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Shandong Longda Meat Foodstuff Company
 
 
A newly listed pork supplier with too much slaughtering capacity, not enough vertical integration.
 
by David LIN and YANG Yang
 

Founded in July 2003 with a capital of RMB8.60 million (US$1.39 million), Shandong Longda Meat Foodstuff Company Limited (Longda) was initially a small enterprise. In February 2010, the company opted to incorporate itself. Longda Group took the controlling interest, with ITOCHU (China) Holding Company Limited and Chinese private equity firm Laiyang Yinlong Investment Company Limited holding the remaining equity.
 
In the decade since its founding, Longda has become a vertically integrated meat processor. Its internal supply chain spans feed milling, pig breeding, hog farming, slaughtering, meat processing and product distribution. With five wholly-owned and two partially-owned subsidiaries, it offers chilled pork, frozen pork and cooked pork products.
 
 
Financial status

In the three years after its incorporation, Longda's revenue has grown steadily. The company generated operating income of RMB2.17 billion (US$349.48 million) in 2011, RMB2.54 billion (US$409.07 million) in 2012, and RMB3.16 billion (US$508.92 million) in 2013, respectively.
 
Unfortunately, operating income is income before the cost of goods sold. In the case of Langda, China's swine sector has suffered notoriously thin margins between live hog costs and pork prices over the past three years.
 
Consequently, while 2013's net profit grew 7.4% to RMB116 million (US$18.68 million) from 2012's RMB108 million (US$17.39 million), it was the same amount the company posted in 2011.
 
While the company achieved an impressive 46% jump in operating income from 2011 to 2013, its net profit stayed stagnant. The company says the slack performance is mainly because pork prices were higher in 2011 but much lower in 2013.
 
This year, China's oversupplied, depressed pork market again did the company no favours. In the first quarter of 2014, while operating income nearly doubled on-year to RMB760 million (US$122.36 million), net profit dropped by 18% to RMB48.02 million (US$7.73 million). 
 
 
Recent development

On June 26, 2014, Longda was listed on Shenzhen Stock Exchange. The company issued 54.60 million shares and raised RMB498 million (US$80.18 million) in its IPO.
 
The IPO's funds will be used to build a new 310,000-head hog farm and a 6,000-tonne cooked food processing plant. The company also plans to build a new grand parent stock breeding farm, along with accompanying slaughtering and processing facilities to complement the hog production.
 
 
Claiming a stake in China's competitive hog market

China's National Bureau of Statistics shows that the country's major integrated meat processors generated a combined operating income of RMB1.20 trillion (US$193.21 billion) in 2013.
 
Company
Income in 2013 (RMB billion)
Market share 
in China
Henan Shuanghui Development
44.95
3.74%
Jiangsu Yurun Group
16.86
1.40%
Sichuan Goldkinn Foods
3.52
0.29%
Shandong Longda
3.16
0.26%
Shandong Delisi Group
2.05
0.17%
Table 1: Incomes and market shares of public listed pork companies in 2013 (source: China National Bureau of Statistics)
 
In 2013, Longda generated sales revenue of RMB3.16 billion (US$508.92 million). Its revenue trailed those of Shuanghui, Yurun and Goldkinn Foods, accounting for a 0.26% share of China's pork market.
 
That may not sound impressive to readers from economically mature countries. But one must remember that China's pork industry is very large and highly fragmented, with uncountable thousands of producers.
 
According to eFeedLink, China produced 490.39 million head of hogs and 44.04 million tonnes of pork in 2013. The combined market share of China's top three pork suppliers: Shuanghui Development, Yurun Group and Jinluo Group, accounts for less than 8% of the total output.
 
In this context, Longda's 0.26% share, though numerically small, makes it a top pork supplier in a market of 1.3 billion people. With China's per capita pork consumption at exceptionally high of 38kg, this actually makes Longda one of this vast market's leading pork suppliers.
 
 
Need to invest IPO funds into vertical integration

What sets Longda apart from its competitors is the company's vertically integrated production chain, which incorporates feed milling, hog farming and slaughtering, pork processing and sales.
 
In comparison, larger rivals such as Shuanghui, Yurun and Jinluo are mainly engaged in hog slaughtering and processing. Despite their recent forays into hog farming, the hog production capacities of these larger rivals are very mall and disproportionate to their slaughtering capacities.
 
