涪陵榨菜(002507)

Key points

Pricing power on the back of brand equity.

Raw material price likely to increase; channel expansion is underway.

Strong balance sheet to provide sufficient ammunition for M&A.

Event

We visited Fuling Zhacai’s factory in Chongqing and talked with mgmt. duringour recent consumer tour. The company develops, produces and sells pickledmustard, pickled mustard sauce and other appetizers under two brands,Wujiang and Huitong. Fuling’s market share in 2017 reached 16.8%, morethan twice that of the second largest company (Yuquan, 7.1%).

Key findings

Pricing power on the back of brand equity. From November 2018, FulingZhacai lifted CIF (cost, insurance and freight) price for some products by 10%,mainly for areas outside Guangdong to avoid transhipments. The company willprovide rebates for some distributors to maintain a competitive margin before itis able to lift retail prices. On the back of its brand equity, the company wasable to consecutively raise its CIF price YoY, resulting in a 4% and 16% ASPincrease in 2016 and 2017 respectively. Currently, all of Fuling’s products aresold at above Rmb2/package, while the retail price of mainstream pickledvegetables is at Rmb1.5-2/package.

Raw material price likely to increase; channel expansion is under way.According to the company, mustard vegetables accounted for 45% of COGS,while packaging and worker force cost 22% and 10%, respectively. Recently,the purchase price of mustard vegetables for 2019 has been set atRmb800/ton and above by the company, 14% higher than the floor price for2018. Meanwhile, for pickled mustard products, Fuling Zhacai has started toexpand into the restaurant channel, as it sees significant potential there alongwith the fast growth of delivery services. For Sichuan pickled vegetables andother appetizers, the penetration rate among its 1,200+ distributors was ~20%in 2017 and will improve in the future, according to the company.

Strong balance sheet to provide sufficient ammunition for M&A. Thanksto its strong cash generative ability, the company recorded 61.6% net cashposition as at end-3Q18. Post the acquisition of 100% of Huitong’s equity in2015, the company keeps sufficient ammunition for potential M&A, with focuson condiments area, such as soybean paste, according to mgmt.

Financials, valuations, and risks

Fuling Zhacai reported 9M18 revenue of RMB1,545m, up 26% YoY, with netprofit up 72% YoY to RMB523m. 3Q18 revenue increased 11% to RMB482m,with net profit increasing 65% to RMB218m.

The stock is trading at 23x FY19E PER, compared with the average 27xFY19E PER for domestic condiment peers, all based on Bloombergconsensus.