China milk quarterly tabulation

I've some time at hand to crunch some numbers for China milk. I've always wanted to do that but never really got around to doing it. Here's the figures:



I didn't read through the whole annual report nor its business in details, so let's do it another time then. Here's a few thoughts:


1) Despite the s-share saga, there are some s-shares like China milk whose business are still very sound and the debts are not stacked sky high. A cursory look at the revenue and net profits shows that China milk is very much in business despite the tainted milk saga in China too. The business is doing well without the much debts too. Debt/equity ratio is pretty good and is much lower than that in FY07.


2) The cash and cash equivalent is growing bigger and bigger since 1Q07. China milk did not announced dividends but there are official announcement of China milk proposing to buy back part of their convertible bonds - the only long term debts in China milk's balance sheet. The details are quite beyond me, not very sure what they are talking about. But it's important to note that by doing so, they would have reduced their long term liabilities in their balance sheet (by how much, I'm not sure) and book a non-taxable accounting gain of US$654,600 or around RMB 4.5 mil. That is around 3-4% of the 3Q08 net profits.

There are of course questions regarding what is the use of this cash if the management did not distribute back as dividends to shareholders. I think besides buying back their bonds, they intend to get more dairy livestocks.


3) Is there a problems with China milk running into liquidity problems? Very unlikely. Their current ratio are off the charts, being so well bathed in cash. With their repurchase and subsequent cancellation of their convertible bonds, their liabilities will reduce further. We're talking about a very debt-free s-share over here.

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Erratum in Business Times report

This is slightly interesting.

Lynette Khoo, BT, made a mistake in her report regarding corporate scandals rocking the s-shares locally. For those uninitiated, s-shares refers to China companies but listed in SGX. China milk announced in SGX about the error without explaining much or reassuring. I guess it's self explanatory. Here's the report:


I've highlighted the parts that need to be corrected. The erratum is here:


Not that it matters. In this kind of market, prices will get slashed anyway. But s-shares seem to have taken the bulk of it, perhaps due to the perception that their management or corporate governance is not good, or simply that the business quality is just not that good. The best are in China or in HK, I must say.

These are the list of s-shares scandals that I know of:

1. CAO - china aviation oil debacle, where the CEO Chen Jiulin ran up losses of up to $550 m on trading losses back in 2005.

2. Ferrochina - unable to pay off debts, and banks unwilling to revolve their short term debts.

3. China printing and dye holdings - CEO and deputy CEO went missing. Rumors are that their parent company is unable to repay creditors money.

4. Tianjin Zhong Xin Pharma and New Lakeside filed adjustments to previous financial statements. Don't it all remind us of Worldcom and enron?

I've said that I'm getting sick of all these kind of quality of companies listed in Singapore. I shall stay clear of them and have my reservations against them. Don't get me wrong, I'm still pretty bullish on China, it's just most of the china companies listed here are not that great. With Cosco dragged down from $6 to today's close of $0.815, I think it's safe to say that ALL s-shares are now below $1.

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News from milk industry

Some news from the milk industry in china.

News 1:

BEIJING -- Hangzhou Wahaha Group Co. is considering an acquisition of the dairy company at the center of China's milk scandal, company officials said Monday.

A spokesman for Wahaha, China's largest domestic beverage producer and a joint-venture partner of Groupe Danone SA, confirmed that chairman Zong Qinghou has said the company is interested in acquiring Shijiazhuang Sanlu Group Co.

The scandal over tainted milk, which has sickened tens of thousands of children, is expected to force a consolidation of China's fragmented dairy industry. Scores of dairy producers with complicated supply chains around the country made the industry difficult to monitor ...


My take:

After every major crisis, there are also opportunities abound. Those who survive this saga will emerge much stronger, for there are fewer competitors around. With Wahaha considering an acquisition of troubled Sanlu group, I expect to see perhaps more consolidation of the China's milk industry


News 2:

Three Chinese dairy companies have publicly apologized for their involvement in a toxic milk scandal that has killed at least four children and led to Chinese-made products pulled from shelves around the world. All three brands have lost there status as ‘China National Brands’. This won’t bring back the prestigious label but is seen as a first step to regain consumer trust….

Inner Mongolia Yili Industrial Group, Mengniu Dairy and Bright Dairy Group were found earlier to have produced milk contaminated with melamine, a compound used to cheat nutrition tests.




The scandal has savaged the companies’ share prices and prompted Seattle-based coffee chain Starbucks Corp to pull Mengniu milk from its 300-plus stores last month.

