The National Bureau of Statistics of China recently released the preliminary GDP figures for the second quarter of 2020, citing a 3.2% increase in GDP on the prior corresponding period. The increase in GDP came in after a sharp fall of 6.8% in the first quarter. On a quarter-on-quarter basis, GDP increased by 11.5% in the June quarter, as compared to a decline of 10% witnessed in Q1. For the half-year to June 2020, the economy contracted by 1.6% in comparison to the same period last year. The construction sector depicted remarkable signs of recovery, with a growth rate of 7.8% for the quarter. Wholesale and retail trades witnessed a growth rate of 1.2%. Details of preliminary accounting results of GDP for the second quarter and the first half of 2020 are as under:
Preliminary Accounting Results of GDP (Source: NBS)
So far, China’s economy has been the first one to come out of the red zone, with the turnaround attributable to a boost in manufacturing activity and consumer spending. The country’s success in controlling the coronavirus and accelerated efforts for revival has finally paid off in the form of a V-shape recovery in 2Q 2020.
Recovery in Industrial Capacity Utilisation: In the second quarter, China's industrial capacity utilization rate was 74.4% according to the National Bureau of Statistics, which stood 7.1% higher than that of the previous quarter. However, utilisation declined by 2% in the same period of last year. This increase is again attributable to the diligence in battling with the novel coronavirus and well thought of plan for reopening the economy. Economic recovery is partially contributed by the value-added of industries above designated size in June’20, which stood 4.8% higher on a y-o-y basis and 0.4% higher than the growth rate in May’20. The value-added of the mining industry increased by 1.7% year-on-year; that of the manufacturing industry increased by 5.1% and by 5.5% for the production and distribution of electricity, heating, gas, and water.
Industrial Capacity Utilisation (Source: NBS)
Trends in Retail Sales of Consumer Goods: In June 2020, retail sales went down by 1.8% YoY, representing an improvement from a decline of 2.8% in May 2020. Retail sales of supermarkets in retail enterprises above designated size witnessed an increase of 3.8% from January to June. Over this period, online retail sales in the country increased by 7.3% on a YoY basis, majorly contributed by the sale of physical goods, including food and use goods. During January – June, retail sales of Grain, Oil, and Foodstuff reported a rise of 12.9% and that for Beverage witnessed a growth rate of 10.5% year-on-year. Notably, in the first half of 2020, the per capita consumption expenditure on food, tobacco and alcohol increased by 5% YoY in China, forming 31.9% of the total per capita consumption expenditure. During the half, the per capita disposable income of residents nationwide witnessed a nominal increase of 2.4% on the prior corresponding period and an actual decrease of 1.3% after deducting the price factor.
Key Risks: Despite the growth in GDP and emerging positive economic conditions, there are some bottlenecks or challenges that may hinder a smooth recovery. As the country is now headed towards the new normal and is witnessing increased activity in all sectors, the threat of a second wave of coronavirus lingers over the economy. While the recent growth in GDP has boosted confidence in a brighter and healthier future for China’s economy, it does not assure a stable environment in the quarters ahead. Recent bilateral tensions with the U.S and territorial conflicts with India also add to the list of challenges that may affect international relations and offset domestic recovery.
Notwithstanding the above risks, China has fought a remarkable battle against the novel coronavirus and has reported economic recovery alongside several challenges. While other parts of the world are struggling with COVID-19, accelerated efforts by the Chinese government towards epidemic preventions and control, resumption of work, production, business, and market, have enabled a sharp spike in 2Q 2020 GDP growth. During the first half of 2020, agricultural production in the country remained sound, with the value added of agriculture up by 3.8% YoY. Industrial production recovered quickly, and the decline in the Service sector narrowed down. Moreover, improvement in retail sales and growth in online sales provided further support.
The above developments, especially an increase in online retail spending and increased purchase of consumer staples, are deemed to have a positive impact on business activity. Further economic recovery and increased people movement will eventually heal the COVID-19 sickness by enabling increased revenue generation. In light of the above factors, let us have a look at a few Australian businesses that have a considerable market share in China.
