Chaoda cream of the crop on mainland
Vegetable producer's radical model is set to grow, writes Chris Oliver
There may be more behind the story of mainland vegetable producer Chaoda Modern Agriculture (Holdings) if the buzz among fund managers is an indication.
Trading on the Hong Kong stock exchange at just 6.35 times this year's estimated price/earnings, the mainland organic food producer is valued well below its peers despite a compelling business model that has been heralded as 'revolutionary' by Credit Suisse.
Most of the mainland's farming land is based on a collectivist model, but Chaoda is among the first to introduce new methods improving efficiency using a combination of science and entrepreneurial ingenuity. Credit Suisse said Chaoda's twin strengths were knowledge-based farming and controlling how vegetables move from the field to the consumer shelves.
'The improvement in farming efficiency is astounding,' said a Credit Suisse report on the company last year, entitled A Rural Revolution. 'It is exactly the kind of solution package to the central government's rural initiatives. Policy support is likely to further accelerate growth.'
During the past five years, earnings have been on a long march upwards while the share price has roughly been unchanged, although it has been volatile with sharp peaks and troughs. In October 2002, the share price collapsed when its former auditor PricewaterhouseCoopers refused to endorse full-year earnings because of accounting discrepancies at two subsidiaries. Worries over the company accounts faded with assurance from chairman Kwok Ho and new audits in 2003 by Ernst & Young.
The key to its future, said fund managers, was Chaoda's fast-rising reputation as a trusted brand among mainland consumers who were becoming more discerning about what they put on their dinner tables. The World Brand Lab/World Economic Forum said Chaoda had ranked highest among all agricultural brands in its peer group. And with rising affluence in society, winning the hearts of mainland palates could prove profitable. Sales this year are estimated to reach 2.22 billion yuan, a 19 per cent increase from last year.
Instead of chemical pesticides, Chaoda has embraced organic growing technologies and located its production bases far from polluted industrial sites. Seed and organic fertiliser farming techniques are on par with large-scale growers worldwide. It also uses computerised systems for crop planning and to lift other production efficiencies.
'I think it's the best story to come out of China,' said fund manager Brook McConnell, president of South Ocean Management. He believes the company should enjoy another five years of rising margins and fast growth before the competition catches up. Chaoda ranks as the single largest holding in his Hong Kong Partners LP fund.
'It's going to prove itself to be a quality company,' he said.
Chaoda operates 33 agricultural production bases in 12 provinces and municipalities. Total production covers 10,500 hectares, employing more than 12,000 staff.
JPMorgan initiated coverage on Chaoda earlier this month with an 'overweight' recommendation and a 12-month price target of $3.60, an 18 per cent premium to its current price. The broker forecasts net profit growth of 14 per cent for the financial year 2005, with a dividend yield of 2.6 per cent. The company plans to expand its production area 25 per cent a year as part of an aggressive 1.5 billion yuan annual capital expenditure plan, which will be funded from new equity and debt. The company raised US$225 million in a bond issue in February.
Unlike many other areas of China's economy, Chaoda faces little marginal squeeze from industrial overcapacity and falling prices. JPMorgan said the business model was expensive and hard to copy, and it would also be difficult for new competitors to break into the company's distribution network.
'Stable farming margins will make Chaoda a good proxy to China's consumption story,' said JPMorgan analyst Molly Chen.
'In recent years improvements in living standards have encouraged an increase in the consumption of fruits and vegetables when compared with crops such as rice or wheat.'
Key costs include fertiliser and unskilled labour, inputs that are less affected by high energy costs and wage inflation. On the downside, Chaoda cannot charge too high a premium on its vegetables, as 70 per cent of product is sold locally, competing with small collective-run farms. JPMorgan also cautions that Chaoda's venture into dairy cow breeding looks like a bad idea.
JPMorgan also believes Chaoda's business model has Beijing's blessing and is viewed as an important moderniser of the collectivist land-leasing system, a scheme considered mutually beneficial for farmers and the environment.
'We believe Chaoda's good relationship with the Chinese government will assist its rapid development,' Ms Chen said.
Mr McConnell said that at a market cap of $7.44 billion, its profile was just large enough to emerge on the radar scopes for large funds. 'It is the size where institutions can buy,' he said.
A large orange-growing subsidiary, Asian Citrus Holdings, will list on London's Alternative Investment Market on Wednesday. Chaoda owns 49 per cent of Asian Citrus, but its holding will be diluted to 40.3 per cent in the placement by issuing 20 per cent new shares. The listing should raise $212 million, with funds earmarked towards improving one of two orange groves in Jiangxi .
The orange juice subsidiary operates two groves comprising 6,800 hectares.
Mr McConnell estimates the spin-off could add 20 cents to the Hong Kong share price.