Consumer Staples / China 25 June 2014

Initiation: snacks the main China Packaged Food and Beverage Sector course as drinks lose fizz Positive

• Although expensive, China F&B companies offer strong earnings Neutral (initiation) growth and resilience to macroeconomic headwinds Negative • We prefer the snack producers to beverage brands given better

competitive landscape and product-mix diversification potential • Want Want is our top pick in the sector How do we justify our view?

In the drinks segment, we expect the players to rise in 2015 as their bottled-water players to fare better market shares increase. than the juice-drink and carbonated- drink producers over the near term, ■ Valuation on the back of downtrading by Our target PERs are based on, or at Anson Chan consumers and increased health a premium to, the companies’ (852) 2532 4350 awareness. We prefer Tingyi, on average past-5-year 12-month [email protected] which we initiate coverage with an forward PERs, as we see operating Outperform (2) rating, to UPCH – margins improving gradually and Alison Law, CFA Hold (3) rating – as Tingyi has a restoring earnings growth. (852) 2532 4308 [email protected] more diverse soft-drink portfolio. Trading at 27% below its past-5-year

■ Catalysts PER average, we believe Want Want ■ Investment case China has a low per-capita is the most attractively valued We initiate coverage of the China consumption rate for snacks, at less among the companies in the sector. Packaged Food and Beverage Sector than 10% of the global average. with a Neutral rating. While the Given this, and the significant room  China Packaged F&B Sector: target PERs companies in the sector are trading we see for product diversification Company Target PER (x) 2014-15E EPS average through new product launches, we Want Want 24.6 USD0.068 at high valuations, we believe this is Tingyi 27.0 USD0.109 justified for some of them by high expect sales growth in the country’s UPCH 30.0 CNY0.151 earnings visibility and their snack market to maintain Source: Daiwa resilience to macroeconomic momentum over the next 3 years ■ Risks headwinds. (2006-12 sales CAGR of 16%), while we expect single-digit sales growth The main downside risks to our view Among the different sub-segments, for the instant-noodle and soft-drink are food-safety issues, sharp rises in we prefer the snack and instant-food markets over the same period. commodity costs, and aggressive companies to the non-alcoholic promotions and discounts. The main beverage (soft drinks) ones given less We believe the success of new upside risks are falls in raw-material fierce competition in the former. products will be important in driving costs and successful price rises. earnings and serve as positive share- Want Want, on which we initiate price catalysts for stocks. Want Key stock calls coverage with a Buy (1) rating, is our Want and Tingyi have begun New Prev. top sector pick on the back of the launching new products to diversify Want Want China (151 HK) recent share-price sell-off (it is down their customer bases, supported by Rating Buy 22% from its peak in April this year) their strong execution capabilities Target 13.00 and the acceleration we expect in and distribution networks. Upside  27.2% revenue over 2H14. We forecast the Tingyi Cayman Islands (322 HK) company to maintain an operating Further declines in the costs of raw Rating Outperform Target 22.90 margin of more than 22% over 2014- materials, such as imported milk Upside  8.8% 16, compared with 4-6% for the soft- powder, sugar, and PET chips, should continue and be favourable Uni-President China (220 HK) drink players and a range of -3% to Rating Hold 13% for the instant-noodle makers. for the snack and some soft-drink Target 5.60 producers. We expect the pricing Downside  3.4% power of the leading instant-noodle Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 72 China Packaged Food and Beverage Sector 25 June 2014

Positive How do we justify our view?

Neutral (initiation)  Growth outlook

Negative  Valuation

 Earnings revisions

 Growth outlook  China Packaged F&B Sector: revenue and reported net profit Revenue. Due to its exposure to snacks, we believe Reported EPS growth Revenue growth Want Want will see the greatest revenue-growth (YoY %) 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016E momentum in the sector over 2014-16. We expect Want Want 32 24 20 19 17 14 14 16 15 14 Tingyi 10 -14 34 31 14 17 19 15 10 10 Tingyi’s revenue to grow faster than UPCH’s on the back UPCH 160 -49 2 38 23 26 9 7 7 5 of market-share gains in the instant-noodle segment. Source: Company, Daiwa forecasts

Margin and profit. We forecast Tingyi’s net profit to  China Packaged F&B Sector: revenue breakdown by product rise at a 26% CAGR over 2014-16 on the back of category (2014E) efficiency gains in the Pepsi unit and reduced promotion Snacks* Instant noodles Dairy beverages Soft drinks Want Want 45% <1% 55% 0% expenses for noodles. For Want Want, we forecast a Tingyi 3% 38% 0% 59% 2014-16 EPS CAGR of 18% on the back of price rises and UPCH 1% 32% 0% 67% new product launches. We forecast UPCH’s adjusted Source: Daiwa forecasts EPS CAGR over the period to be 20% (excluding one-off Note:*Include rice crackers for Want Want items) as the noodles segment turns around in 2015E.

 12-month forward PER (x) band of China F&B companies vs.  Valuation index The packaged F&B companies are trading currently at a 30 2014E PER of 24.0x, compared with 2014 PERs of 10.6x 25 for the Hang Seng Index and 9.0x for the MSCI China, 20 based on our and the Bloomberg consensus forecasts. Although the valuation looks rich, we expect the sector’s 15 resilience to macroeconomic headwinds and high 10 earnings visibility to continue. 5 Our 6-month target prices for Want Want and Tingyi 0 are based on the averages of the companies’ past-5-year Feb-14 Feb-13 Feb-12 Feb-11 Feb-10 Feb-09 Aug-13 Nov-13 Aug-12 Nov-12 Aug-11 Nov-11 Aug-10 Nov-10 Aug-09 Nov-09 May-13 May-12 May-11 May-10 12-month forward PERs, as we expect the stocks to be May-09 re-rated to these average levels as operating margins Sector's PER average HSI MSCI China improve. UPCH is trading currently at a 2015E PER of Source: Bloomberg, Daiwa forecasts 27x, which we believe has priced in an operating-margin recovery for the noodles segment in 2015.  Earnings revisions  EPS forecasts: Daiwa vs. consensus (%) Compared with the Bloomberg consensus, our 2014-16 20 EPS forecasts for Want Want are 5-14% higher. We are more optimistic than the market on the profit margins 10 of the company’s new products and its ability to pass on cost increases. 0

(10) Supported by market-share gains, we expect the consensus to raise Tingyi’s 2015 EPS forecast as the (20) company’s pricing power for noodles, and hence the operating margin of the noodle segment, improves. (30) Given the weak market-share gains we expect and the Want Want Tingyi UPCH lack of new revenue engines, our 2015-16 EPS forecasts 2016E 2015E 2014E for UPCH are respectively 17% and 1% below those of Source: Bloomberg, Daiwa forecasts the consensus.

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Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Tingyi Cayman Islands 322 HK 21.05 Outperform 22.90 0.094 0.123 Uni-President China 220 HK 5.80 Hold 5.60 0.127 0.175 Want Want China 151 HK 10.22 Buy 13.00 0.062 0.074 Source: Daiwa forecasts

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Contents

Competitive landscape by sub-segment ...... 5 Overview ...... 5 Snacks ...... 6 Instant noodles – competition likely to abate ...... 8 Soft drinks – we like diversified players ...... 12 Valuations and recommendations ...... 16 Sector valuation sustainably high ...... 16 Valuation methodology ...... 18 Want Want ...... 18 Tingyi ...... 18 UPCH ...... 19 Key financials to monitor ...... 20 Revenue ...... 20 Operating margins ...... 20 Cash flow and ROE ...... 21 Investment risks ...... 22

Company Section Want Want China ...... 23 Tingyi Cayman Islands ...... 38 Uni-President China ...... 56

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highest in the packaged-food universe. The dividend-payout ratios of the other packaged-food companies, based on the Bloomberg-consensus forecasts over the same period, range from 20- 50%. Competitive landscape 5) M&A potential. We analyse the M&A opportunities and how they can enlarge a by sub-segment company’s product portfolio and revenue base. The instant food industry in China is more fragmented than the beverage segment and provides more We prefer the snack and instant-food opportunities for M&A. producers to the soft-drink manufacturers as they have greater  Overview of investment potential for different sub-segments ASP upside potential to raise ASPs and the per-capita potential 5 consumption level is low. 4 3 Instant noodles Cash flow & 2 Volume Overview profitability 1 expansion Non-alcoholic 0 beverages Our stock recommendations and industry analysis are Snacks based on the following 5 criteria. Cash- 1) ASP outlook. We assess the outlook for ASPs M&As reduction potential based on: 1) a comparison of the retail prices of

different packaged food items with those in Source: Daiwa overseas markets and similar domestic products, and 2) the potential for upgrades in quality or As shown in the preceding radar chart, the snack product mix to drive price rises. We see greater segment ranks higher in every aspect compared with room for ASP increases among the snack players the instant-noodle and non-alcoholic beverage on the back of new product launches. In addition, segments (soft drinks). we believe that it will be easier for the snack players to raise the ASPs of their products than Snacks noodle and beverage producers as the former face Snack companies in China have considerable room to less fierce competition. increase their revenue and operating margin through 2) Volume-growth outlook. We compare the per- product diversification and direct price rises. capita consumption levels of different food and Compared with the average level globally, the packaged items in China and with their averages consumption of snacks in China is still very low. Snack globally. Snack consumption in China is less than companies’ operating margins are also higher than 10% of the average for developed countries. those of players in other segments due to better pricing Meanwhile, the consumption of instant noodles is power and less fierce competition. above the global average but below the average for Asia. Per-capita soft-drink consumption in China is Instant noodles 30% of the global average. We believe the competitive landscape is favourable for the market leader, Tingyi, which has a more than 50% 3) Cost-reduction potential. The potential for share of the market. However, we believe the market cutting costs over the near term depends on volume-growth potential is not as good as for the other commodity prices. Over the long run it should 2 segments given an already high per-capita depend on technology levels, such as the use of consumption level. The pricing power of small players automation and advanced machinery. is meanwhile inferior to that of the big players given an 4) Cash flow and balance sheet. Due to the snack inability to differentiate their products and a lack of companies’ higher ROEs and profit margins, we financial resources for advertising and promotions. see their cash flow and balance sheets as being stronger than those of the other packaged-food Soft drinks companies. The dividend-payout ratios of 65-80% This market is an oligopoly, shared between Coca-Cola we forecast for Want Want over 2014-16 are the and a few domestic players (including the Tingyi-Pepsi

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joint venture). However, price competition is intense in  Want Want: some new snack products launched in 2014 China as consumers are highly price-sensitive. The operating margin in this market in general is lower than those in the other packaged-food segments.

Snacks

ASP and volume-growth outlook Snacks include a wide variety of product categories, including savoury, confectionery, nuts, and baked products. For 2012, per-capita consumption of packaged snacks in China was less than 30g/year, far below the average of 3.2kg/year for developed countries, according to the Institute of Economics of Source: Want Want the Chinese Academy of Social Sciences. The consumption levels in China of confectionery items Competitive landscape such as chocolate and soft candies are only one-tenth of As shown in the following chart, the top-5 snack brands the average level globally. accounted for about 65% of the market in China. However, we observe that they have different product According to AC Nielsen, China’s packaged-snack focuses. Want Want enjoys strong brand recognition in market increased at a 16.4% CAGR from 2006-12, and rice crackers, nuts, soft candy, popsicles and Chinese- exceeded CNY19bn for 2012. The main drivers of this style crispy snacks. Pepsi Co. mainly distributes potato included rises in per-capita consumption and new chips (under the brand Lays) in its snack segment. product launches. We expect increased urbanisation to Liwayway and Orion have diversified snack portfolios, raise the demand for branded and packaged snacks including pies, biscuits, potato chips, and gum. Dali has over the coming years, as consumers move away from strong brand recognition in biscuits, potato chips and home-made snacks (for convenience) or unbranded bakery products. products (due to concerns about food safety and health issues) to packaged products and well-known brand  China: snack segment market-share breakdown (2012) products. Want Want  China: packaged snacks market growth in terms of revenue 23.0% (CNYbn) Others 35.0% 20

15 Pepsi Co. 15.0% 10 DaLi 8.0% Liwayway Orion 10.0% 5 9.0% Source: Calbee, Nielsen

0 2006 2007 2008 2009 2010 2011 2012 We believe domestic players such as Want Want have a Source: AC Nielsen, Calbee annual report 2013 better knowledge of Chinese-style snacks and understanding of regional flavour preferences New-product potential compared with their international competitors. The As there are a lot of sub-segments in the snack domestic companies’ relationships with distributors segment, the room for snack companies to develop new and retailers also put them in a better position when it products and diversify their product portfolios is large. comes to new-product development. Meanwhile, For example, Want Want already had about 400 stock international players can leverage on their product keeping units (SKU) at the end of 2013 and plans to portfolios in other countries and introduce these add another 50-70 SKUs in 2014. products to China consumers quickly.

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Pricing power  Modelez: gross margin and operating margin (%) We believe snack companies have greater pricing 40 35.9 36.4 36.6 37.3 37.1 power than other food and beverage players. By 35 launching new flavours, new packaging, or new product 30 categories, snack companies have the flexibility to 25 adjust their products’ ASP should raw-material costs 20 rise sharply. Although snacks are not daily necessities, 13.2 15 11.6 11.9 we observe that young snack consumers are usually 9.8 10.52 willing to try new products from their favourite brands, 10 which means there is room for new-product launches 5 and hence product-mix improvements. Rising wages in 0 China also support the consumption of inexpensive 2009 2010 2011 2012 2013 food items, such as snacks. Gross margin Operating margin Source: Modelez, Bloomberg As the leader in China’s snack market, Want Want’s pricing power is stronger than that of its domestic Cost trends peers. According to AC Nielsen, the company’s share of Diversification the rice-cracker market stood at 70% for 2007 and it For snack companies with diversified product has remained dominant since then. Meanwhile, Want portfolios, their gross margins are more resilient than Want claimed to rank No.1 in soft candies (such as milk those of single-product players. For example, Want candies), crispy snacks, and dairy beverages for 2010. Want has a diversified cost of goods sold (COGS) structure, with no food items accounting for more than As a result of its strong brand recognition, Want Want 20% of its COGS. The largest single item, milk powder, is able to attract consumers’ attention when it launches is mainly used in its dairy beverage production and is new products, and is able to pass on raw-material cost not related to the profit margin on snacks. Even the rises through direct price increases if needed. For packaging segment, which accounts for about 28% of example, the company’s gross margin (for snacks and its COGS, includes a wide variety of packaging rice crackers) dropped to 36.1% for 2010 from 40% for materials, such as plastic film, tetrapak, metal cans, 2009 due to a sharp rise in the costs of a wide range of etc. raw materials, such as sugar and packaging. However, through gradual price rises and new-product launches,  Want Want: COGS breakdown (2013E) the gross margin returned to about 40% a year later. Other overhead costs 13.6%  Want Want: gross and operating margins (%) of snack and Packaging 27.5% rice-cracker segments Other raw 50 44.8 materials 41.9 40.8 39.7 (starch, flour 40 36.1 etc) 17.8%

30 26.1 Palm oil 22.7 22.3 1.7% 19.0 20.1 Rice 20 Milk powder 4.6% 18.4% Sugar 10 16.4% Source: Want Want, Daiwa estimates 0 2009 2010 2011 2012 2013 Technology upgrades can reduce the wastage of raw Gross margin Operating margin materials and the use of manpower. For example, Want Source: Want Want Want is investing in packaging machines and other technologies to automate labour-intensive production Want Want’s international snack-company peers also procedures. We estimate labour costs accounted for 7- have stable profit margins. We observe that the profit 8% of the COGS of our packaged food coverage margins of Modelez (Not rated), an international snack universe. firm, has been steady at 36-37% for the past 5 years, despite volatile global commodity prices.

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Cash flow and balance sheet  Selected acquisitions in the China snacks industry Acquirer Target Date Size Valuation Industry As a result of the higher operating margin on snacks Nestle Hsu Fu Ji 2011 USD1.7bn 25x past-1-year PER Candy and lower capex requirements for the snack producers for 60% compared with the beverage and noodles makers, we stake Hershey Golden Monkey 2014 USD498m 2.8x price/sales Candy see the former as having stronger cash flow and higher for 80% dividend payouts. This strong cash flow provides them stake with a strong war chest for acquisitions should Qia Qia Qiakang Foodstuff 2013 CNY96m 13x past-1-year PER Food sauces Food for 60% opportunities arise. stake Lunar Guizhou Yonghong 2013 n.a. n.a. Meat snacks As shown below, Want Want can generate more than Capital Food Lunar Sichuan Zhiqiang 2012 n.a. n.a. Walnut USD470m in free cash flow per year over 2014-16E, Capital products based on our estimates. Its high ROCE also suggests Source: Daiwa that it enjoys a high return on its assets and investments compared with other food companies. Tingyi could soon be included in the above list, having been actively looking for acquisition targets in China’s  Want Want: free cash flow and ROCE instant food segment since 2012, in order to diversify (USDm) its revenue and further tap its strong distribution 1,200 35% 40% 33% network. 30% 31% 35% 1,000 29% 29% 26% 30% 800 25% Instant noodles – competition 600 20% 15% likely to abate 400 10% 200 5% Over the next 3 years, we expect ASPs to continue to be 0 0% the main revenue driver for the instant-noodle brands 2010 2011 2012 2013 2014E 2015E 2016E rather than sales volume. Following on from the fierce Free cashflow (LHS) ROCE (RHS) price competition in 2012-13, we expect promotional

Source: Company, Daiwa forecasts budgets and pricing strategies to be scaled back in 2014, and product ASPs to trend up as a result of M&A potential product mix upgrades.

As discussed above, the top-5 snack player brands ASP outlook accounted for about 65% of the market share in China Prices likely to trend up on easing competition for 2013. The remaining 35% market share is highly and product mix upgrades fragmented and was shared among a lot of players. Since 2010, revenue growth for the instant noodles

industry has accelerated more rapidly than sales- According to the CEIC, as of 1Q14, there were 659 volume growth. According to AC Nielsen, sales volume baked goods producers and 359 candy/chocolate for the instant-noodle market has been declining since producers in China. Many of them are focused on just 2011, yet revenue has continued to rise, showing that one product category and have become No.1 or No.2 in consumers have been willing to pay higher prices for that sub-category. For example, Strong Food Group better products, but did not consume more noodles (not listed), which is based in Guangzhou, is the No.1 over the past 3 years. jelly snacks maker in China, with about a 23% market share in 2012, according to Euromonitor. Such Note that since AC Nielsen data just captures the producers make good acquisition targets for large information and trade data from chain stores such as companies seeking product diversification. supermarkets and convenience stores, we believe the

data has captured the price trend of the products in the Below we show some of the acquisitions of Chinese country, but underplayed the growth in rural areas. snack companies in the past, many undertaken by According to the World Instant Noodles Association, foreign companies or listed companies. Private-equity noodles consumption volume has been growing in firms have also been active in acquiring small-sized, China over the past 5 years (see the next section for single product snack manufacturers in China. more details).

