Deutsche Bank initiates BUY call for China Fishery Group

October 7, 2010 10:14

China Fishery Group (CFG) looks poised to capitalize on increasing consumption of fish and rising fish prices, reports with reference to China Fishery Group.

It is a leading integrated commercial fisher operating in North Pacific, South Pacific and Peruvian waters. It is expected the company to deliver a 3 year earnings CAGR of 31% driven by a full catching season in the South Pacific, efficiency gains from its fishmeal and fish oil business in Peru and to benefit from an increase in fish prices over the long term. Deutsche Bank initiated with Buy and a target price of S$2.60, implying a potential total return of 28%.

Integrated commercial fisher with a sizeable trawling fleet and catch quota

The company is one of the largest integrated commercial fishers with fishing rights to vital sustainable fishing grounds around the world. CFG has a 20% market share of Pollock in Russia and a 17% market share in the South Pacific (Jack Mackerel) and Peru (Anchovy) via quota allocations and fishing licenses. CFG utilizes state-of-the-art technology on board its vessels and uses trawling and purse seining fishing methods to capture and process fish onboard and on land.

Potential catalysts to prompt a re-rating of the stock

CFG plans to:

(1) acquire more fishing quotas (in 1Q11) in Russia;

(2) reverse start­up costs in the South Pacific;

(3) expand its fishmeal and fish oil business in Peru;

and (4) target new fishing species and regions in Mauritania and Alaska.

It is believed that the price outlook for its three key catches - Alaska Pollock (eight-year CAGR of 9%), Jack Mackerel (nine-year CAGR of 13%) and fishmeal (12-year CAGR of 7%) - remains positive. This is driven by population gains, higher living standards, increasing health awareness and rising demand from aquaculture.

Outlook for the company and key catalysts to watch out for

China Fishery Group (CFG) is a leading integrated commercial fisher operating in North Pacific, South Pacific and Peruvian waters. The company operates over 60 fishing vessels and its major markets are China (66% of sales), Japan/Korea (16%) and Europe (11%). It is expected fish prices to continue to rise steadily on increasing worldwide demand driven by limited supply and stricter regulation. The quota restriction also acts as a significant entry barrier and the quota-controlled supply helps to underpin a structural and steady rise in fish prices.

The price of Alaska Pollock has been stable and has seen steady growth with an eight-year CAGR of 9%. It is believed that the price outlook for Alaska Pollock remains positive, driven by increasing demand for fish. Alaska Pollock has a wide usage from frozen fillets, roe and processed foods (e.g., surimi, fish fingers and ready-meals) for human consumption. The price of Jack Mackerel has increased at a nine-year CAGR of 13%, helped by the increasing usage of Jack Mackerel for human consumption. Rising demand for fishmeal and fish oil in China and a flat supply of fishmeal have lead to a steady increase in the price of fishmeal and fish oil, which has grown at a 12-year CAGR of 7%.

The company's share of Alaska Pollock was 5% in 2004 and this increased to 10% in 2006 and 20% in 2007. China Fishery Group's maiden entry into Peru's fishmeal market was in 2006 and over the past four years the company has made a series of acquisitions to expand its footprint to become one of the top five largest fishmeal producers in Peru. In total, the company has spent US$338.4m to acquire 41 fishing vessels and nine processing plants in Peru at 1.0x price to book and has a total plant capacity of 140k MT pa.

China Fishery Group's business is highly cash generative and we forecast it should generate a free cash flow of US$344m over FY09-12. The company has a net gearing target of 0.6x, which the company sees as a comfortable level given its strong cash flow generation. This would give the company a war chest of US$600m, which should facilitate the acquisition of future quotas, build up its fishing capabilities and ease entry into new fishing regions. If CFG were to utilize US$150m of the proceeds (US$190m private equity placement to Carlyle Group in June) to acquire more market share in Russia, this could add US$15m, or 8%, to our FY11E earnings based on an acquisition PE of 10x.

Trading at 12.2x and 8.9x FY10-11E PE; three-year EPS CAGR growth of 31%

The target price of S$2.60 is based on an 11x PE multiple on the FY11SepE EPS. It has cross checked the PE multiple using an ROE/COE model (ROE-g / ROE*(COE-g)) and DCF as a secondary valuation. The stock is trading at a 40% discount to its global peers and a 70% discount to its Chinese peers. Downside risks are climate change, regulatory, fuel costs, quotas and fish prices (pp 5 &13).

It is forecasted a three-year earnings CAGR of 31%, which would help to drive the stock's valuation down to 7.7x in three years' time (by FY12E). The earnings forecasts are 20% above consensus in FY11 as we expect the company to reverse its start-up costs in the South Pacific and achieve a higher earnings contribution from its Russian Peruvian fishing operations. And the target price of S$2.60 implies a total return of c.28%.


The key downside risks include:

1) changes in climate;

2) regulatory changes in Russia and Peru that might result in a reduction in the Total Allowable Catch (TAC)/ quota, which is set by the authorities;

3) a drop in the catch volume and/ or price of fish and its key products and;

4) increases in fuel costs, which could affect the company's profitability.

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