China Forestry 4 February 2010

Transcription

1 China/Hong Kong Basic Materials China Forestry 4 February 2010 Riding the next resources boom Sector Rating: Overweight (maintained) The next resources boom. Wood is a major raw material and its demand is highly correlated to general economic activities. Our analysis indicates wood demand in China is accelerating. We expect demand for key products sawn timber, veneer and plywood to grow at a CAGR of around 10% in after a 12% CAGR in the past five years. Forestry in China on the starting line. In October 2009, China announced the Forestry Industry Revitalization Plan ( ). The government is keen to speed up the reform and development of the industry, which is very fragmented in China. Plenty of opportunities will emerge for forestry companies, especially those with solid track record, to expand in China. Top picks: Sino-Forest and China Forestry. We initiate coverage on five forestry companies with Outperform ratings. Our top picks are Sino-Forest (TRE CN, TP: C$28.40) given its 14 years of solid track record and sound expansion plan, and China Forestry (930 HK, TP: HK$3.70) given its high and sustainable margins. We also like Samling Global (3938 HK, TP: HK$1.02) as its downstream expansion in end-user products e.g. floorings will pay off in the medium term. While the other two companies Omnicorp (94 HK, TP: HK$3.00) and Bright Prosperous (723 HK, TP: HK$1.10) are small, they have rich overseas hardwood resources. Notably, China is a net importer of hardwood. Unparalleled growth prospects, undemanding valuations. In light of strong sales volume growth and fairly stable margins, we expect the combined companies earnings to increase by 65% in FY10F and by another 54% in FY11F. Sino-Forest and China Forestry are only trading at PERs of x in F, implying strong upside potential from the current share prices given their bright earnings prospects. Valuation matrix China Sino-Forest Forestry (TRE CN) (930 HK) Bright Samling Omnicorp Prosperous (3938 HK) (94 HK) (723 HK) Market cap 4,173 1, (US$m) Rating O O O O O Price (local currency) Current Target Upside (%) EPS (local currency) FY (0.01) (0.04) (0.00) FY FY PER (x) FY N/A N/A N/A FY FY EV/EBITDA (x) FY FY FY P/BV (x) FY FY FY Note: Closing price on 3 February, 2010 Source: CCBIS estimates An under-researched industry on HK-listed stocks. Forestry has been an under-researched industry yet the IPO of China Forestry and recent capital market activities in Hong Kong should arouse investors attention. Increasing capital market exercises expected in the next 12 months should further enhance the profile of the sector. Key investment risks. Weather, natural hazards, legal issues and political issues are major risks for the forestry industry. Our assumptions conservatively factor in the potential impact of these risks. Yan Tsui (852) yantsui@ccbintl.com Felix Lam (852) felixlam@ccbintl.com

2 Table of Contents Riding the next resources boom...1 Executive summary...3 What is Forestry?...6 China needs wood...10 Forestry Industry Revitalization Plan ( )...13 Industry risks...14 Forestry companies at a glance...15 Sino-Forest (TRE CN)...19 China Forestry (930 HK)...31 Samling Global (3938 HK)...41 Omnicorp (94 HK)...54 Bright Prosperous (723 HK)...66 Appendix 1 Global forestry resources and industry trends...78 Appendix 2 Sustainable Forest Management (SFM) and certifications...84 Appendix 3 What is REDD?...85 Appendix 4 Major tree species

3 Executive summary The next resources boom Wood is an essential raw material, and is of comparable importance to steel and cement to a country s development. While demand for all these materials are highly correlated to general economic activities, they also correspond to different stages of an economy s development. At the nascent stage of development, economic growth is generally driven by infrastructure and heavy industries. This is going to drive robust demand first for cement, then moving to steel. China is a precise illustration for that. In , China steel demand grew at a ~16% CAGR, compared to ~8% in and ~5% in As economic growth and the wealth of a society reach a certain level, demand for higher quality of living increases, leading to an acceleration of demand for wood products. In our view, China has just reached this stage. We estimate the demand for sawn timber, veneer and plywood, which together accounted for over 60% of roundwood fibre demand, will increase at CAGR of about 10% in after growing at a 12% CAGR in the past five years. Forestry is on the starting line Forestry is still a fledgling industry in China and is highly fragmented. Notably, Sino-Forest, being the top three privately-held Chinese forest plantation companies in terms of forest area under management, is only managing less than 5% of the nation s forest resources. To regulate the forestry industry and encourage sustainability of forest resources, China announced the Forestry Industry Revitalization Plan ( ) in October last year. This is a milestone for China s forestry industry. We see plenty of opportunities for companies, especially those with solid experience, to expand their business in China. While we expect domestic production to grow rapidly in the next few years, China will need to rely heavily on imports of wood, especially hardwood. According to International Tropical Timber Organization (ITTO), China is a net importer of logs and sawnwood and its import volume is on an increasing trend, except for 2008 when the financial crisis hit the economy. We expect domestic wood shortage to persist in the medium term. As a result there is ample room for companies with quality forest resources overseas to tap into booming Chinese demand. The hidden gem Forestry companies, upstream companies in particular, generally enjoy stable and healthy margins as well as strong cashflow after the initial stage of investment, depending on the business model and maturity of trees. If the company purchases immediately harvestable forests, cash inflow could be realized shortly. Sino-Forest and China Forestry are the obvious examples. 3

4 We initiate coverage on five forestry companies with Outperform ratings. Our top picks are Sino-Forest (TRE CN, TP: C$28.40), given its strong management team and 14 years of outstanding track record in China forest plantation, and China Forestry (930 HK, TP: HK$3.70), given its high and sustainable margins. We also like Samling Global (3938 HK, TP: HK$1.02) for its integrated business model. The company is expanding into end-user products e.g. flooring and furniture distribution through Elegant Living in China and Brewster in Australia. The other two companies are Omnicorp (94 HK, TP: HK$3.00) and Bright Prosperous (723 HK, TP: HK$1.10). Although they have a shorter track record in the industry and smaller in terms of market capitalization, they have rich overseas hardwood resources. Omnicorp has tropical hardwood resources in Suriname while Bright Prosperous has forest resources in Brazil and Russia. We are optimistic on demand and prices for hardwood products. China is a net importer of hardwood, with import volume increasing from less than 1m m 3 in 1996 to around 3m m 3 in Unparalleled growth prospects, undemanding valuations Our target prices for Sino-Forest, China Forestry and Samling are based on PERs as their forest resources and business models are already mature. Omnicorp and Bright Prosperous are new to the forestry business (although their management is well experienced). They recently acquired forest assets that will take some time to develop. We believe DCF based target prices will be more appropriate to capture the substantial earnings beyond Our group of companies will enjoy a combined earnings growth of 65% in FY10F and 54% in FY11F based on our estimates. This is underpinned mainly by rapidly rising sales volume and modest increase in selling prices. Sino-Forest and China Forestry are only trading at PERs of x in F, implying strong upside potential from the current share prices given their bright earnings prospects. Our target prices imply 29-45% upside for these companies. An under-researched industry Forestry has not been a well covered industry, which can be explained by the fact that most of the listed companies in Hong Kong are relatively small in terms of market capitalization. We initiate coverage with this comprehensive sector report. While the industry is still small, there have been increasing capital market activities over the past year. This includes: February 2009: Sino-Forest increased its holdings of convertible bonds of Omnicorp in February 2009 and became its single largest shareholder. Omnicorp has hardwood forest resources in Suriname. July 2009: Bright Prosperous (to be renamed as Sustainable Forest Holdings) completed an acquisition of a forestry company. The company has forest resources and processing plants in Brazil, Russia and China. December 2009: The IPO of China Forestry among the top three private forestry companies in China in terms of forest resources. 4

5 Given that forestry is a capital intensive industry and China s booming demand is providing the industry new growth opportunities, we expect to see more fund raising and M&A activities in the HK-listed forestry sector in the coming years, therefore raising the profile of the sector. China aims to reform and develop forestry In October 2009, the State Forestry Administration (SFA) published the Forestry industry Revitalization Plan ( ), highlighting the country s near-term plan to promote industry development and its corresponding measures. We believe this is just the beginning of a reform of China s forestry industry. To maintain sustainable economic development going forward, we expect China to announce more policies and regulations to support the industry. This will gradually arouse investors attention. Forestry Sustainability is the key Sustainability is gaining increasing focus in forest management and wood products manufacturing. An increasing number of forestry companies practice Sustainable Forest Management (SFM) and apply for internationally recognized certifications in responsible forest management, such as Forest Stewardship Council (FSC) certification. The Copenhagen submit (COP15) held in late 2009 concluded without a binding agreement regarding forestry, but an accord was reached including a guideline for carbon emission reduction from forests, the first ever in COP s history. The agreement called for the immediate establishment of forest-based carbon reduction mechanism including REDD-plus (Reduced Emissions from Deforestation and Forest Degradation). 5

6 What is Forestry? Forestry is the management of forest resources. The objective of managing forests is to explore, prioritize and optimize the biological, recreational, aesthetic and economic resources in forests. In considering the economic value of a forest, one should understand the present value, growth rates, crop rotation and corresponding regulations. Sources of trees natural forest and plantation Trees are either naturally grown or planted. According to the Food and Agriculture Organization of the United Nations (FAO), total world forest area as at 2005 was estimated to be 3,952m hectares (ha), representing around 30% of total land area. Natural forests represent over 95% of the world s forest resources. As a result of rapid deforestation and illegal logging, we increasingly rely on plantation to meet our wood demand. Forest resources in China Forest resources in China is scarce compared to the global average. The country has 0.2 ha of forest area per capita, only one third of the global average while it ranked fifth in terms of total area (~197m ha). China relies on imports and plantation to fulfill its domestic demand. Please refer to the next section China needs wood on page 10 for further information. Types of trees hardwood and softwood Trees are classified broadly into two species hardwood and softwood. According to Pöyry, an international forestry consulting firm, global growing stock of timber resource amounted to around 426m m 3 in 2005 of which 67% is hardwood. The geographical distribution of the resources is detailed below. 6

7 Figure 1: Global growing stock of timber resources, 2005 (million m 3 ) Hardwood Softwood Source: Pöyry Hardwood. Tropical hardwood species, from tropical and subtropical forests, are mainly found in South America, Africa and secondarily in Asia. Examples of hardwood species include oak, beech, birch and cherry. There are about a hundred times as many types of hardwoods as compared to that of softwoods. Hardwood species are typically more desirable for their strength, durability and appearance (color and wood grain). They usually command a higher selling price. Softwood. Softwood is a term used as opposed to hardwood, coming from different types of trees. They are mainly found in Europe and North America. Examples of softwood species include fir, pine and spruce. Forest plantations typically produce a larger portion of softwood than natural forests, indicating that softwood is easier to be replanted/regenerated. Thus, they usually demand a relatively lower selling price than hardwood. Figure 2: Comparison between hardwood and softwood Hardwood Softwood Tree types Angiosperms Conifers Common tree species Oak, beech, birch, eucalyptus Fir, pine, spruce Location South America, Africa, Asia Europe, North America, Asia Characteristics Typically better strength, durability and appearance Typically better strength, durability and appearance Application Furniture, floorings etc. Furniture, floorings, paper and pulp etc. Selling price Typically higher Typically lower Source: CCBIS 7

8 Supply chain of wood The supply chain of forestry is fairly straightforward and easy to understand. Management, planning, logging and transportation are generally classified as upstream operations while processing of logs and timbers falls into downstream operations. Figure 3: Production process Source: Samling Global Upstream activities focus on forest resource management including forest planning, planting, as well as harvesting and transportation of logs. Downstream activities focus on processing of logs into products e.g. plywood, veneer, sawn timber, paper and pulp etc. as well as other value-adding processing activities such as production of building materials including flooring and furniture. 8

9 In general, developing countries e.g. Brazil, Suriname focus on raw materials and primary process products, while developed countries focus more on higher value-adding products. However, rapidly increasing demand for end-products is observed in emerging markets such as China and India. Wood products Woods can be used in different areas, such as construction, furniture, pulp and paper. The products from upstream to downstream are: Logs are directly cut from trees in forests. Logging from a forest is the most upstream step in the value chain. They are the unprocessed raw material for further processing. Lumber/timber is a general term for the semi-raw products cut from raw logs. They are supplied rough or finished, some cut into standard sizes. They are then used for further cutting and processing, moving further downstream. Logs are often processed into sawn timber in sawmills. Plywood is a piece of manufactured wood made from veneer i.e. very thin sheets of wood, glued together. Plywood is used in many applications such as floors, walls and packages, depending on the type and quality of wood. Plywood needs to be further processed to produce end-products for these applications. Fiberboard is a type of engineered wood product that is made from wood fibers e.g. wood chips. A common type of fiberboard is medium-density fiberboard (MDF), which is heavily used in the furniture industry. End-products made from wood comprise of a wide variety of products, including flooring, doors, furniture, kitchen cabinets and so on. Varying types and qualities of woods are best suitable for different products. Figure 4: Production process from logs to end products Logs Veneer Fibreboard Plywood Sawn Timber Other Wood Products Door Facings Housing Products Doors Flooring Furniture Kitchen cabinets Source: Samling Global 9

10 China needs wood China lacks local forest resources, be it natural forests or plantations, to support its growth in the years ahead. According to the FAO report in 2005, China has approximately 197m ha of forests, ranking the fifth in the world after Russia, Brazil, Canada and the United States. However, China s forest area per capita is approximately 0.2 ha, only about one-third of the global average of 0.6 ha. China s forest area accounts for around 21% of total area, compared to the global average of 30%. Thus, China has been a net importer of logs and sawnwood since 1993, the oldest year which ITTO data is available. Figure 5: China import/export of logs, F Figure 6: China import/export of sawnwood, F 40,000 9,000 35,000 30,000 25,000 20,000 8,000 7,000 6,000 5,000 4,000 15,000 3,000 10,000 5, ,000 1,000 0 (1,000) (5,000) (2,000) Import Export Net import F Import Export Net import F Source: ITTO Annual Timber Review Source: ITTO Annual Timber Review The next commodity boom Similar to demand for steel, demand for wood products (ex-logs) has a close relationship with general economic growth. More steel is needed when a developing economy enters the industrialization era. China is a great example to illustrate this. China s steel consumption per capita is over 410kg now, up substantially over the past 10 years (~110kg in 2000 and ~270kg in 2005) and is now much closer to the average of the developed countries. In , China steel demand grew at a ~16% CAGR compared to ~8% in and ~5% in We expect a similar story for wood to emerge. Based on our analysis, China has just entered or is soon to enter a long up-cycle for log and wood products. In F, consumption of sawn timber, veneer and plywood rose at a CAGR of 12%, compared to an average decline of 3% in We estimate that consumption per capita of sawn timber, veneer and plywood in China was about 0.056/m 3 in 2008F, only 24% of that of developed countries. The demand outlook for wood is promising, providing remarkable growth potential for Chinese-based forestry companies. We also see abundant opportunities for companies with rich overseas forest resources to import wood into China. 10

