Third report
Broker | Date | Call | Target | Valuation Basis | Upside |
DMG | Jul 10 | Buy | 88 cents | 12.5x FY08PE | 100% |
UOBKH | Jun 23 | Buy | 74 cents | 10.5x FY08PE | 68% |
Westcomb | Jul 10 | Buy | 60 cents | 9x FY08PE | 36% |
DMG REITERATED its buy recommendation with price target of 88 cents on China Farm Equipment last Thursday after the farm equipment maker’s road show on Monday July 7.
On the same day, Westcomb initiated coverage with a price target of 60 cents. The stock last closed at 44 cents, with potential upside of 68%.
The company’s market leader position in a trade that alleviates the world’s dilemma of decreasing arable land makes it a hot favorite with fund managers.
China Farm is benefitting from China’s government policy of subsidising products that raise harvest yields.
The company’s attraction lies in the fact that as much as 70% of Chinese farmland is yet to be mechanized, suggesting vast untapped demand.
Subsidy qualification, containment of rising costs, market position and new markets were top on the minds of analysts and fund managers who attended the agri-roadshow organized by Financial PR.
Excerpts of the Q&A session fielded by its CFO, Eric Sho:
Subsidies for the nation’s critical industry
Q: Please describe what is the process for receiving subsidies?
A company must be reasonably large to qualify. To get a subsidy, the machine must be proven to be able to improve harvest yield. Our rotary harvesters reduce loss rate by 3%-5% compared to manual use of knives.
The process involves government officers verifying product specifications. Then, an audit is made to determine yield improvement levels.
It takes 2.5 months before a model is listed on the National Product Catalogue of equipment qualified for subsidies.
Q: What is the percentage of your competitors who have a subsidy?
Farm equipment in China is dominated by a handful of manufacturers, meaning that our competitors are all listed on the Catalogue.
Each however, has its niche. We specialize in harvesters suitable for wet paddy in southern China.
Our edge is a complete product range. We have 8 models in the Catalogue. Hunan-based Beiqi Futian Automobile, for example, focuses on agricultural trucks.
Q: How difficult is it to get a subsidy?
There are only a few manufacturers in the market able to make farm equipment that actually improve harvesting rates.
We have as many as 35 researchers in three plants designing new models and analyzing how to improve existing ones.
Q: How many harvesters from other manufacturers are listed on the Catalogue in addition to the eight from China Farm Equipment?
Numerous.
Q: How is quantum of subsidy determined?
Quantum of subsidy varies from model to model, depending on the model’s harvesting capacity and the manufacturer’s production cost structure.
The amount subsidized also varies from place to place and may be influenced by one’s clout with government officials.
Q: How do subsidy levels to competitors compare with yours?
In Jiangxi, our equipment gets subsidy of Rmb 15,000. Competitors generally get less than us.
Q: How long does it take for the government to pay out its subsidy?
2-3 times a year, depending on location.
Q: If so, will trade receivables days be extended from 34 currently now that your products are subsidized?
We believe our receivables turnover can be kept to within 40 days.
This is because subsidies contribute only 20% to sales. We are also working on shortening our credit terms.
Q: Can you lobby for the government to free up working capital for you by cutting their subsidy payment time?
We are working on this.
The fact that some places pay three times a year instead of semi-annually is a fruit of our hard work.
Rising Costs
Q: How has cost of goods sold been affected by raw material prices?
Our raw materials are steel sheets and steel bars. Cost has gone up by at least 18% over the past year. We have some measures to address this, which have proven quite effective.
First, lock in costs. We have about 10 local suppliers. We negotiate with them to lock-in costs as long as 3-6 months forward. If necessary, we even pay in advance to secure good prices for raw materials.
Second, adjust raw material composition. We cut cost by reducing usage of steel.
Third, introduce more lucrative products. We recently launched a harvester with higher gross margins (31%-35%) compared to older models. It has so far been well received and we will focus on promoting it. All done, we hope to maintain last year’s margins.
40% of diesel engine market in China
Q: What is your estimated market share?
We are the biggest manufacturer in Hunan for farm equipment and diesel engines. We have about 40% of China’s diesel engine market.
Q: Who are your competitors in diesel engine?
We are the most influential diesel engine maker in Hunan. In fact, we are the first company to provide the A-cool water-cooling there.
Q: Will there be a drop in farm equipment sales?
Farm equipment is a seasonal business. The peak season starts in late March, all the way to October. So you see a sales spike in Q2 and Q3. Q4 is winter when no one harvests.
Trucks in addition to harvesters
Q: What’s the rationale for getting into the truck business last year, knowing that its margins are significantly lower than harvesting equipment?
Firstly, as our existing customers need trucks, we don’t spend much building a customer network for the new product line.
Secondly, trucks operate on diesel engines, which we produce. We are developing a diesel engine for the truck.
Thirdly, Hunan Juzhou is the only truck maker in Hunan with an export permit. It already has a client network in Vietnam.
The deal enabled us to sell our traditional product – harvesters – in Vietnam.
Last year, 3% of group sales came from exports. We expect this to increase to 5%-6% this year.
Lastly, our cost structure is much lower than Japanese truck makers such as Mitsubishi and Isuzu.
(Note: China Farm Equipment made its first foray into truck manufacturing last November by leasing the entire operations of Hunan Juzhou, an established truck maker.)
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Report No. 1 from the Agri Roadshow: GMG taps on Africa's vast resources
Report No. 2: OCEANUS: Daiwa's target price is 53.5 cents
Related report: CHINA FARM EQUIPMENT: Gains from govt action to boost farm output
