20150916-大和证券-辉山乳业-06863.HK-Time_to_Sell_on__unjustifiable_valuation,_end_of_share_buybacks_14页_399kb

China Huishan Dairy Holdings 6863 HK Summary

Core Content

China Huishan Dairy Holdings (6863 HK) is the second-largest dairy-farm operator in China, based in Liaoning Province. The company supplies raw milk to third-party processors and produces fresh milk and UHT dairy products under its own brand.

Main Points

• Downgrade to Sell: The stock has been downgraded from Hold to Sell due to unjustifiable valuation and the end of share buybacks.
• Valuation Concerns: The FY16E PER is at 35x, which is considered too high given the company's weak fundamentals and execution risks.
• Share Buybacks Cease: Share buybacks by the chairman and the company will stop by the end of October 2015, following the blackout period before the 1H FY16 results.
• EPS Cuts: The FY16-17E core EPS is cut by 20% each year due to pricing pressure, slower volume growth, and rising net gearing.
• Revenue Challenges: Revenue growth is expected to slow, with FY16E and FY17E estimates reduced by 4% and 11% respectively.
• Margin Pressure: The company will need to increase sales of lower-margin UHT milk and beverages to digest higher output, resulting in a lower operating margin.
• Net Gearing Rise: Net gearing is expected to rise to 57% for FY16E, from 36% in FY15, due to share buybacks and negative free cash flow.
• Share Price Performance: The share price has increased by 67% since June 2015, but this is attributed to buybacks rather than strong fundamentals.

Key Information

• Target Price: Reduced from HKD1.55 to HKD1.50, with a downside of 49.3%.
• 15 Sep 2015 Price: HKD2.96.
• Major Shareholder: Yang Kai, holding 70.7% of shares.
• Share Repurchases: The chairman and the company have repurchased a total of 905.24 million shares and 728.799 million shares, respectively, since June 2015.
• Free Cash Flow: Expected to remain negative for FY16E and FY17E due to high capex.
• Operating Profit: Expected to grow at a slower pace than previously anticipated, with FY16E and FY17E estimates at 1,506m and 1,689m CNY, respectively.

Financial Highlights

Metric	FY16E	FY17E	FY18E
Revenue (CNYm)	4,568	5,160	6,139
Net Profit (CNYm)	969	1,133	1,380
Core EPS (CNY)	0.069	0.083	0.102
Operating Margin (%)	33.0%	32.7%	34.2%
Net Debt to Equity	57.2%	58.7%	56.1%
Free Cash Flow (CNYm)	(1,803)	(81)	441

Risks and Concerns

• Valuation: The company's current valuation is considered unjustifiable.
• Execution Risks: Expansion into eastern China and competition in the downstream segment pose significant risks.
• Share Buybacks: Management's share buybacks are not seen as beneficial for long-term growth.
• Downstream Sales: Increased focus on UHT milk may lead to lower margins and less competitive positioning.
• Executive Resignation: Mark Anthony Wilson resigned as an executive director in August 2015, raising concerns about the downstream business development in eastern China.

Forecast Revisions

Year to 31 Mar	Revenue Change (%)	Net Profit Change (%)	Core EPS Change (%)
2016E	-4.0	-22.9	-20.4
2017E	-11.1	-24.8	-20.3

Key Ratios

Ratio	FY16E	FY17E	FY18E
PER (x)	35.1	29.2	24.0
PBR (x)	2.5	2.4	2.2
EV/EBITDA (x)	21.7	19.6	16.3
ROE (%)	7.2	8.4	9.5
ROIC (%)	6.9	7.4	8.2

Share Repurchases

• Chairman's Buybacks: Total of 905.24 million shares, spending approximately HKD2,000m.
• Company's Buybacks: Total of 728.799 million shares, spending approximately HKD1,676.2m.
• Share Price Impact: The strong share price increase is attributed to these buybacks, not fundamental improvements.

Conclusion

The downgrade to Sell reflects concerns over the company's valuation, margin pressures, and execution risks. Despite recent share price growth, the fundamentals remain weak, and the cessation of share buybacks is expected to negatively impact the stock price.