Tingyi’s net profit rises 10% to US$106m in 2Q11

Tingyi reported a weak set of 2Q11 results. Revenues grew 17% YoY in 2Q11 to US$2.1bn, which was slower than the 1Q11 growth rate of 40%. NPAT for 2Q11 was up 10% YoY to US$106m. However, stripping out asset sales, underlying EBITDA and NPAT actually fell 14% and 30% YoY, showing that heavy competition and rising input costs are working against operating leverage. Retain Underperform; target price unchanged at $19.70/sh.

Impact
Our cautious stance is based on the fact that competitive intensity in Tingyi’s main segments will remain high as long as its deep-pocketed international competitors continue to negatively impact market economics as they look to grow market share in China. This will force Tingyi to either cede market share or participate in continued price competition and capex investment – both of which would negate any margin benefit from falling raw material prices and impact FCF performance.

The crucial question for long-term investors, we believe, is how Tingyi is going to react to competition – particularly while the battleground moves closer to the point of sale, as has been seen in many developed markets. However, Tingyi entertained very little discussion on this topic. This makes it difficult to assess the outlook for the company at a time when its competitors, such as Coca-Cola are announcing large investments into China (as much as US$4bn), focussing on expanding their product portfolio, rapidly building out bottling capacity and increasing presence at POS in China.

Tingyi’s 2Q11 result: The key negative in the 2Q result was the sharp deceleration in YoY growth that came through both the noodles and the beverages businesses. Given this growth came in a quarter where there was little growth in POS and there were ASP increases suggests that existing POS may have reached mature penetration and price elasticity may have started becoming an issue. Margins also came under pressure, with GP margins down c.600bps in 2Q. This was due to higher raw material costs and increase in opex as a percentage of sales.

Focussing on the Noodle segment…consumers becoming price elastic?
We think the softer growth in Tingyi’s noodle business was largely driven by heightened competition from Uni-President China, which continues to gather momentum in the noodles segment following the restructuring over the last 2 years. The competition also drove Tingyi’s market share on volume to decline by 90bps to 41.8% in the noodles segment, while value-based market share stayed flat at 57.2%. This indicates that majority of the revenue growth in noodles most likely came from ASP increases rather than volume growth.

The softer growth came through from all segments, with only the mid- to low-end products doing well, showing sequential QoQ improvement in growth rates. The most concerning was bowl noodles, which saw growth rates slip from 38% to 17%. We note that while we cannot be certain of the ASP increases in 2Q11, if we incorporate these into the revenue growth numbers, the underlying volume growth would look even more anaemic.

Ordinarily this trend would suggest that Tingyi may have lost market share. However, given AC
Nielsen data actually showed that Tingyi had gained share of value, we think that the weak growth could illustrate that consumers of these products are becoming increasingly price elastic, i.e., falling demand as prices increase. If this is the case, the outlook for the product growth could suffer.

Gross profit margins in the noodles segment fell by 200bps YoY to 24%. The margin weakness was largely due to the fast rise in the cost of raw materials. This is largely beyond the control of the company. While prices of some raw materials have started to pull back, we think that this is unlikely to translate into margin improvement, given high competition in the space from Uni-President.