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Vitasoy International: Still Expensive – Vitasoy International Holdings Limited (OTCMKTS:VTSYF)

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Via SeekingAlpha.com

Elevator Pitch

I maintain my “Neutral” rating on Hong Kong-listed beverage company Vitasoy International Holdings Limited (OTCPK:VTSYF) [345:HK]. Vitasoy International issued a profit warning on March 27, 2020 guiding for a 25%-35% decline in net profit for FY2020 (YE March) as a result of the coronavirus outbreak. Vitasoy International’s earnings are expected to decline by a greater extent compared with its revenue, due to negative operating leverage, and higher marketing & transportation expenses.

Even with the recent share price correction, Vitasoy International remain expensive on a P/E basis. A “Neutral” rating for Vitasoy International is warranted, taking into account other positive factors such as the company’s dominance in Hong Kong and growth potential in Mainland China.

This is an update of my initiation article on Vitasoy International published on December 3, 2019. Vitasoy International’s share price has declined by -23% from HK$30.10 as of November 29, 2019 to HK$23.20 as of March 30, 2020 since my initiation. Vitasoy International trades at 41.0 times consensus forward next twelve months’ P/E, which represents a premium to the stock’s historical five-year and 10-year mean consensus forward next twelve months’ P/E multiples of 34.5 times and 29.2 times respectively. The stock also offers a trailing twelve months’ dividend yield of 1.8% and a consensus forward FY2020 (YE March) dividend yield of 1.6%.

Readers are advised to trade in Vitasoy International shares listed on the Hong Kong Stock Exchange with the ticker 345:HK where average daily trading value for the past three months exceeds $13 million and market capitalization is above $3 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers, Fidelity, Charles Schwab, or local brokers operating in their respective domestic markets.

Coronavirus Outbreak Hits Company’s Hong Kong And Mainland China Sales

On March 27, 2020, Vitasoy International issued a profit warning stating that the company “is expected to record a substantial decrease in profit attributable to shareholders for the year ending 31st March 2020 (FY2020) by approximately 25% to 35%” as compared to FY2019. This has been reflected in sell-side analysts’ earnings estimates, with market consensus expecting a -27% YoY decline in earnings per share for Vitasoy International in FY2020 (YE March).

Vitasoy International’s key markets are Mainland China and Hong Kong, which accounted for 72.9% and 24.3% of the company’s 1HFY2020 revenue. Mainland China and Hong Kong are also the company’s major earnings contributors, accounting for 76.0% and 21.7% of Vitasoy International’s operating profit for 1HFY2020. Both Hong Kong and Mainland China have been affected by the coronavirus outbreak.

There are 683 confirmed cases (of which 118 have recovered) of coronavirus infections on a cumulative basis and four reported deaths in Hong Kong, as at the time of writing. Notably, there are at least 20 daily cases of coronavirus infections in the city for the past week, as per the charts below. This suggests that things are unlikely to return to normal in Hong Kong anytime soon.

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Total Cases And Daily Cases Of Coronavirus Infections In Hong Kong

Source: Worldometer

Both Vitasoy International’s on-premise and off-premise beverage sales in Hong Kong have suffered because of the coronavirus outbreak. With more people choosing to cut back on unnecessary outdoor activities and dine in at home, beverage sales in the on-premise channel have naturally declined. To add to Vitasoy International’s woes, primary and secondary schools in Hong Kong have been closed since the start of February 2020, as part of the government’s efforts to battle the coronavirus outbreak. Schools in Hong Kong were also closed in November last year because of the ongoing social unrest and protests in the city. Vitasoy International’s flagship Vitasoy brand of soy milk and the Vita brand of lemon tea are equally popular with school children as they are with adults, and the loss of beverage sales from school tuck-shops hurts the company.

Things are not any better in the Hong Kong off-premise channel for Vitasoy International. There has been waves of panic buying in cities affected by the virus, and Hong Kong has been no exception. Supermarkets and other retailers in Hong Kong are allocating shelf space and warehouse storage to consumer goods that people are stocking up, and these include instant noodles, toilet paper, tissue paper, canned food and rice. This in turn means less shelf space an reduction in purchasing volume for other “discretionary items” which includes beverages. While Vitasoy International’s Vitasoy soy milk and Vita lemon tea are unlikely to burn a hole in consumers’ pockets, there are multiple substitutes such as plain water or a cup of hot tea or coffee when one dines in at home.

In Mainland China, the coronavirus outbreak should be past its peak with daily cases stabilizing around the 50 mark, as per the chart below. This is premised on the assumption that there is no second wave of coronavirus infections that hits the country again.

