Forecasting and Valuation: Hogs and Chestnuts

1. Forecasting and Valuation:Hogs and Chestnuts Who profits when the Chinese eat?

2. Bennet’s Law

3. Zhongpin (HOGS) Valuation Ratios • price at 12/31/2010 is $15/shr, 34,660K shrs outstanding, NI = $45,590K and CE = $296,850K. • P/E = 11.4 and P/B = 1.8. • What is the PEG ratio? (use analyst forecasts) • “we believe that, ultimately, the projected 20% top-line growth should fall to the bottom line” • Assuming 0 growth in ‘abnormal earnings’ in future, what is predicted PEG ratio? What if g = .02?

4. PEG ratio at HOGS • forward P/E ratio = 11.4/1.20 = 9.5 • PEG = 9.5/.20*100 = .475. • theoretical PEG? assume r=10% and g=0, PEG=1. • note that h = 20% doesn’t matter • theoretical PEG when g=.02? PEG = 1.125

5. Forecasting Zhongpin (HOGS) • Recall the idea is that • Chinese like pork • Chinese middle class is growing rapidly • desire to improve pork processing safety • So sales growth seems certain • Can they maintain profitability? • Can then do so without buying too many assets?

6. HOGS - accounting analysis

7. Accounts Receivable Allowance

8. HOGS - Ratios and Cash Flows • see my eVal model • ROE has declined. Why? • RNOA has declined. Why? • NOA turnover has declined. Why? • NOT due to Inventory or AR • Mostly, it is due to increases in PPE • Is HOGS becoming less efficient or is this just a lumpy increase in productive capacity?

9. IS – constant or changing?

10. “cheating” with an analyst report

11. HOGS income statement forecasts • Sales – 29% growth in 2010, 24% in 2011 from analyst report. Trend to 3% after that. • CGS/Sales – hold margins constant. With rapidly growing market, less competitive pressure on margins • SGA/Sales – increase from 4.2% to 5.0% because of increased focus on “branded” pork products • depreciation – in steady state, ½ way through the life of a 26 year asset, or 1/13 = 7.7%. • taxes. 0% on chilled and frozen,25% on prepared • interest – 5.3% from footnote

12. is CGS/Sales sensitive to changing pig prices?

13. depreciation rate PPE has 10-30 year useful life (plants and equipment) Construction in Progress is not depreciated Land use rights have 40-50 year life. Eventually Deposits and CIP becomes PPE. Final mix is (190+9+70)/(190+9+70+61) = 80% PPE. Useful life is then .80(20) + .20(50) = 26 year useful life.

14. NOA– constant or changing?

15. HOGS balance sheet forecasts • Trend Cash/Sales from 12% to 3% • don’t seem to be earnings interest rev, so this looks like a temporary cash balance due to large capital offerings • need to maintain restricted cash w bank. 3% of 2009 sales. • Inventory/CGS set to 2008 ratio of .036 • gov’t will let them lower ratio once pork prices stabilize

16. HOGS PPE/Sales forecast • From analyst report: “As shown in Exhibit 1, processing capacity should increase 41% from now to the end of 2012. Besides capacity expansion efforts, Zhongpin should be able to increase capacity utilization over time. Over the last three years, capacity utilization has been 74%, 57%, and 65%, respectively. While we would expect utilization to fall in 2010 given the high level of capacity expansion, these plants should be able to reach utilization rates of 90% or better, similar to Western processors, as the business matures.”

17. HOGS PPE/Sales forecast II • if capacity utilization = used/available = .65 • and this statistic is going to .90, then • new(PPE/Sales) = old (PPE/Sales) * (.65/.90) • new PPE/Sales = .358 * (.65/.90) = .259, trending over 10 years

18. NFO – constant or changing? doesn’t actually matter. Why?

19. is it that easy? • make a list of all the things we could do to improve on our: • IS forecasts • BS forecasts

20. what is it all worth? • r = 10%, Price = $25.94 • check the sensitivity to the PPE/Sales ratio • make the terminal value .31 (due to 75% utilization) • check the sensitivity to CGS/Sales • make it 86.0%.

21. next class • Chestnuts! reverse engineer the analyst report • reverse merger issues with Chinese companies • Projects! • Exam!