Equity Valuation -- Vinda International Holdings Ltd

Transcription

1 Equity Valuation -- Vinda International Holdings Ltd by Zhao Ziyan, Jane Wu Mengqi, Jessica Li Huiyun, Lillian Li Chuan, Katherine Department of Economics & Finance City University of Hong Kong 2010

2 City University of Hong Kong This report is published for educational purposes only by students competing in the CFA Institute Global Investment Research Challenge. Consumer Goods Industry Vinda Intl Holdings Ltd. Market Profile Author Zhao Ziyan, Jane Wu Mengqi, Jessica Li Huiyun, Lillian Li Chuan, Katherine 52 Week Price Range HK$ Average Daily Volume 6.9m Beta 0.75 Dividend Yield (Estimated) 1.02% Shares Outstanding 939m M arket Capitalization 9.58 Institutional Holdings 41.40% Insider Holdings 25.57% Source: Company data Ticker: 3331.HK Price: HK$ Highlights Recommendation: Buy Price Target: HK$11.20 Tissue demand picking up on a better economy and income growth: We expect the tissue demand in PRC will grow by 8.1% for the next few years, due to the robust economic growth in PRC, accelerating urbanization and rising concern of hygiene habits. There is also a significant market trend that premium products are more favored. Despite the synchronized production expansion, we believe oversupply is unlikely to happen, because the production-consumption gap will be fully digested by the strong momentum of net exports. Strong growth dynamics by doubling sales network and accelerating capacity expansion: Besides increasing investment in brand building and product development, Vinda also raised focus on market penetration and capacity expansion. At present, Vinda has over 200,000 POS, covering 40% of the total retail network in PRC. Management targets to lift its coverage to 80% by In 1H10, Vinda has already increased its distributors to over 1000 from 735 in FY09. To speed up market penetration, management has planned to add 380k tonnes capacity by 2014 (current: 320 tonnes). We forecast that Vinda s revenue will grow by 34/42/46% in 2010/11/12. Stable profit margin thanks to easing pulp price and improving product mix: Pulp price in PRC has corrected to US$ /tonne in October from the peak of US$850 in April. Thanks to the restored production of Chile from the earthquake, weak global shipments and rising global pulp inventory, pulp price is expected to ease further and rest around US$ /tonne for Meanwhile, Vinda also plans to increase the contributions from higher margin products to 45.2% in FY12 (33.1% in FY09). After launching sugarcane tissue in May 2010, Vinda also acquired a 39% stake in a napkin and diaper company to diversify its product portfolio, which will help to mitigate the effect of pulp price volatility on its profit margin. We believe mix improvement and the easing pulp price could maintain the GPM at above 30% for Robust earnings growth and booming Asian stock market to support valuation: Our Target Price (TP) of HK$11.20 is the average from P/E model (HK$11.11 based on 17.12x forward P/E), and from DCF model (HK$11.30 based on an 11% cost of equity and 2% terminal growth). At our TP, Vinda would be trading at 5% above its 3-yr average forward P/E, which is warranted by its strong earnings growth, good fundamentals and the expected booming Asian stock market in Source: Bloomberg E 2011E 2012E 2013E 2014E Total Revenue (HK$m) Gross Profit (HK$m) Net Profit (HK$m) Basic EPS (HK$) Dividend (HK$) ROE 5.00% 10.00% 19.00% 17.00% 19.00% 25.00% 24.70% 24.80% ROA 3.00% 5.60% 10.70% 10.10% 9.50% 12.10% 12.50% 12.70% BVPS (HK$) Source: Company Data Important disclosures appear at the back of this report

3 City University of Hong Kong Investment Research Challenge Student Research Nov Business Description Established in Guangdong Jiangmen in 1985, Vinda is one of the three largest tissue paper manufacturers in China. The flagship brand Vinda is widely known in China as a premium tissue paper brand. Vinda was listed on the Hong Kong Exchange in Jul Shareholders Fu An 32.50% SCA 18.80% Cathay Capital 9.40% Invesco 8.10% Merrill Lynch 5.30% Public 25.90% Source: Company data Figure 1: PRC GDP Growth VS Tissue Demand Growth Source: IMF, CNHPIA Vinda has six plants in China located in Guangdong (2 plants), Beijing, Zhejiang, Hubei and Sichuan. Its seventh plant in Liaoning is under construction. The seven plants demonstrate an asterisk-shape distribution for better market penetration and lower transportation cost. (Appendix2) Toilet roll serves as the revenue engine of Vinda, accounting for 60.2% of the total revenue in 1H 2010 (Appendix 3). 87% of revenue is generated from PRC while Hong Kong accounts for 11%. Other overseas markets account for less than 2% of total sales. In terms of raw material supply, more than 50% of its wood pulp is sourced from Canada, Brazil and Indonesia. Vinda maintains good strategic partnership with suppliers and has long term commitment of pulp supply. Svenska Cellulosa Aktiebolaget (SCA), the European manufacturer of Tempo, is one of Vinda s major strategic shareholders (18.8% shares). We expect Vinda may gain potential opportunities, since it may open the door for Vinda to manufacture Tempo in China and other collaborations like information sharing and technique introduction. Vinda s CEO Ms. Zhang Dong Fang joint Vinda in Feb She was the vice president of a global market leader in flavors and fragrances production and was responsible for its Greater China business. She has extensive experience in international business management and consumer goods promotion. Industry Overview and Competitive Positioning Further easing pulp price We expect pulp price in China to ease further and to rest around US$ /tonne for from the peak of US$850/tonne. The slackness is attributed to the following reasons: 1) restored Chilean pulp production from the earthquake, 2) 2.3 mt re-capacity worldwide in , 3) discounts given by Chilean producers to gain market share, 4) global pulp shipments down by 11% YoY, with China plummeting 54% YoY in August, 5) increased global inventory turnover from 29 days to 34 days YoY. Demand: tissue consumption picking up on a better economy and income growth According to China National Household Paper Industry Association (CNHPIA), total tissue consumption in China has enjoyed an average annual growth of 8.98% for the past ten years. We estimate that the tissue demand in PRC will experience an average annual growth rate of 8.1% for the next ten years. 1) Robust GDP growth in China Since 2000, China has enjoyed an annual GDP growth rate of more than 8%. The real GDP growth in China is anticipated to be 10.5% in 2010, followed by 8% for the next few years. Because of an evident correlation with GDP, tissue consumption is estimated to grow in a synchronized pace with GDP. 2) High quality tissue paper favored resulting from accelerated urbanization The accelerating urbanization and growing disposable income also fuel tissue consumption. The living standards in both rural and urban areas have been improved significantly and consumers have developed more hygiene habits. As a result, the market share of mid- to high-end products has doubled to 30% while the low-end has shrunk in market share. We expect that the trend towards premium products will intensify in the future. Figure 2: PRC Population Breakdown Source: National Bureau of Statistics of China 2

