/ thematic-hk

Exposure to the Hottest Commodity in China

2 Apple Stocks in Hong Kong

At the Asian Investor Summit last week we heard a presentation mention that Apple (the fruit 🍎) Futures were becoming one of the most heavily traded commodities in China! Sceptical, we decided to dig into the numbers ourselves.

It turns out Apple Futures are a recently listed product on the Zhengzhou Commodity Exchange (ZCE). There was unexpected cold weather in Northern China toward the end of last year which has fuelled expectations of a supply shortage this year.

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At the peak, the ZCE apple futures traded as much as the combined volume of A-shares on the Shanghai and Shenzhen stock exchanges! While recent measures to cool the market have had an impact, the price is still up ~80% since lows early this year.

This got us wondering if there were any companies in Hong Kong that deal with Apples which might be exposed to this mania.

Methodology

We assume that companies involved in the apple business will mention the word apple in their annual reports. We look at the latest batch of annual reports minimise the universe and keep the results current.

Our initial screen yielded over 350 documents. The major false positives were;

  • Apple Inc.: The American technology giant featured prominently in many reports, ranging from mentions as a macro indicator to developers boasting them as a tenant
  • ESG Reports: Many companies planted apple trees as part of their CSR efforts. At a glance, it appears that this phenomenon is unique to H-shares. Perhaps the Chinese government has explictly given such guidance to companies.

In addition to the above, there were also random mentions of the word apple in project and company names, such as Apple Daily. To reduce the noise we then ranked the reports using Term Frequency in Document Frequency (TF–IDF). This takes our search term 'apple' and weighs the frequency against the total number of words in the document. We used page length as a proxy for the number of words.

This weeded out most of the false positives but still left game companies which mentioned Apple's app stores prominently in their reports. Thankfully there weren't too many so we manually stripped these from the results. This left us with 8 companies, of which 2 were excluded for being too irrelevant.

The remaining 6 companies fall into three broad categories, in descending order of relevance to the theme;

  1. Related, but no meaningful impact
  2. Futures brokers
  3. Apple juice concentrate manufacturers

Results

Related, but no meaningful impact

0413 South China Holdings
South China Holdings is an OEM toy manufacturer. It splits its business lines into [1] Trading & Manufacturing (OEM toys) [2] Property Investment & Development [3] Investment Holdings, and [4] Agriculture & Forestry. As part of its Agriculture & Forestry divsion it owns 144,000 apple trees. However, this division only accounts for 0.36% of revenues so it's unlikely to have any meaningful effect on the company's performance.

0220 Uni-President China Holdings
The company holds a 17.87% stake in Yantai North Andre Juice, a pure-play listed company that appears below. The company adds its share of profits from Andre and other investment to its Operating Profit to come with EBIT. These numbers account for roughly 2% of EBIT.

As a portion of assets the Yantai stake is worth ~2%.

It's worth noting that the company has appointed one of Andre's non-executive directors so it has significant influence over Andre. However, the attributable revenues and assets are too small to be relevant to the company's performance.

Futures brokerages

It's likely that most brokerages that are ZCE participants will benefit from the increased volume. However, rather than list those, we've stuck to the methodology and only report companies that came up in the search for the term 'apples'.

01461 Luzheng Futures Company
As the name implies, the company is a futures brokerage. They explicity mention apple futures as a new product 3 times in their latest annual report. It's hard to say how much they will benefit directly from the explosion in volume, but it's reasonable to assume that there will be a direct correlation between market volumes and revenues.

6881 China Galaxy Securities
China Galaxy Securities is a brokerage firm. The firm trades in stocks and futures, while also earning income from asset management, underwriting, and financial advisory. Commissions from futures brokerage amounted to 6.15% of total commissions earned. The vast majority of commissions are still earned from stocks – 75.8%. As part of their market outlook the company mentioned that Apple futures had commenced on the ZCE.

Apple Juice Concentrate Manufacturers

2218 Yantai North Andre Juice
Andre is a concentrated juice manufacturer. Apple Juice Concentrate accounted for ~85% of the company's revenues, ostensibly making it a good pure-play.

Roughly 35% of the company's business is conducted through subsidiaries. The ratios of operating expenses as a percentage of totals is roughly equal, indicating a similar cost profile across the group.

78% of the company's revenues are from abroad. They cite Europe as a the major competition for juice concentrate. It will require further analysis to determine how much of the cost of goods they can pass on to customers without losing market share. It's worth noting that it appears the company's juice concentrate is used as a raw material by clients.

On inventory they have roughly RMB755 million worth of finished product on hand so it's possible that they ride out the current price increases on existing inventory. Raw materials are 63% of the SG&A at RMB508 million.

0359 China Haisheng Juice Holdings

Haisheng is another juice concentrate manufacturer. Apple juice accounts for 77% of the group's revenues. Unlike Andre, the company is vertically integrated and produces its own apples under its agriculture division. While the company does sell fresh fruit produce directly, it's only 6.4% of total revenues.

This means the majority of the fruit produce becomes a raw input to the juice concentrate. Presumably this is counted in the cost of sales, which is 79% of revenues.

Like Andre, the majority of revenues come from abroad at 71%, indicating a sensitivity to global market prices. Also, like Andre, how well they can pass on incrased costs without losing market share to European competitors will determine how increased apple prices will affect them.


It's worth noting that both companies here reported better year-on-year earnings. They both cited poor European production as the reason. When a cold front affected European production in 2017 customers switched to importing from China instead. It's possible that they will both be affected in the same way if the cost of Chinese production soars.

Summary

0413 South China Holdings – 144K apple trees, agri 0.32% revenues
0229 Uni-President China – 17% stake in Andre = 2% revs/assets
01461 Luzheng Futures Company – Mentioned apple futures
6881 China Galaxy Securities – Mentioned apple futures
2218 Yantai North Andre Juice – >70% Apple Juice Concentrate
0359 Haisheng – >70% Apple Juice Concentrate, vertically integrated

Finding Andre and Haisheng was a good result. They're both pure-plays that are likely to be impacted by the price of apples.

Andre has a market cap of 530MM (USD68MM) and is up 25% in the last month. Haisheng has a market cap of 432MM (USD55MM) and is mostly flat.

Neither company mentions futures or has a line item for hedging so it's unlikely that they've locked in prices. Next steps would be to model their sensitivity to price changes in the underlying commodity. In particular, it's worth looking at how global demand shifted to China when similar weather conditions in Europe hurt production in 2017, and modeling the reverse.

Exposure to the Hottest Commodity in China
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