China New Borun's (BORN) on Q3 2016 Results - Earnings Call Transcript

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China New Borun Corporation (NYSE:BORN)

Q3 2016 Earnings Conference Call

November 23, 2016 8:00 AM ET


Yuanqin Chen - Chief Financial Officer

Bing Yu - Chief Strategy Officer


Sarah Dai - Hillhouse Capital Group

Albert Chan - Prime Capital Group


Good day, everyone and welcome to the Third Quarter 2016 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 the discussion today will contain certain forward-looking statements made under the Safe Harbor provisions of the U.S. 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 28, 2016. The Company does not assume any obligation to update any forward-looking statements, except as required under applicable law.

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

Yuanqin Chen

Thank you everyone for joining us for China New Borun’s third quarter 2016 earnings conference call. Joining me today from management is Ann Yu, the Company’s Chief Strategy Officer.

For today’s call, I will represent Mr. Wang in providing you with a quick review of our business and industry dynamics in the third quarter of 2016. Following that, Ann will offer more details on our operational developments and updates. After Ann, I will discuss 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.

Driven by strong demand from the baijiu industry in the third quarter of 2016, we exceeded our previous revenue guidance and set a new sales volume record for edible alcohol at China New Borun as we produced and delivered more than 94,300 tons capacity with validation of 98%. This year’s mid-autumn and national holidays spot even greater baijiu consumptions throughout China continuing the momentum of positive consumption again for fifth consecutive quarter.

According to research by [Guoxiang] securities, total sales of baijiu increased by 16% in the third quarter 2016, which is nearly twice the Euromonitor International’s estimated annual growth rate of 8.3% for China's overall spirit industry in 2016. The strong baijiu industry growth demonstrates the successful transformation of previously stated industry into a fast moving group that has quickly diversified product and embraced e-commerce to drive greater mass consumption.

The transformation has also caused with Tier 2 brands and in the third quarter it is very encouraging to see that Tier 2 brands outfit the Tier 1 brands with year-over-year growth rate of 20% and 14% respectively. Benefiting from strong sales growth, the baijiu industry as a whole continues to gain better operating leverage and to the majority of Asia listed baijiu manufacturers reported higher profitability during the third quarter.

Once again, we believe the full-year transformation of the baijiu industry has proven quite successful and we believe the improved industry fundamentals continue to set a solid foundation for future demand of edible alcohol. While the overall demand for edible alcohol was robust, the supply of edible alcohol expanded even faster than expected fueled by the lowest corn prices in recent years prompted by cheap supply of corn many smaller edible alcohol producers reentered the industry and aggressively pursued sales with a rationale low prices.

The combination of a spiking supply and aggressive pricing by new entrants led to a bios market and caused our overall ASP of edible alcohol in the third quarter to sharply jump by17.1% compared with the same period of last year. We believe the soft ASP for edible alcohol will eventually cause those thin new entrants to reconsider their pricing strategy towards a more sustainable level.

As for corn prices the Chinese government sees to renew its corn research purchase program this year in order to allow corn prices to fund market driven levels which should eventually approximate those of the international market. The government action is widely viewed as one of the biggest agriculture reform in nearly a decade and the prices have fallen to record low levels in recent years.

Although it is estimated that China's total corn planting area shrunk by more than 1.3 million hectares this year which is the first drop in 13 years with harvest season farmers are still adapting to market driven price mechanism. Without price support from the state for the first time in nine years, the early harvest spot price of corn as grain market Shandong Province this October was roughly RMB5 or more than 25% less than at the same period of last year.

Amid growing concerns as prices could fall even further, the government has started early in state-owned firms to activate participate and purchase corn and is expected to unveil other measures aimed at [selling at supply support]. We anticipate corn prices will remain at these low levels as farmers continue to further adjust to market mechanism.