11 Figure 7: Wood consumption and GDP per capita Consumption per capita (m 3 ) 0.3 Italy Australia R 2 = Germany 0.2 Japan France Malaysia UK Egypt China India Nigeria Brazil 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 GDP per capita (US$) Source: ITTO Annual Timber Review , CCBIS estimates We expect per capita demand reach 0.067m 3 in 2010F and 0.104m 3 in 2015F. Our estimates are based on a GDP per capita growth of 8% per annum, and extrapolating the wood products consumption per capita from the regression line. This implies total demand growth of 10% in F. Figure 8: Demand for wood products, F '000 m 3 160, , , ,000 80,000 60,000 40,000 20, F 2009F 2010F 2011F 2012F 2013F 2014F 2015F Source: ITTO Annual Timber Review , CCBIS estimates Rapidly growing wood products output Production of sawn timber, veneer and plywood has increased fairly rapidly in the past few years in China, outpacing the growth of log output. We attribute this to the expansion of sawn mills which allow more logs to be processed into sawn timbers. Notably, sawn timbers generally have higher value as they are easier to be preserved, stored and transported. 11

12 Figure 9: China log production, F Figure 10: China wood products production, F '000 m 3 80,000 '000 m 3 80,000 70,000 70,000 60,000 60,000 50,000 50,000 40,000 40,000 30,000 30,000 20,000 20,000 10,000 10, F F Source: ITTO Annual Timber Review Source: ITTO Annual Timber Review Forestry is more than an economic issue Deforestation and illegal logging have resulted in rapid depletion in forest resources globally. To ensure the sustainability of wood supply, governments have stipulated various laws and policies to regulate harvesting in forests. After lagging behind in forestry legislation for a long time, we believe China is now aware of the importance of forest management and is catching up to reform the industry. The latest move by the government is the announcement of the Forestry industry Revitalization Plan ( ), which will be discussed in the next section. 12

13 Forestry Industry Revitalization Plan ( ) Recently in October 2009, the State Forestry Administration (SFA) of China published the Forestry industry Revitalization Plan ( ), highlighting the country s near-term plan to promote industry development and its corresponding measures, in light of the financial crisis. We see this as a milestone for China s forestry industry, also a demonstration of the government s intention to promote industry growth through enhancing industry structure and adopting supportive measures. Below is a summary of major targets set by the government to be achieved by 2012: Market value of the industry to reach RMB 2,260b in 2012, up from 1,440b RMB in 2008, targeting a 12% CAGR in the period. Emergence of 100 national-level leading enterprises by 2012 through government support. Total international trade value to reach at least RMB90b by 2012, of which export level targeting to recover to 2007 level; to retain the position as the largest exporter of various products including wood-based panels, flooring and furniture. To achieve the above targets, the government has stipulated the following policies: Reduce Forest Maintenance Fees from 20% of forestry sales revenue to below 10%; Forest Maintenance Fees is paid to the government by forest operators based on the forest they own, such that the government helps to regulate the forest, and provide seedlings for re-plantation in some cases. Reduction in fees incentivizes forest operators and attracts new market entrants. Enhance credit/financing policies for forestry industry, based on the Guidelines on Financial Services for Forestry industry, jointly published by Peoples Bank of China, Ministry of Finance, China Banking Regulatory Commission, China Insurance Regulatory Commission, the State Forestry Administration; going forward, Forestry companies could enjoy more lenient bank credit approval as well as preferential interest rates. Explore the establishment of forest insurance scheme; include forest insurance to fall under agricultural insurance, incentivize insurance companies and forest operators to participate in forest insurance and increase insured forest area. We believe this policy framework is the most impactful and widest in scope among forestry policies in recent years. We are confident that this framework will provide a major boost the industry development, benefiting forestry plays with involvement in China. 13

14 Industry risks Regulatory risk Forest management and wood products processing are subject to many regulations, and differences among countries are significant. Examples being log export tax or restrictions, as well as environmental regulations. Environmental regulations in logging in resources-rich countries with tropical wood e.g. Brazil, Suriname are especially stringent. We believe level of risk is medium overall, but varies across different countries. Weather conditions and natural hazards Logging activities are constrained by weather conditions. Logging operations are limited, if not suspended, during rainy seasons. For example, rainy season typically spans from December to March/April in Brazil. Moreover, natural hazards, especially fire, can destroy forest resources. Although unable to control such external factors, most forestry companies buy insurance for their forests to shield themselves from substantial losses. Legal risk Forestry companies are closely tracked by environmentalists and non-profit organizations on their forest management practices, treatment of local villagers and protection of forest biodiversity. Forest resources and processing facilities are governed by stringent regulations and permits. If any controversial or potentially illegitimate practices are publicly noticed, lawsuits can occur and company reputation could be at risk. In our view, level of such risk is low in general since forestry companies under our coverage mainly practice sustainable forest management, and either possesses or is applying for relevant certifications. Political risk Forest resources are often located in less politically stable and less developed countries like Brazil and Suriname. Political turmoil in these countries could affect in logging activities. Effect on earnings could be devastating. We believe major political turmoil would be unlikely, but remain cautious on the unpredictability of political fluctuations. 14

15 Forestry companies at a glance Out of the five companies under our coverage, Sino-Forest and China Forestry belong to the forest plantation segment. Omnicorp and Bright Prosperous belong to the natural forest segment, while Samling has both types of forest resources. Figure 11: Forestry companies under our coverage Sino-Forest (TRE CN) China Forestry (930 HK) Samling (3938 HK) Omnicorp (94 HK) Bright Prosperous (723 HK) Market cap (US$m) 4,173 1, Segment Mostly upstream, small Upstream Integrated Upstream Upstream downstream Wood type Hardwood/softwood Hardwood/softwood Hardwood/softwood Hardwood Hardwood/softwood Forest resources 474,000 ha across China 171,800 ha in Sichuan, Yunan 3.6m ha in Malaysia, New Zealand, China 180,000 ha in Suriname 287,000 ha in Brazil, Russia Expansion Forest resources acquisition Forest resources acquisition Downstream distribution in China and Australia Sawmill for lumber processing Forest resources acquisition, sawmill for lumber processing, Clear Cut project Source: Bloomberg, CCBIS Earnings and margin comparison We compare the net income and EBITDA growth for the three more established companies Sino-Forest, China Forestry and Samling. China Forestry experienced a substantial earnings growth in FY06-08 owing to rapid volume expansion. Sino-Forest has experienced considerable earnings growth in FY06-08, and we expect such growth to continue. Despite incurring a net loss in FY09, we expect Samling to achieve significant growth going forward. Figure 12: Net income growth comparison 160% 140% 120% 100% 80% 60% 40% Figure 13: EBITDA growth comparison 160% 140% 120% 100% 80% 60% 40% 20% 0% N/A Sino-Forest China Forestry Samling 20% 0% Sino-Forest China Forestry Samling FY06-FY08 CAGR FY09-FY11 CAGR FY06-FY08 CAGR FY09-FY11 CAGR Note: Samling has incurred a net loss in FY09, thus FY09-FY11 net income growth is not meaningful. Note: * EBITDDA (earnings before interest, tax, depreciation, depletion and amortization) is used for Sino-Forest. 15

16 The remaining two companies Omnicorp and Bright Prosperous, are entering into a stage of significant operating leverage. We expect Omnicorp s net income to increase by 718% in 2011F and 254% in 2012F, mainly driven by sales volume increase as well as the commencement of its sawmill production in mid For Bright Prosperous, we expect its net income to increase by 4,088% in FY11F (March 2011) and 65% by FY12F, mainly driven by the Clear Cut project in Brazil and the ramp up of its Brazilian and Russian operations. In terms of profit margins, China Forestry s margins are the highest at around 75% on the gross line. Both China Forestry and Samling s margins were affected by the financial crisis, as reflected in their FY08 (December 2008) and FY09 (June 2009) performance respectively. Sino-Forest is relatively resilient and has been able to achieve fairly stable margins in the past few years, and we expect this trend to continue. Figure 14: Gross profit margin comparison 90% 80% 70% 60% 50% 40% 30% 20% 10% Figure 15: EBITDA margin comparison 80% 70% 60% 50% 40% 30% 20% 10% 0% FY06 FY07 FY08 FY09F FY10F FY11F FY12F Sino-Forest China Forestry Samling 0% FY06 FY07 FY08 FY09F FY10F FY11F FY12F Sino-Forest* China Forestry Samling Note: * EBITDDA (earnings before interest, tax, depreciation, depletion and amortization) is used for Sino-Forest. For the other two companies, we expect both to enjoy high margins given their upstream segment focus. We expect Omnicorp s gross margin to reach 60% in FY11F and 67% in FY12F. We expect Bright Prosperous s gross margin to reach 31% in FY11F and 32% in FY12F. 16

17 Valuation comparison Figure 16: Chinese forestry companies comparison Sino-Forest* (TRE CN) China Forestry (930 HK) Samling (3989 HK) Omnicorp (94 HK) Bright Prosperous (723 HK) Market cap (US$m) 4,173 1, Rating O O O O O Share price (local currency) Current Target Upside (%) PER (x) FY N/A N/A N/A FY FY EV/EBITDA (x) FY FY FY P/BV (x) FY FY FY ROE (%) FY (5.1) (5.3) (2.0) FY FY EBITDA margin (%) FY FY FY EPS growth (%) FY09 (1.5) 27.9 (363.6) (86.5) (91.8) FY N/A (121.7) (158.8) FY ,087.6 EBITDA growth (%) FY (60.3) (102.8) (225.9) FY (61.0) FY ,093.9 Data on 3 February, 2010 Note: * EBITDDA (earnings before interest, tax, depreciation, depletion and amortization) is used for Sino-Forest. Source: Bloomberg, CCBIS estimates 17

18 Figure 17: Global forestry companies comparison Plum Creek (PCL US) Rayonier (RYN US) Potlatch (PCH US) Weyerhaeuser (WY US) Timberwest Forest (TWF-U CN) International Forest (IFPIA CN) Gunns (GNS AU) Market cap (US$m) 6,189 3,367 1,255 8, Share price (local currency) PER (x) FY N/A N/A N/A 12.4 FY N/A N/A N/A 9.2 FY N/A N/A EV/EBITDA (x) FY (105.9) (35.4) 9.7 FY FY N/A P/BV (x) FY FY FY N/A ROE (%) FY (9.3) N/A (10.5) 3.8 FY (3.5) N/A (10.0) 5.0 FY11 N/A N/A N/A 3.7 N/A EBITDA margin (%) FY (6.0) (2.9) 17.5 FY FY N/A EPS growth (%) FY09 (5.0) (55.0) 44.6 (65.5) (110.4) (33.9) (7.1) FY (42.4) (67.4) (81.0) (62.4) 34.7 FY N/A 38.5 (242.4) (158.3) (175.7) 10.3 EBITDA growth (%) FY (15.8) (243.5) 80.0 FY (22.0) (305.3) (357.7) 20.4 FY N/A Data on 3 February, 2010 Source: Bloomberg Top picks Sino-Forest and China Forestry Our top picks are Sino-Forest given its outstanding track record, and China Forestry given its high and sustainable margins. While the other two companies Omnicorp and Bright Prosperous are small, they have rich overseas hardwood resources. Notably, China is a net importer of hardwood. The target prices for Sino-Forest, China Forestry, are based on PERs of 15x in FY10, and that of Samling is based on PER of 18x in FY11 (June 2011) given its rapid growth in the coming two to three years. They are derived by earnings multiples based on their relatively longer track record and meaningful near term growth. Our target prices for Omnicorp and Bright Prosperous are derived by DCF valuation based on their initial ramping-up stage and that earnings will only be meaningful in

19 Sino-Forest (TRE CN) The growing leadership is sustainable Company Rating: Sector Rating: Outperform (initiation) Overweight (maintained) History speaks for itself. With over 14 years of industry experience in China, Sino-Forest has grown from a small company with net income of only US$3m in 1994 to US$229m in 2008, representing a CAGR of 36%. Revenue CAGR was 31% during the same period. Sino-Forest is among the top three privately-run plantation operators in China in terms of forest resources. Price: Target: C$19.58 C$28.40 (Initiation) Entering into a new growth phase. Sino-Forest is gradually moving into sales of harvested logs instead of standing timber. This will result in higher profitability as average yield increases and cost declines. Bright earnings prospect. We expect net income to rise from US$229m in 2008 to US$555m in 2011F, representing a CAGR of 34%, attributable to strong volume growth and gradual increase in unit gross profit. Substantial valuation upside. Sino-Forest is trading at PERs of 10.4x in 2010F and 7.6x in 2011F. The current share price offers an attractive investment opportunity given the company s strong track record and bright earnings prospects. Our target price of C$28.40 is based on PER of 15x in 2010, suggesting a 45% upside potential. Trading data 52-week range C$ Market capitalization (m) C$4,738/US$4,173 Shares outstanding (m) 242 Free float (%) 98 3M average daily T/O (m share) 1.1 Expected return (%) 1 year 45 Closing price on 3 February, 2010 Stock price and S&P TSX Risks. Contractual/execution risks related to the signed timber agreements as well as financing availability to acquire new contracts are the major risk factors. 0 1-Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09 1-Oct-09 1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 Forecast and valuation Year end 31 Dec F 2010F 2011F Source: Bloomberg Sino-Forest S&P TSX Revenue (US$m) ,189 1,658 2,161 YoY change (%) EBITDDA (US$m) ,148 1,400 YoY change (%) Net income (US$m) EPS (US$) YoY change (%) (2) EBITDDA margin (%) Net margin (%) PER (x) Felix Lam (852) felixlam@ccbintl.com P/B (x) ROE (%) Yan Tsui (852) yantsui@ccbintl.com 19

20 Sino-Forest (TRE CN, Outperform, TP: C$28.40) Established in 1994, Sino-Forest has grown from a smaller forestry company into a leading plantation operator in China. Sales of wood fibre, mainly timber and logs, are the key sources of revenue, account for 95% of revenue in the first nine months of The company is also engaged in wood products manufacturing while revenue and earnings contribution from this downstream segment is relatively small. Figure 18: China Forestry in the value chain Sawn Timber Logs End products floorings, door, furniture Veneer Plywood Source: Company data Solid earnings prospect We expect net income to rise from US$229m in 2008 to US$555m in 2011F, representing a CAGR of 34%. We estimate EBITDDA (earnings before interest, tax, depreciation, depletion and amortization) margin to remain healthy at 65-75% and net margin at around 24-26% in F. Figure 19: Net income and margin, F US$m % % % % % 100 5% F 2010F 2011F Net income (LHS) Net margin (RHS) 0% 20

21 Figure 20: Volume and ASP assumptions F 2010F 2011F Total revenue (US$m) ,189 1,658 2,161 Wood fibre operations ,138 1,605 2,106 Plantation fibre ,340 1,813 Other fibre Manufacturing and other operations Plantation fibre (m m 3 ) Total fibre sold Purchased and planted Integrated ASP (US$/m 3 ) Purchased and planted Integrated ASP (US$/m 3 ) YoY change (%) Purchased and planted Integrated (19) We expect total volume of fibre sold from the plantation fibre segment to reach 18.4m m 3 in 2011F, up from 10.1m m 3 in Fibre from integrated model will gradually increase from 16% of total plantation volume in 2008 to 67% in 2011F. Figure 21: Plantation fibre volume sold, F m m F 2010F 2011F Purchased and planted Integrated Valuation Our target price of C$28.40 is based on 2010F PER of 15x. In our view, a 15x PER is conservative given Sino-Forest s strong track record in delivering growth and its robust growth profile in the coming years. Our target price represents a 7% discount to the price derived by DCF valuation. 21

