CHINA: Costs, competition hit profits at meat firm Zhongpin

By Dean Best | 9 November 2012

  • Q3 profits down despite sales increase
  • Hog, labour costs hit earnings
  • Zhongpin needed more promos to protect share 
Zhongpin said more promotions needed to protect market share

Zhongpin said more promotions needed to protect market share

Chinese meat processor Zhongpin has blamed higher costs and increased competition for a fall in quarterly profits.

Zhongpin said its net income fell 40% to US$11m in the third quarter of the year. Sales increased 4% to $415.7m but Zhongpin said more of its revenue came from cheaper products, which, combined with higher hog and labour costs hit profits.

The company, which is listed in the US, also pointed to "higher competition in the market" and the need for more promotions to protect market share.

Show the press release

 

Zhongpin Reports Higher Revenues and Lower Net Income for the Third Quarter 2012

 

BEIJING and CHANGGE, ChinaNov. 8, 2012 /PRNewswire-FirstCall/ -- Zhongpin Inc. ("Zhongpin" or the "Company," Nasdaq: HOGS), a leading meat and food processing company in the People's Republic of China, today reported higher sales revenues and lower net income for the three months ended September 30, 2012 compared with the third quarter 2012.

Third quarter 2012 highlights:

  • Sales revenues increased 4% to $415.7 million for the three months ended September 30, 2012 from $398.1 million in the third quarter 2011 primarily due to higher sales volume for pork products sold at lower average selling prices.
  • Net income decreased 40% to $11.0 million in the third quarter 2012 from $18.3 million in the third quarter 2011 primarily due to a lower gross profit margin, the cost of more employees to support expansion, higher salaries, higher promotional activities, rising labor and utility costs, and higher interest expenses. The higher expenses were mainly due to the higher volume of business and intense competitive pressure in the pork market.
  • Basic earnings per common share (based on net income attributable to Zhongpin shareholders) decreased 35% to $0.30 in the third quarter 2012 from $0.46 in the third quarter 2011. Weighted average basic shares outstanding decreased 7% to 37,198,909 shares in the third quarter 2012 from 39,918,816 shares in the third quarter 2011.
  • Diluted earnings per common share (based on net income attributable to Zhongpin shareholders) decreased 35% to $0.30 in the third quarter 2012 from $0.46 in the third quarter 2011. Weighted average diluted shares outstanding decreased 7% to 37,240,843 shares in the third quarter 2012 from 39,918,816 shares in the third quarter 2011.
  • 40,376,182 common shares were issued as of September 30, 2012, of which 37,209,344 were outstanding and 3,166,838 were held by Zhongpin as treasury shares.
  • The Company maintains its previous guidance for 2012. Zhongpin expects that sales revenues should be within a range of US$1.55 billion to $1.72 billion for 2012. Gross profit margin is expected to be within the range of 8.6% to 10.2%. Net profit margin is expected to be within the range of 3.3% to 4.2%. The resulting diluted earnings per share for the fiscal year endingDecember 31, 2012 is expected to be within the range of $1.36 to $1.92 per share, assuming average diluted common shares outstanding of about 37.5 million shares in 2012. Assumptions and judgments supporting the guidance are shown below.

Mr. Xianfu Zhu, Chairman and Chief Executive Officer for Zhongpin, said, "We achieved 4 percent sales revenue growth in the third quarter on higher tonnage at lower average prices, compared with last year's third quarter, in the face of intense competitive pressure. The competitive pressure in the market remains very high due, in part, to industry consolidation in the pork industry in China. Our costs continued to increase, mainly to support our current operations and planned expansions. While pork prices were generally lower, mainly due to intense competitive market pressure, hog prices also declined, but not as rapidly as pork prices. That is the primary factor for our lower gross profit margin in the third quarter compared with last year's third quarter.