However, as corn prices had already jumped by 25% to 30% thus far in 2006, we believe the price decline in 2007 where being more modest and may even stabilize by the second quarter of next year. When corn enters its new harvest season, encouragingly we noticed that this harvest season corn prices stabilized and even improved slightly in November. As corn prices stabilized, we believe the supply in the pricing for edible alcohol will improve and we anticipate our profitability profile for next few months will gradually normalize.

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

Bing Yu

Thank you, Terence, and good day everyone and appreciate you taking the time to join us on today’s call. We are pleased to achieve the new record at Borun’s for sales volume of edible alcohol which grew by 13.5% year-over-year to nearly 94,350 tons in the third quarter of 2016. This represents a production utilization rate of 98% and as such from an internal view of operations those of our production facilities were running with high efficiency during the quarter.

However, as Terence had discussed earlier due to the variety of imbalance for us in edible alcohol industry, our average selling price for edible alcohol declined by 17.1% year-over-year to RMB4,281 per ton regaining our volume again. Comparatively during the quarter, our average corn cost decreased by only 12.5% year-over-year and as a result our gross margin contracted to 5.4% versus 9.9% in the third quarter of 2015.

Specifically in the third quarter, our branded cost of corn increased 11% quarter-over-quarter to RMB1,721 per ton as we were using after remainder of our purchased corn. During the same period the corns spot price decreased by about 5% to 8% from that of the second quarter. As previously discussed since the government state its corn reserve purchase program, the spot corn price in China had dropped significantly over the past few quarters.

Although we had anticipated with near-term price direction, we were surprised by the space and magnitude after collapse in the corn price and this is also example of the negative side of our surplus strategies as well as many other purchasing strategies where locked in prices can be higher than spot prices in an environment where there is sub job in the commodity price.

As you may recall the purchasing of corns have been objective strategic hedging strategies which leverage our business stably and solid financial position to acquire enough corn in the harvest season in order to secure sufficient supply in latest reduction in our harvest season. In the past few years, our corn purchase strategy had provided us with significant cost advantages in a rising price environment. On the other hand this corn purchase strategy has opposite exact in the rapid declining price environment.

In our most recently purchase program, we have lowered our annual purchase volume historically more than 400,000 tons to 300,000 tons. For this harvest season, we have not yet made final description on our corn purchase trend as we will watch the market closely and adjust our purchase trend economy.

Naturally, we believe our purchase volume during this harvest year is very much smaller than in previous years. Nevertheless as we - back to fully use up our corn storage by the end of November, we anticipate our gross margins will gradually normalize towards the highest single-digit range.

For by-products on edible alcohol, DDGS Feed delivered a strong performance and contributed to RMB135.7 million to total revenues. Noticeably, the price on DDGS Feed increased by 12.6% in the past quarter compared with a sharp decline of 23% from the second quarter of 2015 to the second quarter of 2016. As we have discussed in our previous call, the reversal price trend of DDGS Feed was too good for the second antidumping investigation launched by China’s Ministry of Commerce to what DDGS Feed produces in the United States.

Since our public hearing held in early August it was widely expected that there would be tariff on U.S. imports at a rate of up to 30% to 40%. On September 23, 2016, the Ministry of Commerce ordered preliminary import duties of 33.8% on U.S. or regional DDGS Feed, effectively, significantly and correspondently supplies of DDGS rebounded during the third quarter. We are confident the price of DDGS Feed will continue to be quite healthy and DDGS Feed will generate solid revenue contribution in the upcoming quarters.

Now looking at our CPE business, during the third quarter of 2016, our CPE revenue totaled RMB37.2 million, an improvement of 46% over RMB25.4 million in the previous quarter. Our CPE plans in the third quarter operated utilization rate of approximately 72%. And more importantly, the average selling price of CPE was relatively stable over the past year. We are confident this production line will continue to contribute stable revenue in the upcoming quarters.

Before I hand the call over to our CFO to discuss financial details, I would like to quickly brief you on our recent financials that issuance of our five-year fixed-rate private placement Corporate Bonds on November 2, 2016. Pursuant to the registered plan submitted with Shanghai Stock Exchange, The Bonds were issued at a face value with a simple interest rate of 6.5% per annum. We will make annual interest payment of RMB19.5 million commencing November 2, 2017.

