chaoda__china_green_convertibles_a_ripe_opportunity
CONTENTS
CHINESE AGRICULTURAL CONVERTIBLES – A RIPE OPPORTUNITY? 3
THE AGRICULTURAL BUSINESS MODEL – RISKS AND OPPORTUNITIES 5
Risks (5)
Opportunities (5)
COMPANY SPECIFICS 7
Company overview (7)
Chaoda (7)
China Green (7)
Ownership and related party transactions (8)
Earnings release (10)
Auditors (10)
Assets (10)
Cash and cash equivalents (11)
Debt (11)
Leases (11)
Capex plans (13)
Expansion plans (13)
Equity price targets (13)
CREDIT PROFILE 14
Ratings and indicative ratings (14)
Peer analysis (16)
Recovery analysis (18)
Past willingness and ability to repay debt obligations (19)
FINANCIALS 20
APPENDICES 22
Appendix 1: Chinese agricultural convertibles – the macro picture (22)
Appendix 2: Chinese HY convertibles – performance statistics (24)
Appendix 3: Chaoda and China Green – company structure (25)
CHINESE AGRICULTURAL CONVERTIBLES – A RIPE OPPORTUNITY?
On 2 June 2011, Bloomberg reported that allegations had surfaced regarding Sino-Forest’s operations, with questions raised about the identity of its customers and the accuracy of its disclosed assets. Sino-Forest is a Canadian-listed Chinese forestry company. Its shares are currently trading at C$4.78, 67% below its $14.46 share price prior to the 2 June report. Please refer to Sino-Forest: Strong rebuttal of allegations , 7 June 2011, and Sino-Forest - Rebuttal provides some relief, but raises other concerns , 15 June 2011, for further details.
These allegations have had a knock-on effect on internationally traded Chinese companies, particularly on a number of names in the convertible universe (see Appendix 2 for details), most notably C hina Green and C haoda, which have in the past had their own corporate governance concerns. There is currently heightened sensitivity to news surrounding Chinese companies: on 27 June, headlines on China Yurun Food (1068 HK) emerged on Bloomberg regarding a potentially negative broker report, which led the shares to fall 20%.
There are a number of specific risks associated with the agricultural sector, namely a lack of well-established procedures when it comes to registering land ownership and land-use rights. Hence, agricultural companies lease land. A major impact of this is that rating agencies view credit ratings as constrained by the inability to secure bank financing. This is due to the fact that major assets – ie, production bases – are on leased land, which deems them unsuitable as loan security.
Another characteristic of these companies is that the listed entity is typically offshore while the operating subsidiaries generating cash flows are onshore. International debt obligations are structurally subordinated to obligations of the onshore subsidiaries to local creditors. For Chaoda and China Green, the majority of assets are held onshore at group level rather than offshore at company level.
Taking the preceding factors into account, in our most conservative recovery scenario we include only company held assets, which results in a recovery value of 3% for Chaoda and 41% for C hina Green. In our view, it is important to note that both companies have previously shown the willingness, together with the ability, to repay debt obligations. Chaoda has very high margins compared with peers and there exists a lack of transparency on its land reserves and some long-term prepaid rentals. In addition, fertiliser, purchased from a company owned by Chaoda’s Chairman and CEO, accounts for 30% of its cost of goods sold. Chaoda is with its third auditor since listing in 2000. Credit metrics are strong for its rating and in our analysis we have conservatively included its proposed $250mn straight bond which was shelved in May due to “market conditions”.
C hina Green is planning to transform from an agricultural company to a fast moving consumer goods company, significantly increasing its FY11 and FY12 capex budgets as a result: RMB330mn in FY09 versus a FY10 budget of RMB1030mn. C hina Green is due to release FY10 results on 28 July 2011, which could prove to be a share price catalyst.
Despite the company specific risks, we view the current convertible bond z-spreads – 1710bp for C haoda and 2490bp for C hina Green – as excessive given BB-rated C hinese corporates are trading at 790bp and B-rated at 1120bp on average.
