Company Analysis Report China Starch Holdings Limited

(Stock Code: 3838)

HE Chuchu

December 2019

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TABLE OF CONTENTS

1 SUMMARY 1

2 ECONOMY ANALYSIS 1

2.1 International Economic Situation 1

2.2 Domestic Economic Situation 2

3 INDUSTRY ANALYSIS 2

3.1 PESTEL Analysis 3

3.2 Porter’s Five Competitive Forces Analysis 3

4 COMPANY ANALYSIS 5

4.1 Overview 5

4.2 Business Analysis 5 4.2.1 Products and Branding 5 4.2.2 Boston Box 6 4.2.3 Market Share 7 4.2.4 Market Segmentation 7 4.2.5 Pricing Strategy and Business Partners 8 4.2.6 Manufacturing 8

4.3 SWOT Analysis 9

4.4 Financial Analysis 10 4.4.1 Revenue, Cost and Earnings 10 4.4.2 Interpretation of Financial Statements 12 4.4.3 Financial Ratios 16 4.4.4 Valuation 18

5 CONCLUSION 19

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1 SUMMARY

The objective of this report is to describe the performance of China Starch Holdings Limited (Company) and analyze its investment value. The Company, traded on the Hong Kong stock exchange, is an investment holding company and manufactures cornstarch, lysine, starch-based sweetener, modified starch, and related products in China. The economy analysis indicates that the Company faces some severe problems like slowdown economic situation, narrow trade surplus, and consolidation in the industry. The industry analysis reveals that the Company takes the leading position in the cornstarch industry and has good capacities to compete with rivals in the changing environment. The Company is continuously developing new strategies to improve its products and reduce production costs. As a result, it has a strong technology base, which makes it more competitive in the future. The financial analysis reveals that the company has a robust economy, with strong liquidity. The low debt-to-equity ratio of 12.51% puts the company in a good position for further growth. The Company’s earnings per share (EPS) increased an average of 33.0% over the past five years but decreased by 40.5% in 2018. The P/E ratio and stock price are lower than the average in the food industry. The stock may be undervalued.

2 ECONOMY ANALYSIS

2.1 International Economic Situation

n The United States economy improves modestly In 2018, the GDP of the United States exceeded US$20 trillion, with a growth rate of 2.9%, higher than 2.3% in 2017. Inflation pressure in the United States fell slightly, the unemployment rate continues to decrease, and foreign trade scale continues to expand. n Europe’s economy recovers steadily The overall price level in Europe rose slightly, and the total trade volume in the European Union increased somewhat due to the acceleration of internal trade. However, the uncertain risk of Brexit is still the most significant problem, which may lead to the trade barriers between the UK and other EU countries. Europe economic growth has been further hampered by growing imbalances among EU members, delayed structural reforms and a lack of trust in mainstream policies. n Emerging economies grows continuously Asia’s emerging and developing economies continue to be significant contributors to the world economic growth. China, India, Cambodia, Laos, Vietnam, Myanmar and the Philippines are fast-growing countries, with high growth rates better than the average Asia

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level. However, emerging markets and developing economies still face many challenges. Global trade frictions may lead to some negative impacts, and anti-globalization measures will impede international trade and investment.

2.2 Domestic Economic Situation

n Government policy assistance becomes strong The Chinese government eliminated the costly corn stockpiling policy in 2016 and started to use the marketization policy. The government resumed the Export Tax Rebate policy of cornstarch and provided subsidies for related industries, which improve the producers’ enthusiasm. In 2018, cornstarch’s export reached the highest level in the last 10 years. n Advantages of large and medium-sized agricultural product processing

companies appears gradually Investment in fixed assets in agriculture, forestry, animal husbandry and fishery increased by 12.4% year-on-year in 2018. The fixed investment in agriculture was about RMB1.18 trillion, up 15.4% from a year ago. The cornstarch processing industry experienced its first consolidation in the past few years and eliminated some small-sized producers. The second round of consolidation that could remove inefficient and financially weak producers from the market. However, it is easier for the large and medium-sized enterprises to face the situation, based on their rich experience and strong financial support. n The consumption structure upgrades continuously Consumer market has continued to expand over the past five years and consumption has continued to play its role as the primary driver of economic growth. The structure of urban and rural markets improved steadily, with rural consumption growing faster than urban consumption. Catering revenue grew faster than retail sales, which will provide a reliable guarantee for the cornstarch industry to improve its quality and efficiency. n The trade surplus become narrow Due to the trade frictions between China and the United States, China faces severe challenges, resulting in weak demand of overseas market. The contribution from the net exports of goods and services to the economic growth has been consistently negative since 2018. In this case, Chinese agricultural products still maintain a net import, but the threats and challenges may become intensify in the future.

3 INDUSTRY ANALYSIS

China’s cornstarch industry started late and didn’t establish mechanized production capacities until the founding of the People’s Republic of China. In 1978, the Chinese economic reform made significant impacts on the development of cornstarch industry. The cornstarch production technology in China has reached the advanced international level, and some biological manufacturing technology are even taking the leading position in the world. Now, the cornstarch industry is facing new opportunities and challenges.

