Earnings Hit By Higher Costs And Lower Efficiencies From New

Investment Highlights
• Maintain BUY with a lower target price of S$0.86, based on 3.4x 2012F PE, pegged to Singapore-listed peers’ average.
• Share price has slumped 30% following its 3QFY12 results which came in lower than market expectations. Management has cautioned that they may not be able to meet the internal FY12 profit growth target due to higher cost of production despite higher revenues and ASP.
• We also cut our FY12/13 earnings by 2.8/17.3% respectively.

Financial Results
• China Minzhong Food (CMZ) reported a 7.8% decline in net profit to Rmb240.8m for 3QFY12 mainly due to the late arrival of the winter season and the kicking in of additional operating expenses from the new industrial plant. Climate change has led to a delay in the cultivation and harvesting of its key product - champignon mushrooms, which resulted in sales being booked in April instead of March. Management has highlighted that for Apr 12, CMZ’s revenue already rose by approximately
60% yoy to Rmb280m with a corresponding 60% yoy increase in gross profit to Rmb110m.

• Gross profit fell 6.1% to Rmb311m despite a 7.0% growth in revenue as the group was hit by higher fertiliser costs (+20% yoy), lower yields from new land plots and lower operating leverage from the new production facilities. CMZ also recorded higher selling and distribution expenses to Rmb12.3m (+9.8% yoy) due to additional advertising and promotion expenses for in-house brands and an increase in shipping and transportation costs.

Our View
• We see a fundamental change in the earnings drivers going forward. CMZ had initially wanted to focus on organic products with the Putien government reserving a plot of land to grow organic vegetables but due to heightened competition from similar organic products, the group has realigned its efforts on growing king oyster mushroom (KOM). CMZ produces an average of 18,000 tonnes of KOM/day now and targets to ramp up to 144,000 tonnes/day by FY13. With an ASP of Rmb12/kg, this segment can yield Rmb630m in revenue or 23.8% of FY12’s revenue.

• However, we believe that the group’s aggressive capex plans for KOM in 2013 may erode its cash position although management reiterates that it has untapped credit lines of some Rmb700m. The group has also collected approximately 80% of the Rmb862m trade receivables.

• We also see margin pressure for FY12/13 as the group will only reap full economies of scale for the new production plant over the next three years but will have to incur overheads and depreciation expenses in the initial phase. We forecast gross margins to decline from 41.5% in FY11 to 41.3% in FY12.