corn processing/ china fufeng group (546 hk) group... · fri, 23 aug2013 equity research fufeng...

Fri, 23 Aug2013

Equi ty Research Fufeng Group (546 HK) Corn processing/ China

The Clouds Faded

We initiate coverage of Fufeng Group with a BUY rating and 12-month

target price of HK$4.60 based a blending DCF/PER model.

We expect MSG ASP to recover in 2HFY13 as consolidation is near to

close; Xanthan gum stands out driven by dynamic demand from shale

gas in US.

We forecast Fufeng’s net profit to grow at a CAGR of 40% for FY12-15E

Bottom out opportunity is emerging We expect the market consolidation is

near to close as an Oligarchy has been formed and most competitors are running

toughly with minimal profit or even loss. We expect MSG ASP will rebound in

2HFY13 but with an under controlled recovering profitability in industry-wide. The

potential competitors who weed out in last round consolidation may not enter

again but reward survivors would maintain Oligarchy with even larger market

share in long term.

Xanthan gum stands out Sales volume reached ~30kt in 1HFY13 and GPM

peaked to 58.7% (vs. 39.2% in 1HFY12) with ASP of RMB26,120/t, driven by

dynamic demand from oil exploration area. The company has 65kt order for FY13

and it also has locked price ~RMB 26,000/t, suggesting the earnings from

Xanthan gum will continue to be encouraging in 2HFY13. However, we expect

ASP will drop back to 21,000/t given the downside risk of recovering supply of

Guar gum. The far lower than competitors’ anti-dumping duties will lift up Fufeng’s

market share in US market.

We expect that financial burden will relief with lower gearing ratio, backed by

the slow-down CAPEX in the mid-term and fund-raising from rights issue. We

believe, in the longer run, Fufeng’s margins will above industry average

figures thanks to i) its cost advantage from well-picked plant location; ii) high

margin products contribution.

Valuation Based on a blending DCF/PER model, we estimate a target price of

HK$4.60 per share, which implies FY14/15E PER of 9.0/6.5x and suggests 39%

potential upside. We give a BUY rating on Fufeng.

Tracy Sun

Analyst

+852 2135 0214

[email protected]

Initial Coverage

BUY

Close price: HK$3.31

Target Price: HK$4.60 (+39%)

Key Data

HKEx code 546

12 Months High (HK$) 4.11

12 Month Low (HK$) 2.20

3M Avg Dail Vol. (mn) 5.87

Issue Share (mn) 2,087.56

Market Cap (HK$mn) 6,909.83

Fiscal Year 12/2012

Major shareholder (s) Li Xuechun (46.11%)

Source: Company data, Bloomberg, OP Research

Closing price are as of 23/8/2013

Price Chart

1mth 3mth 6mth

Absolute % 16.1 22.1 -4.6

Rel. MSCI CHINA % 13.9 25.0 1.7

Company Profi le

Fufeng is a leading Chinese manufacturer

corn-based biochemical products. It is

China’s largest MSG producer in China and

Xanthan gum producer in the world.

Exhibit 1: Forecast and Valuation Year to Dec (RMB mn) FY11A FY12A FY13E FY14E FY15E

Revenue 8,399 11,112 11,945 12,826 13,910

Growth (%) 30.9 32.3 7.5 7.4 8.5

Net Profit 604 427 558 852 1,178

Growth (%) (37.5) (29.4) 30.7 52.7 38.3

Diluted EPS (RMB) 0.336 0.246 0.267 0.407 0.563

EPS growth (%) (37.5) (29.4) 30.7 52.7 38.3

Change to previous EPS (%) n.a. n.a. n.a. n.a. n.a.

Consensus EPS (HK$)

ROE (%) 17.7 11.2 11.5 15.2 17.7

P/E (x) 7.9 10.7 9.9 6.5 4.7

P/B (x) 1.5 1.2 1.1 1.0 0.8

Yield (%) 3.6 0.0 3.0 4.6 6.4

DPS (HK$) 0.120 0.000 0.100 0.153 0.211

Source: Bloomberg, OP Research

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

Aug/12 Nov/12 Feb/13 May/13 Aug/13

HK$546 HK MSCI CHINA

Fri, 23 Aug 2013

Fufeng Group (546 HK)

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Table of Contents

Valuation ...................................................................................................................................................... 3

Investment thesis ......................................................................................................................................... 5

Financial forecast ........................................................................................................................................18

Key Risks ....................................................................................................................................................20

Industry landscape: MSG demand is resilient .............................................................................................21

Company overview .....................................................................................................................................23

Financial Summary .....................................................................................................................................27

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Valuation

Based on a blending DCF/PER model, we estimate a fair value of HK$4.60 per

share, which implies FY14/15E PE of 9.0/6.5x and suggests 39% potential upside.

We give a BUY rating on Fufeng.

DCF model

Given its cash flow-generation business nature and long-term development

company, we use DCF-based methodology to derive the 12-month target

price of HK$4.60 for Fufeng. We use WACC of 12.6%, based on the

assumptions are: i) risk free rate of 3%, based on the annual yield on

China’s 10-year government bond; ii) market risk premium of 8.5%; iii) beta

of 1.17 to factor in the stock volatility relative to the Hang Seng index; iv) 2%

terminal growth rate from 2023E forward, in line with our long-term growth

assumption for China consumer players.

We also conduct sensitivity analysis to quantify how target price change in

different scenarios of WACC and terminal growth rate.

