The author is an analyst for Shinhan Securities. He can be reached at sanghoonpure.cho@shinhan.com -- Ed.
Weak top line results in first profit drop in 10 months
Orion reported weak sales growth in November (Korea +10.9%, China -13.5%, Vietnam -5.3%, Russia -26% YoY) with effects of the Lunar New Year’s holiday kicking in later than a year ago and local currencies facing depreciation (China -4.6%, Vietnam -2%, Russia -35.1%). Despite efforts to improve cost efficiency and easing cost burden, the decline in the top line pulled down operating profit (Korea +13.6%, China -16.7%, Vietnam -3.1%, Russia -32.7%).
In China, CNY-denominated sales fell 9% YoY due to unfavorable forex rates (KRW4.7bn), the Lunar New Year’s holiday falling in February next year (KRW5.5bn), and temporary drop in sales caused by a shift to indirect sales at some distribution channels (KRW4bn). However, operating margin came in decent at 19.9%. Although the manufacturing cost ratio climbed 2.5%p with shrinking production volume adding to the fixed cost burden, Orion saw a 2.3%p drop in the SG&A ratio from a change in incentive payments made to distributors as well as efforts to reduce other major SG&A expenses.
Strong operating leverage offsets high base effect
Despite the high YoY base, operating profit from China jumped by 43% in 2Q and 22% in 3Q, driven by sales growth from new product releases, easing cost burden, and cost-cutting efforts. Growth of the Chinese confectionery market as a whole is likely to slow down compared to the past, but we believe Orion has gained the upper hand in market share competition through aggressive product launches. It is also noteworthy that the company continues to see earnings gains on product competitiveness alone without resorting to price hikes like rivals.
Aggressive expansion of overseas investment is planned through 2024. This year's capex spend is estimated to have increased more than twofold YoY to exceed KRW200bn. Investment of earnings gains, secured by creating demand in unfavorable market conditions through the release of highly competitive products, will help to build the foundation for future growth.
Market share gains and category/regional expansion hold the key
We retain BUY on Orion for a target price of KRW170,000. Earnings should improve across all regions and product categories, and the cost burden should fall further on the decline in grain prices. Shares look excessively undervalued at a 12-month forward PER of 11x. To trade at a valuation premium as in the past, Orion will need to increase market share through new product releases and retail channel expansion, add product categories (nut bars, meat jerky, bottled water, mass-produced bread, dairy beverages, etc.), and strengthen regional presence through subsidiaries (India, US, third plant in Russia).