“I feel I have let everybody down. I have done so much, yet still done wrong,” Beijing News quoted Mengniu’s marketing chief, Zhao Yuanhua, as saying on state television.

Zhao and executives from Mengniu and Bright Dairy also promised consumers that their products prices would not rise despite higher costs of quality controls.



Chinese health officials last week said that nearly 10,700 infants and children were still in hospital after drinking toxic milk and formula. More than 36,000 children had left hospital after being treated.

The scandal has rocked faith in the safety of Chinese-made products, already under a cloud from a series of quality scandals involving food, drugs and toys last year, and prompted authorities to issue tighter rules governing milk production.


China’s quality watchdog said a fourth round of tests on baby milk formula and other milk powder from dozens of local brands across 18 provinces had shown no new cases of melamine contamination, Xinhua news agency said in a separate report.

But the Ministry of Agriculture had decided to continue sending quality teams across the country to monitor the clean-up of milk stations and animal feed producers, it said in a notice on its website.

“Supervise and urge local authorities to investigate and punish the illegal use of melamine and other toxins, and other unlawful adulteration,” the ministry said.


My take:

With the three giants in the milk industry stripped off their China National Brands name, I wonder what's in store for these three. How long does it take for them to regain the trust of consumers? Or are consumers forgetful? They did mention that they will keep the prices steady even as their costs increases from the higher quality control. If raw milk prices rises, these companies are going to suffer two fold - first is the lack of demand for their products, second is the squeeze they will feel when the cost rises yet unable to pass the cost to consumers. It'll be interesting to see how they cope with their business henceforth.

Who ask them to do funny things to their products?

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China milk - tainted milk scandal

I read an interesting company update by DMG and partners regarding China milk. While I can't reproduce the entire report by cutting and pasting, I'll summarise the pertinent points here.

What happened


The whole story begins when recently, it was detected that the milk made in China have traces of melamine. A lot of babies in China, after taking in contaminated milk, had fallen ill and some had even died because of the toxicity. While most cases are contained in China itself, there are reports of one baby who suffered in HK. Despite this, a lot of countries had decided to ban china products outright for fear of further contamination. In Singapore, several products had been taken off the shelves too.


What is melamine


Melamine is a compound that is used in making plastics or fertilizers. It is a non-protein nitrogen containing compound, with about 66% nitrogen by mass and is known by it chemical name as 1,3,5-Triazine-2,4,6-triamine. Due to its high nitrogen content and its cheap cost, it is added to milk by farmer and/or companies to boost the nitrogen content of the raw milk so as to pass the protein test, which is used as an indicator that the raw milk supplied is of high quality.

Melamine can cause bladder and reproductive damages, specifically in the formation of kidney stones. The lethal dose of melamine is more than 3 g per kg of body mass. As such, most if not all the affected victims are babies, as their body mass are much lower than adults and hence the ingested amount, over a prolonged period of time, causes the above mentioned effects.


Possible causes of the addition of melamine to milk


China milk's management mentioned that the main reason why Chinese dairy farmers and companies add melamine is because of the poorer quality of raw milk. As the rising cost of animal feed and fertilizers increases (also linked to the rising price of crude oil) in 2008, the cattles are not fed as well as they should. The consequence of this malnutrition is that the milk produced by these cattles are also of poor quality - that is, of lower nitrogen content. In order for farmers and dairy companies to attain higher profit and margins, they need to send the raw milk supplied for protein test to indicate that it is of superior quality. Hence, the addition of melamine will serve this purpose.


How China milk can benefit from this


Management mentioned that earnings will be expected to remain stable because the core business of the company is not in selling milk but in selling bull semen, despite the name of the company. They mentioned the price of each straw of semen (specifically the pedigree Canadian bull semen in which they have a monopoly on) - RMB 70 per straw - and typically two straws are needed to impregnate a cow.

Since Canadian bull semen will produce cows which yield the best quality and volume of raw milk, the management believes that this will be an effective step in rebuilding China's reputation in the milk industry worldwide. China milk will stand to benefit from this process of rebuilding China's reputation. It will take 3 years from conception before a calf can be milked, so the healing process will not be short.

Furthermore, China milk grows 75% of their own feed and produces their own fertilizers, so they have the ability to control quality at each step of their value chain. Since feeds takes about 50%++ of their operating cost, they will stand to gain from their independence off the rising feed/fertilizer price.


Risks


While china milk mentioned in a separate announcement that they are not involved in the scandal, and none of their customers are listed in the affected companies mentioned in mass media, the industry wide scandal affects each and every player in it. It will take years before confidence will be regained.

