l Equity Research l China l Food & Beverage - Emerging Companies 12 March 2014 Labixiaoxin Snacks Group Solid responses to allegations  Chinese media capitalweek.com.cn published an article  OUTPERFORM (unchanged) recently, accusing LBXX of potentially overstating its sales PRICE as of 11 Mar 2014 PRICE TARGET and margins. The company’s stock fell 18% on 11 March HKD 4.85 HKD 7.70 2014.  We see little factual basis for the allegations. In fact, management responded strongly to these accusations during our investor conference call on 11 March.  Investor sentiment has been adversely affected, but we believe that management’s open and transparent approach should help restore investor confidence over time. Our view on the allegations. Based on visits to a handful of Labixiaoxin Snacks Group’s (LBXX) distributors and one of its sales managers, the article alleged that the company was potentially overstating its sales. We consider the argument as weak and unsubstantiated, as LBXX has more than 200 distributors across China, and the article failed to reveal the identity of its interviewees. The article also raised doubts about LBXX’s higher-than-peers’ EBIT margin, relative to Qin Qin, Want Want (151 HK, IL) and Hsu Fu Chi. We note that LBXX’s 2012 EBIT margin of 24% is not materially higher than Want Want’s 21%. More importantly, prior to its acquisition by Nestle in 2011, Hsu Fu Chi’s EBIT margin was in the mid-teens, comparable to LBXX’s at that time. Finally, Qin Qin‘s SG&A ratio was comparable to that of LBXX (in the teens) before Hengan (1044 HK, OP) acquired the company in 2008 and embarked on an aggressive marketing campaign. Takeaways from our conference call. We hosted a conference call for investors, attended by Chairman Zheng Yu Long and CFO Sam Yap (see the call summary on the next page). In our view, management remained highly open, transparent and confident in addressing the concerns that were raised. It considers the accusations against the company to be inaccurate and biased. Negative for sentiment; management is open and transparent. We do not rate the accusations in the article as valid or justifying a change in our fundamentally positive view of the company. Investor sentiment has been adversely impacted, but we expect management’s open and transparent approach to the issues raised to restore investor confidence over time. Bloomberg code Reuters code 1262 HK 1262.HK Market cap 12-month range HKD 5,493mn (USD 708mn) HKD 3.61 - 6.07 EPS adj. est. change 2013E - Year-end: December Sales (RMB mn) EBITDA (RMB mn) EBIT (RMB mn) Pre-tax profit (RMB mn) Net profit adj. (RMB mn) FCF (RMB mn) EPS adj. (RMB) DPS (RMB) Book value/share (RMB) EPS growth adj. (%) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Div. payout (%) Net gearing (%) ROE (%) ROCE (%) EV/sales (x) EV/EBITDA (x) PBR (x) PER adj. (x) Dividend yield (%) 2012 1,547 432 370 369 278 14 0.25 0.06 1.47 25.3 -50.4 28.0 23.9 18.0 25.9 -20.0 18.0 23.7 1.3 4.6 1.7 8.3 3.1 2014E 2013E 1,825 517 435 438 320 (9) 0.28 0.09 1.68 15.0 33.1 28.3 23.9 17.5 30.0 -13.1 18.0 21.4 2.2 7.9 2.3 13.6 2.2 - 2014E 2,257 613 512 510 372 69 0.33 0.10 1.93 15.7 15.7 27.2 22.7 16.5 30.0 -10.2 18.2 20.3 1.8 6.5 1.9 11.4 2.6 2015E 2,660 727 611 609 444 193 0.39 0.12 2.22 19.4 19.4 27.3 23.0 16.7 30.0 -12.1 18.9 21.6 1.5 5.3 1.7 9.4 3.2 Source: Company, Standard Chartered Research estimates Share price performance Labixiaoxin Snacks Group HANG SENG INDEX (rebased) 6.5 4.8 3.0 Mar-13 Jun-13 Share price (%) Ordinary shares Relative to index Relative to sector Major shareholder Free float Average turnover (USD) Sep-13 Dec-13 Mar-14 -1 mth -3 mth -12 mth -3 3 26 -4 8 31 Business founders (63.8%) 36% 3,102,883 Source: Company, FactSet Forrest Chan, CFA [email protected] +852 3983 8505 Important disclosures can be found in the Disclosures Appendix 1262 HK All rights reserved. Standard Chartered Bank 2014 HKD 4.85 HKD 7.70 http://research.standardchartered.com Equity Research l Labixiaoxin Snacks Group Key takeaways from the conference call Management statement LBXX considers the accusations made by capitalweek.com.cn to be inaccurate and unfair. The interviews the author claims to have conducted involved only a handful of distributors (less than 20), while the company has a nationwide distribution