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 China instant-noodle market growth (% YoY) At the same time, UPCH’s noodles’ revenue growth 20 decelerated to 5% YoY for 2H13 from 22% YoY for 15.2 14.6 2012, after sales of its core product (pickled vegetable 15 12.1 12.0 spicy flavour) lost steam. In our view, UPCH lacks new

10 products to sustain its revenue growth momentum over the next few years, as it is focused on promoting its 4.8 4.0 5 existing star products, and lacks the financial resources 2.0 to develop and promote new noodle products. 0  Tingyi and UPCH: revenue changes (% YoY) (1.9) (1.9) (5) (3.9) 100 90 90 2009 2010 2011 2012 2013

Volume Value 80 Source: AC Nielsen 60 51 51 Instant-noodle revenue growth in China decelerated 40 30 30 significantly in 2012 and 2013, due to fierce 22 22 22 22 16 14 11 13 competition and cannibalisation among new and old 20 7 10 10 products. In 4Q12, both Tingyi and UPCH started 22 4 11 offering price discounts of 10-15% on pickled vegetable 0 7 5 5 5 spicy flavoured noodles, and in 2013, started offering 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 free sausages with that product to gain market share in Tingyi UPC that category. Source: UPCH, Tingyi

This flavour of noodles is a fast-growing sub-category Looking forward, we expect more high-priced noodle of the noodles market in China (sales value up 30% products to be launched in China over 2014-16, such as YoY for 2012 and 10% YoY for 2013), accounting for 16- non-fried noodles, large-bowl noodles with extra 18% of the total instant noodles market in China in ingredients (eg, pieces of meat), and snack noodles. 2013, according to AC Nielsen, up from 10.7% in 2011. We estimate that the share of the No.1 flavour – roast Most instant-noodle products in China are priced beef noodles – declined to 20% in 2013 from more than below CNY4/bowl or CNY3/pack. Non-oil fried 25% in 2010. products (which have a higher ASP than other noodle products but also perceived as more healthy) account However, we believe the aggressive promotion of for less than 2% of China’s instant-noodle various noodle products over the past 2 years has consumption, versus 10-20% in Japan. dragged down both the average price and pace of volume growth of the overall instant noodles market, as We believe that such high-ASP products will gradually consumers have moved to the pickled vegetable and attract new consumers to the segment due to their spicy categories from others, and demand for discounts healthy image and further drive up consumption and has risen. Revenue growth for the industry decelerated the noodle ASP in China. to just 4% YoY in 2013, down from a range of 12-16% YoY during 2009-12. We see the instant-noodle segment as a winner-takes- all market. Tingyi’s operating margin is far above that That said, we have seen signs of improvement in of the second largest player, UPCH. Although the third revenue since 2H13. Take Tingyi as an example. Its and fourth largest players, Hualong and Baixiang, are noodles revenue growth was 12% YoY for 2H13, up not publicly listed, we believe their financials and cash from 6% YoY for 1H13. Tingyi has successfully flow condition have been deteriorating over the past reaccelerated its revenue growth by launching more three years as a result of their declining market share new products. (hence revenue).

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 Tingyi vs. UPCH: instant noodles’ operating margin (%)  China (including Hong Kong) instant noodles consumption comparison (bn packs/bowls) 47 6% 15 12.7 12.5 13.1 11.6 11.7 11.3 46 11.2 5% 45 10 44 4% 43 3% 5 2.8 3.1 42 0.5 41 2% (0.3) 0.2 40 0 (1.8) 1% (3.3) 39 38 0% (5) 2009 2010 2011 2012 2013 2010 2011 2012 2013 2014E 2015E 2016E China/HK YoY % (RHS) Tingyi UPCH Source: World Instant Noodles Association Source: Tingyi, UPCH, Daiwa forecasts Cost-reduction potential Volume outlook We expect mild raw-material cost pressure on instant Per capita consumption in China is below that noodles over the next 2 years on the back of likely of other Asian countries rebounds in the prices of palm oil and flour in China in According to the World Instant Noodles Association, 2H14. Even so, we believe most players’ operating an international organisation formed in 1997 by margins will improve slightly over 2015-16 as a result instant-noodle manufacturers, 46bn packs of instant of the scaling back of promotional expenses and noodles were consumed in China (including Hong discounts. Kong) in 2013, making it the largest noodle-consuming country in the world. Palm oil and flour are key cost items for noodle

manufacturing. Other items include packaging and a Although noodles consumption on a per capita basis in number of food ingredients and other flavourings and China is already much higher than the global average, food additives. it is still low in comparison with Asian countries in which noodles (not just instant noodles) are usually  Noodle manufacturers’ COGS breakdown (2014E) served as a key source of carbohydrate. Based on World As a ratio of COGS (%) Lower limit Upper limit Instant Noodles Association data, consumption volume Palm oil 10 15 in China has been growing slightly over the past 5 years Flour 14 20 and is expected to grow steadily over the next 3 years. Packaging (paper, plastic etc) 20 Other food ingredients 37 46 Fixed cost 10 10  Asia: per-capita consumption of instant noodles in 2013 (packs) Source: Daiwa forecasts 80 72 70 Palm oil (10-15% of instant noodles COGS) 60 60 In Tianjin, a major port for importing palm oil into China, the palm-oil price fell by 3% for 5M14. In 50 43 addition, the price of palm oil has trended down 3% 40 34 YTD on the futures market, easing the cost pressure for 30 instant noodles’ producers in China in 2Q14 and 3Q14.

20 15 The main reason for this is that China imports most of its palm oil needs, and the production volume of palm 10 oil in Malaysia (which accounted for about 40% of 0 world palm oil supply for 2013) rose by 7.4% YoY for China/HK Indonesia Japan South Korea Global 5M14. Source: World Instant Noodles Association, Daiwa The Malaysian Palm Oil Council (MPOC) expects supply growth for 2014 of just 0.9% YoY (to 19.20m tonnes from 19.18m tonnes for 2013), while next year’s harvest of palm oil may be affected by El Niño and recent droughts; hence palm oil prices may go up in 2015 from the current level.

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Ong Keng Wee, plantation analyst at our alliance  Flour and wheat prices in China partner in Malaysia, Affin Investment Bank, forecasts (CNY/tonne) (CNY/kg) Malaysian palm oil prices of RM2,700/tonne for 2014E 2,800 5 and RM2,850/tonne for 2015E, implying 14% YoY and 2,600 2,400 4 5.6% YoY increases, respectively. We expect the unit 2,200 3 cost increase for the noodles companies we cover to be 2,000 1,800 lower at 5% YoY and 10% YoY for 2014E and 2015E, 2 respectively, as they can make use of low-cost 1,600 1,400 1 inventory and efficient stock management to mitigate 1,200 the surge in costs. 1,000 0

Jul-08 Oct-12 Apr-13 Oct-13 Jan-08 Jan-09 Mar-11 Mar-12 Feb-10 Aug-09 Aug-10 Sep-11  Palm oil price trend May-14 (CNY/tonne) (USD/tonne) Wheat (LHS) Flour (RHS) 11,000 1,400 Source: Bloomberg

10,000 1,200 1,000 Other food ingredients 9,000 800 These include dried vegetables, MSG and flavourings 8,000 600 (natural and artificial), etc. In general, food inflation 7,000 pressure in China is low at present as indicated by food 400 manufacturing PPI. We also expect less use of 6,000 200 expensive supplemental ingredients as promotion 5,000 0 tools, such as ham sausage in bowl noodles, to lower Jul-10 Apr-12

Jun-13 Jan-14 the food ingredient cost of noodles in 2014 and 2015. Feb-11 Sep-11 Nov-12 Dec-09 May-09 Tianjin (LHS) Malaysia (RHS) Source: Bloomberg  Food PPI in China

14 PPI - Food Flour (14-20% of COGS) 12 The price of wheat (the raw material for flour) has 10 trended up consistently in China over the past 4 years 8 as a result of government support. The China 6 Government has kept raising the official floor auction 4 price for grains in China to provide incentives for 2 farmers to increase plantation sizes. Wheat output in 0 China rose at a CAGR of 1.5% between 2009 and 2013, (2) while the government auction price was up 9% during (4) the period. Jul-07 Oct-05 Apr-09 Oct-12 Jan-04 Jun-10 Jan-11 Mar-05 Feb-08 Mar-12 Aug-04 Dec-06 Sep-08 Nov-09 Aug-11 Dec-13 May-06 May-13 We forecast a mild increase in the flour price of 2-4% Source: Bureau of Statistics of China, CEIC YoY over 2014-16 for the companies within our coverage, in line with the gradual increase of the Cash flow and balance sheets government auction price of wheat. The cash-generating capabilities are not the same between different noodles companies, as utilization  China Government’s purchase price of grains from farmers (CNY/50kg) rates and market segments vary significantly. Thanks Date of announcement to Tingyi’s focus on the mid-to-high-end segment, and Official auction price Nov-13 May-13 2012 2011 2010 2009 its economies of scale, the noodles business is its main Corn 222-226 210-214n.a. n.a. n.a. n.a. cash cow. The segment contributes around USD500m Wheat (mixed) 118 112 102 93 86 83 in operating cash flow for Tingyi every year. Early rice 132 n.a. 120 102 93 90 Late rice 135 n.a. 125 107 97 92 Hard rice 150 n.a. 140 126 103 93 On the other hand, UPCH’s noodles business has been Soybean n.a. n.a. 230 200 190187 loss-making for the past 2 years, and we estimate its Source: National Development and Reform Commission of the PRC utilisation rate is below 50% on average, making it even more inefficient than many peers. For most smaller competitors in China, their balance sheets and operating cash flow are even weaker, as they focus on the low-margin low-end segment.

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M&A potential translating into less than 8% of the total bottled water According to AC Nielsen, the top-4 players in China market in 2013, based on our estimates. We believe accounted for over 85% of the China instant-noodle high-end products will not be important growth drivers market for 2013. As such, we think opportunities for for soft drink companies over 2014-16. M&A in the segment are low due to the little incremental impact on revenue and inferior financials More interestingly, Chinese beverage players’ operating and brand recognition of small players. margins are lower than those of their global peers, such as Coca Cola and Pepsi. This is due to: 1) the more  China instant noodles market share trends competitive landscape in China, 2) differences in (%) operational models. Global carbonated drink 70 companies often adopt a franchisee model and 54.9 55.7 57.4 56 57.1 57.1 57.1 56.2 56.7 56.3 56.5 56.3 56.5 55.6 56 56.4 57.2 60 outsource production procedures to bottlers, while 50 Chinese beverage players’ operating margins are closer 40 to those of bottlers of international brands than to 30 brand owners, and 3) contributions from other higher 17.3 17.6 17.4 17.5 13.9 14.1 14.6 15.6 16.4 16.4 16.6 profit margin businesses, such as snacks. 20 10.7 12.1 13.1 8 8.9 10 10 5.9 We believe Chinese beverage players’ operating 0 margins will remain low in the near term. Long-term

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 upside catalysts include: 1) the launch of higher-value Tingyi UPCH Hualong Baixiang and higher-margin products, such as energy drinks and

Source: AC Nielsen 100% juice, and 2) direct ASP rises on better brand recognition and increasing wage levels.

Soft drinks – we like diversified  Operating margin trends of different beverage players (%) 30 players 23.9 24.5 25 21.9 22.4 22.0 22.3

20 We prefer the soft drink companies with a diversified 15.1 15.4 15.6 14.5 13.9 14.6 product portfolio to single-product players in the face 15 of fast-changing consumer tastes and the diversified 10 6.6 5.2 4.7 5.8 companies’ economies of scale. We believe the pace at 3.4 3.2 which operating margins and product prices of the 5 5.5 5.6 5.8 5.9 5.8 China soft-drink makers catch up with those of their 0 2.1 global peers will be very slow over the next few years, 2011 2012 2013 2014E 2015E 2016E due to the fierce competition among the players in Tingyi UPCH China Foods - bottling Pepsi China, both domestic and international brands, and Coca Cola hence their weak pricing power. Source: Companies, Daiwa forecasts, Bloomberg consensus for Pepsi and Coca Cola

ASP outlook We expect UPCH’s operating margin to remain at 5.8- Beverage prices in China have remained steady in 5.9% only over the next few years, as cost trends recent years. On average, the retail prices of bottled tea remain steady (see the next section for details). For and juice have been kept below CNY3/500ml bottle for Tingyi, we expect its operating margin to gradually the past 5 years, with occasional promotional activities increase due to its continuous cost-saving incentives offered such as up-sizing offers and free gifts. In the and efficiency improvement at the Pepsi unit. face of economic headwinds and fierce competition, brands are reluctant to raise their product prices Sales-volume growth outlook directly. Changes in consumer preference among different categories Over the past 2 years, some brands have launched We expect sales growth in the soft-drink market to products with high retail prices, such as sugar-free tea, continue to slow over 2014-16 due to strong economic sports drinks, and spring water to raise the overall ASP headwinds. For Tingyi and UPC, we forecast respective of their product portfolio. However, such products only beverage revenue-growth rates of 9-11% YoY over 2015- account for a small proportion of the market at present. 16, down from our forecasts of 10-17% YoY for 2014. For example, retail sales of premium bottled water totalled CNY6.1bn in 2013, according to Euromonitor,

- 12 - China Packaged Food and Beverage Sector 25 June 2014

However, if it is a hot summer (which leads to preference for using just one supplier for a wide consumers drinking more water or beverages) and variety of beverages. rainfall is low (increasing the likelihood of outdoor 2. Strong R&D and marketing capabilities, activities and hence bottled-beverage consumption), which are important for a company to be able to revenue growth may exceed our expectations. As the launch new products regularly and respond to retail prices of beverages have been steady in the past market changes quickly. few years, we believe revenue is a good proxy for volume growth.  China: soft-drink market breakdown by category (%) YTD sales-  Tingyi vs. UPCH: YoY beverage revenue growth (%) 2007 2010 2012 2013 growth trend Remarks (%) Bottled tea 11.4 19.1 16.9 16.4 Steady Dominated by Tingyi Shared by a few market 35 30 Bottled water 52.4 30.9 31.2 32.2 Growing leaders 30 27 Carbonated drinks 22.4 28.5 23.6 22.6 Declining Dominated by Coca Cola 23 Shared by a few market 25 Diluted Juice 12.6 18 17.8 16.6 Declining leaders 20 17 Others (sports drinks, Shared by a few market herbal teas) 1.2 3.5 10.5 12.2 Raising leaders 15 12 12 9 10 9 Source: AC Nielsen, Daiwa 10 7 5 Cost-reduction potential 0 2012 2013 2014E 2015E 2016E In general, PET chips and sugar are the main raw Tingyi UPC materials for bottled drinks, respectively accounting for Source: UPCH, Tingyi, Daiwa forecasts about 60% and 10% of COGS for soft drinks in China.

We believe the key challenge for beverage companies is Sugar. China is the second-largest sugar producer in to keep up with ever-changing consumer tastes. For the world, but still imports about 10% of its sugar example, juice drinks’ share of the total beverage needs every year. We expect the sugar price to trend market rose rapidly from 2007-10 on the back of down in 2014 for 2 main reasons. increasing demand for traditional Chinese juices such as kumquat lemon juice and pear juice. However, its First, the global cane sugar surplus is standing at a 3- share fell in 2012 and 2013 as consumers bought more year high currently. The US Department of Agriculture bottled water and other drinks. (USDA) expects the global sugar supply surplus to be 11.6m tonnes by September 2014 on the back of For 2014, we expect bottled water sales to continue to abundant supply. be higher than for the other major beverage categories due to lower prices and the products’ appeal to health- Second, China’s sugar stock is high. It stood at 8.5m conscious consumers. tonnes as at the end of September 2013, which was equivalent to about 50% of the country’s annual Over the long term, we believe the sales growth in the consumption that year. The USDA expects global sugar various market segments and changes in consumer production over 2014-15 to be 176m tonnes, with a tastes between major product categories – carbonated reduction of supply in Brazil largely offset by an drinks, ready-to-drink tea, juice drinks, and water – increase in supply in India. are difficult to predict. Promotional and marketing capabilities, as well as an ability to develop new  China and global sugar price trends flavours and packaging will be the key to earnings (USD/m tonnes) (CNY/m tonnes) growth for the beverage companies over the next few 1,200 9,000 8,000 years, in our view. 1,000 7,000 6,000 Given this, we prefer companies with the following 800 5,000 characteristics. 4,000 600 1. A diversified portfolio, which can: 1) reduce 3,000 revenue and utilisation-rate volatility when 400 2,000 consumers’ preferences change from one category 1,000 200 0 to another or as a result of seasonal changes, and Jan-08 Nov-08 Oct-09 Sep-10 Aug-11 Jul-12 Jun-13 May-14 2) cater to distributors’ and restaurant chains’ Brazil Nanning (RHS) Source: Bloomberg

- 13 - China Packaged Food and Beverage Sector 25 June 2014

PET chip (polyethylene terephthalate). PET  Asset / equity ratio of Tingyi’s business units (x) plastic bottles are the major containers for ready-to- 4.0 3.3 drink soft drinks in China. As a result of the abundant 3.5 supply of petrochemicals (raw materials) and a weak 3.0 2.7 economy, the PET-chip price has fallen by 12% YTD and dropped by 16% YoY for May 2014. Based on our 2.5 2.0 discussions with some beverage producers, we believe 1.6 1.5 the favourable cost outlook for PET chip will continue 1.5 for the remainder of 2014 due to the abundant supply 1.0 in China. 0.5  China: PET-chip price 0.0 Beverage -2013 Beverage -2012 Noodles - 2013 Noodles -2012 (CNY/tonne) 16,000 Source: Tingyi, Daiwa estimates

14,000 M&A potential 12,000 The soft-drinks market in China is highly consolidated. 10,000 The top-4 players of bottled tea, bottled water, and 8,000 bottled diluted juice respectively accounted for 90%, 6,000 67%, and 81% of the market for 1Q14, according to AC Nielsen data. The market leaders have a presence in all 4,000 the major beverage categories, and have national brand recognition and nationwide distribution networks. Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 May-08 May-09 May-10 May-11 May-12 May-13 May-14 Source: Wind The major reason for M&A, if any, would be to enrich their product portfolios, such as Tingyi’s joint venture Cash flow and balance sheet with Pepsi 2 years ago to gain exposure to carbonated In our view, soft-drink production is capital-intensive drinks. and has high financial entry barriers compared with other packaged-food segments due to the high start-up International players can quickly enter new product capex. For example, we estimate Tingyi’s capex on categories (such as Chinese traditional drinks and beverage capacity will be USD600m for 2014, functional drinks, which include sports drinks and accounting for over 70% of the company’s total capex. herbal teas) and improve their product sales in China UPCH has said its capex for 2014 will amount to by working with domestic players. However, we CNY4.5bn, and most of this will be spent on beverage- observe that they are more likely to form joint ventures plant construction. Hence, we also expect UPCH’s free or other forms of alliances with domestic partners cash flow to be negative for 2014. rather than take a majority stake in a local player.