Sino-Forest allegations have had
a knock-on effect on Chinese
companies worldwide
General lack of clarity on land ownership or land-use rights in
agricultural sector
Onshore vs offshore risk; holding
company vs operating
company risk
The most conservative recovery analysis results in a recovery value of 3% for Chaoda and 41%
for China Green
Current convertible z-spreads
are excessive in our view
Figure 2: Chaoda and China Green convertible details
Name Crncy Amt out
(mn) Price Parity Put date Put price Maturity
Red
amt
Z-spd
(bp)
Running
yield YTP YTM
Chaoda 3.7% 2015 USD 200 76.2 35.0 01-Sep-13100.0 01-Sep-15100.0 1710 4.9% 17.8% 11.1% China Green 3% 2013 RMB 1350 77.0 41.0 12-Apr-13106.4 2490 3.9% 23.3% Note: As of 21 July 2011. Source: Bloomberg, Barclays Capital
Absent any credit spread contraction our analysis shows that if Chaoda’s share price were
to increase by 50% over 12 months, its convertible valuation would increase by 10 points.
Likewise, for China Green the valuation would rise by 16 points.
Figure 3: Chaoda and China Green share price charts (HK$)
Note: As of 20 July 2011. Source: Bloomberg
THE AGRICULTURAL BUSINESS MODEL – RISKS AND OPPORTUNITIES
Risks
The Sino-Forest case has highlighted some of the risks of investing in Chinese companies, some of which may be a genuine concern for investors looking at the agricultural products sector, in our view. Below, we discuss the generic key risks before looking at specific company risks in a later section.
According to the risk factors section of Chaoda’s and China Green’s bond prospectuses in rural C hina, there is generally a lack of well-established procedures when it comes to registering land ownership and land-use rights. Hence, agricultural companies that lease cultivation bases are unable to verify the ownership or land-use rights of the parties they have entered into leases with. Therefore, at some point agricultural companies may not have legal and valid land-use rights or leases. This is an issue because companies have prepaid large amounts of its leases that may have to be written off if leases are breached or terminated prematurely. Leases are usually paid in the form of an upfront lump sum, together with some annual rental payments.
Agricultural companies typically lease all of their cultivation bases. In China, under PRC law, lease agreements may not exceed 20 years and the portion of a lease exceeding 20 years is invalid. Therefore, after 20 years, some leases may need to be renewed. C ompanies also have infrastructure on the cultivation bases: if the leases are breached or terminated prematurely, the companies may not be in a position to recover these assets.
A secondary issue with leasing land is that banks generally consider the production bases on this leased land to be unsuitable for use as security (given the risks outlined above). Hence, companies are unable to obtain substantial long-term bank loans.
The majority of sales of fresh produce are in the wholesale market. According to company statements, a significant portion of these transactions are settled in cash, making internal control more difficult. This also highlights the issue of onshore cash reserves versus offshore cash reserves. To release onshore funds, companies must apply to SAFE (the State Administration of Foreign Exchange) in China for regulatory clearance, which can entail a 35-day remittance period.
These companies are generally holding companies (company structure illustrated in Appendix 3) and depend on their subsidiaries for receipts of dividends, distributions, etc. Payments under any international debt obligations are structurally subordinated to all existing and future liabilities and obligations of the onshore subsidiaries to local creditors.
Opportunities
As outlined in Appendix 1, we believe the fundamental macro drivers for the C hinese agricultural sector are positive in the short to medium term. Rising food prices, growing demand from larger urban populations for more nutritional products and declining areas of arable land mean the supply/demand dynamics are favourable for agricultural companies. In addition, there is the C hinese government’s support for the agricultural industry (see extract from the March report on C hina’s economic and social development plan in Appendix 1). According to PRC tax law, enterprises that engage in qualifying agricultural business are eligible for certain tax benefits, including full or half enterprise income tax
Lack of clarity on land ownership
or land-use rights
Long-term leases by law cannot
extend beyond 20 years
Given leased nature of land bank, loans are difficult to obtain
Cash transaction for produce highlights internal control risk
Structural subordination
Macro outlook for agricultural sector is favourable in short to medium term due to rising food prices, growing demand and declining areas of arable land
exemption on profits derived from such business, which include growing and sales of crops and breeding and sales of livestock. Also, some companies are not subject to PRC export duties. However, in our view, this could change, and taxes may be levied if there is a danger of food shortages. Indeed, in a report in The Guardian on Monday, 27 June, the director of the Water Research C entre at Peking University claims C hina needs to reduce food production on its dry northern plains or aquifers will diminish to a “dire” level in 30 years.