22 Figure 22: DCF valuation of Sino-Forest Present value of free cash flow ( ) (US$m) 3,912 Terminal value 3,324 Corporate value 7,235 Net debt (682) Minorities interest Shareholder value 6,553 Number of shares, m 244 NPV per share (C$) 26.9 NPV per share (US$) 30.6 Assumptions Terminal growth 0.0% WACC 10.6% Cost of equity 10.8% Risk free rate 3.0% Risk premium 6.5% Beta 1.20 Cost of debt 6.8% Tax 15% Interest rate 8.0% Debt/capital 5% Source: CCBIS estimates Forest resources Sino-Forest has around 474,000 ha of trees under management as at September 2009, mainly located in the Southern and Eastern parts of China. We expect its forest area to increase to 736,000 ha in 2011F, coming from acquisition of new areas through long-term timber agreements as explained below. Figure 23: Trees under management, F ha 800, , , , , , , , F 2010F 2011F 22

23 Figure 24: Sino-Forest resources in China Hunan: Signed agreements to acquire 400,000 hectares in 4Q06 Mandra: Announced acquisition; ~ 155,600 hectares Heilongjiang Jilin Liaoning Source: Company data Manufacturing Operations Mandra Forestry Plantations managed by Sino-Forest Long-term Wood Fibre and Forestry Regeneration Xinjiang Xizang (Tibet) Yunnan: Signed agreements to acquire 200,000 hectares in 1Q07 Qinghai Guangxi: Signed agreements to acquire 150,000 hectares in 4Q07 Sichuan Yunnan Inner Mongolia Gansu Ningxia Shaanxi Chongqing Guizhou Guangxi Shanxi Hainan Henan Hubei Hunan Beijing Hebei Tianjin Shandong Jiangxi Guangdong Anhui Jiangsu Fujian Suzhou Shanghai Zhejiang Taiwan Fujian: Signed agreement to acquire 200,000 hectares in 3Q08 Jiangxi: Signed agreement to acquire between 15-18m m 3 of fibre (~150, ,000 hectares) in 2Q09 It has signed long-term timber acquisition agreements in Hunan, Yunan, Guangxi, Gujian and Jiangxi to acquire a total of around 1.1m ha over a certain period governed by each contract. As at December 2008, around 256,000 ha has been acquired. For the long-term agreements, the contract period specifies the time frame when forest land could be acquired. After initial harvesting of the acquired area, Sino-Forest could replant the land, wait till maturity e.g. after 6 years, and sell harvested logs. This can be referred to a multiple rotation model. Sino-Forest can repeat the replanting process within the long-term lease period e.g. 50 years. The company is required to pay land lease cost only after the initial harvest (first rotation) of the acquired area. Figure 25: Summary of long-term timber acquisition agreements Hunan Yunan Guangxi Fujian Jiangxi Total Area under agreement (ha) 400, , , , , ,000 ~1.2m Contract signed 3Q06 & 4Q06 1Q07 4Q07 3Q08 2Q09 Contract period (years) Source: Company data 23

24 Business model Sino-Forest operates on mainly three business models. In the purchased model, the company acquires young trees, wait till maturity and then sell them as standing timber. The company acquires only a single rotation, and thus no replanting occurs. In both the planted and integrated models, the company replants the harvested land. The only difference is that standing timber is sold in the planted model while harvested logs are sold in the integrated model. Having begun engaging in long-term timber acquisition agreements, the company is actively migrating to the integrated model, which generates higher unit gross profit. This is attributed to the higher selling prices of logs than standing timber, as well as the ability to capture fibre growth through applying silviculture techniques. Figure 26: Business models Multiple rotation Planted model Enter into long-term leases for recently harvested plantation land Replant and cultivate tress using silviculture techniques Sell standing timber (customers arrange tree clearance) Single rotation Purchased model Acquire young trees and apply silviculture techniques Hold trees under maturity Sell standing timber (customers arrange tree clearance) Multiple rotation Integrated model Source: Company data Purchase immediately harvestable trees Harvest at maturity and sell logs (Sino-Forest arranges harvesting) Enter into long-term leases (timber acquisition agreements) for harvested land Replant harvested land Cash flow from initial harvest used to fund replanting Augmented unit gross profit from migrating to integrated model Selling harvested logs enjoy an approximately 40% higher selling price than selling standing timber. Despite bearing the additional harvesting cost, unit gross margin is still more handsome from selling harvested logs through migrating to the integrated model. Business segments Plantation fibre, which entails selling standing timber and harvested logs from its forest resources, is expected to continue to account the majority of its revenue. We expect Sino-Forest s revenue to grow from US$901m in 2008 to US$2,174m in 2011F, representing a CAGR of 34%. Note that revenue growth is mainly driven plantation fibre, as the company expands it fibre sales volume through migrating to the integrated model as discussed above. Plantation fibre is expected to account for 78% of total revenue in 2009F. 24

25 Figure 27: Net income and growth, F US$m % 50% 40% Figure 28: Revenue breakdown by segment, 2009F Other fibre 18% Manufacturing and other operations 4% % 20% Plantation fibre 78% % F 2010F 2011F Net income (LHS) YoY growth (RHS) 0% Source: CCBIS estimates Plantation fibre All three business models explained above fall under this segment. As mentioned, the company is gradually migrating to the integrated model to enjoy high unit gross profits. Segment gross margin was around 50% in Other fibre Imported wood products and wood logs fall under this segment. The company regards this as a secondary segment to enhance understanding on wood demand and tap into market intelligence. Imported wood products. The company imports wood products including logs, sawn timber, veneer etc. to sell in China. Gross margin was 12% in 2008, and is expected to stay at similar levels. Wood logs. The company sources logs from Chinese suppliers and sells to China. Gross margin was 3% in 2008, and is expected to stay at similar levels. Manufacturing The company also has a small manufacturing segment to produce wood-based products e.g. engineered flooring. It contributed to 7% of 2008 total revenue. Segment gross margin was 5% in 2008, and is expected to stay at similar levels. Experienced management team The company has over 14 years of experience in managing forest plantations in China. Its strong management team with proven track record is one of the key success factors of Sino-Forest. 25

26 Allen Chan, CEO & Founder Co-founded the company in 1992 and has two decades of forestry management and industry experience Prior to founding Sino-Forest, specialized in new town development, project management and consultancy for manufacturing and hospitality industry K. K. Poon, President Co-founded the company in 1992 and has engaged in forestry trading and wood product manufacturing since 1979 Prior to founding Sino-Forest, Mr. Poon was an engineer with the Guangdong Forestry Bureau for 15 years Dave Horley, Senior Vice-President & Chief Financial Officer Joined the company in 2005; was previously the board member of Sino-Forest s Audit, Compensation and Corporate Governance Committees Former CFO of Cygnal Technologies Corp Chen Hua, SVP Administration & Finance, China Jointed the company in 2002; previously board chair of Suzhou New District Economic Development Group and worked in numberous large corporations. Albert Yip, SVP Development & Operations, North-east & South-west China Jointed the company in 1997; specialized in project establishment and production management Zhao Wei Mao, SVP Development & Operations, South & East China Jointed the company in 2002; former General Manager of wood manufacturing arm of China Everbright Group, has extensive experience and knowledge in domestic and foreign downstream wood manufacturing Previously lecturer at Beijing Forestry University 26

27 Future focus and expansion plans Expansion in forest resources We see enormous potential for Sino-Forest to expand its forest resources. Out of 24m ha of plantation forest allocated for industrial use in China, only 7m ha are converted to fast-growing high-yield plantations (FGHY). The government has stipulated that by 2015, 13.3m ha of plantation forest will have to be converted to FGHY plantations. Riding this tide, Sino-Forest is well-positioned to acquire more FGHY. Company risks Contractual risk. Availability of future forest resources is largely dependent on whether the company can acquire land from signed timber agreements. If issues regarding the agreements arise and the company could not acquire land as planned, earnings impact could be substantial. We believe level of such risk is low as Sino-Forest had been able to acquire decent amounts of land from timber agreements in 2007 and Financing needs. The company requires more capital if it continues to acquire more forest resources. In fact, the company has done a few rounds of equity and debt financing in the past for acquisitions. In our view, the company adopts a project finance model raise funds only when needed which has proven to be a fairly successful growth model. As a result, fund raising activities should not pose substantial risk to the shareholders, in our view. 27

28 Financials Figure 29: Consolidated profit and loss account (US$m) Year end 31 Dec F 2010F 2011F Net revenues ,189 1,658 2,161 Cost of sales (471) (537) (722) (1,033) (1,337) Gross profit Selling, general and admin expenses (40) (57) (70) (92) (115) Depreciation and amortization (5) (5) (7) (10) (13) Operating income Interest income Interest expenses (44) (52) (64) (67) (64) Others (8) (22) Earnings before tax Tax (18) (24) (37) (55) (83) Discontinued operations Net income EPS basic (US$) EPS diluted (US$) Figure 30: Consolidated cash flow statement (US$m) Year end 31 Dec F 2010F 2011F Earnings before tax Depreciation, depletion and amortization Net interest expenses EBITDDA ,148 1,400 Taxation (18) (24) (37) (55) (83) Change in working capital 27 (59) (185) (104) (114) Others Operating cashflow ,203 CAPEX (13) (30) (60) (70) (80) Addition to timber holdings (640) (657) (891) (871) (810) Acquisitions & investment (32) (11) Others (7) (6) Investing cashflow (692) (704) (951) (941) (890) Change in debt (17) (100) Change in equity Dividend paid Net interest expenses (29) (41) (56) (63) (58) Others 4 (21) Financing cashflow (40) (63) (157) Net change in cash (319) (15) 156 Net exchange adjustment 5 2 Other adjusting figure Net cash movement (319) (15)

29 Figure 31: Consolidated balance sheet (US$m) As at 31 Dec F 2010F 2011F Current assets ,016 Cash and cash equivalents Short-term deposits Inventories Accounts receivable Prepaid expenses and others Non-current assets 1,310 1,820 2,268 2,584 2,770 PP&E Timber holdings 1,174 1,653 2,048 2,305 2,423 Prepaid plantation costs and lease rentals Others TOTAL ASSETS 1,837 2,604 2,824 3,280 3,786 Current liabilities Interest-bearing loans and borrowings Accounts payable and accrued liabilities Income taxes payable 2 9 Others Non-current liabilities Long-term debt Derivative financial instrument TOTAL LIABILITIES 650 1, Equities 1,187 1,599 1,896 2,301 2,857 Share capital Contributed surplus Accumulated other comprehensive income Retained earnings ,067 1,472 2,027 Equity portion of convertible senior notes TOTAL LIABILITIES AND SHAREHOLDER EQUITY 1,837 2,604 2,824 3,280 3,786 BPS basic (US$) BPS diluted (US$)

30 Figure 32: Valuations and key financial ratios Year end 31 Dec F 2010F 2011F Valuations (x) PER P/B EV/EBITDDA Growth (%) Revenues growth Operating income growth EBITDDA growth EBIT growth Adjusted earnings growth Adjusted EPS growth (2) Margin (%) Gross margin Operating margin EBITDDA margin EBIT margin Adjusted net margin Average return (%) ROE ROA Solvency and cash flow (x) EBIT/net interest expenses Operating cash flow/interest expenses Operating cash flow/current liabilities Leverage (%) Gearing (Net debt/equity) Debt/Equity Debt/Total assets

31 China Forestry (930 HK) Newly listed but the largest Company Rating: Sector Rating: Outperform (initiation) Overweight (maintained) A new HK listing, yet the largest in terms of market cap. Listed in December 2009, China Forestry owns forest resources in Sichuan and Yunan. It is one of the three largest, privately-held plantation forest operators in China and is the largest among its peers listed in Hong Kong based on market cap. Price: Target: HK$2.86 HK$3.70 (Initiation) Straightforward business model with strong cash flow. The company owns immediately harvestable forests, and is solely engaged in selling logs upon receiving a customer order. Transportation is also arranged by the customer. Both working capital and fixed asset requirements are minimal, generating strong cash flow. Robust earnings outlook. We expect China Forestry s adjusted (recurring) net income to surge from RMB242m in 2008 to RMB846m in 2011F, representing 52% CAGR in the period, arising from increasing harvesting rates. Hidden value to be unveiled. The stock is only trading at 11.6x 2010F PER, which is undemanding given its strong cash flow. We believe when market awareness of the company improves, its value will gradually unfold. Our target price of HK$3.70 is based on 2010F PER of 15x, implying 29% upside to the current share price. Trading data 52-week range HK$ Market capitalization (m) HK$8,572/US$1,106 Shares outstanding (m) 3,060 Free float (%) 25 3M average daily T/O (m share) NA Expected return (%) 1 year 29 Closing price on 3 February, 2010 Stock price and HSI Risks. Execution risk in managing large-scale operations and regulatory risk in China s policy are its major risks. Forecast and valuation Year end 31 Dec F 2010F 2011F Revenue (RMB m) ,004 1,229 YoY change (%) EBITDA (RMB m) YoY change (%) Adj. net income (RMB m) EPS, RMB YoY change (%) EBITDA margin (%) Net margin (%) PER (x) P/B (x) ROE (%) Dec Dec Dec-09 1-Jan Jan Jan Jan-10 China Forestry HSI Source: Bloomberg Yan Tsui (852) yantsui@ccbintl.com Felix Lam (852) felixlam@ccbintl.com 31

32 China Forestry (930 HK, Outperform, TP: HK$3.70) Listed in December 2009, China Forestry is a plantation forest operator in China, possessing forestry rights of around 171,780 ha of forests in Sichuan and Yunan provinces. According to the China Council for the Promotion of Environment and Forestry (CCPEF), China Forestry is are one of the three largest, privately-held, naturally regenerated and plantation forest operators in China in terms of forest coverage area. It is a pure upstream forestry company Figure 33: China Forestry in the value chain Sawn Timber Logs End products floorings, door, furniture Veneer Plywood Source: Company data Robust earnings outlook Benefiting from increasing harvesting rates, we expect China Forestry s adjusted (recurring) net income to surge from RMB242m in 2008 to RMB846m in 2011F, representing 52% CAGR in the period. Note that the adjusted net income excludes all non-cash fair value changes of its forest assets, representing operational net income. Fair value change arises from the compulsory IAS41 accounting treatment which requires annual valuation of forest assets. We expect net margin to be gradually expanding from 59% in 2009F to 66% in 2011F, driven by increased volume and selling prices. We saw a lower margin in 2008 mainly due to depressed selling prices from the financial crisis. Figure 34: Net income and margin, F RMB m F 2010F 2011F Net income (LHS) Net margin (RHS) 70% 60% 50% 40% 30% 20% 10% 0% 32