1. Costa Group Holdings Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 1.18 Billion, Annual Dividend Yield: 1.87%)
Costa Group Holdings Rides on Robust Production Growth: Costa Group Holdings Limited (ASX: CGC) is the leading horticulture group in Australia and is engaged in growing, packing, and marketing of fresh fruit and vegetables. During the full year ended 29 December 2019, revenue went up by 5.8% on the prior comparative period to ~$1 billion, which was mainly driven by growth in production, led by new Colignan farm sales and increased table grape marketing volume and international growth from China and Morocco. The company delivered EBITDA-SL of $98.3 Mn, reflecting a fall of 21.5% year over year, on account of lower Produce segment earnings. Notably, on 16th April 2020, the company informed that it has witnessed a strong trading performance year to date with the Group performing above budget for Q1FY20, and ahead from the prior corresponding period.
Outlook: The company’s business fundamentals remain strong, despite the current trading challenges. As food supply has been categorized under priority status within Australia and other countries, the company remains on track to support its customers both domestically and internationally with all farms operating at improved hygiene conditions. Further, CGC remains focused on ensuring the health and wellbeing of its employees and their families. The company remains focussed on delivering value accretive growth, however, given the ongoing uncertainty regarding future impact related to the COVID-19 crisis, the company has withdrawn its previous guidance for FY20. The company expects to release its H1FY20 results on 28th August 2020.
In FY19, the company’s China operation provided a robust year over year growth with the completion of 3rd commercial harvest. Market demand for blueberries also remained strong, particularly for the ‘Jumbo’ product. Further, on-going enhancement of agronomic systems in China witnessed a robust start to the 2020 season. The company reported more than 80% growth in blueberries volume in China, driven primarily by favourable Jumbo mix. Notably, China contributed a total of 23% of total revenues in CY19. China’s earnings contribution to the group remains noteworthy. Further, the production outlook for China is positive and COVID-19 has not had any material impact on the harvest activities.
Key Risks: The company is exposed to risks pertaining to weather and climate cycles. Further, potential pricing pressure on blueberry, stiff competition from peers, and foreign currency fluctuation risks might also put pressure on the business, going forward.
Bankruptcy and DuPont Analysis:
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)
EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs CGC (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last six months, the stock gave positive returns of 8.89% on ASX and is currently trading below the average of its 52-week trading range of $2.32 - $4.033. The stock price has witnessed a decent trajectory after the market fallout in March 2020. The company’s balance sheet, cashflow and liquidity continues to be strong and supports current ongoing operations including new plantings and farm expansion, and is expected to drive business growth, going forward. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $2.91, down 1.02% on 20th July 2020.
2. Synlait Milk Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 1.17 Billion, Annual Dividend Yield: NA)
Synlait Milk Rides on Robust Revenue Growth: Synlait Milk Limited (ASX: SM1) is a dairy manufacturer, which is engaged in providing higher value dairy products to top milk-based health and nutrition companies. During 1H20, the company witnessed a growth of 22% in sales of consumer-packaged infant formula and reported an increase of 19% in revenue to NZ$559 million. In the same time span, the company’s EBITDA stood at NZ$67.6 million, with NPAT of NZ$26.2 million, down 30% due to higher depreciation and interest costs. During the quarter, total milk processed increased by 8.5% due to a higher milk supply for Pokeno.
Outlook: In the times of the global pandemic, the company is operating as an essential service. It has been delegated with a responsibility to help feed New Zealanders. The company is not facing any material operational impact and is managing risks through solid relationships with raw material suppliers and logistics partners. The company has progressed well on its material customer opportunities which are likely to diversify the company’s portfolio and will fill up new facilities. SM1 has a strong customer pipeline and has made robust progress towards its long-term strategy. Recently, the company updated its forecast base milk price to NZ$7.05 kgMS from NZ$7.25 kgMS for the FY20 season. The company expects to release its FY20 results for the period ending 31st July 2020, on 28th September 2020.
