China Essence

25 Feb 2009


China Essence is ramping up its production capabilities and expansion into new business segments. But its margins are slipping as it is forced to lower its selling prices to sustain demand. Still, analysts covering the stock are pretty confident about the business.

China Essence is cautiously optimistic about its performance for Q4 2009 as it expects orders for its core products to remain stable and its selling prices to stabilize. It plans to cut back on advertising spending to pursue further expansion in China. The group is also counting on the government's stimulus measures to encourage domestic consumption.

Upcoming plants by China Essence as stated in its Q3 2009 earnings include:
1) Large-scale production of potato fibre to begin in May 2009
2) Large-scale production of potato starch, its core product, to begin in FY2010
3) Plans to double annual production of potato protein by FY2010.

It said these plans are 'subject to market demand and availability of working capital'.

Q3 2009 revenue inched up 7% to RMB 352.6 million thanks to higher sales, while net profit slipped 19% to RMB 81.2m due to lower selling prices, higher finance costs and increased tax expenses.

The business burned RMB 55.9m in cash for operations compared to the RMB 9.8 m it generated last year.

Westcomb Financial has raised its FY2009 earnings estimates by 3% thanks to the group's better-than-expected Q3 earnings. While it remains skeptical about the business's new potato protein segment, it expects it to be the key performance driver in Q4.

But Westcomb is taking into account the global slowdown and expects net profit to continue falling. It maintains its HOLD call on China Essence with a target price of S$0.25 in its research report released on 13 February.

CIMB-GK still thinks the stock is a BUY as it maintained its call in its 18 February report with a price target of S$0.34. While it notes the company's ailing margins and potential challenges from its potato protein division, CIMB-GK is confident that net profit would pick up by FY2010.

The global slowdown has not deterred China Essence from keeping its eye on the prize. And given the current economic situation, the business may seem like it is in way over its head.

The good news is that China Essence is milking the potato for everything its worth as its products are widely used in various industries such food processing, manufacturing and pharmaceuticals.

The end goal may be sweet but the business has more urgent matters to attend to. On top of declining margins and incurring significant capital expenditures from its upcoming plants, China Essence slipped into negative free cash flow a year after its listing in 2006.

Despite doubling its negative free cashflow to RMB 90.5m in FY2008, it increased its dividend payout to HK$0.07 from HK$0.04 in FY2007.

China Essence is certainly not in a capacity to fund its own dividend payouts. So, the million dollar question to ask is, will the business be able to hold out until its additional plants are ready to take off?

Analysts surveyed by Reuters have on average a BUY call on the stock with a target price of S$0.76.

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