33 Figure 35: Volume and ASP assumptions F 2010F 2011F Revenue (RMB m) Yunan Sichuan Forest area (ha) 12, , , , ,780 Yunan 159, , , ,333 Sichuan 12,447 12,447 12,447 12,447 12,447 Stock volume (m 3 ) 3,374 35,516 35,516 35,516 35,516 Yunan 33,301 33,301 33,301 33,301 Sichuan 3,374 2,216 2,216 2,216 2,216 Harvesting rate (%) Yunan 59k ha Yunan 100k ha Sichuan Log sales volume (m 3 ) 169, , , , ,047 Yunan 59k ha 167, ,700 Yunan 100k ha 340, , , ,024 Sichuan 169, , , , ,323 Sales volume YoY change (%) Yunan Sichuan Log ASP (RMB/m 3 ) 947 1,047 1,120 1,215 1,285 Yunan 1,129 1,197 1,281 1,345 Sichuan ,042 Log ASP YoY change (%) N/A Yunan N/A Sichuan (6) Accounting treatment IAS41. It is important to note that the company s financials includes on-paper gain/loss as required from the accounting treatment of IAS 41. IAS 41 requires an annual valuation of change in value of forests, and fair value changes are booked as unrealized gain/loss. Fair value change represents the difference between the fair value and the usually lower forest acquisition cost. Since such unrealized gain/loss does not generate actual cashflow, we have excluded these items in our earnings forecast. 33

34 Figure 36: Earnings sensitivity to ASP and volume Net income (RMB m) Net income change (%) Change in average log price 2009F 2010F 2009F 2010F +1% Base case % (1.5) (1.5) Change in sales volume +1% Base case % (1.2) (1.2) Source: CCBIS estimates Valuation Given the straightforward earnings model of the company, we derive our valuation using PER. Our target price of HK$3.70 is based on PER of 15x in 2010F. The target multiple is the same as what we apply for Sino-Forest. We adjusted the EPS by excluding the forest revaluations, which are volatile non-cash items. Our target price represents a 3% discount to the price derived from DCF valuation. While the company has a short listing history and relatively shorter track record, it is the largest listed forestry company in Hong Kong based on market capitalization. Arguably, China Forestry deserves a premium valuation to other listed forestry companies in Hong Kong. Figure 37: DCF valuation of China Forestry Present value of free cash flow ( ) (RMB m) 6,065 Terminal value 3,031 Corporate value 9,096 Net debt 1,159 Minorities interest Shareholder value 10,256 Number of shares (m) 3,060 NPV per share (RMB) 3.4 NPV per share (HK$) 3.8 Assumptions Terminal growth 0.0% WACC 10.8% Cost of equity 11.3% Risk free rate 3.5% Risk premium 6.5% Beta 1.20 Cost of debt 6.5% Tax 0% Interest rate 6.5% Debt/capital 10% Source: CCBIS estimates 34

35 Forest resources The company s forest resources are located in Sichuan and Yunan provinces. China Forestry acquired the Yunan Luxi/Shuangjiang forest in Yunan province in March 2008, its first acquisition in Yunan. In July 2008, Yunan Wenshan forest was acquired. Harvesting in Yunan Luxi/Shuangjiang has already commenced, but that of Yunan Wenshan is only expected to start in Total forest resources amounts to 171,780 ha, located in Sichuan and Yunan. Assessed by Chandler Fraser Keating Limited (CFK), an independent forestry consultancy, fair value of China Forestry s forest assets amounts to RMB7.9b. Figure 38: China Forestry s forest resources in Sichuan and Yunan provinces Sichuan Ya An City Le Shan City Liang Shan Zhou De Hong Zhou Yunnan Lin Cang City Wan Shan Zhou Owned Plantation Forest Owned Naturally Regenerated Forest Source: Company data In addition, the company signed an MOU to acquire a total of around 270,000 ha of forest plantation in Lijiang, Yunan province. Forest areas are expected to come in by stages starting from Since the acquisition is not yet completed, we did not incorporate any of this into our forecast. Looking at its current forest resources, around 75% is softwood while the remaining is hardwood. The newly acquired Yunan Luxi/Shuangjiang comprises more hardwood trees than average. Average wood yield (in terms of forest stock volume per ha) of China Forestry s resources are around 200m 3 /ha, significantly higher than the national average of 71m 3 /ha. In addition, almost 90% of its forests are immediately harvestable, as compared to the national average of around 33%. 35

36 Business segment and business model The company is only engaged in logging activities, with main customers being wood processing factories in China. Most of its products are used in construction, infrastructure and the furniture industries. When the company receives an order, it engages local villages nearby, or some cases professional harvesting teams, to provide harvesting services. Then the customer transports the products away to their factories to conduct further processing. Minimal working capital requirement The company s business model gives rise to the advantage of minimal working capital. Harvest activities only begin after a customer order, leading to minimal inventory. In addition, as the company only allows customers to retrieve logs upon full payment, accounts receivable is practically zero. Experienced management team China Forestry has been operating in the forestry industry in China since 2003, the same year when the Chinese government announced the No. 9 Policy which set out the directive for the private sector to participate in China s forestry development. Li Kwok Cheong, Chairman and Executive Director Responsible for the company s strategic development and overseas company operations and investments; co-founded the company s forestry business in 2003 Council member of CCPEF, a national non-profit association in China managed by the SFA Had previously engaged in tobacco trading from , until he saw the opportunity in forestry development and acquired the first piece of forest in 2003 Tong Wai Kit, Raymond, Joint Chief Financial Officer and Company Secretary Joined the company in April 2008; has over 13 years of experience in finance, audit, and accounting Prior to joining, he was the CFO and qualified accountant for ZZNode Technologies (2371 HK) in 2006 to Previously worked as a joint company secretary for China Minsheng Banking Corporation from 2004 to

37 Wu Xiao Fen, Joint Chief Financial Officer Joined the company in January 2005; responsible for overall accounting and financial management Prior to joining, he was the chief officer of the finance department of Beijing Kerui Yilian Energy Solution Technology Development Company Limited Future focus and expansion plans Expansion in forest resources The company looks to aggressively expand its forest resources as soon as possible, initial step being completing the acquisition of the forest plantation in Lijiang, Yunan province. Anticipating that the government to ease control of state-owned forest resources, the company is set to benefit from more available forest plantation areas. Company risks Sustainability of low acquisition cost. The company has historically been able to secure extremely low cost acquisitions, but this might not be sustainable given more competition for forest resources and that future negotiations with the government/land owners bear uncertain outcomes. Although this might affect cash flow and earnings of the company, we are confident that China Forestry could still enjoy cost competitiveness going forward, given its track record in past acquisitions. Execution risk. China Forestry has grown to a scalable forest resources operator in seven years time. It only became a large scale player after acquiring 159,000 ha in Yunan in We see execution risk in terms of managing and harvesting forest resources, but believe the company could gradually prove its capabilities as sales volume grows. Regulatory risk. Changes in logging regulations and the government s attitude towards forestry industry could affect the company s earnings. We believe regulatory risk is low as we do not anticipate imminent changes to the government s support for the industry. 37

38 Financials Figure 39: Consolidated profit and loss account (RMB m) Year end 31 Dec F 2010F 2011F Net revenues ,004 1,229 Cost of sales (39) (146) (189) (262) (321) Gross profit Staff costs (4) (98) (71) (60) (74) Consultancy fees (0) (21) (10) (10) (10) Other operating expenses (12) (36) (25) (30) (35) Operating income Interest income Interest expenses (4) (1) (2) Others 0 0 Earnings before tax Tax Adjusted net income (recurring) Fair value changes of plantation assets less costs 798 6,024 3, Reversal of fair value upon logging and sales (121) (385) (522) (742) (907) Net income 784 5,882 3, (92) Adjusted EPS (RMB) Adjusted EPS (HK$) Figure 40: Consolidated cash flow statement (RMB m) Year end 31 Dec F 2010F 2011F Earnings before tax Depreciation and amortization Net interest expenses (0) 2 (5) (14) (26) EBITDA Taxation Change in working capital (13) 28 (270) 7 6 Others 89 Operating cash flow CAPEX (120) (346) (528) (132) (65) Acquisitions & investment Others 0 (321) Investing cash flow (120) (345) (849) (132) (65) Change in debt Change in equity 248 1,205 Dividend paid Net interest expenses 0 (2) Others (173) Financing cash flow , Net change in cash (24) Net exchange adjustment Other adjusting figure Net cash movement (24)

39 Figure 41: Consolidated balance sheet (RMB m) As at 31 Dec F 2010F 2011F Current assets ,269 2,059 Cash and cash equivalents ,189 1,965 Inventories Trades receivables Prepaid insurance premium Others Non-current assets 1,370 7,926 11,285 11,507 10,656 PP&E Plantation assets 1,338 7,693 10,932 11,130 10,273 Lease prepayments TOTAL ASSETS 1,393 8,068 11,967 12,776 12,714 Current liabilities Interest-bearing bank borrowings Other payables and accrued expenses Others 261 Non-current liabilities 321 Other payables 321 TOTAL LIABILITIES Equities 1,391 7,435 11,902 12,655 12,563 Share capital Share premium 248 1,453 1,453 1,453 Reserves Retained earnings 1,364 6,928 10,189 10,943 10,851 Minority interests TOTAL LIABILITIES AND SHAREHOLDER EQUITY 1,393 8,068 11,967 12,776 12,714 BPS (RMB) N/A BPS (HK$) N/A

40 Figure 42: Valuations and key financial ratios Year end 31 Dec F 2010F 2011F Valuations (x) PER P/B EV/EBITDA Growth (%) Revenues growth Operating income growth EBITDA growth EBIT growth Adjusted earnings growth Adjusted EPS growth Margin (%) Gross margin Operating margin EBITDA margin EBIT margin Adjusted net margin Average return (%) ROE ROA Solvency and cash flow (x) EBIT/net interest expenses (610.0) (76.5) (47.0) (29.9) Operating cash flow/interest expenses (551.7) (28.3) (48.2) (30.5) Operating cash flow/current liabilities Leverage (%) Gearing (net debt/equity) (0.1) (1.4) (5.2) (9.2) (15.3) Debt/equity Debt/total assets

41 Samling Global (3938 HK) Moving downstream Company Rating: Sector Rating: Outperform (initiation) Overweight (maintained) The most integrated model with a solid track record. With operations from upstream logging all the way to downstream distribution, Samling is the most integrated company under our coverage. Coupled with its solid track record of over 40 years, we believe Samling has a more stable business model compared to other players. Price: Target: HK$0.72 HK$1.02 (Initiation) Seeking expansion into distribution. Distribution will be Samling s focus in the near-term future the company is actively expanding distribution in China and Australia. We expect this division to contribute 25% of its revenue in FY12F (June 2012), up from 16% in FY09. Note that distribution is more profitable while being less capital intensive than upstream forest operations. Improving earnings outlook. In light of a recovering macro economy, we expect net income to rise from US$19m in FY10F to US$46m in FY12F, representing a CAGR of 54%. In the same period, net margin is also expected to improve steadily from 3.4% to 6.2% Attractive valuations. Trading at only 12.7x FY11F PER, valuations look attractive given its growth prospect in distribution and solid track record. Our target price of HK$1.02 is based on FY11F PER of 18x, implying a 42% upside. Trading data 52-week range HK$ Market capitalization (m) HK$3,054/US$394 Shares outstanding (m) 4,302 Free float (%) 34 3M average daily T/O (m share) 11.1 Expected return (%) 1 year 42 Closing price on 3 February, 2010 Stock price and HSI Risks. Legal risk and regulatory risks are the major risks. Forecast and valuation 0 1-Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09 Samling HSI 1-Oct-09 1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 Year end 30 June FY08 FY09 FY10F FY11F FY12F Source: Bloomberg Revenue (US$m) YoY change (%) (3) (12) EBITDA (US$m) YoY change (%) (90) (313) (188) Net income (US$m) 14 (37) EPS (US$) 0.00 (0.01) EPS (HK$) 0.03 (0.07) YoY change (%) (95) (364) N/A EBITDA margin (%) Net margin (%) 2.6 (7.8) PER (x) (10.7) P/B (x) ROE (%) 1.8 (5.1) Yan Tsui (852) yantsui@ccbintl.com Felix Lam (852) felixlam@ccbintl.com 41

42 Samling Global (3938 HK, Outperform, TP: HK$1.02) Headquartered in Malaysia, Samling is an integrated forestry company engaging in both upstream forestry management as well as downstream product manufacturing and distribution. Its forests are located in Malaysia, Guyana and New Zealand. Samling is the most integrated forestry company under our coverage. Figure 43: Samling in the value chain Sawn Timber Logs End products floorings, door, furniture Veneer Plywood Source: Company data Improving profitability We expect net income to rise from US$19m in FY10F to US$46m in FY12F, representing a CAGR of 52%. In the same period, net margin is also expected to improve steadily from 3.4% to 6.2%. This is mainly driven by better macro economic outlook which supports demand and prices for wood products, as well as increasing contribution from distribution operations, which is of better profitability. The company incurred a net loss of US$37m in FY09, primarily due to the financial crisis and secondarily due to US$22m of non-cash loss items. These items include unrealized FX losses on loans, unrealized losses in interest rate swaps, and provision for impairment & PPE write-offs. The contribution of non-cash loss can be illustrated from the difference in EBITDA and net income in FY09 the decrease in EBITDA is less drastic than that of net income. In FY08 to FY09, net margin plunged from 3% to -8%, while EBITDA experienced a milder fall from 19% to 9%. Going forward, we expect non-cash losses of such nature to be minimal. Interest rate swap is already switched to a fixed-rate swap while we do not expect any PPE write-offs as production volume picks up from FY10 onwards. 42

43 Figure 44: Net income and margin Figure 45: EBITDA and margin US$m 60 8% US$m % % 4% 2% 0% % 15% 0 (10) (20) (30) (40) (2)% (4)% (6)% (8)% % 5% (50) FY08 FY09 FY10F FY11F FY12F Net income (LHS) Net margin (RHS) (10)% 0 FY08 FY09 FY10F FY11F FY12F EBITDA (LHS) EBITDA margin (RHS) 0% Figure 46: Volume and ASP assumptions, FY08-FY12F FY08 FY09 FY10F FY11F FY12F Log trading Revenue (US$m) Hardwood logs Softwood logs Sales volume (m 3 ) 1,338,959 1,527,969 1,568,450 1,554,879 1,588,027 Hardwood logs 1,102,694 1,128,239 1,160,653 1,168,883 1,228,883 Softwood logs 236, , , , ,144 Sales volume YoY change (%) 14 3 (1) 2 Hardwood logs Softwood logs 69 2 (5) (7) ASP (US$/m 3 ) Hardwood logs Softwood logs ASP YoY change (%) (17) 8 (1) (1) Hardwood logs (14) Softwood logs (5) Veneer Revenue (US$m) Sales volume (m 3 ) 187, , , , ,509 Sales volume YoY change (%) (32) ASP (US$/m 3 ) ASP YoY change (%) (5) Plywood Revenue (US$m) Sales volume (m 3 ) 561, , , , ,104 Sales volume YoY change (%) (32) ASP (US$/m 3 ) ASP YoY change (%) (5)

