Tingyi:Painful transition

Event

Tingyi hosted a conf call after its profit warning wherein the company guidedfor low-single-digit revenue growth and single-digit earnings growth in FY16,factoring in all one-off loss effects. After taking a hit on instant-noodle salespost an unsuccessful price hike, management plans to change tack to activelypromoting Rmb3.5 and Rmb4.5 products. For beverages, management plansto adopt a two-tier strategy to capture the polarizing consumption demand.

We believe these changes in strategy will entail a rise in expenses and hencea hit on margins in the next six months, but we believe they are essential tosecure long-term growth. We maintain our OP rating with a TP of HK$10.7.

Impact

Plan B for instant noodles. Given that instant noodles sales took a hit fromthe ineffective price hike in 4Q15, management has switched to plan B,wherein the company will push for both Rmb3.5 and Rmb4.5 products. Withall pre-price hike Rmb4 old inventory cleared up in the channels, thecompany’s advertising is now in full throttle for both price segments. Also, theRmb3.5 (珍品樂) packaging will be changed back to old packaging in order toretain product awareness, especially in lower-tier cities. Overall, managementremains cautiously optimistic, but expects it needs 6 months for both salesand market share to recover following the unsuccessful price hike.

Beverage facilities write-off expense is a big surprise; two-tier strategyfor beverage. Whilst the exact amount of beverage provisions has yet to bedisclosed, management noted that the majority of the provision came fromequipment and machinery write-offs and only a small portion came frominventory write-offs. In order to regain market share in the water market,Tingyi is adopting a two-tier strategy, whereby it will launch products in threedifferent price segments: Rmb1, Rmb2 and Rmb3. A&P will also be steppedup to strengthen its product competitiveness and improve brand awareness.

On the new product front, more high-end ice tea and green tea will belaunched, targeting more health and quality conscious consumers.

Cash is king in a tough environment. In 2015, utilization rate was c.40% forinstant noodles and c.30-40% for beverages. With this in mind, excesscapacity reduction and production efficiency are key focus areas goingforward. As such, mgmt expects capex to be reduced from c.US$500m in2015 to c.US$250m in 2016 and stay at US$200m to US$250m annually inthe long term. We agree with management’s view that a solid cash position iskey amid volatile times in China. Based on our estimates, the company canmaintain FCF of c.US$705m or c.12% FCF yield in the coming years. Withsufficient cash on hand, Tingyi should have sufficient ammunition for any M&Aopportunities, potential share buybacks and dividend payout in the future.