Feihe Intl (NYSE:ADY)

Rodman and Renshaw on ADY                                          3/22/2011

ADY – Inline 4Q10 EPS results; Stabilizing topline; Above-expectation outlook

Feihe International (NYSE: ADY), yesterday morning, reported 4Q10 EPS of $0.04 (vs. $1.34 LY), essentially inline with the consensus of $0.04 (based on two EPS estimates of $0.03 and $0.04). Higher than expected sales and government subsidy were offset by a lower than expected gross margin and improving, but still-high operating cost base. Note that 4Q10 results included the $1.4MM asset impairment (~$0.05 after-tax EPS impact assuming 25% marginal tax rate) at Shanxi Feihe and ~$900k income (~$0.04 EPS impact) allocated to ADY’s redeemable common stock, which we view as non-core charges. (See page 2 for 4Q10 in detail)

FY 2011 guidance above our expectation. Importantly, the 2011 revenue and net income guidance of $290MM and $22-24MM, respectively, were meaningfully above our previous expectation of $280.8MM and $13.6MM. We are more comfortable with topline guidance rather than the net income guidance given the reduced subsidies and gross margin pressure as input prices continue to climb. In 2011, Feihe will attempt to limit low-GM raw milk powder to ~20% of sales. The company will also restrict selling & marketing expenses to 30-32% of revenues (vs. 38.7% in 2010). Government subsidies are anticipated at ~$10MM (vs. $20.9MM in 2010) as roughly half of the subsidies received in 2010 were attributable to construction projections (including capacity expansion) that should not repeat in 2011. That said, the core subsidy of $8MM tax refund in 2010 (proportional to pre-tax earnings) is expected to continue. In terms of quarterly complexion, government subsidies, which tend to experience a true-up in 4Q, may drive earnings to be more back-end loaded.

Maintaining our 2011 EPS estimate. We are maintaining our 2011 EPS estimate of $0.63, with gross margin being the wild card. Our sensitivity analysis suggests that every 100 bps of margin equates to ~$0.12 in annual EPS. For 1Q11, we are expecting ADY to report $0.13.

Maintaining Market Outperform Rating and $14 PT. While 2010 was marked by the achievement of topline stabilization, 2011 will be centered on setting the platform for long-term growth through deep-seated adjustments in its biological asset management practices and expansion strategy. On the sales & marketing front, both shortening the distribution chain and focusing on improving sell-through at existing retail sales points should allow for more efficient use of the tighter marketing budget. We are comforted by the company’s cash position of $17.5MM, which in addition to the estimated $5MM/qtr in OCF, limited capex needs in 2011, and $40MM in untapped ST loans (available for immediate withdrawal with no covenants), should be sufficient for the majority of WC needs and the debt repayment to Sequoia, barring any unfavorable tectonic shifts in market share. Secondly, note that ADY’s market share rose to 4.5% in December 2010 from 3.3% in the prior month. While we discount minor market share shifts as noise, the 120 bps gain at the retail level could signal directionally stronger consumer reception to wholesalers and bode well for future sales. Our 12-month PT of $14 applies an 11x NTM P/E multiple (ADY’s avg. NTM P/E since January 2007 has been over 10x) to a 2012 net income estimate of $28MM.

Notice Regarding Privacy and Confidentiality:

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

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Rodman and Renshaw on ADY                      02/03/2011

ADY: Favorable renegotiated agreement w/ Sequoia; Stock is oversold; Reiterating $14 PT 

WHAT’S NEW? 

Feihe International (NYSE: ADY) Wednesday after the close announced renegotiated terms with a key shareholder, Sequoia Capital, with regards to its share redemption option. Per terms of the agreement, Sequoia’s 2.625MM shares will be redeemed over the next year at $24/share, allowing the Fund to recoup its original $63MM investment. The redemption will take place in four equal installments within 30 days after March 31, 2011, September 30, 2011, December 31, 2011, and March 31, 2012. In addition, Feihe will be paying Sequoia an annual interest rate of 1.5% on the principal for each closing. Should Feihe be unable to follow the redemption schedule at any particular juncture, the interest rate will increase to 10.0% for the principal due on that closing date, but will not affect the terms of any future closings.

OUR VIEW 

Sequoia’s equity investment essentially reclassified as a low-interest loan, resulting in ~$37.3MM windfall to remaining shareholders. Under the original terms, Sequoia’s 2.625MM shares would have been redeemed at $39/share, resulting in $102.4MM cash outflow. Under the renegotiated terms, we estimate that the total payment to Sequoia would amount to ~$65.1MM, resulting in roughly $37.3MM (~$1.90/share) savings for the remaining shareholders. 

Recent CIC data shows generally declining market shares, directionally consistent with management’s guidance of $54-$56MM revenues in 4Q10, sequentially down from $61.1MM. ADY’s market share slipped to 3.3% by November 2010 from 4.9% In July 2010, which suggests that revenues will likely be sequentially down in 4Q10. We note that CIC retail data tends to be biased towards sales in larger cities, whereas the strength of Feihe’s wholesale channels really lies in tier 2 and 3 cities. We therefore rely on CIC data more as a directional compass than as an absolute tracker of ADY’s sales trends. 

Raising 4Q10, 2010, and 2011 EPS estimates. We are raising our 4Q10, 2010, and 2011 EPS estimates to $0.04, ($0.48), and $0.63, respectively, from $0.03, ($0.63), and $0.58 previously. Our earnings sensitivity suggests that every 100 bps in operating margin equates to ~$0.10-$0.11 in 2010E EPS. 