Exhibit 2: Sensitivity analysis of TP to WACC and Perpetual Growth rate (%)

Sensitive Analysis Perpetual growth rate (%)

4.6 1.0% 1.5% 2.0% 2.5% 3.0%

WACC (%)

11.6% 5.00 5.20 5.40 5.60 5.90

12.1% 4.70 4.80 5.00 5.20 5.40

12.6% 4.30 4.50 4.60 4.80 5.00

13.1% 4.00 4.10 4.30 4.40 4.60

13.6% 3.70 3.80 3.90 4.10 4.20

14.1% 3.40 3.50 3.60 3.80 3.90

Source: OP research

PER model

In order to offer a sanity check, we evaluated Fufeng’s valuation with

relative valuation. We also derive our 12-month price of HK$4.60 from a

PER based methodology. The FY14 PER is 9x, based on a 5% premium to

the peers of corn processing listed on the Hong Kong Stock Exchange,

which are trading at average of 8.6X PER for FY14E . We think Fufeng

deserves a premium valuation to its peers as i) leading market position; ii)

higher profit margins than peers who focus more on upper-stream

corn-processed products with low ROE.

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Re-rating is emerging

Given at the end of industry consolidation, we expect the margins will

recovery led by MSG ASP increase, along with stock valuation re-rating. For

long-term investors, we believe the stock’s valuation in 2008 and 2009 could

be a good reference. Historically, Fufeng used to lift up its MSG ASP and

the margins rebounded significantly after twice industry restruction in 2008

and 2009. Fufeng’s valuation experienced two year re-rating and peaked

to16X PER till the start of another industry consolidation happening on 2011.

Applying this metric to FY13E and FY14E, we believe share-price value

could start to emerge.

Exhibit 3: Fufeng’s PER band, 2008-2013

Source: Bloomberg, OP research

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Jan/08 Sep/08 May/09 Jan/10 Sep/10 May/11 Jan/12 Sep/12

(X)Fufeng Group Ltd

+2std.

avg.

-2std.

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Investment thesis

Bottom out opportunity is emerging

Consolidation is near the end, Oligarchy has been formed

Thanks to its cost advantage (more detail please refer to our following

investment thesis of Cost advantage), Fufeng initiatively hosted an industry

consolidation since early of 2011.The company aggressively expanded its

capacity in Northeast plant with lower ASP of MSG to phase out its

competitors. Since 2011, the MSG industry has faced over capacity problem,

along with the cost of raw material hike, and the overall industry suffered

huge margin pressure. The number of players in this universe reduced to 13

with 2.5mnt total industry capacity and 2.1mnt actual production volume so

far, according to the management. Even possessed a distinct cost

advantage, Fufeng’s MSG segment can only reach breakeven level in

1HFY13. Other players, like China Agri (606 HK, NR) had already shut

down its MSG plant for several months, according the management.

We want to highlight that the market consolidation is close to the end as i)

an Oligarchy has been formed. The top leaders Fufeng and Meihua (600873

CH, NR) totally accounted for over 70% market share by sales volume; ii)

except for Fufeng and Meihua, most competitors are running toughly with

loss. In the near-to-mid term, in our view, the unattractive profitability

industry-wise will not motivate another round of expansion; iii) positive

signal for industry’s healthy development is emerging, led by the active

cooperation between major players to shut down the total capacity since Jul,

2013.

Exhibit 4: Fufeng’s leadship in MSG industry, 2006-1H2013

Source: Company data, OP research

1.8%4.1%

7.9%

20.0%

25.0%

35.0%

40.0%

50%

0%

10%

20%

30%

40%

50%

60%

2006 2007 2008 2009 2010 2011 2012 1H2013

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Exhibit 5: China MSG market share breakdown, by capacity

Source: China Fermentation industry Associate, OP research

Fufeng

Meihua

Lianhua

Shenghua

Linghua

XuehuaOthers

XinleWuyi

Hongmei COFCO

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MSG ASP is recovering after consolidation

At the close of each consolidation, ASP of MSG is witnessed a significant

turnaround historically.

Looking at the past, MSG’s ASP is quite volatile mainly due to the industry

restruction. Once capacity phases out as of industry integration, we would

see an ASP increment driven by supply shortage. For example, after an

irrational expansion in 2006, the government led two round industry

consolidations to weed out the players who have capacity lower than 30kt

and 100kt in 2007 and 2009, respectively. After industry consolidation, the

total number of players squeezed to 30+ from 70+ in 2006. Facing the rising

demand with supply constrains, Fufeng lift its ASP by 8/13%yoy in

2008/2009 that brought GPM jump to15.7/29.6% in 2008/2009 from 8.9% in

2007, along with 554/215% surged in net profit.

Using history as reference, we anticipate the ASP is to recover from

2HFY13, given the consolidation is close to the end. After initiatively

shutting down part of MSG capacities in the summer plant maintenance

period by key players, the total supply shrunk to 1.8mnt which were lower

than domestic demand of 2mnt. Thanks to the miss-match in supply and

demand, the ASP of MSG rebounded by ~11% to RMB 6,720/t in late Jul,

from RMB6,030/t in Jun, 2013.

Exhibit 6: Fufeng’s MSG ASP 1Q2006-2015E


4,000

5,000

6,000

7,000

8,000

9,000

10,000 After 2007 consolidation

After 2009 consolidation

We expectthe ASP will

rebound

(RMB/tonnes)

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ASP to be hike with low-single digit

As a typically upstream player, MSG industry profitability is very sensitive to

ASP change. Significantly recovery profitability may motivate another round

of expansion and further drop down industry profitability again. After

recently rebound in ASP of MSG, some smaller players in Shandong

province intended to restart production. In order to stabilize market position,

Fufeng actively cut the MSG’s price again to RMB 6,500/t in early Aug.

