Shennong Agricultural Industry has formed a relatively mature breeding model with sophisticated standards and biosecurity prevention and control systems, boasting obvious cost advantages. Besides, it has a stable and experienced breeding management team, with the ability to expand and replicate its success beyond the home province of Yunnan. We are optimistic that the Company will post steady and orderly expansion through integrated operations along the value chain and maintain long-term growth by breaking through cyclical constraints. We forecast its 2023E/24E/25E EPS of Rmb-0.37/1.09/2.55, respectively. Considering the Company's leading breeding model, obvious cost advantages, and future　growth potential, and factoring in the industry average valuation level based on PE and PB valuation methods, we assign a target price of Rmb30 and initiate coverage with an “OVERWEIGHT” rating.

Company overview: Rooted in Yunnan, seeking development through integrated operations along the value chain.

Shennong Agricultural Industry was founded in 1999 and has been developing for 23 years. Since its establishment, the Company has been focusing on the construction and development of the hog value chain, building a complete value chain integrating feed processing, hog breeding, hog slaughtering and fresh pork food sales. In 2022, the Company posted operating revenue of Rmb3.304bn (+18.89% YoY), and attributable net profit (ANP) of Rmb255mn. Since the start of 2023, hog prices have been in the doldrums, and declining hog prices have weighed on the Company's earnings. 3Q23 saw a slight rebound in hog prices, and its earnings in 3Q23 alone turned a profit.

Hog farming: Market performance is hovering at the bottom, with the clearance of production capacity entering a substantial stage.

This year, hog prices fell rapidly after experiencing a brief rebound in Jul and currently has returned to posting losses, with hog prices in certain areas falling below Rmb14/kg. Currently in the clearance of hog cycle production capacity, given the relatively high pre-sow inventories and the continuous increase in breeding efficiency, frozen inventories are at relative highs. We anticipate mounting pressures on hog supply during 4Q23-1H24, which, coupled with weak demand, may result in a weak rebound. In addition, hog prices may face a further decline after the Chinese New Year (CNY) holiday next year. The current recurring outbreaks of winter pandemic, combined with comprehensive predictions such as the prices of culled sows falling rapidly and piglets posting deep losses, we believe that the capacity reduction may further intensify, and the reduction of production capacity may enter a substantial stage led by retailers and medium-sized plants. If the current pace of pig capacity reduction persists, it is possible to support the cycle reversal magnitude of the pig breeding industry above the medium sizes, and hog prices may hurtle into an upward cycle in 1H24-2025.

Build a modernized breeding system, with healthy breeding laying a foundation for cost advantages.

Shennong Agricultural Industry is located in Yunnan, with no raw material　　procurement advantages, yet it boasts significant cost advantages. Currently, the breeding costs have fallen to Rmb15/kg, gaining a foothold among the top of the industry, with a number of production indicators running at the forefront. We believe that the Company has achieved a number of excellent breeding indicators, and the underlying cause lies in: the advanced concepts of the Company's chairman, strong strategic determination, the core management in office for a long time, and rich industry experience. Meanwhile, the Company focuses on internal talent training and compensation incentives, allowing it to continue to attract highly educated talents, gradually bringing talent and team advantages to the fore. Based on the health-centered concept with biosecurity at the core, the Company has set up a modern breeding system. Looking ahead, as hog farms are at full capacity and the management level improves, we expect the Company's costs to decline further.

Based in Yunnan and tapping into Guangxi and Guangdong, the Company has been steadily expanding its business coverage. At present, the Company's gearing ratio is as low as 22%, with the liquidity ratio at 2.44, putting it in a leading position in the business. Meanwhile, its sufficient reserves of breeding sows also bode well for laying a solid foundation for its strategic expansion. Based on the experience of building a full presence along the value chain in Yunnan, the Company's business map is gradually expanding to Guangxi and Guangdong. At present, the piglets weaned per sow per year (PSY) of its well-performing pig farms in Guangxi has reached 33, verifying the replicability of its success in breeding models. By tapping into Guangxi and Guangdong, the Company could not only make up for the disadvantages in raw materials, but also sell products at higher prices, thus enhancing its profitability. In the long run, with the Company's 3mn/1mn/1mn hog production capacity being gradually commissioned in Yunnan/Guangxi/Guangdong, its long-term hog slaughtering target of 5mn is likely to be reached. At the same time, the Company will continue to give play to its advantage of building a full presence along the value chain and develop downstream food business to realize sustained and steady expansion.

Potential risks:

Price fluctuations of livestock and poultry products; price fluctuations of raw materials; animal diseases; the risk with business operation models; management risks arising from business expansion; the changes in environmental policies; the risk with industrial policies; the commissioning of incremental production capacity not up to expectations; food safety issues.

Investment recommendation:

Shennong Agricultural Industry has formed a relatively mature breeding model with sophisticated standards and biosecurity prevention and control systems, boasting obvious cost advantages. Besides, it has a stable and experienced breeding management team, with the ability to expand and replicate its success beyond the home province of Yunnan. We are optimistic about the Company's ability to achieve steady and orderly expansion through integration along the value chain and continue to realize long-term growth by breaking through cyclical constraints. We forecast its 2023E/24E/25E EPS of Rmb-0.37/1.09/2.55, respectively. Considering the Company's leading breeding model, obvious cost advantages, future growth potential, and factoring in the PE valuation result (with the comps valuation of 8.6x 2025E PE based on Wind consensus estimates), and our predictions of pig cycles, we give a certain premium by assigning 12x 2025E PE to derive a target price of Rmb30. Considering that the Company belongs to the heavy asset industry,　along with the constant production capacity expansion and the extension along the value chain, combined with the PB valuation result (with the comps valuation of 2.2x 2025E PB based on Wind consensus estimates), and our predictions of hog cycles, we assign 2.6x 2025E PB to derive a target price of Rmb30 and initiate coverage with an "OVERWEIGHT" rating.