The more encouraging developments include the commencement of exports sales of instant noodle to Sweden and Greece and more recently to Tesco plc, a leading international supermarket group based in the United Kingdom. Meanwhile, it has recently received a 100-ton soybean powder order from a leading global beverage company. These developments, along with the acquisition of several state-owned facilities at inexpensive prices in the past two years, have enabled the Company to expand its production capacity and distribution network.
As a result, we expect the Company to enjoy steady revenue and net income growth ahead. However, the restatement of New Dragon Asia’s financial statements for FY2005 and FY2006, with a significant amount of non-cash items and gain or loss on fair value adjustment to embedded derivative would have confused investors and widened its valuation discount relative to peers. Our EV/EBITDA valuation indicated the stock is inexpensive and based on 15x estimated 2007 P/E, our price target for the stock is $2.12. With a further 24.7% upside potential, we maintain our BUY recommendation on the stock.
New Dragon Asia Corp. is engaged in the milling, sale and distribution of flour and related products, including instant noodles and soybean-derived products, to retail and wholesale customers throughout China. With a well-known brand name called “Long Feng”, the Company markets its well-established product line through a countrywide network of over 200 key distributors and 16 regional offices in 27 Chinese provinces.
In addition to domestic sales, New Dragon Asia also exports noodles to other countries such as South Korea, Australia, Malaysia and Indonesia and recently extends its export sales to Sweden, Greece and United Kingdom. In 2005, export sales accounted for approximately 7% of instant noodle sales. As at the end of 2005, the Company has six manufacturing plants in the PRC with an aggregate annual production capacity of 110,000 tons of flour, approximately 1.1 billion packets of instant noodles and 4,500 tons of Soybean powder. Through acquisitions in the past year, the Company further expands its production capacity of instant noodles, export distributorship and packing materials businesses.
Review of Third Quarter Results
New Dragon Asia announced on November 8 its third quarter 2006 financial results. Net revenue for the three months ended September 25, 2006 was $13 mn, up 11.3% compared to $11.6 mn for the corresponding period last year. The increase in revenue was driven by growth in demand for the Company’s instant noodle and flour products, as well as inclusion of results from its soybean business.
Gross profit rose 16.9% to $2.52 mn from $2.16 mn a year ago. Due to increase in higher margin export sales, gross margin for the third quarter 2006 increased to 19.5% from 18.5% a year ago. Income from operation for the third quarter 2006 was $1.55 mn compared to $1.65 mn a year ago.
The decrease in operating income was due to an increase in general and administrative expenses related to professional fees incurred in connection with the amendment and restatement of New Dragon Asia Corp’s financial statements for the year ended December 25, 2005 and the interim periods ended September 25, 2005, June 25, 2006 and March 25, 2006. Net income for the third quarter of 2006 was $4.8 mn as compared to a net loss of $6.4 mn for the same period in 2005.
The increase in net income was due to the growth of New Dragon Asia Corp’s business and more importantly a substantial $3.2 mn gain derived from a change in the fair value of certain derivative instruments deemed to be associated with the Company’s outstanding convertible preferred stock, as compared to a significant $8.4 mn charge recorded in the 2005 period for similar fair value changes to the derivative instruments. Net income available to shareholders for the third quarter 2006 was $4.1 mn as compared to a net loss of $6.7 mn a year ago. EPS were $0.08 for the third quarter of 2006, as compared to a loss of $0.15 per share for the same period in 2005.
Due to the results for the two corresponding periods have been distorted by the significant noncash expenses and restatement of the financial statements for the two periods, management emphasized and we concur that EBITDA is a better indicator of the Company’s operating performance. EBITDA rose to $3.04 mn for the third quarter 2006 as compared to $2.74 mn for the third quarter 2005, an increase of 11.1%. EBITDA margin was 23.4% for the third quarter 2006 as compared to 23.5% in 2005. Growth in export sales, which generate higher margins helped enhance EBITDA margin.
Highlights of Nine Months 2006 Results
For the nine months ended September 25, 2006, New Dragon Asia reported total net revenue of $35.6 mn, a 23% increase as compared to $28.9 mn for the same period in 2005. The increase in net revenue was primarily driven by growth in demand for flour and instant noodles, as well as the inclusion of results for the soybean products business in the 2006 period.
Gross profit for the nine months ended September 25, 2006 increased 29.5% to $6.5 mn from $5.1 mn a year ago. Gross margin showed an encouraging increase to 18.4% for the nine months ended September 25, 2006 as compared to 17.5% in the corresponding period last year. The increase was primarily due to an increase in export sales, which generate higher margins. Income from operation decreased 44.7% to $1.82 mn from $3.29 mn a year ago. The significant decrease in income from operation was due to the inclusion of a $2.32 mn non-cash charge related to stock-based compensation incurred in the first quarter of 2006. Isolating such non-cash charge, income from operation would have increase 25.8% YOY.
Net income for the nine months ended September 25, 2006 was $6.0 mn as compared to a net loss of $4.5 mn in the corresponding period last year. Again, the significant increase in net income was distorted by the $3.2 mn gain derived from a change in the fair value of certain derivative instrument deemed to be associated with the Company’s outstanding convertible preferred stock, as compared to a significant charge of $8.4 mn recorded in the corresponding period in 2005 for similar fair value changes to the derivative instruments.