Thus we expect an under controlled recovering profitability in industry-wide

with modest hike of MSG ASP (i.e. low-single digit growth) in the coming 5

years. Based on this scenario case, the potential competitors who weed out

in last round consolidation may not enter into again but reward survivors

would maintain Oligarchy with even larger market share in long term.

We conservative project the ASP of MSG will stay at RMB6,500/t in 2HFY13,

bringing whole year ASP to RMB6,400/t. Along with muted growth, the ASP

will further revert to ~RMB 6,700/t and ~RMB 7,000/t in FY14E and FY15E.

According to our model, a 1% increase in ASP of MSG will boost 6/5% of

net profit in FY13E and FY14E. Thus, we are eyeing a strong bounce of

bottom line of FY13/14 led by MSG recover from 2HFY13.

Exhibit 7: Net profit sensitivity analysis to MSG price

% Change of MSG price % Change of FY13E net profit % Change of FY14E net profit

-5% -28% -24%

-3% -17% -15%

-1% -6% -5%

0% 0% 0%

1% 6% 5%

3% 17% 15%

5% 28% 24%

Source: OP research

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Xanthan gum stands out

Largest Xanthan gum producer in the world

Fufeng is the largest Xanthan gum producer in the world and the effective

capacity has 46.5kt with 33% market share in 2012. The completion of

Xinjiang plant phase II in Jul has led the total annual capacity to 70kt with

~60% market in 2013.

Exhibit 8: Xanthan Gum Capacity registered a 27% CAGR in 2008-2013E


Solid growth will continue

Xanthan gum sales volume reached 29,978t in 1HFY13, accounting for 46%

of our full year forecast in FY13. Driven by dynamic demand from oil

exploration area, the ASP surged by 41.2%to RMB 26,120/t with 58.7%

GPM in 1HFY13 (vs. 39.2% in 1HFY12).

The company has 65kt order for FY13 and it also has locked price ~RMB

26,000/t, suggesting the earnings from Xanthan gum will continue to be

encouraging in 2HFY13. The management also shared with us that ASP for

June and July kept on the upward trend.

Xanthan gum has higher entry barriers due to its sophisticated technology

used in the fermentation industry and capital intensive nature. Given long

production track record (usually 3 years) requirement from large customers,

we expected it would take some time for new competitors to seize a place

and bring down pricing in the foreseeable future. We conservatively reckon

the whole year sales volume to 65kt in FY13, with ASP of RMB 26,000/t. We

expect sales volume will register a 12% CAGR in 2012-2015E on the back

of decent growth in demand from US shale gas production. However, we

expect ASP will drop to a comfortable level of 21,000/t in FY14E and future

cut to 20,000/t in FY15E given the downside risk of recovering supply in

Guar gum after price softened.

We expect Xanthan gum will well above 35% GPM in long term as i) its cost

21,000

32,000

38,000

44,000

52,000

70,000

0

20,000

40,000

60,000

80,000

2008 2009 2010 2011 2012 2013E

(tonnes)

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advantage due to well-picked plant location in Inner Mongolia and Xinjiang

which has abundant corn and coal supply; ii) high entry barriers as

mentioned above.

Exhibit 9: Xanthan Gum GPM and ASP (RMB/t), 2008-2015E


Exhibit 10: Shale gas production and supply in US, 2010-2020E

Source: EIA, OP research

21,547 21,622

21,853

20,328 19,987

19,085 18,545

17,935 18,501

22,410

26,120 26,000

21,000

20,000

34% 35% 35%38% 39% 38% 37%

35%39%

52%

59%57%

46%42%

0%

10%

20%

30%

40%

50%

60%

70%

14,000

16,000

18,000

20,000

22,000

24,000

26,000

28,000

ASP GPM

4

5

6

7

8

9

10

11

12

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

(trillion cubic feet)

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Exhibit 11: Shale gas leads growth in total gas production through 2040 to

reach half of U.S. output.

Source: EIA, OP research

Exhibit 12: Guar gum price, 2013

Source: Bloomberg, OP research

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

5/2013 6/2013 7/2013 8/2013

(INR/quintal)

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Competitive advantage approved by Lowest anti-dumping duties

According to the management, USDC announced its final decision on

anti-dumping duties for Xanthan gum on 18 May. The final duty reduced to

12.9%, significantly lower than Zhongxuan’s 127% who has 40kt capacity.

The management attributes its lower tax rate to: i) its full-integrated

producer status (i.e. Fufeng produced Xanthan gum using corn while

Zhongxiong uses starch as its key raw material), ii) as a listed company,

Fufeng has detailed information disclosure on Xanthan gum segment; in

comparison, Zhongxuan’s information is less transparent as of its private

company nature; iii) Fufeng’s diversified product portfolio has led to a diluted

cost construction.

According to management, only 4.5k/6k tonnes Xanthan gum was exported

to America, accounting for ~11/12% of FY11/12 sales volume. We expect

the new tariff to force US customers to turn to Fufeng given lower tariff rate

than Zhongxuan, and lift up Fufeng’s market share in US market.

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Balance sheet reverts to healthier

Financing restruction briefs gearing burden

In Nov 2012, Fufeng issued a syndicated loan of US$150mn with an interest

rate of LIBOR plus 4% to re-purchase the Covetable Bond, leading to the

total debt/EBITDA for the full year was 3.5x, translating into 105% net

gearing ratio in the end of FY12.

Thanks to recent successful right issue, the net gearing ratio dropped to 87%

after the net fund-raising with ~RMB500mn. According to the management,

RMB200mn of the proceeds is used for repayment of existing short-term

band loan and the rest is for general working capital purpose.

