China Minzhong

Kim Eng on 1 Aug 2012

Moving towards industrialised farming. We visited Minzhong’s Tianjin king oyster mushroom farm last week. Management showed us the whole stack farming process and at the same time announced its plan to target a few more cities in China to replicate its Tianjin plantation model. In our view, this is a very important step towards the modernisation of the company’s agricultural operations and reducing its reliance on labour in the long run. Maintain BUY.

Is industrialisation a good idea just to sell mushrooms? YES, but only in the long run. It is an important investment for the future in our view. Industrialised farming would allow Minzhong enjoy lower costs, higher yields and better product quality vs. competitors if labour costs in China keep rising, strengthening its pricing power in the long run. Climate-controlled cultivation enables Minzhong to grow vegetables even during off- season, resulting in higher ASPs.

New mushroom factories to come. Management also announced that it is looking at a few target cities to replicate its Tianjin model and build more similar factories to tap on rising demand for king oyster mushrooms in China. We believe that it is likely to open its next mushroom farm in two years, most likely near Hubei.
More balanced revenue split in the future. Currently, the revenue split between “Process” (for foreign markets) and “Cultivation” (for the domestic market) is roughly 65-35. Going forward, management expects this ratio to gradually move towards 50-50. A more balanced revenue split would not only reduce default risks of European counterparties’ given the financial difficulties that many European companies now face, but also improve overall gross margins.

BUY maintained. We reiterate our BUY call with an unchanged target price of SGD1.16 after the company visit. The risk-reward profile of Minzhong is very attractive now, we believe. In our view, moving towards industrialised farming will not only see Minzhong gain an edge over its competitors but also somewhat ease investor concerns on corporate governance issues surrounding the whole S-chips sector.