A Look at Zhongpin's Modest Beat

Missed the fact that Zhongpin (HOGS) was reporting today; looks like a small beat and more importantly their major business metrics continue to improve. Share count unfortunately is up 50% year over year, diluting some of the gains away. Since this is the smallest company in the portfolio by a mile, I really like to delve into the earnings report even more so than larger companies whose quarter to quarter performance is not nearly that important to me, as it is to the lemmings than dominate Wall Street.

• Revenues for the first quarter of 2008 increased for the tenth consecutive quarter to a record $108.7 million, up 94.9% from $55.8 million in the first quarter of 2007. Approximately 20% of the increase was from increased sales volume and the other approximately 80% was from higher average selling prices.
• Operating income for the quarter was $7.8 million, up 67.8% from $4.6 million for the comparable prior year period.
• Net income increased to a record $7.3 million, up 81.8% from net income of $4.0 million in the first quarter of 2007.
• Fully-diluted earnings per share for the quarter were $0.24, compared with fully-diluted earnings per share of $0.19 for the first quarter 2007.
• Weighted average fully-diluted outstanding shares for the first quarter of 2008 were 30,748,961, compared to weighted average fully-diluted outstanding shares of 20,982,304 in the first quarter of 2007.
• Zhongpin's strong revenue growth in the first quarter of 2008 was the result of increased prices for pork and pork products combined with increased sales to food service distributors and to restaurants and non-commercial customers.
• According to the Ministry of Agriculture of the PRC, the average pork price in the first quarter of 2008 increased 74.2% from the same period one year ago. (agflation!)
• For the quarter, chilled pork and frozen pork represented 50.7% and 36.9% of total revenue, compared to 51.0% and 36.4% in the same period of 2007, respectively.

By retail channel

• Revenue from Zhongpin's retail channels, including showcase stores, network stores and supermarket counters, represented 41.2% of total revenues. Revenue from retail channels rose 71.6% to $44.8 million, from $26.1 million in the first quarter of 2007. During the quarter, Zhongpin added seven new retail outlets, including one new showcase store, two new Zhongpin ''branded'' stores and four new supermarket counters, for a total of 2,946 retail outlets. Revenue from restaurants and non-commercial businesses represented 31.3% of total revenues in the quarter, up 138.0% to $34.0 million from $14.3 million in the same period a year ago. Food services distributors generated 25.4% of total revenues and showed the largest increase in revenue growth year-over- year, up 161.8% to $27.6 million from $10.6 million in the first quarter of 2007.

Gross margin

• Gross profit in the first quarter of 2008 was a record $14.2 million, up 83.3% from $7.7 million in the first quarter of 2007. Gross margin was 13.1% in the first quarter of 2008 compared to 13.9% in the first quarter of 2007. The year-over-year decline in gross margin was attributed to hog prices rising faster than the prices of pork products.
• Sequentially, gross margin increased 1.3 percentage points from 11.8% in the fourth quarter of 2007, due to stronger demand for pork consumption which was favorably influenced by the Chinese New Year holidays.

Expenses

• In the first quarter of 2008, general and administrative (''G&A'') expenses were $4.4 million, or 4.1% of total revenues, compared to $2.0 million, or 3.5 % of total revenues, for the same quarter last year. The significant increase of G&A expenses was primarily the result of increased expenses for compensation, advertising, training, amortization and depreciation.

Guidance

• Zhongpin plans to continue to expand its production capacity through both new facility construction and acquisitions. The Company is ahead of schedule in the construction of its western Henan Province facility in Luoyang City which is now expected to begin operations by the end of the second quarter of 2008. Zhongpin's eastern Henan Province facility in Shangqiu City is expected to begin operations in the fourth quarter of 2008. This is slightly behind schedule due to the delay of a waste water treatment facility to be built by local government outside of our facility. The new western and eastern facilities will add 70,000 metric tons and 80,000 metric tons annual capacity, respectively, of chilled and frozen pork. Once these facilities are completed, Zhongpin will have total capacity of 471,560 metric tons of chilled and frozen pork, excluding outsourcing from OEMs.
• In March 2008, Zhongpin began construction of a new prepared meat facility at Zhongpin's Industrial Park located in Changge City, Henan Province. The new facility will add 28,800 metric tons in annual capacity of prepared meat for a 114% increase over Zhongpin's current capacity of 25,200 metric tons, bringing total capacity of prepared meat to 54,000 metric tons. The facility is expected to begin production in September 2008.
• Based on its current expansion plans and its financial results in the first quarter, Zhongpin is confident it will meet its guidance for full year 2008 revenues in the range of $490 million and $520 million, gross margin between 12.6% and 13.0% and net income of between $30 million and $33 million, or between $0.98 and $ $1.07 per share, assuming a fully diluted share count of 30.7 million shares outstanding.

Disclosure: Long Zhongpin in fund; no personal position

Comments

[Chungst]

"Gross margin was 13.1% in the first quarter of 2008 compared to 13.9% in the first quarter of 2007. The year-over-year decline in gross margin was attributed to hog prices rising faster than the prices of pork products."

This reminds of elevator analysis, something I was trained never to do as an analyst. Elevator analysis is something like sales went up, but margins came down more than sales, and thus EBIT is lower than prior year (akin to movements of an elevator), respectively.

Stating the facts is nice and informative at a cocktail party, but it doesn't tell us the reason(s) why the facts happen as it did. Unless you know "why" gross profit declined, then you are just speculating because for we know, the company could have been testing a new product that positively impacted sales but since it carried lower margins, gross profit suffered. It could have been a timing issue as well. Anyone can make speculations.

Cheers.