We believe Fufeng’s liquidity position is manageable. The company has

completed the RMB600mn Mid-term notes with 5.11% effective interest rate

issued on April, with RMB400mn of the proceeds used to reduce its

short-term bank loan with 6.2% effective interest rate, and the rest is for

general working capital purpose.

A slow-down CAPEX in short-term to release its financing cost

The company incurred ~RMB1.8bn of CAPEX in FY12 which was over

target of RMB1.3bn, as earlier-than-expected schedule for construction of

sulphuric acid and liquid ammonia capacities. Fufeng plans ~RMB800mn of

CAPEX for FY13, of which RMB520mn has already used for its Xinjiang

plants and the remaining is for maintenance. The CAPEX of FY14/15E is

projected to ~RMB600mn, of which RMB150mn is for production lines

upgrade. Fufeng’s reluctance to expand in XGM capacity and await the ASP

recovery is the main reason of slow-down CAPEX till FY15E, in our view.

Exhibit 13: Net gearing ratio and CAPEX, 2007-2015E


0%

20%

40%

60%

80%

100%

120%

0

500

1,000

1,500

2,000

2,500

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

CAPEX(RMB mn) Net gearing ratio

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Cost advantage

Well-picked plant location

According to China Fermentation industry Association, geographically,

approximately 31% of China MSG was provided in Shandong province and

14% in Inner Mongolia. In comparison, Fufeng’s around 21/28% of MSG

capacity is located in Shaanxi/Inner Mongolia, and 46% in HulunBuir.

Therefore, Fufeng mainly purchases corn and coal from Inner Mongolia,

Northeast and Shaanxi whose price are largely discounted to Shandong.

Exhibit 14: Corn and Coal procurement breakdown by region


Corn/coal, as two major raw materials, made up ~57/11%of MSG’s COGS

and~42/26% of Xanthan gum. Historically, corn price of Shaanxi/Inner

Mongolia/ Northeast were 5/8/10% lower than Shandong and coal price of

Shaanxi/Inner Mongolia/Hulunbeir were 40/62/68% discounted to Shandong.

Even offsetting by higher freight expense, the attractive procurement price of

corn and coal leading to Fufeng cost advantage over those competitors who

based in Shandong.

Shaanxi21%

Inner Mongolia28%

Northeast46%

Xinjiang5%

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Exhibit 15: China corn price, 2009-2013

Source: Wind, OP research

Exhibit 16: China coal price, 2008-2012


1,300

1,500

1,700

1,900

2,100

2,300

2,500

2,700

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13

Shandong Inner Mongolia Northeast Shaanxi

0

100

200

300

400

500

600

700

800

1HFY08 2HFY08 1HFY09 2HFY09 1HFY10 2HFY10 1HFY11 2HFY11 1HFY12 2HFY12

Shandong Shaanxi Inner Mongolia Hulunbeir

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Not labor intensive industry

Thanks to its high automation level and economic scale, only~4/8% of

COGS in both MSG and Xantham is related to labor cost. Meanwhile, the

labor cost of Fufeng’s production bases is also lower than in the coastal

cities. We believe Fufeng’s low labor intensive nature will bring it less

sensitive to labor cost hike in the coming years, which is a major bottleneck

for other manufactory industry, in comparison.

Exhibit 17: MSG and Xanthan Gum COGS breakdown, 2012


Corn kernels57%

Liquid ammonia7%

Sulphuric acid2%

Coal11%

Depreciation5%

Employee benefits4%

Others14%

MSG COGS breakdown

Coal26%

Corn kernels42%

Soybean7%

Depreciation6%

Employee benefits8%

Others11%

Xanthan Gum COGS Breakdown

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High margin products contribution

We believe the company’s margin will hold well driven by the contribution from

high margin products besides MSG and Xanthan gum in the future.

Historically, Fufeng successfully promoted its new product Xanthan Gum in 2006

after three years’ research. In 2012, Xanthan Gum has grown to 10% of its total

revenue and 30% of its total gross profit in FY12. Back on its successful historical

launch of new products, we believe the company’s Threonine, lysine and

branched-chain amino will be new profit catalysts in the next few years.

The company produced Threonine, lysine and branched-chain amino acid

products starting from 2010. We expect the production capacity of Threonine,

lysine and branched-chain amino acid will reach to 10kt, 20kt and 3kt in FY13E,

respectively, accounting for 2.5% of total revenue. These products enjoy the

same production chain as other products, but with more sophisticated

fermentation technology led to high gross profit margin.

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Financial forecast

We forecast Fufeng could enjoy the net profit growth at a CAGR of 40% in

FY12-FY15E, driven by i) MSG ASP under controlled recovery; ii) gross profit

margin expanding led by product mix upgrade and MSG margin expanding; but iv)

a modest volume upside as of capacity expansion slowdown.

Revenue to rise at a CAGR of 8% in FY12-FY15E led by a 7% CAGR in

sales of MSG segment and a 11% CAGR in sales of Xanthan gum

Based on slowdown CAPEX guidance, it appeared to us the high growth era

of MSG is behind us but a muted volume growth in the coming 2-3 years

after an irrational expansion. We project the sales volume of MSG to grow at

a 5% CAGR in FY12-15E on back of production line upgrade and utilization

rate improvement.

As we mentioned above, as a typical upper-stream player, MSG industry

profitability is very sensitive to ASP change. Significantly recovery

profitability may motivate another round of expansion and further drop down

industry profitability again. Thus we are eyeing an under controlled

recovering profitability in industry-wide with modest rebound of MSG ASP

(i.e. low-single digit growth) in the coming 2-3 years.

