China Star Food Group - DBS Research 2016-07-15: Small Mid Cap Exploration

China Star Food Group - DBS Research 2016-07-15: Small Mid Cap Exploration CHINA STAR FOOD GROUP LIMITED 42W.SI 

China Star Food Group (CSFG SP)

  • China Star Food Group (CSFG) is principally engaged in the production and sale of sweet potato snack food products processed from purple and orange-fleshed sweet potatoes across China. 
  • The stock currently trades at a compelling 3.5x T12M PE, a c.61% discount to SGX-listed China-based food peers’ valuation of 9x T12M PE. 
  • Growth will hinge on higher production capacity and the appointment of more distributors and customers. Its existing production capacity of 28,800 tons is set to double when its third factory is opened by the end of this year. 
  • Other earnings drivers include margin expansion through better raw material procurement and product premiumisation.

CSFG is a manufacturer and seller of sweet potato snack food products. 

  • The company is based in Liancheng county of Fujian province. Its products are sold to over 300 distributors and wholesalers who onsell them to supermarkets, petrol kiosks, convenience stores, specialty stores and online portals throughout China. 
  • CSFG produces six main categories of sweet potato snack food products (baked goods, pastries, roasted nuts, candies, crisps and preserved foods) marketed under proprietary and private label brands. CSFG started operations in 2009 and was listed through an RTO of Brooke Asia. It commenced trading on 20 April 2016 on SGX’s Catalist Board.
  • CSFG is riding on increasing demand for sweet potato health foods and rising disposable income in China. According to market research firm Converging Knowledge, annual sales growth of sweet potato snacks is expected to be at least 20% in the next three years till 2017. Sales growth will be supported by greater consciousness for consuming sweet potato health food, bigger population and higher disposable incomes.

Growth going forward will be driven by higher sales volumes. 

  • CSFG currently has two factories producing 28,800 tons of sweet potato snacks. Its third factory, with an estimated production capacity of 30,000 tons, is expected to come on stream by the end of this year. Additional production will be filled by increasing the number of distributors across the various provinces. Even though it has distributors in every province, coverage and penetration is still not comprehensive. Its key provinces include Xinjiang, Fujian, Guangdong Shanghai and Beijing. There is available room to appoint more distributors in each province. In addition, it is increasing its direct selling to supermarkets and hypermarkets. A fourth factory is planned for construction in 2H16. That will increase production volumes further beyond its completion in 2018.
  • Sales growth has historically been driven by higher sales, production and utilisation of its two existing factories. From 4Q12, CSFG branched out from its existing products of preserved food and crisps to three new product categories of baked goods, pastries and roasted sweet potato nuts. These have helped to increase sales and have brought about a higher gross margin. Preserved food and crisps gross margins were 32% while the new product lines’ margins averaged 43.5%. The company also introduced new products and revamped its product packaging to cater to premium customer segments.

FY16 earnings were dragged by higher opex in R&D expenses and advertising costs. 

  • There were also one-off goodwill and RTO expenses of Rmb37m and Rmb34m. respectively Earnings on a normalised basis would have been Rmb86m, while net margin on a normalised basis would have declined from 22% to 18%.
  • CSFG’s long-term growth strategy apart from immediate increase in production capacity includes 
    1. establishing retail shops and distribution franchise which will sell its products under the trademark “Shugongfrang” which will help promote branding; 
    2. expanding geographical coverage to overseas markets in Asia and Japan; and 
    3. continue developing new products to meet changing market demand for its products. 
  • CSFG is currently working on a new product category of frozen sweet potatoes which can potentially carry gross margins of 50%. Its third factory will have capabilities to produce frozen sweet potato products.
  • Working capital days for the past two years have been positive with payable days at close to 50 and receivable and inventory days collectively at 15-30 days. Cashflows are generally financed by suppliers with longer payable days, while credit extended to customers have ranged from 11-25 days. Inventory days have been minimal at just 5-6 days for the past two years.
  • Key competitors in Liancheng county include sweet potato producers of dried, sliced, soft candy and other traditional products. Key competitors are Lianxiangyuan Food Co., Ltd, Guangdachang Food Factory, and Jintudi Co., Ltd. Other competitors include Beijing Yushiyuan Food Co., Ltd, a Beijing-based specialty snack food producer. The sweet potato snack food market is a relatively new product to China and as such, the product has scope to penetrate the market. Within Liancheng county, CSFG has the largest production capacity.

Key risks: 

  • Growth is largely centred around increase in production capacity and the ability to add more distributors and customers to rake in sales. We identify failure to appoint and increase the number of distributors, as well as failure to start production at its new factory, as key dampeners to growth. 
  • Other risk factors include failure to improve margins from product premiumisation and raw material procurement and decline in demand and spending for sweet potato snack food.

The stock currently trades at 3.5x T12M PE, a c.61% discount to SGX-listed China-based food peers’ of 9x T12M PE. 

  • The stock is backed by S$0.15 net cash per share. Growth will be fuelled by a doubling of production capacity by the end of this year and increase in the number of distributors. Working capital will remain favourable as long as credit terms given to customers and received from suppliers do not change. 
  • Valuation multiples are compelling provided management is able to execute and deliver growth. We believe the stock could even re-rate if management successfully delivers growth over the next few years.

Alfie YEO DBS Vickers | 2016-07-15
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