4 City University of Hong Kong Investment Research Challenge Student Research 11 Nov ) Large potential in tissue consumption in PRC In 2009, PRC s tissue consumption per capita is about 3.96 kg, only about one-third of the global average, while the average annual consumption per capita was 24kg for North America and 15kg for Europe and Japan. The large discrepancy suggests a huge potential and hence an upbeat prospect of PRC s tissue market. Figure 3: PRC Tissue Consumption per Capita (kg) Figure 4: Income Per Capita in Rural and Urban Areas of PRC Source: National Bureau of Statistics of China Source: National Bureau of Statistics of China Supply: growing momentum of capacity expansion unlikely to lead to oversupply Compared with rising tissue demand, tissue production has seen a more rapid expansion over the past ten years, as the production-consumption gap is escalating. However, because of the weak imports and boosting exports, the production-consumption gap is expected to be fully digested by the increasing net exports. Therefore, we hold that oversupply is unlikely to happen. Figure 5: PRC Tissue Production vs. Consumption (in 000 tonnes) Figure 6: PRC Tissue Exports VS Imports (in 000 tonnes) Source: CNHPIA Market consolidation benefiting large market players In 2008, the PRC s tissue manufacturing industry was still fragmented where the top 10 companies contributed only 45% of overall production. However, we can see a noteworthy trend of market consolidation in According to CNHPIA, the leading industrial players are capturing more market shares at the expense of small ones. Large tissue manufacturers are gaining market shares Tissue Hengan 8.20% 9.20% 9.40% Vinda 5.60% 5.80% 5.90% Source: CNHPIA 3

5 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Gross Profit Margin 1H2010 Toilet roll 31.40% Handkerchief tissue 34.50% Hard envelope facial tissue 36.00% Paper napkin 30.90% Soft envelope facial tissue 32.90% Others 30.30% Overall 32.00% Source: Company Data One reason is that the economic downturn in 2009 and stricter environmental protection requirements phased out many poor-performance small companies, thus benefiting large market players. The trend of leaning preference towards medium- to high-end goods will further benefit the top three companies. Moreover, leading players, such as Hengan, Vinda and Asia Pulp & Paper (APP), have been carrying out aggressive marketing strategies and are expected to continue expansion in the coming years. To sum up, we expect the market consolidation will speed up and even bring appealing M&A opportunities for the large players. Investment Summary Wood pulp prices unlikely to erode profitability Pulp prices fell abruptly from its mid 2008 levels, hitting rock bottom at US$482/tonne in Apr However, prices peaked at US$850/tonne in April 2010, translating into a 76% increase from trough to peak. By adopting an aggressive procurement strategy, Vinda has built a pulp inventory costing around US$660/tonne in FY10. But the cheap pulp will be fully consumed by the end of FY10 and Vinda will have to source pulp at spot prices. As a result, we estimate Vinda s pulp inventory will cost US$ /tonne in FY Normally Vinda purchases 70% of the committed quantities signed with the suppliers and enjoys 1.5% -2.5% discounts. Future increase in procurement of wood pulp due to capacity expansion will allow Vinda to enjoy larger discounts from its suppliers. As a result, we estimate the discounts will offset some of the effects from the increased wood pulp price. ASP growth engine to continue in short term Even though the company only implemented a 3-5% ASP hike in 1HFY10, it is negotiating with distributors on a second round of price hike in 2HFY10. There is usually a lag of several months before the effects can be seen. As a result, we forecast an ASP increase of 6% for FY10. As QEII is heading from $600 bn to $2 tn and will continue through 2012, we expect Chinese inflation could reach 4.5-5% by 2Q2011. Additionally, as the Chinese government enforces stricter environmental regulations, many small-to-medium companies will be shut down and an approximate capacity of 600,000 tonnes will be released. Dual-brand strategy to extend penetration but small effects on the group s margin To further extend its geographical and customer coverage, Vinda has launched Rewoo which is targeted at second- and third-tier cities and rural areas in China. As Rewoo uses lower cost raw material, sugarcane pulp, it has a 30% lower ASP than that of Vinda s core products. Even though Rewoo has a gross margin of 25% which is lower than core Vinda products GPM of around 30%, it will not dilute the group s gross margin by much as the new Rewoo brand will contribute little (HK$63m in FY10) to Vinda s total turnover (HK$3732m). Benefit from customers changing preference towards premium brands We expect faster trade-up to wood pulp tissues and higher consumption per capita. At present, over 70% of tissue products in China are made of grass pulp, bamboo pulp and recycled paper, which tend not to score well on quality, hygiene and environmental compliance. But for Vinda, 94% (FY09) of its turnover came from wood pulp tissues, therefore allowing Vinda to ride on this trend of public s preference towards premium products. Shift to higher-margin products Vinda plans to change product mix and shift to higher margin products, such as wet tissue (GPM of 40%), handkerchief (34.5%) and facial tissue (33-36%). With the launch of wet tissue paper and the Pleasant Goat series rolled out in November, higher margin products are expected to contribute 45% of total sales in FY12 (33% for FY09). Small transaction, but strong growth prospects The acquisition of a 39% stake in a napkin and diaper company provides Vinda with the exposure to those industries. Despite the small expected additional earnings contribution, the growth potential is high as the newly acquired company can leverage on Vinda s distribution platform. We expect its sales to expand rapidly in the next few years with the support of Vinda s distribution platform. Nonetheless, to be conservative, we have not included the new business into valuation as the contribution is immaterial in short term. 4