The soft drinks business is, in general, more leveraged  China: major M&As in the soft-drinks business than that of other packaged-food businesses. Based on Foreign China Date partner player Nature Remarks Tingyi’s disclosed segmental information, the asset-to- 2014 Suntory Huiyuan JV Pending official approval equity ratio of the company’s beverage segment was 2012 Pepsi Tingyi JV Achieved the target for the loss-making Pepsi higher than its noodles segment, as the following chart China unit to break even in 2013 shows. 2011 Kirin CRE JV 2008 Coca Cola Huiyuan Acquisition Failed to obtain anti-trust approval

Source: Daiwa

- 14 - China Packaged Food and Beverage Sector 25 June 2014

 China: ready-to-drink tea market shares (%) 54.9 54.4 53.6 60 50.9 50.3 50.8 51.6 52.5 51.3 47.8 47.4 45.2 45.7 50 42.4 43.9 44 41.8 40 36.7 32.9 33.4 31.5 33.8 32.1 30 29.8 28.3 29 25.8 23.7 23.1 20 22.4 21.5 20 21.1 21.9 14.1 13.5 13.6 13.8 10 11.9 11.7 11.7 12.4 12.3 12.5 11.2 10.1 9.3 9 7.4 6.8 0 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 Tingyi UPCH Wahaha Coca Cola

Source: AC Nielsen

 China: bottled water market shares (%)

30 25.7 25.6 25.1 25.3 24.1 22.6 22.5 22.6 22.7 22.5 22.8 22.6 25 21.5 20.3 20.6 19.7 20.3 20 24.1 22.6 22.8 21.5 22.2 21.2 21.2 21.5 15 19.8 17.9 17.4 18 16.1 10 14.3 14.1 13.3 14.2 5 0 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 Tingyi Farmer's Spring Wahaha Yibao Coca Cola Source: AC Nielsen

 China: diluted juice drinks market shares (%) 40 33.6 33.5 32.1 31.9 33.2 31.7 32.4 32.1 32.2 35 29.9 30.1 30.8 29.9 28.9 28.2 27.7 33.2 26.9 31 30 28.9 30 30.2 27.1 25 25.2 25.4 20 21.1 20.4 20.4 21.1 20.3 18.7 17.5 17.8 15 15 19.2 19.2 19.5 19 19.218.4 16.6 17.7 17.8 17.4 10 16.2 15 15 15.5 15.8 15.5 16.1 5 0 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 Tingyi UPCH Coca Cola Wahaha Huiyuan Source: AC Nielsen

- 15 - China Packaged Food and Beverage Sector 25 June 2014

PEG In terms of PER-to-long-term EPS growth ratio (PEG), most F&B stocks are trading currently between 1-1.9x, compared with past-5-year averages of 0.9-1.4x. In the following chart, we do not include UPCH and CRE as Valuations and the consensus forecasts for their 3-year EPS growth rates have been volatile in the past 2 years, sometimes recommendations assuming no growth or even declines. There are no meaningful PEG consensus forecasts for them over the past 2 years. Our top pick is Want Want with a target price of HKD13. We have Outperform and  PER-to-long-term growth rate ratio (x) yearly average 2010 2011 2012 2013 2014 YTD Hold ratings for Tingyi and UPCH, WWC 1.06 1.11 1.23 1.21 1.35 Tingyi 1.32 1.29 1.21 1.26 1.33 respectively. Tsingtao 1.23 1.08 1.44 2.18 1.76 Mengniu 1.85 1.05 1.65 2.97 1.16 Source: Bloomberg Sector valuation sustainably high Valuation premium justified PER As shown in the following table, the China F&B players The China F&B Sector was rerated after the 2008 listed in Hong Kong are trading at a 2014E PER of 24.0 financial crisis. The average 12-month forward PER of and a 2015E PER of 18.9x. These are at premiums of the major F&B players were rerated from about 16x to 95-126% to the Hang Seng Index, which is trading 28x over 2009. Since then they have been trading at currently at a 2014E PER of 10.6x and a 2015E PER of 20-28x. Over the past 5 years, the Hang Seng Index 9.7x. They also represent premiums of 128-166% to the and MSCI China have traded at 12-month forward MSCI China index, which is trading at 2014E and PERs of 9-16x and 9-15x, respectively, based on 2015E PERs of 9.0x and 8.3x, respectively. Bloomberg data. We believe the valuation premium of the China F&B The pool of stocks we use to calculate the packaged Sector relative to other sectors will continue to be F&B sector average comprises Want Want, Tingyi, justified by the following. UPCH, China Mengniu (2319 HK, HKD34.85, Hold [3]), China Resource Enterprise (Not rated) (CRE), and High revenue-growth visibility. In the face of Tsingtao Brewery (Not rated). These companies have economic headwinds, demand growth for many staple made profits over the past 5 years, and each has a items is more resilient than for other products, in market cap exceeding USD3bn at present. particular for basic food items. Moreover, a rising minimum wage, a low per-capita consumption level of  12-month-forward PER: China packaged F&B Sector vs. MSCI some F&B items compared with the global average, and China and Hang Seng Index ongoing urbanisation are all favourable and visible long-term business-growth drivers for the sector. 30

25 Room for margin expansion. The operating 20 margins of most F&B companies in China are only at mid-to-high single digits, which compares with mid- 15 teen percentages to more than 20% for their major 10 international peers. 5 We see the following long-term drivers for an increase 0 in the operating margins of the China players: 1) excluding infant formula, retail (and ex-factory) prices Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Aug-09 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 May-09 May-10 May-11 May-12 May-13 of most F&B items in China are below those in Sector's PER average HSI MSCI China developed countries – upside should come from Source: Bloomberg, Daiwa product-mix improvements, increasing consumption

power, and the brand recognition of leading players, and 2) scale expansion, automation and other

- 16 - China Packaged Food and Beverage Sector 25 June 2014

production-technology developments that improve the This has resulted in strong cash flow and low credit risk operating efficiency of the industry. in the sector.

Strong balance sheets and cash flow. With the exception of UPCH, we expect all downstream F&B companies under our coverage to have a net cash position at the end of 2014. Most of the revenue for the packaged-food companies comes from distributors (on a cash-on-delivery basis) and is generated in China.

 China Packaged Food and Beverage Sector: valuation comparison Stock ROE

Bloomberg Mkt. cap Share price Δ % PER (x) EPS change YoY ( %) EV/EBITDA (x) Revenue YoY (%) EBIT margin (%) (%) Name code Rating (USDm) 23 June 14 3M 1M 2013 14E 15E 16E 2013 14E 15E 16E 2014E 15E 2013 14E 15E 2013 14E 15E 14E China packaged F&B players HKD Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 CRE 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Tenwow 1219 HK NR 760 2.86 -21 -8 10.7 9.8 8.1 6.3 n.a. 9 21 30 8.5 7.0 11 17 17 9.6 9.7 9.9 15.7 Sector average 27.0 24.0 18.9 15.7 -1 13.8 24.5 16.2 11.8 9.7 15.4 18.5 15.4 8.7 11.5 12.2 16.5 Dairy-farm operators HKD China Modern Dairy* 1117 HK Buy 1,931 3.12 -11 -9 24.0 12.2 9.4 7.5 23 97 30 25 10.5 8.8 62 34 20 29.6 36.0 36.2 15.9 China Huishan Dairy* # 6863 HK Buy 3,233 1.75 -22 -7 10.4 7.5 5.9 n.a. 111 32 55 40 8.5 6.7 38 39 34 42.2 51.0 52.6 13.8 Yuanshengtai Dairy 1431 HK NR 611 1.22 -22 -10 9 6.7 5.0 4.1 n.a. 32 33 22 3.7 2.8 28 35 32 39.5 37.3 34.9 9.3 Average 14.5 8.8 6.8 5.8 67 54 39 29 7.6 6.1 43 36 29 37.1 41.4 41.2 13.0 Mainland-listed F&B players CNY Yili Industries 600887 CH NR 10,382 31.56 -13 -10 19.1 17.2 14.1 11.8 54 11 22 19 11.7 9.5 14 13 12 5.3 7.9 8.8 20.3 Bright Dairy 600597 CH NR 3,105 15.75 -10 -13 47.7 30.2 21.3 17.6 18 58 42 21 16.3 12.7 18 23 20 4.2 4.5 5.3 12.6 Henan Shuanghui 000895 CH NR 12,356 34.87 -11 2 19.9 15.9 13.3 11.3 34 26 19 18 10.7 9.0 13 20 20 10.7 11.5 11.5 29.8 Yantai Changyu - A 000869 CH NR 2,241 23.84 -8 -6 15.6 14.5 14.8 14.0 (38) 7 (2) 6 8.4 8.2 (23) 10 6 32.9 29.3 28.3 17.4 Yantai Changyu - B 200869 CH NR 2,222 16.68 -13 -9 10.9 10.2 10.4 9.8 (38) 7 (2) 6 8.4 8.2 (23) 10 6 32.9 29.3 28.3 17.4 Yanjing Brewery 000729 CH NR 2,899 6.41 -4 -6 25.6 20.5 18.7 16.0 2 25 10 17 n.a. n.a. 6 23 9 7.2 7.6 7.8 6.9 Zhejiang Beingmate 002570 CH NR 2,364 14.36 -12 11 20.3 19.4 15.6 11.8 112 5 24 32 13.3 11.1 14 9 21 14.7 14.2 14.8 16.8 Average 22.7 18.3 15.4 13.2 20 20 16 17 11.5 9.8 3 15 14 15.4 14.9 15.0 17.3 Source: Bloomberg, *Daiwa forecasts Note: #Denotes 31 March year-end

 Global packaged food and beverage companies: valuations Share price ROE Bloomberg FY Mkt. cap. (USD) Stock Δ % PER (x) EPS change (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) (%) Company code end (USDm) 23 June 14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 14E 15E 2013 14E 15E 2014E Nestle NSRGY US Dec 251,857 78.10 0 4 n.a. 19.4 18.1 n.a. -2 n.a. 7 n.a. n.a. n.a. 3 1 6 16.0 16.1 16.3 n.a. Coca Cola KO US Dec 183,411 41.73 3 8 21.5 20.0 18.6 17.3 -3 8 7 8 15.3 14.4 (2) 0 4 21.8 23.9 24.6 5.6 Pepsi PEP US Dec 134,004 88.39 3 7 20.2 19.5 18.1 16.8 10 4 8 8 12.1 11.4 1 1 4 14.6 15.1 15.4 5.9 Kraft KRFT US Dec 35,569 59.75 2 7 13.1 18.7 17.3 16.4 64 -30 8 6 11.7 11.1 (0) 1 3 25.8 18.1 18.6 6.7 Mondelez MDLZ US Dec 62,973 37.23 0 8 16.8 21.6 18.8 16.3 44 -22 15 15 13.8 12.8 1 1 2 11.9 12.8 13.6 2.0 General Mills GIS US May 33,348 54.27 0 5 19.0 18.9 17.5 16.4 18 0 8 7 11.7 11.2 7 2 3 16.2 16.3 16.4 4.6 Kellogg K US Dec 23,851 66.43 -3 7 13.3 16.6 15.7 14.5 86 -20 6 8 11.3 10.9 4 2 2 19.2 14.8 15.1 6.8 Average 17.3 19.2 17.7 16.3 31 (10) 8 9 12.6 12.0 2 1 3 17.9 16.7 17.2 5.3 Source: Bloomberg

- 17 - China Packaged Food and Beverage Sector 25 June 2014

Bloomberg consensus as we expect higher operating Valuation methodology margins.

We believe a PER methodology is suitable when As shown in the following chart, Want Want is trading valuing F&B companies given their earnings-growth at close to the middle of its past-5-year PER trading visibility, and steady profit margins. To derive our range of 18-30x. We expect the stock to be rerated over target prices, we first consider the past-5-year average the coming 6 months: 1) as we expect lower raw- PER of the individual companies and apply a premium material costs to kick in gradually in 2H14 once the or discount to the trading average to derive our PER. company has used up its relatively high-priced milk- We believe that any premium or discount is justified by powder inventory, and 2) given the success of new changes in the operating margin, while any discount is product launches. usually a result of potential market-share losses or profit-margin pressure due to commodity-price  Want Want: 12-month forward PER bands volatility. (HKD) 14 We then compare the company’s current trading PER 12 with those of its peers in China to see whether or not 10 the valuation appears attractive or demanding. In 8 general, we believe that a premium for large-cap 6 companies is justified by leading market positions in 4 their respective segments. 2

 China Packaged F&B Sector: past 5-year average PER trading Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Aug-09 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 range May-09 May-10 May-11 May-12 May-13 May-14 151.HK 14x 18x Past-5-year Average 22x 26x 30x 12M forward PER Standard PER (x) PER Company High-end Low-end Average deviation 2014E 2015E2014-15 Source: Bloomberg Want Want 29.6 17.90 24.6 2.7 21.2 17.9 19.6 Tingyi 33.5 21.30 27.1 1.9 28.9 22.1 25.5 UPCH 44.5 8.6 23.8 7.1 36.8 26.6 31.7 Tingyi Source: Bloomberg, 2014-15 EPS numbers are Daiwa’s forecasts We initiate coverage on Tingyi with an Outperform (2) Want Want rating and 6-month target price target of HKD22.9. Our target price is based on a target PER of 27x (which is equivalent to the average of the stock’s 12-month We initiate coverage of Want Want with a Buy (1) forward PERs over the past 5 years) on the average of rating and 6-month target price of HKD13.0. Our our 2014 and 2015 EPS forecasts, of USD0.109. Our target price is based on a target PER of 24.6 (which is target price translates into a 2014E PER of 31x, which equivalent to the average of the stock’s 12-month is at a 24% premium to the sector average (based on forward PERs over the past 5 years) on the average of our and the Bloomberg consensus forecasts). We our 2014 and 2015 EPS forecast of USD0.068. Our believe the premium is supported by Tingyi’s dominant target price translates into a 2014E PER of 26.8x, shares in many of its key F&B markets, and given its which is equivalent to a 3% premium to the sector strong scale advantages when it comes to cost controls. average. We believe the premium is supported by Want All of this supports our expectation of sustainable Want’s higher ROE, operating margin and strong cash earnings growth over 2014-16. flow. The stock is trading currently at close to the middle of The share price has fallen (down 22% since the April its past-5-year PER trading range of 21-33x. We expect 2014 peak) due to concerns in the market about the a gradual rerating of the stock in 2H14 and 2015 if slowing revenue-growth momentum for 1H14E. We Tingyi can gain further share in the instant-noodle view the current share-price weakness as a good market, as this would result in the operating margin opportunity to accumulate the stock, as: 1) we expect returning to growth in this segment. Our 2015-16 EPS earnings growth to remain at 20% and 17% YoY for forecasts are 5-7% higher than those of the Bloomberg 2014-15E, respectively, driven mainly by an expansion consensus, because we expect Tingyi’s pricing power in in the operating margin, 2) we expect Want Want’s new noodles to improve faster than the market expects, products to gradually contribute to the top line for while our 2014 forecast is in line with that of the 2H14E, driving annual revenue growth by 5% YoY. Our consensus. 2014-16 EPS forecasts are 5-14% above those of the - 18 - China Packaged Food and Beverage Sector 25 June 2014

 Tingyi: 12-month forward PER bands  UPCH: 12-month forward PER bands (HKD) (HKD) 30 11 10 25 9 20 8 7 15 6 5 10 4 5 3 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 May-09 May-10 May-11 May-12 May-13 May-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 May-09 May-10 May-11 May-12 May-13 May-14 322.HK 17 21 25 29 33 220 HK 9 18 27 36 45

Source: Bloomberg Source: Bloomberg

UPCH

We initiate coverage of UPCH with a Hold (3) rating and 6-month target price of HKD5.60. Our target price is based on a target PER of 30x, which is at about a 30% premium to the average of the company’s 12- month forward PERs over the past 5 years (23.8x). The premium is in line with the average at which UPCH has traded in 2012, when it reported a 160% YoY increase in reported EPS. We believe UPCH has the potential to trade at similar premium again, given the significant improvement in EPS growth expected for 2015-16E.

Our premium reflects: 1) the removal of concerns among investors about equity fund raising and the strengthening of the company’s balance sheet following the recent share issuance (one rights share was issued at HKD4.56 for every 5 existing shares in early June), 2) the turnaround we expect in the noodle segment in 2015, and 3) the fact that UPCH’s PER has been relatively volatile in the past 5 years, with much higher multiples seen when operating and financial conditions have improved (for example, the rerating of the stock in 2012 and 1H13). We expect the company’s operating margin to return to the positive for 2015, at 0.2%, versus minus 3.3% for 2014. Our 6-month target price translates into PERs of 35x for 2014E and 26x for 2015E.

The UPCH stock is trading above the middle of its 12- month forward PER range over the past 5 years (10- 45x), which looks stretched to us. Our 2014-16 EPS forecasts are 24%, 17% and 1% lower than those of the Bloomberg consensus, respectively, because we expect low operating margins for the noodle segment. In order for the stock to be rerated, we believe UPCH would have to improve the economies of scale for both its beverage and noodle businesses, as well as manage the related execution risks.

