Tissue Profits Are Nothing to Sneeze At

04/14/2010 12:01 am EST

Focus: GLOBAL

Yiannis Mostrous

Editor, The Capitalist Times

Toiletries maker Hengan is set to clean up on China’s rapid growth, writes Yiannis G. Mostrous in The Silk Road Investor.

Hengan International (Hong Kong: 1044, OTC: HEGIF), a longtime Silk Road Investor recommendation, offers exposure to growing domestic demand within China. The company manufactures, distributes, and sells sanitary napkins, disposable diapers, tissue paper products, skin care and cleansing products, as well as other personal hygiene products.

It started making sanitary napkins in China in the early 1990s, effectively creating the market, and has built a strong brand name and distribution network. With over a dozen manufacturing facilities, it ranks number one in high-end tissues and number two in sanitary napkins and diapers.

Hengan posted solid results in 2009: Revenues increased 34% from a year ago to US$1.5 billion, and earnings were up 58%. Tissue paper remains the biggest contributor, accounting for 41% of group sales. Sanitary napkins accounted for 24% of sales.

Several market conditions should act as positive catalysts for Hengan’s stock. For one, pulp prices may not be as big an issue for Hengan this year. At present, the company has enough low-priced wood pulp in its inventories to cover production though August. And analysts expect pulp prices to fall later this year; capacity is increasing globally, while demand remains flat.

Such an outcome would allow Hengan to buy wood pulp later in the year at reduced prices, boosting its profitability. Note that Hengan has increased margins steadily, regardless of pulp prices; management agilely takes advantage of even short-term price weakness to build inventories.

The company should also benefit from Renminbi/yuan (RMB) appreciation. Although many investors are concerned about US efforts to force the Chinese to allow the RMB to appreciate faster, China will go ahead with a gradual appreciation. Expect the Chinese currency to appreciate 5% to 6% this year—an outcome that would benefit Hengan, as almost 50% of its costs are in US dollars while its sales are in RMB.

Management has a track record of success in appraising business conditions and projects solid growth in 2010. Tissue paper sales are expected to grow close to 20% this year; diaper sales should increase 26% from 2009; and sales of sanitary napkins should grow 29% to 30%. And the improved economic picture will lessen the need for extensive promotion, while new and improved products should boost sales.

Hengan is on its way to becoming a Chinese giant, and the stock will continue to command higher multiples as long as it continues to deliver on the growth front. A winner for the long run, Hengan International rates a Buy. [Shares closed at HK$56.80 in Hong Kong Wednesday—Editor.]

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