Jiangnan Group (1366 HK) Target price: N/A Previous TP: N/A Last price: HK$2.42 China / Industrial Goods/ Company Visit Note Potential Return: N/A Targeting to be the No.1 in three years Benefit from the PRC Government policies New products aluminum alloy and double capacity conductors Aggressive expansion plan acquisitions & overseas expansion Encouraging 1H12 results with net profit up 21.9% yoy NOT RATED 19 Oct 2012 Felix Kwok Tel: 852 2826 0006 Felix.Kwok@cpy.com.hk Forecast revision (%) Year to 31Dec 12F 13F 14F Revenue change N/A N/A N/A Net loss change N/A N/A N/A EPS (Loss) change N/A N/A N/A Key Share Data 52-week High / Low 2.800/1.210 30D avg volume 0.56m Issued share 1,539m Market cap 3,723m Major Shareholder Rui Fubin &Family (71.71%) Share Price Performance Key Financials Year to 31 Dec FY09 FY10 FY11 Revenue (RMB mn) 2,995 3,686 4,930 Growth (%) NA 23.1 33.7 Net profit (RMB mn) 164 232 317 Growth (%) NA 41.7 36.9 EPS (RMB Cents) 14.2 20.1 26.5 Growth (%) NA 41.5 31.8 P/E (x)* NA NA 9.7 EV/ EBITDA (x) 16.0 11.3 7.6 Source: Bloomberg and Core Pacific Yamaichi estimates *Based on current outstanding shares What s New Found in 1997, Jiangnan Group Limited (Jiangnan or the Group) is one of the leading wire and cable manufacturers in the PRC. It was listed on the Main Board in Apr2012. Jiangnan announced the encouraging 1H12 results with revenue and net profit increased by 14.7% and 21.9% yoy to RMB2.4bn and RMB158.9mn respectively. Catalyst Benefit from the PRC Government policies. Approximately RMB2.55 trillion will be spent on power grid construction during the 12th Five-Year Plan period. New products to enhance GPM. The new products of aluminum alloy and double capacity conductors will be commercialized in Oct 12 and Jan13 with a relatively higher GPM. Aggressive expansion plan. Targeting to be the largest domestic wire & cable manufacturer in three years, not only will Jiangnan expand its own production lines, it will also expand through acquisitions. In addition, the Group will set up a production base in South Africa to capture the African power cable markets. Valuation Jiangnan is currently trading at 9.7x FY11 PER (based on post-ipo outstanding shares), 7.6x FY11 EV/EBITDA and 1.75x FY12F PBR (based on 1H12 book value). Our View The 12th Five-Year Plan is positive to the wire & cable industry but only to a small group of high-end power cable manufacturers. It is a correct direction for Jiangnan to further develop its EHV power cable business. Jiangnan s GPM is in line with the top tier manufacturers and outperforms industry average. It keeps improving while the industry average is contracting. However, its cash flow pressure, such as high account receivable and inventory levels, and high net gearing of 67% are the concerns. Highly concentrated shareholding is a potential risk. Together with the consideration of its aggressive expansion strategy and high gearing, we believe the probability to place new shares for potential acquisitions is high.
