Posted by: donmihaihai | April 12, 2009

Pfood transformation?

Pfood 2008 annual report like AR2007 is not a joy to read. Their numbers are great and I have confident in them. The best thing about Pfood is that neither its business nor financial statements belong to hard to understand. But the management does not care much about reporting to external shareholders also with little comments out of the “standard format” which can get easily from their number.
Rather than throwing them straight into poor corporate governance list, I don’t think it is a good idea to views all companies as homogeneous. One cannot dump companies like SingTel and SMRT together with UOL and HPL, neither are they can be put together with Pfood and Full Apex. In SingTel and SMRT, they are not run by owners, even if the management own shares of the companies either through exercising of option or purchase from open market, their primary concern beside running the companies well is to “market” them as well. Corporate governance is a tool for them, stock price is a tool for them as well to possible realise the management current and future earning power. For UOL and HPL, where the management/ directors belong to an inner group of owners. And these owners are competitors of other external shareholders in a way that they are constantly buying from the open market trying not to pay a high price for that. In situation like this, UOL and HPL work the opposite of SingTel and SMRT as they just do the bear minimum for “marketing” to reduce competition. They do not write colourful AR as well. But the test for UOL and HPL is whether they are treating minority shareholders as equal with access to same amount of information and benefits. The thing about UOL and HPL is that they can’t be run like Full Apex mostly company like Pfood because they need capital market either for purchasing of shares or rising new capital. UOL and HPL are doing a balancing act. For Full Apex and Pfood, which are owner-manager, and while they may be buying shares in the open market once a while, they doesn’t seem to be a competitor of external shareholders. No balancing acts here because they are not going to need the capital market for foreseeable future. I think it is pretty reasonable to call them private-listed company. Since the management does not need to pay lips service to media, analyst, bankers, potential investor or even shareholders, why care about corporate governance? The test should be how well it is being run and whether it is benefiting all shareholders. For corporate governance, which get so much attention lately, the basic question is always — what is corporate governance for?

On being well run and benefiting shareholders, Full Apex is of no comparison to Pfood. Not just that it is well managed, shareholders benefited greatly from it. From 2001 to 2008, not an easy period for pork industry with competition, SARS and pig disease, the amount of dividends received by shareholders since IPO is about the same as Pfood current stock price and just by dividends alone, it is more than IPO price of $0.45. And share price is pricing as if Pfood is dead like Ufood. Even without its associated, Pine Agritech, Pfood is trading at about 0.5X to 0.6X NBV. Pfood shareholders are getting generous dividends over the years because Pfood is generating huge amount of not just cashflow but free cashflow and a conservative estimate will show that Pfood is trading at 4 to 5X free cashflow with rock solid B/S and wonderful cash generating ability. Rock solid B/S and wonderful cash generating ability is something that is not an easy task even for SingTel, SMRT and UOL.

But Pfood is undergoing some kind of structural change as it is integrating backward into pig farming. Unlike its previous investment, this time the scale is big enough, important enough to change Pfood either for the better or worse. While I hope for the better especially seeing the management being extra careful, evaluating the project for a year, but going into pig farming just for their own needs not just doesn’t bring extra benefits but may consume increasing resources.

Pfood previous investment into Pine Agritech as it integrates backward is a success but it also provides a reality. RMB223 million was invested for a 36.75%(post IPO) stake in 2004 and in less than 5 years, Pfood received dividends of RMB133 million with their stake remain unchanged and Pfood bought RMB482 million of SPI from Pine last year. 1st Pfood needs SPI for processing pork but does it mean Pfoog need to own company like Pine? As long as SPI meet the requirements, it can be purchase from any company. Buying from Pine may stablise its supply but as what happened 2 to 3 years back where selling was one of the best business in the value chain, getting in Pine early, helping it to scale up ensure Pfood crawl back some of the benefits. But the reality is that selling SPI with no differentiation, a commodity intermediate product is unlikely to sustain the kind of return for long so with every players in the whole value chain having low profit, it is only time that Pine will follow and it did, the effects haven’t finish. In this value chain, the only part of the chain that will have some pricing power will be the one selling to consumer with their brand stick outside. That says it will be stupidity that Pfood will transfer benefit from itself to Pine and if that is the case, Pfood doesn’t fit to stay at its current position. Still, I heard about it sometime back when Pine was enjoying high profitability while Pfood profitability dropped. While Pfood profitability haven’t returned back to its past level but Pine slumped(excluding SOS), well this is the facts about value chain and competition. One cannot look at the company alone without whole value chain and competition nature

That lay a foundation for a look at pig farming. Pig farming is the start of the value chain but just like SPI, there is no differentiation, a commodity product. Beside the all kind of risks on farming, the biggest problem is they have no pricing power. Like SPI, their only way for some kind of competitive advantage is scale and control the market but that is a lousy kind of competitive advantage and provided that their customers, like Pfood or Yurun remain small and weak so a few huge pig suppliers with lot of small processors. It is great that I have never heard suppliers with this kind of scale yet but increasing powerful player like Pfood and Yurun.