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3.1 PESTEL Analysis

n Political China cancelled the policy of corn stockpiling, chose to take marketization and gave corn processing industry subsidies. The government also resumed the Export Tax Rebate of cornstarch, which stimulated the cornstarch export rebound. In recent year, the government introduced policies to eliminate the companies who have excess capacity.

n Economic Domestic demand growth showed a downward trend and people lacked consumer confidence due to the escalating trade frictions between China and the United States. Besides, the cornstarch industry faces the second round of consolidation. n Social Cornstarch has become one of the most commonly production materials in daily products. Cornstarch can be presented in different ways, such as the clothes people wear, the food and drinks served in restaurants and even oil exploration. Therefore, cornstarch and related products have a significant influence on people’s daily life. n Technological China’s corn processing technology has taken the leading position in the world. Biological immersion, as well as enzymatic separation technologies, are introduced in cornstarch production to break through the separation limit of traditional “chemical-mechanical” separation process and improve the quality and yield.

n Environmental Dealing with the problem of environmental protection in production is difficult for all corn processing companies. Keeping a balance between production costs, greenhouse gas emissions and sewage emissions will reduce heavy dependence on groundwater and negative environmental impacts.

n Legal Some policies are announced by the country to protect the environment, which means the Company may be required to limit its production temporarily to fulfil regional gas pollutant benchmark set by the local government.

3.2 Porter’s Five Competitive Forces Analysis

n Threat of new entrants Starch industry’s entry barrier is not high, so there are lots of companies in the market, especially small companies. However, the starch industry relies on advanced technology and efficient management, which are the small companies lack. The status of large-size companies with an annual output of more than 1 million tons is hard to shake. The Company is the leader in the cornstarch industry, so the impact of the threat of new entrants is low.

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n Threat of substitute products For upstream products, the corn market price has risen, which will compress the cornstarch processing profits. In recent years, the Southeast Asia cassava showed recovery growth, which led to a strong market demand. China’s main competitors for cornstarch exports are Thailand and Vietnam, who produce tapioca starch and occupy the market of major starch importers such as Japan, Malaysia and Indonesia. For fermented and downstream products, the selling price of white sugar continued to decrease in recent years, so the cost advantage of starch-based sweetener has declined.

n Bargaining power of customers With the living standard improved, the Company’s products may not achieve the customer’s required level of quality or national standard, so poor quality or sub-standard products could have negative impacts on the Company’s brand image and reputation. n Bargaining power of suppliers The Company’s suppliers mainly consist of farmers, cooperatives, agents and traders. The suppliers need transparent offer price of corn kernel and commitment before they deliver the raw material to the Company. It is significant for the Company to set a suitable price when they do business with their suppliers. n Competitive rivalry among an industry Cornstarch is the most significant part of starch production and plays an important role in China’s starch industry. In 2018, there were more than 30 Chinese cornstarch processing companies with an annual output of over 100,000 tons, about 98% of the country’s total cornstarch output. The main competitors of the Company in the domestic market are Zhucheng Xingmao Company Limited, COFCO Biotechnology Company Limited and Xiwang Group Company Limited. Due to excess capacity in cornstarch industry in recent years, the intensity of rivalry among the established companies is becoming huge.

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4

6

8

10

12

14

16

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2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8

2014-2018 Number of Cornstarch Producers Movement

Annual production more than 1,000,000 tons

Annual production between 400,000 to 1,000,000 tons

Annual production between 300,000 to 400,000 tons

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4 COMPANY ANALYSIS

4.1 Overview

n General description China Starch Holdings Limited, an investment holding company, manufactures and sells cornstarch, lysine, starch-based sweetener, modified starch, and related products in China. The Company was founded in 1998 and went public on the Hong Kong stock exchange in 2007. At present, the Company has 2200 employees and six subsidiaries. n Major milestones March 1998 Golden Corn Company was founded.

December 2004 A joint venture, Shouguang the Far East Modified Starch Company Limited was established.

September 2005 Brand Shengyu was entitled as China Famous Brand. September 2007 Golden Corn listed on the Hong Kong stock exchange.

March 2008 Linqing Deneng Golden Corn Biological Company Limited was established by acquisition.

July 2017 Shouguang Golden Corn Biotechnology Company Limited was established.

April 2019 Starch Production Line of Shouguang Golden Corn Biotechnology Company Limited was put into use.

n Corporate structure and operations The Board is currently composed of four executive directors and three independent non-executive directors. To facilitate effective management, the Board has delegated certain functions to three Board committees, including the Audit Committee, the Remuneration Committee and the Nomination Committee. Besides, the executive management team, under the leadership of the Chief Executive Officer, lead Safety Supervision Department, Corporate Strategy and Development Department as well as Internal Audit Department. Employee, suppliers, customers, governments and shareholders are the major stakeholders of the Company.

