Synear Food - Time needed to make a meaningful turnaround

Expect flat sales volume; margin pressure to ease slightly in 2Q09. Synear’s volume growth in 2Q09 is largely flat, reversing previous quarters’ downtrend, but momentum should improve in 2H09 partly due to the lower base in 2H08. As 3Q is traditionally a low season for the frozen food industry, a meaningful turnaround for Synear might only take place from 4Q09 onwards. The lower input cost will help offset some of the negative effects of a shift in product mix towards mid-tier to low-end products. As such, Synear’s gross margin might be flat or slightly wider in 2Q09.

Utilisation rate remains low. Utilisation rates for Synear’s Chengdu and Huzhou plants are expected to reach 20-30% for 1H09, improving slightly from that in 2008 (20% and 15% for the Chengdu and Huzhou plants respectively in 2008). However, the utilisation rate of the Zhengzhou plant has dropped significantly from a historical average of over 80% to about 50% in 1H09. Management attributes this decline to weak demand and production redistribution at its existing plants as Synear transfers some of orders from its Zhengzhou plant to the Huzhou and Chengdu plants.

Capacity expansion. The Guangzhou plant’s building has been completed and its machinery has been installed. However, operations will not commence so soon given weak demand and existing plants’ lower utilisation rates. Synear has also cancelled the construction of new production facilities in Shenyang so as to keep more cash in hand. Given Synear’s long operating history and strong ties with local suppliers in Zhengzhou, Henan province, management has decided to continue with the construction of its new Zhengzhou plant, which is scheduled to be completed by end-10. Long-term outlook still bright due to the following:

• Increasing expenditure on frozen food. Frozen food consumption per capita in China is only 8kg, much lower that that of developed countries: 60kg in the US, 30kg in Europe and 20kg in Japan. In view of the continuous rise in disposable income, growing awareness of food nutrition and hygiene and accelerated urbanisation, the gap is likely to narrow in the near future.

• Continuing with exploration of commercial market. Synear plans to launch a new dessert, Donut, with KFC in the near future. Although we do not expect this new product to perform superbly in the near future, we see huge potential as it can smooth out the seasonal fluctuations for traditional frozen food products and give the company a new income stream.
• Enhancing brand equity. In 2009, Synear was elected one of “China’s 500 Most Valuable Brands” for the sixth consecutive year by World Brand Laboratory. Synear’s brand value also increased 8.6% from Rmb4.1b in 2008 to Rmb4.5b in 2009, much higher than its peers’ (eg Sanquan was ranked 312th with an estimated brand value of Rmb2.4b in 2009).

Although a meaningful turnaround might only take place from 4Q09 onwards, Synear’s current valuation is reasonable as the stock is trading at a 34% discount to Singapore- and Hong Kong-listed food and beverage counters. We maintain our HOLD recommendation but raise our fair price from S$0.23 to S$0.27, which is based on 10x 2010 PE. Our entry price is S$0.21.

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