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Morningstar | Despite 26% Profit Growth, Tingyi's 3Q Result Lower Than Expected; Cutting FVE to HKD 11. See Updated Analyst Note from 27 Nov 2018

No-moat Tingyi’s third-quarter results came in below our projections, with revenue and EBITDA down 4.2% and up 0.7% year on year, respectively, owing to weakened consumer sentiment from the ongoing U.S.-China trade tensions as well as escalating competition in the beverage segment. Despite its leading position in the instant noodle and tea drink markets, Tingyi underperformed the industry averages and saw market share erosion to its direct competitors during the quarter, as the traditional sales channel, which was the company’s strong advantage, no longer drives top-line growth.

While we maintain our no-moat and stable trend ratings, we are trimming our fair value estimate to HKD 11 per share from HKD 13 as we reduce our revenue growth and gross margin forecasts and account for the negative impact from the depreciation of the yuan against the Hong Kong dollar. We reduce our five-year revenue compound annual growth rate to 5% from 6% previously and average gross margin to 30.9% from 32.1%. Operating income and net profits are expected to grow 12.8% and 16% per year, respectively, through 2022. We view the shares as fairly valued relative to our new fair estimate following a big price drop due to the disappointing result.

Tingyi seems to be having difficulty sustaining its strong 8.5% top-line growth of the first half, as revenue decreased 4.2% to CNY 18.86 billion in the third quarter, below our 8.4% full-year growth forecast. On the mix front, the instant noodle business grew 0.7% year over year to CNY 6.75 billion.

The growth momentum from high-priced noodles slowed to a low-single-digit rate compared with high-single-digit growth in the first half. In addition, 12.5% sales declines in mid- to low-priced noodles weighed on the business. For the first three quarters, Tingyi’s 5.3% revenue growth in the instant noodle business fell behind the industry’s 8% sales growth, according to Nielsen data. Market share dropped from 50.2% a year ago to 47.6% by the end of third quarter. That said, management is still confident in its instant noodle business going forward, given more product mix upgrades amid the premiumization trend.

The beverage business experienced more pressure from the slowing economy growth, as sales dropped 6.5% year on year to CNY 11.75 billion, down from 9% growth in the first half. We believe the weak performance was also affected by the price hikes, as the distributors have overly prestocked shipments while the market is still digesting the inventory. Although the carbonated and other drinks segment grew strongly at 18%, sales from tea drinks, bottled water, and juice declined 5.9%, 36.5%, and 16.7%, respectively. For the first three quarters, Tingyi’s 2.6% revenue growth in the beverage business was below the industry's 4.3% growth. Meanwhile, its market share of tea drinks was 37.5% versus 41.1% the year-ago quarter.

On the positive side, profitability continued to improve during the quarter. Gross margin rose 87 basis points from a year earlier to 33.4%, driven by better product mix and higher average selling prices, despite costs of raw material such as PET resin and paper material maintaining at a high level. As a result of the increased gross margin and continuing cost control, the operating expense ratio was down 70 basis points from the prior year to 19%. Operating profit and EBITDA rose 4.8% and 0.7% year on year, respectively, to CNY 2.71 billion and CNY 3.44 billion. Operating profit and EBITDA margins were up 1.2 and 0.9 percentage points, respectively.