Yurun Food (“the Company”) held a conference call this afternoon regarding the recent business operation as well asthe details of connected transaction with the former Chairman of the Company, Mr. Zhu Yicai. The Company startedto source hogs from Yurun Group in May 2012 and there is a possibility that the purchase amount willincrease substantially in the future.
According to the management of Yurun Food, Yurun Group has about 30 farms with an approximate maximum hograising capacity of 3 million heads. The aggregate maximum amount of purchases to be made by the Company toYurun Group will not exceed RMB3.7 billion, RMB5.4 billion and RMB8.6 billion in 2013-2015, respectively. Assuminghog price to be RMB1,500 per head, Yurun Food will be able to procure a maximum of 2.5 million, 3.6 million and 5.7million heads in 2013-2015, respectively, which represents 13% and 15% of our estimated hog slaughtering volume in2013-2014, correspondingly. The management says purchases from Yurun Group are not binding and that theCompany is free to select other suppliers in the market. In addition, the management does not expect supplyfrom Yurun Group to exceed 10% of the Company’s hog procurement volume in 2013-2015.
Owing to better quality control and epidemic prevention of large-scale hog breeding farms, this is expected that YurunFood will keep increasing procurement from large-scale hog breeding farms. Currently, the management says hogsupply from large-scale breeding farms accounts for less than 30% of the Company’s procurement volume but theyexpect such figure to be higher than 50% in 2015. As there is a high possibility that Yurun Group will be able tosell all of its hogs to Yurun Food, Yurun Group may speed up capacity expansion plan for hog breeding in thefuture. Despite the fact that Yurun Group is expected to benefit the most from the agreement, Yurun Food alsobenefits from stable supply and possibly, less quarantine inspection fees.
Regarding Yurun Food’s current business operation, the management says gross margin of upstream business isimproving QoQ and slaughtering volume in 3Q12 improved YoY. However, the Company feels pressure inachieving a slaughtering volume growth of 5% in 2012 owing to weak economy in China. With respect to weak1Q-3Q12 results and tightening financials of Yurun Food’s major subsidiary, Nanjing Yurun Food Co., Ltd., we do notthink this is a good time to bet on possible strong earnings recovery of the Company. We maintain “Neutral” onYurun Food with a TP of HK$6.5.