China Minzhong

Kim Eng on 14 Feb 2012

Look beyond current set of results. Even excluding a loss of RMB4.4m on fair value of biological assets, China Minzhong’s 2QFY Jun12 results still fell slightly short of our expectations. Headline net profit grew by just 11.8% to RMB174.7m on the back of a 19.4% increase in revenue. However, we reiterate our Buy recommendation as we expect strong 3Q numbers to make up the slack.

Seasonal factor in play. According to management, the delayed winter led to a late start in the cultivation of champignon mushrooms, which accounted for 35% of the group’s total revenue in FY Jun11. (The cool temperature is essential for the cultivation of the group’s peak season crops.) We are not unduly concerned about this as it is just a matter of time before sales roll over to the next quarter instead.

Higher costs hit margin. The gross margin for Minzhong’s cultivation business segment took a hit in 2QFY Jun12 as a result of two factors: (1) change in product mix and (2) rise in labour and fertiliser costs. Land improvement expenses also increased as the group prepared for 22,000 mu of new farmland to start contributing. About 5,000 mu of new farmland are already under cultivation while the remainder undergoes the last stage of land improvement, ie, irrigation and road infrastructure.

Healthy export orderbook. As for the processed vegetables segment, revenue nudged up 4.7% YoY to RMB419.4m, driven by a shift towards a higher-value processed vegetables portfolio and higher average selling prices. We understand that Minzhong’s confirmed export orderbook has grown by 30% compared to last year and management expects the New Industrial Park, with a processing capacity about 3x its existing capacity, to achieve full utilisation within the next three years.

Earnings momentum still intact. The recent removal of the value-added tax on vegetable distribution in China will benefit Minzhong as it will help lower transportation costs, as well as indirectly ease rising wage expectations. We roll forward our valuation to FY Jun13F and raise our target price from $1.47 to $1.50, pegged at a lower PER of 5x.