Capacity and market expansions in 2012

Zhongpin is investing approximately $58.5 million to build a new production, research and development, and training complex in Changge, Henan province, excluding the cost of land use rights that it has already obtained. When completed, this new facility is expected to have an annual production capacity of about 100,000 metric tons for prepared pork products. Adjacent to this new production facility, Zhongpin plans to develop a center for research and development, training, and quality assurance and control. Construction for the first phase with a production capacity of approximately 50,000 metric tons for prepared pork products started in the third quarter of 2011 and was completed in the second quarter of 2012. Trial production was started in July 2012, and the plant has been in regular production since the end of September 2012.

Zhongpin established a joint venture company in June 2011, of which the Company owns 65%, with Henan Xinda Animal Husbandry Company Limited. The joint venture company is financed by capital contributions and bank loans. All capital contributions to the joint venture company have been made. The joint venture company is expected to provide 20,000 sire boars annually. Upon the completion of the building of infrastructures for sire boar breeding in the third quarter of 2012, Zhongpin leased the facility to a third party for annual rental in the amount of RMB5.0 million.

Zhongpin is investing approximately $18.0 million in a cold-chain logistics distribution center in Anyang, Henan province. This distribution center will have a temperature adjustable warehouse with a floor area of approximately 27,000 square meters, processing capacity, distribution center, and a quality control center. The distribution center will be used for third-party cold-chain logistics service. Zhongpin expects to put this distribution center into operation in the fourth quarter of 2012.

Zhongpin plans to invest approximately $87.5 million in a chilled and frozen food processing and distribution center in Kunshan,Jiangsu province, which is near Shanghai. The center will be built in three phases. The first phase will include a processing center, cold-chain logistics center, and business complex. Zhongpin expects to invest about $35.0 million on the first phase that should be put into operation in the fourth quarter of 2012.

Zhongpin is investing approximately $10.5 million in a by-product processing plant in Changge, Henan province. This facility will have a production capacity for 100 million meters of sausage casings and 300 billion units of raw material to make heparin sodium. The construction started in March 2012, and the new facility is expected to begin operations in the fourth quarter of 2012.

Zhongpin will be investing approximately $47.6 million to build a cold-chain logistics distribution center in Tangshan, Hebei province. This distribution center will have a 27,000 square meter temperature-adjustable warehouse, processing capacity, distribution center, and quality control center. This distribution center will be used for third-party cold-chain logistics service and is expected to be in operation in the fourth quarter of 2013.

As of September 30, 2012, Zhongpin had an annual capacity of 728,760 metric tons for chilled and frozen pork, 176,000 tons for prepared pork products, 20,000 tons for pork oil, and 30,000 tons for vegetables and fruits, for a combined total of 954,760 metric tons.

Guidance for the year 2012

Mr. Warren Wang, Zhongpin's Chief Financial Officer, said, "We are maintaining our prior guidance.

"Our guidance for 2012 is based on several assumptions that include:

  • Continuation of China's policies designed to stimulate domestic consumption and economic growth.
  • Average hog prices in China are expected to decrease about 15% to 20% in 2012 from 2011, based on the assumed forecasted trend for the supply of live hogs and the increasing cost to raise hogs.
  • A higher percentage of sales from our higher-margin chilled pork and prepared pork products in 2012 compared with 2011, while we plan to continue to increase sales volumes of processed pork products to optimize our product structure.
  • Average capacity utilization for the year of about 75% for pork products.
  • Increasing distribution efficiencies and reduction in the duration of delivery times through the expansion of our cold-chain logistics system, networks, and services.
  • Total government subsidies for Zhongpin are expected to be $5 million in 2012.

"In addition, we have assumed that the more aggressive price competition that we saw in the latter part of 2011 and the first quarter of 2012 will continue in 2012, especially aggressive promotion efforts by our major competitors.

