WH Group Earnings: U.S. Business Remains a Drag; Reducing Fair Value to HKD 6.90 From HKD 7.40

Narrow-moat WH Group 00288 posted another quarter of sluggish results that missed our expectations, due to lackluster performance across the upstream and downstream segments in the U.S. We reduce our fair value estimate to HKD 6.90 per share, from HKD 7.40 per share, with lower profit assumptions. Management reiterated the intent to reduce its low-margin and loss-making hog production exposure in the U.S. But there were no specific updates on the progress or actions to be taken for this business. We think it would take time for the company to spin off its upstream assets given the unfavorable operating environment. Hog prices have been dropping as production bottlenecks normalized in the wake of the pandemic in both the U.S. and China. We think WH Group’s near-term share price is likely to face headwinds as investors focus on the weak earnings outlook.

Revenue across China and the U.S. were hit by lower hog prices, driving a 9.1% year-on-year decline in third-quarter sales. Demand for packaged meat remained soft, which dragged operating margin, especially in the U.S. Downstream operating profit in China held up relatively well, due to price hikes and the availability of low-cost raw material. The resilient margin in China was insufficient to offset weak performance in the U.S., though. Ample hog supply means that elevated feed costs were not passed through, while branded packaged meat volume fell year on year, dampening margins. Operating margin fell to 6.4% at the group level, versus our estimate of 8.0%.

We lowered our 2023 revenue and net income estimates by 2% and 10%, respectively, as we expect only moderate sequential improvement in profitability for the fresh pork business. Packaged meat margins should continue to be squeezed as the supply of low-cost raw material dissipates. We also reduce our 2024 net income estimate, as we expect the associated costs in restructuring the pork business to weigh on profit next year.