As discussed, we conservatively project the ASP of MSG will stay at

RMB6,500/t in 2HFY13, bringing whole year ASP to RMB6,400/t. Along with

muted growth, the ASP will further revert to ~RMB 6,720/t and ~RMB

6,990/t in FY14E and FY15E.

We expect Fufeng to achieve Xanthan gum volume of 64.8kt in FY13, with

ASP of RMB 25,500/t. However, we expect ASP will drop to 21,000/t and

20,000/t in FY14E and FY15E, respectively, given the downside risk from

recovering supply of Guar gum.

Exhibit 18: Sales volume and ASP assumptions for key products

Sales volume (tonne) FY13E FY14E FY15E

MSG 918,750 945,000 997,500

Fertilizers 1,038,800 1,060,000 1,060,000

Starch sweeteners 130,900 169,400 177,870

Corn oil 35,000 38,500 40,425

Xanthan Gum 64,750 70,000 73,500

ASP (RMB/tonne)

MSG 6,400 6,720 6,989

yoy% -10% 5% 4%

Fertilizers 909 955 1,003

yoy% 5% 5% 5%

Starch sweeteners 3,241 3,339 3,439

yoy% 3% 3% 3%

Corn oil 10,509 10,825 11,150

yoy% 5% 3% 3%

Xanthan Gum 25,500 21,000 20,000

yoy% 25% -18% -5%

Source: OP research

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We expected the blended GPM expand to 16.7 % in FY13E supported by

10.3% GPM of MSG and 56.8% of Xanthan gum. We do not expect the

Xanthan Gum’s high GPM in FY13E to be sustainable as the downside risk

we mentioned before. We reckon the GPM will further expand to 18.1/19.7%

in FY14E/15E as of relative stable raw material price and ASP hike of MSG.

Thanks to the financing restruction as we discussed, we expect finance

cost/sales ratio will lower to 2.1/1.7/1.2% in FY13E/FY14E/FY15E, from

2.2% in FY12.

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Key Risks

Raw material price significant hike is the biggest downside risk

As we mentioned above, corn kernel as the major raw material, made up

~57%of MSG’s COGS and~42% of Xanthan gum. Fufeng’s corn kernel

procurement price was closely related to spot market as it purchased corn

kernels locally in the spot market. Thus the price of corn Kernels may be

affected by market demand and supply, domestic government policy,

climate and other natural disaster. According to our sensitivity analysis, a 1%

increase in corn kernel price may cause net profit to decline 5% in FY13E

and 4% in FY14E.

Exhibit 19: MSG gross profit margin and Corn Kernels price


High earning sensitive to the change of ASP MSG

As a typically upper-stream corn process player, Fufeng’s profit is very

sensitive to MSG ASP. Based on our sensitivity analysis, a 1% increase in

ASP of MSG may boost net profit 6% in FY13E and 5% in FY14E. Price of

MSG may be affected by industry consolidation, market supply and demand,

unexpected outbreak of serious contagious diseases (e.g. H7N9).

MSG industry could be adversely affected by unproven perception of MSG

MSG products have a long history of safe and common use in foods by

customers, however, there are opinions that consumption of MSG could

result in adverse reactions, such as headaches. The unproven perception of

MSG may adversely affect the future growth of MSG products.

0%

5%

10%

15%

20%

25%

30%

35%

0

500

1,000

1,500

2,000

2,500

1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11 1Q12 4Q12

Corn Kernels price (RMB/tonne) GPM (%)

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Industry landscape: MSG demand is resilient

According to China Fermentation Association, consumption per cap of MSG is

only 500 grams per year in mainland China, far behind other Asia countries who

have similar cuisine culture which implies strong growth potential in the future.

Exhibit 20: MSG consumption still at nascent stage in Mainland China

(Garms/Year/Cap)

Source: China Fermentation Industry Association, OP research

MSG is widely used in the food processing and catering industry, according to

China Fermentation Association. China catering industry has registered a 16.4%

CAGR in 2001-2012, while MSG sales volume grew at a CAGR of 11.1% during

the same time.

The Ministry of Commerce, in the 12th Five-Year Plan, has set target that China’s

catering industry reaches to RMB3,700bn by 2015, implying 16.7% CAGR in

2012-2015E. We expect the demand for MSG is resilient and expected to

maintain at high-single digits CAGR in 2012-2015E, mainly driven by catering

industry’s decent growth.

Exhibit 21: MSG are mainly used in Food processing and catering sector


0 500 1,000 1,500 2,000 2,500

Mainland China

Taiwan

South Korea

Hong Kong

Japan

Food processing

Household consumption

catering

Fri, 23 Aug 2013


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Exhibit 22: MSG sales volume grew at a 11.2% CAGR in 2001-2012


Exhibit 23: China’s catering industry will maintain 16.7% CAGR in

2012-2015


0

50

100

150

200

250

300

350

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(10kt)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

(RMB bn)

Fri, 23 Aug 2013


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Company overview

Vertically integrated business model

Fufeng is a leading Chinese manufacturer of corn-based biochemical

products. Its highly vertically integrated production process starting from the

production of cornstarch, to the production of corn-based biochemical

products, such as glutamic acid, MSG, Xanthan gum, starch sweeteners

and other high-end products. Its vertical integration offer Fufeng a

competitive cost structure and flexible production planning.