6 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Valuation P/E Model Our Target Price (TP) of HK$11.20 is the average price from P/E model (HK$11.11 based on 17.12x forward P/E), and DCF model (HK$11.30 based on an 11% cost of equity, 2% terminal growth). At our TP, Vinda would be trading on 17.12x forward P/E, 5% above its average forward P/E 16.3x since IPO, which is warranted by its strong earnings growth, doubled sales network, improving market penetration and the overall bullish stock market expectation after QEII. Sensitivity Analysis of Forward P/E 3 Year Average P/E(x) Premium rate 0% 5% 10% 15% Target Forward P/E (x) FY11 Estimated EPS(HK$) FY11 Target Price (HK$) from P/E Model Source: Bloomberg, CityU Estimates With a reference by comparing Vinda with Hengan, the 17.12x forward P/E we applied is at 38% discount of Hengan, which is priced at 27.68x forward P/E. Historically, Vinda s P/E is at around 40% discount of Hengan s due to Vinda s smaller scale, lower profit margin and single product risk. Nevertheless, we expect the discount to be narrowed from Vinda s strong sales expansion, enhancing diversification in product mix and diminishing profit margin and EPS gap with Hengan GPM (Vinda Less Hengan) % % % OPM (Vinda Less Hengan) % % -5.20% Basic EPS (Vinda: Hengan) 1:10 1:6 1:4 Source: Company, RISI Figure 7: Hengan Forward P/E VS Vinda Forward P/E Source: Bloomberg 5

7 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Ticker Name Last Px Mkt Cap P/E ROE LF P/B 5Yr Avg LF EV/EBITDA Nxt YRel P/E Average Average HK Equity VINDA INTERNATIONAL HOLDINGS HK Equity HENGAN INTL GROUP CO LTD HK Equity WANT WANT CHINA HOLDINGS LTD HK Equity CHINA RESOURCES ENTERPRISE HK Equity CHINA YURUN FOOD GROUP LTD HK Equity YUE YUEN INDUSTRIAL HLDG HK Equity CHINA MENGNIU DAIRY CO HK Equity UNI-PRESIDENT CHINA HOLDINGS N.A HK Equity STELLA INTERNATIONAL Source: Bloomberg DCF Model During Vinda s rapid expansion period, it plans to double its capacity from 320k tonnes in 2010 to 700k tonnes in 2014, thus increasing its capital expenditure by $ m per year. But thanks to the strong revenue growth for the following years, the free operating cash flows will turn positive. Since 84% of our current price target arises from the terminal value, we adopt a conservative valuation by assuming that the terminal growth rate is 2% based on the forecasted future long-term inflation rate in China. Equity Financing Assumptions Variable Value Unlevered Beta 0.75 Risk-free return 2.3% Market return 14% Terminal growth 2% Cost of equity 11% Source: Bloomberg, CityU Estimates Valuation Summary Total 2011E 2012E 2013E 2014E Operating cash flow Capex Net Debt FCFE FCFE after 2015E Present Value of FCFE Shares outstanding Present Value per Share Risks to Price Target The upside risks to our TP are better-than-expected sales and lower-than-expected pulp price. The downside risks to our TP are higher-than-expected pulp price and unsuccessful price increment. Financial Analysis Turnover analysis We project turnover to reach HK$11.8bn by FY12, a 34% CAGR for FY09-14, based on 1) the addition of 380k tonnes of capacity to bring FY14 capacity to 700k tonnes, 2) an ASP increase of 4-7% for the core Vinda brand in FY11-14, 3) a sales volume increase of % and 4) revenue contributions of HK$63m-152m in FY10-14 from the Rewoo brand. Figure 8: Revenue Growth and Product Mix Shift Source: Company Data, CityU Estimates 6

8 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Gross profit margin shrinks in FY11 but slightly increases in FY12 FY09 s gross margin was exceptionally high due to the cyclical trough in pulp prices. Vinda adopted an aggressive pulp purchasing policy at the trough and thus raw material costs have been locked in at US$660/tonne for FY10 below the market price. Market pulp prices peaked at US$850/tonne in April 2010, and will retreat 20% in 2H10 and stabilize thereafter. We assume an average pulp price of US$725/tonne and US$750/tonne in FY11 and FY12. Therefore, we forecast that its gross margin will shrink 1% in FY11 from increasing pulp cost. Simultaneously, Vinda s product mix is changing as the company plans to shift to higher margin products (GPM: 35%). As a result, we estimate that the product mix shift will offset some of negative effect on GPM from rising pulp cost. Therefore, we estimate that the GPM will increase to 31.8% due to the stabilized pulp cost and increasing weight of high margin products. Figure 9: Average Pulp Cost and GPM Source: Company Data, CityU Estimates Raising advertising and promotion (A&P) to promote brand In 2009, management has intensified marketing and promotions to boost sales to cope with financial crisis. It carried out a comprehensive promotion campaign, including advertisement, internet, buspak and print media. In FY09, the selling and marketing expense increased by 55% YoY and accounted for 10.12% of total sales (7.50% in FY08), while SG&A accounted for 15.73% of total sales (12.26% in FY08). We estimate that the SG&A ratio will climb from 15.73% in FY09 to % in FY10-12 as Vinda devotes more resources and efforts on A&P to promote the brand. Net gearing to reach 25% in FY11 Capex(annual) is projected to be in the range of HK$ m between FY10 and FY11. But since the group raised HK$300m through placing existing shares in 2HFY10 and the management said that it will adopt a prudent and consistent financing policy in the near future, we expected its debt level will not increase dramatically. As a result, we estimate the company s net gearing will increase slightly to 25.47% in FY11 from 24.93% in FY09. DuPont analysis For the DuPont analysis, we estimate the company will remain a constant ROE between 20% and 25% in the coming four years, mainly benefiting from its expansion plan across China absorbing excess demand. DuPont analysis FYE DEC E 2011E 2012E 2013E 2014E ROE (%) 10.00% 21.00% 19.00% 19.14% 24.59% 24.72% 24.81% Net profit margin (%) 7.00% 14.00% 12.37% 11.48% 12.33% 12.36% 12.38% Asset turnover (x) Equity multiplier (x) Source: Company Data, CityU Estimates 7

