China New Borun's (BORN) CEO Jinmiao Wang on Q2 2014 Results - Earnings Call Transcript

Aug.22.14 | About: China New (BORN)

China New Borun Corporation (NYSE:BORN)

Q2 2014 Results Earnings Conference Call

August 22, 2014, 8:00 am ET


Terence Chen - Chief Financial Officer

Jinmiao Wang - Chairman of the Board, Chief Executive Officer

Ann Yu - Chief Strategy Officer


Hover Chen - Caledonia Investments

Sarah Dai - Hillhouse Capital


Good day, everyone, and welcome to the second quarter 2014 earnings conference call for China New Borun Corporation. Today's conference is being recorded.

Before we get started, I am going to review the Safe Harbor statement regarding today's conference call. Please note that discussion today will contain certain forward-looking statements made under the Safe Harbor Provisions of the US Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

To understand the factors that could cause results to materially differ from those in the forward-looking statements, please refer to our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 25, 2014. The company does not assume any obligation to update any forward-looking statements except as required under applicable law.

At this time, I would like to turn the call over to Mr. Terence Chen, Chief Financial Officer of China New Borun Corporation, for opening remarks and introductions. Please go ahead, sir.

Terence Chen

Thank you, everyone, for joining us for China New Borun's second quarter 2014 earnings conference call. Joining me today from management is Jinmiao Wang, our Board's Chairman and Chief Executive Officer and Ann Yu, the company's Chief Strategy Officer. On our call today, Mr. Wang will provide a quick review for our business and industry fundamentals in the second quarter of 2014. Following that, Ann will offer more details of our operation development and updates. At the end, I will then provide you second quarter 2014 financial details. I would like to note that on this call today all of our financial results will be referred to in Chinese RMB unless otherwise noted.

At this point, I would like to introduce Mr. Wang, Chairman and Chief Executive Officer of China New Borun. Mr. Wang will speak in Mandarin and I will translate. Mr. Wang?

Jinmiao Wang


Hello, everyone and welcome to China New Borun second quarter 2014 earnings conference call.

For second quarter of 2014, we recorded revenue at the high-end of our second quarter guidance, better-than-expected volume shipments as demand and ASP for edible alcohol was solid during the first half of 2014. However, during the first week of May, the market took a sharp jump and ASP particularly fell in June which lowered our profitability. As a result, our gross profit contracted year-over-year.

Although China's June PMI, driven by government's mini-stimulus measures pointed to a recovery on the production side, household consumption actually weakened and probably the cyclical products decreased. Furthermore, this July the growth rate for food and beverage sales decelerated 200 basis points to 10.2% year-over-year, due largely to beverage demand from individuals and lower consumption by the public sector, and that is being a natural focus during central government's campaign to suppress beverage consumption by public servants.

In light of the softer demand, we have tried to continue to set the focus away from the premium segment towards the mid to low segment and most of the traditional high-end baijiu producers enter the low-end mass market, a flood of marketing campaign offering discounts and gifts promotions started a real price war. The average discount for baijiu during the second quarter was higher 50% and some baijiu producers even discounted by as much as 50%. The price war sacrifice the profit in favor of volume and market share which clearly squeezes the profitability for the whole baijiu industry.

Based on industry estimates, overall net profit for the whole baijiu industry decreased by at least 12% in the first six month of 2014, with June being the worst. Ultimately the struggle by baijiu producers total squeezed price and profit toward their suppliers, the edible alcohol producers.

It is worth noting that after the tough month in June, prices of edible alcohol have stabilized in July and we are also seeing modest positive net sign in August. China cyclical has a surge in baijiu demand in September and October, driven by the upcoming Mid-Autumn Festival and Chinese national holidays, respectively. During these holidays baijiu is traditionally a popular gift and widely consumed at dinner with friends and family.

Despite challenges in the edible alcohol business, we continue to make further progress in our new CPE and foam insulation business. During the second quarter, we expanded CPE production and achieved 100% capacity. We continue to gain wider market acceptance as revenue from CPE grew 44% from the prior quarter and revenue from foam insulation doubled. We will continue to commit more development efforts to broaden the foam insulation product offering to match the large variety of pipe types and sizes. We believe with a solid foundation in place, the new business will steadily grow and will eventually contribute meaningfully to our revenue and profits.

At this point, I will now turn the call over to Ann Yu for more details on our operational developments and updates.

Ann Yu

Thank you very much, Mr. Wang, Terence and many thanks to everyone for participating on our call today.

