People's Food : Downgrade to SELL

Declining ASPs and gross margins in 1Q09. In anticipation of further pork price decline, several PFH's commercial customer reduce their purchase volume, together with lower ASPs, turnover from the frozen pork recorded 32% yoy decline in 1Q09. Although ASP for the fresh pork also faced downward pressure, thanks to the pick up of sales volume, turnover for the fresh pork achieved 12% yoy growth in 1Q09. Sales for the downstream products (HTMP and LTMP) both experienced decrease due to lower ASP as a result of fierce competition. The lower hog price helped gross margin for the downstream products, as HTMP and LTMP improved by 2.4ppt and 8.6ppt respectively in 1Q09 on the year-on-year basis. However, lower gross margin for the upstream products, which contributed 52% of total turnover (vs. processed meat products' 32%) , dragged down the overall gross margin by 1.9ppt in 1Q09.

Fall behind its peers in 1Q09. According to Henan Shuanghui's (000895 CH) 1Q09 results, turnover declined 6.7% yoy due to lower ASPs which is in tandem with lower hog price. However, lower raw material cost was translated into higher margins, resulting gross margin expanding by 4.2ppt from 7.5% in 1Q08 to 11.6% in 1Q09. China Yurun (1068 HK) didn't not release the 1Q09 results, but management gave positive guidance that its slaughtering volume grew by no less than 30% yoy and sales volume of its LTMP products rose by over 20% yoy in 1Q09. Considering PFH's lower utilization rate (35.1% in 1Q09 vs. 43.9% in 1Q08) for its slaughtering business and contracted gross margin, we believe that PFH has limited pricing power and is losing market share to its peers.

2Q09 might be even worse. Wholesale pork price has declined for consecutive 15 weeks to Rmb14.4/kg in the second week of May, downing 34% yoy. This downward trend will continue in 2Q09, which will further put pressure on PFH's ASP and gross margin. Other than the lower disposable income which restricts consumer' spending power, several negative news, such as the food safety concerns and H1N1 flu spreading also have negative impact on the pork consumption. As such, management guide that gross margin in 2Q09 might be even lower than that of 1Q09 (6.4% in 1Q09).

Pig farm project post further downside risk. PFH intends to expand its upstream business by investing approximately Rmb2b to build several pig farms with land area of approximately 4.7m sqm in the following five years. The first site of the stage I is near completion and a batch of pig breeders was purchased. This will offer quality and stabilized supply for the company in the long-term. However, considering that the ratio of hog unit price to corn unit price have already been lower than 6:1, the breakeven point, in 36 big and middle-sized cities and some cities have already showed loss for pig rearing, we concerns that the pig farm project might drag down the company's profit.

Downgrade to SELL. We cut our earnings forecast by 28.5-48.3% fro FY09-11 to factor in our lower ASP and lower gross margin assumptions. Downgrade to SELL with fair price of S$0.55, which is based on 8.5x FY09 PE (70% discount to China Yurun's 12.2x FY09 PE).

Sponsored Links