9 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Peer Comparison Vinda is often compared with Hengan as Hengan is the only listed company among the top ten tissue manufactures in China. Compared to Vinda, Hengan has a higher profit margin, well-diversified product mix and more high-margin sanitary products. Besides their differences, Hengan and Vinda are both expanding their capacity and further upgrading product mix to accelerate market share gain. Hengan Vinda Major Products Tissues, Sanitary Napkins Tissues, Toilet rolls Diapers, Snacks Turnover (in HK$ '000) ,833,839 2,776,117 Gross Profit Margin % 20.60% % 21.20% % 34.20% Production Capacity , , , , , , , ,000 DPS Source: Company Data Investment Risks Pulp price volatility risk Pulp price volatility is major swing factor to Vinda s profit margin. Based on our forecast pulp price US$725 in 2011E, we estimate that every US$25 increase will result in a GPM decline of ppt YoY and a net margin decline of ppt YoY. In other words, holding other factors constant, a 1% change in price will deliver a 3% change in earnings for Vinda. Pulp Price US$/tonne GPM 32% 34.30% 32.80% 31% 29.80% 28.40% 26.90% 25.40% YoY (ppt) Net Margin 12.40% 14.70% 13.30% 12% 10.30% 8.80% 7.40% 5.90% YoY (ppt) EPS Forward PE TP (HK$) Base Interest Rate Risk In 2008 and 2009, if interest rates on bank borrowings had been 0.1% higher or lower, holding other factors constant, the after-tax income would have changed about 0.165% lower or higher respectively. As PBOC has just raised the benchmark interest rate by 0.25%, we expect the interest rate to increase further. TO mitigate the interest rate risk, Vinda is actively securing more HKD-denominated loans and cutting its RMBdenominated debt. 8

10 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Dec 31, 2009 Dec 31, 2008 Post-tax profit increase/(decrease) HK$ % HK$ % 0.1% higher -659, % -274, % 0.1% lower 659, % 274, % Source: Company Data Credit Risk Vinda s credit risk mainly comes from cash and cash equivalent, pledged bank deposit and trade and other receivables. If its counterparties default, Vinda will suffer great credit loss. To evade this risk, Vinda places all cash equivalents and pledged deposits in reputable banks and to settle most sales in cash or in check with good-credit customers. Liquidity risk Since Vinda needs substantial funds to finance its capacity and network expansion, it will be exposed to liquidity risk. However, as Vinda has sound creditability, banks are upbeat on lending to Vinda. Currently, Vinda has obtained HK$3.2 bn credit lines from three banks (HSBC, BOC and Heng Seng Bank). It also considers converting short-term borrowings into long-term borrowings. Government policy risk If PRC government further tightens environmental protection policy, Vinda might be exposed to potential erosion of profit margin. As market consolidation speed up, Vinda may face potential threat of M&A by large companies. To mitigate this risk, Vinda has to keep high-standard machinery and take aggressive position in M&A activities. Inflation Risk Although PRC government has already tightened monetary policy, we still expect that inflation rate in PRC will climb to 4.5-5% in Under such circumstances, we expect Vinda can raise its ASP by less than10% in 2011 while maintains its annual sales volume growth rate above 18%, as tissue is relatively price inelastic and the market trend towards premium products also help to enhance Vinda s price raising ability. 9

11 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Figure 1: Income Statement in millions Source: Company Documents, CityU Team Estimates E 2011E 2012E 2013E 2014E Revenue Toilet Paper Paper Handkerchief Facial tissue Paper Napkins Others Sugarcane Tissue Total Revenue Total COGS Gross Profit Other gains/loss selling & marketing Administrative exp Operating Income Finance Income Finance Cost Profit before income tax Income Tax Net Profit Figure 2: Balance Sheet in millions Source: Company Documents, CityU Team Estimates E 2011E 2012E 2013E 2014E Non-current Asset Fixed asset Leasehold land and land use rights Others Total non-current asset Current Asset Inventories Trade receivables, other receivables Others Pledged bank deposits Cash Total Current Assets Total Assets

12 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Current Liabilities AC Payable ST Borrowing Others Total Current Liabilities Long Term Liabilities Debt Others Total Long Term Liabilities Total Liabilities Share capital and premium Other reserves Minority interest Total Equity Figure 3: Statement of Cash Flows in millions Source: Company Documents, Student Estimates E 2011E 2012E 2013E 2014E Operating cash flow Profit before income tax Depreciation & amortization Change in working capital Others Investment cash flow Net Capex Acquisition of stakes in associates Change in LT investment Change in others Financing cash flow Change in share capital Net change in debt Change in others Net cash flow

13 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Figure : Other Statements or Exhibits in millions Source: Company Documents, Student Estimates Appendix 1: Production Capacity Expansion Plan Source: Company Data Appendix 2: National Coverage Source: Company Data 12

14 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Appendix 3: Product Breakdown (1H 2010) Source: Company Data Appendix 4: Cost Breakdown ( 1H 2010) Key cost inputs (% of sales) FY06 FY07 FY08 FY09 1H2010 Pulp 44.10% 50.40% 50.10% 37.50% 40.50% Packaging 11.60% 11.30% 10.90% 9.90% 10.20% Chemicals 1.40% 1.50% 1.40% 1.20% 1.00% Water & Electricity 8.20% 7.70% 7.70% 8.10% 8.30% Labour costs 3.00% 2.70% 2.80% 3.00% 3.20% Depreciation 4.00% 3.60% 3.90% 3.80% 3.30% Others 2.70% 2.20% 2.00% 2.30% 1.50% Total COGS 75.00% 79.40% 78.80% 65.80% 68.00% Source: Company Data Appendix 5: Administration, Selling And Marketing Expense Between 2006 and 2010E Source: Company Data, CityU Estimates 13