Encouraging 1H12 results Company background. Found in 1997, Jiangnan Group Limited (Jiangnan or the Group) was listed on the Main Board in Apr2012 with the stock code of 1366 HK. The Group is one of the leading wire and cable manufacturers in the PRC based in Yixing city, Jiangsu province with over 2,000 employees. They have three core businesses: power cables, wires and cables for electrical equipment and bare wires. The current distribution network covers around 300 cities in the PRC and their products are exported to over 50 countries and regions. Net profit of RMB158.9mn, up 21.9% yoy, in 1H12. Jiangnan announced encouraging 1H12 results with revenue increased by 14.7% yoy to RMB2.4bn and a recording net profit of RMB158.9mn, up 21.9% yoy. During the reported period, the copper and aluminum prices were relatively stable but both recorded yoy decline. 90% of the Group s revenue was generated from domestic market where power cable was the key growth driver. On the other hand, driven by the orders from South Africa and Singapore, overseas markets recorded 74% yoy growth in revenue. In addition, the Group did a good job in cost control leading the EBITDA margin improved by 1.4 pts yoy. However, high net gearing of 67% leading to a 52% yoy increase in finance costs while both the account receivable and inventory turnover days remained high at 127 days and 106 days respectively. Table 1: 1H12 result snapshot YoY HoH Year to 31 Dec (RMB mn) 1H12 1H11 2H11 Chg (%) Chg (%) Turnover 2,406.2 2,098.5 2,831.4 15 (26) Power cables 1,680.8 1,482.0 1,782.7 13 (17) Wires and cables for electrical equipment 567.4 458.2 643.2 24 (29) Bare wires 158.0 158.2 405.5 (0) (61) Gross profit 376.5 326.7 408.2 15 (20) Other income 6.8 5.0 9.4 35 (47) Selling and distribution costs (46.9) (46.0) (57.4) 2 (20) Administrative expenses (39.2) (47.2) (48.8) (17) (3) Other expenses (21.9) (13.8) (9.7) 59 42 Other gains and losses (0.0) (11.5) 0.0 N/A N/A EBITDA 293.1 226.0 319.8 30 (29) EBIT 275.2 213.3 301.7 29 (29) Finance costs (81.9) (54.0) (72.4) 52 (25) Taxation (34.4) (29.0) (42.2) 19 (31) Net Profit 158.9 130.3 187.1 22 (30)
Figure 1: 1H12 Revenue breakdown Figure 2: Revenue trend Figure 3: GPM by segments
Time for market consolidation A large but fragmented market the PRC wire & cable market. According to CEIC with the source from National Bureau of Statistics (NBS), there were 3,497 players in the PRC wire & cable market generating RMB1,066bn revenue in 2011. Even the market leader, Far East Cable (subsidiary of S&P Pharmaceutical (600869 CH)), accounts for only 1.0% market share in this highly competitive market while Jiangnan accounts for 0.5% market share. Due to the rapid growth of electricity consumption, the demand in power cables was very strong leading the wire & cable market to grow by 22.1% CAGR in the past five years. However, the current global economy downturn lowers the manufacturing activities in the PRC and slowed down the growth of electricity consumption. This dragged down the growth of wire & cable market to only 8% yoy in 1H12. Figure 4: Total revenue of wire & cable industry 22.1% 5-year CAGR Source: CEIC, NBS and Core Pacific-Yamaichi Over supply in wire & cable market. During the first decade of 2000s, the number of wire & cable manufacturers surged by 168% to 4,588. The significant expansion of production capacity leads to a problem of over supply today when the demand is weakening under the global economy downturn and the slowdown of PRC economic growth. As approximately 90% of the wire and cable products belong to the low-end segment, such as middle-to-low voltage power cables, there is great pressure on the pricing of the manufacturers, resulting in the decline in profit margins since the peak in 2010. Because of the limitations in quality and technology, the high-end products, such as nuclear power specialty cable and vessels cable, are still mainly relying on imports. Figure 5: Number of wire & cable manufacturers the market starts to consolidate Source: CEIC, NBS and Core Pacific-Yamaichi