"We have assumed that we will increase our expenses in four areas in 2012:

  • First, we will continue to build our brand more aggressively;
  • second, we will increase our  investments in human resources, especially in training and recruiting;
  • third, we will increase research and development for new customized products with different styles and tastes to further satisfy customer needs in different regions, with the objective of capturing more market share for prepared pork products; and
  • fourth, we will advance our information technology and information systems more  rapidly to support our cold-chain logistics system, optimize the structure of the supply chain, and to reduce the management cost.

"Lastly, we have assumed that the historical trend of increasing costs for labor, energy, environmental protection, and quality assurance and control will continue into the future, including in 2012.

"Given those comments and assumptions, we are maintaining our prior guidance.

"For the year 2012, we expect that Zhongpin's sales revenues should be within a range of US$1.55 billion to $1.72 billion.

"Gross profit margin is expected to be within the range of 8.6% to 10.2%.

"Net profit margin is expected to be within the range of 3.3% to 4.2%.

"Diluted earnings per share for the year 2012 are expected to be within the range of $1.36 to $1.92 per share, assuming average diluted common shares outstanding of about 37.5 million shares in 2012."

Sales revenues in the third quarter 2012

 

Total sales revenues increased $17.6 million or 4% to $415.7 million for the three months ended September 30, 2012 from $398.1 million in the third quarter 2011 primarily due to higher sales volume for pork and pork products sold at lower average selling prices.

The higher revenues resulted mainly from continued increases in the number of retail outlets, geographic expansion of its distribution network and processing facilities, and higher sales to chain restaurants, food service providers, and wholesalers and distributors inChina, and higher selling prices for prepared pork products, partly offset by lower average selling prices for chilled and frozen pork. The following table shows tonnage, sales revenues, and average price per metric ton by product division for the third quarters of 2012 and 2011.



Sales by Product Division
(unaudited)



Three months ended
September 30, 2012


Three months ended 
September 30, 2011


Metric
tons


Sales revenues (millions)


Average price per metric ton


Metric tons


Sales revenues (millions)


Average price per metric ton

Pork and Pork Products













  Chilled pork 


101,198


$        253.6


$        2,506


73,771


$          247.7


$         3,358

  Frozen pork 


38,101


84.9


$        2,228


33,045


93.0


$         2,814

  Prepared pork products 


28,754


72.3


$        2,514


21,600


52.4


$         2,426

Vegetables and Fruits 


5,733


4.9


$           855


6,034


5.0


$            829

Total


173,786


$       415.7


$        2,392


134,450


$        398.1


$         2,961

Chilled pork revenues increased on higher tonnage at lower average prices per ton. Chilled pork revenues increased 2% in the third quarter 2012 from the third quarter 2011. Chilled pork tonnage increased 37% and the average price per metric ton decreased 25% in the third quarter 2012 from the third quarter 2011. The higher revenues from chilled pork were mainly due to higher tonnage sold as a result of higher capacity, increased sales to existing customers, and increased volume of sales from new geographic markets, expanded points of sales, and added new customers, partly offset by the lower average selling price that resulted from fluctuations in market price for chilled pork or chilled pork-related products in a more competitive market.

Frozen pork revenues decreased on higher tonnage at lower average prices. Frozen pork revenues decreased 9% in the third quarter 2012 from the third quarter 2011. Frozen pork tonnage increased 15% and the average price per metric ton decreased 21% in the third quarter 2012 from the third quarter 2011. The lower average selling price of frozen pork products was the result of fluctuations in market prices for frozen pork or frozen pork-related products in a more competitive market, which was partly offset by higher tonnage sold.

Prepared pork revenues increased on higher tonnage at higher average prices. Revenues from prepared pork products increased 38% in the third quarter 2012 from the third quarter 2011. Prepared pork tonnage increased 33% and the average price per metric ton increased 4% in the third quarter 2012 from the third quarter 2011. Prepared pork products are becoming more important to our business since customers are increasingly demanding them for their flavor and convenience and are willing to pay higher average prices for these products. We plan to gradually increase sales from prepared pork products by increasing our brand recognition and expanding our capacity for these products.