COMPANY SPECIFICS
Company overview
Chaoda
C haoda is a $1.5bn market cap producer of fresh fruit and vegetables and rice. As of 31 October 2010, vegetables account for 81% of revenue, fruit 10% and rice 8%. The domestic market accounts for 74% of Chaoda’s revenues. The company has 30 cultivation bases (24 for vegetables, four for fruit and two for tea) covering 47,662 hectares. 36,301 hectares is used for vegetables, with an average yield of 28 tonnes/hectare and an average selling price of RMB2.74/kg. According to a company presentation, Chaoda has a total land reserve for vegetable farming of 20,000 hectares as of 31 December 2010. It is our understanding that this land is not farmed and does not contribute to revenues. Its five largest customers account for 9% of total sales in aggregate.
China Green
C hina Green is a $0.7bn market cap producer of fresh, processed and branded beverage products. Fresh produce and beverage products are primarily for the domestic market, whereas processed products are exported predominantly to Japan and the rest of Asia. The company has 42 cultivation bases (36 for vegetables, five for fruit and one for rice) covering 6,180 hectares with an average yield of 20 tonnes/hectare. China Green has 12 processing plants with a processing capacity of 532,800 tonnes. Its five largest customers account for 10% of total sales in aggregate.
Figure 4: Chaoda revenue by segment
Figure 5: China Green revenue by segment
Source: Company data as 31 December 2010
Source: Company data as of 31 October 2010
Vegetables main driver
of revenue
Revenues approximately evenly split between fresh produce,
processed products and
beverage products
Figure 6: China Green revenue by geography
Figure 7: China Green costs for fresh & processed products
Source: Company data as of 31 October 2010
Source: Company data as of 31 October 2010
Figure 8: China Green costs for beverage products
Figure 9: Chaoda costs of goods sold
Source: Company data as of 31 October 2010
Source: Company data as of 31 December 2010
Ownership and related party transactions
The main shareholder in Chaoda is Mr. Kwok Ho, who is Chairman, CEO and founder of the group. According to the latest filings in Bloomberg (Figure 10), he owns 19.6%, which is less than the 30% stake that Moody’s views as a concentration of family ownership. His most recent large share purchase (155mn shares) was in August 2010 following the sharp decline in share price driven by China Green delaying the release of its FY results. Our analysis shows there is a historical correlation over the past five years between Chaoda and China Green daily share prices with an R 2 of 60%. Mr Ho last bought shares (1mn) in May 2011. The company has bought back 60mn shares since 26 May following a report published in Next magazine that Chaoda had overstated its farmland area. In October 2002 Next magazine reported that Chaoda inflated sales, an allegation that has never been proven.
By Asia standards, Chaoda Chairman has a relatively small
company stake
Figure 10: Share transactions in Chaoda by Chairman Kwok Ho
Source: Bloomberg
In May 2009, Fuzhou C haoda, a subsidiary of C haoda, entered a supply agreement for organic fertilisers for three years with Fujian C haoda Trading, a company ultimately controlled by Mr. Kwok Ho. The agreement was approved by shareholders who stipulated a maximum annual amount of RMB870mn to be spent. The price of the fertiliser was agreed not to exceed the ex-factory price at which the same fertiliser was supplied to independent third parties. For FY 2010, Chaoda spent RMB678mn on fertiliser.
The main shareholder in C hina Green is Mr. Sun Shao Feng, who is C hairman, C EO and founder of the group. According to the latest filings in Bloomberg (Figure 11), he owns 46.1% of China Green. His last large share purchase (7.2mn shares) was in December 2006. Mr. Shao Feng most recently bought shares (111,000) in February 2011.
In November 2009, liquidators were appointed to Thumb C hina Holdings (TC H), which is owned by Mr Sun Jiangrong ,who is a brother of Mr Sun Shao Feng. TC H is a controlling shareholder with a 52.41% stake in Radiance Group. Bank of New York has commenced legal proceedings against TCH and Hero Key Limited, a company owned by Mr. Sun Shao Feng. These proceedings are in respect of a share charge issued by TCH in favour of Hero Key over all of its shares in Radiance Group as security for loans purportedly granted by Hero Key to TCH pursuant to a loan agreement dated March 2008.
Chaoda has a related party agreement for supply of fertiliser that accounts for 30% of COGS
China Green Chairman has a
controlling 46% stake in
the company
BoNY has started legal
proceedings against one of Mr Shao Feng’s companies, Hero Key
Figure 11: Share transactions in China Green by Chairman Mr Sun Shao Feng
Source: Bloomberg
Earnings release
Chaoda is estimated to report FY11 results on 18 November 2011. China Green is due to report FY11 results on 28 July 2011.