This company owns and markets the Akara and e-Akara infant formula brands in the China market, which are solely produced by the group. Though the company sells its products to many different countries, a significant proportion of both infant nutritional and ingredients sales are ultimately consumed in China. In 1HFY20, around 63% of total revenues were from the top three external customers. By geographic distribution, China accounted for 8% of total revenue in 1HFY20 and the rest of Asia accounted for 23% of total revenues. In May 2019, Synlait Business Consulting (Shanghai) Limited was incorporated, with principal activities to provide services to assist Synlait to market products in China. On the back of higher investments in its infant nutrition business, the company extended its supply agreement with the a2 Milk Company to July 2025. The a2 Milk Company will remain on track to provide robust growth in all channels in China. Synlait expects to strengthen its scale of operations and build a best-in-class highly integrated value chain through this strategic partnership.
Key Risks: There remains significant uncertainty around the potential impact of COVID-19 on supply chains and consumer demand in SM1’s core markets. Further, higher costs related to managing impacted Australian and New Zealand customers along with costs associated with health and safety measures are potential headwinds. Stiff competition and pressure on the broader supply chain, particularly container space availability and shipping schedules, are other potential headwinds to the company.
Bankruptcy and DuPont Analysis:
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)
P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs SM1 (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last six months, the stock has corrected by ~21.88% on ASX and is currently trading close to the average of its 52-week trading range of $4.33 - $9.75. Over the last 3 months, the stock price has been on stable grounds, supported by the resilience of the business. Synlait continues to invest in long-term strategic opportunities and remains on track to develop and offer new opportunities to existing and prospective customers. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $6.56, up 0.923% on 20th July 2020.
3. BWX Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)
(M-cap: A$ 539.24 Million, Annual Dividend Yield: 0.92%)
Sukin Brand Delivers Significant Revenue Growth: BWX Limited (ASX: BWX) is a developer, manufacturer, distributor and marketer of branded skin and hair care products. In a recent trading update, the company informed that it has successfully delivered FY20 guidance on a preliminary and unaudited basis, with revenue amounting to $187.6 million, up 25% on pcp. Revenue growth was delivered across all core brands with continued market share gains. During the year, the company saw significant revenue growth of 55% in its Sukin brand. Revenue from Nourished Life gained momentum in the second half and went up by 26% on 2HFY19. EBITDA on a pre-AASB 16 basis came in at $27.5 million, up 30%, and NPAT stood at $14.1 million, up 48% on pcp. Moreover, disciplined working capital management resulted in reduced net debt of $32 million as on 30th June 2020, as compared to $42.8 million at the end of FY19.
Outlook: The company has recently completed a $40 million fully underwritten institutional placement, through the issue of ~11.8 million new fully paid ordinary shares at a price of $3.40 per share. Proceeds from the Placement will be utilised to enhance manufacturing capability and strengthen the balance sheet. With the capital raised, the company plans to future-proof its supply chain by investing ~$33.7 million in a new Operations Facility. For FY21, the company expects ongoing growth in revenue and EBITDA of at least 10% and is confident about its long-term growth potential. The new Operations Facility is expected to be completed in December 2021 and will be EPS accretive in FY23 and onwards. The facility will provide incremental growth on the Three-Year Strategic Plan announced earlier, which entails delivery of growth opportunities and attractive returns, manufacturing efficiencies, and risk mitigation.
The company’s cross border e-commerce (CBEC) business in China has been resilient to the changing market environment. The move to a single trading partner for China as well as targeted investments in marketing and resources resulted in significant business growth since January 2019. Going forward, the company aims to adapt to the needs of Chinese consumers and build a robust and sustainable business model for China. The recent capital raising is expected to support the company’s strategic plan to capture growth opportunities in key markets including China.
Key Risks: Changes in market interest rates expose the business to Interest rate risk i.e. the risk of fluctuation in the fair value or future cash flows of a financial instrument. In addition, the Group’s exposure to credit risk arises from the carrying value of each class of receivables. Certain transactions denominated in foreign currencies expose the business to foreign exchange rate fluctuations. Moreover, the inability to maintain sufficient funds gives rise to liquidity risk.
Bankruptcy and DuPont Analysis:
Valuation Methodology: Price to Earnings based Market Multiple Valuation (Illustrative)
Price to Earnings based Market Multiple Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs BWX (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last one month, the stock gave positive returns of 28.78% on ASX. The stock price has demonstrated favourable movements since the COVID-19 fall and recently witnessed a spike, after completing the equity raising. The recent capital raising is aimed at solving capacity constraints, unlocking significant efficiency gains, and delivering growth over and above BWX’s Three-Year Strategic Plan. Going forward, the delivery of the above objectives is expected to act as a key catalyst for growth. We have valued the stock using the Price to Earnings based market multiple valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Hold” recommendation on the stock at the current market price of $4.27, down 1.613% on 20th July 2020.