4.2 Business Analysis

4.2.1 Products and Branding

n Product designs and features The production of products relies on advanced biotechnology, strict manufacture control and inspection control. The product packaging is environmentally friendly and biodegradable. n Product range The Company’s complete portfolio of products divides into upstream products and downstream products, both of which appeal to different market segments. Upstream products represent cornstarch and ancillary corn-refined products. Downstream products

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consist of lysine, starch-based sweetener, modified starch, and other fermented products derived from cornstarch. n Branding The Company used a unique brand “Shengyu” to produce and sell products of cornstarch and starch-based sweetener, and it was rated as Chinese Famous Brand in 2005. The brand represents its products’ high quality in China and creates a good image in customers’ minds. n Positioning The market demand for cornstarch was affected by industry consolidation and China economic slowdown, so the Company shifted its sales focus to overseas customers. Due to the problem of African Swine Fever, the Company changed the position of lysine products and shifted its sales focus to foreign markets to mitigate the negative impact. n Differentiation With the advantage of bio-fermentation technology, the Company has completed the industrialization project of D-lactic acid with an annual production of 10,000 tons. D-lactic acid have broken the monopoly of foreign countries and filled the gap in China. At present, its D-lactic acid has become superior in China and gradually occupied the domestic market. n Development The Company and the Academy of State Administration of Grain jointly experimented with reducing “Zearalenone” and “Deoxynivalenol” by fermentation from April 2015 to December 2017, which removed more than 80% toxin to improve the safety of cornstarch products and provide better benefits for customers. 4.2.2 Boston Box

• D-lactic acid, which has gradually occupied the local market, is actively exploring the overseas market.

• Cornstarch is becoming the mature

products of the Company. • Lysine, which has small market

shares compared to other companies in the same industry, need further investment to expand in the domestic and international markets.

• Modified starch products have weak

demand now. Market share

Gro

wth

rate

Low High

Low

H

igh

Star Problem

Cash cow Dog

D-lactic acid Lysine

Modified starch

Cornstarch

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4.2.3 Market Share

The Company’s cornstarch products have a larger market share in China, taking a leading position. In 2017, 41 companies had an annual output of more than 100,000 tons of cornstarch, about 98% of the country’s total cornstarch output. The cornstarch output of the Company reached 1.57 million tons, with a market share of 6.1%. In 2018, 38 companies had an annual output of more than 100,000 tons of cornstarch, the same 98% of the country’s total cornstarch output. The Company produced 1.6 million tons of cornstarch, occupied 5.7% of the market share.

4.2.4 Market Segmentation

Cornstarch is widely used as an important raw material in food, chemical and pharmaceutical industries. China is a major corn producer in the world, so cornstarch is made from less expensive raw materials than other starch products, such as tapioca and potato starch. Therefore, cornstarch occupies the large market share of starch in China. Indonesia, the Philippines, Vietnam and Malaysia are the major importers of Chinese cornstarch. Lysine products, mainly presented in fodder, are mainly used in the poultry industry. Pig is not only the animal that consumes the most lysine products, but also the animal that has the fastest growth in lysine products demand. Netherlands, Germany, Thailand, Vietnam, USA, Canada, Lithuania and Japan are the major importers of Chinese lysine products. The output of sugary products, especially carbonated beverage, keeps increasing in recent years, which boosts the consumption growth of starch-based sweetener. The Company provides edible glucose products in the market, which are mainly used in beverage, sugar, candy, dairy products and other industries. Southeast Asia areas like Indonesia, Vietnam, Thailand and Malaysia are the major importers of Chinese starch-based sweetener.

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 50.0%

Other

Zhucheng Xingmao Company Limited

COFCO Biotechnology Company Limited

Xiwang Group Company Limited

China Starch Holdings Limited

Ningxia Eppen Biotech Company Limited

Hebei Yufeng Fecula&Sugar Industry Company Limited

Heilongjiang Jinxiang Biochemical Company Limited

Changchun Dacheng Industry Group Company Limited

Shandong Zhonggu Starch Sugar Company Limited

Shandong Luzhou Foodstuff Group Company Limited

2017-2018 Top 10 Cornstarch Companies’ Market Share

2017 2018

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Market Segmentation Cornstarch Lysine Starch-based sweetener

Geographic China, Indonesia, Philippines, Vietnam, Malaysia

China, Netherlands, Germany, Thailand,

China, Indonesia, Vietnam, Thailand,

Target Customers

Pulp and paper industry; Food and beverage industry; Chemical industry; Pharmaceutical industry

Poultry industry Beverage industry; Sugar and candy industry; Dairy products industry

4.2.5 Pricing Strategy and Business Partners

2014-2018 Annual Price of Cornstarch in Different Regions of China (RMB/Ton) Year 2018 2017 2016 2015 2014

Northeast China 2,263 1,956 2,141 2,751 2,816 North China 2,404 2,147 2,224 2,834 3,047 Northwest China 2,574 2,254 2,288 2,862 3,055

The Company uses geographical pricing to sell its products. Taking cornstarch as an example, the supply of raw materials in northeast China was sufficient, so the price was the lowest. The consumption of cornstarch in north China was large, and the cost of corn was relatively high, so the price was higher than that in northeast China. In recent years, due to the reduction of corn planting area, the cornstarch price in the northwest Chins rose to the highest level.

