Investment positives

We initiate coverage on Meihua Holdings Group Co., Ltd. (Meihua) with an OUTPERFORM rating and a target price of Rmb13.70, implying 12x 2024e P/E under a relative valuation model. Meihua is a synthetic biology company that develops comprehensive amino acid products.

Why an OUTPERFORM rating?

Amino acid leader will likely see improvement in supply and demand conditions. Demand for amino acid products increased after Chinese regulators proposed reducing and substituting soybean meal. Domestic amino acid output increased at a five-year CAGR of 11.7% to around 4.3mnt in 2023, according to www.boyar.cn.

On the supply side, we think capacity expansion in the industry has slowed down. The market is unlikely to see new threonine capacity in 2024-2025 while there will be some new lysine projects from leaders. Meihua ranked No.1 in the industry (by capacity) with 550,000t of threonine and 1mnt of lysine. We expect its earnings to improve as supply-side expansion slows and demand recovers.

The firm is increasing shareholder returns via cash dividend payout and share buyback and cancellation. Total cash dividends paid by Meihua since 2018 was around Rmb6.34bn, and annual average dividend payout ratio and dividend yield were 48.9% and 5.6%. Since 2021, the firm has repurchased and canceled 216mn shares with a cumulative value of Rmb2.06bn, resulting in higher earnings per share. In 2023, Meihua planned to pay a cash dividend of Rmb1.2bn, and it canceled Rmb860mn worth of repurchased shares. Based on its share prices, we think its dividend yield was about 7.2%.

Meihua accelerating measures to build technology and product platforms to support development of synthetic biology business. It has the volume-based biomanufacturing capabilities required for the development of synthetic biology. At present, it is developing technologies related to synthetic biology and bio-fermentation as well as new amino acid-based products. It is also tapping growth potential in fields of basic biotechnologies, precision fermentation, and non- grain fermentation. Given its R&D of advanced production and new products, we expect the firm to develop into a platform-based firm.

How do we differ from the market? The market is concerned that the increase in monosodium glutamate (MSG) capacity and price declines of xanthan gum may pressure the firm’s earnings, thus weighing on its dividend payout and share buyback. As the concentration ratio of the top three leaders (CR3) in the MSG industry exceeds 90%, we do not expect a new round of price competition. In our view, the profit margin of xanthan gum will remain reasonable despite price declines. In addition, we expect the firm to maintain solid capex over 2024-2025, and we believe its cash flow will be enough to cover capex and expenses related to dividend payout and share buyback.

Potential catalysts: Stronger-than-expected amino acid demand triggered by hog price hikes; faster-than-expected R&D progress in the field of synthetic biology; higher dividend payout ratio and share buyback ratio.

Financials and valuation

We estimate the firm’s EPS at Rmb1.14 in 2024 and Rmb1.27 in 2025, implying a CAGR of 6.5%. The stock is trading at 8.9x 2024e and 8.1x 2025e P/E. The MSG industry is highly concentrated and the supply growth of threonine has slowed. Given that Meihua has ample growth potential in the field of synthetic biology, we initiate coverage on the firm with an OUTPERFORM rating and assign a target price of Rmb13.7 based on relative valuation method. Our target price implies 12x 2024e P/E with 34% upside.

Risks

Intensifying competition caused by capacity expansion; anti-dumping duties from overseas regulators; disappointing returns from new projects.