network (more than 300 distributors by end-2013). Moreover, reliability of the information collected from the interviews, where no details are available, is also questionable. Management stated that LBXX’s operating cash flow has been steadily growing. It further stated that the company has paid a significant amount of tax and has maintained a consistent dividend payout ratio of 20% in the past. Moreover, PricewaterhouseCoopers (PwC) has been auditing its accounts since 2003 and there has been no qualified opinion ever issued on the company. According to management, during the company’s two-time listing procedures in Singapore and Hong Kong, numerous professional parties, such as bankers and lawyers, conducted sophisticated due diligence on LBXX (which included its distributor network). Management emphasised that investors should be cautious about interpreting Qin Qin’s numbers that were presented in the article, as Qin Qin, a subsidiary of Hengan, provides limited disclosure on its SG&A breakdown. It further stated that it was unclear about how much overhead Qin Qin had absorbed, following the Hengan acquisition. LBXX encouraged investors to refer to the circular published at the time of the Qin Qin acquisition that revealed the company had a very low SG&A ratio prior to the Hengan takeover. Q&A Q): Will LBXX or its management consider share buybacks? Is legal action against capitalweek.com.cn being considered? A): LBXX is currently in a blackout period that restricts the company and its management from buying back shares. Both the chairman and the CFO stated that, if not for the restrictions, they would be keen to buy back shares. LBXX reserves the right to take legal action against the media company. Nevertheless, management emphasised that it respects the rights and freedom of the media to look at LBXX from a different perspective. Management believes that media supervision is beneficial to the long-term, healthy development of the company and the jelly industry. Management stated that it is willing to provide assistance and additional information for capitalweek.com.cn in their follow-up analysis. Q): Will LBXX take measures to improve its transparency? A): LBXX reiterated that it always strives to achieve high transparency and is open to any suggestions from investors in this regard, so long as the measures will not lead to significantly higher costs and reveal its business-sensitive information. Q): Will LBXX form a special committee or appoint third-party consultants to look into the issues raised? A): LBXX welcomed suggestions from investors. The company realises that the accuracy of Euromonitor’s market share survey is being increasingly challenged. Therefore, it is now in talks with A.C. Nielsen to explore the possibility of getting statistics from a back-up source. 12 March 2014 2 Equity Research l Labixiaoxin Snacks Group Income statement (RMB mn) Year-end: Dec Sales Gross profit SG&A Other income Other expenses EBIT Net interest Associates Other non-operational Exceptional items Pre-tax profit Taxation Minority interests Exceptional items after tax Net profit Cash flow statement (RMB mn) 2011 1,280 512 (226) (3) 0 284 (8) 0 0 0 276 (55) 0 0 222 2012 1,547 633 (274) 10 0 370 (1) 0 0 0 369 (91) 0 0 278 2013E 1,825 765 (338) 8 0 435 3 0 0 0 438 (118) 0 0 320 2014E 2,257 907 (402) 7 0 512 (3) 0 0 0 510 (138) 0 0 372 2015E 2,660 1,056 (452) 7 0 611 (2) 0 0 0 609 (164) 0 0 444 222 332 278 432 320 517 372 613 444 727 0.20 0.20 0.13 1,126 0.25 0.25 0.06 1,126 0.28 0.28 0.09 1,127 0.33 0.33 0.10 1,133 0.39 0.39 0.12 1,133 Year-end: Dec Cash Short-term investments Accounts receivable Inventory Other current assets Total current assets 2011 522 0 243 80 36 882 2012 406 0 270 73 21 769 2013E 761 0 350 96 28 1,235 2014E 734 0 478 134 32 1,377 2015E 815 0 499 139 36 1,489 PP&E Intangible assets Associates and JVs Other long-term assets Total long-term assets 933 0 0 71 1,004 1,142 0 0 125 1,267 1,480 0 0 57 1,537 1,709 0 0 79 1,788 1,923 0 0 101 2,024 Total assets 1,885 2,036 2,772 3,165 3,513 157 183 102 443 75 182 103 360 50 213 121 384 50 304 146 500 50 294 169 513 0 0 9 0 9 0 0 17 0 17 461 0 19 0 480 461 0 21 0 482 461 0 23 0 484 452 377 865 982 997 Shareholders’ funds Minority interests 1,433 0 1,659 0 1,907 0 2,183 0 2,516 0 Total