So with over RMB 2 billion to be invested into pig farming for its own needs, the benefits may likely be lower cost as Pfood get the pig farming returns and possible intangible return like safe for consumption from clean and known source and more stable supply situation if things like what happened recently happened again. But there is no guarantee. There is also no straight forward answer that integration is the source for competitive advantage or synergy. I believe what Pfood and Yurun currently doing is already laying the foundation for competitive advantage with weak suppliers, products that meet the needs of consumers and sticking their brands onto the packages. Even with minimum advertising, competitive advantage can be built.

With commercial farming, it creates competition for resources. Going forward, Pfood will still need to expand and that required capital, depending on how fast Pfood want to grow. With the rate Pfood is growing, cashflow is not just available but in excess. Add in commercial farming if it proved to be successful, there are chances that cash, generated internally and borrowed may not be enough to sustain high rate of growing, which create the situation for competition for resources. That may not be a good sign unless management never lost sight of how what got them here, up to this point.

Is this going to be a transformation for Pfood? I don’t know. But at its current valuation, I don’t care. Neither do I really care much competitor China Yurun. A quick look at China Yurun suggest that it is not much bigger than Pfood despite growing faster, but that grow is likely to slow without help from raising new capital. financially it is not stronger than Pfood but I think it is being reasonable price at a valuation of about 3X richer than Pfood. Well, with Ufood getting out of the picture, I shouldn’t delay and should start reading Yurun after I finished looking at UOL, HPL, UIC and SingLand.

Investing is a never ending journey.




  1. Sorry to disturb you again. I know this is off-topic but I wanted to ask you about Ezra from your previous comment on my blog.

    I am still waiting for some confirmation of the 20x interest coverage you mentioned in your previous comment, as well as the debt-equity ratio rising rom 0.5x to 0.7x. Kindly provide some numbers on this to support, and we can discuss the issues.

    Appreciate it. I’ve done some preliminary numbers of my own so perhaps we can talk now, I wasn’t ready before when you posted comments on my blog. Sorry if I seemed childish previously, I sincerely apologize. But I hope you don’t come across too strong either.

    Let’s try to learn from each other.


  2. Musicwhiz,

    Interest coverage.
    1) If a company total assets are funded by 50% equity and 50% debts. Cost of debt is 5%. Company ROE must at what range to have a interest coverage of 20X? I don’t even need to know the exact % but ROE of EZRA is way below the mimimum level to has a coverage of 20X. Remember what is ROE and ROA?

    2) With IFRS and FRS required interest on funds borrow and spent on Capex to be capitalised, finance expenses at P&L is no longer accurate. The only way to look for it is at cashflow statement other than digging into the notes.

    Debt to equity ratio from 0.5 to 0.7.
    1) Given by management.
    2) + – all assets related purchases, deposal, depreciation will show that there is a gap.
    3) compare debts in B/S to cashflow statement for financing. The differences are there.
    4) Is it finance lease? pre-payment or post payment? Or even sale and lease back? All these require another smiliar move on item on B/S. Search for that, I can’t find and din dig hard enough.
    5) Let me ask you again. If all assets being purchased by cash and with cash inflow from operating at around zero, why cash level doesn’t dropped by about the same amount of increased assets?
    6) The end result is the same at B/S so I don’t know why these are being left out in the cashflow loop but the impact can range from minimum to significant.

    Lastly, If you read the statements line by line and consider it in term of similar movements in other part of the statement and in what its mean in real world, there are going to be more. I found some but throw them out as they are inmaterial.

  3. Thanks Donmihaihai,

    I like your argument. Clear and concise.

    Actually there’s one thing I want to clarify with you. Interest coverage is defined as EBIT divided by interest expense correct ? I assume one would take EBIT for 6 months divided by interest expense over 6 months, thus this is comparable. Using this, I got a number averaging about 6+x. Ezra stated that their interest coverage is about 7.7x. Not too sure how you arrived at 20x ? Maybe you would like to share on the exact computation ? Much appreciated.

