Investment Summary

Hengan's competitor Vinda announced its 2018 annual results. Its total revenue increased by 10.3% y.o.y to HKD14.879 billion, GPM fell 1.6 ppt to 28.1%. Vinda increased its price twice last year, but GPM are still falling, reflecting the impact of a sharp rise in wood pulp price during the year. Affected by factors such as price hikes, and the advance payment of 618 e-commerce consumption, Hengan and Vinda's tissue business all faced a significant slowdown in the third quarter, but recovered in the fourth quarter.

Compared with Vinda and other peers` multiple price hikes last year, Hengan only raised price of 3 to 5% for rolled paper products in the first half of the year, which made some products cheaper than its competitors and help driving sales, and this can be reflected in the market share. Vinda's market share decreased in Q2 and Q3, whereas Hengan's market share in the second half was about22%, up from 19% to 20% last year, and it is still the market leader. The business was slowed down to single-digit growth in July to August last year, but the growth was better than that of its competitors. It began to return to double-digit at the end of the third quarter and the fourth quarter.

According to the management team, the business performance in the fourth quarter of last year was satisfied, including the performance on 11th November. The performance in December was also good, and that of Temple brand was outstanding. It do have confidence the business will continue to resume to normal growth in the first two quarters of this year. It does not expect there will be price hikes this year. Due to the keen market competition, it expects that competitors will have more promotions such as cash rebates to keep prices competitive.

The price of wood pulp fell in the fourth quarter of last year. The management team expects that there will be fewer chances of continuing decline this year but keep at a high level. We believe that the stabilization of wood pulp prices will help GPM of companies in the industry to recover. Among them, Vinda's GPM is expected to to resume to around 30%. Hengan's GPM is also expected to be benefited. Notwithstanding the strong market competition, Vinda's sales and marketing cost as a percentage of sales declined by 1.4ppt over last year. General & administration expenditure as a percentage of sales also decreased by 0.3ppt. Operating margin therefore only slightly decreased by 0.4ppt to 6.9%. Net profit increased by 4.6% to HKD649 million.

During 1H of 2018, Hengan increased brand promotion, resulting in promotion and distribution costs and administrative expenses increased by 7.1% compared with the same period of last year, but the proportion to revenue still fell by 1.4 ppt to 17.2%, which was mainly attributable to the implementation of “small sales team” operation model which effectively improved the sales efficiency.

According to the management team, there is investment in branding and special promotion such as for new products this year. For next year, investment will mainly focus on special advertising next year. We expect that if the income growth this year can reach double digits, the expenses to revenue ratio will be improved. We maintain Buy rating, a forecast PE ratio of 18.4, and thus a target price of HKD77.5. (current price as of February 21, 2019)

Business Overview

Market competition of feminine care is expected to heat up

In addition to the tissue business, Hengan and Vinda plan to develop the feminine care business. Vinda's revenue growth target for this year is double digit and plans to expand local production of feminine care and incontinence care products this year. It plans to increase its production capacity by 60,000 tons in Hubei in the second quarter and eliminate unperformed production capacity. The total production capacity is expected to increase from 1.22 million tons to 1.25 million tons by the end of this year.

The management team of Hengan maintains the guidance of overall sales revenue for the next three to five years with double-digit growth and same as its tissue business. Among them, the sanitary napkin business is expected to be difficult to achieve double-digit growth as the market is already saturated, so it will be repositioned as premium personal hygiene business. Hengan originally planned to launch new product categories such as cosmetics, cotton pads and facial care masks this year. As related R&D and registrations still need time, it is expected to be launched as soon as next year. We expect it will become a new growth driver of revenue.

The tissue business is the largest business of the two leading companies. From the perspective of percentage share of overall revenue, tissue business is the main business of Vinda, and Hengan's business model is more diversified. Last year, the proportion of Vinda's tissue business remained at 81%, and the personal care business accounted for 19%. Hengan's tissue business accounted for 50.2% in the first half of last year, sanitary napkins was 31.8%, and diapers was 8%.

The profitability of the Hengan sanitary napkins business has been better than that of its peers. Thanked for the increase in the proportion of high-end and upgraded products in the product mix during the period, offsetting the impact of rising petrochemical raw materials costs. Gross profit margin increased by 0.6 ppt to 69.3%. According to the information given by the management, the sanitary napkins increased by less than 5% in the third quarter, but still maintained a market share of 27% and maintained the leading position in the industry. The recovery trend in the fourth quarter has been accelerated. Considering the low base factor last year, we expect that this year end's performance will be better.

Vinda's feminine care business is included in the personal care business, which had a 7.3% increase in revenue last year with GPM of 30.4%. According to management team, Libresse has consolidated the No.1 position and increased its share leadership in Malaysia. In China, its focus was on the preparation of product localisation starting from 2019.

Investment Thesis, Valuation & Risk

Our valuation model suggests a target price of HK$77.5: We maintain Buy rating, a forecast price-earnings ratio of 18.4, and thus a target price of HKD77.5. The risks that need to be watched include top-line growth rate missing from expectation, wood pulp prices fluctuating sharply, industry competition increasing significantly, and Ameba units missing sales target. (current price as of February 21, 2019)

Financials

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