Sino Grandness – potential spin off in the making

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Most readers would be aware of Mr Koh Wee Meng, Executive Chairman and CEO of Fragrance Group who joined the ranks of Singapore Billionaires as shares of Fragrance Group doubled (including dividends) after Fragrance announced its intention to explore the possibility to spin off its hotel assets via a separate listing on 15 Aug 2011.

A company that may follow Fragrance’s footsteps is Sino Grandness.  Sino Grandness, through its wholly owned subsidiary Garden Fresh, has issued two tranches of zero coupon convertible bonds (“CBs”) worth a total of RMB370m. These CBs offer the bond holders to convert into shares of Garden Fresh should Garden Fresh be listed. In the announcement of the Goldman Sachs CB, Mr Huang, Chairman and CEO of Sino Grandness, had also indicated that one of the future developments to add value to the group may include future plans to list Garden Fresh.
The potential spin off aside, there seems to be more positive developments since my write-up on 18 Apr 2012.
1.     Issuance of CB to Goldman Sachs inspires confidence
As mentioned above, Sino Grandness announced that its wholly owned subsidiary Garden Fresh had issued RMB270m CB to Goldman Sachs and its co investors. According to management, before deciding to invest in Garden Fresh, Goldman Sachs has appointed a Big Four auditor to audit Garden Fresh business. In addition, Goldman Sach will appoint a representative to sit on Garden Fresh’s board of directors. The entry of Goldman Sachs does inspire some degree of confidence.
2.     Presence of new locations & new channels
Since launching its beverage business in 2QFY10, Sino Grandness has made significant inroads to China’s burgeoning domestic market. Recently, Sino Grandness announced that it has expanded network further in new locations such as Beijing and new channels such as 7-Eleven convenience stores.
3.     Results likely to exceed analysts’ estimates
With reference to Table 1 below, 1HFY12 result already posted a net profit of RMB140m. Some of you who are quick would have mentally annualized its 1HFY12 results to get its full year FY12 results. However, it is noteworthy that we should not annualize 1HFY12 results because
a)    One off professional fees of around RMB7m to be incurred in 2H for the issuance of CB to Goldman Sach and its co investors;
b)   Higher amortization of quarterly convertible bond expenses, as there are two CBs in place vs one previously;
c)    A&P expenses likely to be higher in 2HFY12. However, overall expenses are likely to be kept around 6% of its beverage business sales;
d)   Product mix, especially the beverage segment changes with the weather. For example, during summer periods such as June to end August, consumers tend to drink less concentrated beverage juices (i.e. more water content) than cold seasons. Typically, more concentrated beverage juices command slightly higher margins.
 
Table 1: Analysts FY12F estimates vs Sino Grandness 1HFY12 results
FY12F Estimates
1HFY12
UOB
DMG
Poems
Revenue
756.1
1,536.3
1,567.1
1,523.0
Net Profit
139.8
210.0
171.3
194.0
Source: Ernest’s compilations
Notwithstanding the above factors, 2HFY12 is usually a stronger season for their export business. Consequently, barring any unforeseen sharp deterioration in company’s fundamentals, it is likely that Sino Grandness should   be able to comfortably meet or (likely) to exceed analysts’ estimates.
4.     Domestic canned fruits business doing surprising well
During its 4QFY11 results briefing, Sino Grandness mentioned that they would be launching their in house branded products (i.e. domestic canned products) in 2012. This took off surprising well. In 2QFY12, this segment contributed RMB38.2m of revenue in 2QFY12 vs RMB1.3m in 2QFY11. These domestic canned fruits business leveraged on Sino Grandness existing distribution network and command gross margins 37.1% (higher than its overseas products). To put this in perspective, domestic canned fruits business constituted 8% of 2QFY12 sales and net profit respectively.
5.     Active efforts in investor relations increase investor awareness
Company has been active in the investor relation front. It frequently gives presentations and talks at brokerage houses. It also hosts regular plant tours to fund managers and analysts. The upcoming investor conference which the company would be presenting would be at UOB Kayhian Consumer Conference at around 10-11 Oct.
Some noteworthy risks
As with all investments, there are some noteworthy points to take note:
1.     Performance benchmark of RMB140m for Garden Fresh FY12 net profit
If Garden Fresh can meet the benchmark of RMB 140m and RMB250m in net profit in FY12F and FY13F, then CB holders are likely to convert their CB into shares of Garden Fresh based on a value of RMB1.5b for Garden Fresh. According to management, the beverage business is commanding a net margin of around 18%. 1HFY12 beverage revenue was around RMB392m, thus its net profit is likely to be around RMB70m. With the expansion of more locations and more channels for their beverage business, it is likely to reach the benchmark of RMB140m for this year.
2.    Failure for Garden Fresh to attain RMB80m net profit in FY12F
If Garden Fresh business fails to achieve RMB80m net profit in FY2012F, it constitutes a default for CB holders where CB holders can redeem their CBs. However, this situation is unlikely to materialize given the strong performance of its beverage business in 1HFY12 (Refer to point 1 above).
3.    Cash intensive business à May distribute little dividends, if any
It is apparent that Sino Grandness, in their industry and in this current high growth phrase, is likely to distribute very little dividends, if any. For example, it did not distribute dividends in FY11.
4.     S chip risk
Besides the usual corporate governance risk surrounding S chips, they also face liquidity risk and price risk as sentiment is still pretty poor on S chips. Sino Grandness is still pretty liquid (vs other S chips) with its average 30D and 100D EMA volume amounting to 2.3m and 2.8m of shares respectively. Sino Grandness has traded within a tight range between $0.455-0.480 on a closing basis since 31 Jul 12 (See Chart 1 below).
Chart 1: Sino Grandness chart
Source: Shareinvestor (5 Oct 12)
Conclusion: Valuations undemanding; strongest re-rating catalyst likely in 2HFY13
According to Bloomberg, Sino Grandness trades at FY12F PE of 3x and FY13F PE of 2.1x. Given the (still) poor sentiment on S chips, it is likely that market is waiting to see whether Sino Grandness can consistently deliver its results. The strongest potential re-rating catalyst is likely to be in 2HFY13 where it may commence work on the potential spin off of its subsidiary.
*I had previously highlighted Sino Grandness to my clients on 2 Oct 12. For readers, please note
that this is just an introduction on Sino Grandness. Feel free to email me at crclk@yahoo.com.sg for the analyst reports if you are interested to know more about Sino Grandness.

Disclaimer

The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied. In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.

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