    Actually I didn’t know about the FRS and IFRS requirements. You must be a good accountant cos I don’t keep up with all the new standards. I find it a little weird though – interest payments also capitalized instead of expensed ? Doesn’t sound right to me either.

    I agree there is a BIG gap when I observe the cash flow statement and compare with the movements in the BS.

    If you would care to check back on my blog about 1-2 days later, I will be putting up my analysis and some reasoning behind the differences, as well as a follow-up to the IR of Ezra to enquire on their accounting treatment for these amounts. Suffice to say the amounts are material yes, but after a rough computation and comparison I believe the amounts may have undergone a different type of accounting entry which bypasses cash, which is why it did not show up in the CFS.

    Regarding your 5), I agree. That is what I noticed too. As for 6), I saw the differences but did not go into the smaller amounts as they are immaterial.

    Just curious too, do you always compare the BS and CFS for every company you analyze to see if the amounts tie up exactly ? Or is this the first time ? Have there been cases where the amounts do not tie up as in Ezra’s case ?

    Thanks, and appreciate the discourse.


  4. Musicwhiz,

    1) If you remember, I have never put the coverage at 20X. I put it way lower with my own calculation depending on cash inflow from operating activities and cash outflow for expenses. I remember you put it at max 20X. I believe my earlier reply already proved that it is not achievable in EZRA case.

    2) model ratio and practical. I change the computation to suit the needs not the other way

    3) Not knowing FRS is another sign of problem. 1st 3 to 5 “notes to consolidiated financial statements” in all annual report is the key to understand the arrival of those numbers by stating the policy. No point of reading AR without reading these notes.

    4) Stretching your limited for explaintion is dangerous. And remember in accounting, depending on how the company account for these items, it will show up in the statement one way or another. This is the basic.

    5) EZRA is the 1st case for me.

    6) comparing BS and CFS is a must. But depending on the amount of interests, confident and past record I have on the company.

    Take EZRA case where I have zero confident because a) obs items b) aggressive c) most of the important items have been flipping around for the past few years d) low profitability. But I have low interests in their number too, reading for the sake of margin and cashflow. Still it is hard to miss it as I read the number line by line.

  5. Hi Donmihaihai,

    Not too sure what you mean by 1 and 2. As for 3, I do read Notes in AR and all the accounting policies, in case you think I didn’t. So perhaps I missed it. I will try to be a better investor such as yourself.

    4) I don’t think I am “stretching the imagination” as you phrase it.

    5) Thanks. I just wanted to find out.

    6) I used to prepare BS and CFS all the time as well, so I know what you mean.

    Not sure what you mean by “low profitability”, but I will take it that you can justify yourself.

    I guess the discussion should end here. It would be helpful if you can give more numbers though.


  6. Well you can’t be helpful because you are unable to explain that “loop”. The only thing I am interested in EZRA.

    As usual, before I end, I will always throw out something — That interests being capitalised thingy… it will appear at least once in all AR I went thru for FY2007 and FY2008.

    So lets end it there.

  7. “2) With IFRS and FRS required interest on funds borrow and spent on Capex to be capitalised, finance expenses at P&L is no longer accurate. The only way to look for it is at cashflow statement other than digging into the notes.”

    Good lesson for me. Further to this point, I learned that Legal Fees can also be capitalized.

    Can’t wait to see your writings on Wee’s Group of Companies…

  8. “Further to this point, I learned that Legal Fees can also be capitalized.”

    Interesting. Will look for it… but I guess in order for legal fees to be capitalised, it must be like intangible assets or interests.

    I hope I will write on them some time in the future.. but it is likely that I will disappoint you..

  9. Hi donmihaihai,
    China Yurun Food Group recalls tainted luncheon meat as mentioned in CNA..It may be a good thing for P Food to setup a pig farming where they may have better control?..But b’cos of the CNA also affect P food stock price for now?

  10. Hi mitchell,

    I will let you know the answer by next weekend.

    The only way for me to win(know) is to cheat.

  11. Hi donmihaihai,

    I’m interested in this because consolidation of a fragmented industry can mean strong growth for the biggest and best run players. Am considering to sell pfood in exchange for Yurun – not finished studying them yet.