equity 1,433 1,659 1,907 2,183 2,516 Total liabilities and equity 1,885 2,036 2,772 3,165 3,513 Net debt (cash) Year-end shares (mn) (365) 1,126 (331) 1,126 (250) 1,133 (222) 1,133 (304) 1,133 Net profit adj. EBITDA EPS (RMB) EPS adj. (RMB) DPS (RMB) Avg fully diluted shares (mn) Balance sheet (RMB mn) Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible bonds Deferred tax Other long-term liabilities Total long-term liabilities Total liabilities Year-end: Dec EBIT Depreciation & amortisation Net interest Tax paid Changes in working capital Others Cash flow from operations 2011 284 49 (8) (53) (51) 5 226 2012 370 62 (1) (70) (28) 5 338 2013E 435 81 3 (115) (64) 0 341 2014E 512 101 (3) (134) (57) 0 419 2015E 611 116 (2) (161) (21) 0 543 Capex Acquisitions & Investments Disposals Others Cash flow from investing (362) 0 0 0 (362) (324) 0 0 0 (324) (350) 0 0 0 (350) (350) 0 0 0 (350) (350) 0 0 0 (350) Dividends Issue of shares Change in debt Other financing cash flow Cash flow from financing (40) 604 65 10 639 (56) 0 (82) 8 (130) (72) 0 436 0 364 (96) 0 0 0 (96) (112) 0 0 0 (112) 504 0 (136) (116) 0 14 355 0 (9) (27) 0 69 82 0 193 2011 2012 2013E 2014E 2015E 40.0 26.0 22.2 17.3 19.8 37.4 50.0 50.0 50.0 -15.1 41.0 28.0 23.9 18.0 24.7 20.8 25.3 25.3 25.3 -50.4 41.9 28.3 23.9 17.5 27.0 18.0 15.2 15.0 15.0 33.1 40.2 27.2 22.7 16.5 27.0 23.7 16.2 15.7 15.7 15.7 39.7 27.3 23.0 16.7 27.0 17.9 19.4 19.4 19.4 19.4 21.2 27.0 0.9 0.8 0.1 37.3 55.7 86.9 18.0 23.7 0.8 0.9 0.2 30.6 60.5 72.9 18.0 21.4 0.8 0.8 0.2 29.0 62.0 68.0 18.2 20.3 0.8 0.8 0.3 31.0 67.0 70.0 18.9 21.6 0.8 0.9 0.3 31.0 67.0 68.0 -25.5 10.9 32.4 0.4 2.0 -20.0 4.5 50.3 0.3 2.1 -13.1 21.4 49.5 0.6 3.2 -10.2 19.2 28.6 0.8 2.8 -12.1 17.0 34.1 0.7 2.9 1.4 5.3 6.2 8.6 8.6 1.3 7.6 1.3 4.6 5.3 8.3 8.3 1.7 3.1 2.2 7.9 9.4 13.6 13.6 2.3 2.2 1.8 6.5 7.8 11.4 11.4 1.9 2.6 1.5 5.3 6.4 9.4 9.4 1.7 3.2 Change in cash Exchange rate effect Free cash flow Financial ratios and other Year-end: Dec Operating ratios Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin adj. (%) Effective tax rate (%) Sales growth (%) Net income growth (%) EPS growth (%) EPS growth adj. (%) DPS growth (%) Efficiency ratios ROE (%) ROCE (%) Asset turnover (x) Op. cash/EBIT (x) Depreciation/capex (x) Inventory days Accounts receivable days Accounts payable days Leverage ratios Net gearing (%) Debt/capital (%) Interest cover (x) Debt/EBITDA (x) Current ratio (x) Valuation EV/sales (x) EV/EBITDA (x) EV/EBIT (x) PER (x) PER adj. (x) PBR (x) Dividend yield (%) Source: Company, Standard Chartered Research estimates 12 March 2014 3 Equity Research l Labixiaoxin Snacks Group Disclosures appendix The information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered Bank Singapore Branch, Standard Chartered Securities (India) Limited, Standard Chartered Securities Korea Limited and/or one or more of its affiliates (together with its group of companies, ”SCB”) and the research analyst(s) named in this report. 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Recommendation and price target history for Labixiaoxin Snacks Group HKD 7.70 1 6.56 5.42 4.27 3.13 1.99 Jan-12 Date Apr-12 Recommendation Jul-12 Oct-12 Price target Date Jan-13 Recommendation Apr-13 Jul-13 Price target Oct-13 Date Jan-14 Recommendation Apr-14 Price target 1 26 Feb 14 OUTPERFORM 7.70 Source: FactSet prices, SCB recommendations and price targets Recommendation Distribution and Investment Banking Relationships % of covered companies currently assigned this rating % of companies assigned this rating with which SCB has provided investment banking services over the past 12 months OUTPERFORM 53.2% 14.5% IN-LINE 35.2% 12.8% UNDERPERFORM As of 31 December 2013 11.6% 8.3% Research Recommendation Terminology OUTPERFORM (OP) IN-LINE (IL) UNDERPERFORM (UP) Definitions The total return on the security is expected to outperform the relevant market index by 5% or more over the next 12 months The total return on the security is not expected to outperform or underperform the relevant market index by 5% or more over the next 12 months The total return on the security is expected to underperform the relevant market index by 5% or more over the next 12 months SCB uses an investment horizon of 12 months for its price targets. 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