44 Figure 47: Earnings sensitivity to ASP and volume Net income (US$m) Net income change (%) Change in average selling price FY10F FY11F FY10F FY11F +1% Base case % (17.1) (11.7) Change in external sales volume +1% Base case % (1.2) (1.0) Source: CCBIS estimates Valuation Given the straightforward earnings model of the company, we derive our valuation using PER. Our target price of HK$1.02 is based on PER of 18x in FY11F (June 2011). The earnings multiple is higher than that of Sino-Forest and China Forestry, given its rapid expansion into distribution which is more profitable, coupled with its solid track record. Our target price represents an 11% discount to the price derived by DCF valuation. Figure 48: DCF valuation of Samling Present value of free cash flow ( ) (US$m) 419 Terminal value 337 Corporate value 756 Net debt (38) Minorities interest (79) Shareholder value 639 Number of shares (m) 4,302 NPV per share (US$) 0.15 NPV per share (HK$) 1.15 Assumptions Terminal growth 0.0% WACC 9.8% Cost of equity 10.7% Risk free rate 3.5% Risk premium 6.5% Beta 1.10 Cost of debt 4.9% Tax 25% Interest rate 6.5% Debt/capital 15% Source: CCBIS estimates 44

45 Forest resources Samling s forest resources are located in Malaysia, Guyana, New Zealand and China, consisting of both forest concessions and plantations. Total area of forest resources amount to around 3.6m ha. Figure 49: Samling s forest resources PRC Forest plantation (3,000 ha) MALAYSIA Forest concessions (1,330,000 ha) Forest plantation (458,000 ha) GUYANA Forest concessions (1,611,000 ha) NEW ZEALAND Forest plantation (35,000 ha) Source: Company data Samling carries out Sustainable Forest Management (SFM) in its forest concessions. Selective harvesting is conducted in which only mature trees are selected and cut in a manner to allow regeneration. The company is dedicated to pursuing SFM as verified by the various certifications its facilities have achieved. An example of that is receiving the Forest Stewardship Council (FSC) Certificate for Chain-of-Custody of several of its plywood manufacturing facilities. Business segment Samling is the most integrated company under our coverage. We expect revenue to increase from US$571m in FY09 to US$753m in FY12F, representing a CAGR of 15%. Log trading and plywood & veneer are expected to remain the major revenue contributors, accounting for 27% and 40% of FY12F revenue respectively. Downstream operations and also expected to contribute to an increasing portion of revenue. 45

46 Figure 50: Revenue by segment, FY08-FY12F US$m FY08 FY09 FY10F FY11F FY12F Log trading Plywood and veneer Upstream support Flooring products Other timber operations Other operations Logging Logs are cut and transported through various channels, dependent on the location of the forest resource. Some logs are directly exported while some are sent to Samling s processing plants to be produced into plywood, veneer or other products. A major portion of logs are sold to growing economies including China and India. We expect these growing economies to contribute to an even larger percentage going forward. Local demand in Malaysia is also picking up. In sum, we expect demand for logs to be on a recovering trend. Product manufacturing/processing Plywood and veneer are the major products in this segment. Other products include flooring, chipboard, sawn timber, furniture and etc. Figure 51: Revenue from logs by market, FY09 Figure 52: Revenue from plywood and veneer, FY09 Japan 8% Others 10% Malaysia 27% Other Asia 7% Europe 7% Rest of World 7% Japan 38% Korea 10% Greater China 8% India 19% Greater China 26% Korea 15% Malaysia 18% Source: Company data Source: Company data 46

47 Developed markets like Japan and Korea account for a significant portion of plywood and veneer markets. Going forward, we expect more sales to growing markets such as China and India. Production facilities Samling possesses production capacities for a wide range of products in Malaysia, China and Guyana. A new plywood and veneer mill is under construction in New Zealand. Phase 1 of the mill with a target annual production capacity of 100,000m 3, is expected to be completed by around mid Figure 53: Samling s processing facilities MALAYSIA Plywood/Veneer (950,000 m 3 p.a.) Sawn timber (54,000 m 3 p.a.) MDF (100,000 m 3 p.a.) Other value-added products GUYANA Plywood/Veneer (108,000 m 3 p.a.) Sawn timber (64,000 m 3 p.a.) New Sawmills Work in progress PRC Plywood/Veneer/LVL (160,000 m 3 p.a.) Engineered & solid wood flooring (3.6 mil m 2 p.a.) Laminate flooring (3.6 mil m 2 p.a.) NEW ZEALAND Plywood/Veneer Mill Work in progress Source: Company data Distribution The company has further expanded downstream by acquiring distributors in China and Australia. We expect such downstream expansion could enhance Samling s earnings stability as end-user prices are relatively stable than upstream prices. Distribution accounted for 16% of the company s FY09 revenue, and we expect its contribution to gradually increase to 25% in FY12F as more emphasis is placed on enhancing distribution of end products. 47

48 Figure 54: Revenue from distribution, FY09-FY12F US$m FY08 FY09 FY10F FY11F FY12F Distribution (LHS) % of total revenue (RHS) 30% 25% 20% 15% 10% 5% 0% China. The company acquired Elegant Living ( 生活家 ), a leading engineered flooring distributor in China, in August The company will gain access to approximately 700 distributor outlets across China, as at January Samling owns 70% of Elegant Living. Through Elegant Living, the company manufactures and gains a distribution network to sell flooring products. A new plant went operational in Chengdu, Sichuan province, in October 2009, mainly for the production of laminated and solid wood flooring. Furthermore, the company has aggressive plans to expand Elegant Living s network from currently 700 outlets to 1,000 outlets in two to three years time. We expect synergy to be achieved as Elegant Living could be a substantial outlet for Samling s plywood and logs, at the same time Samling could leverage Elegant Living s distribution network to sell other wood products e.g. doors and furniture going forward. Australia. The company acquired Brewster, one of the largest distributors of panel and timber products in Australia with 80 years of history, in December Brewster has 8 distribution outlets mainly in coastal cities, including Sydney, Melbourne, Adelaide and Perth, and in Tazmania. This network will play an important role as a major outlet of products from the under-construction processing plant in New Zealand. Experienced management team Samling has a knowledgeable management team with over 20 years of experience in the timber industry across various countries including Malaysia, Guyana, New Zealand and China. Selected profiles of its management team are as follows. 48

49 Yaw Chee Ming, CEO and Executive Director Appointed CEO and Executive Director since August 2006 Also the Managing Director of both Lingui and Glenealy, the company s associate; and the CEO and Executive Director of Samling Strategic, one of Samling s controlling shareholders Over 22 years of experience in the timber industry Cheam Dow Toon, CFO and Executive Director Appointed CFO and Executive Director since August 2006 Also the Finance Director of both Lingui and Glenealy, the company s associates Over 19 years of experience in the timber industry and over 10 years of experience in the oil palm industry James Ho Yam Kuan, Vice-President of upstream operations in Malaysia Joined the Log Marketing Division of the company in 1993 and served as its Vice-President (Marketing) till 1997 Over 14 years of operational and managerial experience in the timber industry Yaw Chee Chik, Vice-President of downstream operations in Malaysia Brother of Yaw Chee Ming, CEO and Executive Director Joined the company in 1988 and has held various managerial positions, including Vice-President of Plywood Division and Marketing Manager of Log Marketing Division in Sarawak, Malaysia Over 19 years of experience in the timber industry 49

50 Future focus and expansion plans Downstream expansion Downstream expansion is one of the company s major focuses. We expect distribution to account for 25-30% of revenue in the coming two to three years, as compared to 16% in FY09. China. The company plans to expand Elegant Living s network from currently 700 outlets to 1,000 outlets in two to three years time. Penetration into lower tier cities to capture augmenting rural demand is also in the company s core plan. In addition, possible acquisitions of distributors and manufacturing capabilities are anticipated. Australia. The company has plans to enhance Brewster s distribution network from currently mainly coastal cities to a national coverage within the next two years. Synergy could be achieved through selling products from the under-construction processing facility in New Zealand. India. In light of the country s rapidly increasing demand for wood products, the company is looking at tapping into distribution in India. We expect the company to adopt a similar business model to that of China acquiring an established, local distributor to leverage on its already-built network. Malaysia. As a pilot to tap into the growing local market, the company established Ainokitchen, a retail arm with eight stores in the country selling mainly high-class kitchen cabinets. This initiative is more of a concept testing rather than a significant earnings contributor. Processing facility in New Zealand A processing facility is under construction, producing plywood mainly for export using the company s forest resource in New Zealand. Phase 1 of the mill, with a target annual production capacity of 100,000m 3, is expected to be completed by around mid The new facility will focus on higher-valued products to cater to existing and new markets. Phase I will focus on Australia, New Zealand, and secondarily Japan. Company risks Legal risk. Managing forest resources and local villagers can be difficult, and is closely monitored by environmental protection associations; Samling was accused to be carrying out logging without a legitimate/valid permit in December Although the company has already defended and clarified that they possess the relevant government certification, such an incident does impair its reputation. Regulatory risk. Negative regulations such as restriction of log exports might affect Samling s logging business. These uncontrollable factors will remain an uncertainty although we believe an experienced player like Samling should be able to adapt to changes in regulations. 50

51 Financials Figure 55: Consolidated profit and loss account (US$m) Year end 30 Jun FY08 FY09 FY10F FY11F FY12F Net revenues Cost of sales (494) (446) (497) (564) (634) Gross profit Selling and distribution expenses (10) (17) (16) (17) (18) General and admin expenses (30) (35) (34) (36) (40) Other expenses (0) (5) (2) (2) (2) Operating income 11 (24) Interest income Interest expenses (17) (14) (17) (18) (18) Others 23 (4) Earnings before tax 28 (38) Tax (2) (5) (2) (3) (5) Minority interest (12) 6 (2) (4) (6) Net income after tax and minorities 14 (37) EPS (US$) 0.00 (0.01) EPS (HK$) 0.03 (0.07) Figure 56: Consolidated cash flow statement (US$m) Year end 30 Jun FY08 FY09 FY10F FY11F FY12F Earnings before tax 28 (38) Depreciation and amortization Net interest expenses EBITDA Taxation (18) (6) (2) (3) (5) Change in working capital 1 (15) (4) (12) (12) Others (17) Operating cash flow CAPEX (44) (33) (56) (59) (62) Acquisitions & investment (12) (10) Others 2 (24) 7 Investing cash flow (54) (67) (49) (59) (62) Change in debt (15) (17) Change in equity Dividend paid (30) (5) (3) (5) (8) Net interest expenses (16) (17) (12) (13) (11) Others (32) (31) 3 Financing cash flow (72) (29) 40 (33) (36) Net change in cash (55) (48) Net exchange adjustment 1 (2) Other adjusting figure Net cash movement (54) (50)

52 Figure 57: Consolidated balance sheet (US$m) As at 30 Jun FY08 FY09 FY10F FY11F FY12F Current assets Cash and cash equivalents Inventories Trades receivables Prepayments, deposits and other receivables Others Non-current assets PP&E Construction in progress Plantation assets Intangible assets Others TOTAL ASSETS 1,357 1,244 1,333 1,365 1,410 Current liabilities Interest-bearing loans and borrowings Trade payables Other payables Accrued expenses Others Non-current liabilities Interest bearing bank borrowings Obligations under finance leases Deferred tax liabilities Others TOTAL LIABILITIES Equities Share capital Share premium Reserves (243) (281) (281) (281) (281) Retained earnings Minority interests TOTAL LIABILITIES AND SHAREHOLDER EQUITY 1,357 1,244 1,333 1,365 1,410 BPS (US$) BPS (HK$)

53 Figure 58: Valuations and key financial ratios Year end 30 Jun FY08 FY09 FY10F FY11F FY12F Valuations (x) PER (10.7) P/B EV/EBITDA Growth (%) Revenues growth (3) (12) Operating income growth (90) (313) (188) EBITDA growth (51) (60) EBIT growth (76) (182) (229) Adjusted earnings growth (86) (367) N/A Adjusted EPS growth (95) (364) N/A Margin (%) Gross margin Operating margin 2.1 (5.1) EBITDA margin EBIT margin 6.4 (5.9) Adjusted net margin 2.6 (7.8) Average return (%) ROE 1.8 (5.1) ROA 2.6 (2.2) Solvency and cash flow (x) EBIT/net interest expenses 2.2 (1.6) Operating cash flow/interest expenses Operating cash flow/current liabilities Leverage (%) Gearing (net debt/equity) (3) Debt/equity Debt/total assets

54 Omnicorp (94 HK) A small company with a powerful shareholder Company Rating: Sector Rating: Outperform (initiation) Overweight (maintained) Affiliation with Sino-Forest. Sino-Forest is the largest shareholder of Omnicorp, owning 20% its ordinary shares and 90% of its convertible bonds. Potential cooperation opportunities with this forest plantation leader give Omnicorp a unique edge over competitors. Price: Target: HK$2.26 HK$3.00 (Initiation) An emerging tropical hardwood provider. Omnicorp acquired 60% of Greenheart Holdings in August 2007, transforming itself into a tropical hardwood provider with forest resources in Suriname in South America. The company is building a large-scale sawmill that is expected to be operational in mid Logs will be cut into sawn timber which is of better profit margins. Prior to the commissioning of the sawmill, logs will be exported and sold to China and overseas. Trading data 52-week range HK$ Market capitalization (m) HK$698m/US$90 Shares outstanding (m) 315 Free float (%) 80 3M average daily T/O (m share) 0.6 Expected return (%) 1 year 33 Closing price on 3 February, 2010 Drastically improving earnings. We expect earnings to surge from HK$4m in 2010F to HK$125m in 2012F. Profit margin will also expand during the period. Undiscovered value. We believe its enormous growth prospect is overlooked by the market. Our target price of HK$3.00 which is derived by DCF valuation implies a 33% upside. Stock price and HSI Risks. Major risks are execution risk given the company s early development stage, and regulatory risks in Suriname. 0 1-Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09 1-Oct-09 1-Nov-09 1-Dec-09 1-Jan-10 1-Feb-10 Omnicorp HSI Forecast and valuation Source: Bloomberg Year to 31 Dec F 2010F 2011F 2012F Revenue (HK$m) YoY change (%) (15) EBITDA (HK$m) (92) YoY change (%) (31) (103) Net income (HK$m) (104) (14) EPS, HK$ (0.33) (0.04) YoY change (%) (54) (86) (122) EBITDA margin (%) (1,963.1) (3.2) Net margin (%) (2,169.0) (54.2) PER (x) (2.6) (52.6) Felix Lam (852) felixlam@ccbintl.com P/B (x) ROE (%) (30.2) (5.3) Yan Tsui (852) yantsui@ccbintl.com 54

55 Omnicorp (94 HK, Outperform, TP: HK$3.00) Omnicorp acquired 60.39% of Greenheart Holdings in August Greenheart owns forest concessions in Suriname, South America and commenced logging activities at the end of It sells tropical hardwood logs and lumber to China and overseas markets. The company engages in logging and plans to install a sawmill in by mid Figure 59: Omnicorp in the value chain Sawn Timber Logs Expansion plant End products floorings, door, furniture Veneer Plywood Source: Company data Currently, the company mainly directly sells tropical hardwood logs to China without further processing. In addition to a small sawmill acquired in 2008, the company is now building a large-scale sawmill in Suriname to expand downstream. It is expected to become operational by mid Drastically improving profit and margins We expect Omnicorp s profit to improve from a net loss in 2009F to HK$125m 2012F. At the same time, we see a rapid net margin expansion from a net loss to 32% in the same period. Both income and margins are heavily dependent on whether the company is directly selling logs or processing logs into sawn timber before selling. Figure 60: Net income and margin, F HK$m (20) (40) 2009F 2010F 2011F 2012F Net income (LHS) Net margin (RHS) 40% 30% 20% 10% 0% (10)% (20)% (30)% (40)% (50)% (60)% 55

