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Summary of Document: Potential Earnings Upsides in 3Q for Tingyi

Core Content

This document provides an analysis of Tingyi's potential earnings performance in the third quarter of 2013 (3Q13), along with its financial outlook and valuation metrics. It is authored by Tony Tseng, CFA, a Research Analyst at Merrill Lynch (Hong Kong), and includes detailed financial data, forecasts, and insights into the company's operations and market position.

Main Points

Earnings Outlook for 3Q13

• Earnings Upsides: The analysis suggests that Tingyi might report better-than-expected earnings in 3Q13 due to:
  • Improved operating profit margin (OPM) from better noodle performance.
  • Higher beverage revenue growth than previously estimated, potentially reaching 13% (vs. 6% in 2Q13).
  • Positive impact from well-managed inventory, positive feedback on product expansion, and high temperatures in July and August.
• Rating: Despite the potential earnings growth, the analyst retains a Neutral rating, citing limited upside potential to the 30x P/E multiple for 2014E.

Noodle Promotions

• Modern Channels: Tingyi has reduced promotions on bowl and roasted packed noodles, but has rebalanced promotions for sour & spice and braised packed noodles across cities.
• Traditional Channels: The company has reduced rebates to wholesalers and may raise end-product prices by 5% shortly.
• Competitive Position: Tingyi is focusing on profitability, regardless of peer actions.

Beverage Segment

• 3Q Growth: Beverage revenue growth is expected to be higher than the 13% estimate, driven by:
  • Inventory management.
  • Positive product feedback.
  • High demand due to warm weather in July and August.
• OPM Trends: OPM is expected to increase YoY in 3Q due to scale benefits and stable promotions.

4Q13 Earnings Growth

• Anticipated Growth: The analyst expects decent YoY earnings growth in 4Q13, attributed to:
  • A low base from 4Q12.
  • Reduced noodle promotions.
  • Improved performance from Pepsi's bottling business.
  • Positive beverage growth.
• 4Q12 Impact: 4Q12 results were negatively impacted by high operating expenses (30.2% of sales) due to China-Japan tensions.

Key Financial Estimates (Dec 2013)

Price Objective and Valuation

• Price Objective (PO): HK$22.00, up from the previous PO of HK$20.45.
• Basis for PO: Based on a 30x P/E multiple for 2014E.
• Valuation Justification: The 30x P/E is justified by Tingyi's stronger market positioning post-acquisition of the Pepsi bottling business and anticipated turnaround in 2013.
• Sector Comparison: The P/E is slightly higher than other leading staple companies (22-25x), due to larger revenue base, strong brand recognition, and better channel coverage.

Investment Thesis

• Concerns: The analyst expresses incremental concern about pricing competition in the instant noodle segment.
• Outlook: Despite the recovery in the beverage business, the company is expected to trade sideways in 2013.
• Risks:
  • Upside: Price hikes, stronger-than-expected volume growth, easing input costs, and strong RMB appreciation.
  • Downside: Rising input costs, competition in the beverage segment, demand slowdown in the instant noodle segment, and food safety issues.

Company Description

• Industry: Leading producer of instant noodles, beverages, and baked goods in the PRC.
• Market Position: Significant market share and exposure in key segments.
• Brand: Markets many products under the 'Master Kon' brand.
• Revenue Mix: Expected to generate 40% from instant noodles, 57% from beverages, and 3% from others in 2013.

Key Financial Statements

Income Statement (Dec 2013)

Balance Sheet (Dec 2013)

Cash Flow Statement (Dec 2013)

Investment Rating Distribution

• Neutral rating is retained for Tingyi, reflecting moderate upside potential.
• Coverage Universe: Includes various companies in the HK/China Consumer sector.

Analyst Certification

• Tony Tseng, CFA, certifies that the views expressed in the report reflect his personal views and that no part of his compensation is related to the specific recommendations.

Key Metrics and Definitions

• iQmethodSM includes measures such as Return on Capital Employed, Return on Equity, Operating Margin, and EBITDA Margin.
• Valuation Toolkit includes P/E, Price / Book Value, Dividend Yield, and Free Cash Flow Yield.
• Quality of Earnings is measured through Cash Realization Ratio and Asset Replacement Ratio.

Conclusion

The report outlines potential earnings improvements for Tingyi in 3Q13, driven by better OPM, higher beverage growth, and reduced promotions. Despite these positives, the Neutral rating is maintained due to limited upside to the P/E multiple. The price objective of HK$22.00 is based on a 30x P/E multiple for 2014E, reflecting the company's stronger market positioning and anticipated performance. The investment thesis emphasizes moderate growth and potential risks, including input cost increases and competition in the beverage segment.