Time for market consolidation. To guide the market consolidation, the PRC government put the wire and cable industry under the Guidance Catalogue for Industrial Structure Adjustment (2011) ((2011 )). This leads to a restriction on issuing new China Compulsory Certification ( ) (CCC), a compulsory safety and quality mark required for wire and cable products sold in China, (except the special wire and cable that is used for new energy, information industry, aeronautics and astronautics, rail traffic, oceanographic engineering) starting on 1 June 2011. This has set a high entry barrier to the new players resulting in a significant drop in the number of market players in 2011. To enhance the margin, enterprises move towards economy of scale. Mergers and acquisitions become more active in this market. For example, Far East Cable acquired Anhui Cable, which generated RMB303mn revenue in 2011, in Sep2012. Figure 6: Industry profit margins started to decline since the peak in 2010 Source: CEIC, NBS and Core Pacific-Yamaichi High correlation with copper and aluminum prices. Copper and aluminum are the key components of costs for the wire & cable manufacturers. For example, copper and aluminum accounted for 68% and 11% of the cost of goods sold of Jiangnan respectively in FY11. The fluctuation of the metal prices will lead to direct impact to their ASP and profit margin. As most of the manufacturers are generally taking the cost-plus pricing approach, the appreciation of metal prices is favorable to them. Especially, they generally hold around one-month inventory. Although the metal prices recorded yoy decline in 1H12, the prices were relatively stable. The prices started to increase in 3Q12 as a result of the QE3 in US. Figure 7: Copper price Figure 8: Aluminum price Source: Bloomberg and Core Pacific-Yamaichi Source: Bloomberg and Core Pacific-Yamaichi
Benefit from the PRC Government policies Power grid development under the 12th Five-Year Plan. According to the Guiding Principles of China s 12th Five-Year Plan for National Economic and Social Development (12 th Five-Year Plan, 2011-2015), the PRC government will accelerate the construction of modern electricity network, further increase the volume of electricity transferred from western China to eastern China, improve the regional backbone electricity network, and promote smart grid development. Approximately RMB2.55 trillion will be spent on power grid construction during the period, up 66% comparing with the 11th Five-Year Period. RMB270bn of UHV backbone power grid development plan. For the electricity transmission from western China to eastern China, the ultra-high voltage (UHV) backbone power grid (1000kV AC or above) is planned to build with an investment scale of RMB270bn. Apart from the backbone grid, we believe regional power grid (EHV level with 220-500kV) will also gain benefits. Besides, rural area power grid enhancement with a budget of RMB522bn is another positive factor which will also stimulate the demand for EHV power cable. All these are positive to the wire & cable industry but the major beneficiaries are likely to be a small group of high-end power cable manufacturers. To share the benefits, Jiangnan has built a production line with annual production of 1,000Km EHV power cable. The Group has budgeted 33% of IPO proceeds (approximately HK$147mn) to set up additional three production lines, which are anticipated to start operating in 2H13 and contribute additional 9,000km annual production capacity of EHV power cable. Figure 9: Electricity production and consumption by region in 2011 Source: Wind, China Electricity Council and Core Pacific-Yamaichi
New products to enhance GPM New products aluminum alloy and double capacity conductors. Apart from developing EHV power cable, Jiangnan is also keen on developing new products to enhance the profit margin. The Group has noticed the opportunities of growing demand in power cable used aluminum alloy in both domestic and overseas markets and high power grid loading rate in the PRC. Comparing with copper, aluminum alloy has the advantage of lower cost and lighter weight for making bare wires. Aluminum alloy wires are now widely used for high voltage overhead transmission and distribution cables. Aluminum alloy is also a key raw material for producing the double capacity conductors, which can expand the capacity of electricity transmission. According to the information from State Grid, the average power grid loading rate in 2011 was high at about 88.5%, especially in the northwest region which was generally above 90%. With the increasing demand in electricity, even though the current growth is relatively low, adopting double capacity conductors can be a good solution to release the pressure on the capacity of power grid. The Group has budgeted 25% of IPO proceeds (approximately HK$115mn) to set up production facilities for aluminum alloy and double capacity conductors. It will be commercialized in Oct2012 with annual production capacity of 70,000 tons aluminum alloy and in Jan2013 with 30,000 tons double capacity conductors. However, since the profit margin of bare wires is low in the market, approximately 10% GPM, we anticipate the double capacity conductors to achieve only about 2pts extra GPM comparing with other bare wire products. Figure 10: Power grid loading rate Source: Wind, State Grid and Core Pacific-Yamaichi