The Company has established good cooperative relations with well-known domestic enterprises such as Yanjing Brewery Company Limited, Tsingtao Brewery Company Limited and Shandong Chenming Paper Holdings Limited. The Company has also made long-term cooperative business partners with America International Corn Products Company, Japan Mitsui & Company Limited East Asia Bloc and Japan New East Asia Company Limited in the overseas market. 4.2.6 Manufacturing

The Company ensures strict control in the production process which equipped with advanced starch separator, lysine filtration system, sewage treatment system and many manipulators. The Company also holds strict quality control and product testing, establishing an internal laboratory to monitor the quality of products and recalling periodic products to retest, to ensure products comply with national standards and food safety standards. The Company’s production lines rely on automation, so it puts announcement of the purchase of spare parts on its official website every month to regularly updates the production equipment. Farmers, cooperatives, agents and traders are the key suppliers of the Company. It uses mobile technology to contact with suppliers and tries to develop trust with them to buy the best corn kernel.

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4.3 SWOT Analysis

n Strength The production base of Shouguang Golden Corn Biotechnology Limited has principally completed the major cornstarch production facilities. The cornstarch production scale will be further increased to its designed annual operation capacity of 800,000 tons. The Company continues to invest in updating production equipment and buying more advanced automated machinery. The Company also upgrades the planning system to improve its analysis ability in sales, tender management, storage management and financial issues. The Company has a healthy financial position and makes continuous progress in cost control. It takes the leading position in terms of profitability and energy consumption. The Company has set up a Research & Development Center to improve its capability of scientific and technological innovation and signed long-term cooperation agreements with Shandong University, Nankai University and Chinese Academy of Sciences. n Weakness The Company’ production schedule may be affected by working safety and regional gas pollutant benchmark set by the local government, which will limit the production. Days in both inventories and receivables increased, which limited the cash liquidity of the Company. n Opportunity Cornstarch is the primary material of other industries like paper and food, so the market demand is large and stables. The Company’s cornstarch products are almost unaffected by the trade war because it doesn’t need to import corn kernel from America. The raw material of the Company’s products is not directly affected by import tariff measures. The Company has supply chain advantages because it is close to the main corn planting areas and cornstarch consumption market. The transportation distance of corn procurement and cornstarch distribution is short, which can save costs. n Threat The Company is heavily dependent on the prosperity of the Chinese market, so it has a high domestic market risk. The challenge of excess capacity and weak demand for cornstarch accelerate over the past three years. The government will make more efforts to control the problem of air pollution, so the cost of environmental protection will continue to increase in the regular expenses of the Company. The market price of corn showed an upward trend in the past three years, which will

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compress the profit of cornstarch and other related products. Other production coat like electricity and steam, which rose under the impact of high coal price in the recent years, will still significantly affect the company’s profits. Starch’s relative strength in the market is becoming less attractive, and the export market of cornstarch is under increasing competitive pressure. With the continuously depressed prices of international sugar and recovery growth of Southeast Asia cassava, the Company’s cornstarch export advantage will weaken in the future.

4.4 Financial Analysis

4.4.1 Revenue, Cost and Earnings

n Revenue model The Company use transaction revenue model to sell products. It needs to produce and ship the products every single time to make money. To attract more customers, the Company has to create something new for sale such as using advanced technology, opening more distribution channels and improving products’ quality. n Sale analysis

Business Segments to the Company’s Revenue 2018 2017 2016 2015 2014

Cornstarch 70.1% 67.7% 69.0% 76.6% 71.3% Upstream products 70.1% 67.7% 69.0% 76.6% 71.3% Lysine 16.3% 20.0% 19.3% 12.6% 16.1% Starch-based sweetener 6.4% 5.8% 6.0% 5.9% 6.1% Modified starch 6.4% 5.9% 5.1% 4.7% 5.2% Other 0.8% 0.6% 0.6% 0.2% 1.3% Fermented and downstream products 29.9% 32.3% 31% 23.4% 28.7% Total sale 100% 100% 100% 100% 100%

