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Morningstar | Raising Haitian’s FVE to CNY 56 on Higher Profit Growth Forecast, but Shares Overvalued

Wide-moat Foshan Haitian Flavouring and Food’s 2018 EBITDA of CNY 5.51 billion and net profit of CNY 4.36 billion were ahead of our forecasts (CNY 5.28 billion and CNY 4.2 billion), owing to better-than-expected revenue growth and operating margin. We are raising our fair value estimate for Haitian to CNY 56 per share from CNY 49.50 after taking account into higher profit growth forecast over the next five years. This fair value estimate implies a forward P/E of 30 times and a dividend yield of 2%. We maintain our wide-moat rating and expect the company will strengthen its leadership in the condiment market and continue to gain market shares from other smaller peers amid the consolidating industry trend, bolstered by its cost advantages and intangible assets. That said, we think the shares are unattractive at current levels, trading at a 46% premium to our fair value estimate.

As sauces are only accounting for a small portion of catering expenses, we think the condiment industry is less sensitive to the slowing economic growth and expect it will grow slightly faster than the catering market. The promising revenue growth from Haitian’s soy sauce and oyster sauce segments surprised us. Management was optimistic about its growth and guided for a strong outlook for 2019, with revenue and net profit expected to grow 16% and 20% year on year, respectively. We are more confident that the company’s strong growth in the soy sauce and oyster sauce segments will be sustained longer than we previous anticipated. Thus, we revise up our revenue growth forecast in the medium term and anticipate its revenue to grow at a CAGR of 11.2%. On the segment front, we expect the soy sauce, oyster sauce, and dipping sauce segments to grow at CAGRs of 11%, 13.5%, and 8%, respectively.

We also increase our projections for the average operating margin to 30.3%, from an average of 29.5% previously. We think the margin improvement will be sustainable, mainly driven by higher gross margins on the back of better product mix and the positive outcomes from the economies of scale, while the operating expense/sales ratio remains largely unchanged compared with 2018. Our five-year operating profit growth is 11.7% per share through 2023.

Revenue in 2018 was up 16.8% year on year to CNY 17 billion, slightly higher than we expected, mainly stemming from volume growth, as the average selling prices were nearly flat compared with 2017. This implied the fourth-quarter revenue growth remained strong at 15.6% from the year-ago quarter. The company has the largest sales distribution network in China, and it covers almost 100% of tier-1 to tier-3 regions. In order to drive its top-line growth in the longer term, management plans to expand its sales channel depth in the lower-tier markets. Meanwhile, online sales also grew rapidly at 46% from last year, but only accounted for a very small portion (less than 2%) of total sales. The production capacity was close to fully utilized to nearly 2.8 million metric tons due to its strong growth. The company expects the new capacity addition in the Kaoming and Jiangsu plants will be ready to ramp up later this year or early 2020.

Haitian’s largest business soy sauce revenue, accounting for 60% of total sales, grew 15.9% year on year to CNY 10.2 billion, underpinned by 15% volume growth and 0.9% increase in average selling prices. Oyster sauce segment had a great year in 2018 and revenue went up 26% from last year to CNY 2.86 billion, with volume and ASP up 25% and 1%, respectively. Dipping sauce sales grew 2.6% year on year to CNY 2.1 billion.

Gross margin increased 78 basis points from 2017 to 46.5%, mainly owing the lower production costs per ton and better product mix toward higher-end products. We reckon the production costs per ton for soy sauce, dipping sauce, and oyster sauce segments went down 1.1, 4.7, and 1.9 percentage points from last year, which reaffirm our view on company’s cost advantages will continue to boost its profitability. As a result, the gross margin for the soy sauce, dipping sauce, and oyster sauce segments improved 102, 237, and 178 basis points, respectively. The upbeat operating margin was the biggest surprise to our expectation, as It increased 150 basis points year on year to 29.9%, which was 80 basis points higher than our forecast. This was attributable to management’s effective cost control and the positive effect from developing a large, mature sales network, the selling expense/sales ratio dropped 29 basis points to 13.1%, due to a lower fixed cost/sales ratio.