15 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Appendix 6: Profitability and Balance Sheet Comparison between Vinda and Hengan Profitability and Balance Sheet Comparison in HK$' Turnover-Hengan 4,114,943 5,686,972 8,001,545 10,833,839 Tissue paper segment only -Hengan 1,789,440 2,585,105 3,874,924 4,455,841 Turnover-Vinda 1,358,172 1,777,721 2,424,044 2,776,117 Turnover growth -Hengan 35.80% 38.20% 40.70% 35.40% Tissue paper segment only -Hengan 42.10% 44.50% 49.90% 15.00% Turnover growth - Vinda % 36.40% 14.50% Gross profit margin -Hengan 41.80% 40.00% 40.00% 46.00% Tissue paper segment only -Hengan 35.60% 31.50% 31.60% 42.10% Gross profit margin -Vinda 25.00% 20.60% 21.20% 34.20% Operating profit margin -Hengan 22.30% 22.10% 19.10% 24.00% Operating profit margin -Vinda 11.70% 6.90% 9.10% 18.80% Net profit -Hengan 696,624 1,005,939 1,340,914 2,117,509 Net profit -Vinda 106,814 78, , ,800 Net profit growth -Hengan 54.70% 44.40% 33.30% 57.90% Net profit growth -Vinda % % % Operating Cash Flow -Hengan 687, ,050 1,324,077 2,515,552 Operating Cash Flow -Vinda -24,647-69, , ,555 Production capacity -Hengan 180, , , ,000 Production capacity -Vinda 170, , , ,000 Net gearing -Hengan 26.90% -7.40% 2.80% % Net gearing -Vinda % 27.00% 33.40% 24.90% Basic EPS-Hengan Basic EPS -Vinda Diluted EPS-Hengan Diluted EPS-Vinda Dividend per Share -Hengan Dividend per Share -Vinda Price/BV per share -Hengan Price/BV per share -Vinda Trailing PE-Hengan Trailing PE-Vinda BEst P/E Ratio -Hengan BEst P/E Ratio -Vinda Source: Company Data, RISI 14

16 City University of Hong Kong Investment Research Challenge Student Research 11 Nov 2010 Appendix 7: SWOT Analysis Strength: High-quality of products Large production capacity allowing a scale of economies Wide distribution network Aggressive market penetration Opportunities: Rapid urbanization and improved hygiene habits in PRC will drive tissue demand Tightening environmental policies is phasing out small competitors Weakness: High sensitivity to fluctuation in pulp prices Product concentration on tissue resulting in a single product risk High capex in the FY10-13 capacity expansion, leading to potential liquidity risk Threats: Pulp price fluctuations may erode it s profit Interest rates in PRC is expected to increase further Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report knows the existence of any conflicts of interest that might bias the content or publication of this report. The conflict of interest does not exist. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company. Market making: The author(s) does [not] act as a market maker in the subject company s securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Investment Research Challenge and Global Investment Research Challenge Acknowledgement: City University of Hong Kong Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name], CFA Institute or the Global Investment Research Challenge with regard to this company s stock. 15

17 Chuan LI Mengqi WU Huiyun LI Ziyan ZHAO City University of Hong Kong 20 November 2010

18 Target Price:HK$11.20 Recommendation: Buy Source: Company Data

19 Robust tissue demand growth over 8% BUY RECOMMENDATION 17% UPSIDE $12.00 Vinda Daily Stock Price Doubled capacity and sales network $10.00 $8.00 $6.00 $4.00 HKD$9.59 (NOV 18) $2.00 Sustainable high profit margin $0.00 7/9/2007 7/9/2008 7/9/2009 7/9/2010 Source: Bloomberg

20 PRC Tissue Demand Estimates GDP Growth: 8+% Fast Urbanization '000 tonnes E Demand: 10m tonnes E 11E 12E 13E 14E 15E 16E 17E 18E 19E 20E Source: CNHPIA, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

21 PRC Tissue Demand & Supply Estimates Tightening Gov t Policy '000 tonnes E Demand: 10m tonnes Cutting down 15% market capacity Accelerating market consolidation Existing Production: 5.8m tonnes E 11E 12E 13E 14E 15E 16E 17E 18E 19E 20E Source: CNHPIA, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

22 High Quality Low Brand Awareness High Brand Awareness Industry Outlook Company Growth Drivers Low Quality Financials Valuation Risks

23 Market Trend Towards Premium Products % % Industry Outlook Company Growth Drivers Financials Valuation Risks

24 More than double its production capacity in 5 years Aggressive Expansion 800, , ,000 Aggressive expansion FY14 700k tonnes Favorable Product Mix 500, , , , ,000 0 FY09 320k tonnes Favorable product mix shift FY09 FY10E FY11E FY12E FY13E FY14E Source: Company Data Industry Outlook Company Growth Drivers Financials Valuation Risks

25 Aggressive Expansion Double its net work in 3 years New Liaoning plant Favorable Product Mix Source: Company Data Plant Sales network Industry Outlook Company Growth Drivers Financials Valuation Risks

26 Aggressive Expansion Handkerchief Tissue Facial Tissue Favorable Product Mix High Margin/ASP GPM around 35% Increase revenue contribution from high margin products Industry Outlook Company Growth Drivers Financials Valuation Risks

27 Increasing revenue contribution of high margin products Aggressive Expansion Favorable Product Mix 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 33% 46% 0% FY09 FY10E FY11E FY12E FY13E FY14E Source: Company data, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

28 HK$ Increasing Average Selling Price (ASP) 16,566 15,897 15,256 14,214 12,283 13,078 FY % CAGR E 2011E 2012E 2013E 2014E ASP Increasing contribution of high-asp products High inflation Market trend towards premium products Source: Company Data, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

