Fufeng Group (546, $5.35) 12M Target $6.34 BUY

Zhihui Jiang – zhihui.jiang@guoco.com (86 755) 8209 2443

Event: Strong interim results ahead will stimulate share price of Fufeng Group.

• Fufeng is the largest glutamic acid and the second largest MSG producer in China, with respective market share of 22% and 12% in terms of production volume in 2009. The company is also the world’s largest xanthan gum producer. Its annual production capacity of xanthan gum will increase by 38% yoy to 44,000 tonnes in 2010 representing about 50% of the global demand.
• The company is expected to release strong interim results in mid-Aug, driven by robust sales volume growth in both MSG and xanthan gum, and the margin improvement in xanthan gum segment.
• Sales volume of MSG is expected to increase 89% yoy in 1H10, since almost 100% of glutamic acid produced was used in-house for MSG, and effective capacity of glutamic acid increased 31% yoy in 1H10. While ASP might decline from 4Q09’s abnormal high, gross margin would drop to about 25%, a sustainable level in the long run. Gross margin of MSG segment was 29.6% in 2009.
• Sales volume of xanthan gum might grow 261% yoy in 1H10, thanks to oil production recovered globally. Despite ASP may decline slightly, gross margin were expected to improve to about 40%, compared to 35.1% in 1H09. To be conservative, we model a trend-down gross margin for xanthan gum segment in 2H10 and following years.
• China's MSG demand is expected to grow by 10% per annum in the next few years. The management plans to expand its market share to 40% in China's MSG market and maintain its share of global xanthen gum market at about 50%.
• We estimate fully diluted EPS for 2010-2012 at RMB 0.586, RMB0.698 and RMB0.822, respectively, based on assumptions: 1) Effective MSG capacity rises to 540k, 640k and 740k tones for 2010-2012 with utilization rate at 92%, 95% and 95%, respectively; 2) Effective xanthan gum capacity increases to 41k, 44k and 44k tones for 2010-2012 with utilizeation rate at 90%, 100% and 100%, respective. 3) gross margins of MSG segment maintain at 25% in following years, while gross margins of xanthan gum segment trend down from 40% in 1H10 to 38% in 2H10, 36% in 2011 and 36% in 2012.
• The counter is trading at 2010 PER of 8.0x and 2011 PER of 6.8x. Considering its good dividend yield of 3.9% and strong 3-year EPS CAGR of 15.4%, the valuation of Fufeng Group is undemanding in our view.
• We rate Fufeng Group a BUY with a 12-month target price at $6.34, based on 8x 2011 PER.