Aggressive expansion plan Expansion through acquisitions. Jiangnan targets to be the largest domestic wire & cable manufacturer in three years. To achieve this target and achieve the benefits from the economy of scale, it takes an aggressive expansion strategy. The Group not only sets an annual production capacity expansion plan, but also looks for potential acquisition targets. Jiangnan has reserved 6% of IPO proceeds (approximately HK$28mn) for potential acquisitions. Although the Group has mentioned to look for vertical integration, we believe it is more practical to have horizontal integration. However, source of capital is a concern as its net gearing reached 67% and its interest coverage ratio is 3.4x in 1H12, much lower than the sector average of 6.5x. We believe Jiangnan will take the equity financing if there are any acquisitions. Overseas expansion South Africa. Jiangnan has explored overseas markets in recent years and the proportion of revenue contribution from overseas markets has increased from 2.3% in FY09 to 10.2% in 1H12. Its clients include Eskom (South Africa), Power Works (Singapore) and National Grid (UK/US). The Group plans to strengthen the relationship with Eskom, the Group s largest overseas client, with setting up a production base with 10,000km annual production capacity of power cables in South Africa. Management also hope this can help them to explore other African markets. We stay cautiously optimistic on the expansion in South Africa because (1) there are higher political risks, (2) there are no special offers to the Group, such as tax benefits and land premium discounts, and (3) Management do not have much experience and track record for overseas operations. Table 2: Annual production capacity plan Units FY09 FY10 FY11 FY12F FY13F Power cables 000 km 36.0 36.0 60.0 68.0 75.0 YoY Change % 0% 67% 13% 10% Wires and cables for electrical equipment 000 km 535.0 535.0 540.0 580.0 630.0 YoY Change % 0% 1% 7% 9% Bare wires 000 km 72.2 77.2 77.2 79.5 103.0 YoY Change % 7% 0% 3% 30%
Peer comparison Profit margins outperform industry average. Although there was still a revenue gap between Jiangnan and the leading peers, its GPM was in line with the top tier manufacturer, Far East Cable. The competitive advantage of Jiangnan will be more obvious when its figures are comparing with the wire & cable industry average. Its profit margins keep improving while the industry averages are contracting. However, the cash flow pressure, such as high account receivable and inventory levels, and high net gearing of 67% in 1H12 are the concerns. Table 3: Peer comparison GPM in line with top tier peer RMB Mn Power cables Wires and cables for electrical equipment Bare wires Overall comparable products FY11 (As at 31 Dec) Revenue GPM Revenue GPM Revenue GPM Revenue GPM S&P Pharmaceutical (600869 CH)- Far East Cable 7,662.5 16.2% 1,610.9 18.3% 1,371.0 9.7% 10,644.4 15.7% Baosheng (600973 CH) 4,251.9 7.2% 875.5 15.9% 1,491.8 1.1% 6,619.1 7.0% Jiangnan (1366 HK) 3,264.7 15.9% 1,101.4 14.9% 563.7 9.3% 4,929.9 14.9% 1H12 (As at 30 Jun) S&P Pharmaceutical (600869 CH) - Far East Cable 2,955.6 15.5% 804.4 24.5% 583.3 10.0% 4,343.3 16.4% Baosheng (600973 CH) 2,528.4 10.5% 345.5 13.5% 835.7 0.3% 3,709.6 8.5% Jiangnan (1366 HK) 1,680.8 17.3% 567.4 12.0% 158.0 11.1% 2,406.2 15.6% Figure 11: Comparison on profit margins Source: Company data, CEIC, NBS and Core Pacific-Yamaichi Figure 12: Comparison on interest expanses level Source: Company data, CEIC, NBS Core Pacific-Yamaichi Figure 13: Comparison on AR level Source: Company data, CEIC, NBS and Core Pacific-Yamaichi Figure 14: Comparison on inventory level Source: Company data, CEIC, NBS and Core Pacific-Yamaichi *Only consider finished goods and assume the finished goods to total inventory ratio in 1H12 equals to that in FY11.