56 Before its sawmill commences operations by mid-2011, the company will be purely selling logs, thus contributing all of its gross profit until 2010F. Going into 2011F, the company s gross profit will drastically increase to HK$260m, up from HK$11m in 2009F, representing a 190% CAGR, as sawn timber production is expected to begin by mid By 2012F, all gross profit will come from sawn timber as all harvested logs will be processed into sawn timber before selling. Figure 61: Gross profit by segment, F HK$m F 2010F 2011F 2012F Log Sawn timber Figure 62: Volume and ASP assumptions 2009F 2010F 2011F 2012F 2013F Revenue (HK$m) Log Sawn timber Revenue (US$m) Log Sawn timber Sales volume (m 3 ) 20,000 30,000 50,000 80, ,000 Log 20,000 30,000 30,000 Sawn timber 20,000 80, ,000 ASP (US$/m 3 ) Log Sawn timber

57 Figure 63: Earnings sensitivity to ASP and volume Net income (HK$m) Net income change (%) Change in average log/sawn timber price 2011F 2012F 2011F 2012F +1% Base case % (2.4) (1.9) Change in sales volume +1% Base case % (1.6) (1.3) Source: CCBIS estimates Valuation Our target price of HK$3.00 is based on the mid-point of the DCF valuations in the following scenarios: Assuming Omnicorp to maintain its 60.39% stake in GreenHeart DCF price would be HK$2.40 Assuming Omnicorp to acquire the remaining 39.61% of GreenHeart in 2010 through debt financing DCF price would be HK$3.50 We apply DCF valuation to capture its meaningful earnings growth when the company fully ramp up its operations in Our target price implies P/B of 2.1x in 2010F and 1.8x in 2011F. Figure 64: DCF valuation of Omnicorp 60% Greenheart 100% Greenheart Present value of free cash flow ( ) (HK$m) 1,171 1,220 Terminal value Corporate value 1,755 1,803 Net debt 7 (300) Minorities interest (705) Shareholder value 1,057 1,503 Number of shares (m) NPV per share (HK$) Assumptions Terminal growth 0.0% 0.0% WACC 10.5% 10.5% Cost of equity 10.7% 10.7% Risk free rate 3.5% 3.5% Risk premium 6.5% 6.5% Beta Cost of debt 3.4% 3.4% Tax 38% 38% Interest rate 5.5% 5.5% Debt/capital 2% 2% Source: CCBIS estimates 57

58 Affiliation with Sino-Forest Note that Sino-Forest, a leading forest plantation play with concessions in China, become the single largest shareholder of Omnicorp since February 2009, owning around 20% of Omnicorp s outstanding shares as well as 89.6% of outstanding convertible bonds. Assuming full conversion of convertible bonds, Sino-Forest will own approximately 40% of Omnicorp on a fully diluted basis. Original maturity date of the convertible bonds was 9 November, 2009, but it was now extended to 8 November, At the same time, the shareholding restriction prohibiting Sino-Forest to exercise convertible bonds to more than 30% is lifted. In another words, Sino-Forest reserves the right to exercise to more than 30%, making a General Offer to Omnicorp. Omnicorp has the advantage of a close-knit relationship with a world leading forestry player, suggesting potential cooperation opportunities and thus synergies. This will be further discussed in Further focus and expansion plans section on page 61. Besides, we see a considerable possibility for Sino-Forest to exercise a major portion of its convertible bonds, triggering a General Offer for the company. Forest resources in Suriname Greenheart has two groups of concessions in Suriname Epro Forest Management Unit (Epro FMU; consist of three concessions) and Dynasty concessions (consist of four concessions). Omnicorp engaged Pöyry Forestry Industry Limited, a renowned independent international consulting firm, to conduct a Standing Stock valuation of Greenheart s forestry concessions in Suriname. Based on Pöyry s report dated July 2007, Greenheart has a total of 178,743 ha of forest concession, of which 146,525 ha is under Epro FMU and remaining under Dynasty concessions. According to Pöyry, total value of the concessions amounts to around US$296m. Figure 65: Omnicorp s forest resource in Suriname Suriname South America Source: Company data Location of concessions 58

59 The concessions are strategically located at an average distance within 70km to the nearest water port. It takes around three days for the log to be transported from the nearest water port to the international sea port in the capital of Suriname. As water transport is the most cost effective and common means for logs and lumber, proximity to river/sea port is of importance. This level of distance is considered convenient compared to other similar natural forests. Sustainable Forest Management (SFM) practice Omnicorp carries out Sustainable Forest Management (SFM) in its forest concessions. Omnicorp follows the CELOS system, an SFM system practiced by the Suriname Government, which allows a maximum harvest quantity of up to 40m 3 /ha over a 20-year growth cycle, or 2m 3 /ha per year. Suriname applies strict rules as to what types of trees can be cut e.g. only trees of 35 dbh (diameter at breast height) can be cut and constantly monitors logging activities. In addition, inventory level needs to be monitored per 500 ha of area. The company s planned maximum harvest level of 250,000m 3 per year over the total size of the timber concessions and cutting rights of 177,965 ha, equivalent to 1.4m 3 /ha per year. Application for Forestry Stewardship Council (FSC) certification Omnicorp is applying for Forestry Stewardship Council (FSC) certification for its concessions, which typically take around 18 months for official inspection and review. As per management, their forests comply with most regulatory elements as Suriname s forestry regulations are more or less in line with FSC regulations. The company expects FSC certification to be achieved by the end of Business segment Logging After preliminary on-site processing, round logs are carried for an average of 70km to the nearest water port, and then carried by barges to the international sea port to be exported. Lumber processing Currently, without a large-scale sawmill in place, the company mainly directly sells tropical hardwood logs to China. Greenheart acquired an existing sawmill in Suriname in September 2008 as a testing project, whereby small amounts of sawn timber are being produced and sold. A new sawmill with an annual processing capacity of 200,000m 3 to 250,000m 3 of logs is also under construction, expected to commence operations by mid When the sawmill goes online, all logs harvested is expected to be processed in this sawmill in the future. 59

60 Higher unit profit and margins from sawn timber. Both the unit gross profit and gross margin for sawn timber is substantially higher than logs. Thus, we expect the company to harvest only a small volume of logs before its sawmill commences. Figure 66: Gross margin and unit gross profit by product, 2011F Unit gross profit (HK$/m 3 ) Gross margin (%) Logs Sawn timber 3, The higher unit gross profit and margins from sawn timber can be partly attributed to the log export tax of US$24/m 3 charged by Suriname. Purpose of this tax is to retain processing value-add within the country to stimulate local economy. Before the sawmill begins operations in mid-2011, the company has to incur such export tax from selling logs to China, and is expected to have the following cost structure. Moving into 2012 with a full year contribution from the sawmill, all logs will be processed into sawn timber before being exported. Thus, export tax can be eliminated. Experienced management team Greenheart has a professional management team with over 20 years of forestry operations experience. Selected profiles of its top management and operational expertise are as follows. John Henderson, Joint-CEO Responsible for overall strategy and Sustainable Forestry Management (SFM) Internationally renowned expert with over 30 years of forestry management experience Led and participated in many projects organized by WWF, World Bank, Food and Agriculture Association (FAO) in Asia and South American countries including Brazil, Guyana, Indonesia etc. Raymond Lau, Joint-CEO Responsible for operations Has been working in Suriname and the timber industry for the past 8 years Previously held general management and sales/marketing roles in a number of industries including banking, retail and media 60

61 Ray Alexander Hilgerink, Forestry Planning Manager Over 10 years of experience in South American forestry sector and has participated in various Food and Agriculture Association (FAO) and WWF projects Was previously the Superintendent of the Division for Production Planning SBB, Forestry Department of Suriname Government Daphne Tse, CFO Certified Public Accountant with over 10 years of experience in audit, accounting and finance with a focus in manufacturing and trading fields Future focus and expansion plans The company plans to remain as a relatively upstream player focusing on logs and lumber, thus we expect future expansion to be mainly horizontal. In addition, its close knit connection with Sino-Forest would enable further cooperation opportunities which offer Omnicorp an edge over other forestry plays. Cooperation with Sino-Forest With Sino-Forest being the single largest shareholder of Omnicorp, we see solid potential for the two companies to achieve strategic cooperation. Two possible forms of work distribution are by forest type and by geography. In terms of forest type, Omnicorp focuses on natural hardwood forest while Sino-Forest focuses on forest plantations. In terms of geography, Omnicorp operates in South and Central America while Sino-Forest operates in China. We expect the two companies to realize synergy from a clear distribution of responsibilities. Expansion in concessions The company is looking at acquiring more concessions primarily in South and Central America, almost the only region with tropical hardwood resources. Possible candidates are concessions in Brazil, Guyana, Peru etc. Acquisitions will be carefully considered based on a comprehensive set of factors including location (proximity to water port), sovereign risk and concession arrangement. Acquisition of remaining interest in Greenheart Omnicorp currently holds 60.39% of Greenheart, and has the option to acquire the remaining interest. We see the possibility for the company to do so although timing is uncertain. 61

62 Non-timber initiatives Revenue stream can be diversified by new initiatives. The company is closely tracking on the research of cellulose bio-fuel to generate electricity. It is also exploring the possibility of producing wood pellets from wood waste, which could be burnt to obtain energy. Furthermore selling carbon credits from CDM on forestry could be a potential revenue stream without additional cost, dependent on the development of forestry CDM and relevant policy framework. Company risks Execution risk Currently, the company has not harvested and sold logs on a scalable basis. Execution risk as to whether it can operate as we forecasted remains. Under the same rationale, we do not have much visibility for the level of demand for its products. We believe the level of execution risk will gradually diminish as the company starts harvesting more logs and when the sawmill commences operations in mid Regulatory risk Exporting logs would be a lot more costly if Suriname further raises log export tax, and even worse if Suriname bans log export. However, as the company is already heading downstream with a sawmill under construction, we believe such regulatory risk is only valid in the near term. 62

63 Financials Figure 67: Consolidated profit and loss account (HK$m) Year end 31 Dec F 2010F 2011F 2012F Net revenues Cost of sales (3) (15) (23) (55) (127) Gross profit Selling and distribution expenses (0) (2) (2) (5) (14) General and admin expenses (40) (9) (7) (15) (35) Other expenses (10) (0) (0) (1) (4) Operating income (49) (1) Interest income Interest expenses (22) (23) (1) (3) (3) Others (42) Earnings before tax (112) (23) Tax Discontinued operations (3) Minority interest 11 9 (3) (23) (82) Net income after tax and minorities (104) (14) EPS (HK$) (0.33) (0.04) Figure 68: Consolidated cash flow statement (HK$m) Year end 31 Dec F 2010F 2011F 2012F Earnings before tax (114) (23) Depreciation and amortisation Net interest expenses EBITDA (92) Taxation (0) Change in working capital (12) (27) (2) (11) (28) Others 38 Operating cashflow (65) (24) CAPEX (8) (23) (54) (2) (2) Acquisitions & investment (7) Others 2 Investing cashflow (14) (23) (54) (2) (2) Change in debt (41) 7 (212) 30 Change in equity Dividend paid Net interest expenses (22) (1) (2) (0) Others Financing cashflow (41) (16) (0) Net change in cash (120) (64) (21) Net exchange adjustment Other adjusting figure (6) Net cash movement (126) (64) (21)

64 Figure 69: Consolidated balance sheet (HK$m) As at 31 Dec F 2010F 2011F 2012F Current assets Cash and cash equivalents Pledged deposits Inventories Trades and bills receivables Prepayments and deposits Others Non-current assets PP&E Prepaid land lease payments Timber concessions and cutting rights Goodwill Interests in associates Others TOTAL ASSETS Current liabilities Interest-bearing loans and borrowings Convertible bonds Trade payables Other payables Others 23 Non-current liabilities Convertible bonds Interest bearing bank borrowings Deferred tax liabilities TOTAL LIABILITIES Equities Issued capital Share premium Equity component of convertible bonds Reserves Retained earnings (306) (320) (316) (281) (155) Minority interests TOTAL LIABILITIES AND SHAREHOLDER EQUITY BPS (HK$)

65 Figure 70: Valuations and key financial ratios F 2010F 2011F 2012F Valuations (x) PER (2.6) (52.6) P/B EV/EBITDA (3.9) Growth (%) Revenues growth (15) Operating income growth 26 (98) (1,048) EBITDA growth (31) (103) EBIT growth (33) (99) (1,048) Adjusted earnings growth (21) (86) (131) Adjusted EPS growth (54) (86) (122) Margin (%) Gross margin Operating margin (1,030.1) (3.2) EBITDA margin (1,919.4) EBIT margin (1,963.1) (3.2) Adjusted net margin (2,169.0) (54.2) Average return (%) ROE (30.2) (5.3) ROA (14.9) (0.2) Solvency and cash flow (x) EBIT/net interest expenses N/A (0.0) Operating cash flow/interest expenses N/A (1.1) Operating cash flow/current liabilities (0.5) (0.5) Leverage (%) Gearing (net debt/equity) (1) (11) (32) Debt/equity Debt/total assets

66 Bright Prosperous (723 HK) Transforming Company Rating: Sector Rating: Outperform (initiation) Overweight (maintained) Recent transformation to forestry business. The company acquired a forestry company in July 2009, essentially owning forest resources in Brazil and Russia. Its original business was building materials, property development, and magnesite mining. The company will be renamed as Sustainable Forest Holdings. Logging has already begun, and the company is striving to get all operations on track. Phenomenal earnings outlook. We expect net income to surge from a HK$17m in FY10F to HK$1.15b in FY12F, mainly driven by the contract signed for a 200,000 ha Clear Cut project in Brazil and the rapid ramp-up of logging and processing operations. Undemanding valuations. Trading at only 7.3x FY11F PER (March 2011), we believe the company s enormous earnings potential is overlooked by the market. Our target price of HK$1.10 is based on DCF valuation, implying a 29% upside. Price: HK$0.85 Target: HK$1.10 (Initiation) Trading data 52-week range HK$ Market capitalization (m) HK$1,821/US$235 Shares outstanding (m) 2,160 Free float (%) 70 3M average daily T/O (m share) 74.9 Expected return (%) 1 year 29 Closing price on 3 February 2010 Stock price and HSI Risks. Major risks are execution risk given its early ramping-up stage, regulatory risk in Brazil and Russia, and contractual risk concerning delivery of the Clear Cut project in Brazil. Execution risk is a considerable concern, we believe it will gradually diminish as the company implements its expansion plans and delivers earnings Jan-09 1-Feb-09 1-Mar-09 1-Apr-09 1-May-09 1-Jun-09 1-Jul-09 1-Aug-09 1-Sep-09 1-Oct-09 1-Nov-09 1-Dec-09 1-Jan-10 Forecast and valuation Year to 31 Mar FY08 FY09 FY10F FY11F FY12F Revenue (HK$m) ,732 5,683 YoY change (%) , EBITDA (HK$m) (95) ,025 1,671 YoY change (%) (30) (191) 3, Adjusted net income (HK$m) (113) (13) ,154 EPS diluted (HK$) (0.06) (0.00) YoY change (%) (92) (159) 4, EBITDA margin (%) (78.2) Net margin (%) (92.8) (7.6) PER (x) (10.1) (180.9) P/B (x) ROE (%) (10.5) (2.0) Source: Bloomberg Yan Tsui (852) yantsui@ccbintl.com Felix Lam (852) felixlam@ccbintl.com SFH H SI 66

