Reducing cost will stimulate hog-breeding capacity hence supply. Starting 2013, MOF increases insurance premium subsidy to hog - breeding farms: central MOF will cover 40%- 50% of insurance premium up from previous ~10%, while local MOFs are required to cover no less than 30%. The issuance covers death and other loss directly caused by natural disasters, major diseases and accidents etc. As a result, we expect 1) hog farms will enjoy a large reduce of insurance cost as well as business risk that will improve profitability, especially large -scale farm such as Yurun group’s. 2) at a lower insurance cost, smaller hog farms have more incentives to increase capacity, hence increasing supply of hogs, positive to Yurun Foods.
Yurun ’ s slaughtering volume to reach over 30M heads in 2015. We derive our forecast based on its parent company’s over 10M heads hog- breeding capacity by 2015 and Yurun Foods ’ plan of purchasing 5M heads under the frame of Continued Connected Transaction (CCT). As such, Yurun Foods 2015’s slaughtering volume will be ~33M heads. The management’s targeted utilization rate of above 60% of its planed slaughtering capacity (70M heads) by 2015 also supports our calculation. 30M- head slaughtering volume implies a slaughter volume 30%+ CAGR for 2013 – 15. Furthermore, as utilization rate gradually improves and EOS -effect kicks in, we expect margins to recover at least to FY11’s level. If the company continues to execute its expansi on plan, both a high earning CAGR and a revaluation can be expected.
Valuation and TP: We maintain our view that, for long- term investors, currently Yurun Foods is at its historical trough of both valuation and earnings growth. Although in FY12 we expect a recurrent loss of HKD681M (HKD319M reporting profit, down 82.2%) based on 6.97M heads slaughtering volume in 2H12 (up 6% yoy) and 13.61M heads in FY12 (down 11% yoy). But we believe loss in 2H12 has largely reduced and Yurun will turn to positive earnings in FY13 based on a 20% growth in slaughtering volume in FY13 and GPM recovers to FY11 level in 2H13. We maintain Outperform rating with TP HKD8.5 on FY12- 14 EPS forecasts of HKD HKD0.18/0.41/0.63. The stock is traded at 13.7x FY13 P/E and 0.7x FY13P/B, risks of poor FY12 results and corporate governance have been priced in.