Auditors
Chaoda’s current auditor is BDO Limited. This is the company’s third auditor since it listed in 2000. BDO merged with Grant Thornton in November 2010 to practise in the name of BDO Limited. Grant Thornton were auditors to China Milk; China Milk was unable to redeem its 0% 2012 $146.2mn convertible when bondholders exercised their put option in January 2010. The shares were suspended. In April 2010, KPMG was appointed as a special auditor and issued its independent review on 7 June 2011.
China Green’s current auditor is CCIF CPA, which has been auditor to Fu Ji Food & Catering, which defaulted on its 2009 and 2010 convertible bonds in October 2009. China Green has appointed Deloitte Touche Tohmatsu to improve internal controls and could appoint it as its auditor after FY11 results.
Assets
According to its most recent financial statements, Chaoda has total assets of RMB26.2bn at a consolidated level. Of the RMB22.3bn excluding cash, RMB8.3bn is in Plant, Property and Equipment (PPE), which is at a group and not company level, while RMB5.8bn (26%) is in long-term prepaid rentals, RMB2.7bn (12%) in biological assets (fruit trees, tea trees and
Chaoda is with its third auditor
since listing, China Green employs a local auditor. Both
auditors have in the past overseen companies that have
defaulted on convertibles On a positive note, China Green has appointed Deloitte Touche
Tohmastu to improve
internal controls
Chaoda has RMB8.3bn in PPE, 26% of total assets is long-term
prepaid rentals
trees in plantation forests, valued by an independent valuer, Jones Lang LaSalle Sallmanns) and RMB1.4bn (6%) in a stake in Asian Citrus (73 HK, 19.09% stake worth RMB1.3bn based on closing share price of HK$6.96 on 20 July 2011).
According to its most recent financial statements, China Green has total assets of RMB4.7bn at a consolidated level. Of the RMB2676mn excluding cash, RMB1246mn is in PPE, which is at a group and not company level, while RMB807mn (30%) is in long-term prepaid rentals. The remaining RMB222mn is accounted for as interests in leasehold land held for own use under operating leases. This refers to office building and factory land, ie, not farmland.
Cash and cash equivalents
As of December 2010, Chaoda has RMB3886mn in cash and cash equivalents. The majority of its cash is with banks onshore in C hina. According to the company’s FY2010 annual report, 2% of the cash (RMB2.0bn at April 2010) was at company level – ie, RMB41mn. The company cash is held in currencies other than RMB in banks in Hong Kong.
As of 31 October 2010, C hina Green had RMB2009mn in cash and cash equivalents and RMB88mn in short-dated bank deposits. According to the company’s annual report, the short-dated bank deposits (RMB704mn at April 2010) were held at company level and 33% of the cash (RMB2327mn at April 2010) was at company level – ie, RMB773mn. In discussions with the company, currently 25% of cash is held offshore.
Debt
As of 31 December 2010, Chaoda had a RMB70mn secured banking facility that had not yet been drawn down. In the company accounts, the interest expense on the $200mn (approximately RMB1300mn) 3.7% 2015 convertible, puttable at par in September 2013, is calculated using an effective interest rate of 10%. The convertible was issued in August 2010 when BB Chinese corporate spreads were at 835bp.
As of 31 October 2010, C hina Green’s only outstanding debt was its RMB1350mn 3% convertible due April 2013. In the company accounts, the interest expense is calculated using an effective interest rate of 7.756%. The convertible was issued in March 2010 when BB Chinese corporate spreads were at 600bp. The bond contains financial covenants: total gross debt/EBITDA should be less than or equal to 4.0x (currently 1.3x). We do not view this as a particularly stringent covenant in restricting further debt issuance.
Leases
Chaoda typically has leases ranging from 10 to 70 years; 85% are less than 50 years. It has operating lease commitments of RMB4.7bn, 76% of which are due in more than five years. C haoda’s prepaid premium for land use as of 31 December 2010 amounts to RMB5.8bn. Long-term prepaid rentals for the farmland that has not yet been used amounts to RMB875mn. As of 30 June 2010, the carrying value of the infrastructure on the cultivation bases was RMB7.2bn.
C hina Green uses 20-year leases (or longer) for its cultivation bases. Average rental is RMB33/hectare. C hina Green has a 5-10y payment term of long-term leases. It has operating lease commitments of RMB213mn, 82% of which are due in more than five years. Long-term prepaid rental amounts to RMB807mn. As of 30 April 2010, the carrying value of infrastructure on the cultivation bases was RMB258mn.
