Synear Food - Expect flat gross margin in 2Q09

Stagnant sales in 2Q09. Given fierce competition and weak demand, Synear did not raise its ASP in 2Q09. Although the company continued to launch new products with higher margins, the blended ASP for Synear in 2Q09 was continuously under pressure as more sales were generated by mid-tier to lowend products. Despite the low base of comparison caused by the Sichuan earthquake in the previous year, sales volume for Synear was still disappointing, which resulted in a decrease in turnover growth by over 20% yoy in 2Q09. Since 3Q is traditionally the low season for the frozen food industry, a meaningful turnaround for Synear might take place only from 4Q09 onwards.

Expect flat gross margin in 2Q09. The gross margin pressure in 1H08 is no longer a major challenge this year as most input prices have been on a downtrend since 1Q09. The lower input cost will help to offset some of the negative effects from a shift in product mix towards mid-tier to low-end products. However, as Synear’s raw material purchases are based on wholesale prices, which experience fewer fluctuations than retail prices, Synear is not expected to benefit significantly from the raw material price corrections. Together with the seasonal effect (due to the Dragon Boat Festival, 2Q is a peak season for selling rice dumplings, which command higher margins than the savoury dumplings and glutinous sweet dumplings), Synear is expected to record flat or slightly wider gross margin in 2Q09, compared with 1Q09.

Net profit decline might continue in 2Q09. In order to boost sales and maintain its market share, Synear’s marketing expenses remained at a high level even after the Beijing Olympic Games. The percentage of selling and distribution expenses over turnover in 2Q09 might be higher than that in 2Q08, partially due to the lower turnover growth. Operating margin expansion was unlikely in 2Q09 as the utilisation rate for its two new plants (Huzhou and Chengdu) lingered at 20-30% levels, and the utilisation rate for its Zhengzhou plant dropped significantly from a historical average of over 80% to approximately 50% in 2Q09. The decrease in turnover growth, high operating expenses and low utilisation rate will cause Synear to experience another 30-40% yoy earnings decline in 2Q09.

Maintain HOLD on Synear Food. Although a meaningful turnaround might only take place from 4Q09 onwards, Synear appears to be reasonably valued as it is trading at a 40% discount to Singapore- and Hong Kong-listed F&B counters. Synear’s strong brand name, nationwide distribution channel and leadership position also support its long-term growth potential. Maintain HOLD with a fair price of S$0.27, based on 10x 2010 PE. Entry price is S$0.21.

Sponsored Links

Pine Agritech - Gross margin remains low despite lower input cost

Sales decrease continued in 2Q09. Due to the decelerating economy, consumers cut their discretionary spending on healthcare products, which resulted in Pine encountering weak demand and sales decline across all product categories in 1Q09. We expect this downward trend to continue for most of Pine’s products in 2Q09 (except its SPI product). Benefitting from the recovery in overseas demand, the utilisation rate of Pine’s SPI product was expected to improve from 42% in 1Q09 to approximately 50% in 2Q09, but still lower than its historical level of over 60%, as demand in the domestic market remained weak. Sales of its soy oligosaccharide syrup (SOS) products were still disappointing.

The utilisation rate for this product was hovering at low levels in 2Q09, probably reaching the same level as that in 1Q09 (6%), which was significantly lower than 44.7% in FY07 and 12.1% in FY08. The poor sales of SOS were within our expectation and we do not expect sales to rebound quickly, considering that consumers are cutting their discretionary spending. Moreover, since 4Q08, Pine has scaled back its advertising and promotional (A&P) campaigns in order to reduce operating expenses, which also caused the slowdown in SOS sales, given the current depressing market atmosphere and Pine’s weak brand recognition.

Gross margin remains low despite lower input cost. In line with the decrease in commodity prices, soybean cost for Pine fell by 15-20% yoy in 2Q09. The lower input cost, together with higher demand from the overseas markets which command higher ASPs as well as higher margins, will help Pine to increase the gross margin of its SPI products in 2Q09, to some extent. However, the collapsed sales of SOS would drag down the company’s overall profitability, causing Pine’s gross margin to be flat compared to 1Q09 (8.0% in 1Q09), lower than the 23.8% registered in 2008 and 20.5% in 2Q08.

High probability of recording a loss in 2Q09. Pine reported a net loss of Rmb22.6m in 1Q09. Although sales volume and gross margin for its SPI product would see some improvement in 2Q09, this will not boost Pine’s sales and net profit. The plunge in SOS sales, lower gross margins and heavy CBsincurred financial burden will further drag down its earnings, leading to a high probability that Pine might record a loss again in 2Q09.

Reiterate SELL on Pine Agritech. The net loss in 1H09 reflected the tough operating environment for the Group and we expect it to be the same in the near term. International soybean price has jumped 60% from its lowest point in 2008. Together with the probability of an output reduction in North China, domestic soybean price has continued to rebound since Jun 09. This will put further pressure on Pine’s profitability in the next few quarters. Pine’s earnings remain at risk as the demand for health products may continue to fall. Reiterate SELL. Our DCF-based fair price is S$0.06 (cost of equity of 17.4% and terminal growth rate of 3% on a 10-year horizon).

People Food - Pork price bottoming out might help margin recovery in 2H09

Top-line growth still under pressure. In tandem with the declining hog price, Pfood experienced an ASP decrease for the majority of its product categories in 1Q09. Utilisation rate reached only 35.1% in 1Q09 as the company tried to reduce its high-cost frozen pork inventory, given the sharp drop in hog prices. As hog supply continued to pick up in 2Q09, which caused hog price to fall further, we did not expect Pfood’s utilisation rate to improve drastically in 2Q09. Moreover, the downward pressure on Pfood’s ASPs still exist, especially without the Chinese New Year effect in 2Q09, when compared with 1Q09.

Pork price bottoming out might help margin recovery in 2H09. Affected by the accumulation of frozen pork by the central government and feed price increase, domestic pork price rebounded from the bottom in Jun 09, but remained at a relatively low level. Pfood’s management expects sales and margin improvement in 2H09, backed by hog price recovery.

Expect poor 2Q09 results. Gross margin contraction for upstream products might continue in 2Q09 as hog price continues to decline. Although a lower hog price will lift the gross margin for downstream processed meat products to some extent, given that upstream products contributed more than half of the Group’s gross profit, we expect Pfood’s gross margin to be even lower in 2Q09 than 1Q09. Other than the lacklustre turnover growth and contracted margins, losses from its associates, including Pine Agritech, also dragged down Pfood’s net profit in 2Q09. Thus, we expect Pfood to record another 60-70% yoy earnings decrease in 2Q09.

Maintain SELL on People’s Food. Pfood is on the path of an upstream integration to tap into hog farming. The first stage target is to raise about 40,000 heads by end- 10, which can meet approximately 10% of the Group’s slaughter demand. Considering the fluctuations in the profitability of rearing pigs and the risk of an outbreak of pig illness, we are concerned that the pig farm project might drag down Pfood’s profit. The operating environment for Pfood is still challenging, and it takes some time for the Group to experience a recovery and boost its pricing power. Maintain SELL on Pfood with a fair price of S$0.55, based on 8.5x FY09 PE and a 30% discount to China Yurun’s 12.2x FY09 PE.