    Brief look at Yurun vs Pfood trends here:

    First impressions:
    – Yurun has expanded fast in the past, and is expanding again in the future. Horizontal integration. Concerned with market share and scale.
    – Pfood is more efficient. With the proposed vertical integration, they seem more concerned with production effeciency.
    – Both companies affected by the 06-07 pig shortage, but pfood worse.
    – Worried that Pfoods gross margins not as good as Yurun’s. Could be due to branding. Whatever the reason, Yurun seems to have a compeditive advantage here.
    – My first instinct is that Yurun’s horizontal expansion plans make more sense – given the fragmented nature of the pork processing industry and the govt’s desire to consolidate it.
    – Worried abt Yurun’s sharp 2H08 operating margin decline due to rising costs. Is expansion costing them too much?
    – SGX website sucks compared to HKEX.

  12. Hi Black Cat,

    I know little about Yurun but my 1st impression on this company is that their real financial status is not as good as what being presented.

    Perhaps they have higher A&P and possible better branding but I don’t see pork products having lot of brand value. It is more of a reliable issue.

    My 1st look also tell me that their past growth was fuelled by cheap assets, government grants and access to capital market. Provided these are to continue, then growth will be continue as well. If not they will need to pay market price and more debts or growth may stalled.

    My views on pork industry in China are already being written above. It will not be a one company win all kind of stuff but rather a number of winners. And the one being most conservative in financially will last till the end. That may take 10 years , 20 years or even longer.

  13. Thanks donmihaihai,
    Looking forward to your reply..

    With your recent post, I did a quick receivables, payables and inventory turnover day look for both PFood and Yurun..

    Sales 10810.3
    COGS 9770
    FY1 FY2 Ave
    A/R 3 5.3 4.2 0.1
    Inv 1001.5 924.5 963.0 36.0
    A/P 174 112 143.0 5.3
    CCC 30.8

    Sales 13024
    COGS 11334
    FY1 FY2 Ave
    A/R 704 709 706.5 19.8
    Inv 703.5 681.8 692.7 22.3
    A/P 903.8 756 829.9 26.7
    CCC 15.4

    – At first look, it may seem that Yurun has a shorted cash conv cycle (CCC)..but P food actually has a shorter A/R days… collecting money faster due to their having of their own stalls?

    – However, P Food inventory days looks slightly longer than that of Yurun…If P Food can bring this down to say 20 would be equally as good as Yurun in their CCC..but how will they be able to do this?

    – maybe a good time to hunt for these stocks due to not only contaminated meat but also the swire flu?

  14. Hi donmihaihai, thanks for your reply,

    For the point about Yurun’s past growth, I have no answer, not knowing if they received preferential treatment from govt or from related companies. Not sure if Yurun was previously an SOE?

    Assuming everything is normal, even if they burn cash on expansion,which they have for the past years, if they make enough back in the subsequent year their debt can still be manageable. I am still going thru their cashflow statements to determine this. More risky than pfood.

    Agree that, since the pork market is so fragmented, all the major players can expand for a long time. Not sure that the most conservative player always wins though – if Yurun ends up with double the market share of Yurun, who has more pricing power?

    My main aim in looking at Yurun was as a competitor to Pfood, which I hold. For commoditised products, market share and both gross and operating margins should tell us who has a competitive advantage. Unfortunately I can’t get figures for Shanghui.

    I still think Pfood is a good and undervalued company, otherwise I would not hold it.

  15. Hi mitchell,

    I am unable to discuss more on Yurun and Pfood because I really don’t know much about Yurun.

    CCC while important, is just a small part of total. For a same company, there are times where all focus are on CCC and also times where CCC doesn’t even matter at all. The key is to know when.

    Without knowing the business, environment and business model, having CCC is as good as another beautiful number with no meaning.

  16. Hi Blackcat,

    My way of looking at company is dig out all negatives. The positives will take care of itself if negatives are not serious enough. So I am not defending Pfood but Yurun negatives start ‘poping’ out in front of my eyes even before I start.

    To me being conservative might not win but it will not loss easily. That take care one of the negative.

    Of all the “good and mature companies” that I have the chances to read about, none get there without being conservative. Some is able to be conservative and expanding at high rate.

    As for market share and pricing power, I don’t see China as a whole market which says that I don’t think having double market share = having pricing power. Unless it is the case of controlling the market. Each player will have their stronghold in different provinces, cities, regions, etc. They will have pricing power in their strongholds and it won’t be easy for other to muscle in and create something easily in short time period without going into destructive competition.

    I think at this moment, it is pre-mature to talk about market share, pricing power, moats or competitive advantage and branding.

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