Initiate at Buy. We initiate Muyuan Foods at Buy with TP of Rmb83.3, implying 21%upside.
Company background: Founded in 1992 in Henan Province, Muyuan Foods has beenfocusing on hog raising business for nearly 30 years. The company is the No.2 hogproducer in China, with 2% market share as of 2018. The company’s internal cultivationmodel gives it full control over the hog production process, from the breeding herd tomarket hogs.
Investment thesis: (1) Positive earnings momentum. We expect Muyuan Foods tobenefit from the hog price upcycle in China for multiple years, driving unit net profit ofmarket hog from Rmb0.1/kg in 2018 to Rmb2.7/kg in 2019E, Rmb7.1/kg in 2020E, andRmb7.5/kg in 2021E. We expect the strong earnings and cash flow to significantlyimprove the company’s gearing in the next two years, from 65% in 2018 to 27% in2020E.
(2) Strong potential to gain market share and cost advantage. We are positive onMuyuan’s potential to gain share in the fragmented live hog production industry. Thanksto leading techniques in breeding and large-scale industrial production, Muyuan Foodshas the lowest unit production cost in the industry (c. Rmb11.5/kg in 2018 vs. smallerplayers Rmb13-15/kg), which we think is a sustainable advantage.
Valuation: We value Muyuan Foods using a PE multiple of 13.5X to 2020E earnings, toreflect a sustainable hog price upcycle over the next two years. 13.5X PE multiple isderived from a 10% discount to Wens Foodstuff’s mid cycle PE, to reflect the highervolatility of Muyuan’s earnings.
Key risks: (1) lower-than-expected hog prices; (2) lower-than-expected sales volume; (3)potential ASF infection