China Green has RMB1.2bn in PPE, 30% of total assets is long-term prepaid rentals
Only 2% of Chaoda’s cash is held
offshore – ie, RMB41mn
33% of China Green’s cash held
offshore – ie, RMB773mn
Convertible bond only
outstanding debt
RMB1.1bn of Chaoda’s operating
leases due within five years
RMB38mn of China Green’s
operating leases due
within five years
Figure 12: Liquidity (RMB mn) Figure 13: Total debt/EBITDA and interest coverage
Note: Liquidity = Cash & cash equivalents – short-term debt. LTM as of 31 December 2010 for Chaoda and 31 October 2010 for China Green. Source: Bloomberg Note * For Chaoda includes senior straight debt proposed in May 2011, assuming 8% coupon, otherwise Total debt/EBITDA would be 0.2 and interest coverage would be 93.3. Source: Bloomberg
Figure 14: Total debt/total capital
Figure 15: Capex/operating cash flow
Note * For Chaoda includes senior straight debt proposed in May 2011, assuming 8% coupon, otherwise would be 4.1. Source: Bloomberg Note: * For China Green assuming similar operating cash flow but increasing capex to RMB1.03bn in accord with FY11 budget this percentage would increase to 113%. Source: Company data, Bloomberg
Capex plans
C haoda spent RMB489mn on acquiring 10,867 ha of land and RMB1.7bn on developing farmland and building infrastructure in H1 (ie, as of 31 December 2010). C haoda has contractual capex commitments of RMB29mn as of 31 December 2010.
C hina Green’s capex budget for FY11 is RMB1.03bn, compared with RMB330mn in FY10, split 44% for fresh/processed produce and 56% for the branded beverage segment. 45% of the budget is earmarked for the building of processing plants, frozen warehouses and storage. 34% is budgeted for the installation and enhancement of production lines, logistics etc. RMB289mn was spent in capex in H1 (ie, as of 31 October 2010). As at 31 October 2010, the group had contractual capital commitments of approximately RMB106.8mn.
Expansion plans
Chaoda expects to expand its production land area at an annual rate of 25-30% in the next three years.
China Green plans to transform from an agricultural company to a fast-moving consumer goods (FMCG) company as the growth driver is seen as its branded beverage business. To this end, it intends to expand capacity in its branded beverages business to 120,000 tonnes by end of FY11, a further 67% increase since October 2010. There is a capex budget of RMB579mn to build new production lines and expand/enhance its existing beverage/branding facilities. China Green also announced plans to list its beverage business in Hong Kong but has not given a timetable for the potential spin-off. In terms of its fresh produce and processed products segment, it plans to expand its cultivation area by 10-15% y/y in FY11. The capex budget is RMB216mn for renting new bases and infrastructure improvements and RMB236mn for new processing plants.
Equity price targets
According to Bloomberg data Chaoda’s median price target is HK$7.50 with a buy/hold/sell ratio of 3:0:1. Its current P/E ratio is 2.1x, versus an average for Hong Kong listed Agricultural Products stocks of 22.5x. The current dividend yield is 3.0%, versus a 4.9% running yield on the convertible. Market indications are that short interest in the shares is at a 12-month high with an estimated 696mm shares shorted, representing 63% utilisation of lendable assets. The average short interest over the past 12 months is approximately 400mm shares. Borrow is indicated in the market at 4.25%, up from previous 0.5-2.0% levels.
According to Bloomberg data, C hina Green median price target is HK$9.73 with a buy/hold/sell ratio of 8:1:1. Its current P/E ratio is 6.2x, versus an average for Hong Kong listed Agricultural Products stocks of 22.5x and 20.1x for Hong Kong-listed non-alcoholic beverage stocks. The current dividend yield is 3.7%, versus a 3.9% running yield on the convertible. Market indications are that short interest in the shares is close to a 12-month high with an estimated 75mm shares shorted, representing 80% utilisation of lendable assets. Short interest has rallied since the end of November 2010, from a 12-month low of 35mm shares to current levels. Borrow liquidity is tight with levels indicated up from 4% to 8.5%.