Pork products totaled 98.8% of total sales revenues in the third quarter 2012 and 98.7% in the third quarter 2011.

Geographic coverage and distribution channels

The sales of pork and vegetable products are closely related to the particular regional markets in which our distribution channels are located. Therefore, the increase in metric tons sold in the third quarter of 2012 was partly attributable to our efforts to expand our geographic coverage and broaden our distribution channels since the third quarter 2011.

The following table shows sales revenues by distribution channel. In the third quarter 2012, sales to wholesalers and distributors accounted for 42% of sales revenues, restaurants and food services were 29%, retail channels were 27%, and exports were 2%.



Sales Revenues by Distribution Channel
(unaudited)

U.S. $ in millions except %


Three months ended 
September 30,


Net

c hange


Percent

c hange



2012


2011



Wholesalers and distributors 


$          172.8


$       152.9


$        19.9


13%

Restaurants and food services


122.1


113.9


8.2


7%

Retail channels 


112.7


120.2


(7.5)


(6)%

Export 


8.1


11.1


(3.0)


(27)%

Total


$         415.7


$      398.1


$        17.6


4%

 

The increase in sales revenues from different distribution channels was mainly due to the following factors: (a) our production capacity has increased because we completed the expansion of our facilities in Taizhou, Jiangsu province and in ChangchunJilin province inDecember 2011, and Changge, Henan province, in July 2012; to increase the utilization of our new facilities, we focused our sales efforts on the wholesalers and distributors, as it is easier to achieve higher volume sales within this channel; as a result, we had significantly higher sales in the wholesalers and distributors channel than in other distribution channels, with the overall capacity utilization rate maintained at a level consistent with that in the prior year; (b) we have built our brand image and brand recognition through general advertising, display promotions, and sales campaigns; (c) we have increased the number of stores and other channels through which we sell our products; and (d) we believe consumers are placing more importance on food safety and are willing to pay higher prices for safe food products.

As of September 30, 2012, Zhongpin's customers included 148 international and domestic fast food companies, 143 processing factories, and 1,395 school cafeterias, hotels, factory canteens, army bases, and government departments. As of September 30, 2012, Zhongpin also sold directly to consumers in 3,447 retail outlets in China.

The following table shows the retail channels and number of stores and counters that generated sales volume in the third quarters of 2012 and 2011.

 



 Numbers of Retail Stores and Counters
(Generating Sales Volume, unaudited)



As of September 30,


Net 
change


Percent

change

Retail channels


2012


2011



Showcase stores


159


164


(5)


(3)%

Branded stores 


1,352


1,239


113


9%

Supermarket counters 


1,936


2,016


(80)


(4)%

Total


3,447


3,419


28


1%

 

Geographic expansion and broader channel coverage together have been important factors in our long-term success, including in the third quarter of 2012. The table below shows the number of cities, subdivided by the size, in which we distribute our products through all of our distribution channels as of the end of the third quarters of 2012 and 2011.

 

 



Number of Cities by Tier
for All Distribution Channels 



As of September 30,


Net 
change


Percent

change



2012


2011



First-tier cities (largest)


29


29


-


0%

Second-tier cities 


135


133


2


2%

Third-tier cities 


436


429


7


2%

Total cities


600


591


9


2%

Cost of Sales

Cost of sales primarily includes the costs of raw materials, labor costs, and overhead. Of the total cost of sales, the cost of raw materials typically accounts for about 95% to 96%, overhead typically accounts for 2.5% to 3%, and labor costs typically account for 1.5% to 1.7%, with slight variations from period to period. All of our meat products are derived from the same raw materials, which are live hogs. Vegetable and fruit products are purchased from farmers located close to Zhongpin's processing facility in Changge in theHenan province. As a result, the purchasing costs of live hogs and vegetables and fruits represent substantially all of the costs of raw materials. The increase in the cost of sales was consistent with but considerably higher than the increase in sales revenues.

