Sino Grandness’ revenue doubles to RMB177.8m in 1H2011

Sino Grandness is issuing zero coupon convertible bond to raise net proceeds of RMB80 million after expenses. The CB is structured a-la private equity deal. Essentially the bondholders get to participate in a hopeful listing of the subsidiary Garden Fresh, most likely in Hong Kong exchange. Garden Fresh was incorporated in Jan 2011 to undertake the business operations of the beverage segment of Sino Grandness.

The conversion ratio when fully converted ranges from 6.7% to 19.9% into shares of Garden Fresh depending on profit targets achieved and benchmark listing valuation. If the bondholders choose not to convert, either by choice or by circumstance (i.e. events of default), we estimate that the CB would have a yield ranging from 5%-31% on maturity. Redemption value then ranges from RMB100m to RMB195m.

From the CB issue, we can see that it is the company’s intention to segregate its 2 main operations into 2 separate entities. The net proceed of RMB80 million will be used to fund investment in the beverage business. In the first half of 2011, beverage sales have already garnered RMB177million in revenue and RMB70million in gross profit. Applying the consolidated net profit margin for 1H11 of 18.5% would give a net profit for the beverage of RMB33million. We believe 2011 target of RMB70 would be achievable.

We are more reserved on subsequent years profit targets, which exceed our current forecasts. We estimate that production would have to at least triple to hit RMB250m net profit in 2013. The dilution factor that commensurate with the performance targets becomes an incentive for company management to work towards, given the CEO stake of 44% in Sino Grandness.

The salient point that we wish to highlight is the underlying assumption that the listing is done at minimum valuation of 9x FY13 earnings. The stakes are high if the listing fails to go ahead, given the costly redemption value. The sector valuation averages 20x-30x. 9x valuation would be a low hurdle in comparison. And if successful, the subsidiary accretion to Sino Grandness book value would be substantial. Currently Sino Grandness market cap is approximately S$100m. Applying the conservative parameters (see table illustration below) would see Sino Grandness book value at least doubling.

The beverage business had a good strong start. 1H2011 revenue rose over 200% y-y to RMB 177.8m. The drinks are currently sold in just 1st and 2nd tier cities in 6 provinces of China including Guangdong, Zhejiang, Fujian, Sichuan, Yunnan and Shanghai. There are over 6000 point-of-sales including supermarkets, convenience stores as well as F&B outlets and even the Chengdu airport. In a recent trip to the Sichuan plant, we saw first hand stocks running low in a few F&B outlets. We spoke to a distributor who is managing the Chengdu area and understand that his sales are constrained by the supply. Company’s management plan is to roll out the bottled juices country-wide eventually.

As mentioned earlier, we think this year net profit target for the beverage segment of RMB70m is achievable. Incremental sales growth would depend on geographic penetration and production execution. Geographically, the company intents to expand into the 3 and 4 tier cities in existing provinces and also to add at least 3 new provinces per year. We believe sales growth would be significant if the geographic expansion is successful.

The Sichuan plant is schedule for commercial production in 1QFY12 while the Hubei plant is schedule for commercial production in 2013. We have revised up our net profit forecast for FY11-13 BY 24-70%, mostly on optimism in the beverage business. However we maintained a conservative stance relative to the performance targets benchmarks.

In our simulation, we assumed FY13 net profit of RMB175m and listing valuation of 9x. This would gives a per share value accretion of SGD0.60 to Sino Grandness. Therefore our valuation roadmap would be (A) 6x earnings (on canned products) + (B) present value of per share value (beverage subsidiary upon listing). We are taking a discount rate of 15.2% on (B) which is the yield of the CB if CB holders opt to redeem at listing valuation of less than 9x.

Naturally a higher listing valuation acreages more value. In addition we are applying an uncertainty discount to our target prices. The uncertainty discount factors in for FY11, the few months remaining for a resolution of the Europe debt crisis, for FY12-13, the variability of our net profit forecasts due to unforeseen macro factors.