came in about 10% below expectations. This trend closely so as to control obsolescence risks. would be the company’s first quarterly yoy profit decline since listing.

So far the prepayment milestones have been on track, collecting about RMB30-70mln a month, but given the But trade receivables rose 82% sequentially versus only same store sales slowdown experienced in Feb ’09, we 23% qoq increase in sales, straining its working capital. would monitor collections closely going forward. The increase in trade receivables of RMB216mln resulted Management targets to recover the RMB1.16bln by in negative operating cash flow of RMB24mln, up from 1H2010.

RMB9.5mln last year. After capex of RMB27mln and repayment of loans, cash holdings fell from RMB2.059bln Capital expenditure is expected to be around RMB120mln to RMB1.982bln. in 2009, down from RMB178mln in 2008 which the company is able to finance comfortably with their cash The company also disappointed by skipping their final holdings of RMB1.982bln.

dividend payment versus RMB2.2 cents last year and RMB1.5 cents during the interim. If they had maintained As a result of management’s warning of very challenging final dividend, full year yield would have been 4%. near term business conditions, we are reducing our 2009 profit forecast from RMB 500mln (consensus is currently Management said that while the company is currently well at RMB520mln) to RMB404mln, which implies a 10% capitalized with cash of RMB1.982bln versus little debts, decline from 2008’s RMB449mln.

the challenging and uncertain near term business outlook means that the board deems it more appropriate to be While valuation is not demanding (87% of its share price prudent to keep as much cash in the company as possible. backed by cash, 0.6x price to book and 5x trailing PE), we 2008 payout ratio is only 10% and the company does not believe the stock will not be able to perform given have a dividend policy at the moment, and would review management’s warning about the very challenging near this on a half yearly basis. term business outlook, negative suprise on the final dividend payment and rapidly weakening same store sales growth. We downgrade to HOLD.

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