Synear - Lack of dividends and share buybacks

Challenging outlook. We held a conference call with Synear’s management yesterday. Management shared that the challenging outlook has led them to rethink its competitive and expansion strategy. It also provided details on the company’s cash balance and checks in place for cash movements.

Targeting mid-to-lower-priced products. Weakness in the economy and consumer affordability issues have led management to switch its focus to mid-to-lower-priced products from premium offerings. Pricing in the mid-to-low-end segments is 60-70% below the premium segment, while margins are 5-10% lower. Mid-to-low-end products are priced at Rmb5,000-8000/tonne vs. Rmb20,000/tonne for premium products. Management also plans to continue its aggressive advertising spending on account of intense competition in the industry.

Still spending despite excess capacity. Despite talk of weak economies and the need to conserve cash by not paying dividends, management is going ahead with capex of Rmb400m-500m in FY09 on its new Zhengzhou plant even as weak end- demand has forced the deferment of operations in the new Guangzhou plant.

Meanwhile, capacity utilisation in the newer Chengdu and Huzhou plants remains low, in the 15-20% range. Management also said that production at some factories could be temporarily halted in the seasonally weak 3Q. Construction of the Shenyang production plant and cold-storage warehouses in Shenyang and Wuzhong, on the other hand, has been postponed.

Where’s the cash? Management disclosed that the company’s Rmb845m cash is split almost equally between working capital and fixed deposits. The cash for working capital is placed with China Construction Bank, China Merchant Bank, Shanghai Pudong Development Bank and Guangdong Development Bank, with the finance director, Ms. Cai Hong, being the signatory to move the cash. For amounts exceeding a pre-set limit, the signature of the chairman, Mr Li, is also required. The other half of the cash balance is in a fixed-deposit account with Guangdong Development Bank, and is allocated for capex.

Lack of dividends and share buybacks. Essentially, management said that cash on the balance sheet has been reserved for working capital and capex uses, and is therefore not available for distribution. While receivables and prepayments had ballooned by Rmb414m in 4Q08 as distributors requested for longer credit periods, management claims that it has collected more than half as at end-Feb 09 and believes it can collect the remainder by end-March. However, receivables are likely to remain high in FY09.

Cutting FY09-11 EPS estimates by another 24-37% on the back of lower sales and margin assumptions, and higher advertising expenses.

Maintain Underperform; target price cut to S$0.10 (from S$0.13). Confirmation of continued huge capex spending despite excess capacity, and bloated receivables is bad news. The decision to repeat high advertising expenditure amid the gloom is also baffling. As the cash balance is not likely to be distributed to shareholders, we do not see valuations being supported by a net cash position. With risk aversion to S-chips at a high and a lack of earnings visibility, we have changed our target valuation to 0.2x P/BV from 5x CY10 P/E. Accordingly, our target price has been reduced to S$0.10 from S$0.13. Maintain Underperform.

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