 

 



Cost of Sales by Product Division 
(unaudited)



Three months ended
September 30, 2012


Three months ended
September 30, 2011



Metric tons


Amount (millions)


Average 
cost per
metric ton


Metric
tons


Amount (millions)


Average
cost per
metric ton

Pork and Pork Products













  Chilled pork 


101,198


$      231.2


$      2,285


73,771


$        223.6


$        3,031

  Frozen pork 


38,101


80.1


$      2,102


33,045


86.4


$        2,615

  Prepared pork products


28,754


60.7


$      2,111


21,600


43.9


$        2,032

Vegetables and Fruits 


5,733


4.2


$         733


6,034


4.1


$           679

Total


173,786


$      376.2


$      2,165


134,450


$       358.0


$        2,663

Gross profit margin (gross profit divided by sales revenues) decreased to 9.5% in the third quarter 2012 from 10.1% in the third quarter 2011 primarily due to (a) higher competition in the market, (b) the decrease in the gap between pork prices over hog prices, (c) increased promotional activities to grow our market share, and (d) the increase in overhead due to the higher labor costs and utility costs.

General, administrative, and selling expenses

General and administrative expenses increased $2.3 million or 31% to $9.7 million in the third quarter 2012 from $7.4 million in the third quarter 2011. As a percent of revenues, general and administrative expenses increased to 2.3% in the third quarter 2012 from 1.9% in the third quarter 2011. The higher general and administrative expenses in the third quarter 2012 were primarily due to a $0.6 million increase in salary expenses that resulted from hiring more employees required to support the expansion of the business, an increase in the average salary we paid to our employees, an $0.9 million increase in the bad debt provision due to increases in revenues and accounts receivable, and a $0.4 million increase in other taxes due to land of property placed into service in December 2011 for two new facilities in Taizhou and Changchun on which the Company started paying land and property taxes in the first quarter of 2012.

Selling expenses increased $3.5 million or 44% to $11.4 million in the third quarter 2012 from $7.9 million in the third quarter 2011, mainly as a result of higher sales of pork and pork products and primarily due to a $1.5 million increase in advertising expenses, a$1.2 million increase in transportation fees due to the increase in sales volume, a $0.2 million increase in supermarket management fees, and a $0.2 million increase in salaries. Selling expenses as a percent of revenues increased to 2.7% in the third quarter 2012 from 2.0% in the third quarter 2011.

 

Interest expense, net

 

Interest expense, net of interest income, increased $1.3 million or 19% to $8.3 million in the third quarter 2012 from $7.0 million in the third quarter 2011. The increase in interest expense was primarily the result of an increase of $39.1 million in long-term bank loans and an increase of $105.6 million in short-term bank loans. The interest expense increase was partly offset by higher interest income due to higher bank deposits.

Other income and government subsidies

Other income and government subsidies increased $1.0 million to $2.4 million in the third quarter 2012 from $1.4 million in the third quarter 2011 primarily due to higher government subsidies.

Provision for income taxes

The enterprise income tax rate in China on income generated from the sale of prepared products is 25% and there is no income tax on income generated from the sale of raw products, including raw meat products and raw vegetable and fruit products. The provision for income taxes increased $0.5 million in the third quarter 2012 from the third quarter 2011 due to higher sales of prepared pork products.

Net income

 

Net income decreased $7.3 million or 40% to $11.0 million in the third quarter 2012 from $18.3 million in the third quarter 2011. The Company's net profit margin (net income divided by sales revenues) declined to 2.7% in the third quarter 2012 from 4.6% in the third quarter 2011.

