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Morningstar | WH Group Jumps on Trade Truce News; Upside to Our FVE of HKD 8.10 Remains Attractive

Narrow-moat rated WH Group jumped more than 11% following news of a trade truce between the U.S. and China, and we think the movement mainly reflects reduced risk of additional import tariffs on U.S. pork by China rather than any tangible change to the company's fundamentals. With hog futures prices already recovering in the fourth quarter on anticipation of a rebound in exports of pork to China, this trade truce has little impact on our earnings and cash flows projections on WH Group. Nonetheless, the trade truce affirms our expectation that 2018 should represent the trough in WH Group's earnings. We expect earnings to jump 18.6% in 2019 with less volatility in hog futures, helped by reduced supply in China. However, we note that there remains the risk that trade relationships could still deteriorate and President Trump could change his mind. Regardless, we think the shares remain attractive.

The USDA's report last week that volumes of exports had already picked up affirms that China is relying on imports to meet domestic needs after the spread of African Swine Fever reduced domestic supply and that the price gap had made U.S. imports viable despite the tariffs. WH Group, nonetheless, is the main beneficiary of any uptick in exports to China as wholly owned Smithfield makes up over 75% of total U.S. pork exports to China. A combination of lower hog prices in China and increased tariffs in April and July had dampened U.S. exports of pork to China by around 25% year-to-Sept. 30, leading to sharply lower U.S. hog futures prices. And although hog production contributes little to group profit, since much of it is consumed internally, the drop in hog prices led to sharply lower fresh pork revenue as this is a commodity product. Hence group operating margin had fallen to 7.3% for the nine months ending September 2018 from 8.3% in 2017. Packaged meat prices, in contrast, are mainly impacted by consumer demand and so far, this has been stable.