- 19 - China Packaged Food and Beverage Sector 25 June 2014

the companies’ annual COGS. The depreciation costs of the beverage companies are usually higher than those of other packaged-food companies due to their higher initial fixed asset investment costs. However, the beverage companies usually have lower labour costs than the instant-food companies as they tend to have Key financials to more automated production processes. We believe the raw-material cost outlook for Want Want is more monitor stable than for UPCH and Tingyi, given Want Want’s more diversified raw-material cost structure, which Snack company Want Want’s operating makes its gross margin less sensitive to price fluctuations of one single commodity. margin and ROE are higher than those of the other packaged-food producers. SG&A expenses Want Want’s SG&A expenses are the lowest among the 3 companies we cover in the sector, thanks to: 1) its more effective control of sales personnel costs and Revenue more efficient use of distributors, and 2) its lower advertising and promotional expenses given the less We have found that revenue growth of the packaged- competitive landscape for its snack foods compared food companies has slowed gradually over the past 3 with the competitive environment for the instant- years as their overall revenue bases have expanded. We noodle and soft-drink markets. UPCH’s ratio of SG&A expect Want Want’s revenue growth over 2014-16 to be expenses to revenue is higher than Tingyi’s due to slightly faster than those of its China peers, as Want UPCH’s smaller production scale and revenue base. Want plans more new product launches and price hikes this year. We expect UPCH’s revenue growth to be the  China Packaged Food and Beverage Sector: breakdown of slowest of the 3 companies in our sector coverage due SG&A expenses as a percentage of revenue for 2014E (%) to its less diversified product mix and our expectation 35 of sluggish market-share gains. We expect Tingyi’s 30 3.9 revenue growth to be faster than UPCH’s over 2014-16, 25 on market share gains. 3.2 12.3 20  China Packaged Food and Beverage Sector: revenue growth 8.1 7.0 15 (YoY %) 4.5 4.3 40 10 4.8 35 35 31 5 4.0 9.6 11.5 30 3.5 26 0 25 Want Want Tingyi UPCH 19 18 17 A&P Logistics Others Administrative 20 16 14 14 15 15 14 15 Source: Daiwa forecasts 10 10 9 10 7 7 5 As a result, Want Want’s operating margin has been 5 higher than Tingy’s and UPCH’s over recent years (as 0 the next chart shows). We expect the operating margins 2011 2012 2013 2014E 2015E 2016E for the packaged-food companies to expand over 2014- Want Want Tingyi UPCH 16, on the back of new product launches and better Source: Company, Daiwa forecasts economies of scale. We forecast Tingyi’s operating margin to expand each year over 2014-16 (as the next chart shows), on the back of promotion cost reductions Operating margins at its noodles unit and efficiency improvements at its beverage unit. COGS Raw materials generally account for about 80-85% of Given UPCH’s smaller production scale and aggressive the annual COGS of the packaged food companies, on promotional strategy for its noodles business, its our estimates. Labour costs and utility costs generally operating margin has remained low and volatile over account for around 8-10% and 2-4%, respectively, of 2011-13.

- 20 - China Packaged Food and Beverage Sector 25 June 2014

 China Packaged Food and Beverage Sector: operating margins Cash flow and ROE 30% 24.9% 25.4% 23.1% 24.0% 25% 21.2% ROE trends

20% 17.7% Want Want’s ROE is the highest among the 3 major packaged food and beverage companies in China, 15% which we attribute to its elevated operating margin and 9.2% 8.1% 8.4% 8.6% 10% 6.7% 7.5% relatively lower fixed asset investment requirements for its production of snack foods. Though UPCH has a 5% 4.1% 3.7% 4.2% stretched balance sheet currently, we expect its ROE to 1.5% 2.0% 2.4% 0% remain the lowest among the 3 companies over 2014- 2011 2012 2013 2014E 2015E 2016E 16 (as has been the case since 2011), due to the poor Want Want Tingyi UPCH profitability of its noodle business. We believe Tingyi’s

Source: Company, Daiwa forecasts ROE of 14.5% for 2013 marked a trough level and forecast a gradual improvement to 17.3% for 2014 and Net profit growth and dividend payouts 20.1% for 2015, as we expect the Pepsi beverage unit in China (part-owned by Tingyi) to become profitable We expect Want Want’s net profit growth to remain (following the breakeven reached in 2013). steadier and more consistent than those of its peers since 2011 and we expect it to remain so over 2014-16.  China Packaged Food and Beverage Sector: ROE comparison UPCH’s net profit growth has been the most volatile since 2011, and we see this continuing out to 2016, due 45% 38.8% 38.7% 38.7% 39.0% 40% 37.6% to: 1) UPCH’s low operating margin in the range of just 34.5% 1.5-4.2% over 2011-16E, and 2) its rapid capacity 35% expansion, which has pushed up its interest expenses 30%

25% 21.4% 20.3% 20.1% We expect Tingyi’s net profit growth to accelerate over 19.8% 20% 17.3% 2014 and 2015 to 34% YoY and 31% YoY, respectively, 14.5% 15% 12.0%

from a decline of 14% YoY for 2013, as we project 7.6% 6.6%

10% 5.6% 5.2% continuous operating margin expansion on the back of 5.0% 5% promotion cost reductions at its noodles unit and 0% efficiency improvements at its beverage unit. 2011 2012 2013 2014E 2015E 2016E Want Want Tingyi UPCH

Tingyi and Want Want’s dividend-payout ratios have Source: Companies, Daiwa forecasts remained at above 50% annually for the past 5 years, while UPCH’s dividend payout has ranged from 20- Cash conversion cycles 30%, due to its heavy capex needs over the period. As about 90% of the packaged-food companies’

 China Packaged Food and Beverage Sector: reported net revenue is generated by their distributors, who are paid profit growth (YoY %) on a cash-on-delivery basis, the receivable days for 200 these packaged-food companies are generally very low (as can be seen in the following table). Want Want’s 150 inventory turnover days are higher than those of its 100 peers, as it has an inventory of imported milk powder that is equivalent to about 3 months. 50 0  China Packaged Food and Beverage Sector: cash conversion cycles (50) Want Want Tingyi UPCH (No. of days) 2013 2014E 2013 2014E 2013 2014E (100) Inventory days (a) 81 81 23 23 33 34 2011 2012 2013 2014E 2015E 2016E Receivable days (b) 16 15 8 8 8 8 Want Want Tingyi UPCH Payable days (c) 42 43 60 60 33 30 Source: Companies, Daiwa forecasts Cash conversion cycle (a+b-c) 55 52 -29 -29 8 12 Source: Companies, Daiwa forecasts

- 21 - China Packaged Food and Beverage Sector 25 June 2014

Changes in consumer preferences and greater awareness of health issues Changes in the public’s awareness of health issues and attitudes towards snack foods and soft drinks could affect adversely the demand for packaged food and Investment risks beverages. Companies can manage such risks by launching new products (such as sugar-free tea and non-oil fried noodles) to target health-conscious Food safety hazards, commodity price consumers. volatility and changing consumer preferences are the key risks to our Changes in regulations and price investment thesis. intervention Direct price interventions by the China Government Food safety – the main risk to our could put pressure on ASPs and subsequently on the revenue of the packaged food and beverage companies. investment case We believe the risk of this is greater for the instant- Food-safety hazards or negative talk in the market noodle players than for the other packaged-food about the companies’ products could have an adverse segments, as instant noodles are a basic food item and effect on their sales volumes, causing the latter to fall any price hikes could create more public concern than a below our current forecasts. For example, in October price increase for non-essential items such as snacks. 2008, the Slovakia Government said it found that the That said, given low inflation pressure that Daiwa’s level of melamine in Want Want’s products had economics team sees in the near term (it forecasts 2.5% exceeded the maximum standard set by the EU. YoY inflation for 2014), we see a very low risk of official However, Want Want has never exported to or price intervention at present. Note that the government marketed its Hot-kid milk beverage in Slovakia, and intervened on pricing in 2008 and 2011 (when inflation thus we are not sure if the product in question was an was high), so there is a potential risk of this occurring authentic Want Want product or was illegally exported. again if inflation is high in the future. The PRC Government has declared that Want Want’s products comply with China’s requirements. Similar  China CPI and food CPI (%) reports of food-safety issues, regardless of whether the 25 China packaged food and beverage companies are 20 responsible or not, could undermine their brand value and sales volumes. 15 10

Extreme weather changes 5 A cooler-than-expected summer could dampen 0 demand for bottled drinks. Heavy rainfall could curb outdoor activities, which in turn could lower demand (5) and thus consumption of bottled drinks and packaged Jul-08 Jul-13 Oct-09 Apr-07 Apr-12 Jan-06 Jun-06 Jan-11 Jun-11 Mar-10 Feb-08 Feb-13 Dec-08 Nov-06 Sep-07 Dec-13 Aug-10 Nov-11 Sep-12 May-09 food. May-14 Food CPI CPI Commodity prices Source: CEIC

As raw materials (including many types of agricultural products and packaging) account for over 80% of the COGS of the China packaged food and beverage companies in general, our profit-margin assumptions for the companies that we cover factor in commodity- price risks. Many of the raw materials they use, such as juice concentrates and palm oil, are imported into China, and hence the companies are exposed to fluctuations in the global supply of these commodities.

- 22 -

Consumer Staples / China 151 HK Consumer Staples / China 25 June 2014

Want Want China

Want Want China Target (HKD): 13.00 Upside: 27.2% 151 HK 23 Jun price (HKD): 10.22

Initiation: good entry point now 1 Buy (initiation) • We forecast a 21% YoY revenue rebound for 2H14 (vs. +9% YoY 2 Outperform for 1H14E) on new products and beverage growth recovery 3 Hold • Operating margin should expand in 2014-16 on declining milk 4 Underperform powder cost, new product launches and beverage price hikes 5 Sell • Post recent correction, 2015E PER looks attractive at 27% discount to past-5-year mean; top sector pick, initiate with Buy

How do we justify our view?

differentiated snacks and beverages growth since its 2008 IPO and we where it enjoys first-mover expect it to sustain for 2014-16, 2) advantages should enable it to higher-than-peers 2014E ROE and maintain a higher 24% operating operating margin, and 3) the expected margin for 2014E, vs. 14% on average high dividend payout. Anson Chan for its China packaged F&B peers. ■ Risks (852) 2532 4350 Along with a falling milk powder cost We see key risks as food-safety issues, [email protected] and price hikes, we forecast operating and selling and production cost rises. margin expansion of 0.9pp YoY for Alison Law, CFA both 2014-15 (24.9% for 2015E), and (852) 2532 4308 to 25.4% for 2016. [email protected] Share price performance

How we are different. Our 2014- (HKD) (%) ■ Investment case 16E EPS are 5-14% above the 13.5 115 We initiate coverage on Want Want 12.6 108 Bloomberg consensus as we are more 11.8 100

China (Want Want) with a Buy (1) optimistic on operating margins. We 10.9 93 rating. Want Want is the top pick in believe Want Want’s past-2-month 10.0 85 our China Packaged Food and share-price weakness on concerns of a Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Beverages universe, and we see a good revenue slowdown in 1H14E is Want Want (LHS) Relative to HSI (RHS) entry point post its 22% share-price overdone, as we expect 2014 earnings correction from its all-time peak in to be driven by margin expansion 12-month range 10.04-13.06 April 2014. It trades at an 17.9x 2015E rather than revenue growth. Market cap (USDbn) 17.42 PER, at a 27% discount to its past-5- 3m avg daily turnover (USDm) 21.63 year average 12-month forward PER, ■ Catalysts Shares outstanding (m) 13,212 Major shareholder Eng-meng Tsai (48.0%) and we expect a re-rating in the Along with operating margin drivers, coming months, driven by a sales we see share-price catalysts from a Financial summary (USD) growth recovery from 2H14 and further successful diversification of its Year to 31 Dec 14E 15E 16E operating margin expansion. revenue base with new products and Revenue (m) 4,425 5,078 5,782 continuous share buybacks. Operating profit (m) 1,061 1,265 1,469 Pricing power supported by Net profit (m) 820 972 1,133 brand strength. We forecast its ■ Valuation Core EPS (fully-diluted) 0.062 0.074 0.086 EPS change (%) 19.7 18.5 16.5 beverage ASP to rise by 5% YoY for Our 6-month target price of HKD13 is Daiwa vs Cons. EPS (%) 5.2 8.2 14.3 2014, and expect price rises and new based on our average 2014-15E EPS PER (x) 21.2 17.9 15.4 product launches this year to drive a and a 24.6x PER (past-5-year Dividend yield (%) 3.1 4.5 5.2 15% revenue CAGR for 2013-16. average). Our target PER is at a DPS 0.041 0.059 0.069 PBR (x) 7.6 6.4 5.6 premium to China peers’ current EV/EBITDA (x) 14.0 11.5 9.8 Further margin expansion. 2015E average (20.7x), given Want ROE (%) 38.7 38.7 39.0

Want Want’s focus on niche and Want’s: 1) double-digit YoY EPS Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 72 China Packaged Food and Beverage Sector 25 June 2014

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Want Want: net profit and net profit growth Want Want looks well positioned to tap further into 1,200 35% what we regard as strong long-term growth potential for 30% the China snacks and beverage market, by leveraging on 1,000 33% 25% its strong brand and extensive distribution network 800 built up over more than 20 years. Per capita 25% 20% 600 consumption of snacks in China is still low compared 20% 15% 17% 19% with the global average (below 30 grams per year, 1% of 400 17% the level in Japan in 2011, according to data from 10% Calbee, suggesting substantial further sales-growth 200 5% potential for Want Want’s wide range of snacks and 0 0% beverages. We forecast robust EPS growth of 20% YoY 2011 2012 2013 2014E 2015E 2016E for 2014, 19% YoY for 2015 and 17% YoY for 2016, with Net profit YoY a 15% revenue CAGR for 2013-16E. Source: Company, Daiwa forecasts

 Valuation  Want Want: 12-month forward PER bands

The Want Want stock has been re-rated since its IPO in (x) Hong Kong on 2008, reflecting its track record of 14 consistent profit growth. Based on our EPS forecast, it 12 now trades at a 2015E PER of 17.9x, at a 27% discount 10 to its past-5-year average, which we consider 8 undemanding given our 2013-16E EPS CAGR of 18%. 6 We believe Want Want deserves to trade at a premium 4 to its China peers’ average trading 2015E PER of 20.3x, 2 given its high payout ratio (above 65% for 2014E on our Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Aug-09 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 forecast) and elevated ROE (2014E: 39% vs. 14% on May-09 May-10 May-11 May-12 May-13 May-14 average for its China peers). Continuous good execution 151.HK 14x 18x of new product developments, revenue diversification, 22x 26x 30x network expansion and cost control would also drive a Source: Bloomberg re-rating, in our view.

 Earnings revisions  Want Want: consensus EPS forecast revisions (2014-15E)

Since 3Q13, the Bloomberg consensus 2014-15 EPS (USD) forecasts for Want Want have been generally steady, on 0.08 caution about the company’s new product launches. Our 0.08 2014-16 EPS forecasts are 5-14% above the consensus 0.07 ones, due to our higher operating margin assumptions. Thanks to its diversified raw-material cost structure, 0.07 Want Want’s gross margin and thus earnings are less 0.06 volatile vs. its China packaged food and beverage peers 0.06 to raw-material cost rises. Our sensitivity analysis 0.05 detailed in the Financial analysis section further on Jul-13 Apr-13 Oct-13 Jan-13 Jun-13 Jan-14 Feb-13 Mar-13 Feb-14 Mar-14 Aug-13 Sep-13 Nov-13 Dec-13 indicates a limited impact on our current 2014E EPS May-13 from potential rises in raw-material unit costs. 2014E 2015E Source: Bloomberg

- 24 - China Packaged Food and Beverage Sector 25 June 2014

Financial summary

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales growth YoY - rice crackers (16.6) 34.3 30.0 (0.6) 12.0 11.3 11.8 9.1 Sales growth YoY - beverages 48.8 33.8 30.6 22.6 17.0 20.7 15.7 16.2 Sales growth YoY - snacks (2.7) 22.0 36.1 14.8 8.4 10.1 15.7 13.1 Gross margin % - rice crackers 44.1 40.8 37.6 39.0 40.8 41.9 42.4 42.7 Gross margin % - beverages 36.0 34.6 33.4 39.5 41.3 42.9 43.9 44.1 Gross margin % - snacks 45.5 40.7 34.5 40.4 43.0 42.8 42.2 42.0

 Profit and loss (USDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Rice crackers 468 629 817 812 910 1,013 1,132 1,235 Beverages 798 1,067 1,394 1,709 1,999 2,412 2,791 3,241 Other Revenue 445 548 736 838 909 1,000 1,155 1,306 Total Revenue 1,711 2,244 2,947 3,359 3,818 4,425 5,078 5,782 Other income 40 41 61 46 78 73 75 76 COGS (1,019) (1,400) (1,922) (2,031) (2,232) (2,537) (2,884) (3,277) SG&A (376) (447) (564) (664) (781) (900) (1,003) (1,112) Other op.expenses 0 0 0 0 0 0 0 (3) Operating profit 356 439 522 711 883 1,061 1,265 1,469 Net-interest inc./(exp.) 4 4 16 38 49 65 67 83 Assoc/forex/extraord./others (7) (6) (5) (3) (1) (0) 1 2 Pre-tax profit 353 437 533 745 931 1,126 1,333 1,553 Tax (47) (84) (119) (195) (247) (304) (360) (419) Min. int./pref. div./others 1 0 0 0 (1) (1) (1) (1) Net profit (reported) 307 353 415 550 683 820 972 1,133 Net profit (adjusted) 307 353 415 550 686 820 972 1,133 EPS (reported)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086 EPS (adjusted)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086 EPS (adjusted fully-diluted)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086 DPS (USD) 0.021 0.023 0.020 0.029 0.035 0.041 0.059 0.069 EBIT 356 439 522 711 883 1,061 1,265 1,469 EBITDA 407 500 596 798 988 1,184 1,407 1,626

 Cash flow (USDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 353 437 533 745 931 1,126 1,333 1,553 Depreciation and amortisation 51 61 74 88 105 124 141 154 Tax paid (40) (72) (82) (186) (222) (304) (360) (419) Change in working capital 249 (16) 54 (14) 191 56 50 58 Other operational CF items (11) (10) (21) (42) (53) (69) (70) (84) Cash flow from operations 602 400 558 590 952 932 1,094 1,261 Capex (127) (171) (224) (243) (273) (458) (250) (250) Net (acquisitions)/disposals 0 0 0 0 0 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (127) (171) (224) (243) (273) (458) (250) (250) Change in debt 190 287 381 (22) 255 0 0 0 Net share issues/(repurchases) (7) (14) (5) (4) (8) (17) (1) 0 Dividends paid (260) (317) (259) (299) (419) (478) (617) (822) Other financing CF items (11) (20) 36 (29) (20) (0) 63 24 Cash flow from financing (88) (63) 153 (353) (192) (496) (555) (798) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 388 166 487 (7) 486 (22) 289 213 Free cash flow 476 229 335 347 679 474 844 1,011 Source: FactSet, Daiwa forecasts

