Dongfang Modern IPO and China – Showing the real China

Long term Dawes Points readers will know I first visited China in 1982 on a tourist visa when Beijing and Guangzhou were bicycle-city and almost everyone had a Chairman Mao blue suit and motor vehicles were indeed a rarity, as was a decent main road.  Underemployment was rife but visits to markets in cities and villages showed me one very important thing then – everywhere I went the Chinese impressed me that individually they were capitalists at heart and loved to do business and make money.  Interestingly I can recall no beggars (unlike most other Asian countries in my travels of the time) and food was abundant.

I revisited China again about ten years ago and found a very different country.  Food still abundant and massive city building underway.  Go there today and the building activity continues and the food picture is surprisingly different.

The 100m people moving into the cities has been accompanied by rising living standards and changes in diets.  Protein demand has jumped and the importance of rice has declined.  The demand for more healthy foods like fruit and nuts has also risen strongly.

So what.

However, if you believe in the Asian Century though you will want to be able to share in that transformation that is making hundreds of millions wealthier as they throw off the heavy restraining yokes of central planning and feudal systems.

We all thought sending iron ore, copper, LNG and coal to Asia were great ways to participate in the growth with familiar products and companies to invest in.   The numbers are already on the board with export revenues from these products that strengthened our currency, paid lots of taxes and made us all much wealthier.

But the last few years have not been so happy as export volumes surged but against prices that were declining and this made everyone quite gloomy.  Resources stocks just tanked.

Market sentiment has been that China will collapse economically and that demand for raw materials will just keep declining .  Funny how that hasn’t really happened.

Iron ore imports for China rose 13.8% in 2014.  Metals consumption reached consecutive record highs into 2015 and China takes almost half of all metals.

Funny too how the China steel industry was about to collapse as well. Funny how June 2015 provided the second highest monthly annualised output ever of 838.8mtpa.

Annualised Crude Steel Productoin

Iron ore has seen a 50-60mt global stock drawdown while crude steel output has remained firm.  Port stocks have fallen back to 80mt after reaching 110mt earlier in 2015 and steel mills’ stocks are well down.  Some restocking is coming.

Then we look at some other simple data like Qtly annualised GDP growth and Indexed GDP.  No economic collapse here.


Source: China National Statistics

And then something even simpler as average annual personal disposable income in China.   At <5 RMB :A$  this is ~A$6,000pa in the cities and just ~A$2,000 in the country.


Source: Dongfang Prospectus

China is growing and its citizens are becoming wealthier.

Diets are changing.  More protein.  More fruit and nuts.  And less cereals.


Source: Dongfang Prospectus

So demand for higher quality, unadulterated, clean healthy food is rising.  So are prices – as demand can’t match supply and flows into imports.

 Source: Dongfang Prospectus

You are all familiar with the 100m people moving from rural areas to the cities. Well you might like to imagine that farm food output suffered somewhat and led to rising food prices.  The PRC government, eyeing their remaining 800m farmer supporters, reacted as true agrarian socialists by exempting  agricultural food production from Enterprise Income Tax and personal income tax and VAT.  At least until 2025.

So now you have a major market of 1400million people that just wants more and better food.

Having 800 million individual farmers means a lot of individual farms.  Try about 10 million!

So lots of little inefficient farms.  Fragmented industries I think is the term.

Now how to play it.

Here we come to Dongfang Modern Agricultural Company.

Could it get any better?

This company was set up in 2005 and in 2008 the current Chairman injected about US$6m to acquire an 89% holding.

This was the last capital injection to the company.  No more equity and no debt at all.

The plan was to acquire as many plantations as possible and by 2012 it was 9 plantations over 4500 hectares and by end 2015 it will be 19 plantations over 9,000 hectares.

In calendar 2014 DMF earned RMB 315m ( ~A$56m) and in 2015 this should be over RMB 370m (~A$75m but over A$80m at the current exchange rate). How many Australian companies make this amount of earnings?  And at a 43% margin?  Without any debt?

The company acquires uncapitalised plantations from village cooperatives and manages them professionally.   It then takes the products that were generally suitable only for local town markets and sells them in high volume premium markets in supermarkets and hotels for double the price.