2548

2385

1903

1868

2121

2526

2357

1939

1956

2105

5961

5818

5653

5977

5661

0 1000 2000 3000 4000 5000 6000 7000

2014

2015

2016

2017

2018

2014-2018 Main Products’ Average Selling Price Movement

Lysine Starch-based sweetener Cornstarch RMB/Ton

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The Company’s sales volume of upstream products was relatively stable, average 70% of the total revenue, but the average selling price was greatly affected by the China economic situation. In the past three years, the cornstarch average selling price has risen continuously due to the rising cost of raw materials, which reduced the competitiveness of the products in the market. The Company must enhance its technology to take a reasonable cost control. Lysine products’ sales volume were highly volatile. Due to the oversupply, its production capacity was much higher than the domestic market’s demand, and the average selling price was under high pressure. The Company needs to expand overseas market to stabilize the performance of lysine products. Sales performance of starch-based sweetener was affected by the excessive supply in the domestic market, which made a continuously rising average selling price in the past three years. To avoid building up excessive inventories, the Company needs to review the market demand of different starch-based sweetener products and adjusts production schedule in the near future. The sales volume of modified starch showed an upward trend from 2015 to 2018, which indicated that the market demand was expanding. At present, modified starch products only occupy a small part of the Company’s products, so the Company could consider to add more production lines of modified starch products and develop them with advanced technology to earn more market share. n Cost structure

Common-Size Cost Structure 2018 2017 2016 2015 2014 Direct variable costs 95.4 94.0 94.9 95.1 94.2 Fixed or semi-fixed overheads 4.6 6.0 5.1 4.9 5.8 Total cost 100.0 100.0 100.0 100.0 100.0

The Company has a stable cost structure from 2014 to 2018, an average 95% of the direct variable costs and 5% of the fixed or semi-fixed overheads. The cost structure shows that the Company heavy relies on direct labour and direct material, so it tends to have higher variable costs than fixed or semi-fixed costs. n Capitalization

Common-Size Capital Structure 2018 2017 2016 2015 2014

Equity 69.5 77.6 79.3 73.8 70.8 Liabilities 30.5 22.4 20.7 26.2 29.2 Assets 100.0 100.0 100.0 100.0 100.0

The Company showed a stable capital structure from 2014 to 2018, average 74% of the equity and 26% of the liabilities. It indicates that the Company has a low level of gearing, which means it has low debt and it will have a good financial growth in the future. Investors would like to invest in the Company because low gearing gives them a sense of security.

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4.4.2 Interpretation of Financial Statements

n Income Statement Consolidated Income Statement (RMB’000)

2018 2017 2016 2015 2014 Revenue 5,073,489 4,694,541 4,397,844 4,360,110 4,169,785 Cost of sales (4,630,325) (4,074,998) (3,900,749) (4,005,778) (3,806,266) Gross profit 443,164 619,543 497,095 354,332 363,519 Distribution expenses (91,425) (96,664) (101,132) (108,771) (110,953) Administrative expenses (148,475) (132,294) (115,865) (153,265) (117,164) Other gains and losses 67,968 105,868 12,558 27,978 19,004 Provision for impairment — — — — (86,437) Operating profit 271,232 496,453 292,656 120,274 67,969 Finance income 44,147 32,424 24,851 29,888 38,184 Finance expenses (444) (290) (1,862) (9,919) (22,196) Profit before tax 314,935 528,587 315,645 140,243 83,957 Income tax expenses (76,900) (134,526) (96,426) (38,330) (17,612) Profit after tax 238,035 394,061 219,219 101,913 66,345 Attributable to: Owners of the Company 230,897 388,167 213,682 98,877 62,725 Non-controlling interests 7,138 5,894 5,537 3,036 3,620

Common-Size Consolidated Income Statement 2018 2017 2016 2015 2014

Revenue 100.0 100.0 100.0 100.0 100.0 Cost of sales 91.3 86.8 88.7 91.9 91.3 Gross profit 8.7 13.2 11.3 8.1 8.7 Distribution expenses 1.8 2.1 2.3 2.5 2.7 Administrative expenses 2.9 2.8 2.6 3.5 2.8 Other gains and losses 1.3 2.3 0.3 0.6 0.5 Provision for impairment — — — — 2.1 Operating profit 5.3 10.6 6.7 2.8 1.6 Finance income 0.9 0.7 0.6 0.7 0.9 Finance expenses 0.0 0.0 0.0 0.2 0.5 Profit before tax 6.2 11.3 7.2 3.2 2.0 Income tax expenses 1.5 2.9 2.2 0.9 0.4 Profit after tax 4.7 8.4 5.0 2.3 1.6

The Company’s revenue showed a continuing rising trend over the past five years, but the gross profit fell 28.5% in 2018 because the cost of sales was up 13.6%.

The Company’s profit attributed to owners of the company (earnings) had grown significantly by 53.72% per year over the past five years, higher than an average of 9.7% in the food industry. However, the Company had negative earnings growth (-40.52%) in 2018, lower than 2.0% in the food industry.

