Ho Chi Minh Securities Bullish on Steelmaker Hoa Phat Group

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February 23, 2016

Disclaimer: the opinions expressed herein are that of  Ho Chi Minh Securities and not of VietnamAdvisors.  This is NOT a solicitation to buy or sell securities.

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  • HPG FY2015 results rather disappoints overall showing a net sales of VND27,453 billion, (+7.8% y/y) and NPAT of VND3,504 billion, (+7.8%y/y).
  • Core steel division grew on volume sales although ASP fell. Animal feed made a top line contribution from the 2-H FY2015 but made a small loss for the bottom line.
  • Outlook for this year is mixed with very modest growth from the steel segment and decent growth from animal feed sales.
  • Then we see slippage in GPM on a further deterioration in product mix and a tricky pricing environment for steel.
  • For FY2016, HSC forecasts the company will post a net sales of VND27,548 billion, flat y/y and NPAT of VND3,404 billion, (-2.9% y/y).
  • FY2016 EPS would come to VND4,388 and giving us a forward P/E of 6.2 times.
  • Few short term catalysts other than the cheap valuation and attractive dividend yield. However growth should return next year assuming the steel sector stabilizes.
  • While prospects in the animal feed-husbandry vertical look more interesting now that we understand it better.
  • No big rush to buy but we see longer term growth here. Reiterate Outperform.

HPG results rather disappoints overall

MAIN TAKEAWAY – Core steel division grew on volume sales although ASP fell. Real estate fell as most of the Mandarin Garden bookings had been made already. Animal feed made a top line contribution from the 2-H. GPM was flat although if we adjust for a previous inventory loss it actually fell on a deteriorating product mix. Animal feed made a small loss even. Outlook for this year is mixed with very modest growth from the steel segment and decent growth from animal feed sales. However with nothing from real estate the top line will not move much. Then we see slippage in GPM on a further deterioration in product mix and a tricky pricing environment for steel. Shift to expand the animal feed vertical into animal husbandry looks interesting however. While a new real estate project should support future earnings.

ACTION – Reiterate Outperform. Few short term catalysts other than the cheap valuation and attractive
dividend yield. However growth should return next year assuming the steel sector stabilizes. While prospects in the animal feed-husbandry vertical look more interesting now that we understand it better. No big rush to buy but we see longer term growth here.

Hoa Phat Group (HPG – Outperform) recently released fairly lacklustre FY2015 results showing 7.8% y/y sales growth and 10.8% y/y NPAT increase – Net profit after tax was 5% below expectations. HPG posted net sales of VND27,453 billion, (+7.8% y/y), exceeding targets by 22% given the contribution from the new animal feed segment, steady growth in the core steel segment even as real estate sales dropped sharply. The company then posted NPAT of VND3,504 billion, (+7.8% y/y) exceeding their revised target by 7.8%. GPM was unchanged on FY2015, and a narrower net financial loss was fully offset by higher SG&A expenses.

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Top line growth of 7.8% was mainly driven by the 9.7% growth in steel sales – Although we also note a contribution from animal feed even as real estate fell 63% y/y. In FY2015, the company reported net sales of VND21.9 trillion, (+9.7% y/y) from steel products. This was thanks to the 37.9% & 40% y/y growth in construction steel and steel pipe sales volume respectively. Although steel product ASP fell 16.9% y/y. Then as the Mandarin Garden revenue stream dried up, real estate sales saw a sharp decline of around 63% y/y. From Q3 FY2015, the company began to book some sales contribution from the animal feed market where they have started life as a raw material trader. After 6 months, the company was able to book VND1,300 billion in sales by selling animal feed ingredients. For other segments such as furniture & refrigeration, construction equipment and energy & mining, we saw a 8%, 6% and 3% respectively.

Gross profit margin was almost unchanged in FY2015 at 20.3% – In FY2015, the company made a gross profit of VND5,581 billion, (+7.6% y/y) translating into an overall flat GPM of 20.3%. GPM of key segments trended lower, however as the inventory revaluation loss booked in FY2014 mostly dropped out the net result was an offset. Details for GPM breakdown were not provided yet so what follows is HSC’s own approximate analysis. First we note that in HPG booked a diminution of
the value of inventories of just VND56 billion in FY2015 vs. VND179.4 billion in FY2014. Now if we exclude this from COGS in both years, FY2014 & FY2015 adjusted GPM comes to around 21% and 20.5% respectively. The reasons FY2015 adjusted GPM trended lower y/y are as follows;

  1. ASP for steel fell sharply especially during the 2-H last year.
  2. High margin real estate revenues dropped out.
  3. The new animal feed division added since 2-H FY2015 had a negative GPM. And indeed, they booked a loss totaling VND46 billion in FY2015.