Exhibit 24: Diversified product range

Source: Company, OP Research

Corn refinery

By-products

Corn germ Corn bran Corn protein

Corn oil

Starch sweeteners

Maltose

syrupCrystallised

glucose syrup

Crystallised

glucose

Corn kernels

Corn starch

Corn starch

syrup

Synthetic

ammonia

Waste

residue

Fertilisers BricksCompound

Seasonings

MSG

Glutamic

acidThreonine Pharmaceuticals

Xanthan

gum

Fermentation Tank

Fermentation Technology

Coal

Electricity

Steam

Xanthan Gum

segment

MSG segment

+Yeast

Fri, 23 Aug 2013


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Capacity review

Exhibit 25: Capacity Overview and Forecast, 2006-2015E

(tonnes) 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

MSG

Junan, Shandong 33,333 75,000 65,000 80,000 90,000 90,000 - - - -

Baoji, Shaanxi

16,667 100,000 150,000 150,000 300,000 300,000 300,000 300,000

Hohhot, Inner Mongolia

90,000 125,000 300,000 300,000 300,000 300,000 300,000 300,000

Hulun Buir, Northeast

66,667 408,333 450,000 450,000 450,000

Xinjiang

- -

Total 33,333 75,000 171,667 305,000 540,000 606,667 1,008,333 1,050,000 1,050,000 1,050,000

Glutamic acid

Junan, Shandong 50,000 40,000

Baoji, Shaanxi 120,000 120,000 135,000 150,000 240,000 240,000 240,000 240,000 240,000 240,000

Hohhot, Inner Mongolia 10,000 120,000 140,000 200,000 220,000 220,000 240,000 240,000 240,000 240,000

Hulun Buir, Inner Mongolia - - - - - 53,333 306,667 370,000 370,000 370,000

Xinjiang - - - - - - -

- -

Total 180,000 280,000 275,000 350,000 460,000 513,333 786,667 850,000 850,000 850,000

Xanthan Gum

Junan, Shandong 5,333 8,000 8,000 8,000 8,000 8,000 - - - -

Baoji, Shaanxi

- -


3,333 13,000 24,000 30,000 36,000 42,000 42,000 42,000 42,000

Hulun Buir, Inner Mongolia

- -

Xinjiang

4,500 23,000 23,000 23,000

Total 5,333 11,333 21,000 32,000 38,000 44,000 46,500 65,000 65,000 65,000

Fertilizers

Junan, Shandong

90,000 5000 60,000 60,000 60,000 60,000 60,000 60,000 60,000

Baoji, Shaanxi

200,000 200,000 200,000 300,000 300,000 300,000 300,000 300,000 300,000


200,000 200,000 200,000 200,000 283,333 300,000 300,000 300,000 300,000


398,333 400,000 400,000 400,000

Xinjiang

- -

Total

490,000 405,000 460,000 560,000 643,333 1,058,333 1,060,000 1,060,000 1,060,000

Starch sweeteners

Junan, Shandong

40,000 40,000 40,000 52,000 - - - - -

Baoji, Shaanxi

- -


100,000 60,000 60,000 78,000 140,000 140,000 140,000 140,000 140,000


- - - - -

Xinjiang

- -

Total

140,000 100,000 100,000 130,000 140,000 140,000 140,000 140,000 140,000


Fri, 23 Aug 2013


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Production base

Exhibit 26: Production bases


Company shareholder structure.

Exhibit 27: Shareholding & corporate structure


Xinjiang BaseIM

Base

Baoji

Base

Hulunbeir

Base

Headquarters

in Beijing

Shandong

Base

Shenhua

Pharmaceutical

Li Xuechun

(Chairman)

30 management

team membersPublic

46.11% 20.60% 33.29%

Incorporated in Cayman Islands

Compound

seasoning, corn oil,

high-end amino acid

products

Shandong

Base

MSG, fertilisers,

corn refined

products

Baoji

Base

MSG, xanthan gum,

fertilisers, starch

sweeteners,

threonine, corn

refined products

Inner Mongolia

Base

Pharmaceuticals

Shenhua

Pharmaceutical

MSG, threonine,

fertilisers, corn

refined products

Hulunbeir

Base

Xanthan gum,

high-end amino

acid products

Xinjiang

Base

Junan, Shandong Baoji, Shanxi Hohhot, Inner Mongolia Jinhu, Jiangsu Zhalantun, Hulunbeir Urumqi, Xinjiang

Fri, 23 Aug 2013


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Management team

Exhibit 28: Management team

Name Age Position Profile and professional experience

Li Xuechun 61 Founder, Chairman and

Executive Director

Mr. Li is responsible for the strategic planning and formulation of overall corporate development

policy of the Group

Mr. Li first joined Shandong Furui Brewery Group in 1982 as the factory manager.

Mr. Li established the Group starting by set up Shandong Fufeng in June 1999

Mr. Li has 31 years of experience in the fermentation industry

Wang Longxiang 51 Executive Director and

general manager

Mr. Wang is responsible for the overall management of the Group’s daily operations.

Mr. Wang joined the Group in 2005 and has over 21 years of experience in the fermentation industry

Feng Zhenquan 43 Executive Director and

vice general manager

Mr Feng is in charge of the operations of Hulunbeir Fufeng.