China Green has spent RMB289mn of a FY11
RMB1.03bn capex budget, up
212% from FY10 level
China Green: change in direction, branded beverage business seen
as main growth driver
P/E ratios significantly below
sector average
Short interest in shares at or close to 12-month highs, stock
borrow significantly higher
CREDIT PROFILE
Ratings and indicative ratings
Chaoda is rated BB/Ba2, both with Stable Outlooks by S&P/Moody’s. Moody’s announced in April that it had assigned a Ba2 rating to C haoda’s proposed USD-denominated senior unsecured straight bond, which was intended to fund its capex plans. The straight bond issue was subsequently shelved due to “market conditions”. The Ba2 rating according to Moody’s reflected Chaoda’s well-established market position and growth supported by the Chinese government’s agricultural policy and the favourable demand for vegetable produce in C hina. In addition, Moody’s expects C haoda’s credit metrics to remain strong after including the proposed bond issuance. C haoda has a stronger financial profile compared with other Ba2-rated issuers in the region, but Moody’s says its rating is constrained by a lack of bank financing and material party-related transactions. Upward rating pressure could be limited according to Moody’s.
Figure 16 illustrates the OAS spreads for USD-denominated straight bonds according to the Barclays Capital EM Asia USD bond indices. High-yield BB-rated Chinese corporates (790bp) are currently trading 100bp wider than EM Asia high-yielding BB-rated corporates (690bp) and have, on average, traded 80bp wider since the beginning of 2010. For B-rated corporates, high-yield Chinese bonds (1120bp) are currently trading 195bp wider than EM Asia high-yielding B-rated corporates (925bp) and have, on average, traded 165bp wider since the beginning of 2010.
Figure 16: OAS levels for BB rated EM Asia USD-denominated straight bonds
Source: Barclays Capital POINT
In Figure 17 and Figure 18 we compare S&P’s key industrial financial ratios for long-term debt for Chaoda and China Green. We have used a three-year average up to the last full year financial statement – ie, June 2010 for Chaoda and April 2010 for China Green – and also the past 12 months (LTM).
Moody’s says Chaoda’s Ba2 rating is constrained by a lack of
bank financing and material party-related transactions but that it has a stronger financial profile compared with other Ba2-rated issuers in the region
BB rated Chinese corporates typically trade 80bp wider than EM Asia HY corporates. The differential for B rated corporates
is 165bp
In our view, China Green seems a
weaker credit than Chaoda
Figure 17: S&P’s key industrial financial ratios for long-term debt based on a 3y average
Chaoda* China Green
EBIT interest coverage (x) 25.5 12.9 EBITDA interest coverage (x)
30.7 15.3 Free operating cash flow/total debt (%) 464.0 28.8 Total debt/EBITDA (x) 0.3 1.8 Return on capital (%) 18.9 15.4 Total debt/total capital (%)
6.9
31.5
Note: * Does not include 3.7% 2015 convertible which was issued in August 2010. Source: S&P, Bloomberg
Across all metrics, China Green is weaker than Chaoda, on average, by three rating notches. Neither company is highly levered: the weaker metrics are due to free cash flow and return on capital; however, even these are relatively strong. We believe the same rating methodology applies to China Green as Moody’s applies to Chaoda (see previous page). We would make allowances for no evidence of material party-related transactions and greater transparency on land, capex and long-term prepaid rentals. We also believe that C hina Green’s move to transform from an agricultural company to a FMC G company, while resulting in lower margins, would also lead to a less risky business model, in our view. We would assign a BB-/B+ indicative rating to China Green.
Figure 18: S&P’s key industrial financial ratios for long-term debt based on LTM
Chaoda* China Green
EBIT interest coverage (x) 19.6 7.4 EBITDA interest coverage (x)
24.7 9.0 Free operating cash flow/total debt (%) 24.4 15.4 Total debt/EBITDA (x) 0.6 1.3 Return on capital (%) 15.1 15.6 Total debt/total capital (%)
9.7
28.4
Note: * Includes 3.7% 2015 convertible and senior straight debt proposed in May 2011, assuming 8% coupon. Source: S&P, Bloomberg
Figure 19: OAS levels for B rated EM Asia USD-denominated straight bonds
Source: Barclays Capital POINT
We would assign a BB-/B+ indicative rating to China Green
Peer analysis
In the Agricultural Products sector, we view Le Gaga and Minzhong as comparable peers (Figure 20), albeit with significantly smaller market caps and a shorter trading history. In terms of outstanding debt, Le Gaga has a RMB81.7mn ($12mn) long-term bank loan with with DEG, part of KfW, bearing a 12% interest rate. Minzhong has a secured short-term loan at 5.31%; its long-term secured bank loans have interest rates ranging from 0% to 2.3%. The government of Singapore has a 17% stake in Minzhong. We view Minzhong as the strongest credit amongst this peer group. We believe Chaoda and China Green should trade tighter than Le Gaga given Le Gaga’s very short trading history and negative cash flow.
