Vinda International: Premiumization Remains Key Long-Term Growth Driver

Summary

• The coronavirus pandemic had a negative impact on Vinda International's revenue in 1Q2020, but that was outweighed by the company's profit margin expansion.
• A spike in wood pulp prices and price competition are the key downside risks for margins, but Vinda International remains confident in achieving a double-digit operating margin for FY2020.
• Premiumization is a key long-term growth driver for Vinda International, and the proportion of revenue contribution from higher-margin premium products continued to grow in 1Q2020.
• Vinda International trades at 16.7 times consensus forward next twelve months' P/E, and it offers a consensus forward FY2020 dividend yield of 1.8%.
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Elevator Pitch

I maintain my "Bullish" rating on Hong Kong-listed Asian hygiene company Vinda International Holdings Limited (OTC:VDAHF) (OTCPK:VDAHY) [3331:HK].

Vinda International's profit margin expansion in 1Q2020 more than offset the negative impact of the coronavirus pandemic on its sales. The company is still targeting a double-digit revenue growth for FY2020, despite downside risks from the Southeast Asian market and B2B sales channel in 2Q2020. Vinda International's net profit grew by +64.8% YoY in 1Q2020, as the company's gross margin expanded by +11.2 percentage points to 37.5%. A spike in wood pulp prices and price competition are the key downside risks for margins, but Vinda International remains confident in achieving a double-digit operating margin for FY2020.

Premiumization remains a key long-term growth driver for Vinda International, and the proportion of revenue contribution from higher-margin premium products continued to grow in 1Q2020, which justifies my "Bullish" rating on the company. Furthermore, the company's valuation remains reasonable. Vinda International trades at 16.7 times consensus forward next twelve months' P/E, which represents a discount to its historical five-year and 10-year mean consensus forward next twelve months' P/E multiples of 20.6 times and 19.1 times respectively. The stock also offers a consensus forward FY2020 dividend yield of 1.8%.

This is an update of my prior article on Vinda International published on January 31, 2020. Vinda International's share price has increased by +22% from HK$18.94 as of January 30, 2020 to HK$23.10 as of April 29, 2020 since my last update.

Readers are advised to trade in Vinda International shares listed on the Hong Kong Stock Exchange with the ticker 3331:HK, where average daily trading value for the past three months exceeds $9 million and market capitalization is above $3.5 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Impact Of Coronavirus Pandemic

The coronavirus pandemic had a negative impact on Vinda International's revenue in 1Q2020, but that was outweighed by the company's profit margin expansion.

Vinda International's top line decreased by -16.2% YoY, or -12.4% YoY in constant currency terms, to HK$3,419 million in 1Q2020. In the company's 1Q2020 financial results announcement released on April 22, 2020, Vinda International attributed the weak revenue growth to "the slower growth of mainland China which (was) mainly due to temporary supply shortage of products."

But the YoY revenue decline for Vinda International is not likely to continue into 2Q2020 and the remainder of the year. Market consensus expects the company to grow its revenue by +8.4% YoY from HK$16,074 million in FY2019 to HK$17,425 million in FY2020. This represents a +8.4% YoY top line growth, which is on par with the +8.0% YoY revenue growth achieved for FY2019.

At the company's 1Q2020 earnings call on April 23, 2020, Vinda International highlighted that "production is basically back to normal everywhere" and "across China, all the factories are working well." The company also noted in the earnings call that it is currently "operating at 90% plus utilization" and it does not "foresee any short-term supply issues due to raw materials, packaging materials or anything else." Vinda International's production facilities in Hubei province were closed till March 11, 2020, while its production facilities in other parts of Mainland China re-opened after February 3, 2020. Wuhan, the epicenter of the coronavirus pandemic, is the capital of Hubei.

The production disruptions and supply shortage that hurt Vinda International's sales in China in 1Q2020 are unlikely to be an issue for the company going forward. The key downside risks for Vinda International's revenue growth prospects in 2Q2020 come from the company's Southeast Asia business and the B2B (Business-to-Business) sales channel.

Vinda International noted in the company's 1Q2020 results announcement that "the business outside mainland China still maintained a good momentum" last quarter, which helped to partially offset weak revenue growth in China. The company cautioned at its 1Q2020 earnings call on April 23, 2020, that it expects "some small impact of the coronavirus in Southeast Asia for this and in particular for the second quarter" due to the "different timing of the pandemic being basically spreading to different countries." Vinda International does not disclose the company's revenue breakdown by geographic markets, but it is expected that the company still generates the majority of its revenue and earnings from Mainland China.