Mr. Feng was appointed as a director of Shandong Fufeng in May 2002

Mr. Feng has over 19 years of experience in the fermentation industry

Xu Guohua 44 Executive Director and


of the Group

Mr. Xu is responsible for Shenhua Pharmaceutical and the research and development of the Group

Mr. Xu joined the Group in June 1999

Mr. Xu has over 22 years of experience in the fermentation industry

Li Deheng 44 Executive Director and


of the Group

Mr. Li is responsible for the general operation of production and purchasing of the Group

Mr. Xu joined the Group in January 2001

Mr. Li has over 12 years of experience in business management

Chen Yuan 43 Executive Director and

the chief financial officer

Mr. Chen is responsible for financial management, capital markets, corporate development and

investor relations matters, and assists the Group to develop strategic planning and long-term

development plan

Mr. Chen joined the Group in September 2010

Mr. Chen has over 20 years of experience in the corporate finance, corporate development and

investor relations sector

Li Guangyu 34 Executive Director and

a vice general manager

Mr. Chen is responsible for the project of Hulunbeir Plant of the Group

Mr. Li has over 7 years of experience in the fermentation industry


Fri, 23 Aug 2013


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Financial Summary

Year to Dec FY11A FY12A FY13E FY14E FY15E


Income Statement (RMB mn)

Ratios

MSG Segment 7,563 10,046 10,294 11,356 12,440

Gross margin (%) 18.1 14.7 16.7 18.1 19.7

Xanthan Gum 836 1,066 1,651 1,470 1,470

Operating margin (%) 9.3 6.6 7.7 9.7 11.4

Turnover 8,399 11,112 11,945 12,826 13,910

Net margin (%) 7.2 3.8 4.7 6.6 8.5

YoY% 31 32 7 7 8

Selling & dist'n exp/Sales (%) (5.0) (5.1) (5.8) (5.5) (5.5)

COGS (6,880) (9,474) (9,945) (10,501) (11,170)

Admin exp/Sales (%) (4.4) (4.0) (4.1) (3.9) (3.4)

Gross profit 1,520 1,637 2,000 2,325 2,740

Payout ratio (%) 30.3 0.0 30.0 30.0 30.0

Gross margin 18.1 14.7 16.7 18.1 19.7

Effective tax (%) (15.7) (13.0) (17.0) (17.0) (17.0)

Other income 118 129 146 158 169

Total debt/equity (%) 104.2 117.3 86.6 64.1 37.5

Selling & distribution (421) (570) (689) (702) (761)

Net debt/equity (%) 87.0 104.7 68.4 50.5 26.1

Admin (374) (440) (493) (495) (466)

Current ratio (x) 1.04 0.75 1.02 1.22 1.20

Other opex (64) (21) (40) (43) (97)

Quick ratio (x) 0.69 0.50 0.67 0.81 0.78

Total opex (859) (1,032) (1,222) (1,240) (1,324)

Inventory T/O (days) 41 43 46 46 45

Operating profit (EBIT) 778 735 924 1,243 1,585

AR T/O (days) 56 67 68 64 63

Operating margin 9.3 6.6 7.7 9.7 11.4

AP T/O (days) 119 114 116 104 101

Provisions 0 0 0 0 0

Cash conversion cycle (days) (22) (5) (1) 7 8

Finance costs (62) (245) (252) (217) (166)

Asset turnover (x) 0.85 0.93 0.96 1.02 1.09

Profit after financing costs 716 490 672 1,026 1,419

Financial leverage (x) 2.89 3.15 2.57 2.24 1.92

Associated companies & JVs 0 0 0 0 0

EBIT margin (%) 9.3 6.6 7.7 9.7 11.4

Pre-tax profit 716 490 672 1,026 1,419

Interest burden (x) 0.92 0.67 0.73 0.83 0.90

Tax (112) (64) (114) (174) (241)

Tax burden (x) 0.84 0.87 0.83 0.83 0.83

Minority interests 0 0 0 0 0

Return on equity (%) 17.7 11.2 11.5 15.2 17.7

Net profit 604 427 558 852 1,178

YoY% (37) (29) 31 53 38


Net margin 7.2 3.8 4.7 6.6 8.5

Balance Sheet (RMB mn)

EBITDA 1,134 1,257 1,532 1,870 2,171

Fixed assets 6,298 7,626 7,756 7,707 7,691

EBITDA margin 13.5% 11.3% 12.8% 14.6% 15.6%

Intangible assets & goodwill 0 0 0 0 0

EPS (RMB) 0.336 0.246 0.267 0.407 0.563

Associated companies & JVs 0 0 0 0 0

YoY% (37) (29) 31 53 38

Long-term investments 0 0 0 0 0

DPS (RMB) 0.096 0.000 0.080 0.122 0.169

Other non-current assets 29 40 40 40 40

Non-current assets 6,327 7,666 7,796 7,747 7,731


Cash Flow (RMB mn)

Inventories 1,180 1,415 1,596 1,637 1,793

EBITDA 1,134 1,257 1,532 1,870 2,171

AR 1,739 2,340 2,122 2,395 2,428

Chg in working cap (669) (73) (274) (339) 33

Prepayments & deposits 30 69 69 69 69

Others (7) (40) 11 15 19

Other current assets 0 0 0 0 0

Operating cash 458 1,144 1,268 1,546 2,223

Cash 584 481 884 762 761

Interests paid (148) (284) (252) (217) (166)

Current assets 3,533 4,305 4,671 4,864 5,050

Tax (62) (100) (114) (174) (241)

Net cash from operations 248 760 902 1,154 1,815

AP 2,631 3,304 2,992 2,968 3,189

Tax 54 47 47 47 47

Capex (2,228) (1,816) (758) (602) (598)

Accruals & other payables 0 0 0 0 0

Investments 0 0 0 0 0

Bank loans & leases 394 2,358 1,558 958 958

Dividends received 0 0 0 0 0

CB & othe debts 310 50 0 0 0

Sales of assets 0 0 0 0 0

Other current liabilities 0 0 0 0 0

Interests received 10 6 8 10 9

Current liabilities 3,388 5,759 4,598 3,973 4,194

Others 94 112 0 0 0

Investing cash (2,124) (1,698) (749) (592) (589)

