Synear

Since quite a lot of people are interested in Synear, especially the recent fall from heaven, and wondering if it’s a good bargain now, I thought I’ll be interesting to find out a little more about Synear. Synear doesn’t have a lot of history since it only IPO in SGX on August, 2006. I’m thankful for its investor friendly statements too – means that I don’t have to spend a lot of time reading fine print and such.

--------------------------------2005--------------2006----------------2007--------
COGS (% to revenue)------68.6%-------------66.4%--------------67.8%------
Gross margin----------------31.4%------------33.6%--------------32.2%------
Net margin------------------16.3%-------------21.8%--------------21.5%------
Financial leverage-----------3.53---------------1.35-----------------1.16--------
Asset turnover---------------2.28---------------1.12-----------------0.70--------
ROE-------------------------131.3%------------33.0%--------------17.4%-----

There are a few things I noticed about Synear just by coming up with this table of comparison between the financial years:

1. Synear managed to control their costs, keeping it near 66 to 68% of revenue. As can be seen from their gross margin, it’s also a stable figure around the vicinity of 32%. It’s only depressing when one looks at the 4th quarter results.

-----------------------------------4QFY06---------------------4QFY07------------
COGS (% to revenue)----------64.6%-------------------------72.4%-------------
Gross margin ------------------35.4%-------------------------27.6%-------------
Net margin----------------------21.8%-------------------------10.7%-------------

While 4QFY06’s COGS is more or less in line with the full year FY06, it’s a different story for FY07. We can see that there is a huge difference between 4QFY07 gross margin of 27.6% and full year FY07 gross margin of 32.2%.

As mentioned by the management, the price of the Group’s main raw materials (pork, flour and packaging materials) have increased by an average of approximately 13% in 2007 as compared to that of last year. If we increase 4QFY06’s 64.6% COGS to revenue by 13%, we’ll get 73.0% (64.6 x 1.13 = 73.0), which is quite the figure for 4QFY07. Management isn’t joking when they say it’s 13% increment in raw materials!

2. Gross margin is kept nearly constant for the full year results, but again looking at quarterly results, the higher cost of goods sold reduced the gross margin from 35.4% in 4QFY06 to 27.6% in 4QFY07. Management did say that they raised their average selling price for their products by about 8% in April 2007 (2Q FY07).

Let’s review what companies can do to raise their revenue:

a) Raise the price of the products (which they did, by 8%)
b) Sell more products
c) Sell a new range of products
d) Growth by acquisition

a) They did raise the price of their products by 8%. However, this is still less than the price increment for their raw materials. Unless they can fill the gap by selling more, it’s hard to raise prices anymore since the products they are selling isn’t staple. I mean consumers can totally do without it if the price is too much for them to pay. That’s the bad thing about this food business – there is no discernible economic moat and too many similar products and substitutes. I don’t think price increment will go down well with consumers, unless their products are really different from their competitors (then they can charge a higher price for it).

b) They did sell more products.

From FY06 to FY07,

Savoury dumplings products---- sales revenue increase by 21.3%
Glutinous sweet dumpling products ----- sales revenue increase by 16%
Other quick freeze products ---- sales revenue increase by 18.9%

(% to the total sales)
------------------------------FY05---------------FY06---------------FY07------------
Savoury dumplings------44.8%--------------45.0%---------------45.9%----------
Glutinous dumplings----38.5%--------------35.8%---------------34.9%---------
Other quick freeze-------16.6%--------------19.1%---------------19.1%---------

Take note that part of the sales increase is due to the increase in price and not the volume of sales. This increase must at least be partially attributed to the increase in the number of distributor from 515 to 604 in FY07.

We can see from the table above what is the trend that consumers like for their product mix. Their savoury dumpling products is getting more sales year on year, while their glutinous dumpling products isn’t that popular. In fact, their quick freeze products seem to be taking in more share while their glutinous dumpling products dropped. This is totally what I expected since I like savoury rather than sweet products, haha 

c) Management said that having a premium range of products increased their sales (page 12 from 4QFY07 result). I believe they are talking about their new pan-fried dumpling series and their premium “Shoudatianxia” series of savoury and sweet dumpling, which commanded higher gross profit margins. This shows that Synear do sell new range of products so that customers will always find something fresh in their product range. The good thing is that these new product range draws a higher margin, but whether people buy it is another thing (which I can’t tell).