Figure 20: Financial summary of Agricultural Products peers
RMB mn
Chaoda China Green Minzhong Le Gaga As of
Jun-10 Apr-10 Jun-10 Jun-10 Listed Dec-00 Jan-04 Apr-10 Oct-10
Mkt Cap ($mn) 1,382 631 114 45 Free Float 80.4%
53.9%
64.6%
N/A
Profit & loss
Operating revenue 6,963.7 1,900.8 1,422.6 406.8 Gross profit
4,577.4
1,000.4
574.3
49.6
EBITDA 4,225.1 862.3 534.4 188.6 EBIT 3,439.1 708.2 459.3 141.2
Gross interest expense 33.3 73.7 24.2 4.6 Net income 3,697.1
563.8 367.5 133.4 Cash flow
Operating cash flow 3,455.5 818.2 585.2 129.5 C apex -3,264.7 -330.5 -159.0 -272.2
Free cash flow 190.9 487.7 426.2 -142.8 Balance sheet Cash and cash equivalents 2,044.3 3,030.6 1,170.5 598.7
Total assets 21,758.3 5,349.7 2,384.5 1,405.0 Short-term debt 14.5 0.0 10.0 6.0 Long-term debt 0.0 1,286.8 6.4 78.8 Total debt 1,050.5 1,286.8 16.4 84.8 Net debt -993.8 -1,743.9
-1,154.1
-513.9 Total shareholders' equity 21,508.5 3,070.4 2,286.8 1,279.7
Credit ratios Gross margin 65.7% 52.6% 40.4% 12.2% EBITDA margin
60.7%
45.4%
37.6%
46.4%
EBITDA/Interest 127.0x 11.7x 22.1x 40.6x EBIT/Interest 103.3x 9.6x 19.0x 30.4x
Total debt/EBITDA 0.2x 1.5x 0.0x 0.4x Net debt/EBITDA -0.2x -2.0x -2.2x -2.7x Total debt/Total capital 4.7% 29.5% 0.7% 6.2% Operating cash flow/total debt 328.9% 63.6% 3567.9% 152.6% Free cash flow/total debt
18.2%
37.9%
2598.4%
-168.3%
Note: Includes Chaoda’s $200mn 3.7% convertible due 2015 issued in August 2010. Source: Bloomberg
Chaoda and China Green should trade wider than Minzhong but
tighter than Le Gaga
In the Non-alcoholic Beverages sector, we list peers in Figure 21. As of 31 December 2010, C hina Huiyuan Juice had a total of RMB2.3bn (RMB1.8bn unsecured) in bank loans outstanding at an annual effective interest rate of 4.2%. C hina Huiyuan Juice’s 4% 2016 convertible is implying a z-spread of 700bp to its April 2014 put date versus a 93.1 price. However, we note that parity is 60.0 and, hence, the convertible is relatively balanced. Tianyi Fruit in May 2010 issued $22mn of 0% convertible bonds due 2012 to Sequoia Capital, a venture capital firm at a 5% yield-to-maturity. Tianyi Fruit also has a 5.04% RMB82.4mn secured loan. Vitasoy as of 31 March 2011 has bank loans of HK$141mn due within a year and HK$114mn of longer-dated bank loans. HK$86mn of these loans are fixed rate with an effective interest rate of 5.45%. Based on the metrics below, both Tianyi Fruit and Vitasoy have stronger credit profiles than China Green, whereas China Huiyuan Juice looks weaker.
