Thursday, January 7, 2021

Fufeng (HK:546)

 An ingredients and animal nutrition producer, Fufeng is the largest and lowest cost monosodium glutamate (MSG) producer in the world.

1H20 breakdown by revenue: 40% from MSG, 30% from animal nutrition (half of that from corn products), and 30% others.

Industry Overview

MSG is a commodity - producers have no pricing power so the lowest cost wins.  It takes 2.4 tons of corn and 2.6 to 3 tons of corn  to produce 1 ton of MSG.  Fufeng's production plants are in the north of China near cheap coal and corn, giving them a cost advantage over their competitors.

Source: CICC Research 2013 (Meihua Holdings)

MSG Demand is not affected by the economic cycle:

My research (the first google result) sees MSG demand rising around 3% per year for the next 5 years.

The MSG industry is concentrated.  Fufeng has an estimated 31% global share of MSG by volume, and is the largest in the world.  It has an estimated 57% volume share in China, with the top three producers having a 90% domestic share.  The industry in China has experienced 3 consolidations and 2 booms in the past 20 years (p5).  The number of companies has dropped from over 200 to the current 3 major players (plus a handful of minor ones).  The last boom was in 2008-2012, followed by a bust in 2013-2018.

Their main cost is raw materials, especially corn.  In 1H20, corn kernels were the company's largest cost (55%), followed by coal (15%).  As well as MSG, half of their animal nutrition business is also from corn based products.  Other costs are depreciation (8%) and Employee Benefits (5%).

So this business takes corn & coal and processes them into bulk food materials, for which there is steady or rising demand.  Profits depend on total industry production vs demand.  Long term profits depend on how much new production capacity is added industry-wide.

The company's production capacity:

Source: Fufeng Group: A Leader in an Oligopolistic Market (July 2019)

Numbers

Profitability:

CFO is usually greater than profits, which is expected due to depreciation:

The wild swings in the difference are caused by changes in working capital.

Inventories and Receivables levels swing wildly, but at least they are not trending upwards:

Debt and Equity

As of 1H20, total debt is equal to roughly the last 3 years PBT.  And 40% of this debt is covered by cash.  They have some USD debt.  Overall, their debt is small enough not to worry about.  

The company issues stock options to staff.  Potential dilution from options issued is less than 1% of existing shares (p85) as of end 2019.  But the company is authorised to issue up to new options for up to 8.4% of existing shares.  Something to watch out for.

They had convertible bonds which were redeemed in 2018.

Risks

First risk is the trade war reducing their exports.  With the effect of increasing supply in the domestic China market.

Second risk is the industry going back to being irrational, with new players coming in and adding more production.  Fufeng and the leading players need to keep adding just enough new capacity to discourage them.  Should be possible with the current industry structure, but in China - where new production capacity is not always driven by economics - it may not.

People may switch from MSG over health concerns.

Rising corn/coal prices.

Any China company can be a fraud.  This one does not fit that profile, generating cash (but not holding too much), paying a dividend, and producing a bulk tangible product.  It would be difficult to fake production of 30% of the world's MSG - many people might notice their food has no taste.

Valuation

At a price of HKD 3:

  • Their TTM dividend is HKD 13.8c, giving a yield 4.6% (4.1% after 10% WHT), with a payout ratio under 40%.  I did not see a dividend policy.
  • Its trading at a PE of 4.5 to 6, if we use 2018 or 2019 profit numbers (excluding exceptional items).

Conclusion

Worth a bet at current prices.  They produce an essential ingredient in an oligopolistic market.  There may be short term fluctuations due to rising corn prices and its hard to know where we are in the cycle.  But in the long run they should make a good return if the industry remains rational.

Bought this for 2% of my portfolio.  Limit to 2% because its a China stock and I can't follow this industry closely.  Also cause I got no more money.

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