Their FY06 annual report stated that Synear had acquired land to build a new product development centre in Zhengzhou, Henan Province. This new product development centre will work on improving existing products, improve production efficiency and product safety, as well as launch new and innovative products.

d) No plans for acquisition mentioned by Synear.

3) ROE drop is interesting. I’m waiting for the ROE to stabilize itself, maybe to around 10 to 15% into the future. We can see that the ROE drops because the financial leverage of Synear actually decline a lot in the past 3 years. They have less short term debts and reduced their long term debts to zero, which may or may not be a good thing.

Another factor that contributed to the drop in ROE is due to their decreasing asset turnover. There is tremendous spending in property, plant and equipment (PPE) and a big chunk of their total assets is in cash and cash equivalents. The increase in PPE (and land rights) is due to Synear’s plan for new plants in Chengdu city, Huzhou city and Guangzhou city, amounting to a total of RMB 383.4 million, offset by amortization and depreciation charge of about RMB 20.2 million.

I think ROE will definitely drop more as they had plans to relocate their production facilities out of the city area to suburban areas in Zhengzhou city. It’ll take about 4 years to construct, with the first phase of construction comprising cold storage warehouses to be completed within a year from Feb 08. The new facilities, termed “Synear Industrial District” will amount to about RMB 1,200 million. Basically, as long as the facilities can really boost up their revenues, I don’t see a problem with the drop in ROE due to low asset turnover. It’ll take some years (at least 4) to realize the potential of all these new plants.

Let’s take a tally for the $$ needed for future expansion

(a) Synear Industrial District – RMB 1,200 million
(b) Acquring land and building cold storage warehouse – RMB 310 million
(c) New production facilities in Shenyang city – RMB 180 million

Total amount = RMB 1,690 million
Net proceeds from placement of new shares in April 07 = RMB 1,140 million
Short fall = RMB 550 million

In RMB (million)
-----------------------------------FY05---------------FY06---------------FY07------------
Net cash from operation-----397------------------290-----------------514-------------
Cash balance--------------------86-------------------822----------------1,153------------
% op cash to sales------------26.7%---------------15.6%-------------23.2%------------

It does look like Synear have enough cash from its operations to fund the short fall of RMB 550 million, perhaps with a little more long term borrowings from banks. Since they have no long term debts, perhaps borrowing is a better way to finance the expansion plants. I could be wrong, as I’m no expert in financing. As Synear mentioned, they will use the earnings generated from the Group’s operations and/or external borrowings.

Summary:

Actually I’m pretty satisfied with Synear statements. I’m a little worried about their escalating cost (as shown in their latest 4Q results) and how they plan to overcome this cost. I’m also a little skeptical about how they can keep growing their revenue. Maybe their brand is more than what I think is worth, but it remains to be seen since their history is so short. Very satisfied with their debts and cash flow too.

Using my very quick method of getting an approximate value for Synear, I get around 1.14. (pls dun ask me how I get this value, as I said it’s very approximate and not tested fully, just empirically). I'll do a more detailed one maybe tonight.

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I tried to work out some value for synear but realised that I can't. The reasons mainly due to the fact that the free cash flow for synear is not consistent as they are spending a lot on capex. Being unfamiliar with the industry and the business, the estimate I have is going to be very wide. Another thing is that they are in this expansion and growth phase, making the valuation hard too as their metrics are not stable (and I have only 3 years of data).

I'll stick to my rough estimate of 1.14 then. Applying 50% error margin, I think a good chance to buy is around 0.570. PE (earnings based on FY07, price as $0.665) is 9.4. PE based on my buy price of 0.57 is 8.0. PE based on my estimate of 1.14 is 16.0. Should be a real bargain if that price is reached. Do your due diligence as ultimately it's not my money!