China Animal Healthcare: The Privileged Animal Drug Manufacturer

Leading animal drug manufacturer. China Animal Healthcare (CAL) manufactures and distributes: (i) powdered animal drugs; (ii) injection animal drugs; and, (iii) biological animal drugs, ie vaccines in China.

1st non-SOE licensed to manufacture animal Hand-Foot-Mouth (HFM) disease vaccine. We expect CAL to grab 20% of China’s HFM vaccine market when its 60%-owned Bewei Antai commences production end 2009, which will boost Group’s earnings by c. 45% from FY10 onwards. The market size of animal HFM vaccine in China is expected to reach RMB1.8-2.0b in FY09.

China was the largest consumer of pork in 2008, consuming over half of global total or > 33kg per capita a year, according to USDA. As one of the biggest manufacturers of powdered animal drugs, CAL is well positioned to ride on the booming demand for meat products, buoyed by rising Chinese residents’ affluence.

Initiating coverage with BUY, Price Target S$0.27, based on 10x FY10 P/E, which is pegged to its closest peer and backed by 45% earnings growth expected in FY10. The counter is now trading at 5.1x FY10 P/E, which is >70% discount to peers’ average.

Risks. The Group’s earnings growth in FY10 is highly dependent on the successful launch of HFM vaccine. Hence, downside risk mainly lies in the ramp-up of the new plant.

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S-Chips - Who could be next?

Who could be next, after China XLX? Speculation is widespread post China XLX’s proposed dual listing in HK, possibly in search of better valuation. We attempt to uncover possible names.

Better valuation is key motivator. FTSE China Index has historically traded at an average of 47% discount to Hang Seng CEI (pg 2 chart). But, with valuation gap running as high as 40% and 70%, companies with equally bright prospects and good earnings visibility will find it attractive to list in HK, if depressed valuations do not fairly reflect the underlying assets or potential. Hence, good quality companies would gravitate towards exchanges that offer them the best valuations and investor reception.

Most S-shares would pass financial criteria of HK listing. Most S-shares under our coverage, by virtue of their listing status in Singapore, will probably meet the criteria by HKSE. (see appendix for financial criteria). Other key criteria to clear are accounting standards, jurisdictions, minimum market cap (>HK$200m) and public float (>25%). Epure and China Hongxing likely candidates to venture out.

Epure has a proven track record of earnings delivery to attract interests in HK/ China, where environmental themes are well received by investors. Besides, Epure’s management is familiar with China’s listing. China Hongxing’s huge discount of 70% vis-à-vis HK peers, coupled with its low ex-cash PE of c.1.5x and a net cash of 17.6cents/share looks compelling, in our view.

But not without risks/hurdles. While the benefits of dual listing/ privatization and relisting look appealing, hurdles to consider include the ability to secure funding for privatization, and the ability to relist at a premium thereafter. Companies with dual listing may also need to contend with managing different set of shareholders and the added cost of duplicate listing.

Cosco - still struggling ahead

Another quarter of disappointment: Net profit of S$37 (-71% Y/Y) for 2Q09 was 26% below our and consensus estimates, with no clear sign of earnings recovery ahead due to on-going weak execution, in our view. Reversal of a previous bad debt provision at Cosco Shipyard Group amounting to S$25.9MM provided a ~S$13.2MM boost to group net income. Interest income rose 6 times on higher borrowings. Total borrowings of S$1.2B were almost double the S$657MM at end-2008 as the company geared up to fund yard expansion and make up for the mismatch in liabilities duration when it previously funded yard capex with customer advances. Net cash now stands at S$672MM, and customer advance payment is at ~S$2.4B.

Newbuilding effectively unprofitable for now: Management guided that gross margin for newbuilding for 1H09 was at 1% as a result of still less than optimal execution. 11 vessels will go on sea trial soon and are expected to be delivered this year, comprising 3 for third parties owners and 8 for China Cosco. Management highlighted that it does not expect further cancellation from China Cosco post the recent cancellation of 8 vessels and the amendment of delivery schedule for 3. 39 vessels are underconstruction.

Shipping contributed major part of earnings: Earnings from the 12 dry bulk vessels contributed about 42-43% of the company’s net income with 8vessels on short-term charter, 3 on spot charter and 1 expected to come off its previously locked-in high charter rates in August.

Do not expect major offshore surprises: As Cosco is still unable to perform turnkey rig-building, participation in potential Petrobras pipeline will be indirect via contracts like hull construction similar to the Sevan 650.

Reduce Jun-2010 SOTP PT to S$0.66 as we trim our 2010 and beyond gross margin assumption for conversion to 18%, offshore to 15% and newbuilding to 8%, cutting earnings estimate by 35%/28%/17% for FY09E/FY10E/FY11E. The current order backlog of 100 dry bulk vessels may continue to pose a drag to its operational efficiency and earnings as it continues to struggle to move up the learning curve. Maintain UW.