HUABAO INT'L(00336.HK)： RE-POSITIONING RISKS DOWNGRADING TO SELL

德意志銀行 · Jun 26, 2015 00:00 · Researches

We care about execution; downgrading to Sell

Huabao is aiming for HKD10bn revenue in five years, representing an 18% CAGR, to be comprised of both organic and inorganic growth from tobacco and non-tobacco businesses, and is considering A share financing. We think the new strategy will lead to a change in the profile of its investors, from value investors to growth investors, and from H share discipline to A share mentality. We expect selling pressure in the short term and medium-term performance to be event-driven. Longer term, we care about execution, but we note that Huabao has little experience outside of tobacco. Downgrading to Sell.

Switching to expansion mode from a cash cow

Under the new five-year plan, Huabao expects incremental revenue to comefrom 1) e-cigarettes and other innovative products, 2) cigarette raw materials,and 3) food seasonings/flavours. It is actively seeking M&A to cope with the plan, and has therefore decided not to pay a final dividend to prepare for future financing needs; it is also considering tapping the A share market for low-cost financing. Note that, just six months ago, Huabao increased the dividend payout ratio to 100%, given strong free cash flow and no imminent M&A.

FY16-17E NPAT lowered by 18-20%; target price cut by 39%, to HKD4.27; risks

For FY16, management targets stable top-line growth, with GPM coming under pressure, as the lower-margin food flavour business will outpace the higher-margin tobacco businesses, and budgets a double-digit increase inSG&A expenses yoy to prepare for future expansion. We cut our FY16-17 NPAT forecasts by 18-20%, and lower our dividend payout forecast to 30%,from 50%. As a DCF does not reflect the risk of the company’s proposed transformation, we change our valuation methodology to 7.06x forward PE, which is based on its three-year average forward PE, and our new target priceis HKD4.27/share. This puts Huabao back to its PE level before the re-rating, owing largely to a rising dividend payout, in our view. Key upside risks: betterthan-expected execution of the new plan; new government policy driving tobacco industry consolidation. See page 5 for more details.

We Care About Execution; Downward to Sell Huabao is Benefit for HKD10BN Revenue in Five Years, Income an 18% CAGR, to Be a CARE of Both Organic and Inorganic Growth from Tobacco and non-tobacco cigarettes, and is tobacco A share tobacco. We think the new strategy will lead to a change in the profile of its investors, from value investors to growth investors, and from H share investors to a share mentality. We expect selling pressure in the short term and long-term performance to be event-driven. Excitement term, we care about execution, but we note that Huabao has a little experience outside of tobacco. Downstairs to Sell. Switching to Expansion Mode from a Cash Cow Under the New Five-Year Plan, Huabao Incremental Revenue to ComeFrom 1) e-Investments and Other Innovative Products, 2) Expanding Raw materials, and 3) food seasonings/flavours. IT IS ALSO SEEKING M&A TO COPE WITH THE PLAN, AND HAS PREVIOUS NOT TO PAY A FINAL NEEDED TO PREPARE FOR FUTURE NEEDED NEEDS; IT IS ALSO SEELED TO COPE THE A SHARE Market for beginners Note that, just six months ago, Huabao wants the optional payout ratio to 100%, given strong free cash flow and no imitation M&A. FY16-17E NPAT salary by 18-20%; target price cut by 39%, to HKD4.27; Salaries For FY16, Management Targets Stable Top-Line Growth, With GPM Coming Under Pressure, As The Lower-Margin Food Flavor Business Will Outpace The Higher-Margin Tobacco Salaries, and a double-digit salary inSG&A expenses yoy to prepare for future expansion. We cut our FY16-17 NPAT salary by 18-20%, and lower our subsequent payout forecast to 30%, from 50%. As a DCF does not reflect the risk of the company's career transformation, we change our motivation to 7.06x forward PE, which is based on its three-year average forward PE, and Our new target priceis HKD4.27/share. THIS PUTS HUABAO BACK TO ITS PE LEVEL BEFORE THE RE-RATE, OWING ENDURING TO A RISING END PAYOUT, IN OUR VIEW Key Upside Initiatives: Betterthan-Expected Execution of the New Plan; New Government Policy Driving Tobacco Industry Initiatives. See page 5 for more details.

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HUABAO INT'L(00336.HK)： RE-POSITIONING RISKS DOWNGRADING TO SELL

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