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n Balance Sheet Consolidated Balance Sheet (RMB’000)

2018 2017 2016 2015 2014 Property, plant and equipment 1,781,270 1,131,849 1,230,397 1,344,642 1,263,365 Right-of-use assets 201,132 — — — — Prepaid payment — 205,587 210,474 215,688 215,253 Deposits for acquisition of prepaid payments

— — 20,830 20,830 20,830

Deposits for acquisition of property, plant and equipment

119,621 21,759 — 1,503 39,779

Deposits for acquisition of right-of-use assets

30,896 — — — —

Deferred income tax assets 77,957 48,527 7,369 26,236 22,537 Total non-current assets 2,210,876 1,407,722 1,469,070 1,608,899 1,561,764 Prepaid payments — — — — 4,917 Inventories 409,822 224,532 213,885 202,951 276,679 Trade and other receivables 462,391 409,692 336,545 384,634 381,268 Financial assets at fair value through profit or loss

— — 19 245 —

Pledged bank deposits 6,062 3,000 1,063 37,916 6,000 Fixed deposits with maturity period over three months

340,000 390,000 390,000 290,000 430,000

Cash and cash equivalents 782,904 1,103,160 493,810 298,075 184,568 Total current assets 2,001,179 2,130,384 1,435,322 1,213,821 1,283,432 Total assets 4,212,055 3,538,106 2,904,392 2,822,720 2,845,196 Share capital 532,656 532,656 532,656 532,656 532,656 Other reserves 401,491 423,560 419,205 395,759 415,419 Retained earnings 1,853,538 1,659,287 1,314,815 1,124,579 1,038,709 Equity attributable to owners of the Company

2,787,685 2,615,503 2,266,676 2,052,994 1,986,784

Non-controlling interests 138,658 131,520 35,626 30,089 27,053 Total equity 2,926,343 2,747,023 2,302,302 2,083,083 2,013,837 Borrowings — 224 1,110 1,996 2,882 Deferred income 342,142 220,183 33,543 35,432 34,067 Deferred tax liabilities 23,944 9,838 1,000 — — Total non-current liabilities 366,086 230,245 35,653 37,428 36,949 Trade and other payables 807,330 444,560 496,239 570,162 465,609 Income tax payable 83,559 88,302 40,601 8,336 20,972 Borrowings 4,432 4,208 3,322 97,436 281,550 Employee housing deposits 23,768 23,768 26,275 26,275 26,279 Lease liabilities 537 — — — — Total current liabilities 919,626 560,838 566,437 702,209 794,410 Total liabilities 1,285,712 791,083 602,090 739,637 831,359 Total equity and liabilities 4,212,055 3,538,106 2,904,392 2,822,720 2,845,196

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Common-Size Consolidated Balance Sheet 2018 2017 2016 2015 2014 Property, plant and equipment 42.3 32.0 42.4 47.6 44.4 Right-of-use assets 4.8 — — — — Prepaid payment — 5.8 7.2 7.6 7.6 Deposits for acquisition of prepaid payments

— — 0.7 0.7 0.7

Deposits for acquisition of property, plant and equipment

2.8 0.6 — 0.1 1.4

Deposits for acquisition of right-of-use assets

0.7 — — — —

Deferred income tax assets 1.9 1.4 0.3 0.9 0.8 Total non-current assets 52.5 39.8 50.6 57.0 54.9 Prepaid payments — — — — 0.2 Inventories 9.7 6.3 7.4 7.2 9.7 Trade and other receivables 11.0 11.6 11.6 13.6 13.4 Financial assets at fair value through profit or loss

— — 0.0 0.0 —

Pledged bank deposits 0.1 0.1 0.0 1.3 0.2 Fixed deposits with maturity period over three months

8.1 11.0 13.4 10.3 15.1

Cash and cash equivalents 18.6 31.2 17.0 10.6 6.5 Total current assets 47.5 60.2 49.4 43.0 45.1 Total assets 100.0 100.0 100.0 100.0 100.0 Share capital 12.6 15.1 18.3 18.9 18.7 Other reserves 9.5 12.0 14.4 14.0 14.6 Retained earnings 44.0 46.9 45.3 39.8 36.5 Equity attributable to owners of the Company

66.2 73.9 78.0 72.7 69.8

Non-controlling interests 3.3 3.7 1.2 1.1 1.0 Total equity 69.5 77.6 79.3 73.8 70.8 Borrowings — 0.0 0.0 0.1 0.1 Deferred income 8.1 6.2 1.2 1.3 1.2 Deferred tax liabilities 0.6 0.3 0.0 — — Total non-current liabilities 8.7 6.5 1.2 1.3 1.3 Trade and other payables 19.2 12.6 17.1 20.2 16.4 Income tax payable 2.0 2.5 1.4 0.3 0.7 Borrowings 0.1 0.1 0.1 3.5 9.9 Employee housing deposits 0.6 0.7 0.9 0.9 0.9 Lease liabilities 0.0 — — — — Total current liabilities 21.8 15.9 19.5 24.9 27.9 Total liabilities 30.5 22.4 20.7 26.2 29.2 Total equity and liabilities 100.0 100.0 100.0 100.0 100.0

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From 2014 to 2018, the Company’s short-term assets always exceed its short-term liabilities and its long-term assets also highly exceed its long-term liabilities, which show the Company has good control of assets and liabilities as well as excellent financial plans. n Cash Flow Statement

Consolidated Statement of Cash Flows (RMB’000) 2018 2017 2016 2015 2014 Cash and cash equivalents at 1 January

