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Morningstar | Haitian's 2Q Results Beat Our Forecasts; Raising Our FVE to CNY 48, but Shares Remain Expensive. See Updated Analyst Note from 15 Aug 2018

Wide-moat Foshan Haitian Flavouring and Food, or Haitian, reported robust second-quarter results that were slightly ahead of our forecasts, with revenue up 17.5% and net income up 23.5% year on year, driven by strong sales volume growth in soy sauce and oyster sauce segments, coupled with gross margin expansion.

We lift our fair value estimate by 3% to CNY 48 per share from CNY 46.50, as we revise up our full-year 2018 revenue growth and gross margin forecasts, as well as the time value of money, partially offset by higher average operating expense projections. We maintain our wide moat and stable trend ratings, and believe the company's leading position in China's condiment market will be strengthening with further market share gains in the longer term. That said, we think the shares are overvalued at current levels, trading at 1.43 times price/fair value estimate and 44 times price/earnings ratio.

Revenue came in at CNY 4.03 billion, up 17.5% year on year, which was higher than our 14% forecast. We attributed the outperformance to higher average selling price due to faster sales growth in the high-end products and strong volume growth through expanding distribution networks, such as high-end caterings and increasing its shelf spaces. Meanwhile, we expected sales from the soy sauce and oyster sauce segments growing 15% and 20% year on year during the quarter. We are confident that the company will be able to meet management's 16% sales growth target for 2018, after a strong growth in the first half.

On the bright side, Haitian's gross margin improved 2.5 percentage points from the year-ago quarter to 47.6%, a record high. This improvement was higher than we anticipated. We attributed this to product mix improvement, increasing productivity efficiency, and lower raw material costs. As we expected, the accelerating premiumization trend has helped the growth of its premium products, given high-end soy sauce sales grew more than 20% year on year and the sales contribution continues to increase. Moreover, lower sugar price also helped the margin hikes, while the negative impact from the higher packaging costs has eased. As a result, we raise our five-year average gross margin assumption to 47.4% from 46.8% previously.

Given the improving gross margin, the company increased its operating expenses, with selling expense ratio and administrative expense ratio rising 36 and 37 basis points year on year, respectively, to 13.9% and 4.8%. The advertising and promotional costs increased 20% from prior year. Thus, we revise up our selling, general, and administrative costs ratio to 17.9% from 17.6% previously to account for higher than expected operating expense ratio going forward. The 24.7% operating profit growth was higher than our 14% projection, with operating profit lifting 1.8 percentage points year on year to 24.7%.