4. The A2 Milk Company Limited (Recommendation: Watch)
(M-cap: A$ 14.35 Billion, Annual Dividend Yield: NA)
Decent Revenue Growth Across All Key Regions: The A2 Milk Company Limited (ASX: A2M) is primarily engaged in the sale of branded products made with milk from cows that produce milk naturally containing only the A2 protein type. During the half-year ended 31st December 2019, total revenue increased by 31.6% to NZ$806.7 million. Net profit after tax came in at NZ$184.9 million, up 21.2% on pcp, reflecting strong growth across core markets and product categories. In the latest trading update released on 22nd April 2020, the company notified that since the release of half-yearly results on 27th February 2020, revenue grew strongly in all key regions, particularly in respect of infant nutrition products sold in China and Australia. The company also confirmed that its revenue for the 3 months ended 31st March 2020 went beyond expectations, impacted by changing consumer behavior due to COVID-19.
Outlook: The company expects FY20 revenue to grow across its key regions, on the back of increased levels of marketing investment in China and the USA. Despite the uncertainty associated with COVID-19, the company expects FY20 revenue to be in the range of NZ$1,700 million to NZ$1,750 million. FY20 EBITDA margin is expected between 31% - 32%, higher than the previous announcement, due to higher margin nutritional products, favourable impact arising from exchange rate movement, and delayed costs due to COVID-19. While the company revised its FY20 EBITDA margin guidance based on the factors discussed above, it is unlikely that these factors will be sustained as the unprecedented circumstances begin to unwind. Therefore, the Company targets an EBITDA margin of ~30% in the medium-term. The company will be releasing FY20 results on 19th August 2020.
During the first half, the company made a marketing investment of NZ$84.1 million targeting opportunities in China and the USA. Infant nutrition segment contributed the highest amount of revenue in the half at NZ$659.2 million. The company reported a 30% growth in infant nutrition revenue across APAC, driven by a 76.7% increase in China. The momentum continued through to the second half, as reflected in the latest trading update. In 1HFY20, the company expanded its footprint in China to 18,300 stores, up from 16,400 stores at the end of 2HFY19. Notably, stores in China have witnessed a continuous increase since June 2017.
Key Risks: Since the company supplies products for human consumption, its business is inherently exposed to potential product quality, food safety or food integrity events that may cause concerns among consumers and can impact brand reputation. Increasing competitive intensity can lead to erosion of market share in core markets, thereby, impacting revenues. Last but not the least, the business’ success is underpinned by key relationships with strategic partners, including key supply and distribution partners and any reduction in support from such parties can impact operations.
Bankruptcy and DuPont Analysis:
Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)
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P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)
Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months
A-VIX vs A2M (Source: Refinitiv, Thomson Reuters)
Stock Recommendation: In the last six months, the stock gave returns of 32.08% on ASX and is currently trading close to its 52-week high of $20.05. The stock price has recorded exuberant growth after strong revenue growth across all regions, despite the COVID-19 related challenges. Moreover, continued marketing investment and maintenance of guidance were other positive factors contributing to growth. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a price correction of low single-digit (in percentage terms). Hence, considering future business prospects, key risks, and current trading levels, we have a watch stance on the stock at the current market price of $19.28, down 0.567% on 20th July 2020.
Comparative Price Chart (Source: Refinitiv, Thomson Reuters)
Note:
Altman’s Z-Score Model:
(1) When Z-Score <1.81, then it is in Distress Zone
(2) When Z-Score is between 1.81 and 2.99, then it is in Grey Zone
(3) When Z-Score > 2.99, then it is in Safe Zone
The above relative valuation implies a target price incorporating the key positive factors driving the business and indicate long term potential of the stock. Prices, however, remain subject to any short-term movements due to the impact of coronavirus on the business fundamentals.
All the recommendations and the calculations are based on the closing price of 20 July 2020. The financial information has been retrieved from the respective company’s website and Thomson Reuters.
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