The reduction in net income was mainly due to (a) higher competition in the market; (b) higher sales revenues from higher tonnage sold at lower average prices per ton; (c) the higher sales revenues were more than offset by higher cost of sales since the cost of hogs increased at a higher percentage than did the price of pork products, higher promotional activities were required to maintain and grow market share, and labor and utility costs that continued to rise; (d) general and administrative expenses were higher, mainly due to hiring more employees to support the Company's expanded operations, higher average salaries paid to employees, a higher bad debt provision due to higher revenues and higher accounts receivable, and higher land and property taxes due the addition of two new plants in December 2011; and (e) higher interest expense due to higher borrowings, partly offset by higher government subsidies.

The higher expenses were mainly due to intense competitive pressure in the pork market as the industry continues to consolidate and companies are required to vie aggressively to win additional market share in a variety of ways.

Earnings per share

The earnings per share numbers below are based on net income attributable to Zhongpin Inc. shareholders.

Basic earnings per common share decreased 35% to $0.30 in the third quarter 2012 from $0.46 in the third quarter 2011. Weighted average basic shares outstanding decreased 7% to 37,198,909 shares in the third quarter 2012 from 39,918,816 shares in the third quarter 2011.

Diluted earnings per common share decreased 35% to $0.30 in the third quarter 2012 from $0.46 in the third quarter 2011. Weighted average diluted shares outstanding decreased 7% to 37,240,843 shares in the third quarter 2012 from 39,918,816 shares in the third quarter 2011.

40,376,182 common shares were issued as of September 30, 2012, of which 37,209,344 were outstanding and 3,166,838 were held by Zhongpin as treasury shares.

For a discussion of the Company's first nine-month results of 2012 and 2011, please see the Form 10-Q that Zhongpin will file with the Securities and Exchange Commission on November 9, 2012.

Liquidity and capital resources

During the nine months ended September 30, 2012, Zhongpin's net cash flow increased cash and cash equivalents by $10.4 million. Cash and cash equivalents (excluding restricted cash) totaled $146.2 million as of September 30, 2012 compared with $135.8 millionas of December 31, 2011. As of September 30, 2012, working capital (current assets minus current liabilities) was a negative $16.8 million. Based on the anticipated operating cash flow of the company and its subsidiaries, the availability remaining under its banking facilities, as well as alternative sources of financing available to the company, Zhongpin believes it will have the ability to meet its liabilities as and when they become due within the next 12 months.

Net cash used in operating activities in the first nine months of 2012 was $5.5 million, primarily from net income that provided $34.2 million, depreciation and amortization that provided $19.0 million, a provision for allowance for bad debts that provided $2.8 million, accounts receivable and accounts payable that used a total of $58.0 million, purchase deposits that provided $6.3 million, inventories that used $10.8 million, tax refunds receivable that used $5.1 million, and other items that provided $6.1 million, net.

Net cash used in investing activities in the first nine months of 2012 was $85.2 million, primarily for construction in progress, additions to land use rights, and prepayment for and additions to property, plant, and equipment that together used $85.9 million.

Net cash provided by financing activities in the first nine months of 2012 was $102.2 million, primarily from the proceeds from loans and notes, net of repayments, that provided $113.2 million, an increase in restricted cash that used $5.0 million, a repayment of a capital lease obligation that used $4.6 million, repurchases of common stock that used $2.8 million, and other items that provided a net of $1.4 million.

As a result, including the effect from foreign currency exchange rate changes on cash, Zhongpin increased its cash and cash equivalents in the first nine months of 2012 by $10.4 million. Cash and cash equivalents on September 30, 2012 totaled $146.2 millioncompared with $135.8 million as of December 31, 2011.

Zhongpin believes its existing cash and cash equivalents, together with its ability to secure bank borrowings, will be sufficient to finance its investment in new facilities, with budgeted capital expenditures of about $114.4 million over the next 12 months, and to satisfy its working capital needs. It intends to satisfy its short-term debt obligations that mature over the next 12 months through additional short-term bank loans, in most cases by rolling over the maturing loans into new short-term loans with the same lenders as the Company has done in the past.

 

Original source: Zhongpin

Sectors: Emerging markets, Financials, Meat & poultry

Companies: Zhongpin

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