This second quarter, the average selling price for edible alcohol fell to RMB5,100 per ton which is the lowest level in the past two years. Meanwhile, the spot price of corn during the same period kept trending upward. Historically, corn prices are relatively higher in the second quarter than those during the harvest season in the first quarter. However this second quarter, corn prices increased more sharply due to the drought in many provinces in China with Henan province, one of the country's key corn grown areas, being most severely impacted.

The nationwide drought this summer has started reduce the output of corn this upcoming harvest season and accordingly the spot prices of corn have already increased. According to the data from the reference, Spot Price of Corn Ex-Warehouse from Dalian, the average cost of corn during the second quarter of 2014 increased 3.2% sequentially and we are seeing an even steeper trend for July and August thus far. This inverse relationship between the average selling price of edible alcohol and the crop of corn has dramatically hurt the profitability of the entire edible alcohol sector.

Internally at Borun, as we have enjoyed our favorable crop advantage, thanks to our ability to pre-stock (inaudible) corn during the harvest season and lock it in prices, our unit cost of corn continues to be notably lower than the full prices. Our average cost of corn during the second quarter of 2014 increased by only 0.7% sequentially to RMB1,958 per ton compared to the spot price of corn ex-warehouse from Dalian of RMB2,074 per ton. This significant cost advantage can really demonstrate the exact effectiveness of our stocking strategy and we estimate that our plan to secure 500,000 tons of corn during the last harvest season will be sufficient for our production trend through November, and this should continue to provide us with competitive advantage.

During the second quarter, after average selling price of edible alcohol unexpectedly jumped in June, we started our annual maintenance one week earlier than we do and shut down production during the last week of June. As such, our utilization of edible alcohol for the second quarter decreased to 84%, down from 89% in the same period of last year. In July, we continued our annual maintenance and correspondently we anticipated the utilization of edible alcohol for the third quarter would be around 70%.

Despite the unexpected happenings in edible alcohol business, we continue to make progress in ramping up many our CPE and foam insulation businesses. Once again, our customer feedback is mainly positive and we were able to sell out over 95% of our finished goods for the new products. The progress of CPE is ahead of trends as we were able to reach full capacity in June which is beyond our expectation of reaching 80% of capacity in the second half of this year.

During the second quarter, sales of CPE products grew by 44% sequentially to RMB21.3 million, while the total revenues from both CPE and foam insulation grew by 47% sequentially to RMB23.4 million. We are delighted to be at this revenue level. The new businesses have started to generate profits during the second quarter. And we as continue to ramp up foam insulation production, the new businesses should be able to positively contribute our overall profit going forward.

And as you may know, we purchased corn during harvest season in the first quarter, financed partially by our cash on hand and by short term loans from local banks. This quarter, we converted the purchased corn inventory into revenue and cash flow, which we used to proactively repay a portion of short term loans in the second quarter. We believe that subsequent lower interest is expected to generate in millions of saving in the next quarter and we will continue to manage our loan facilities to keep our loan balance at a most efficient level.

Importantly, we continued to see strong financial support from local banks, thanks to their recognition of our leading position in the edible alcohol industry and confidence in our financial position and profitability. When the next harvest season for corn arrives, we would evaluate our financial position and may choose to enlarge our borrowing activities at that time.

So in summary, despite the adverse and tough market environment during the quarter, we believer we are doing our best in generating a (inaudible) operation. Looking ahead at the third quarter, which is another peak season due to the upcoming Mid-Autumn Festival and national holidays, we believe that the present tighter environment will rapidly improve.

That wraps up my part. Now let me turn the call over to Terence Chen for a review of financial performance in the second quarter of 2014.

Terence Chen

Thanks, Mr. Wang. Thanks, Ann. I am glad that even with the unexpected sharp drop in demand and ASP for edible alcohol in the quarter, we did generate ample cash flows from operations to pay back a part of the short term loans and earned meaningful net income in the past three-month period.

Now let me review our financial performance. For the second quarter of 2014, our total net revenue increased by 6.4% year-over-year to RMB668.9 million, which was mainly driven by higher sales and volume of edible alcohol, partially offset by lower average selling price, and as well as incremental revenue contribution from our CPE and foam insulation businesses, which were introduced in the fourth quarter of 2013.

Now let's look in at the revenue breakdown during this quarter. Revenue from edible alcohol increased by 4.1% to RMB425.9 million with the sales volume increase by 6.1% year-over-year to approximately 83,500 tons, while offset by a decrease of 1.9% in ASP of RMB5,100 per ton compared to the same period of last year.

Revenue from DDGS Feed increased by 2.1% to RMB159.8 million, with sales volume decreased slightly by 1.2% year-over-year to approximately 74,155 tons, and ASP increased by 3.3% year-over-year to RMB2,155 per ton.