- 25 - China Packaged Food and Beverage Sector 25 June 2014

Financial summary continued …

 Balance sheet (USDm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 706 906 1,437 1,499 2,060 2,127 2,504 2,817 Inventory 223 339 410 461 534 591 672 763 Accounts receivable 73 101 160 166 164 191 219 249 Other current assets 74 107 96 142 152 152 152 152 Total current assets 1,076 1,454 2,103 2,268 2,911 3,061 3,547 3,982 Fixed assets 624 758 891 1,046 1,236 1,573 1,685 1,784 Goodwill & intangibles 1 1 1 11111 Other non-current assets 58 77 128 146 201 201 201 201 Total assets 1,758 2,290 3,123 3,461 4,348 4,836 5,434 5,968 Short-term debt 217 294 775 350 410 410 410 410 Accounts payable 109 184 211 231 281 320 364 413 Other current liabilities 300 386 531 599 823 924 1,039 1,168 Total current liabilities 625 864 1,517 1,181 1,515 1,654 1,813 1,992 Long-term debt 140 350 250 653 847 847 847 847 Other non-current liabilities 0 0 24 24 34 34 34 34 Total liabilities 765 1,214 1,791 1,858 2,396 2,535 2,694 2,873 Share capital 264 264 264 265 265 265 265 265 Reserves/R.E./others 724 809 1,065 1,331 1,679 2,028 2,467 2,821 Shareholders' equity 988 1,073 1,330 1,595 1,943 2,292 2,731 3,086 Minority interests 53389999 Total equity & liabilities 1,758 2,290 3,123 3,461 4,348 4,836 5,434 5,968 EV 17,074 17,158 17,008 16,927 16,618 16,550 16,173 15,860 Net debt/(cash) (349) (262) (413) (496) (802) (870) (1,247) (1,560) BVPS (USD) 0.075 0.081 0.101 0.121 0.147 0.173 0.207 0.234

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 10.1 31.2 31.3 14.0 13.7 15.9 14.8 13.9 EBITDA (YoY) 15.8 22.7 19.3 33.9 23.8 19.8 18.8 15.6 Operating profit (YoY) 16.1 23.4 19.0 36.0 24.3 20.1 19.3 16.1 Net profit (YoY) 20.1 15.1 17.4 32.7 24.7 19.6 18.5 16.5 Core EPS (fully-diluted) (YoY) 19.4 15.1 17.4 32.5 24.6 19.7 18.5 16.5 Gross-profit margin 40.5 37.6 34.8 39.5 41.5 42.7 43.2 43.3 EBITDA margin 23.8 22.3 20.2 23.8 25.9 26.8 27.7 28.1 Operating-profit margin 20.8 19.6 17.7 21.2 23.1 24.0 24.9 25.4 Net profit margin 17.9 15.7 14.1 16.4 18.0 18.5 19.1 19.6 ROAE 32.0 34.3 34.5 37.6 38.8 38.7 38.7 39.0 ROAA 19.3 17.4 15.3 16.7 17.6 17.9 18.9 19.9 ROCE 29.0 28.6 25.6 28.6 30.4 31.3 33.5 35.2 ROIC 42.2 48.6 46.9 51.8 57.5 59.9 63.1 70.8 Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cash Effective tax rate 13.3 19.2 22.3 26.2 26.5 27.0 27.0 27.0 Accounts receivable (days) 18.3 14.2 16.2 17.7 15.8 14.6 14.7 14.8 Current ratio (x) 1.7 1.7 1.4 1.9 1.9 1.9 2.0 2.0 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 90.4 84.6 62.4 68.7 67.4 65.3 80.2 80.1 Free cash flow yield 2.7 1.3 1.9 2.0 3.9 2.7 4.8 5.8 Source: FactSet, Daiwa forecasts

 Company profile Want Want China is the leading producer of rice crackers and flavoured milk drinks in China, with market shares of about 70% and 40%, respectively, in terms of revenue for 2013, based on our estimates. The company also makes dairy products and savoury and sweet snack foods.

- 26 - China Packaged Food and Beverage Sector 25 June 2014

We forecast Want Want to generate total revenue growth of 16% YoY for 2014, of which 12% would be from existing products and 4-5% from new products. We forecast total revenue growth of 15% YoY for 2015 and 14% YoY for 2016, supported by the company’s programme of new product launches for this year that Further diversifying we detail further on. and differentiating its  Want Want: revenue and revenue growth

(USDm) (YoY) product mix 8,000 40%

6,000 30% Want Want’s focus on niche products and 31.2% 31.3% differentiation should underpin high 4,000 20% 2,000 15.9% 10% operating margins and robust revenue 14.0% 13.7% 14.8% 13.9% growth for 2014-16 and beyond. 0 0% 2010 2011 2012 2013 2014E 2015E 2016E Want Want has a diversified mix of packaged food and Rice crackers Dairy products and beverages Snack foods Others beverage products, with more than 400 stock-keeping YoY (RHS) units (SKU) currently, which reduces its reliance on a Source: Company, Daiwa forecasts single product. We expect the company to maintain a balanced revenue split between its beverages and food We believe the market’s concerns about a likely items over the coming years. For 2014, we forecast rice slowdown in Want Want’s revenue growth for 1H14 crackers and other snack foods to account for 23% and due to unfavourable macro headwinds in China (eg, 22%, respectively, of its total revenue, and beverages to slower consumer spending growth) have been represent 55%. Within beverages, we forecast the overdone. We forecast revenue growth of 9% YoY for company’s Hot-kid milk (its flavoured milk products) 1H14 but a strong rebound of 21% YoY for 2H14. to account for 80% of its beverage revenue this year. The key reasons for sluggish 1H14E top-line growth are  Want Want: revenue breakdown by product category (2014E) as follows: 1) most of the orders related to this year’s Others Lunar New Year (eg. gift packs) took place in 4Q13 Snack 0.2% foods Rice crackers (rather than in 1Q14) due to the early Lunar New Year 22.4% 22.9% (January), and 2) price hikes put through by the company in its beverage segment in 4Q13 and 1Q14 prompted distributors to stock up on its dairy beverages, thereby contributing to slower sales to its distributors. We expect Want Want’s organic revenue growth for 1H14 to be driven by its product price increases. Also, most of the company’s new product Dairy products launches planned this year (which we detail further on and beverages in this report) will take place in 2Q14 and 3Q14, and 54.5% hence should drive revenue growth acceleration in Source: Daiwa forecasts 2H14 and also 2015.

Should generate steady revenue growth amid a tough macro climate Diversified product mix to tap Want Want’s management targets organic (ie, snack and instant food markets excluding new product launches) revenue growth by segment for 2014 as follows: 1) a high-single digit We describe Want Want’s major product categories percentage YoY increase for rice crackers, 2) high-teen and its key development strategies for these categories percentage YoY growth for beverages, and 3) low-teen in the following table. Since the company was percentage YoY growth for snacks. In addition, established in China in the early 1980s, its management expects new products to account for management has developed several product- about 5% of the company’s total revenue for 2014. development strategies that have proved effective at

- 27 - China Packaged Food and Beverage Sector 25 June 2014

differentiating the company from its domestic competitors. These have enabled Want Want to develop strong brand power and generate high operating margins, and we expect it to enable Want Want to continue to enjoy these advantages over the coming years, backed by its product strategies that we discuss below.

 Want Want’s current product portfolio Product categories Product details Target customer groups Current position Strategy and latest developments Rice crackers Core brand- Want Want Sweet, savoury, spicy, seaweed flavours, available Mid-to-high-end consumers Market leader with New flavours and packaging (旺旺) in various packages about a 70% market share Gift packs (大禮包) Selection of Want Want branded products (mainly Festival gifts Brand enhancement More promotions and new festival themes, eg, for China’s mid- rice crackers) in appealing packaging and strong sales autumn festival during festivals Sub-brands – Mitailong Lower-priced than its core-brands Low-end market 3% of 2013 segmental Raised prices in 2013 to improve profit margins and gain (米太郎), Yappy (黑皮) sales market share in mid-tier markets Dairy products and beverages Hot-Kid milk (旺仔奶) Dairy products of various flavours. They contain Children and their parents Market leader with More promotions among school children and adults (Flavoured milk) docosahexenoic acid (DHA), which is widely about a 40% market believed to support healthy brain development. share Others Coffee, yoghurt drinks, herbal tea and other non- Children, teenagers and About 10% of its total Developing new products (eg, functional drinks) and flavours carbonated drinks adults 2013 beverage sales (eg, banana-flavoured milk); JVs with firms offering specific expertise (eg, Natori Co., Ltd and Marubeni Corporation) to strengthen its research and development capability Snack foods Candies Gummy sweets and milk candies Children and adults One of the leading Cross-promotions with its beverages; launches of new flavours brands in soft candy Popsicles and jellies Fruit-flavoured iced-bars; jellies Children and adults Fourth-largest jelly New flavours and packages such as 'Rock n Roll' series, cup brand in China jellies, liquid-fruit jellies Ball cakes Snacks made from potato starch, eggs and honey; Children Launches of new products and flavours milk- and sweet-flavoured Beans & nuts; biscuits Selected beans and nuts, produced in cooperation Children and adults Launches of new products and flavours with Kobayashi's technology Other products Instant food: Rice noodles, oatmeal, etc. New customers Launches during 2014 Targeting health-conscious consumers Plum wine, sake, distilled liquor Export markets Less than 1% of sales Source: Company, compiled by Daiwa

Capturing a first-mover advantage. Want Want capacity 10-fold this year in order to handle the strong seeks to avoid head-on competition with its peers by growth in demand. developing new products that do not have a major presence in China. This has given the company a  Want Want’s soft-packaging for its yoghurt drinks significant first-mover advantage for many of its products (its dairy beverages and its new “sip-and- slurp” yoghurts). Thanks to its well-established brand, Want Want is able to defend its market share in the face of price wars by late-comers. According to AC Nielsen, Want Want had domestic market shares of about 70%, 40% and 29% in rice crackers, flavoured dairy beverages and soft candies, respectively, based on revenue for 2013.

Eye-catching product packaging. Want Want aims to attract consumers’ attention with new visually Source: Company appealing package designs for products that are not Thematic product developments. These include new consumers. For example, Want Want was among gift packs targeting sales during festival periods, such the first few beverage players in China to use soft as the Lunar New Year, which accounts for over 40% of packaging, with its launches of fruit juices in soft packs Want Want’s annual sales of rice crackers, based on in 2009. It then introduced room-temperature our estimates. The company’s gift packs contain rice yoghurts in soft packs in 2012 and received a very good crackers, candies or its other snack foods and are response from the market for both the above soft pack available in different sizes and packaging. Want Want launches. It plans to expand its soft-pack production has been able to so far, and in our view should continue - 28 - China Packaged Food and Beverage Sector 25 June 2014

to easily increase its gift pack ASPs and attract new different flavours from others (eg, Thai-style genmai- customers each year by adjusting the content and flavoured milk tea). Also, we note that many of its new adding its latest products to the packs to promote the products are priced at a premium to competitors’ new products. products in the same category, signalling to us that Want Want seeks to continue to avoid price In addition, during 1Q14 Want Want launched other competition and preserve profitability. thematic and festival products, such as soft candies in large packs (for banquet gifts) and gift boxes of yoghurt  Want Want’s new beverage product line-up for 2014 drinks. Proposed retail Beverage Differentiating features vs. competitors price Milk tea Thai-style milk tea with a genmai taste CNY4.5/450ml PET  Want Want’s gift pack products bottle Nectar Mixed fruit juices and vegetable juices targeting CNY4.5/250ml PET children and health-conscious consumers bottle O-bubble drinks in Launching these products (previously only available CNY4.5/450ml PET PET bottles in tetrapaks) in PET bottles to attract new consumers bottle Room-temperature Produced from imported milk powder and special CNY54/16x132g yoghurts lactobacillus bacteria tetrapack Sports drinks Contain L-carnitine additives to speed up weight CNY4.5/750ml PET reduction bottle "Sip and slurp" fruit Sorbet if chilled and juice drink if served at room About CNY2.1/60ml juices temperature soft pack Source: Company

 Want Want’s new product line-up of snack foods and instant foods for 2014 Product Differentiating features vs. competitors Proposed retail price Q - Rice noodles Target health-conscious consumers CNY7/bowl (106-118g) Source: Want Want "Sip and slurp" Ice-cream if chilled and yogurt drink if served at CNY2.5/80ml soft pack yoghurts room temperature Oatmeal New flavours such as chocolate, available in CNY2/35g pack bowl and cup containers 2014: an active year for new New packages for For banquets and gift purposes CNY45/300g box product launches candies Rice crackers New flavours such as cinnamon and cheese n.a. Baby rice crackers Snacks for babies aged above 6 months CNY20/50g Want Want plans to launch more than 50-70 new SKUs Small-pack mini-rice Convenience packs targeting children CNY1.8/27g crackers in 10 product categories during 2014, which is Source: Company considerably more than its track record of about 20 new SKU launches a year in 10 product categories on  Examples of Want Want’s new beverage products for 2014: average over the past 5 years. Management targets the PET-bottled O-bubble, room-temperature yoghurt, sports drink company’s new products to account for about 5% of Want Want’s total revenue for 2014, compared to 1-2% a year for the past few years.

Management believes the company’s new product launches in 2014 will have an even better success rate compared to past years, as the company has carried out detailed research and upgrades to quality ahead of official launches. Some of the products are developments of its existing and most popular Source: Company products, such as new rice cracker flavours.  Examples of Want Want’s new snack food products for 2014: baby snacks, small rice crackers, new flavoured rice crackers We are confident in Want Want’s ability to launch and promote such new products, given its good track record on this front over recent years and ongoing product differentiation from those of its competitors. The next 2 tables that detail the company’s new product line-up for this year show that Want Want maintains a focus on differentiating its new products from those of competitors – either these products have no close substitute in the market at present (eg, its “sip and slurp” fruit juices and yoghurts), or they offer very Source: Company

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Strong track record of pricing power Over recent years, Want Want has consistently been able to raise its prices during periods when raw- material costs have increased. In the following table we show the company’s ex-factory price increases Strong brand and thus implemented since 2009, based on data from the company’s annual reports and our estimates. By virtue strong pricing power of its ability to raise prices, the company’s gross margin has ranged from 38-41% over the past 10 years (except in 2011), a higher level compared to most food and We believe Want Want will maintain its beverage players listed in Hong Kong. strong pricing power, supported by its  Want Want: YoY price hikes in its segments and raw-material high brand recognition, good execution cost trends (2009-1Q14) record for product launches, cost control, Snack General raw-material cost trend in the Rice crackers Beverages foods year (YoY ) and well-established sales network. 2009 Up 11% n.a. n.a. Packaging, milk powder, sugar, rice: up 5-6%, 10%, 2.5% and 20%, respectively 2010 Up 1% and 9% Up 1-2% on n.a. Packaging, milk powder, sugar, rice: flat, for core brand average up 7%, 45% and 19%, respectively Strong pricing power supported and gift packs, respectively by brand and product mix 2011 2H11: up 8% Up 4% on Up 11% in Packaging, milk powder, sugar, rice: up average aggregate 7-8%, 10%, 35% and 15%, respectively 2012 Up a mid-single- Up 7% Up 10% Packaging, milk powder, sugar, rice: A brand that is easy to remember and digit percentage -3%, -3%, -10% and flat, respectively recognise 2013 Rises for non- Oct: up 8% None Milk powder cost up 50% YoY core brands More than 20 years on from Want Want’s 2014 n.a. 1Q14: up None establishment in China, both its core brand, Want 3% Want (“旺旺”) and its Hot-Kid flavoured milk drink Source: Company, Daiwa estimates for cost changes logo have become very popular with Chinese consumers. Want Want means prosperity and good We expect the company’s price increases in beverages fortune in Chinese. This auspicious association means put through in 4Q13 and 1Q14, along with new product Want Want’s products are easily remembered by launches, and declining costs for some of its some raw customers, and make them popular gift items for adults materials, to bring about further gross margin and children. This branding also helps to boost the expansion to 42.7% for 2014, 43.2% for 2015 and company’s sales during traditional Chinese festivals 43.3% for 2016, compared with 41.5% recorded for such as the Lunar New Year. 2013.

 Want Want: gross margin trend by product Children are an important customer group for Want 45 Want, which targets many of its products and tastes, 43.3 such as sweet milk beverages, candies etc., to the 43.2 children’s market. 42.7 40 41.5  Want Want's brand portfolio (selected sub-brands) and Hot- 39.5 Kid logo 35 34.8

30 2011 2012 2013 2014E 2015E 2016E Rice crackers Beverage Snacks Average

Source: Company Source: Company, Daiwa forecasts

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Building and maintaining close and direct relationships Good cost control and with its distributors and key retailers is important for penetration of retail channels Want Want to compete effectively in order to secure shelf space and better product displays at the POS, in Our research shows that Want Want spends less than particular for traditional retail channels, which account its China packaged food and beverage peers on direct for 85-90% of its total revenue. Many traditional advertising and on-site promotions. Based on our channel POS are standalone stores or small-scale chain estimates, Want Want spends 3-4% of its annual stores run by individuals. In our view, they welcome advertising and promotional (A&P), compared to more the support and advice they receive from a large than 6% on average for its peers. We believe this can be supplier like Want Want, on how and what to promote attributed to the company’s efficient cost control. As a in their stores in order to enhance their revenue. result, Want Want has generated a higher operating margin annually (above 20%) compared with its major  Want Want: Paradise and product stacks at a POS peers (3-15%) since 2011, and we expect its operating margin to remain above those of its peers for 2014-16, as the next chart shows. Also, our research indicates that Want Want generally has better control over distributors in terms of price control, inventory management and new product promotions.

Want Want vs. other major China F&B players: operating margin comparison 30% 24.9% 25.4% 24.0% 25% 23.1% 21.2%

20% 17.7%

15% 9.2% 8.6% 8.4% 8.1%

10% 7.5% 6.7% 4.2% 4.1% 3.7%

5% 2.4% 2.0% 1.5%

0% Source: Company 2011 2012 2013 2014E 2015E 2016E Tingyi UPCH Want Want

Source: Companies, Daiwa forecasts Note: Tingyi = Tingyi Cayman Islands, UPCH = Uni-President China

Want Want has continued to improve its distribution network since its establishment in the early 1990s, notably through the following: 1) enhancing its services and connections with points of sale (POS), such as stepping up the frequency of visits by its sales personnel to retail channels, and 2) expanding its penetration into rural areas. Like most large food and beverage brands, Want Want depends on distributors to sell its products and get a national presence. At the same time, it continues to improve its penetration and network management; the subsequent table shows the history and statistics associated with Want Want’s distribution network.

The company’s 13,000 sales representatives (2012 data) frequently visit retailers served by the distributors, taking orders and promoting new products to the retailers directly. The distributors manage inventory levels and provide logistics services.

