Forecasting and Valuation:Hogs and Chestnuts

Who profits when the Chinese eat?

Bennet’s Law

Zhongpin (HOGS) Valuation Ratios

price at 12/31/2010 is $15/shr, 34,660K shrs outstanding, NI = $45,590K and CE = $296,850K.

P/E = 11.4 and P/B = 1.8.

What is the PEG ratio? (use analyst forecasts) “we believe that, ultimately, the projected 20% top-

line growth should fall to the bottom line”

Assuming 0 growth in ‘abnormal earnings’ in future, what is predicted PEG ratio? What if g = .02?

PEG ratio at HOGS

forward P/E ratio = 11.4/1.20 = 9.5 PEG = 9.5/.20*100 = .475. theoretical PEG? assume r=10% and

g=0, PEG=1. note that h = 20% doesn’t matter

theoretical PEG when g=.02? PEG = 1.125

Forecasting Zhongpin (HOGS)

Recall the idea is that1. Chinese like pork2. Chinese middle class is growing rapidly3. desire to improve pork processing safety

So sales growth seems certain Can they maintain profitability? Can then do so without buying too many

assets?

HOGS - accounting analysis

Accounts Receivable Allowance

HOGS - Ratios and Cash Flows see my eVal model ROE has declined. Why?

RNOA has declined. Why? NOA turnover has declined. Why?

NOT due to Inventory or AR Mostly, it is due to increases in PPE

Is HOGS becoming less efficient or is this just a lumpy increase in productive capacity?

IS – constant or changing?

Income Statement AssumptionsSales GrowthCost of Goods Sold/SalesR&D/SalesSG&A/SalesDep&Amort/Avge PP&E and Intang.Interest Expense/Avge DebtNon-Operating Income/SalesEffective Tax RateMinority Interest/After Tax IncomeOther Income/SalesExt. Items & Disc. Ops./SalesPref. Dividends/Avge Pref. Stock

“cheating” with an analyst report

HOGS income statement forecasts Sales – 29% growth in 2010, 24% in 2011 from

analyst report. Trend to 3% after that. CGS/Sales – hold margins constant. With rapidly

growing market, less competitive pressure on margins

SGA/Sales – increase from 4.2% to 5.0% because of increased focus on “branded” pork products

depreciation – in steady state, ½ way through the life of a 26 year asset, or 1/13 = 7.7%.

taxes. 0% on chilled and frozen,25% on prepared interest – 5.3% from footnote

is CGS/Sales sensitive to changing pig prices?

depreciation rate

PPE has 10-30 year useful life (plants and equipment)Construction in Progress is not depreciatedLand use rights have 40-50 year life.

Eventually Deposits and CIP becomes PPE. Final mix is (190+9+70)/(190+9+70+61) = 80% PPE.

Useful life is then .80(20) + .20(50) = 26 year useful life.

NOA– constant or changing?

Balance Sheet AssumptionsWorking Capital AssumptionsEnding Operating Cash/SalesEnding Receivables/SalesEnding Inventories/COGSEnding Other Current Assets/SalesEnding Accounts Payable/COGSEnding Taxes Payable/SalesEnding Other Current Liabs/SalesOther Operating Asset AssumptionsEnding Net PP&E/SalesEnding Investments/SalesEnding Intangibles/SalesEnding Other Assets/SalesOther Operating Liability AssumptionsOther Liabilities/SalesDeferred Taxes/Sales

HOGS balance sheet forecasts Trend Cash/Sales from 12% to 3%

don’t seem to be earnings interest rev, so this looks like a temporary cash balance due to large capital offerings

need to maintain restricted cash w bank. 3% of 2009 sales.

Inventory/CGS set to 2008 ratio of .036 gov’t will let them lower ratio once pork

prices stabilize

HOGS PPE/Sales forecast

From analyst report:“As shown in Exhibit 1, processing capacity should

increase 41% from now to the end of 2012. Besides capacity expansion efforts, Zhongpin should be able to increase capacity utilization over time. Over the last three years, capacity utilization has been 74%, 57%, and 65%, respectively. While we would expect utilization to fall in 2010 given the high level of capacity expansion, these plants should be able to reach utilization rates of 90% or better, similar to Western processors, as the business matures.”

HOGS PPE/Sales forecast II

if capacity utilization = used/available = .65

and this statistic is going to .90, then

new(PPE/Sales) = old (PPE/Sales) * (.65/.90)

new PPE/Sales = .358 * (.65/.90) = .259, trending over 10 years

NFO – constant or changing?

Financing Assumptions

Current Debt/Total Assets

Long-Term Debt/Total Assets

Minority Interest/Total Assets

Preferred Stock/Total Assets

Dividend Payout Ratio

doesn’t actually matter. Why?

is it that easy?

make a list of all the things we could do to improve on our:

IS forecasts

BS forecasts

what is it all worth?

r = 10%, Price = $25.94

check the sensitivity to the PPE/Sales ratio make the terminal value .31 (due to 75%

utilization)

check the sensitivity to CGS/Sales make it 86.0%.

next class

Chestnuts! reverse engineer the analyst report

reverse merger issues with Chinese companies

Projects!

Exam!