Revenue from liquid carbon dioxide decreased by 17% to RMB11.4 million, with sales volume decreased by 2.6% to approximately 32,750 tons, and ASP decreased by 14.8% year-over-year to RMB347 per ton.

Revenue from crude corn oil decreased by 1.4% to RMB48.5 million with sales volume increased by 4% year-over-year to approximately 6,750 tons, while ASP decreased by 5.3% year-over-year to RMB7,185 per ton.

Total revenues from CPE and foam insulation totaled RMB23.3 million. Revenue from CPE was RMB21.3 million and the sales volume was approximately 2,450 tons at an average price per ton of RMB8,718. Revenue from foam insulation was RMB2.0 million with sales volume of approximately 1,870 cubic meters at a price of RMB1,094 per cubic meter.

Our gross decreased by 5.4% to RMB67.5 million from RMB71.4 million in the prior year period. Gross margin narrowed to 10.1%, compared to 11.4% in the second quarter of 2013. The decrease of gross margin was primarily contributable to -- sorry. The decrease of gross margin was primarily attributable to a sharp drop in ASP of edible alcohol.

Due to lower gross margins, income from operations decreased by 7.8% to RMB55.3 million in the second quarter of 2014, from RMB60 million in the same period of 2013.

Benefiting from effective expense control, general and administrative expenses, as a percentage of total revenue remained at 1.6% in the second quarter of 2014, unchanged from the year ago, while selling expenses, as a percentage of total revenue, slightly improved to 0.23% in the second quarter of 2014 compared to 0.24% a year ago.

Interest expense increased slightly by RMB0.3 million to RMB26.7 million in second quarter of 2014 from RMB26.4 million in the same period of 2013. As we have successfully lowered our tranche of Borun Bond, we anticipate that the interest expense would be lower in the next quarter.

Income tax expenses in the second quarter of 2014 were approximately RMB7 million, representing an effective tax rate of 25%.

Our net income decreased by 17.8% year-over-year to RMB21 million from RMB25.5 million a year ago. Diluted earnings per share and per ADS were RMB0.83 in second quarter of 2014. The company had 25,700,000 weighted average basic and diluted shares outstanding during the quarter ended June 30, 2014.

On the balance sheet side, we have paid a total of RMB150 million in short-term bonds during this quarter in order to (inaudible) finance expenses. Our cash and bank deposits balance decreased to RMB361.8 million, as compared to RMB521.3 million at the end of 2013. Our net trade accounts receivable balance as of June 30, 2014, was RMB353.5 million, slightly increased from RMB350.9 million at the end of the prior quarter.

Our inventory balance as of June 30, 2014, totaling RMB915 million, decreased from RMB937.4 million at the end of prior quarter, and we still have approximately 400,000 tons of corn on hand which could definitely (inaudible) during non-harvest season from July to November. And cash flows provided by operating activities for the second quarter of 2014 were approximately RMB77.3 million, which were mainly contributed from our decreased inventory balance.

So that wraps up the financial reviews, and let me now mention our business outlook. During the first quarters, we conduct an annual maintenance of our production facilities, because the hot weather is not suitable for our production. Annual maintenance will requires a temporary shutdown for all the production lines for approximately one month, which will correspondingly lower this quarter production volume. Reflecting the annual maintenance period sooner and lower average selling price, we currently estimate revenue for third quarter of 2014 will be in the range of RMB520 million to RMB540 million, a increase of approximately 0.4% to 4.2% over the same quarter of 2013. This forecast reflects our current and preliminary estimates of market and operating conditions and customer demand which are all subject to change.

This concludes our prepared remarks. Operator, we will now open the call up for questions.

Question-and-Answer Session


(Operator Instructions). Your first question comes from the line of Hover Chen from Caledonia Investments. Please ask the question.

Hover Chen - Caledonia Investments

Hi. Thanks for taking my question. I have two questions. First thing is, do you expect the third quarter of 2014 gross margin will remain stable? Or will it decrease from that of the previous quarter level?

And the second question is, how do you say the ASP trend for EA in the rest of this year? Thank you. And then I have a follow-up.

Terence Chen

Thanks for the question, Hover. Now let me answer the first question about the gross margin in that quarter. Well, as we discussed in our prepared remarks, they are currently in inverse relationship to ASP of edible alcohol and the corn price. So we anticipate that the gross margin for third quarter will be lower from that of the second quarter, because that we all know, we will conduct the annual maintenance in third quarter. So the utilization rates will be definitely lower than the current quarter. However to compare to third quarter of 2013, the ASP of edible alcohol will be lower in the next quarter. But our corn cost is also lower. So we think we can maintain a similar gross margin level on a year-over-year basis.