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 Development history of Want Want’s distribution network Increased A&P spending for modern retail Direct- Product channels not a major concern to us Year Achievements delivery display at POS POS Want Want believes its extensive product portfolio can Jun Dec help it to penetrate the modern retail channels (eg,

2007 The "Delivering Want Want to villages" programme kicked off hypermarkets, supermarkets and convenience stores) more quickly. Currently, its ice cracker product Obtained direct control of 1m+ POS through the "Delivering 2008 depends more on modern channels (20% of revenue) Want Want to villages" programme than other segments. Retailers in the modern channels 2009 SAP system installed fully in sales and production systems n.a. n.a. n.a. usually incur higher A&P and channel expenses, such Consolidation of distribution channels in first-tier and second- as product display fees, entry fees for new products, tier cities to clear up overlap issues and price competition

among distributors etc. However, we expect Want Want’s A&P budget to be Number of county-level cities covered by "Delivering Want contained at its past-9-year range of 3-4% of revenue, Want to villages" programme reaches 1,500+ by: 1) re-allocating some of its A&P budget from existing to new products and from traditional retail Use of "Want Want Paradise”, "National Pillar Display" and other eye-catching marketing decorations and product stacks channels to modern ones, and 2) absorbing the extra 2010 300 in large POS. Different seasonal themes used throughout the costs through enhanced operating leverage. year to promote products

Expansion of direct deliveries to county-level POS and urban Since 2012, management has aimed to boost sales per 2011 POS POS, rather than just increase the number of POS, Set-up of on-site promotion counters 400 ~50 through more advertising, product stacks and well- Enhanced product portfolio and sales force to ensure products at POS occupy eye-catching shelf space in stores planned promotional activities at the POS. This should

across the nation throughout the year help Want Want control fixed costs (sales personnel) and enhance efficiency. Upgrades done for distributors by setting up several 2012 standards for quality verification 600 71 158 Built an direct-sales initiatives in treating small and medium Leverage on existing facilities for new POS products

The sales network was sub-divided into over 2,800 sales Want Want aims to generate a high gross margin (more regions (mainly county-level cities with populations of over than 40%) on its new products. Though the company 500k each). Aside from promoting existing strong products, 2013 such as rice crackers and Hot-kid Milk, sales start to focus on already has over 350 SKUs in hand, it still has improving the sales performance of less popular products considerable room for new product development by, (eg, snacks) and new products (eg, the banana beverage). for example, adding new flavours to existing categories Detailed sales information analysis and sales representative team support are given at each sales region. Want Want (eg, rice crackers or beverages) or launching completely encourages distributors to develop more sub-distributors to new items. Making use of its existing facilities and its enhance its presence in retail channels. SKUs were sub-divided into 10 categories (from 3 previously) production units designed and constructed in-house to for more detailed management of each category. develop new products should enable Want Want to Above changes focus on currently weak items (in terms of maintain both an elevated net margin and ROE over sales), such as selected snacks and pocket drinks A Sales Force Assessment System (SFA) was set up to 2014-16, as has been the case in past years, in our view provide more efficient, high-frequency services to distributors (demonstrated in the following chart). and to provide timely information. All sales personnel were equipped with hand-held devices to deliver timely information  Want Want: trend in ROE and net margin (%) and for promotions of products to obtain better shelf space at POS. 45% 25% 38.8% 38.7% 38.7% 39.0% 40% 37.6% Source: Company, compiled by Daiwa 34.3% 34.5% 35% 32.0% 20% 30% 15% 25% 20% 10% 15% 10% 5% 5% 0% 0% 2009 2010 2011 2012 2013 2014E 2015E 2016E ROE (LHS) Net margin (RHS)

Source: Company, Daiwa forecasts

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 Want Want: breakdown of cost of goods sold

Employee Utility Others 3.2% 3.6% expenses Packaging 9.7% 25.6% Depreciation 3.0%

Financial analysis Other raw materials (starch, flour We forecast net profit growth of 20% YoY etc) 16.6% Milk powder for 2014, 19% YoY for 2015 and 17% YoY Palm oil 17.2% 1.6% Rice for 2016, to USD820m, USD972m and Sugar 4.3% USD1.13bn, respectively. 15.3% Source: Daiwa estimates

We forecast Want Want to generate robust net profit Costs of most of the company’s raw materials have growth of 20% YoY for 2014, 19% YoY for 2015 and been steady or on a slight downward trend since the 17% YoY for 2016, driven mainly by: 1) revenue growth beginning 2013, except for milk powder. As a result of of 16% YoY for 2013, 15% YoY for 2014 and 14% for the raw milk supply shortage in China and short-term 2015, and 2) operating margin expansion of supply disruption in New Zealand, international milk 0.9pp/0.9pp YoY for 2014 and 2015, respectively, powder prices rose by more than 48% YoY in 2013, thanks to higher gross margins supported by new according to data from New Zealand’s Fonterra (FCG products in all its segments, and by price increases in NZ, unrated). As Want Want usually keeps 6 months of its beverage segment. milk powder inventory (including those in shipment),

 Want Want: reported net profit and YoY growth (USDm) and due to its effective use of low-cost inventory and 1,200 35% practice of making bulk purchases during periods when the milk powder price is low, we estimate that the unit 1,000 33% 30% cost increase for Want Want was 5% YoY in 2013, and 25% 800 look for a further 10-15% rise in 1H14, before a fall 25% 20% starting from 2H14. 600 20% 15% 17% 19% In particular, Want Want already raised the ASP of its 400 17% 10% dairy beverages by 8% in 4Q13, and by a further 3% in 200 5% 1Q14. We believe these increases are more than enough to offset a likely sharp rise in costs, as our sensitivity 0 0% 2011 2012 2013 2014E 2015E 2016E analysis that follows shows that a 1% ASP increase Net profit YoY could enhance the company’s 2014E net profit by about Source: Company, Daiwa forecasts 2% relative to our current forecast.

Diversified cost structure Our sensitivity analysis also indicates limited earnings sensitivity to fluctuations in raw material prices. It Due to the numerous types of products and packaging indicates that a 1% rise in the unit costs of milk it produces, Want Want uses more than 10 kinds of powder, sugar and packaging would only reduce Want major raw materials. Except for packaging and milk Want’s 2014E net profit by 0.5%, 0.1% and 0.7%, powder, no one raw material accounts for more than respectively, relative to our current forecasts. A 1% rise 20% of its COGS; hence fluctuations in individual in the ASP of its rice crackers, beverages and snack commodity prices only have a mild impact on its foods would imply respective 2014E net profit uplifts of earnings. 0.9%, 1.9% and 0.8% relative to our current forecasts.

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 Want Want: Daiwa sensitivity analysis of gross margin and net  Want Want: operating margin and selling costs/revenue ratio profit to ASP increases 12.6% 30% Gross margin (%) Net profit (USDm) 24.9% 25.4% 12.4% 23.1% 24.0% 2014E 2015E 2014E 2015E 25% 12.2% 21.2% Base case 42.7 43.2 823 974 19.6% 12.0% 17.7% 20% 11.8% Impact +/- pp +/- % 1% increase in ASP for: 2014E 2015E 2014E 2015E 11.6% 15% Packaging -0.16 -0.16 (0.68) (0.66) 11.4% 10% Milk powder -0.11 -0.11 (0.46) (0.48) 11.2% Sugar (0.11) (0.10) -0.07 -0.07 11.0% 5% Rice -0.03 -0.03 (0.30) (0.28) 10.8% ASP hike 10.6% 0% Rice crackers 0.14 0.13 0.89 0.83 2010 2011 2012 2013 2014E 2015E 2016E Beverages 0.32 0.33 1.89 1.94 S&D ratio (LHS) Operating margin (RHS) Snack foods 0.12 0.12 0.80 0.76 Source: Company, Daiwa forecasts Source: Daiwa estimates

We believe declining imported milk powder costs will Want Want’s cash-generating capability is strong due lift Want Want’s gross margin from 2H14 onwards. As to its high operating margin and ROE. As such, we shown below, global whole-milk powder prices forecast operating cash flow of USD932m for 2014, dropped by 17% YoY in May 2014, according to Global rising to USD1.09bn for 2015 and USD1.26bn for 2016. Dairy Trade. Thanks to an abundant global supply of The company targets to distribute all of its free cash milk powder, we expect imported milk powder prices to flow (net operating cash flow minus capex) as continue to decline in 2H14 and 2015, providing a dividends. We believe this will translate into a payout strong cushion for the company’s profit margin in case ratio of 65% in 2014E. We forecast an increase in the costs of its other items rise sharply in 2015. payout ratio to 80% for each of 2015 and 2016, as we project rising operating cash flow and stable capex  Whole milk powder price: China imports and global prices needs. (USD/tonne) 6,000  Want Want: DPS and net cash position 5,000 (USD) (USDm) 0.08 1,800 4,000 0.0687 0.07 3,000 0.0590 1,500 0.06 2,000 1,200 0.05 0.0405 1,000 0.04 0.0348 900 0.0286 0.03 0.0226 0 0.0196 600 0.02 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 300 0.01 China import Global Dairy Trade 0.00 0 Source: Global Dairy Trade, China Customs 2010 2011 2012 2013 2014E 2015E 2016E DPS (LHS) Net cash (RHS) On operating costs, we forecast the ratio of selling costs Source: Company, Daiwa forecasts to revenue to come down gradually to 11.8% in 2015, from our forecast of 12.3% for 2014 and 11.9% reported Although Want Want is in a strong net cash position, it for 2013. In our view, the channel restructuring and issued senior debt notes worth USD600m in May 2013 product display enhancement Want Want completed at at a coupon rate of 1.875% per year. The notes will its POS in 2013 will bear fruit in 2014 and bring about mature in 5 years. We believe these notes will help the positive operating leverage. company to contain the level of its financial costs over 2014-16.

Want Want bought back some of its shares in January and May this year when its share price was between HKD10.40 and HKD11. It has bought back 31m shares in aggregate since June 2013, 27m this year-to-date. We believe it will carry out further share buybacks if its share price should weaken further, given its strong net cash position.

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beverage companies, such as Tingyi (322 HK, HKD21.05, Outperform [2]).

Want Want is also trading at a discount to its past-5- year PER average, due we believe to investor concerns about a slowdown in revenue growth in 1H14. We Valuation believe such concerns are unwarranted, as 1) a slowdown in revenue growth that we expect for 1H14 We initiate coverage with a Buy (1) rating (we forecast growth of 9% YoY) should be compensated by a strong 21% YoY pick-up for 2H14, driven by the and target price of HKD13, based on a new products that are being rolled out in 2Q14 and 24.6x PER applied to the average of our 3Q14, and 2) we expect net profit for 2014 to be driven 2014 and 2015 EPS forecasts. Our target by 0.9pp YoY operating margin expansion. price implies 27% upside from the current  Want Want: 2012-13 revenue and earnings and Daiwa share price. forecasts vs. Bloomberg consensus 2012 2013 2014E 2015E 2016E Revenue (USDm) 3,359 3,818 4,425 5,078 5,782 We believe PER is a suitable methodology to value YoY growth (%) 14 14 16% 15% 14% Want Want given its profile as a downstream food and vs. consensus (%) n.a. n.a. 0.4% -0.4% 0.1% beverage company, with what we regard as good Net profit (USDm) 550 686 820 972 1,133 earnings visibility and stability. To value Want Want, YoY growth (%) n.a. n.a. 20% 19% 17% we use the average of our 2014-15 EPS forecasts and vs. consensus (%) 32 24 6.3% 8.5% 11.9% EPS (USD) 0.042 0.052 0.0621 0.0736 0.0858 assign a target PER of 24.6x, which is in line with the YoY growth (%) n.a. n.a. 20% 19% 17% stock’s past-5-year average 12-month forward trading vs. consensus (%) 33 23 5.2% 8.2% 14.3% PER. Our target PER corresponds to a 21% premium to Source: Company, Bloomberg, Daiwa forecasts the major China food and beverage companies’ average 2015E PER at current share prices, of 20.3x (based on  Want Want: 12-month forward PER bands our and the Bloomberg consensus EPS forecasts). 14 12 In our view, this premium is justified by Want Want’s: 10 1) quality earnings growth record of consistent double- 8 digit YoY EPS growth since its IPO that we expect it to 6 maintain over 2014-16, 2) higher-than-peers ROE and operating margin for 2014E, and 3) high payout ratio 4 (past-5-year average of 74%) that we expect it to 2 -14 maintain over 2014-16. y Feb-14 Feb-13 Feb-12 Feb-11 Feb-10 Feb-09 Aug-13 Nov-13 Aug-12 Nov-12 Aug-11 Nov-11 Aug-10 Nov-10 Aug-09 Nov-09 Ma May-13 May-12 May-11 May-10 May-09 Trading currently at a PER of 17.9x (based on our EPS 151.HK 14x 18x forecast), Want Want’s valuation looks attractive 22x 26x 30x compared with other large-cap China food and Source: Bloomberg

 Want Want and peers: valuation comparison Bloomberg Mkt.Cap. Price Stock Δ % PER (x) EPS Growth (%) EV/EBITDA (x) Revenue Growth (%) EBIT margin (%) ROE(%) Name Code Rating USDm 6/23/14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E Major China Food and beverage players Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 average except Want Want China 29.2 26.1 20.3 17.1 (4) 14 26 14 11.9 9.7 16 19 15 6.8 10.1 10.9 13.8 Source: Bloomberg, *Daiwa estimates

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Investment risks Competition Want Want faced fierce competition in the rice cracker segment from 2000 to 2004, which led to market share Food safety issues erosion for its core rice cracker brand as a result of the This constitutes the main risk to our positive ensuing price war from low-end products. As Want investment case on Want Want. Food safety hazards, or Want’s production costs are now much higher, and the talk in the market about perceived food safety issues public in general is more aware of brand and food with the company’s products, could have an adverse safety issues, we believe a similar price war is less likely effect on the company’s sales volume and take it sales going forward. Still, the company faces continuous below our forecasts. For instance, on October 2008 the competition as more substitutes become available and Government of Slovakia said it found melamine levels new competitors enter the market, which could in some of Want Want’s products of a concentration translate into pricing pressure and a decline in its that exceeded the EU’s maximum standard. However, market share in the future. Want Want has never exported or marketed its Hot- Kid flavoured milk products in Slovakia, so we are not Ageing of its brand sure whether the above products were Want Want’s or Want Want has always used TV advertising as its main illegal exports that were not checked by the authorities. promotional medium. In our view, however, its TV ads China’s General Administration of Quality Supervision, today are still similar to those it aired in the 1980s. As Inspection and Quarantine and the authorities in Want such, its brand position may be weakened if its Want’s export markets have declared its products to be competitors come out with more innovative and stylish in compliance with the applicable requirements. advertising to boost short-term sales growth (in the

long run, we believe continuous and sustainable growth Given this incident, if similar cases were to occur in the is dependent on product quality and customer loyalty. future, and whether or not Want Want were responsible, might undermine the company’s sales volume and brand value.

Commodity price rises Want Want has a diversified cost structure and is therefore less sensitive to the volatility of costs for a single item than its packaged food and beverage China peers. However, a rebound in raw-material costs, which could be driven by supply disruptions, foreign exchange fluctuations or significant rises in production costs (eg, oil or energy costs), would have an adverse impact on Want Want’s gross margin if a wide variety of commodities were affected.

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Company background

Want Want started producing rice crackers in 1983 in Taiwan, after the chairman collaborated with Iwatsuka Confectionery (Not rated), a leading Japanese producer of rice crackers. Want Want began selling rice crackers in China in 1992, making it one of the pioneers in introducing these products to the China market.

Want Want subsequently entered the beverage and snack food market in the Greater China region in the late 1990s, expanding its geographical coverage and distribution network. As at December 2012, Want Want had 365 sales offices and 96 factories throughout China.

About 85-90% of Want Want’s sales are generated through its 8,000 distributors, with the remaining sales derived from the modern channels and e- commerce. Distributors mainly provide logistics services and watch for over-stocking in the channels.

Want Want was listed on the Singapore Stock Exchange from 1996 to 2007 then was delisted in 2007. It was subsequently listed via an IPO on the Hong Kong Stock Exchange in 2008. Iwatsuka has remained a strategic investor in Want Want since it was listed in Singapore. Since June 2013, Want Want bought back about 31m shares at a price of between HKD9.63 and HKD11.

 Want Want: current shareholding structure

Tsai Iwatsuka Public Eng-meng (2221.JP)

47.3% 48% 4.7% Want Want China (151.HK)

Dairy and Rice crackers other Snacks Others beverages

Source: Company

- 37 -

Consumer Staples / China 322 HK Consumer Staples / China 25 June 2014

Tingyi Cayman Islands

Tingyi Cayman Islands Target (HKD): 22.90 Upside: 8.8% 322 HK 23 Jun price (HKD): 21.05

Initiation: widening its lead 1 Buy • With its competitive pricing strategy and effective promotions, 2 Outperform (initiation) Tingyi looks poised to pull further ahead of its peers 3 Hold • Its product diversification and strong scale advantages in both 4 Underperform beverages and noodles deserve a premium valuation 5 Sell • Initiating with an Outperform (2) rating and target price of HKD22.90, based on 27x PER

How do we justify our view?

short-term aggressive promotions line with the stock’s past-5-year 12- on selected products to squeeze out month forward average PER. competitors yet maintain its segment’s profitability. We forecast ■ Risks the company’s noodles’ operating The major risks we see are food Anson Chan margin to trough in 2014 at 11.2%, safety issues and further profit (852) 2532 4350 and gradually expand from 2015 margin erosion due to increases in [email protected] onwards as it regains pricing power. promotional costs. We look for Tingyi’s market share in Alison Law, CFA this segment to reach 60% in 3 (852) 2532 4308 years, up from 56% in 2013. [email protected] Share price performance

Pepsi – from a drag to a (HKD) (%) contributor: Pepsi China’s bottling 24 105 ■ Investment case 22 100 We initiate coverage of Tingyi operation reached break-even at the 21 95 Cayman Islands (Tingyi), the largest net profit level in 2013 following a 19 89 instant noodles, bottled tea and cost-reduction push. We expect unit 18 84 bottled water brand in China, with output increases for the Pepsi unit, Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 an Outperform (2) rating. coupled with Tingyi’s emerging scale Tingyi Hdg (LHS) Relative to HSI (RHS) in bottled water and its other After a year or so of aggressive beverage activities, to lift its 12-month range 18.38-23.30 promotional activity in the noodles beverage operating margin from Market cap (USDbn) 15.19 segment, which led to declining 3.2% in 2013 to 4.7-6.6% in 2014- 3m avg daily turnover (USDm) 10.48 16E, respectively. Shares outstanding (m) 5,594 margins, we expect Tingyi to stage a Major shareholder Wei Ing-chou (36.9%) recovery in 2015 and regain market ■ Catalysts share in this segment over 2015-16E. Financial summary (USD) This, coupled with a further In our view, continuous market- Year to 31 Dec 14E 15E 16E enhancement of the operational share gains for the noodles segment Revenue (m) 12,548 13,850 15,298 efficiency of the Pepsi unit, should and further cost reductions for the Operating profit (m) 943 1,188 1,400 Pepsi unit will drive up Tingyi’s Net profit (m) 527 688 784 drive a further re-rating of the Core EPS (fully-diluted) 0.094 0.123 0.140 shares over the next 6-12 months. share price and earnings over the EPS change (%) 33.6 30.7 13.9 next 2 years. Daiwa vs Cons. EPS (%) (0.9) 6.9 4.5 Noodles segment: the strongest PER (x) 28.9 22.1 19.4 becomes stronger. We estimate ■ Valuation Dividend yield (%) 1.7 2.3 2.6 Our 6-month target price of DPS 0.047 0.062 0.070 that Tingyi’s noodles revenue is at PBR (x) 4.7 4.2 3.7 least 3x that of the second player in HKD22.9 is based on the average of EV/EBITDA (x) 11.9 9.6 8.1 China. This gives it much greater our 2014-15E EPS and a 27x PER, in ROE (%) 17.3 20.1 20.3 financial resources to carry out Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 72 China Packaged Food and Beverage Sector 25 June 2014

1 Buy How do we justify our view? 2 Outperform (initiation)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Tingyi: net profit YoY growth and breakdown We expect Tingyi’s instant noodles segment to account 1,000 40% 33.7% for 72-75% of its net profit over 2014-16E. We look for 30.7% net profit growth for instant noodles to accelerate from 5% YoY in 2013 to 18% YoY for 2014, 24% YoY for 2015 500 20% and 13% YoY for 2016, as the operating margin should 11.9% 13.9% expand gradually as promotional activity slows, market 6.7% 0 0.0% 0% share likely increases, and new products are launched. -2.9% With the Pepsi unit having turned around in 2013, we expect the beverage business to become the key (500) (20%) earnings growth engine for Tingyi, with the segment’s 2010 2011 2012 2013 2014E 2015E 2016E net profit rising by 93% YoY, 39% YoY and 21% YoY for Others (LHS) Beverages (LHS) 2014E, 2015E and 2016E, respectively. We forecast Noodles (LHS) Recurring profit growth YoY % (RHS) Tingyi’s total recurring net profit growth to accelerate to Source: Company, Daiwa forecasts 34% YoY, 31% YoY and 14% YoY over 2014-16E, respectively, up from -3% YoY for 2012 and 7% YoY for 2013.