Moreover, because China has a tainted history of making safe food, Chinese consumers still lack confidence in domestically-produced products. Most food-safety problems originate in the suppliers to large meat processors. Hence, any company that can exert vertical feed mill-to-fork control over its pork production would be more favoured, especially among educated, health conscious consumers.
 
Sadly, Longda does not hold a decided edge over its competitors with regards to vertical integration. Data from Longda's annual report reveals that the company slaughtered 1.98 million hogs but raised only 175,200 of them in 2013. Hence, only 8.85% of its pork came from internally raised hogs.
 
According to the company's data shown in the accompanying graph, in 2011, the gross profit margin on pork products processed from hogs at its own farms was 3.3 times higher than the margin on hogs purchased from third parties. The difference increased to 3.4 times in 2012 and went up to 4.1 times in 2013.  
 
This shows that Longda's profitability depends on its capacity to vertically integrate a larger proportion of its pork production. This is something which the re-investment of its IPO funds into integrated hog rearing facilities is meant to address.
 

Aside from its smaller size, one of Longda's key disadvantages is the fact that its business is too concentrated in Shandong province.
 
As of 2013, Longda had set up 2,670 sales outlets, the majority of which are within 17 cities in Shandong province. The top five customers of the company's pork products are also from the same province. In 2011, 2012 and 2013, sales generated in Shandong contributed to 85%, 80% and 75% respectively of the company's total revenue. Hence, it needs to accelerate its sales diversification to maintain its market position.
 
Another weakness of Longda is that its production capacity is underutilised. Although the situation is not as bad as it was several years back, it had a capacity utilisation rate of 60% in 2013, based on the company's annual slaughtering capacity of 3.31 million head that year.
 
This shows that relative to internal hog rearing, slaughtering capacity has been overexpanded. By comparison, vertical integration, which offers cost-savings, has not been expanded by enough over the last three years.
 

Transacted prices of sulphate feed additives in China

Item

2011

2012

2013

(million head)

(million head)

(million head)

Slaughtering capacity

3.20

3.20

3.31

Number of slaughtered hogs

1.04

1.57

1.98

Capacity utilisation rate

32.50%

49.10%

59.80%

Table 2: Longda's slaughtering capacity and utilisation rate from 2011 to 2013.


By contrast, China's largest pork company Shuanghui Development boasts a slaughtering capacity of 20 million head in 2013, when its capacity utilisation rate stayed at 76%.
 
Longda's product portfolio also puts it at disadvantage against the competitors. Fresh pork and chilled pork are the company's main products, generating nearly 90% of the total revenue.
 
However, further processed pork products (cooked food, frozen ready-to-eat meals, etc.), which have higher profit margin, account for only 8%. It is considerably lower than that of Shuanghui Development and lags behind other pork companies.
 

Company

Product

2011

2012

2013

Shuanghui Development

Fresh and chilled pork

38.09%

39.18%

41.92%

Cooked food

57.94%

58.37%

56.42%

Others

3.97%

2.45%

1.66%

Yunrun Group

Fresh and chilled pork

85.51%

90.22%

86.66%

Cooked food

11.49%

9.78%

13.34%

Others

0

0

0

Delisi Group

Fresh and chilled pork

69.69%

65.98%

62.36%

Cooked food

23.25%

22.03%

20.65%

Others

7.06%

11.99%

16.99%

Longda 

Fresh and chilled pork

86.17%

89.05%

89.77%

Cooked food

12.49%

9.02%

8.24%

Others

1.34%

1.93%

1.99%

Table 4: Proportion of revenue generated from different types of product for Longda and its rivals from 2011 to 2013.

 
Since it commenced trading on Shenzhen's stock exchange on June 26th of this year, Longda's share price had risen exponentially within the first two weeks. It shot to RMB28.52 (US$4.59) on July 10 from the initial RMB11.75 (US$1.89).
 
However, rather than reflecting Longda's performance, the huge gain in the company's share price is fuelled by the fervour of the Chinese stock market. Given the fact that the company again posted an 18% slip in its Q1 net profit, this trend is unlikely to continue for long.
 
 


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