And your second question is about the ASP trends for edible alcohol. Right?

Hover Chen - Caledonia Investments


Terence Chen

Yes. As we have mentioned in our prepared remarks, with the coming to the carnivals in China in September and October, I mean the Mid-Autumn Festival and then the national holidays, the demand from baijiu is firming which will help to stabilize our ASP for edible alcohol by August and in September. However, we do remain cautious for the later months of the year.

Hover Chen - Caledonia Investments

Yes. Okay. My follow-up is about the competition landscape for EA, because the depressed market environment has resulted in a squeeze for EA producers. Are you seeing the smaller EA producers being forced to shut down? And will you consider doing merger and acquisitions? Thank you.

Terence Chen

Yes, Hover. You are correct about the against the tough industry fundamentals, more and more of us, more of edible alcohol producers are being squeezed out form the industry. And we believe this will help to improve the balance of supply and demand for the entire edible alcohol industry in the long future. And we also capitalize that smaller producers cease the production. Many of them are hoping to be acquired by industry leaders like Borun and we also continue to evaluate every strategic opportunity.

We feel that it is more prudent for Borun to reduce M&A at this point in time. We have two reason. The first is that we are currently running at below 100 % utilization and given the weakened market demand, we don't think it is very good time to acquire additional capacity. And the second reason is that we are having initial success with our new CPE and foam insulation businesses. It is true, we have already hit 100% utilization in our CPE plant and we still need time to further ramping up our foam insulation business.

Hover Chen - Caledonia Investments

Okay. Thank you.

Ann Yu

Thank you.

Terence Chen

Thank you, Hover.


Thank you. Your next question comes from the line of Sarah Dai from Hillhouse Capital. Please ask your question.

Sarah Dai - Hillhouse Capital

Hi. Thanks for taking my question. My first two question is actually regarding your new product lines, the CPE and foam insulation. If I hear it right, if the CPE has already reached its full capacity in the second quarter, does it mean that quarterly revenue contribution of about RMB22 million is already the most revenue that the CPE could deliver?

Ann Yu

Thank you for the question, Sarah. Yes, we reached 100% capacity in second quarter. But I want to emphasize that our CPE reached full capacity only in June, and it was below full capacity in the months before that. So as such, if our CPE runs at full capacity for a full quarter, we expect the revenue trend, again, the (inaudible) from CPE products will reach roughly RMB7 million per quarter. Thank you.

Sarah Dai - Hillhouse Capital

Okay. That's very helpful. So what's the current utilization rate for the other products, the foam insulation? And how long do you think you need to dully ramp up this line?

Ann Yu

Currently in the second quarter, our foam insulation is running at roughly 20% capacity. And as you know, our CPE have reached at full capacity because we have been a little more focused on ramping up CPE, which proved to be very successful. And now we are paying greater attention on our foam insulation business, as foam insulation comes in many different sizes and shapes and we have announced that the high-end segment that requires more customization. So it would take a longer time to fully ramp the foam insulation business. But we think particularly the high-end customized market segment will be sustainable for us, for the whole company in the long run. Thank you.

Sarah Dai - Hillhouse Capital

Okay. So do we have an estimate of how long do you need to fully ramp up? A few quarters? Or?

Ann Yu

Yes. So we still need a few quarters to fully ramp up the foam insulation.

Sarah Dai - Hillhouse Capital

Okay. I still have a follow-up question regarding your key raw material, the corn. So you just mentioned that there are drought happening in many provinces in China. So I am wondering how serious is this going to impact your cost of corn this year? And how do you see that corn price trend for the rest of the year?

Terence Chen

Yes. We have also noted that there are serious drought in Henan as well as Jilin provinces, two of China's top corn producers and this will surely push higher the cost of corn. But as we have mentioned, we still have 400,000 tons of purchased corn in inventory, which should be adequate for our production trends through November. So although we are seeing the spot price of corn turning up this August, but benefiting from our stocking strategy. As I have just mentioned, we can buffer against the higher cost of corn price. And also it is important to know that also most of the corn for upcoming harvest season has already been planted. There is still another four to five months into harvest. So if we get a decent amount of rain in September or October, we could still end up with a good harvest season coming up.

Sarah Dai - Hillhouse Capital

All right. That's helpful. Thank you. That's all my questions.

Terence Chen

Thank you.


Thank you. I would now like to hand the conference back to today's presenter. Please continue.

Terence Chen

Once again, on behalf of the entire China New Borun management team, we want to thank you for your interest and participation in this call. Thank you for joining us today and this concludes our second quarter 2014 earnings conference call. Thank you very much.


Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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