We paid three annual installment of RMB100 million for the principal portion of The Bonds commencing November 2, 2019. We are well pleased that The Bonds were guaranteed by China United SME Guarantee Corporation and received an investment-grade rating of AA- by one of China's notable independent rating agencies, validating our strong financial position and consistently positive annual net income. This year's Corporate Bonds fixed-rate of 6.5% is a noticeable improvement from the 2013 Corporate Bonds fixed-rate of 9.3%.

With the [proceeds from] our Corporate Bonds, we now have cash on hand of almost RMB1.3 billion and nearly US$200 million, and as such, we are confident about our ability to execute on our objectives for the remainder of 2016 and our strategic initiatives of 2017.

And that wraps up my part. Now, let me turn the call over to Terence Chen, our Chief Financial Officer for review of the financial performance in the third quarter of 2016.

Yuanqin Chen

Thanks, Ann. Now turning into details about our financial performance. For the third quarter of 2016, revenue decreased by 8.9% year-over-year to RMB602.2 million from RMB661.4 million in the same period of 2015. The decrease in revenue was mainly due to a sharp decrease in ASP for edible alcohol and its by-products, and lower sales from crude corn oil.

Looking at the revenue breakdown during this quarter. Revenue from edible alcohol decreased by 5.9% to RMB403.9 million. Sales volume increased by 13.5% to approximately 94,350 tons, but the average selling price decreased by 17.1% to approximately RMB4,280 per ton compared with the same period of last year.

Revenue from DDGS Feed decreased by 3.3% to RMB135.7 million as sales volume increased by 11.7% year-over-year to approximately 80,750 tons, while average selling price decreased by 13.4% year-over-year to approximately RMB1,680 per ton.

Revenue from liquid carbon dioxide decreased by 17.1% to RMB6 million as sales volume increased by 11% year-over-year to approximately 35,230 tons while average selling price decreased by 25.3% year-over-year to approximately RMB170 per ton.

Revenue from crude corn oil decreased by 51.4% to RMB19.5 million as sales volume decreased by 51% year-over-year to approximately 3,080 tons while average selling price decreased by 0.9% year-over-year to approximately RMB6,320 per ton. The significant decrease in revenue from crude corn oil is due to shutdown of this production line Daqing facility.

Total revenues from CPE decreased by 16.4% to RMB37.2 million as sales volume decreased by 12.9% year-over-year to approximately 4,530 tons, while average selling price decreased by 4% year-over-year to approximately RMB8,210 per ton.

Our gross profit decreased by 50.9% to RMB32.6 million from RMB66.3 million in the prior year period. Gross margin contracted to 5.4%, compared to 10% in the third quarter of 2015. G&A decreased by 23.1% to RMB10.5 million in the third quarter of 2016, from RMB13.6 million in the same period of last year while selling expenses decreased by 49.9% to RMB1 million in the third quarter of 2016, from RMB1.9 million in the same period of last year.

Reflecting the lower gross profit partially offset by saving in operating expenses, operating income for the third quarter 2016 was RMB21.1 million, a decrease of 58.4% from RMB50.7 million for the third quarter of 2015.

During the third quarter of 2016 we were able to lower interest expenses by 52.2% to RMB11.1 million from RMB21.8 million in the same period of 2015. As you may recall, we have been proactively retiring our Corporate Bonds that we issued in 2013 with a carrying interest rate of 9.3%. And this April we completed this process, thereby greatly reducing our interest expenses.

Income tax expenses in the third quarter of 2016 were approximately RMB2.7 million, representing an effective tax rate of 25%. All-in-all, our net income decreased by 63.2% year-over-year to RMB8 million from RMB21.8 million a year ago. Diluted earnings per share and per ADS were RMB0.31 in the third quarter of 2016. The Company had 25.7 million weighted average basic and diluted shares outstanding during the quarter ended September 30, 2016.