1,103,160 493,810 298,075 184,568 155,200

Operating activities 50,397 466,349 468,242 387,116 444,125 Investing activities (311,408) 92,341 (175,645) (46,019) (214,990) Financing activities 92,341 50,660 (96,862) (227,590) (199,767) (320,256) 609,350 195,735 113,507 29,368 Cash and cash equivalents at 31 December

782,904 1,103,160 493,810 298,075 184,568

The Free Cash Flow (FCF) of the Company rose continuously from 2014 to 2017, which indicated that the Company had capacities to generate cash after funding operation activities and capital expenditures. However, the FCF of the Company first showed a negative result in 2018 because of the big decline of net operating cash flow and the rising

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

2014 2015 2016 2017 2018

2014-2018 Assets and Liabilities Movement

Short-term assets Short-term liabilities Long-term assets Long-term liabilities

0.000.100.200.300.400.500.600.700.800.90

-1,000,000-800,000-600,000-400,000-200,000

0200,000400,000600,000800,000

2014 2015 2016 2017 2018

2014-2018 FCF and OCF of the Company

Free Cash Flow Operating Cash Flow RatioRMB’000

16

capital expenditures. In 2018, the 40.4% decrease of profit before tax and the 1640.3% increase in inventories led to 89.2% down of net operating cash flow. Besides, the construction of a new production base of Shouguang Golden Corn Biotechnology Limited, which increased the investment in property, plant and equipment, led to 575.1% up of capital expenditures. Negative FCF may not be bad because the Company is making significant investment, but it can’t last in the long-term. The Operating Cash Flow (OCF) ratio of the Company dropped from 0.83 to 0.05 in 2018 because of the smaller scale of net operating cash flow and huge payable for construction and equipment in current liabilities. The ratio was less than 1 over the five years, which meant the Company had generated less cash in the period than it needed to pay off its short-term liabilities. However, the Company is building a new production base, which will be helpful to generate more cash in the near future.

4.4.3 Financial Ratios

n Leverage Ratios 2018 2017 2016 2015 2014

Interest coverage ratio 610.88 1711.91 157.17 12.13 3.06 Equity multiplier 1.44 1.29 1.26 1.36 1.41 Debt-to-equity ratio 12.51% 8.38% 1.55% 1.80% 1.83%

Interest coverage ratio showed a low level of approximately three times in 2014. The Company completed the relocation of the production plants and facilities to the new production site, which causes an increase in average borrowings. Therefore, a large amount of finance expenses was spent. Compared with 2014, the interest coverage ratio rose 382% to about 1712 times in 2017. The reasons included the low average cost of corn and increasing market demand, which led the Company’s operating profit recorded RMB496 million in 2017, 7 times higher than that in 2014. The Company earns more interest than it pays at present, so coverage of interest payments is not a concern. The debt-to-equity ratio grew continuously in the past five years because the Company received more government grants, which was recorded as deferred income and became a part of non-current liabilities, to develop the production facilities in Shouguang and Linqing respectively. However, the gearing ratio still keeps at a low level, which means the Company is in a good position for further growth and more independent choices. n Operating Efficiency Ratios

2018 2017 2016 2015 2014 Days in inventory 25.00 19.64 19.50 21.85 31.72 Inventory turnover 14.60 18.59 18.71 16.70 11.51 Days in receivable 7.98 11.00 12.45 12.54 13.67 Receivable turnover 45.73 33.17 29.31 29.11 26.70 Days in payable 10.07 13.86 14.17 11.23 9.76 Payable turnover 36.25 26.34 25.76 32.52 37.39

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Days in inventory dropped from 31.72 days in 2014 to 21.85 days in 2015. The reason is because the price of corn kernel in Shandong Province plunged sharply in the second half of 2015, which reduced the production cost of lysine products and improved the sales volume dramatically. However, days in inventory grew from 19.64 days to 25 days in 2018 because the production of cornstarch highly exceeded the domestic demand, which led to the inventory piling.

Both days in receivable and payable showed a downward trend from 2014 to 2018, which signalled the Company had proper debtor management and credit control respectively. n Liquidity Ratios

2018 2017 2016 2015 2014 Cash conversion cycle 22.91 16.78 17.79 23.17 35.63 Current ratio 2.18 3.80 2.53 1.73 1.62 Quick ratio 1.35 2.70 1.47 0.97 0.71 Cash ratio 0.85 1.97 0.87 0.42 0.23

Current ratio, quick ratio and cash ratio fell in 2018, indicating a worsening in the short-term financing activities. The reasons are as followed: First, days in inventory increased, which took the Company longer to collect its cash from revenues. Second, payable for construction and equipment increased, which increased the non-current liabilities. Third, the Company paid more dividends, with the dividend payout ratio increased from 15% to 27.3% in 2018. n Profitability Ratios

2018 2017 2016 2015 2014 Gross profit margin 8.73% 13.20% 11.30% 8.13% 8.72% Net profit margin 4.69% 8.39% 4.98% 2.34% 1.59% Return on assets (ROA) 6.14% 12.23% 7.66% 3.60% 2.27% Return on equity (ROE) 8.39% 15.61% 10.00% 4.98% 3.32%