Reiterating 12-month price target of $14. Stock is oversold. We view the agreement as highly favorable towards ADY shareholders, having created roughly ~$1.90/share in instant equity value. The market appears to be reacting to the uncertainty of any potential distressed equity raise to cover the redemption, which we interpret as an overreaction considering that continued cost savings (more geographically-focused use of selling expenses) and further equipment leasing deals will likely cover most of the cashflow shortfall, in our view. In addition, ADY has the option to delay any of the four redemption periods by paying a penalty interest rate of 10.0% for any delayed redemption tranches (~$1.6MM per year, per tranch), which we do not view as overly burdensome for the company. Our 12-month PT of $14 assumes 10x NTM P/E multiple (ADY’s avg. NTM P/E since January 2007 has been ~10.0x) to a 2012 net income estimate of $28MM, which we view as conservative.

Notice Regarding Privacy and Confidentiality:

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

Member FINRA.
Member SIPC.

Rodman & Renshaw on ADY

WHAT HAPPENED? 

Feihe International (NYSE: ADY) reported 3Q10 EPS Of $0.16, significantly ahead of the ($0.02) consensus, and our $0.02 EPS estimate, and vs. $0.02 LY, driven by the combination of higher than expected sales and gross margin as well as extremely tight expense controls. 

• 3Q10 revenues fell 15.2% YoY to $61.1MM, but ahead of our $55MM estimate. 
• The gross margin contracted 661 bps YoY to 44.7% but came in higher than our 42.0% estimate due to higher than anticipated sales of high-margin infant milk formulas. 
• The operating expense rate improved 470 bps to 41.4%, attributable to extremely tight marketing / promotional expense controls. SG&A dollars fell 23.9% YoY to $25.3MM. Biological asset impairment improved sequentially to $468k from $5.8MM LQ. 
• 3Q10 net income margin fell 960 bps to 5.9%, with the majority of the decline owing to a $6.1MM YoY decline in government subsidies. 

OUTLOOK 

Based on QTD transacted orders, ADY expects 4Q10 revenues to come in at $54MM-$56MM, inline with our $55MM estimate and vs. $44MM LY. It was noted that competition from both new entrants and old competitors are amping up again.

OUR TAKE 

ADY turned out a significantly better than expected financial results in 3Q10 with strength across all line items, marked by sequential improvement in the topline, very cautious expense controls, and low asset impairment. That said, the stock has run up from ~$10 per share from the end of October 2010 to $12+, largely incorporating the above-expectation results. We would not be surprised if ADY shares trade off a bit on an inline 4Q10 outlook and some short-term profit-taking. Given our expectations of measurable progress in ADY’s efforts to drive productivity in its downstream functions (distribution, marketing, and sales), we would recommend that long-term investors accumulate on short-term weakness, if any. Our EPS estimates are under review as a result of the 3Q10 EPS beat.

Reiterate Market Outperform Rating and $14 PT. Applying a 10x-12x NTM P/E multiple (ADY’s avg. NTM P/E since January 2007 has been ~10.0x) to our 2012 net income estimate of $40MM results in a current share price of $13-$16. We have therefore arrived at our 12-month target price of $14, at the lower end of the aforementioned range.

Notice Regarding Privacy and Confidentiality: 

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

Member FINRA.
Member SIPC.

Rodman & Renshaw on American Dairy

We met with Roger Liu (Vice Chairman) and Judy Tu (Investor Relations) in Beijing and later in New York for the Rodman & Renshaw Investment Conference and came away with the following updated thoughts: 

What happened in 2Q10? In 2Q10, ADY reported significantly below-expectation EPS of ($0.92) vs. the consensus of $0.22. Overly optimistic internal and Street expectations for the rebound in infant milk formulas combined with intense competition led to a sales mix shift from infant milk formulas into a higher proportion of whole milk powders, which carried (2%) GM in 2Q10. Furthermore, inventory, ending at $58.3MM at the end of 2Q10, has declined only 1.6% sequentially vs. a sales drop of 35.9%, which also signifies lack of demand in 2Q10. The fact that ADY pays, on average, 10-15% premium for their fresh milk, partly due to the higher cost of operating their proprietary dairy farm, further depressed the gross margin. Thirdly, selling expenses in 2Q10 did not bring the expected returns due to inefficient pass-through of promotional items (e.g., rattles, free samples, etc.) through the distribution layers. In 2H10, while selling expenses may not necessarily be higher on a dollar basis, they are expected to be more effective in driving sales as ADY has become more vigilant of these issues. 

We overestimated the extent of topline volatility that had been priced into ADY shares prior to the company’s 2Q10 earnings announcement…hindsight is 20/20.…but we’ve come full circle, and expectations have been reset. Frankly, things are on the upswing. If there is one market more volatile than the financial markets over the past couple of years, it has been Chinese dairy market shares. For ADY, fortunately, expectations are fairly low at this point, with 3Q10 and 4Q10 EPS consensus of ($0.02) and $0.02, respectively. Recall that the company expected to be slightly profitable for the remainder of the year following its disappointing 2Q10 earnings results. Since then, market share gains have trended a bit ahead of our expectations, largely due to renewed fears over product safety for both domestic and international brands, which ADY benefits from due to its vertically-integrated farm-to-market model. Therefore, we believe there could be upside to current consensus EPS estimates.

Recent market share gains are kicking off a virtuous cycle. In the realm of consumer behavior, good things (and bad) come in waves; isolated standout quarters are rare. We believe that ADY is on the upswing again for quarters to come, again winning consumers’ trust due to its high quality, vertically-integrated milk source.

Notice Regarding Privacy and Confidentiality:

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).