29 HK$m Increasing Revenue and Net Profit Revenue: 33.6% CAGR (FY09-14) FY07 FY08 FY09 FY10E FY11E FY12E FY13E FY14E Revenue Net Profit Net profit: 30% CAGR (FY09-14) Source: Company Data, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

30 Vinda s Wood Pulp Cost US$/tonne FY08 FY09 FY10E FY11E FY12E Stabilize between US$ in next 2 years Pulp cost Source: Company Data, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

31 Sustain high GPM at above 31% 40% 35% 30% 25% 20% 15% 20.6% 21.2% 34.3% 32.0% 31.0% 31.8% 31.7% 31.6% Pulp price trough in 2009 Increasing ASP Pulp costs increase but will stabilize 10% 5% 0% FY07 FY08 FY09 FY10E FY11E FY12E FY13E FY14E Gross Profit Margin Source: Company Data, CityU Estimates Industry Outlook Company Growth Drivers Financials Valuation Risks

32 DCF & P/E Models Model Target Price Key Data P/E HK$ Forward P/E: x 2011 EPS 0.65 DCF HK$ Cost of equity: 11% Terminal growth: 2% Average Price: HK$ 11.2 Upside Case: HK$14.44 Industry Outlook Company Growth Drivers Financials Valuation Risks

33 HKD Millions Operating Cash Flow and Capex Operating cash flow Construction requires only half of OCF for new plants 2010E 2011E 2012E 2013E 2014E Source: Company Data, CityU Estimate Cash shortage covered by 320 million bank credit line & 300 million new equity in 2010 Industry Outlook Company Growth Drivers Financials Valuation Risks

34 HK$ Millions Debt and D/E Ratio Total Debt and D/E Ratio 44% 13% E 2011E 2012E 2013E 2014E 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Company Data, CityU Estimate Total debt D/E ratio Industry Outlook Company Growth Drivers Financials Valuation Risks

35 HKD Millions Free Cash Flow to Equity E 2011E 2012E 2013E 2014E Source: CityU Estimate Equity Financing Assumptions Variable Value HEALTHY CASH GENERATION Levered Beta 0.75 Recurring streams of cash flows from increased Risk-free sales return and stable GPM 2.3% Market return 14% Terminal growth 2% Cost of equity 11% Target Price HKD11.3 Upside 17% Addition of 150,000 tonnes of capacity cost RMB 1.5 Billion Industry Outlook Company Growth Drivers Financials Valuation Risks

36 P/E Model 3 Year Average P/E(x) 16.3 Premium rate 5% Target Forward P/E (x) FY11 Estimated EPS(HK$) Peer PEG Ratio 2011 Average PEG Ratio:0.9 FY11 Target Price (HK$) Industry Avg 0.9 Vinda 0.6 Hengan 1.2 Source: Bloomberg Industry Outlook Company Growth Drivers Financials Valuation Risks

37 Risks Wood pulp price volatility Interest rate risk Inflation risk Mitigating Factors Stronger connection with wood pulp suppliers More diversified product mix Larger discount due to larger procurement More HKD-denominated loans More RMB-denominated deposits Ability to raise price Industry Outlook Company Growth Drivers Financials Valuation Risks

38 Robust tissue demand growth over 8% BUY RECOMMENDATION 17% UPSIDE $12.00 Vinda Daily Stock Price Doubled capacity and sales network $10.00 $8.00 $6.00 $4.00 HKD$9.59 (NOV 18) $2.00 Sustainable high profit margin $0.00 7/9/2007 7/9/2008 7/9/2009 7/9/2010 Source: Bloomberg

39 Thank You Q & A

40 Business Description Investment Merits Industry demand Demand & Supply Market positioning Market trend Production capacity expansion Sales network expansion High margin products Product mix shift ASP Revenue & profit Main PPT Peer Comparison Vinda pulp cost Yearly GPM Two models OCF & Capex Debt & Gearing FCFE P/E Model Investment risk Total ASP ASP Growth Rate & Inflation ASP by Products Tissue ASP in China Total sales volume Sales volume by products Revenue% by products & region Revenue% by distribution channel Revenue by products COGS % breakdown Market pulp price Vinda pulp cost Pulp cost sensitivity DuPont Analysis Financials GPM by products SG&A Debt & gearing ratio Interest cost DCF calculation DCF upside Risk free rate PE compared to Hengan Current PE comparison Income Statement Balance sheet Cash flow statement P/E Sensitivity Interest rate sensitivity Company & Macro Asian stock performance QEII SWOT Expansion scheme Plants distribution Detailed Sales network expansion Pleasant goat series OEM Machine & hi-tech Wood pulp suppliers Production process Li Chao Wang Zhang Dong Fang Historical Supply &Demand Regional Demand Growth Profitability & BS HSI, HA & V stock Industry capacity distribution Tissue Market share by value & volume HA revenue breakdown HA COGS breakdown HA plants distribution HA sales growth in tissue paper HA M&A expense Sanitary napkin ASP in China Sanitary market share Sanitary consumption growth Diaper ASP in China Diaper market share Diaper consumption growth

41 Increasing ASP Market trend towards premium products Increasing contribution of high- ASP products

42 Vinda s ASP growth outperform inflation rate Intensified bargaining power over customers Market trend towards premium products Increasing contribution of higher-asp products E 11E 12E 13E 14E Product mix shifting to highermargin products ASP Growth Inflation Source: Company Data, City Estimates

43 HK$/ton Vinda ASP by Products Toilet Paper Paper Hankerchief Facial tissue Paper Napkins 9431 Sugarcane Tissue Source: Company Data, City Estimates

44 China s Domestic ASP in Tissue Paper Products

45 Sales volume growth

46 000 tonnes Vinda s Sales Volume by Product Toilet Paper Paper Hankerchief Facial tissue Paper Napkins 100 Sugarcane Tissue Source: Company Data, City Estimates