Gross profit margin grew 39% to 11.3% in 2016 (8.13% in 2015) following by several reasons. First, corn kernel price in the domestic market dropped substantially due to the suspension of the corn stockpiling policy, which resulted in a decrease in the production cost of the animal feeds and corn refinery industries. Second, new generation and environmental-friendly products like D-lactic acid enhanced the Company’s profitability. Third, using automated machinery improved production efficiency. However, gross profit margin dropped a third from 13.20% in 2017 to 8.73% in 2018. The Company didn’t adjust the products’ selling price when the cost of corn kernel, electricity and steam increased by about 9.6%, 35.1% and 13.8% respectively in 2018, which showed poor cost control of the Company. Net profit margin showed a very low level in 2014, approximately 1.59%. The reason is that the Company completed the relocation of industry, which causes a large amount of provision for impairment losses of property, plant and equipment. Although the net profit margin rose

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to 8.39% in 2017, it plummeted by half to 4.69% in 2018. The reasons are because of the increasing cost and the suspension of government subsidies. The Company ROA and ROE were considered lower than that of the food industry, an average of 10% in 2018.

4.4.4 Valuation

Per Share Data 2018 2017 2016 2015 2014

Net assets per share (RMB) 0.49 0.46 0.38 0.35 0.34 Earnings per share (RMB cents) 3.85 6.47 3.56 1.65 1.05 Dividends per share (HK cents) 1.2 1.2 0.75 — 0.69 Share price at the year ended (HK$) 0.169 0.305 0.17 0.151 0.172 Number of shares (’000) 5,995,892 5,995,892 5,995,892 5,995,892 5,994,109

Valuation Ratio 2018 2017 2016 2015 2014

Dividend payout 27.3% 15.0% 18.8% — 51.4% Dividend yield 7.10% 3.93% 4.41% — 4.01% P/E ratio 3.85 3.93 4.27 7.65 12.81

Dividend payout ratio and dividend yield ratio were zero in 2015 because the global and mainland China’s economy was uncertainty as well as the increasing volatility of the cornstarch and its related markets, which led the Board of the Company didn’t recommend any final dividend for the year ended 2015. With the Company’s reasonably low dividend payout ratio over the past three years, its dividend payments were well covered by earnings. However, the Company’s dividend yield (7.10%) in 2018 was in the top 25% of dividend payers in the Hong Kong market, which will attract more shareholders soon. Although the Company’s EPS increased an average of 33.0% over the past five years, it decreased by 40.5% in 2018. The P/E ratio showed a downward trend, and the numbers were very low, far away from the average P/E ratio (15.6) in the food industry, which means the stock is very cheap and has little risk in investment. The stock might be undervalued.

00.050.10.150.20.250.30.35

01234567

2014 2015 2016 2017 2018

2014-2018 EPS and Share Prices Movement

Earnings per share (RMB cents) Share price as at the year ended (HK$)

19

The Company has net cash and cash equivalents of RMB783 million. It is fairly high, at 88.2% of its market capitalization (HK$1.013 billion). That might mean it should help push the P/E a bit higher than it in the past. The recent drop in EPS would make investors cautious, but the net cash position means the company has time to improve. It may be an opportunity, and the stock could surprise the market on the upside.

5 CONCLUSION

The report includes economy analysis, industry analysis and company analysis. The economy analysis shows the macroeconomic situation in the international market and the domestic market. The Company are facing both opportunities and challenges of the economy. In the industry analysis, PESTEL analysis and Porter’s five competitive forces analysis show that the Company is benefiting from political regulations focused on marketization and Export Tax Rebate in cornstarch market. Besides, the Company has reasonable control and knowledge of technology that is likely to improve profits growth in the future. However, the escalating trade frictions, as well as excess capacity in the cornstarch market, are posing as a threat. Although the risk of new entrants is relatively low, the intensity of rivalry among the established companies in the industry is huge. The demand of cornstarch will still fall because of the rising cost of raw materials and oversupply. Other products, like cassava and tapioca starch, which can substitute cornstarch, are likely to be a considerable threat to the Company. In the company analysis, a business analysis indicates that the Company takes the leading position in the domestic cornstarch market, and it is serving major customers in Asian regions. The financial analysis focuses on the development of the company’s key figures, like solidity, operating efficiency, liquidity and profitability. The solidity was at satisfying levels. The Company had an average equity ratio of 74 % from 2014 to 2018 and a fast-growing interest coverage ratio over the past five years. There is no difficulty for the Company to coverage its interest payments. However, the Company experienced falling profitability trends. Both the gross profit margin and net profit margin declined because of the high increase of cost and days in inventory. The excess capacity and construction of a new production base also influenced the liquidity of the company, indicating in the liquidity ratios and free cash flow. The Company’s stock might be undervalued based on the valuation analysis. The stock price possibly could surprise the market on the upside.