Dali Foods IPO to quench thirst for non-bank paper

Chinese food and beverage manufacturer hopes to replicate success of IMax China with a flotation that satisfies investors' appetite for non-financial sector paper.
Can Dali Foods pep up Hong Kong IPO sentiment?
Can Dali Foods pep up Hong Kong IPO sentiment?

Chinese food and beverage manufacturer, Dali Foods, has begun pre-marketing an initial public offering in Hong Kong, which should not only provide welcome diversification from the year's heavy supply of financial sector paper, but may also benefit from improving market sentiment.  

Global equity markets have been re-bounding since early October and were given a new boost last week following Thursday's dovish comments by the European Central Bank and Friday's rate cut by the People's Bank of China (PBoC).

How long it will last divides opinion. In a research piece published on Monday, BoCom argued that "with the PBoC cuts as a trigger, sentiment should trump fundamentals in the near-term and stretch the bear market rally."

As such investors believe IPO candidates should take heed of market volatility by not trying to push valuations and instead provide primary markets with a much-needed confidence boost. 

Many mainstream international accounts were wrong-footed by the pricing of China Reinsurance Group's HK$15.58 billion ($2.10 billion) IPO at the top of its indicative range at the beginning of last week. Shortly before the deal closed, price guidance had been at the mid-point, a level where international accounts felt the deal stood a chance of bucking recent precedent and trading up.

As it was, shares began trading on Monday at HK$2.70 and ended flat on the day. 

"China Re only managed to hold its head above water because overall market sentiment turned between pricing and listing" one investor told FinanceAsia. "It was really not priced to trade up at all."

Instead, investors will be hoping Dali Foods offers the same kind of upside as IMAX China's recent HK$2.2 billion ($283 million) flotation. Since listing at HK$31 per share on October 8, the film technology group has so far delivered upside of 30.9%.

Likewise, clothing manufacturer Regina Miracle attracted strong institutional demand for its HK$1.685 billion ($217 million) IPO, which priced at HK$5.6 per share and closed Monday at HK$6.59, up 17.6% since its listing date on October 7.

"There has been a noticeable shift in sentiment," one banker commented. "Global long only investors are definitely more interested in China consumer stories as long as they are market leaders."

This means that joint sponsors Bank of America Merrill Lynch and Morgan Stanley may not pre-package Dali Food's deal with a large number of Chinese cornerstone investors. One observer said there may be a limited cornerstone tranche with a handful of international accounts, but the general idea is to create a true institutional deal.  

Pre-marketing began last Thursday, with formal roadshows scheduled to begin around November 5. Pricing is slated for the week of November 16 and listing around November 24. 

Appetising valuation?

According to one investor the 1.7 billion all new share offering is being pre-marketed with a fair value of $10.5 billion to $13.4 billion based on Morgan Stanley's 2016 estimates. Given the company is set to offer 12.4% of its enlarged share capital pre-greenshoe, this equates to a fair value IPO range of $1.24 billion to $1.66 billion.

In terms of valuation, this represents roughly 19 to 25 times forecast 2016 earnings. After applying an IPO discount, pricing about 10% below the bottom end of the fair value range would place Dali Foods on a par with lower-growth consumer staple companies such as Want Want and Tingyi. 

Pricing towards the top end of the fair value range would place it line with higher-growth companies such as Uni-President, which is currently commanding a higher valuation because it has been able to consistently underpin revenues with new product launches.

At Monday's close, Uni-President was trading on a 2016 forward multiple of about 25 times earnings, but is down 8.68% year-to-date. The consumer staple sector has long been an investor favourite, but has underperformed the general market so far this year as investors worry about slower earnings growth.

Tingyi is down 22.25% to trade at 20.5 times 2016 earnings, while Want Want is down 37.57% to trade around the 16 times level. 

International comparables have fared much better. In Korea, Orion Corp derives roughly half its revenues from China and is currently valued at 24 times 2016 earnings. The sweet snacks group is down 2.5% year-to-date. 

In the US, dairy-based food and beverage producer WhiteWave is trading at 28 times 2016 earnings and is up 14.69% year-to-date.

Branding for Chinese taste buds

Dali Foods has been positioning itself as a more diversified operator than Uni-President as well as a truly homegrown private sector Chinese company with an inherently better understanding of local tastes than its three big Taiwanese rivals.

The company's strategy has been built on taking successful global food and drink products then creating its own brands based on Chinese tastes. For example, it big new product launch of 2013 was Hi-Tiger, China's answer to Red Bull, while its Copico brand is China's version of Pringles.

Dali Foods has successfully built its businesses providing copycats or Chinese derivatives of successful Western brands. But growing competition means that it could, in turn, be at mercy of being undercut by local rivals. 

So far, successful product innovation has resulted in strong net income growth over the past few years. Profits rose 71.9% in 2013 and 74.4% to Rmb2.076 billion ($327 million) in 2014.

In the first half of 2015 net profit rose 46.6% compared to the same period last year.

In its research report, Morgan Stanley forecasts more conservative profit growth of 20% in 2015 and the same again in 2016, with gross profit margins remaining stable around the 33% to 36% mark. 

One key consideration will be how successful the 16 food products and six beverage products in the company's R&D pipeline will prove to be. In 2014, new products accounted for 33.5% of sales. 

The company's most popular new brand, Hi-Tiger, reported sales growth of 101.4%, in the process creating one of China's most popular energy drinks in the space of just two years.

"Dali Foods has a big R&D facility," one sector specialist noted. "It generated feedback that Chinese lorry drivers work much longer shifts than their Western counterparts and were looking for bigger cans than is generally the norm so that is what the company delivered."

Other products catering to Chinese tastes include Dali Food's longest-standing product, custard pies, which it first began selling in 2002. In 2007 it introduced the kind of breakfast victual that no Scot would ever recognise - silver ear fungus and lotus seed mixed porridge.

The company has six main product lines.

Breads, cakes and pastries operate under the Daliyuan brand and accounted for 35.3% of revenues in 2014. The company had a 21.4% market share at the end of that year according to Frost & Sullivan, giving it the country's leading brand by sales.

Crisp-based snack foods under the Copico brand accounted for 11% of revenues and had a 15.1% market share in 2014, making Dali Food's the third largest domestic player.

Biscuits are sold via the Daochidian label and contributed 8% of 2014 revenues. Dali Foods is the largest domestic player by sales. 

Herbal drinks come under the Heqizheng label and contributed 17% of 2014 sales. The company is the third largest producer of ready-to-drink herbal tea.

Plant based drinks largely derive from its peanut drink, which was launched in 2010 and now accounts for 12.1% of revenues, while other beverages accounted for 8.9%.

Finally energy drinks under the Hi-Tiger label accounted for 7.5% of 2014 sales.  

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