By focusing on the more meaningful EBITDA performance, the Company’s EBITDA for the nine months ended September 25, 2006 rose 34.7% to $7.8 mn as compared to $5.8 mn a year ago. EBITDA margin also recorded a visible increase to 21.9% from 20.0% a year earlier. EPS was
$0.08 for the nine months ended September 25, 2006 as compared to a loss per share of $0.11 a year ago. Following is a summary of the Company’s income statement for the 3 months and nine months ended September 25, 2006 as compared to the previous corresponding periods.
Overall, based on revenue and EBITDA analysis, New Dragon Asia’s financial performance is making good progress.
Exporting noodles to Tesco
On October 19, New Dragon Asia Corporation announced that it has begun exporting its instant noodles to Tesco plc, a leading international supermarket group based in the United Kingdom. The exporting of its products followed the Company’s receipt of HACCP certification in June 2006. The first order from Tesco was processed by New Dragon Asia Yantai factory. Tesco plc is one of the world’s most successful supermarket groups and New Dragon Asia is pleased to have been chosen to provide them their products.
Company CEO Li Xia Wang further indicated that its instant noodle export business is beginning to gain momentum. Expansion of the Company’s business through exports is a key strategic component for growth, as export sales generally produce higher margins than domestic sales.
The Company now has customers in Sweden, Greece and a high profile customer in the United Kingdom. Management plans to continue seeking new sales opportunities in Europe and indicates the Company is on track to meet its goal to increase export sales by 50% in fiscal 2006, which should lead to export sales comprising 12% of total instant noodle sales for the year. We are happy with the Company’s progress on increasing export sales, which would become a key growth driver for its noodle business.
Soybean powder orders from a leading global beverage company
On October 13, 2006, New Dragon Asia announced that it has received purchase orders for approximately 100 tons of soybean protein powder from the China operations of one of its existing customers, one of the world’s premier global beverage companies. The order will be processed by New Dragon Asia’s Longkou City factory in Shandong Province. These substantial orders, placed by an existing New Dragon Asia customer, demonstrate the satisfaction with the quality of the Company’s soybean powder and the potential for revenue growth from such business segment. Company CEO Li Xia Wang anticipates that by the end of 2006, soybean powder products may account for 15% of New Dragon Asia’s total revenue and become a key growth driver for the Company.
Company Progress Report
On October 5, 2006, Company Chairman Heng Jing Lu issued as shareholder update, which focused on the following areas:
Acquisitions: In July 2005, the Company acquired a soybean powder facility from a state-owned enterprise at net book value. In October 2005, the Company acquired a state-owned distributor at net book value. In February 2006, the Company acquired a state-owned noodle manufacturing facility in Chengdu, Sichuan Province at net book value and the acquisition increased its production capacity by 30%. In April 2006, the Company acquired the remaining equity interest in its packaging facility at net book value. These acquisitions, priced at net book value, appear inexpensive.
In short, these acquisitions have not only increased the Company’s production capacity or expanded its distribution network, but also extended its geographic coverage in other parts of the China market. Management plans to continue to seek strategic partnerships and work to identify possible acquisition targets among formerly state-owned assets in China to drive business growth and expansion of its distribution network. During the Company’s 3Q results announcement web cast, management indicated that it would announce an acquisition of state-owned asset in Hunan Province and increase its business coverage in Southern China.
Exports: The Company’s instant noodle business is gaining momentum as it has expanded sales in key markets in China and other parts of Asia and commenced exports to Europe. New Dragon Asia now has customers in Sweden and Greece and continues to seek opportunities in that region. Management expects export sales of instant noodles continue to grow as a percentage of total revenue in this segment and expect this to be one of the key growth driver for the Company.
Revenue guidance: Management maintains its guidance of more than 30% increase in revenue to $60 mn when the Company announced its financial results for the second quarter of 2006. Given the announcement of the exporting noodles to Tesco plc and sales orders for soybean powder from a leading global beverage company, we concur with management’s guidance of over $60 mn revenue for fiscal 2006.
Given the restatement of the Company’s financial accounts for 2005 and 2006, the distortion of bottom line figures by non-cash expensive and the significant gain or loss on fair value adjustment to embedded derivatives, we have to substantially revised our profit forecasts for FY2006 ad FY2007 in our research report released in June 2006. Due to the highly unpredictable gain or loss on fair value adjustment to embedded derivatives, we believe it is more appropriate to focus on revenue growth and EBIDTA analysis.
Given that the fourth quarter of 2006 is the peak season for New Dragon Asia and its progress on instant noodle export sales and soybean powder orders from a leading global beverage company, we believe management guidance of total revenue in excess of $60 mn is achievable. We have raised our revenue forecast for FY2006 by $0.2 mn to $6.29 mn from $6.09 mn. This represents a hefty 36.5% YoY growth.
Due to reclassification of interest expense on preferred stock and the significant $3.2 mn gain on fair value adjustment to embedded derivative, we have substantially raised our net income available to shareholders to $6.36 mn from $2.95 mn in our June 2006 report. EPS will double to $0.12 from $0.06. Based on EBITDA analysis, EBITDA for FY2006 will increase 37.1% to $11.87 mn from $8.66 mn in FY2005, while EBITDA margin for FY2006 is expected to edge up slightly to 19.7% from 19.6% a year ago.
In FY2007, we forecast revenue to grow 26.8% to $76.5 mn from $60.3 mn a year ago. Gross profit and EBITDA are expected to increase 28.9% to $14.4 mn and 16.6% to $13.8 mn respectively. In the absence of distortion from non-cash expense, gain or loss from fair value adjustment to embedded value, we expect gross margin, EBIDTA margin and net margin to come at 18.8%, 18.1% and 9.8% respectively. Net income available to shareholders and EPS are forecast at $7.46 mn and $0.14 respectively.
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