Pine Agritech

Continuing high soybean cost lead to short-term pressure
High soybean costs rocketed up in 4Q07. Soybean cost soared over 60%
yoy in 4Q07 and reached a historical high level of around Rmb3.6-4/kg. We
believe the upward trend to continue into 1H08 due to several reasons: 1)
Planting area reduced. Due to the low planting profitability, many farmers
abandoned the low price soybeans and changed to grow corns. According to the
statistics of Ministry of Agriculture, the countrywide planting area of soybeans
decreased 6% yoy in 2007; 2) Soybean output reduced. In general, the soybean
output of Hei Longjiang Province accounts for 40% of overall output. However,
due to the unwonted droughty and weather, the output of soybean in Hei
Longjiang Province in 2007 reduced 30% compared with common annual value;
3) Import soybean price hike. Currently, only 36% of the overall annual demand
of soybean in China is domestically produced. The reduction of international
planting area and the cut-down of export of developed countries result in the
persisting high soybean price.
Expected margin squeezing continued. Continuing pork price hike and
nationwide pig supply shortage in 4Q07 cause the operation environment for
domestic meat processed companies to remain tough. Therefore, we expect
demand for Pine’s soy protein isolates (SPI) products may lower compared with
that in 3Q07. Although Pine raised its ASP for SPI by 5-8% in 4Q07, this can
not fully pass on the cost pressure to customer since soybean cost accounts for
80-90% of COGS in terms of its SPI products. On the other hand, weak demand
from its exclusive distributor, Shenji is expected to continue in 4Q07, revealing
a lower sales of soy oligosaccharide syrup (SOS). With less contribution from
this higher margin product, Pine’s profitability improvement in 4Q07 is still under
pressure. Therefore we lower our gross margin forecast for FY07-09 to 42.6%,
42.9% and 43.2% respectively from 45.1%, 45.8% and 45.7% respectively.
Launch TV commercials to enhance awareness. Pine has started the TV
commercials on local and provincial TV channels to promote its new products,
soybean peptide and Ditiang from the end of Sep FY07. By the end of 2007, TV
commercials had been expanded to other channels with national coverage, such
as CCTV and PhoenixTV. The Group expects to spend approximately
Rmb15m/month in the remaining months of FY07 and Rmb150m in FY08 for TV
commercials. We believe these heavy marketing campaigns will gradually
increase the Group’s brand awareness and promoted the demand for its
products. However, it will erode the Group’s net margin as well.
Key adjustments that lead to potential turnaround. 1) Anticipating that
soybean price will remain high and ever increase in the future, Pine stocked up
soybean inventory around 160,000 tons in Oct 2007. In view of the fact that Pine
needs approximately 200,000 tons of soybean for annual production, the Group
can offset some parts of the cost pressure with these low-cost inventory in FY08.
2) Nationwide pig supply shortage is expected to ease in 2H08, hence the
demand for SPI products would increase onwards. 3) Small soybean
manufacturers are expected to experience a tougher time as they do not have
enough funds to build up inventory. Therefore, Pine Agritech might receive some