It is important to note how the demand for china milk will be affected. If less domestic milk is consumed, then farmers will be less inclined to have more cows to produce milk, and the subsequent drop in demands for cow embryos and sperms will also be reduced.

JP Morgan listed china milk under high cash high debts - meaning a possibility of management's poor financial discipline.


How to benefit from this


PE of China milk is around 3x. I think one needs to do a projection of the earnings at much lower percentage than one based upon historical rates. Even if using a earnings growth of 5%, we have a PEG of 0.6. My views is that not much can go wrong, though I said it with a biased views of an investor with vested interest in it.


Addition announcement dated 26th Sept 2008


China milk posted another announcement on SGX. Here's a summary of the new announcement:

a. Management believes that the sales of raw milk are not expected to be materially affected as there is still demand from milk processor and milk product manufacturer

b. As the Group believes in the quality of its raw milk (which contain no additives) and because the shortage of good quality dairy cows in China still persists, the Group is cautiously optimistic that it will be able to continue securing orders to supply raw milk to its current customers (none of which are manufacturers of the affected milk powder brands in China).

c. In addition, the Group believes that there will not be any material adverse effect (financial or otherwise) on its other business relating to the sales of bull semen and cow embryos. Although the Group expects that there may eventually be some consolidation and/or adjustments in the milk production industry in China, the Group believes that there is still sufficient underlying consumer demand for dairy products in China. On the other hand, demand for its bull semen and cow embryos (both for breeding of dairy cattle as well as for fertilisation of dairy cows for the purposes of raw milk production) is expected to remain relatively consistent given the shortage of good quality dairy cows in China as a whole and the fact that dairy cows need to be fertilised every year in order to produce milk.

(I've seriously not thought about that before. I've always thought that the main economic moat of China milk is that it holds a substantial herd of Canadian Holstein, known for its high quality and high volume milk production, before China banned the import due to outbreak of mad cow disease. Now that they said it, it does make sense that the continued demand for sperm is due to the fact that diary farmers need to fertilize their cows every year to produce milk!)

d. The Group further believes that the demand for its bull semen and cow embryos will remain good as the Group only produces bull semen and cow embryos of Canadian pedigree.

e. Purely as a precautionary measure, the Group has sent samples of its raw milk to an independent laboratory for the relevant testing and will follow up with an announcement on the results of the tests after receipt of the same.

(I should wait for their report of the lab test. I like China milk's way of handling the crisis. How a company manages a crisis and offer words of confidence is as important as how they capitalise on the opportunity posed by the crisis.)

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China milk 1Q09

China milk's 1Q results are out.

Only have time to browse through press release and power point slides. I'll do a more detailed analysis when I've the time.

To summarise:

1. EPS increased from 0.11 RMB in 1Q08 to 0.14 1Q09, a 27.3% growth

2. Revenue grown from 124.2 mil RMB to 158.4 mil RMB, 27.6% growth

3. NAV rose from 2.46 to current 2.61 in 1Q09

4. announced JV with a govt owned bureau and a third party (unnamed) to acquire like 200 pedigree bull sires. That's 140 mil RMB investment with 40% stake - all self funded

5. raw milk processing, OEM basis, will be out in 2Q towards end of year

6. Interim dividend declared, around SGD $5.60 per lot


Quick thoughts:

Not sure if they are going to give interim dividends for the next 3 quarters. If they do, that will give an annualised dividend yield of around 3% at last closing price. Great growth from EPS - what's good is that they are not as badly hit by rising material cost as other companies. In fact, they played the inflation game pretty well. Read that they had to buy more fertillisers as they do not have enough generated internally - will this be a long term running cost for the company? Have to read more.

The raw milk processing, having being delayed for some time, had been finalised to be 2Q towards end of this year. Let's hope no more delays now. The announced JV with Heilongjiang govt, with china milk taking a 40% stake, will see them acquire 200 pedigree bull sires. This will strengthen their monopolistic status on their sperm business...a very good sign to me.


Quick valuation

EPS at 1Q is 0.14 RMB. Annualising it gives us SGD 0.112. At last closing price of 0.695, that's a forward PE of 6.21x. Not sure if this is high or low, cos this must be the first time I'm analysing their results. Price is around 1.3x NAV value too. Considering their high current ratio and low gearing, this company will have no solvency issues in the near future.

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Thks to littlecupid, who pointed out that my PE calculation for china milk is wrong. It read as 16x initially but I've changed it to the correct 6.21x now.

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