 Valuation  Tingyi: historical 12M-forward PER bands

Over the past 5 years, Tingyi has traded at an average (x) 12-month forward PER of 27x, based on the Bloomberg 30 consensus data. The stock has traded at a premium to 25 its China food and beverage peers over the same period due to its strong scale advantage, No.1 market share in a 20 number of sub-segments, and cost-control capability. It 15 is now trading at a PER of 28.9x for 2014E and 22.1x for 2015E, based on our EPS forecasts. We expect Tingyi to 10 rerate further if it successfully expands its noodles 5 market share to protect its pricing power and profit Jan-14 Jan-13 Jan-12 Jan-11 Jan-10 Jan-09 Sep-13 Sep-12 Sep-11 Sep-10 Sep-09 May-14 May-13 May-12 May-11 May-10 margins, and further enhances the operational May-09 efficiency of the Pepsi unit. 322.HK 17 21 25 29 33

Source: Bloomberg

 Earnings revisions  Tingyi: consensus EPS

The Bloomberg consensus has revised down its 2014- (USD) 15E EPS continuously since the beginning of 2013, as 0.180 the gross margin for Tingyi’s noodles business continued to deteriorate. However, the consensus 0.160 numbers have turned slightly more positive since 0.140 Tingyi’s 1Q14 results announcement in late-May. We expect the consensus to turn more positive on Tingyi’s 0.120 operating margin upon the successful launch of new 0.100 products and as its production scale for beverages and 0.080 noodles expands further. Our 2014-15E EPS are 1% Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 below and 7% above the consensus figures, respectively (the 2015E variance is likely due to our higher noodle 2014E 2015E operating-margin forecast). Source: Bloomberg

- 39 - China Packaged Food and Beverage Sector 25 June 2014

Financial summary

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales growth YoY - instant noodles 10.7 27.0 22.5 10.2 9.4 10.5 9.0 9.1 Sales growth YoY - beverages 32.1 38.9 13.2 23.3 27.1 17.3 11.6 11.5 Gross margin % - instant noodles 31.5 28.8 27.2 30.0 29.2 29.2 29.5 29.9 Gross margin % - beverages 36.9 28.5 25.7 29.6 30.8 32.2 32.3 32.6 Sellling and distribution expense ratio 0.0 16.8 16.8 20.3 21.1 20.9 19.9 20.0 (%)

 Profit and loss (USDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Instant noodles 2,308 2,932 3,592 3,960 4,332 4,788 5,221 5,695 Beverage 2,542 3,532 3,999 4,931 6,268 7,355 8,208 9,154 Other Revenue 232 218 266 321 341 406 421 449 Total Revenue 5,081 6,681 7,857 9,212 10,941 12,548 13,850 15,298 Other income 80 46 131 255 201 133 125 163 COGS (3,322) (4,782) (5,770) (6,457) (7,631) (8,629) (9,502) (10,438) SG&A (1,129) (1,247) (1,512) (2,164) (2,663) (3,029) (3,205) (3,543) Other op.expenses (82) (92) (73) (75) (118) (80) (80) (80) Operating profit 628 606 633 771 730 943 1,188 1,400 Net-interest inc./(exp.) (13) (7) (9) (33) (37) (55) (30) (30) Assoc/forex/extraord./others 10 147 39 94 30 11 11 11 Pre-tax profit 625 747 663 832 723 899 1,169 1,381 Tax (125) (134) (163) (228) (229) (252) (316) (373) Min. int./pref. div./others (117) (136) (80) (145) (86) (121) (165) (224) Net profit (reported) 383 477 420 460 409 527 688 784 Net profit (adjusted) 383 340 380 369 394 527 688 784 EPS (reported)(USD) 0.069 0.085 0.075 0.082 0.073 0.094 0.123 0.140 EPS (adjusted)(USD) 0.069 0.061 0.068 0.066 0.070 0.094 0.123 0.140 EPS (adjusted fully-diluted)(USD) 0.069 0.061 0.068 0.066 0.070 0.094 0.123 0.140 DPS (USD) 0.034 0.043 0.038 0.032 0.035 0.047 0.062 0.070 EBIT 628 606 633 771 730 943 1,188 1,400 EBITDA 833 810 911 1,092 1,118 1,396 1,680 1,927

 Cash flow (USDm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 625 747 663 832 723 899 1,169 1,381 Depreciation and amortisation 205 203 278 321 388 452 492 527 Tax paid (56) (96) (130) (138) 386 (223) (225) (281) Change in working capital 141 215 464 (158) 273 284 224 201 Other operational CF items (4) (9) 4 25 18 42 18 19 Cash flow from operations 911 1,059 1,279 882 1,788 1,455 1,678 1,847 Capex (507) (966) (1,349) (882) (896) (700) (700) (700) Net (acquisitions)/disposals00000000 Other investing CF items 00000000 Cash flow from investing (507) (966) (1,349) (882) (896) (700) (700) (700) Change in debt (232) 299 616 234 192 (915) 0 0 Net share issues/(repurchases) 0 0 0 00000 Dividends paid (130) (192) (239) (210) (180) (197) (263) (344) Other financing CF items 44 93 (36) (85) 57 (100) (93) (117) Cash flow from financing (318) 201 341 (61) 69 (1,212) (357) (461) Forex effect/others 00000000 Change in cash 86 294 271 (60) 961 (457) 621 686 Free cash flow 404 94 (70) 1 892 755 978 1,147 Source: FactSet, Daiwa forecasts

- 40 - China Packaged Food and Beverage Sector 25 June 2014

Financial summary continued …

 Balance sheet (USDm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 520 893 600 838 1,250 391 970 1,652 Inventory 213 310 313 478 481 544 599 658 Accounts receivable 116 128 155 233 260 293 317 343 Other current assets 176 357 368 419 419 419 419 419 Total current assets 1,025 1,688 1,436 1,968 2,410 1,647 2,304 3,071 Fixed assets 2,217 2,923 4,030 5,002 5,485 6,082 6,263 6,408 Goodwill & intangibles 7 0 0 29 28 28 28 28 Other non-current assets 159 281 343 474 501 501 501 501 Total assets 3,408 4,891 5,809 7,473 8,424 8,258 9,096 10,009 Short-term debt 218 457 701 500 1,017 102 102 102 Accounts payable 622 1,084 974 1,043 1,252 1,415 1,559 1,712 Other current liabilities 468 687 753 1,252 1,357 1,513 1,649 1,796 Total current liabilities 1,308 2,228 2,428 2,795 3,625 3,030 3,310 3,610 Long-term debt 117 177 549 985 660 660 660 660 Other non-current liabilities 74 117 145 197 213 239 274 313 Total liabilities 1,499 2,522 3,123 3,976 4,498 3,929 4,243 4,582 Share capital 2727282828282828 Reserves/R.E./others 1,435 1,794 2,072 2,523 2,852 3,182 3,607 4,047 Shareholders' equity 1,463 1,821 2,100 2,551 2,880 3,210 3,635 4,075 Minority interests 446 548 587 946 1,046 1,118 1,217 1,351 Total equity & liabilities 3,408 4,891 5,809 7,473 8,424 8,258 9,096 10,009 EV 15,392 15,482 16,429 16,701 16,556 16,572 16,093 15,545 Net debt/(cash) (185) (259) 650 647 426 370 (208) (890) BVPS (USD) 0.262 0.326 0.376 0.457 0.515 0.574 0.650 0.728

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 18.9 31.5 17.6 17.2 18.8 14.7 10.4 10.5 EBITDA (YoY) 33.1 (2.8) 12.5 19.9 2.3 24.9 20.4 14.7 Operating profit (YoY) 32.1 (3.5) 4.4 21.8 (5.3) 29.2 26.0 17.9 Net profit (YoY) 47.2 (11.3) 11.9 (2.9) 6.7 33.7 30.7 13.9 Core EPS (fully-diluted) (YoY) 47.2 (11.3) 11.9 (2.9) 6.6 33.6 30.7 13.9 Gross-profit margin 34.6 28.4 26.6 29.9 30.3 31.2 31.4 31.8 EBITDA margin 16.4 12.1 11.6 11.9 10.2 11.1 12.1 12.6 Operating-profit margin 12.4 9.1 8.1 8.4 6.7 7.5 8.6 9.2 Net profit margin 7.5 5.1 4.8 4.0 3.6 4.2 5.0 5.1 ROAE 28.7 20.7 19.4 15.9 14.5 17.3 20.1 20.3 ROAA 12.0 8.2 7.1 5.6 5.0 6.3 7.9 8.2 ROCE 28.9 23.1 18.2 17.3 13.8 17.6 22.2 23.7 ROIC 29.2 26.0 17.5 15.0 11.7 15.0 18.6 22.3 Net debt to equity net cash net cash 31.0 25.3 14.8 11.5 net cash net cash Effective tax rate 19.9 18.0 24.6 27.4 31.6 28.0 27.0 27.0 Accounts receivable (days) 8.8 6.6 6.6 7.7 8.2 8.0 8.0 7.9 Current ratio (x) 0.8 0.8 0.6 0.7 0.7 0.5 0.7 0.9 Net interest cover (x) 49.7 93.1 67.6 23.6 19.5 17.2 39.0 46.0 Net dividend payout 50.0 50.0 50.0 39.2 48.2 50.0 50.0 50.0 Free cash flow yield 2.7 0.6 n.a. 0.0 5.9 5.0 6.4 7.5 Source: FactSet, Daiwa forecasts

 Company profile Tingyi Cayman Islands (Tingyi) is the world’s largest producer of largest instant noodles, and has a leading 56.4% market share in China (in terms of revenue for 2013). The company’s beverage unit, owned jointly with Pepsi and Asahi Group, has shares of 52%, 26% and 24% of the China markets for ready-to-drink (RTD) tea, juice drinks and bottled water, respectively, by revenue, for 2013.

- 41 - China Packaged Food and Beverage Sector 25 June 2014

By achieving market shares of more than 70% in all 4 major instant noodle flavours, Tingyi’s pricing power and economies of scale should improve further over our forecast horizon, on our estimates. By 2015, we believe Tingyi could consider reducing the use of Noodles – the strongest discounts and free sausage gifts. becomes even stronger Scale advantages to suppress competitors We expect Tingyi’s operating margin to recover slightly YoY in 2014E and resume As discussed in the industry section of this report, its expansion from 2015E onwards, as the revenue growth in the noodles market has slowed significantly since the end of 2012 in terms of value. As company’s pricing power and market competition has intensified, both Tingyi and rival Uni- share improve. President China (UPCH) have aggressively promoted their new products by giving away free sausages and offering price discounts, in particular for the new More market share, more pricing Laotan flavour, first launched by UPCH in 2009 and power then by Tingyi in 2011.

That said, the impact of such promotions on gross Tingyi has one of the largest sales networks in China margins and operating margins has been much less for (110,000 direct distributors as of end-2013), giving it a Tingyi than for UPCH, because in Tingyi’s case, the substantial competitive advantage in terms of new profit contributions from its other products have been product penetration and a sound platform for its enough to cover the expenses related to promoting promotional efforts (using discounts and ham sausage Laotan. We estimate that Laotan accounted for less gifts for selected products only). The company is the than 15% of Tingyi’s noodles sales in 2013, versus more largest instant noodles, bottled tea and bottled water than 60% for UPCH. As a result, Tingyi’s operating brand in China, with market shares of with 56%, 52% margin is still much higher than UPCH’s. and 24%, respectively, in 2013, according to AC Nielsen.  Tingyi vs. UPCH: noodles operating margin and revenue comparison Tingyi targets to reach a 60% total market share in (%) (x) China by: 1) cementing its leadership in roast-beef 15 12.7 12.5 13.1 7 11.6 11.7 11.3 11.2 flavoured and spicy beef flavoured noodles, in which it 6 has dominant market shares (more than 80%), by 10 5 advertising and building a young and trendy image 4 among young consumers, and 2) continuing with its 5 2.8 3.1 3 consumer promotional activities to gain market share 0.2 0.5 in the sub-categories that it does not dominate (eg, 0 2 -0.3 1 spicy pickled vegetables, braised meat, etc.). -1.8 (5) -3.3 0 2010 2011 2012 2013 2014E 2015E 2016E As shown in the table below, in 2013, Tingyi was the No.2 brand in 3 of the top-4 flavours of instant noodles Tingyi (LHS) UPCH (LHS) Tingyi/UPCH revenue (RHS) in China, based on comments from Tingyi’s Source: Tingyi, UPCH, Daiwa forecasts management, AC Nielsen’s data and our estimates. Pricing and promotions gradually being  Tingyi: position in the major flavours of noodles in China scaled back Category’s share Tingyi's segmental Rank Flavour in total market share in 2013 (%) As most of Tingyi’s domestic competitors are either 1 Roast beef 紅燒牛肉 20 90 losing market share or under significant profit margin 2 Spicy pickled vegetable & beef 老坛酸菜牛肉 ~15% 45 (and hence financial) pressure at present, they will not 3 Spicy beef 香辡牛肉 ~15% 80 be able to sustain expensive promotions like Tingyi for 4 Braised meat 卤肉 <5% 50 very long, in our view. We believe the aggressive Source: Company’s management comments, AC Nielsen, Daiwa promotional war involving free sausage gifts will ease

gradually over 2H14E and 2015E. Hence, we expect a

- 42 - China Packaged Food and Beverage Sector 25 June 2014

mild operating margin recovery for both Tingyi and  Tingyi: new products UPCH from 2015E onward.

However, if the price war and aggressive promotions continue for longer than we expect, we believe Tingyi would be able to maintain its operating margin at the current level, with slight upside potential, given it has much greater financial resources than peers to spend on promotions.

If we assume Tingyi spends 10% of the revenue generated by its noodles segment on advertising and promotions (A&P), its A&P budget in 2014E would exceed USD470m, almost 40% of UPCH’s noodles revenue, based on our estimates. We expect Tingyi’s Source: Company noodles revenue to remain 3x higher than that of UPCH over 2014-16E. Fresh Banquet: These steamed noodles are mono- sodium glutamate (MSG)-free, and target health- In fact, Tingyi has already gradually allocated some of conscious consumers who are not frequent consumers its A&P budget to products other than Laotan and of instant noodles at present. The retail ASP is about braised beef noodles. In 4Q13, it launched new TV and CNY6 per bowl, versus CNY3.5-3.8 for Tingyi’s other online advertisements for its core roast beef noodle bowl noodle products. Dried vegetable and meat pieces products, and in 1Q14 it introduced advertisements for are also added to justify the higher retail ASP. its snack noodles and other new products in an effort to establish new revenue growth engines. Mian Ba cooked noodles: This product targets home consumption. Emphasising Mian Ba’s improved taste compared with some of Tingyi’s other high-end New products to enlarge the pack products, the retail price is around CNY3 per customer base pack, versus CNY2.3-2.5 for other high-end packs.

Tingyi has launched 3 new products in 1H14: 1) non-oil Crispy Fatty: This product is an improved version of fried noodles under the “Fresh Banquet” name, 2) a the fried crispy noodles known as Cui Xuan Feng new cooked noodle called “Mian Ba Cooked Noodles”, launched in 1Q13. It targets consumers who want a and 3) snack noodles under the “Crispy Fatty” name. small portion of noodles as a snack. The revenue We are more positive on these new products than those contribution from this snack noodle product is small at launched over the past 3 years, such as Laotan. These present (1Q14: 2.6% of segment’s revenue), but is new, higher-quality products, in our view, target new growing fast (sales volume up by 50% YoY for 1Q14). customers with relatively high disposable incomes, and  Tingyi: noodle revenue breakdown by product: 1Q13 vs. 1Q14 hence could enhance the per-capita consumption of (USDm) noodles in China rather than cannibalising the 1,400 company’s existing products. 1,200 20 30 1,000

800 524 568

600 138 127 400

200 423 425

0 1Q13 1Q14 Highend pack Mid-end pack Bowl Snack noodles

Source: Company, Daiwa forecasts

- 43 - China Packaged Food and Beverage Sector 25 June 2014

A rebound in revenue and profit growth would serve as a cash-cow We forecast Tingyi’s noodles’ revenue to rise by 11% YoY for 2014, 9% YoY for 2015 and 9% YoY for 2016, faster than the industry averages for those years. With the gradual reduction in promotional discounts on selected products and the launch of new products, we assume a mild ASP increase of 3% YoY for 2015E

With further operating leverage, we forecast the net margin to improve slightly over 2014-16, and hence drive the segment’s net profit to rise by 18% YoY, 24% YoY and 13% YoY over 2014-16E, versus 5% YoY growth reported for 2013. We expect noodles to remain the major net profit contributor for Tingyi, accounting for about 72-75% of its total net profit over 2014-16E, versus 85% in 2013.