On balance sheet side, our cash and bank deposits balance increased to RMB990.7 million as of September 30, 2016 compared with RMB495.6 million by the end of 2015. The increase of cash and bank deposits was mainly attributable to usage of pre-purchased corn during the quarter.

Cash flows provided by operating activities for the third quarter 2016 were approximately RMB382.1 compared with RMB624 million during the same period of last year. As of September 30, 2016, our inventory balance totaled RMB296.7 million and net trade accounts receivables balance totaled RMB395.9 million. And that wraps up the financial review, and let me mention our business outlook.

Reflecting a sharp year-over-year decrease in ASP for edible alcohol and its by-products, we estimate that revenue for the fourth quarter of 2016 will be in the range of RMB480 million to RMB530 million, a decrease of approximately 24.2% to a decrease of 31.3% over the same quarter of 2015. This forecast reflects our current and preliminary estimate of market and operating conditions and customer demand, which are subject to change.

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

Question-and-Answer Session


Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Ms. Sarah Dai of Hillhouse Capital. Please ask your question.

Sarah Dai

Hi. Thank you for taking my questions. Could you please walk us through on this sequential increase of your corn cost, I think it’s up by over 10% in light of this downward trend of spot price of corn?

Yuanqin Chen

Thanks for your question, Sarah. We have mentioned in our script, our hedging strategy cost and negative impact on our corn cost during this quarter. Our hedging strategy failed to stabilize our corn cost in a new harvest season – in this new harvest season when we [indiscernible] declining price environment.

Sarah Dai

Okay. So overall how do you anticipate your cost of corn for the next two quarters?

Yuanqin Chen

As we during at all the remaining for purchased corn by the end of November, we could also take advantage of the new corns in this harvest season and our overall corn cost will be definitely lower than this quarter.

Sarah Dai

Okay. I have another question regarding your guidance, so ASP of edible alcohol was down by I think 15% to 20% year-over-year. However, your guidance is a decrease of 24% to 31% which seems to be a little weak especially considering this strong pricing for DDGS Feed. Could you also provide us some more color on the guidance?

Yuanqin Chen

Yes. The ASP of edible alcohol was decreased by approximately 17% year-over-year. And you may recall, the Company usually performed annual maintenance in the third quarter and you should be noted that our utilization rates for this third quarter is nearly 98%, so that means we delayed our annual maintenance to the fourth quarter I mean in October. In October, we ceased operation and performed our annual maintenance for about one week and that caused the expected lower production volume in the fourth quarter. So despite…

Sarah Dai

Okay. That’s helpful.

Yuanqin Chen

Okay. Thanks for the question.

Sarah Dai

Okay. Thank you, Terence.


The next question comes from the line of Albert Chan of Prime Capital. Please ask your question.

Albert Chan

Yes. Thank you for taking my questions. I just have a couple of quick questions on your Corporate Bonds. Could you please provide us with a little more color on your plans for the proceeds from the recently issued Bond?

Yuanqin Chen

Thanks for the question, [Brian]. With the successful issuance of our Corporate Bonds in November, we may have more flexibility to choose our strategies. The Company may rely on the Corporate Bonds to perform some industry transformation and also some equipment upgrading for us to improve our profitability in the future.

Albert Chan

Okay. And regarding The Bond itself, I noted you provided the annual cost on the interest, but how would that impact your financing cost on a quarterly basis?

Yuanqin Chen

We issued this bond with annual fixed rate of about 6.5% with annual interest rate and the annual interest expense will be RMB19.5 billion which split into every quarter with less than RMB5 million.

Albert Chan

Okay. Great. Thank you. That’s all I have.

Yuanqin Chen

Thank you.

End of Q&A


Thank you. At this time, I would now like to turn the call back to the management for closing remarks.

Yuanqin Chen

Once again, on behalf of the entire China New Borun management team, I want to thank you for your interest and participation in this call. Thank you for joining us today and it concludes our third quarter 2016 earnings conference call. Thank you again.


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

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