Margins are over 40%.  And no tax.

The villagers are happy.  They get to sell or lease out their plantations and still get to work as harvesters.

The PRC government is very happy  because plantation productivity is significantly better and output is rising.  Food quality is improved. Food adulteration risks are lowered. Imports reduced.

Shareholders are very happy because the returns are strong and the risk and volatilities are low.

The returns on paid up capital of just ~US$10m are huge while the returns on shareholder funds which includes RMB 1,000m in retained earnings (~A$180m) are over 30%.

Can you find a better company track record anywhere?  In any industry?

Taking the next step, DFM is the second biggest producer by revenue of citrus in China.  Produces over 200,000t with just over half being tangerines (mandarins to us) – which is more than Australia’s total of mandarins.

It has about 1.1% market share in these very fragmented industries.  Aims to have a much bigger share over the next few years. Wants to be the market  leader.

So there.  Market leader in the world’s largest and rapidly growing consumer market producing a consumer staple that is in rising demand.

High margins, PRC Govt support in almost everything it does, no debt, and 10-15 years of growth ahead.

What more do you want?

The replacement DFM prospectus can be downloaded here

Please down load the DFM Application form here, if you have already read the prospectus and just need an application form

DFM IPO presentation Final 5 July 2015

DFM term sheet (PDM) finalParadigm 7 July 2015

Now the Chinese Stock Market.

I sent out a commentary recently on the China hysteria and suggested it was just hysteria.

Now look at this again.  The Shanghai Stock Exchange Composite Index (` SSEC’) peaked in 2007. China’s GDP grew almost 100% over the period that the SSEC fell 65% into the 2013 lows before surging after mid 2014.  Did a spectacular +150% in about 10 months.   Has had a sharp pull back but didn’t get anywhere near the previous highs.

Keep in mind too that in my presentations to finance sector investors in China over 2013-14 I called for a strong Shanghai stock market (see Dawes Points over this period!) but was laughed at by most.  People hated shares!  So this first run up would not have had a big support base.  Much more to come yet!

The Shanghai and Shenzhen markets are volatile but have a look at some more sedate alternatives.  These ETFs might give you a better idea of listed stocks in China.  Not overextended.

Code Entity

Size US$m

PERx

Yield %

FXI FT 25 Major stocks

8,000

11

1.6

CHIX Global X China Financials

108

9

0.9

CHII Global X China Industrials

8

16

0.6

CHIX Global X China Consumer

108

18

1.8

Source: Yahoo Finance

I can only conclude that those who gave us warning of the US Greater Depression in 2009 and the Collapse of the European Banking System (over 2009-2015) are just as accurate on the Collapse of China (2010-2015) and that over the next 12 months all those in the market places now sitting on vast hoards of cash (A$17.17bn here in Australia, >RMB 100Trillion (US$18tn) in China and so on all around the world) will be in buying all these stocks.

Stock markets have been climbing a wall of worry for years now and many investors are out.

Many funds are loaded up with ridiculously overpriced and very dangerous bonds or are sitting on mountains of cash.

Meanwhile, so many indices around the world are at or very near all time highs while the bears keep calling the next Crash.

And just think.  Half the world is already sitting cautiously in these highly defensive investment positions and 10% has been (we in the Resources Sector)thumped by falling commodity prices.  40%, especially in Asia, is just having a great time.   Corporations also have mountains of cash too.

And just like Sydney property sellers are finding, the supply is just not there to quickly get back into the market.

So think about China just beginning to hit its straps as hundreds of millions of increasingly wealthy consumers demand more and higher quality products.  And as industry and commerce utilise all of China’s amazing new infrastructure that is assisting with the consolidation of its many internal markets.  We are seeing the rise of hundreds of well positioned growing companies who are just totally unaffected by what Janet Yellen thinks.

Dongfang Modern is one that the ASX is lucky to get and I am sure there will be many more quality Chinese companies offering ASX investors an eye and a dividend link into China.

So don’t delay.  Fill in that application form or contact me –  bdawes@psec.com.au

Even ask your broker to access ASX Bookbuild DFMXBB.  Closing soon.

And also, I have a special note coming soon on gold so don’t get too bearish now.

Barry Dawes

2 August 2015

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