67 Bright Prosperous (723 HK, Outperform, TP: HK$1.00) Bright Prosperous engages in the sustainable management of natural forests, as well as timber and wood processing operations. The company owns and leases natural forests in Brazil and Russia. Currently Bright Prosperous engages only in log harvesting but it plans to add saw mills in part of its forests. Figure 71: Bright Prosperous in the value chain Sawn Timber Logs Expansion plant End products floorings, door, furniture Veneer Plywood Source: Company data Phenomenal earnings outlook We expect net income to surge from a HK$17m in FY10F to HK$1.15b in FY12F, mainly driven by its Clear Cut project in Brazil (please refer to Further focus and expansion plans section on page 73 for details) and ramping up of Brazilian and Russian logging/processing operations. Net margin is expected to gradually increase from 8% to 20% in the same period. Earnings in FY08-FY09 were not meaningful since the company only engaged in forestry after acquiring a forestry company in July Before the acquisition, it was engaged in building materials, property development, and magnesite mining. Figure 72: Net income and margin, FY08-FY12F HK$m 1,200 1, (200) Transition to forestry business FY08 FY09 FY10F FY11F FY12F Net income (LHS) Net margin (RHS) 40% 20% 0% (20)% (40)% (60)% (80)% (100)% 67

68 Valuation Our target price of HK$1.10 is based on DCF valuation, and implies P/B of 1.7x in FY11F (March 2011) and 1.3x in FY12F. We apply DCF to capture its meaningful earnings growth when the company fully ramp up its operations in the coming few years. Figure 73: DCF valuation of Bright Prosperous Present value of free cash flow ( ) (HK$m) 5,483 Terminal value 658 Corporate value 6,141 Net debt 499 Minorities interest Shareholder value 6,640 Number of shares (m) 6,054 NPV per share (HK$) 1.10 Assumptions Terminal growth 0.0% WACC 11.1% Cost of equity 11.2% Risk free rate 3.5% Risk premium 7.0% Beta 1.10 Cost of debt 3.9% Tax 30% Interest rate 5.5% Debt/capital 2% Source: CCBIS estimates The transaction Bright Prosperous is originally engaged in building materials, property development, and magnesite mining. Acquisition of Amplewell Holdings, a sustainable forest management company was completed in July As of now, all non-forestry operations have been divested or terminated. The company is now a pure forestry company. Total consideration of the acquisition is HK$1.86b (US$240m), with the following settlement structure: Figure 74: Settlement structure of the acquisition Convertible preference shares HK$ 1.51b New common shares HK$43.17m Promissory notes HK$232m Cash HK$70.50m Total consideration HK$1.86b Source: Company data 68

69 Forest resources in Brazil and Russia The company owns and leases approximately 287,250 ha of natural forests in Brazil and Russia. Brazil Bright Prosperous s forest resource in Brazil is located in the State of Acre, City of Feijoe, in the Northwest of Brazil, covering a total area of 44,503 ha. Under Sustainable Forestry Management (SFM) Plans, the maximum logging in this area is 30m 3 /ha on a 30-year cycle. Scaled cutting is expected to start at around April 2010 i.e. in FY2011. Figure 75: Brazil forest resource and processing facility Source: Company data In September 2009, Bright Prosperous signed an MOU for the acquisition of a further 137,500 ha of neutral tropical rain forest in Para State and two associated processing facilities for around US$47m. Upon completion of the acquisition, expected to happen in the near future, total forest area in Brazil will reach 182,003 ha. Russia and China Bright Prosperous has seven concessions in Russia in the Chita region in Siberia, covering a total area of around 242,745 ha. Wood products from Chita are transported by roads or railways to the company s Chinese subsidiary in Manzhouli for value-added processing. Scaled cutting is expected to start in March/April

70 Figure 76: Russia and China forest resource and processing facility Chukotka Komi Taymyrskiy Yamalia Perm Khantia-Mansia Evenkiyskiy Yakutia Magadan Tomsk Omsk Krasnoyarsk Irkutsk Buryatia Amur Altai Chita Khabarovsk Inner Mongolia Mongolia Manzhouli Primorsky Source: Company data Business segment We expect revenue to surge from HK$223m in FY10F to HK$5,683m in FY12F, coming from three major business segments, namely logging, wood processing, and wood products trading. Bright Prosperous signed an exclusive wood clear-cut contract for the 6 th largest hydroelectric power plant project in Brazil, which will generate the bulk of its earnings in the coming few years. It is expected to account for 60% of total revenue in FY12F. Since this project will be a major earnings driver in the next two to three years, execution risk and contractual risk associated could affect Bright Prosperous s earnings significantly. Note that the Clear Cut project is currently an operating contract and is not reflected on the balance sheet. Going forward, we see the possibility for the contract to be recognized as a capital lease, which will be reflected on the balance sheet and amortized. However, we expect the impact would be insignificant. Figure 77: Revenue breakdown, FY10F-FY12F HK$m 6,000 5,000 4,000 3,000 2,000 1,000 0 FY10F FY11F FY12F Brazil Russia China (Manzhouli) Belem (processing) Trading Rondonia (Clear Cut) Wood Pellets 70

71 Logging Bright Prosperous has concessions in Brazil and Russia totaling approximately 287,250 ha. Scaled cutting is expected to start in April 2010 in Brazil and March/ April 2010 in Russia. All logs harvested will be further processed through outsourced capacity in Brazil and in the company s owned facilities in Russia and China. Exclusive Wood Cutting Contract for Hydroelectric Power Plant in Brazil. Bright Prosperous has signed a 5-year Exclusive Right to Clear Cut areas for the Santo Antonio Hydroelectric Power Plant on 25 November, It involves an estimated total of 200,000 ha of forest areas, with a mixture of high-grade and low-grade forests. The company holds the right to keep all timber and residues from the cleared areas. Please refer to page 73 for further details of the contract. We expect gross margin from the Clear Cut project to be around 37%. Processing Brazil. After logging operation starts, the company plans to outsource processing of most logs through OEM and subcontracting. The company also operates a FSC certified sawmill facility in Belem, which is located in Para State where Bright Prosperous just signed an MOU to acquire forest resources (please refer to above map of Brazil). Since wood products from Belem will all be FSC certified, most of them will be transported to markets which value FSC more, such as in Europe and Japan. Gross margin is expected to remain high at 55-60% mainly due to premium selling prices of tropical hardwood. Russia and China. Bright Prosperous s Russian operations is more vertically integrated, with four processing facilities in Russia and one facility in Manzhouli in China, all within proximal distance to its forest resources. Bright Prosperous is in the process of upgrading old processing facilities and acquiring new production lines. Below is the expected capacity of its Russian and Manzhouli facilities by end of Segment gross margin is expected to be around 14-17%. Trading The company engages in wood products trading, sourcing products from Columbia, Peru etc. and exporting them to overseas markets. As Bright Prosperous has only recently started logging in the Clear Cut Project in Rondonia State of Brazil and other operations are yet to begin, trading contributes to most of the company s earnings currently. Management and shareholding structure After acquiring forestry operations, Bright Prosperous has put together a solid management team with rich operational experience. Bright Prosperous s core management team has also abundant managerial experience. 71

72 Paul Leung, Chief Executive Officer Involved in Bright Prosperous for over two years and responsible for many business initiatives Over 28 years of experience in the Australian and Asian internet, telecommunications, computer and commercial industries Sandy Fletcher, Chief Financial Officer Over 16 years in financial and accounting fields, including auditing, corporate finance, fund and asset management Previously founded AMF, a firm focusing on real estate investment opportunities; prior to that, she was the founder and managing director of the Asia Pacific office of a private asset management company; also previously worked 10 years in Deloitte in New York and Hong Kong Leandro Dos Martires Guerra, Chief Operating Officer & President of Brazilian Operations Over 15 years of experience in the forestry and timber industry, involving in multiple aspects including Sustainable Forest Management, FSC certification and carbon credit certification Previously held the role of the President of Brazilian Operations of Precious Woods, a leading Swiss-based forestry and timber company; his family has been in the Brazilian timber industry for three generations, he managed his family timber business which was later sold to Precious Woods Was also the Director President of Produtos Floerstais Certicados na Amazonia, a trade organization comprising of owners of FSC certified forests or chain-of-custody processing facilities Sergey A. Seleznev, President of Russian Operations Over 18 years of experience in the Russian forestry industry Has built up Russian operations which was later sold to Bright Prosperous David C Shih, President of China Operations Over 26 years of experience in the forestry industry in Taiwan, China and Indonesia Previously worked in Chungchun Glory Wood Company in China; had worked in the forest products industry in Taiwan and Indonesia before 72

73 Future focus and expansion plans Exclusive Wood Cutting Contract for Hydroelectric Power Plant in Brazil Bright Prosperous has signed a 5-year exclusive rights contract to clear cut areas for the Santo Antonio Hydroelectric Power Plant on 25 November, It involves an estimated total of 200,000 ha of forest areas, with a mixture of high-grade and low-grade forests. The company holds the right to keep all timber and residues from the cleared areas. The Santo Antonio Hydroelectric Power Plant is located in the city of Porto Velho in the Rondonia State of Brazil. It will be Brazil s 6 th largest hydro power project with more than 3,150MWt. Construction began in November 2008 and is expected to be completed by mid The agreement is structured in a way that Bright Prosperous will receive R$2,500 (US$1,470)/ha for clear cutting for low-grade forest areas, and will pay R$2,600 (US$1,470)/ha for clear cutting for high-grade forest areas. A 3 rd party harvesting company provides harvesting services. Forest areas will be allocated by stages, of which the first stage of 5,000 ha has already started clear-cutting in January The company expects later stages to come in by 1Q of FY2011 i.e. June For the outputs from the initial stages, the company plans to sell logs locally in light of the growing local demand in Brazil. In fact, Brazil prohibits the export of logs. For later stages as volume grows gradually, the company has plans to carry out some processing locally, selling timber products locally and exporting to overseas markets. Clear cutting forests gives seven to eight times more wood volume than SFM. In addition, the advantage of clear cut lies in the ability to continuously harvest all year, even in rainy seasons. In SFM, forest operations are limited during rainy seasons. Such seasonal supply shortage enables the company to enjoy higher log selling prices during rainy seasons. Rainy season in Brazil is typically December to around March or April. Expansion in concessions In September 2009, Bright Prosperous signed a Memorandum of Understanding (MOU) to acquire a further 137,500 ha of neutral tropical rain forest in Para State in Brazil. On top of this and the Clear Cut contract above, the company is looking to aggressively acquire new concessions in South America, especially in Brazil. 73

74 Contract and partnership with customers In December 2009, Bright Prosperous signed a long-term supply contract with China Flooring Holdings Co. to supply hardwood products South America, from its own forest resources and from external sourcing. China Flooring, with Nature as its brand name, is one of the leading wood flooring companies in China. It has around 2,800 outlets in China. International Finance Corporation and Morgan Stanley invested into China Flooring in Such an arrangement ensures a stable outlet for Bright Prosperous s products. This also indicates the company s aggressive plan to penetrate into the Chinese market. We expect announcement of more agreements or partnerships with a similar nature in the near future. Non-timber initiatives Revenue stream can be diversified by new initiatives including but not limited to wood residue, wood pellets, and Clean Development Mechanism (CDM). The company has plans to sell wood pellets produced from wood residue from sawmill processing. Company risks Execution risk. The company s forestry business was only acquired in July 2009, and is still at a rapidly ramping us phase. Bright Prosperous has aggressive expansion plans, but without a proven track record, execution risk remains a considerable concern. We believe execution risk will gradually diminish as the company implements its expansion plans and delivers earnings. Political risk. Political risk remains an uncertainty in Brazil and Russia, where all of its forest resources are located. Political instability could affect the bulk of Bright Prosperous s operations. Although we believe political stability should gradually improve, it remains an uncontrollable factor. Contractual risk. Although forests under the Rondonia Clear Cut project is contracted to be allocated by stages until 2015, actual area allocated and time frame is yet to be known. As this project is a major earnings contributor in the coming few years, any delay and less-than-expected forest resources would impair Bright Prosperous s earnings significantly. 74

75 Financials Figure 78: Consolidated profit and loss account (HK$m) Year end 31 Mar FY08 FY09 FY10F FY11F FY12F Net revenues ,732 5,683 Cost of sales (108) (157) (157) (2,594) (3,841) Gross profit ,138 1,843 Selling and distribution expenses (4) (4) (18) (37) (57) General and admin expenses (41) (23) (18) (82) (114) Other operating expenses (9) (11) (4) (19) (28) Operating income (39) (27) 25 1,000 1,644 Interest income Interest expenses (2) (63) (4) (4) (11) Others Earnings before tax (29) ,001 1,649 Tax (2) 6 (5) (300) (495) Discontinued operations (84) (246) Minority interest 2 20 Net income (113) (13) ,154 EPS basic (HK$) (0.06) (0.00) EPS diluted (HK$) (0.06) (0.00) Figure 79: Consolidated cash flow statement (HK$m) Year end 31 Mar FY08 FY09 FY10F FY11F FY12F Earnings before tax (113) (38) 22 1,001 1,649 Depreciation and amortization Net interest expenses (0) 62 3 (1) (5) EBITDA (95) ,025 1,671 Taxation (3) (3) (5) (300) (495) Change in working capital (75) (43) (19) Others 51 (132) Operating cash flow (122) ,157 CAPEX (2) (1) (273) (47) (25) Acquisitions & investment (168) Others 15 (37) (2,241) Investing cash flow 13 (38) (2,682) (47) (25) Change in debt 7 (14) 126 (92) 100 Change in equity ,026 Dividend paid Net interest expenses (3) (0) (3) 1 5 Others (3) (0) 491 (95) Financing cash flow 174 (9) 2,640 (186) 105 Net change in cash 64 (45) ,237 Net exchange adjustment 0 0 Other adjusting figure (14) 0 Net cash movement 51 (45) ,237 75

76 Figure 80: Consolidated balance sheet (HK$m) As at 31 Mar FY08 FY09 FY10F FY11F FY12F Current assets ,213 Cash and cash equivalents ,786 Pledged bank deposits Inventories Trades receivables Others Non-current assets 2, ,721 2,743 2,741 PP&E Biological assets Intangible assets 2, Goodwill 1,394 1,394 1,394 Others 2 59 TOTAL ASSETS 2, ,897 3,597 4,953 Current liabilities Interest-bearing loans and borrowings Trade payables Others 3 1 Consideration payables 5 Finance lease payables 9 Non-current liabilities 1, Interest-bearing loans and borrowings 100 Promissory notes Deferred tax liabilities Other payables Convertible note 855 Others TOTAL LIABILITIES 1, Equities 1, ,244 2,944 4,098 Share capital Share premium ,932 1,932 1,932 Reserves Retained earnings (158) (176) (159) 541 1,695 Minority interests TOTAL LIAB AND SH EQUITY 2, ,897 3,597 4,953 BPS basic (HK$) BPS diluted (HK$)