Vinda International also highlighted at the recent earnings call that "the channel which I see is the weakest in quarter two is the B2B because people are still at home" and "we still have home working therefore the offices are of less use than in normal times." The company derived 13% of its 1Q2020 revenue from the B2B sales channel.

Nevertheless, Vinda International is still targeting a double-digit revenue growth for FY2020, which implies that the company's sales have started to pick up in Mainland China, while the negative impact of the coronavirus pandemic on revenue growth in the Southeast Asia market and the B2B channel is likely to be milder than expected.

As opposed to the lackluster revenue growth last quarter, Vinda International's net profit grew by a very strong +64.8% YoY to HK$377 million in 1Q2020. The main driver of Vinda International's improved profitability was a +11.2 percentage points expansion in gross profit margin from 26.3% in 1Q2019 to 37.5% in 1Q2020. Lower wood pulp prices and an increase in sales contribution from higher-margin premium products were the key factors for the significant gross margin expansion, and these two factors will be discussed in subsequent sections of this article.

Pulp Price Spike And Price Competition Are The Key Downside Risks For Margins

Lower wood pulp prices drove Vinda International's gross profit margin expansion in 1Q2020, but it is uncertain if wood pulp prices will remain low for the rest of the year. As per the charts below, wood pulp prices have been on the decline since March 2019 and have remained low for the past year, but wood pulp prices have been trending up since the end of March 2020.

Wood Pulp Prices Between 2017 And 1Q2020

Source: Vinda International's 1Q2020 Financial Results Presentation Slides

Chinese Wood Pulp Prices In The Recent Three Months Up To End April 2020

Source: SunSirs Commodity Data Group

At the company's 1Q2020 earnings call on April 23, 2020, Vinda International noted that "my expectation is that the pulp prices will go up in the future" and "our overall profitability will be better than last year and clearly, maybe not as good as quarter four." But the company also emphasized that it "has the opportunity to retain a double-digit operating margin" if the rise in wood pulp prices was gradual and happened over a period of time (versus a sudden spike). Vinda International achieved operating margins of 15.4% and 9.8% in 1Q2020 and FY2019 respectively, and market consensus expects the company to deliver a 12.4% operating margin in FY2020.

Apart from wood pulp prices, another key risk factor for Vinda International's FY2020 profitability is price competition, which could potentially have a negative impact on profit margins. Historically, the company's competitors in the Chinese tissue market have typically engaged in price competition, when wood pulp prices were low. It is difficult to predict the actions of competitors, but it is reassuring that Vinda International is clearly prioritizing profitability over market share or sales volumes.

Vinda International emphasized at its 1Q2020 earnings call on April 23, 2020 that the company "will not engage in a significant price war but we will continue to build our premium section of our brand portfolio."

Company Continues To Make Good Progress On Product Premiumization

Vinda International highlighted in the company's 1Q2020 results presentation slides that the company continues "to invest for brand building with a focus on premium products" and its profitability enhancement will be driven by "portfolio management in tissue (segment) with focus on premium."

Margin pressures due to a spike in wood pulp prices or stiffer-than-expected price competition will be less of a concern, if Vinda International can increase its pricing power by growing its premium products portfolio and increase the sales contribution from such higher-margin products.

The company increased its proportion of revenue contribution of premium products in Mainland China from 20% in 1Q2019 and 21.8% for full-year FY2019 to 27% in 1Q2020. This implies that Vinda International has continued to make good progress with respect to its product premiumization strategy.

The recent coronavirus pandemic also had a positive effect on the penetration rate of premium products. Vinda International mentioned at the company's 1Q2020 earnings call on April 23, 2020 that "during the pandemic, people started to consider hygiene products as something totally essential" and "they are interested in what they were buying and the quality of the products they choose."

Valuation

Vinda International trades at 24.3 times trailing twelve months' P/E and 16.7 times consensus forward next twelve months' P/E based on its share price of HK$23.10 as of April 29, 2020. As a comparison, the stock's historical five-year and 10-year mean consensus forward next twelve months' P/E multiples were 20.6 times and 19.1 times respectively.

Vinda International offers a historical FY2019 dividend yield of 1.2% and a consensus forward FY2020 dividend yield of 1.8%.

Risk Factors

The key risk factors for Vinda International include weaker-than-expected revenue growth for the Southeast Asia market and the B2B sales channel in 2Q2020, an unexpected increase in wood pulp prices, stiffer-than-expected price competition, and a failure to increase revenue contribution from premium products.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VINDA INTERNATIONAL HOLDINGS LIMITED [3331:HK] over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.