47 Revenue Breakdown (1H2010) Soft envelope facial tissue 8.5% Revenue Breakdown by Product Others 10.0% Revenue Breakdown by Region Hong Kong 11% Overseas 2% Napkin 3.7% Hard envelope facial tissue 5.8% Toilet roll 60.2% Handkerchief tissue 11.8% China 87% Source: Company Data, City Estimates Overseas: Vietnam, Thailand, Malaysia, the United Kingdom, Japan, New Zealand, Australia, etc

48 Revenue Breakdown by Distribution Channels Source: Company Data

49 HK$ Millions Vinda s revenue by products Toilet Paper Paper Hankerchief Facial tissue Paper Napkins Others Sugarcane Tissue Source: Company Data, City Estimates

50 COGS Breakdown

51 Increasing pulp cost 850 $ for FY Trough 1) Restored Chilean pulp production from the earthquake 2) 2.3 mt re-capacity worldwide in ) Discounts given by Chilean producers to gain market share 4) Global pulp shipments down by 11% YoY with China plummeting 54% YoY in August 5) Increased global inventory turnover from 29 days to 34 days YoY Source: Bloomberg

52 Pulp Cost Sensitivity Analysis Pulp Price Base US$/tonne GPM 32% 34.30% 32.80% 31% 29.80% 28.40% 26.90% 25.40% YoY (ppt) Net Margin 12.40% 14.70% 13.30% 12% 10.30% 8.80% 7.40% 5.90% YoY (ppt) EPS Forward PE TP (HK$) Source: Bloomberg, CityU Estimates

53 Pulp Suppliers More than 50% pulp is from Canada, Indonesia and Brazil Other sources include the US, Chile, China, Finland, Germany, Russia, South Africa and Thailand. However, these markets represent only a fraction of total procurement. Source: Company Data

54 Gross profit margin by products

55 HK$ Million Administration, Selling And Marketing Expense Between 2006 and 2010E % 8% 10% 12% 11% 11% 11% 11% 11% 10% 8% 6% 4% % 5% 6% 5% 5% 5% 5% 5% 6% 5% 4% 3% 2% 200 2% 100 1% E 2011E 2012E 2013E 2014E 0% E 2011E 2012E 2013E 2014E 0% selling & marketing selling & marketing% Administrative exp. Administrative exp.% Source: Company Data, City Estimates

56 HK$ Million Debt and Gearing Ratio % 50% 40% % 13% 30% 20% % 200-6% 0% E 2011E 2012E 2013E 2014E Total debt D/E ratio Net gearing ratio -10% Source: Company Data, City Estimates

57 HK$ Millions Interest Costs Finance Cost Source: Company Data, City Estimates Currency Debt Weight Interest rate RMB % HKD % USD % 0.38 WEIGHTED AVERAGE INTEREST 3.359% Shift to HKD-denominated loans

58 Interest Rate Sensitivity Analysis Dec 31, 2009 Dec 31, 2008 Post-tax profit increase/(decrease) HK$ % HK$ % 1% higher -6,594, % -2,743, % 1% lower 6,594, % 2,743, % Source: Company Data

59 DCF Calculation HK$ Million E 2011E 2012E2013E 2014E Operating cash flow Less: Capex Free operating CF Add: Net debt FCFE Total Value # shares 939,023,686 Price/Share Source: Company Data, City Estimates

60 DCF Model- Upside Case We apply a two-stage DCF Model Upside case key assumptions Cost of equity 11% growth rate 8% Terminal growth after % g= industry average growth rate and China s GDP long-term growth rate 12-mth Target Price: HK$ % Upside Based on DCF-FCFE

61 Forward P/E Sensitivity Analysis Sensitivity Analysis of Forward P/E 3 Year Average P/E(x) Premium rate 0% 5% 10% 15% Target Forward P/E (x) FY11 Estimated EPS(HK$) FY11 Target Price (HK$) Source: Bloomberg, CityU Estimates

62 Risk-free Rate in HK: 2.23% Source: HKMA, Bloomberg

63 P/E Model-with reference of Hengan s P/E 3-yr average forward P/E Vinda: 16.3x Hengan: 27.7x We believe the discount to be narrowed: 1. more diversified product mix 2. decreasing OPM gap between Hengan 40% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Hengan Vinda Historically, Vinda s P/E is at 40% discount of Hengan Currently, Hengan is priced at a forward P/E of 27.68x. The forward P/E we applied for Vinda is 38% discount of Hengan Vinda is not overvalued at the 17.12x P/E

64 Current P/E Peer Group Comparison

65 Major Asian Stock Performance 2008 to 2010

66 Quantitative Easing II Goldman Sachs expects that QE2 is heading from $600 billion to $2 trillion and will continue through 2012 by buying long-term Treasuries. Fed may avoid any tightening measures until That means no interest rate hikes for half a decade. Money flows to emerging market Blow asset bubble in emerging market Drive up inflation rate HK P/E in the short run

67 Income Statement Figure 1: Income Statement in millions Source: Company Documents, CityU Team Estimates E 2011E 2012E 2013E 2014E Revenue Toilet Paper Paper Handkerchief Facial tissue Paper Napkins Others Sugarcane Tissue Total Revenue Total COGS Gross Profit Other gains/loss selling & marketing Administrative exp Operating Income Finance Income Finance Cost Profit before income tax Income Tax Net Profit

68 Figure 2: Balance Sheet in millions Source: Company Documents, CityU Team Estimates Balance Sheet E 2011E 2012E 2013E 2014E Non-current Asset Fixed asset Leasehold land and land use rights Others Total non-current asset Current Asset Inventories Trade receivables, other receivables Others Pledged bank deposits Cash Total Current Assets Total Assets Current Liabilities AC Payable ST Borrowing Others Total Current Liabilities Long Term Liabilities Debt Others Total Long Term Liabilities Total Liabilities Share capital and premium Other reserves Minority interest Total Equity

69 Figure 3: Statement of Cash Flows in millions Source: Company Documents, Student Estimates Cash Flow Statement E 2011E 2012E 2013E 2014E Operating cash flow Profit before income tax Depreciation & amortization Change in working capital Others Investment cash flow Net Capex Acquisition of stakes in associates Change in LT investment Change in others Financing cash flow Change in share capital Net change in debt Change in others Net cash flow