77 Figure 81: Valuations and key financial ratios Year end 31 Mar FY08 FY09 FY10F FY11F FY12F Valuations (x) PER (10.1) (180.9) P/B EV/EBITDA (2.7) Growth (%) Revenues growth , Operating income growth (30) (191) 3, EBITDA growth (226) (61) 2, EBIT growth (121) 5 3, Adjusted earnings growth (89) (232) 4, Adjusted EPS growth (92) (159) 4, Margin (%) Gross margin Operating margin (32.4) (16.4) EBITDA margin (78.2) EBIT margin (93.2) Adjusted net margin (92.8) (7.6) Average return (%) ROE (10.5) (2.0) ROA (4.8) Solvency and cash flow (x) EBIT/net interest expenses (34.9) (1,058.3) (332.7) Operating cash flow/interest expenses (37.7) (721.6) (234.1) Operating cash flow/current liabilities (0.4) Leverage (%) Gearing (net debt/equity) 22.3 (26.7) 1.9 (16.9) (42.3) Debt/equity Debt/total assets

78 Appendix 1 Global forestry resources and industry trends Trees are either naturally grown or planted. According to the Food and Agriculture Organization of the United Nations (FAO), total world forest area as at 2005 is estimated to be 3,952m ha, representing around 30% of total land area. Natural forests (primary forest, modified natural forest and semi-natural forest) represent around 96% of the world s forest resources. As a result of rapid deforestation and illegal logging, we increasingly rely on plantation to meet our wood demand. Figure 82: Forest characteristics, 2005 Prodcutive forest plantation 3% Semi-natural forest 7% Protective forest plantation 1% Modifed natural forest 53% c Primary forest 36% Source: FAO Global Forest Resources Assessment 2005 Figure 83: Changes in forest by characteristics, Primary forest Modified natural forest Semi-natural forest Productive forest plantation Protection forest plantation ,000 1,200 1,400 1,600 m ha Source: FAO Global Forest Resources Assessment 2005 Natural forests diminishing supply Although natural forests represent 96% of the world s forest resources, we see a diminishing trend of natural forest areas, both in primary forest and modified natural forests. Deforestation, the conversion of forests into agricultural land or for other uses, is occurring at an alarmingly rapid rate at about 13m ha per year. 78

79 Forest plantations increasing supply Although forest plantations (productive and protective forest plantation) only amount to 140m ha in 2005, representing around 4% of the world s forest resources, they are rapidly increasing. The area of forest plantations has increased by about 2.8m ha per year in , mainly driven by increase in productive forest plantation. Geographical distribution of forest resources Forest resources are mainly located in South America and Europe (primarily in Russia). Around 96% of total forest resources are natural forests and out of this, tropical and sub-tropical forests, mainly located in South and Central America, is the scarcest resource. The highest-grade wood products, which are made from tropical hard wood species, are showing increasing demands. Figure 84: Distribution of forest by sub-region, 2005 South America 21% Africa 16% Oceania 5% Asia 14% North and Central America 18% Europe 26% Source: FAO Global Forest Resources Assessment 2005 If we focus our attention only on productive forest plantation, which occupy only 3% of total forest area, a vastly different geographical distribution can be observed. Area designated under productive forest plantation has the objective of producing wood and non-wood goods. We can see that Asia account for 40% of world productive forest plantation, much more significant than that of total forest resources. This can be partly attributed to and growing plantation area in China. On the contrary, South America and Africa s share of forest plantation is significantly smaller than that of total forest resources. 79

80 Figure 85: Distribution of productive forest plantation by sub-region, 2005 Oceania 4% South America 10% Africa 10% North and Central America 16% Asia 40% Europe 20% Source: FAO Global Forest Resources Assessment 2005 Reduction in unprocessed log export Resource-rich countries around the world are increasingly discouraging export of logs in order to retain the value-add and investment in processing facilities within the country. This is particularly observed in developing countries e.g. Brazil, Russia and Suriname, which needs the forestry industry to help stimulate local economy. Some examples of log export restriction or prohibition are listed below: Log export has been banned in Brazil. In Russia, tax on unprocessed log export has been increased from 20% to 25% of value in April The next stage of this process is for the tax to jump to 80% of value, expected to happen in late 2009, but yet to be formally announced. Suriname, a country in South America with abundant forest resources, imposes a US$24/m 3 of log export. This reflects the country s intention to retain log processing within the country and to boost local employment, benefiting the local economy growth. This trend induces upstream players to engage in log processing in the country where their forest resource lies. We see more players building their local sawmills or acquiring local processing capabilities. Actually, the companies enjoy higher unit profit levels from higher economic value though processing logs into lumber, or even further downstream products. 80

81 Reduction in illegal logging There has been a growing concern on illegal logging and forestry activities around the world. Illegal logging is a major suppressor of wood prices. Governments around the world, including China, Suriname and Malaysia have adopted measures to restrict illegal logging. For example, tighter enforcement on illegal logging has reduced the volume of Brazil sawn timber export by 30% in Major consumer regions have also implemented regulations to combat illegal logging: In the USA, amendments to the Lacey Act were effected in May 2008 to assist in efforts to combat illegal logging. It is unlawful in the US to import or trade in timber and related products harvested in contravention of the laws of any country. In Europe, the EU intensified efforts to tackle illegal logging through the EU Forest, Law Enforcement, Governance and Trade (FLEGT) legislation Although reduction in illegal is hard to be quantified, we provide an example of log trade discrepancy in 2004 and 2007 to illustrate possible signs of reduction. In 2004, ITTO reported Malaysia s large log trade discrepancy with China (140% or 1.6m m 3 ), which is in stark contrast to its relatively close agreement with other importers reports. This suggests misreporting of China s imported tropical logs from Malaysia. In 2007, this discrepancy was significantly reduced to 13%, possible reason being measures against illegal log trafficking in Malaysia to import into China has taken effect. Reduction in illegal logging raises the demand for logs from legitimate sources, while supporting the prices of wood products. Forestry companies which only strictly carry out legal logging will be benefited both from a volume and price perspective. Sustainable Forest Management Sustainable Forest Management (SFM) refers to managing forest resources without reducing its inherent value and harming the physical and social environment. (For more details, please refer to Appendix 2 on page 85). With the benefit of reducing resources depletion, we see as an increasingly mainstream way for upstream forestry companies to engage in SFM. Companies carrying out SFM practices, or even better, holding forest certification licenses will have a definite advantage. Wood-to-energy/biomass Wood-based biomass energy is one of the focuses in the renewable energy space, especially the developed countries. Major research efforts aim at developing improved technologies for bio-energy production. For example, wood chips and pellets made from wood residues can be used to generate power. We also see potential for larger forestry companies to build or participate in biomass power plants to supply clean energy. With on-going research and establishment of a commercial value chain, wood-to-energy could bring significant revenue enhancement for forestry companies. 81

82 Timber products The timber market covers all wood products from upstream to downstream. In this section we will look at the production and consumption of timber products in the world, with members of International Tropical Timber Organization (ITTO) as a proxy. ITTO s members represent approximately 80% of the world s tropical forests and 90% of global tropical timber trade. Figure 86: Consumption of timber products by ITTO members, F m F CAGR (%) Logs 1,311,740 1,355,952 1,319,850 1,345,827 1,361, Sawnwood 362, , , , ,650 (0.9) Veneer 10,008 9,793 9,781 9,624 9,600 (1.0) Plywood 66,769 68,252 67,433 73,075 74, Source: ITTO Annual Timber Review 2008 Figure 87: Production of timber products by ITTO members, F m F CAGR (%) Logs 1,250,391 1,292,731 1,254,750 1,280,453 1,309, Sawnwood 348, , , , ,343 (0.9) Veneer 10,416 10,496 10,408 10,258 10,241 (0.4) Plywood 65,080 68,595 69,423 76,060 76, Source: ITTO Annual Timber Review 2008 Production of upper stream timber products mainly come from resource-rich countries, such as in South America, Africa and secondarily in Asia. They are exported to more developed countries e.g. US, Europe and rapidly growing economies e.g. China and India. China spotlight of demand growth In light of the rapid economic growth in China, consumption of timber products have generally increased at a rapid pace in F (2008 was a forecasted number as the ITTO Timber Review report was published in Consumption of logs and sawnwood, the two products with significantly larger volumes, increased at 7% and 14% F CAGR respectively. This is much higher than the average CAGR of ITTO members of 1% and -1% respectively. Figure 88: China s consumption of timber products, F 000 m F CAGR (%) Logs 74,744 80,238 96, ,755 97, Sawnwood 22,478 23,968 30,962 34,116 38, Veneer 3,043 3,047 2,990 2,939 2,945 (0.8) Plywood 18,504 20,199 19,505 12,435 13,094 (8.3) Source: ITTO Annual Timber Review

83 Figure 89: China s production of timber products, F 000 m F CAGR (%) Logs 47,120 50,230 61,120 64,920 67, Sawnwood 15,325 17,903 24,865 28,291 32, Veneer 3,000 3,000 3,000 3,000 3,000 0 Plywood 20,986 25,150 27,288 35,616 35, Source: ITTO Annual Timber Review 2008 Production of sawnwood and plywood has increased fairly rapidly in the past few years in China, outpacing the growth of log output. We attribute this to the expansion of sawmills which allow more logs to be processed into sawnwood. Notably, sawnwood generally have higher value as they are easier to be preserved, stored and transported. Local production is unable to satisfy the large and growing domestic demand. It is worthwhile to note that China is a net importer of logs and sawn timber (as illustrated above on page 10), which are on the upper stream of the value chain. Many of these are imported to be further processed in China. Going forward, we expect the import of logs to gradually slow down as an increasing number of countries exert log export restrictions. Instead, more imports will fall under products further downstream. All in all, China will remain as a net importer of wood products due to inadequate domestic forest resources. Further digging into product types, we expect to see a rapid growth in demand for end-consumer products such as floorings and furniture in China. Demand for hardwood-made higher-end products will be on an even more apparent rising trend, as Chinese consumers, with increased affordability and living standard, gradually go for quality products. 83

84 Appendix 2 Sustainable Forest Management (SFM) and certifications According to ITTO, Sustainable Forest Management refers the process of managing permanent forest land to achieve one or more clearly specified objectives, with regard to the production of a continuous flow of desired forest products and services without undue reduction in its inherent values and future productivity, and without undue undesirable effects on the physical and social environment. SFM practices can be reflected in forest management certifications. According to the FAO Forest Products Annual Market Review 2008 report, the area of independently certified forest worldwide totaled 320m ha, representing 8.3% of total forest area, by May Certifications can be applied through multiple principal systems, both international and local ones. Examples of international schemes are Forest Stewardship Council (FSC), Program for the Endorsement of Forest Certification Schemes (PEFC). Examples of local schemes are Malaysia Malaysian Timber Certification Council (MTCC) and Indonesia s Lembaga Ekolabel Indonesia (LEI) systems. Forest Stewardship Council (FSC) Founded in 1993, FSC is an independent, not-for-profit organization established to promote the responsible management of the world s forests. It grants certification to forest managers and products producers complying with FSC standards. FSC-certified products are recognized by many multinationals, for example IKEA, HSBC, B&O, Home Depot, just to name a few. Typically, FSC certification takes around 18 to 24 months, whereby forest operations are reviewed in terms of managerial aspects as well as environmental and social requirements e.g. biodiversity preservation, treatment of local villagers. FSC bodies conduct site visits and detailed inspection of forest operations. Program for the Endorsement of Forest Certification Schemes (PEFC) Founded in 1999, it is a global umbrella organization for the assessment mutual recognition of national forest certification schemes. PEFC council currently consists of 33 member countries. 84

85 Appendix 3 What is REDD? Reducing Emissions from Deforestation and Forest Degradation (REDD) is an effort to create a financial value for the carbon stored in forests, offering incentives for developing countries to reduce emissions from forested lands and invest in sustainable development. The rationale of REDD The basic idea of REDD is for developing countries which could reduce their deforestation rate to receive some form of financial compensation. REDD credits offer the opportunity to utilize funding from developed countries to reduce deforestation in developing countries, also resulting in co-benefits including biodiversity preservation and poverty reduction. REDD-plus In the 2007 Bali UNFCCC meeting (COP13), an agreement known as the Bali Action Plan was reached. It called for activities with serious implications directed towards the local communities, indigenous people and forests which relate to reducing emission from deforestation and forest degradation. Therefore this will involve enhancing existing forests and increasing forest cover, thereby increasing carbon stock. This is what is known as REDD-plus. The deadline for reaching an agreement on the specifics of an international REDD mechanism, at least as regards to its being implemented in the nearer term, was set to be the COP15, which was held in December COP 15 the milestone The Copenhagen submit (COP15) held in late 2009 concluded with no binding agreement regarding forestry, but an accord was reached including a guideline for carbon emission reduction from forests, the first ever in COP s history. The agreement called for the immediate establishment of forest-based carbon reduction mechanism including REDD-plus (Reduced Emissions from Deforestation and Forest Degradation). 85

86 Appendix 4 Major tree species Hardwood is wood from angiosperm trees. They are usually broad-leaved. In temperate and boreal latitudes, they are mostly deciduous, but in tropics and subtropics, they are mostly evergreen. Hardwoods can be used in wide range of applications including construction, furniture, flooring, utensils, etc. Softwood is wood from conifers. They tend to be evergreen. Softwood can be used in furniture making, paper and pulp, and construction. There are about a hundred times as many hardwoods as there are softwoods. Figure 90: Major hardwood tree species Eucalyptus( 桉树 ) Beech( 山毛榉 ) Birch( 桦木 ) Oak( 橡木 ) Diverse genus of flowering trees growing up to 15m Mostly native to Australia; there are more than 700 species of Eucalyptus, but only 15 species occur outside Australia Nearly all Eucalyptus are evergreen Mainly used for paper and pulp A genus of ten species of deciduous trees growing up to 40m Native to temperate Europe, Asia and North America. It can be used in flooring and furniture Small to medium-size trees or shrubs, mostly of temperate climates simple leaves may be toothed or pointed fine-grained and pale in colour furniture-making A genus about 400 species of deciduous trees, growing up to 15-18m Native to the Northern Hemisphere Often used in hard furniture making and flooring Source: CCBIS Figure 91: Major softwood tree species Fir( 杉木 ) Pine( 松树 ) A genus of between species of evergreen A genus of about 120 species of coniferous trees, conifers, growing up to 80m growing up to 45m Has needle like leaves Native to the Northern Hemisphere Used in the manufacture of plywood and rough timber Used in furniture, window frames, floorings etc. Spruce( 云杉 ) A genus of about 35 species of coniferous evergreen trees growing up to 60m One of the most important woods for paper manufacture Source: CCBIS 86

87 Figure 92: Pictures of forestry companies China Forestry forest resource in China China Forestry harvested logs Source: China Forestry Source: China Forestry Samling Elegant Living outlet in China Samling Elegant Living outlet in China Source: Samling Global Source: Samling Global Bright Prosperous forest in Brazil Bright Prosperous harvested logs Source: Bright Prosperous Source: Bright Prosperous 87