Figure 21: Financial summary of Non-alcoholic Beverages peers
RMB mn China Green China Huiyuan Juice
Vitasoy Tianyi Fruit As of
Apr-10 Dec-10 Mar-11 Jun-10 Listed Jan-04 Feb-07 Mar-94 Jul-08
Mkt Cap ($mn) 631 916 916 358 Free Float 53.9% 27.8% 73.9% 23.9% Profit & loss Operating revenue 1,900.8 3,708.0 2,872.7 479.3 Gross profit
1,000.4
1,362.0
1,424.8
185.5
EBITDA 862.3 471.4 463.6 127.0 EBIT 708.2 171.1 365.2 118.2
Gross interest expense 73.7 63.0 6.3 1.3 Net income 563.8 219.3 285.9 158.2 Cash flow
Operating cash flow 818.2 247.8 387.5 124.1 C
apex -330.5 -2,340.9 -402.6 -48.2
Free cash flow 487.7 -2,093.1
-15.2 75.9 Balance sheet
Cash and cash equivalents 3,030.6 192.0 305.4 431.7 Total assets 5,349.7 9,000.9 2,235.1 818.5 Short-term debt 0.0 748.5 123.2 0.0 Long-term debt 1,258.7 2,547.6 107.1 133.5 Total debt 1,258.7 3,296.1 230.3 133.5 Net debt -1,771.9
3,104.1
-75.1 -298.2 Total shareholders' equity 3,070.4 5,012.4 1,338.7 633.7
Credit ratios Gross margin 52.6% 36.7% 49.6% 38.7% EBITDA margin
45.4%
12.7%
16.1%
26.5%
EBITDA/Interest 11.7x 7.5x 73.8x 99.4x EBIT/Interest 9.6x 2.7x 58.1x 92.5x
Total debt/EBITDA 1.5x 7.0x 0.5x 1.1x Net debt/EBITDA -2.1x 6.6x -0.2x -2.3x Total debt/Total capital 29.1% 39.7% 14.7% 17.4% Operating cash flow/total debt 65.0% 7.5% 168.2% 93.0%
Free cash flow/total debt
38.7%
-63.5%
-6.6%
56.9%
Note: Includes China Huiyuan Juice’s $150mn 4% convertible due 2016 issued in April 2011. Source: Bloomberg
China Green has a weaker credit
profile than Tianyi Fruit and Vitasoy, but, in our view, is
stronger than China Huiyuan Juice
Recovery analysis
In our recovery analysis, we compare the convertible bond redemption amount with the assets held at company level that we believe are recoverable. Figure 22 lists the total assets at a group level. Given the holding company nature of C haoda and C hina Green, most assets are mainly held onshore, with bondholders only having a realistic claim on offshore assets and possibly some onshore current assets, in our view (see earlier section on risks in the agricultural business model and also Appendix 3).
Figure 22: Total assets
RMB ‘000
Chaoda
China Green
Non-current assets
Property, plant and equipment 8,307,559 1,245,757 C onstruction-in-progress 736,804
Prepaid premium for land leases
5,816,783
806,853 Interest in leasehold land held for own use under operating leases 221,631
Biological assets
2,715,735 Available-for-sale investments 1,370,619 Deferred development costs 26,955 Deferred expenditure
527,640 Intangible assets
868,600 Interests in associates 7,902 Current assets
Prepaid premium for land leases 158,735 50,943 Biological assets 930,666 91,074 Inventories 69,816 62,068
Trade receivables
221,746 41,589 Other receivables, deposits and prepayments 509,301 156,476 Cash and cash equivalents
3,885,557
2,008,662
Total 26,154,418 4,685,053
Source: Company reports as of 31 December 2010 for Chaoda and 31 October 2010 for China Green
In general, in Figure 23, we include a 10% portion of each current asset, apart from prepaid premium for land leases that we view as unrecoverable. For bank deposits and cash, we only include the amount held at company level (ie, offshore). For C haoda, according to its FY2010 annual report, 2% of cash was held offshore. For C hina Green, according to its FY2010 annual report, the short-dated bank deposits were held at the company level. In discussions with the company it was stated that 25% of cash is held at company level. This results in a recovery value of 16% for C haoda and 43% for C hina Green. If we were to include only current assets held at company level, the recovery levels would decline to 3% and 41%, respectively.
It is worth noting that there has been a limited history of corporate recoveries in China for foreign investors; workout scenarios are more likely.
We calculate recovery values of 16% for Chaoda and 43% for China Green; this could decrease to 3% and 41%, respectively, if we discard all non-company assets
Figure 23: Assets potentially available in recovery
Chaoda China Green
Current assets (RMB ‘000)
Biological assets 93,067 9,107
6,207 Inventories 6,982
Trade receivables 22,175 4,159
Other receivables, deposits and prepayments 50,930 94,805
Cash and cash equivalents 40,000 502,166
616,444 213,153
Convertible bond amount due at redemption 1,300,000 1,436,265
Recovery value 16% 43%
Note: As of 31 December 2010 for Chaoda and 31 October 2010 for China Green. Source: Company reports
Past willingness and ability to repay debt obligations
Both companies have previously shown the willingness, together with the ability, to repay
debt obligations. In June 2009, Chaoda called its HK$1.344bn 0% convertible bond at 116.5,
while in February 2010 its repaid its $225mn 7.75% straight bonds. In October 2010 China
Green repaid its RMB1bn 0% convertible at 104.6.