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As mentioned better inventory management helped to offset the above negative factors in the unadjusted numbers.

Narrower net financial loss – In FY2015, the company posted a net financial loss of VND(317.6) billion compared to a loss of VND(403.5) billion in FY2014. This was mainly thanks to a jump of 58.4% y/y to VND254 billion in financial income given higher interest deposit received as the cash balance increased. Meanwhile financial expense increased slightly by 1.4% y/y to VND571.5 billion given lower interest expense.

And higher SG&A expense – Reported at VND1,183 billion, (+21.5% y/y) and accounting for 4.3% of net
sales from 3.8% in FY2014. We understand that selling expense increased by 15.8% to VND424 billion as they are building up their distribution network for their new animal feed business which is separate to the existing core steel segment.

Administration costs increased to VND758.8 billion, (+25% y/y) as the company booked all remaining goodwill related to their iron ore mining subsidiaries namely An Thong, Hoa Phat mining, etc in Q4 last year. Given the poor profitability of the mines, the auditor advised HPG to make this booking. Thus total FY2015 cost came to around VND291 billion versus VND120 billion normally. Besides that, we note a 20% increase in headcount last year, and a higher bonus payment which was booked in Q4 FY2015. Plus a provision totaling VND26 billion.

Other loss item expanded also – The company also posted a wider loss of VND(90.3) billion comparing to VND(40.5) billion in FY2014 in other profit item.

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Finally, pre-tax profit & NPAT increased by 5.8% y/y & 7.8% y/y respectively – Pre-tax profit was posted
at VND3,990 billion, (+5.8% y/y) while NPAT came to VND3,485.5 billion, (+7.8% y/y) given a lower effective CIT. Net margin was unchanged at 12.8%. FY2015 EPS came to VND4,518 translating into a trailing P/E of 6 times.

FY2015 dividend will be around at 30% of par value – Combining elements of both cash and stock dividend.
The company will make the final decision on this soon. We assume the cash dividend portion will be in the range of VND1,000 – 2,000/share, with a dividend yield range of 3.67% – 7.34%.

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Phase 3 expansion of integrated steel complex still on track for Q1 launch – As we mentioned in our previous note, HPG launched blast oxygen furnace No.3 (BOF No.3) at September-end with a capacity of 40 tonnes/batch. The company is working on a new steel rolling mill which should be completed by March this year. This will allowing construction steel output to increase once P3 is launched by another 750,000 TPA (tonnes per annum), equivalent to a 60% increase in capacity. Regarding capacity of steel pipes, the current designed capacity is around 450,000 TPA, (+20% y/y).

Animal feed segment is expanding operations – In Q3 last year, the company began trading animal feed to wholesalers. HPG has begun to cooperate with some local manufactures to produce in-house animal feed carrying HPG’s brand name and test launched these products in late Q4 last year with small volumes. To begin with, the strategy is to sell these products to wholesalers and therefore they will compete with existing offerings mainly on price. Once the animal feed factories come on stream, the company will distribute their own products under the “Big boss” brand name via more than 100 distributors or so. The first animal feed factory in Hung Yen should come on stream in April this year. While the second animal feed factory in Dong Nai starting construction in Q4 last year and should be complete by the end of this year. Total capex for these 2 factories is around VND500 billion with a combined capacity of 500,000 tonnes per annum.

We estimate the total market size is around 15.6 million tons in FY2015 and expect to come at 16.7 million tons this year (+7.1% y/y). And HPG hopes to capture only around 1% or so of this by selling around 120,000 tonnes of in-house product this year. And HSC assume the FY2016 GPM would come to around 5% or so. And then widen their presence in the animal farm to fork vertical by expanding into animal husbandry.

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Part of a broader vertical including animal husbandry – In January this year, HPG established a new company namely Hoa Phat Agricultural Development JSC with chartered capital of VND2,500 billion. The business scope is includes animal husbandry, producing animal feed and related activities. HPG owns 99.999% stake of this company.