High Concentration of Shareholding Highly Concentrated Shareholding. Securities and Futures Commission (SFC) made an announcement on 19Sep2012 stating the shareholding of Jiangnan is concentrated in the hands of a few shareholders as at 10 September 2012. According to the announcement, there were 13 shareholding parties, including the Power Heritage Group Limited (71.71% shareholding), holding 98.21% of Jiangnan s issued shares. Highly concentrated shareholding can be a risk leading to irrational fluctuation or movement on the stock price under the poor equity liquidity. Together with the consideration of its aggressive expansion strategy and high gearing, we believe the probability to place new shares for the potential acquisitions is high. Table 4: Shareholding as at 10Sep2012 Number of Shares held (Shares) % of total number of issued Shares (%) Power Heritage Group Limited (Note 1) 1,103,400,000 71.71 Chen Weiping 108,900,000 7.08 A group of 11 shareholders (Note 2) 298,772,000 19.42 Other shareholders 27,528,000 1.79 Total 1,538,600,000 100.00 Note 1: Power Heritage Group Limited is owned as to 83% by Mr. Rui Fubin (Chairman and Executive Director of the Company) and 17% by Mr. Rui Yiping (Executive Director of the Company). Note 2: 4 of the 11 shareholders held 163,036,000 Shares (representing 10.6% of the issued Shares). They initially obtained 169,000,000 Shares through the international placing under the global offering of the Company in April 2012. Source: SFC, Company data and Core Pacific-Yamaichi
Historical financial summary Profit & loss (consolidated) Year to 31Dec (RMB mn) 2009 2010 2011 Revenue 2,995 3,686 4,930 Gross profit 400 531 735 EBITDA 276 373 544 EBIT 256 352 515 Pretax profit 196 283 389 Profit for the year 164 232 317 EPS (RMB Cents) 14.20 20.10 26.50 DPS (RMB Cents) 0.00 0.00 0.00 Balance sheet (consolidated) Year to 31Dec (RMB mn) 2009 2010 2011 Current assets 2,163 2,661 3,773 Cash and cash equivalents 434 622 678 Accounts & notes receivable 700 1,083 1,426 Inventories 591 778 1,186 Non-current assets 347 408 412 Current liabilities 1,929 2,102 2,978 Accounts Payable 471 937 1,540 ST Borrowing 919 914 1,402 Non-current liabilities 6 92 26 LT Borrowing 0 80 0 Total equities 575 876 1,182 Minority interest 0 0 0 Common equities 575 876 1,182 Net debt 485 371 724 Cash flow statement (consolidated) Year to 31Dec (RMB mn) 2009 2010 2011 Net operating cash flow 67 322 385 Net investing cash flow 77 207 (325) Net financing cash flow 26 (312) 55 Net cash flow 142 187 58 Financial ratios Year to 31Dec 2009 2010 2011 Growth (%) Turnover 23.1 33.7 Gross profit 32.9 38.4 EBITDA 35.4 45.9 EBIT 37.5 46.3 Net profit 41.7 36.9 Profitability (%) Gross margin 13.3 14.4 14.9 EBITDA margin 9.2 10.1 11.0 EBIT margin 8.5 9.5 10.4 PBT margin 6.6 7.7 7.9 Net profit margin 5.5 6.3 6.4 ROA 6.5 7.6 7.6 ROE 28.5 26.5 26.9 Net gearing (%) 84.4 42.4 61.2 Source: and Core Pacific-Yamaichi I, Felix Kwok, the author of this research report and the license holder of Type 4 Regulated Activity registered with Hong Kong Securities and Futures Commission ( SFC ), hereby declare that all the views expressed in this research report accurately reflect my personal views and that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Besides, I confirm that (a) neither I nor my associates serve as an officer of any of the Hong Kong listed companies covered in this research report; and (b) neither I nor my associates have any financial interests in the stock(s) covered in this research report.