China | Packaged Food & Meats
WH Group (WHG) is the largest pork company in the world, with number one positions in China, the U.S. and key markets in Europe. Leading in all key segments of the pork industry, WHG’s global platform integrates hog production, hog slaughtering, processing and distribution of packaged meats and fresh pork.
The company owns 73% of Henan Shuanghui Development (000895 CH), which is listed on Shenzhen Exchange and is China's largest meat processing business, having acquired a 100% stake in the largest US pork company, Smithfield Foods (SFD) in 2013.
In China, persistently low hog prices favour WHG as more than 80% of China’s operating profit comes from the downstream packaged meat business. In the US, efficiency gains and synergies realised from the Smithfield integration are near-term drivers. For Smithfield, we believe the fall in fresh pork profit on weak pork price could be offset by the benefits from reduced tax rate post US tax reform, higher packaged meat profit and expansion in Europe. Product mix shift to high-end products and downstream business (lower earnings volatility) should drive re-rating in long term.
· US pork price to remain under pressure on elevated trade tension, -ve to US fresh pork business– Pork price in US dropped ~12% y/y in April-May from -5% in 1Q18, mostly due to the addition of slaughtering capacity and concern over trade retaliation against US. In addition to China, Mexico announced to impose 20% tariff on US pork products by 5 July. As Mexico and HK/China accounted for 40% of US pork export by value, pork price in US may remain under pressure in near term. This may hurt the profits of midstream fresh pork business which accounted for ~20% of WH group’s EBIT in 2017.
· Share price over-reacted and ignore the cost benefits for downstream– In fear of further drop in pork price in US, share price corrected by ~10% over the past two days. This is merely pricing in no profits from fresh pork business from US (2017: EBIT of USD433m), which we believe to be over conservative. Moreover, the low pork price sets to favour the downstream packaged meat business and offset part of the decline in fresh pork business. This could be overlooked by the market.
· Bumpy share price as trade negotiation ongoing, but further downside is limited. On lower US pork price assumption in 2018 (from flattish y/y to -15% y/y), we trim our earnings forecast by 10% and lower fair value estimate from to HKD9.5 (from HKD10.9). Recent share price correction has set the expectation for 1H18 result low. Stripping out the market value of its 73%-owned subsidiary Henan Shuanhui listed in China (000895 CH), the US and Europe operation (Smithfield) are implied to trade at only 7x 2018 P/E, which is much lower its peer who are also vertically integrated meat processor.
· We find deep value and limited downside in WH Group.