Hog raising project making progress will be kicked off soon – HPG is considering some small M&A deals to buy animal husbandry related companies in the Highlands to build up capacity quickly in hog raising. Besides that, we understand that the company will start to construction 2 farms in Bac Giang and Yen Bai this year. Hog raising will start this year by importing hogs for raising at HPG owned farms. The company plans to raise the F1 generation at their farms and sell qualified pigs to meat processing plants in Vietnam. This project is still in the early stage hence there is a dearth of information disclosure.

New real estate project in 493 Truong Dinh should contribute to 2018 results – This is a residential apartment project on 1.25 ha of land in Tan Mai, Hoang Mai District Hanoi with total of 640 apartments and targeting the burgeoning mid-end segment. Total disbursement to date is around VND200 billion out of total planned capex of VND1,500 billion. They will launch the units for sale later this year. Each unit will be less than 100m2 with an expected selling price of VND25-26 million per square meter. HSC forecasts sales proceeds of the residential units will be VND1,468 billion assuming a GPM of about 25%-27% or so. Besides that, we also expect the company will earn VND621 billion from shopping center leasing. Total project sales value then would be around VND2,098 billion. It’s not clear when HPG will hand over the units and book sales but in our model we assume in FY2018 or so.

For FY2016 as a whole, HSC forecasts the company will post a net sales of VND27,548 billion, flat y/y and NPAT of VND3,404 billion, (-2.9% y/y) – Based on our following assumptions;

1. HSC assumes sales volume of construction steel and steel pipe would come to 1,627,461 tonnes, (+17.9% y/y) and 420,000 tonnes, (+20% y/y) respectively and that ASP of construction steel will decline by 17.5% y/y to VND8.7 million/ton from VND10.55 million/ton in FY2015. In the first 2 months of this year, the ASP of construction steel was around at VND8.9 million/ton, (-24.6% y/y). Based on this, we forecast steel sales of VND22,204 billion, (+2.3% y/y).

2. We expect animal feed sales to expand to VND1,700 billion, (+30.8% y/y) as the company will start to sell their own finished product in Q2 this year. HSC assume that the sales of raw material will be the key driver in Q1 this year while for the rest of the year, the company will then reduce the sales of raw material gradually.

3. Regarding real estate segment, FY2015 was the last year of Mandarin Garden booking, hence we assume nothing from real estate.

4. For other segment, we assume the company will deliver a growth from 7-10% for each segment.

5. All in all, we forecast the company will deliver net sales of VND27,548 billion, almost flat y/y.

6. Further assume GPM will fall to 19.5% comparing to 20.3% last year as steel segment margins will be decrease further. Although we also assume the GPM of animal feed will turn to a slight positive of around 5% this year.

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7. We expect a net financial loss to expand a tad from VND(322.5) billion from VND(318) billion last year on the lower financial income as the company increases cash disbursement to fund animal feed and real estate projects.

8. HSC further forecasts SG&A expense of VND1.157 billion, (-2.2% y/y) on a 9.2% drop in administration cost as the extra-ordinary cost drop outs. While we estimate selling expense then increases by 10.4% y/y to support sales of additional steel and animal feed capacity. We assume the huge bonus payment mainly booked in FY2015 will be decreased this year while other provision cost will also fall. We project SG&A as a % of net sales will be around at 4.2% comparing to 4.3% last year.

Finally, HSC forecasts the company will earn a pre-tax profit of VND3,868 billion, (-3% y/y) and net profit of VND3,404 billion, (-2.9% y/y). Assuming no change in AOS, FY2016 EPS would come to VND4,388 and giving us a forward P/E of 6.2 times. The company will held their FY2015 AGM on March 31st FY2016.

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Prospects this year are mixed but the stock is cheap while dividend yield looks attractive – HPG will show a negative growth in term of bottom line this year on the squeeze in GPM given the tough environment in steel segment plus the negative GPM of animal feed. However, at this level, HPG’s valuation looks attractive at a forward P/E of 6.2 times. Dividend yield is also reasonable in range of 3.67% – 7.34%. Longer term prospects for the steel sector should improve as prices stabilize although the threat from Formosa Steel is ever present. While the new animal feed to husbandry vertical looks a bit more enticing than we earlier thought. Given decent management the company should resume steady growth from 2017. Reiterate Outperform.

FINANCIAL RATIO

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