Bank loans & leases 1,853 2,045 2,645 2,645 1,545

FCF (1,876) (937) 153 562 1,226

CB & othe debts 991 0 0 0 0

Issue of shares 0 0 500 0 0

Deferred tax & others 220 372 372 372 372

Buy-back 0 0 0 0 0

MI 0 0 0 0 0

Minority interests 0 0 0 0 0

Non-current liabilities 3,064 2,417 3,017 3,017 1,917

Dividends paid (358) (42) 0 (84) (128)

Net change in bank loans 149 1,723 (250) (600) (1,100)

Total net assets 3,407 3,795 4,853 5,621 6,671

Others 1,901 (846) 0 0 0

Financing cash 1,692 835 251 (684) (1,228)

Shareholder's equity 3,407 3,795 4,853 5,621 6,671

Share capital 174 176 676 676 676

Net change in cash (184) (103) 403 (122) (2)

Reserves 3,233 3,619 4,177 4,945 5,995

Exchange rate or other Adj 0 0 0 0 0

Opening cash 768 584 481 884 762

BVPS (RMB) 1.78 2.21 2.32 2.69 3.19

Closing cash 584 481 884 762 761

Total debts 3,548 4,453 4,203 3,603 2,503

CFPS (RMB) 0.305 0.280 0.423 0.365 0.364 Net cash/(debts) (2,964) (3,972) (3,319) (2,841) (1,742)


Fri, 23 Aug 2013


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Exhibit 29: Peer Group Comparison

Company Ticker Price

Mkt

cap

(US$m)

3-mth

avg t/o

(US$m)

PER

Hist (x)

PER

FY1 (x)

PER

FY2 (x)

EPS

FY1

YoY%

EPS FY2

YoY%

3-Yr EPS

Cagr (%)

PEG

(x)

Div yld

Hist (%)

Div yld

FY1 (%)

P/B

Hist (x)

P/B

FY1 (x)

EV/

Ebitda

Hist

EV/

Ebitda

Cur Yr

Net

gearing

Hist (%)

Gross

margin

Hist (%)

Net

margin

Hist (%)

ROE

Hist

(%)

ROE

FY1

(%)

Sh px

1-mth %

Sh px

3-mth %

Fufeng Group Ltd 546 3.31 891 2.3 10.6 9.5 7.3 11.5 30.9 22.2 0.43 N/A 1.5 1.22 1.26 7.7 6.2 104.6 14.7 3.8 8.8 14.1 24.9 23.0

HSI 21,863.51 10.1 10.4 9.6 (3.0) 8.2 4.8 2.20 3.5 3.7 1.39 1.30 13.7 12.5 (0.2) (3.6)

HSCEI 9,932.35 8.2 7.5 6.8 9.8 9.5 9.9 0.76 4.1 4.2 1.20 1.10 14.6 14.7 1.6 (7.6)

CSI300 2,286.93 11.3 9.9 8.5 13.5 17.5 16.1 0.62 2.5 2.6 1.57 1.44 13.9 14.4 0.9 (11.5)

Adjusted sector avg* 13.5 10.0 8.6 43.2 16.0 23.1 0.5 2.7 1.9 0.8 1.1 13.8 8.3 53.3 11.1 1.8 3.5 11.8 5.2 (3.6)

H-Share players

China Agri-Indus 606 HK 3.61 2,444 3.7 12.7 11.2 9.2 13.4 21.1 15.9 0.70 1.8 2.1 0.70 0.65 19.0 10.4 71.8 6.4 1.3 5.0 6.2 0.6 (4.2)

Changshouhua Foo 1006 hk 6.52 482 2.3 13.3 8.9 8.0 49.4 10.9 30.4 0.29 1.5 1.7 1.77 1.54 6.7 6.1 0.0 19.9 7.6 14.2 17.4 4.2 20.7

Global Bio-Chem 809 hk 0.63 265 0.6 N/A N/A N/A N/A N/A N/A N/A N/A N/A 0.21 N/A 15.8 N/A 69.2 12.9 (4.7) (5.6) N/A (6.0) (14.9)

Xiwang Sugar 2088 HK 0.96 125 2.4 N/A N/A N/A N/A N/A N/A N/A 78.1 N/A 0.28 N/A N/A N/A 55.0 6.5 (0.4) (0.7) N/A 35.2 49.3

Global Sweetener 3889 HK 0.49 96 0.0 N/A N/A N/A N/A N/A N/A N/A N/A N/A 0.32 N/A N/A N/A 53.5 7.8 (5.5) (10.1) N/A (1.0) (13.4)

China Starch Hld 3838 hk 0.20 157 0.1 5.7 N/A N/A 66.7 N/A N/A N/A 3.3 N/A 0.50 N/A N/A N/A 0.0 11.8 6.7 11.3 N/A 2.5 (7.3)

A-share players

Henan Lianhua-A 600186 CH 2.95 512 5.2 85.8 N/A N/A N/A N/A N/A N/A N/A N/A 3.66 N/A N/A N/A 64.7 1.0 1.4 5.5 N/A 18.5 (2.3)

Meihua Holding-A 600873 ch 4.93 2,503 7.5 22.4 N/A N/A N/A N/A N/A N/A 4.1 N/A 1.95 N/A N/A N/A 112.5 22.5 8.2 8.2 N/A 17.7 (4.1)

* Outliners and "N/A" entries are in red and excl. from the calculation of averages

Source: Bloomberg, OP Research

Fri, 23 Aug 2013


of 30

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