Total Cases Of Coronavirus Infections In Mainland China

Source: Worldometer

Nevertheless, Vitasoy International’s revenue in Mainland China has already taken a hit during the January-February 2020 period. More importantly, the peak the coronavirus outbreak happened in the Chinese New Year period in Mainland China, which started on January 25, 2020 and ended on February 8, 2020. The Chinese New Year is traditionally a peak period for beverage sales in Mainland China, as people return to their homes to mingle and dine with their families. According to data by Statista, soft drink production in China decreased by -23% YoY from 21.67 million metric tons in the first two months of 2019 to 16.74 million metric tons in 2M2020.

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Similar to the situation in Hong Kong, Vitasoy International’s on-premise and off-premise sales in Mainland China are likely to have decreased significantly. In the company’s profit warning, Vitasoy International noted that a “large proportion of our Mainland China business was contributed by general trade channels”, which implies lockdowns in certain cities and the shut-down of retailers and other food & beverage outlets on a nationwide basis earlier were negative for the company.

Furthermore, Vitasoy International’s sales in Mainland China were negatively impacted by disruption to logistics operations in the country. In Vitasoy International’s profit warning, the company highlighted that initiatives to contain the coronavirus outbreak “significantly disrupted our route-to-market planning and supply chain across Mainland China.” That meant if even if there was demand for Vitasoy International’s beverages, the difficulties associated with deliveries resulted in a loss of revenue.

Looking ahead, with Mainland China perceived to be in the later stages of the coronavirus outbreak compared with other countries and cities, it is expected that Vitasoy International’s beverage sales will recover and normalize faster in Mainland China versus the company’s other markets.

Pressure On Profitability

Vitasoy International’s earnings are expected to decline by a greater extent compared with its revenue, due to negative operating leverage, and higher marketing & transportation expenses.

The company has exhibited signs of operating leverage in the past. In FY2019, Vitasoy International’s operating profit grew by +18.7% compared with a +16.4% increase in revenue. For FY2018, the company’s operating profit was up +24.4% YoY versus a +19.6% YoY increase in top line over the same period.

Market consensus expects Vitasoy International’s revenue to be almost flat YoY for FY2020 with an estimated revenue growth of +0.6% YoY, which implies a YoY decline in revenue for 2HFY2020, given that the company delivered a +5% YoY revenue growth in 1HFY2020. Vitasoy International’s earnings will almost certainly decline YoY in 2HFY2020 and FY2020 as a result of negative operating leverage. One example of negative operating leverage for Vitasoy International is that the company’s manufacturing plants in Mainland China are likely to have operated at very low utilization rates in January and February 2020.

Also, Vitasoy International is likely to have committed to significant marketing expenses for the Chinese New Year period in Mainland China, considering that the company has significant room for expansion there. While Vitasoy International has a 31.6% market share in the Hong Kong drinking milk products market, the company only has a marginal 0.9% share of the Mainland China drinking milk products market. The pre-committed marketing expenses meant to drive Vitasoy International’s expansion in Mainland China have unfortunately resulted in higher costs without a corresponding increase in sales, as it coincided with the peak of the coronavirus outbreak in the country.

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As earlier mentioned in the preceding section, Vitasoy International’s transportation costs and supply chain-related costs in Mainland China should have increased in the early part of 2020, due to travel restrictions implemented within the country to curb the coronavirus outbreak.

Valuation

Vitasoy International trades at 35.0 times trailing twelve months’ P/E and 41.0 times consensus forward next twelve months’ P/E based on its share price of HK$23.20 as of March 30, 2020. In comparison, the stock’s historical five-year and 10-year mean consensus forward next twelve months’ P/E multiples were 34.5 times and 29.2 times respectively. During the 2008-2009 Global Financial Crisis, Vitasoy International traded as low as 14.9 times trailing twelve months’ P/E and 10.6 times consensus forward next twelve months’ P/E.

Vitasoy International is also valued at a premium to the company’s Hong Kong-listed Chinese non-alcoholic beverage peers based on P/E multiples.

Valuation Of Comparable Chinese Non-Alcoholic Beverage Companies

Source: Author

Vitasoy International offers a trailing twelve months’ dividend yield of 1.8% and a consensus forward FY2020 (YE March) dividend yield of 1.6%.

Risk Factors

The key risk factors for Vitasoy International are a longer-than-expected time taken for the coronavirus outbreak to be contained, and higher-than-expected operating costs that are a drag on the company’s profitability.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.




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