70 SWOT Analysis

71 Detailed Expansion Scheme Source: Company Data

72 Vinda plants distribution Source: Company data

73 Sales Network Expansion sales offices 559 distributors sales offices 715 distributors 2. Ten Thousand Shops in Over a Hundred Cities strategy Source: Vinda website 3. Dual Brand Strategy Sugarcane pulp tissue Rewoo penetrates into 2 nd and 3 rd tier cities and rural areas

74 Pleasant Goat Series Come out in 2 nd half year of 2009 Source: Company Data

75 OEM Wet tissue Expected to comprise 10% of total revenue in 3 4 years. The production of wet tissue is outsourced to OEM suppliers. Napkin and diaper: Vinda acquired a 39% stake in a napkin and diaper company with a small consideration of HK$70mn. Additional earnings contribution is about HK$7-9mn per annum in the preliminary stage But the potential is high as the new acquired company can leverage on Vinda s distribution platform. Vinda also has the option to increase its stake to 61% in 2 years if the performance is strong.

76 Machine & Hi-tech company Machine Among Vinda s high-tech facilities, the super-speed papermaking machines imported from the United States can operate at a speed of 2200 meters per minute and produce 100 tons per day. It is one of the fastest running machines of this kind in the world. Hi-tech company Vinda has submitted the application to be a high-tech company, if the application is approved, its tax rate could decrease by much starting from 2H10 onwards.

77 Tissue Paper Production Source: automation

78 Mr. Li Chao Wang- Chairman and Founder Mr. LI Chao Wang, was appointed executive director on 17 Aug 1999 and has been the chairman since 28 Apr Until Jan 2010, he was also the CEO of the group. In his current capacity, he spearheads overall corporate development and strategic planning. Mr. Li has over 25 years of experience in the household paper industry and executive business management. Member of the Guangdong Political Consultative Committee Vice president of the China Household Paper Association

79 Ms. ZHANG Dong Fang- CEO and Executive Director Joined Vinda in Feb 2010 as its CEO and ED. She has extensive experience in business management, which she gained in a multinational corporate environment. Before joining Vinda, she was the vice president, North Asia division, of Firmenich, which produces flavours and fragrances for use in perfumes, cosmetics, food and beverages and household products. (15% market share) She emphaiszes greatly on marketing and promotion.

80 Profitability and Balance Sheet Comparison between Vinda and Hengan Profitability and Balance Sheet Comparison in HK$' Turnover-Hengan 4,114,943 5,686,972 8,001,545 10,833,839 Tissue paper segment only -Hengan 1,789,440 2,585,105 3,874,924 4,455,841 Turnover-Vinda 1,358,172 1,777,721 2,424,044 2,776,117 Turnover growth -Hengan 35.80% 38.20% 40.70% 35.40% Tissue paper segment only -Hengan 42.10% 44.50% 49.90% 15.00% Turnover growth - Vinda % 36.40% 14.50% Gross profit margin -Hengan 41.80% 40.00% 40.00% 46.00% Tissue paper segment only -Hengan 35.60% 31.50% 31.60% 42.10% Gross profit margin -Vinda 25.00% 20.60% 21.20% 34.20% Operating profit margin -Hengan 22.30% 22.10% 19.10% 24.00% Operating profit margin -Vinda 11.70% 6.90% 9.10% 18.80% Net profit -Hengan 696,624 1,005,939 1,340,914 2,117,509 Net profit -Vinda 106,814 78, , ,800 Net profit growth -Hengan 54.70% 44.40% 33.30% 57.90% Net profit growth -Vinda % % %

81 Profitability and Balance Sheet Comparison between Vinda and Hengan Profitability and Balance Sheet Comparison in HK$' Operating Cash Flow -Hengan 687, ,050 1,324,077 2,515,552 Operating Cash Flow -Vinda -24,647-69, , ,555 Production capacity -Hengan 180, , , ,000 Production capacity -Vinda 170, , , ,000 Net gearing -Hengan 26.90% -7.40% 2.80% % Net gearing -Vinda % 27.00% 33.40% 24.90% Basic EPS-Hengan Basic EPS -Vinda Dividend per Share -Hengan Dividend per Share -Vinda Trailing PE-Hengan Trailing PE-Vinda BEst P/E Ratio -Hengan BEst P/E Ratio -Vinda

82 Stock Quote of HSI, Vinda and Hengan HSI 39% increase from 2009

83 Industry Capacity Distribution in 2009 Company Capacity (1,000 ton/annum) % of total capacity in China APP China % Hengan Paper Group % Vinda Paper % Guangzhou Zhongshun Paper % Industry Group Ningxia Zijinhua Paper % Fook Woo % Ningxia Meijie Paper, Helan, % Ningxia Gugangxi Guitang Group % Shengda Group Jiangsu Sund % Paper Shanghai Orient Champion % Group Top 10 Total % Industry Overall % Source: RISI, Company Data

84 Market Share in Tissue Paper Industry By Value and Volume

85 Hengan sales breakdown

86 Hengan COGS breakdown Source: Hengan CSI

87 Hengan Capacity Location

88 Sales Growth of Hengan s Tissue Paper

89 Hengan s Marketing and Advertising Expenses

90 Sales growth and ASP for Sanitary Napkins

91 Market Share in Sanitary Napkin Industry

92 Growth of Sanitary Napkin in China

93 China s Domestic ASP in Baby Diaper Products

94 Market Share in Baby Diaper Industry

95 Sales Growth of Baby Diaper in China

96 Vinda DuPont Analysis DuPont analysis FYE DEC E 2011 E 2012 E 2013 E 2014 E ROE (%) % % % % % % % Net profit margin (%) 7.00% % % % % % % Asset turnover (x) Equity multiplier (x) Source: Company Data, CityU Estimates

97 000 Tonne PRC Tissue Production & Consumption Tissue Demand & Supply Net Export Production Consumption Source: CNHPIA