 Tingyi: noodle segment’s revenue and net margin (USDm) (%) 6,000 12

5,000 10.4 10 9.5 9.8 8.5 8.3 4,000 8.1 7.8 8 3,000 6

2,000 4

1,000 2

0 0 2010 2011 2012 2013 2014E 2015E 2016E Revenue (LHS) Net margin % (RHS)

Source: Company, Daiwa forecasts

- 44 - China Packaged Food and Beverage Sector 25 June 2014

 Revenue breakdown by category 10,000

8,000

6,000 Beverage – multiple 4,000 engines to diversify 2,000 risk 0 2010 2011 2012 2013 2014E 2015E 2016E Tea Water Juice drinks Carbonated drinks and others After merging with Pepsi (2012), Tingyi’s Source: Company, Daiwa forecasts beverage business has a big product portfolio and strong R&D capabilities,  Tingyi: diversified beverage portfolio Tingyi’s original products which is important to tap the long-term growth of the China market and satisfy the ever-changing consumer tastes.

A diversified product portfolio

As shown in the following chart, Tingyi’s beverage portfolio consists of 4 major types of beverage Pepsi’s product portfolio categories – tea, water, juice drinks and carbonated drinks. Those categories accounted for over 95% of revenue for the soft drinks market in China in 2013, according to AC Nielsen. Tingyi achieved No.1 or 2 position in all these major categories. Based on AC Nielsen’s data, we estimate Tingyi’s market share in non-alcoholic beverages in China at around 28% in 2013, making it the largest player in China. Source: Company Tingyi is the only beverage player in China with significant exposure to all the major soft-drink Moreover, together with Pepsi, Tingyi has a strong categories in the country. The beverage portfolios of portfolio in categories that are seeing fast revenue the second-largest player, Coca-Cola (little presence in growth in China, such as sports drinks, 100%-pure bottled tea), and the third, UPCH (no carbonated juice, and spring water. In 2014-15E, these products drinks), in China are inferior to Tingyi’s, in our view. will likely account for a small proportion of the segment’s revenue as they are not affordable for many As discussed in our industry section, consumers’ consumers. However, we see long-term potential in preferences for beverages shift between different such products as consumers become more health categories almost every year, depending on the conscious, income levels rise, and the westernisation of weather, affordability, the availability of new products Chinese consumers’ drinking habits and tastes and marketing campaigns. Diversification lowers continues. product concentration risk, and provides a comprehensive portfolio for distributors and customers in the catering industry.

- 45 - China Packaged Food and Beverage Sector 25 June 2014

 Tingyi: potential star products: sports drink, spring water, company, Ting Hsin (not listed), with a 17.1% stake. 100% juice Pepsi has the option to increase its stake in the business to 20% in October 2014 or October 2015, for a consideration of USD3.7bn.

 Current shareholding structure of Tingyi’s beverage unit

Ting Hsin 33% 17.1% Asahi Tingyi 322.HK Pepsi

30.4% 47.5% 5%

Brands: Master Kong, Pepsi, 7-up, Gatorade, Mirinda, Tropicana, New Taste for Traditional Drink

Source: Company Products: bottled tea, juice drinks, water, carbonated drinks and other beverages Rapid expansion in the water business Source: Company

For 2014-15E, we expect water to be the key revenue As a result of what we see as inefficient management, driver for Tingyi’s beverage unit, as sales momentum Pepsi China was loss-making between 2008 and 2012. should remain robust (following 1Q14: up 33% YoY) Tingyi’s operating margin was also impacted adversely and Tingyi continues to expand its bottled water as it had to absorb such losses. However, besides capacity. Tingyi plans to increase its number of bottled product portfolio enhancements and an immediate water plants in China from 83 at present to 100 by end- boost in revenue, Tingyi is considering potential 2014 and to 120 by end- 2016, to gain scale advantages. synergies with Pepsi China through the sharing of a We forecast water sales growth to exceed that of its production and distribution network with Pepsi. other beverage categories over 2014-16E at 30% YoY for 2014E, 21% YoY for 2015E and 20% YoY for 2016E. Through a series of changes implemented since 2012 to operations and the management system, Tingyi is using Spring water is another high-value item under its cost control expertise and scale to lift the profit development by the company. Tingyi is looking to margin of the merged beverage unit. secure safe and quality natural spring water sources in China to develop its spring water business in the Phase 1 – immediate direct cost reductions post future. the Pepsi deal. Immediately after the deal was completed in 1Q12, Pepsi brand-related advertising  Tingyi: beverage sales growth by category promotional expenses and raw material costs were (YoY %) 2011 2011 2012 2013 2014E 2015E 2016E reduced, as Pepsi provided discounts for its Tea 37 9 -26 25 16 8 8 concentrate sales (essential raw materials for Water 27 23 7 27 30 21 20 carbonated drinks production) to the merged unit and Juice drinks 70 19 74 13 10 7 7 Carbonated drinks and others n.a. n.a. n.a. 47 15 15 10 provided more A&P resources. Moreover, Tingyi has Source: Company, Daiwa forecasts started central procurement of major raw materials, such as sugar and PET chips, to lower Pepsi’s production costs through Tingyi’s scale. As a result, the Pepsi unit should help to improve Pepsi unit reached breakeven at the net-profit level in operating margin 2013, from loss-making in 2012.

Phase 2 – from 2012 onwards. Since 3Q12, Pepsi In 1Q12, Tingyi’s beverage unit merged with Pepsi and Tingyi have been sharing their beverage China. Following Pepsi’s injection of its China bottling production and distribution channel resources. As a plants into the unit, Pepsi now owns a 5% stake in result of this drive, Tingyi was able to launch in 2013 Tingyi’s unit and Tingyi owns 47.5%. The beverage Pepsi’s non-carbonated drinks (Topicana juice, Lipton unit’s other shareholders are: 1) Japanese partner milk tea, etc.) though its national production and Asahi Group (Asahi) (2502 JP, JPY3,121, Outperform distribution network without incurring extra capex. [2]), which has been investing in the unit since 2004 and owns a 30.4% stake, and 2) Tingyi’s parent

- 46 - China Packaged Food and Beverage Sector 25 June 2014

Phase 3 (2014E-16E) – revenue enhancements.  Tingyi’s beverage unit: revenue and net-profit margin Currently, the Pepsi China beverage unit is not as (USDm) (%) efficient as Tingyi’s other beverage operations, with 10,000 7.3 8 revenue per staff only about one-third that of Tingyi’s 7 8,000 other beverage units. Tingyi plans to train staff coming 4.9 5.2 6 from the original Pepsi China unit and simplify the 6,000 3.9 4.0 5 unit’s management structure – not by shedding junior 4 4,000 2.4 sales or production staff but by restructuring the sales 1.8 3 2 and distribution units. 2,000 1 In view of the above measures, we are optimistic that 0 0 2010 2011 2012 2013 2014E 2015E 2016E Tingyi’s beverage unit should stage an improvement in profitability over 2014-16E. As such, we forecast the Revenue (LHS) Net margin (RHS) unit’s gross margin to improve to 32.6% by 2016E, Source: Company, Daiwa forecasts (from 30.8% for 2013), and its operating margin to expand to 4.7% for 2014, 5.8% for 2015 and 6.6% for 2016 (from 3.2% reported for 2013). We project faster operating-margin than gross-margin expansion as we assume operating leverage and improving efficiency among the sales force.

 Tingyi’s beverage unit: gross and operating margins (%) (%) 35 30 32.2 32.3 32.6 30.8 25 28.5 29.6 20 25.7 15 9.2 6.6 10 5.2 4.7 5.8 3.4 3.2 5 0 2010 2011 2012 2013 2014E 2015E 2016E

Gross margin Operating margin Source: Company, Daiwa forecasts

We also expect the above measures to drive a rapid net margin improvement for the beverage unit over the next 3 years (as shown in the following chart), and forecast net profit growth for the unit of 93% YoY for 2014, 39% YoY for 2015 and 21% YoY for 2016. Our forecasts imply that Tingyi’s beverage unit should account for 20-25% of the company’s total net profit over 2014-16E (vs. a minimal contribution for 2013).

- 47 - China Packaged Food and Beverage Sector 25 June 2014

 Tingyi and major China peers: comparison of revenue per staff member and size (2013) Revenue No. of wholesale Revenue per staff (CNYm) No. of staff distributors (CNY/person) Tingyi 67,834 80,541 33,504 842,661 UPCH 23,329 38,453 n.a. 606,688 Huiyuan 4,504 7,121 5,000 632,495 Strong scale advantage Want Want 23,670 53,500 8,000 442,425 Tsingtao 28,291 42,235 n.a. 669,847 Source: Companies, Bloomberg, Daiwa Tingyi has one of the most extensive Note: Huiyuan = China Huiyuan Juice Group, Tsingtao = Tsingtao Dairy; the data excludes Mengniu given its inclusion of the infant formula business, which operates using a distribution and production networks in very different distribution model compared with other F&B products.

China, which keeps down its logistics  Tingyi and major China peers: comparison of selling and costs and gives it a good platform to distribution expenses as a percentage of revenue (2013) 35 distribute new products and co-operate 29.3 with joint venture partners. 30 27.7 25 21.1 19.8 19.1 20 A strong distribution and product 17.0 15 network 11.9 10 Tingyi started producing and distributing instant 5 noodles during the year it was founded and later 0 expanded into the beverage businesses in 1996. It now Tingyi Tingyi - ex- UPCH Huiyuan Want Want Tsingtao Mengniu Pepsi China has about 35,000 wholesalers and over 110,000 Source: Companies, Daiwa estimate for ex-Pepsi unit directly serviced retailers, giving it one of the largest Note: Mengniu – China Mengniu Dairy distribution networks in China’s food and beverage industry. Tingyi also has about 120 production plants Pepsi China’s higher operating cost structure, as in China which distribute Tingyi’s products nationwide, evidenced by its loss-making condition during 2010- even to 6-or-below tier cities. 2011, caused Tingyi’s ratio of selling and distribution expenses to revenue to increase from about 17% in 2011  Tingyi: production and distribution capability in China (period- (ie, prior to the merger of its beverage unit with Pepsi’s end) (Number) 2009 2010 2011 2012 2013 1Q14 China unit) to 20.3% in 2012 and 21.1% in 2013. Sales offices 493 548 555 571 566 584 Warehouses 79 89 91 95 75 85 However, we forecast this ratio to come down gradually Wholesale distributors 5,798 6,155 6,188 32,424 33,504 35,500 to close to 20% for 2015 as we expect Pepsi’s efficiency Directly-serviced retailers 72,955 73,282 86,755 107,131 110,355 114,421 to improve, on the back of the measures discussed in Employees 50,023 64,436 64,309 79,419 80,541 n.a. Production lines 414 457 510 607 654 668 an earlier section. That said, Tingyi’s operating margin Production centres 56 53 65 108 119 n.a. is still substantially above that of UPCH, its major Source: Company competitor in both the beverage and instant noodles segments, as the next chart shows, and we expect it to Our analysis indicates that Tingyi has a high level of remain so over 2014-16 as synergies continue to be operational efficiency, based on our assessment of the unlocked. company’s operating margin and selling cost control. In terms of selling and distribution expenses (excluding its beverage unit owned jointly with Pepsi and others), we estimate that Tingyi’s annual selling and distribution costs as a percentage of revenue are the lowest of the major food and beverage companies in China, except at Want Want China (Want Want). We believe Tingyi’s bottled-water business has a higher ratio of selling and distribution costs to revenue than most of Want Want’s products due to the lower value of bottled water products on a weighted basis compared with other beverages.

- 48 - China Packaged Food and Beverage Sector 25 June 2014

 Tingyi and UPCH: operating margin comparison (under the brand Ebisen). Tingyi plans to launch new 10% potato-based snacks via this joint venture to further 9.1% 9.2% 8.6% enhance its profitability over the next 2 years. 8% 8.1% 8.4% 7.5% 6.7%  Revenue breakdown of Calbee-Tingyi JV (FY14, ie, year-end 31 6% March 2014) 4.4% 4% 4.1% 4.2% 3.7% 2.4% Ebisen 2% 2.0% 1.5% 31.0%

0% 2010 2011 2012 2013 2014E 2015E 2016E Jagabee 49.0% Tingyi UPCH

Source: Tingyi, UPCH, Daiwa forecasts

BQ Developing more long-term 20.0% business-growth drivers Source: Calbee

We believe Tingyi’s distribution network assets still offer substantial potential for further operating Joint venture with Prima leverage, and that Tingyi is one of a very few food and Prima (Not rated) processes and sells ham and beverage companies in China with such strong sausages, and is the third-largest ham processor in distribution and a product presence in most parts of Japan. Tingyi formed a joint venture with Prima in the country. This should enable the company to 2012 and owns a 60% stake in it. The plant is located in continue to launch new products swiftly and at lower Jiangsu Province and has been producing ham, bacon costs compared with most of its competitors, in our and sausages since 4Q13. Its current customers are view. mainly business-to-business (B2B) customers. Tingyi’s management believes this joint venture can help Tingyi To further utilise such assets and resources, in 2012, to diversify its product mix further in the future. Tingyi formed a new instant-food business unit (for instant foods excluding noodles), which is responsible Joint venture with Wakodo for introducing new products (mainly international In 1H14, Tingyi established a joint venture with brands) into China. Leveraging on its existing network Wakodo to engage in marketing and sales of infant and sales expertise in China, Tingyi distributes these formula and baby foods and owns a 45% stake. The instant-food brands through its existing sales channels joint venture will import original packaging infant (supermarkets and wholesale distributors) and sells formula from Japan to sell in China, starting from these brands to develop its presence in new channels 2H14. Wakodo is the third-largest baby food brand in (eg, catering). So far, the company has embarked on 3 Japan with a 12.8% market share for 2013. projects in the form of joint ventures with other companies that we go on to describe. Considering other acquisitions in instant foods Joint venture with Calbee According to management, Tingyi is considering In 2012, Tingyi formed a joint venture with Japanese domestic acquisition targets in instant foods, which: 1) instant-food producer/snack producer Calbee (2229 generate sales of more than CNY 3bn per year, 2) have JP, JPY2,828, Buy [1]) and Japanese trading company a niche product portfolio, 3) sell to consumers rather Itochu (8001 JP, JPY1,296, Outperform [2]). Tingyi, than industrial users, and 4) preferably have a No. 2 Calbee and Itochu own respective stakes of 45%, 51% market share in their product categories. and 4% in the venture. The venture’s production plant is in Hangzhou Province and started production in Tingyi believes several attractive targets could become 2Q13. available over the next 5-10 years, as many entrepreneurs who started their businesses in China in Based on Calbee’s disclosures, about 49% of the joint the 1980s-2000s, when China’s economy was booming, venture’s sales come from Jagabee, which is Calbee’s will likely gradually retire and therefore may be sub-brand of potato sticks packaged in cups, followed interested in selling their businesses. by potato chips (under the brand BQ) and prawn chips - 49 - China Packaged Food and Beverage Sector 25 June 2014

Instant foods should remain a small revenue and earnings contributor over 2014-16E The instant foods segment overall is still a small contributor to Tingyi’s revenue and earnings, and the segment has seen its operating costs increase since 2012 due to start-up costs for its new business initiatives. We forecast the segment to remain loss- making at the net level in 2014E and contribute about 2% to Tingyi’s total revenue and less than 1% to its total net profit over 2015-16. Management targets to grow the instant food (ex-noodles) segment so that it contributes about 10% to the company’s total revenue by 2020.

 Tingyi’s instant food segment (ex-noodles): revenue and net profit (USDm) (USDm) 350 10

300 5 250 0 200 (5) 150 (10) 100 50 (15) 0 (20) 2010 2011 2012 2013 2014E 2015E 2016E Revenue (LHS) Net profit (RHS)

Source: Company, Daiwa forecasts

- 50 - China Packaged Food and Beverage Sector 25 June 2014

29.9% and 2016E, up 0.3pp and 0.4pp YoY, respectively. Note that we assume no segmental gross margin improvement for 2014, as competition remains keen for some categories such as Laotan flavours.

 Tingyi: gross margin by segment Financial analysis (%) 40

We forecast Tingyi’s recurring net profit 35 growth to accelerate to 34% YoY for 2014 31.2 31.4 31.8 30 29.9 30.3 (vs. 7% YoY for 2013), 31% YoY for 2015 28.4 26.6 and 14% YoY for 2016. 25

20 Profit growth accelerating 2010 2011 2012 2013 2014E 2015E 2016E Instant noodles Beverage Instant foods Company The strong pick-up that we project in Tingyi’s recurring Source: Company, Daiwa forecasts net profit growth for 2014-16E compared to 2013 is driven by: 1) revenue growth that we forecast at 15% Operating costs. Tingyi’s ratio of selling and YoY for 2014 and 10% YoY for each of 2015 and 2016, distribution expenses to revenue rose sharply to 20% in and 2) operating margin expansion at both the noodles 2012 and 21% in 2013 from 17% in 2011) due to the and beverage segments. inclusion of the less-efficient Pepsi unit from 2012. We forecast the ratio to come down from 21% in 2013 and  Tingyi: recurring net profit and YoY growth in revenue and recurring net profit 2014E to close to 20% for 2015, driven primarily by the company’s drive to improve efficiency at the Pepsi unit. (USDm) We believe that the ratio could improve further to 18- 1,000 40% 784 19% in the long-run, although this would still be above 30% 800 688 the level of 17% pre-merger of part of the beverage 20% 600 527 394 business with Pepsi’s in China, due to rising labour 340 380 369 10% 400 costs and intensified competition in the beverage unit. 0%

200 (10%) We expect Tingyi’s administrative costs to be contained 0 (20%) 2010 2011 2012 2013 2014E 2015E 2016E at 3.2% of revenue over 2014-16E, in-line with the 2013 Net profit (ex- one-offs) (LHS) level. Recurring profit growth YoY % (RHS) Revenue YoY (RHS)  Tingyi: ratio of selling and distribution expenses to revenue, and operating margin Source: Company, Daiwa forecasts 25% 10% 9.1% 9.2% 8.6% Gross margin should improve gradually 20% 8.1% 8.4% 8% 7.5% We forecast mild gross margin improvements for both 6.7% the beverage and noodles segments over 2014-16, as 15% 6% shown in the following chart. For the beverage segment, we expect efficiency gains at the Pepsi unit, 10% 4% economies of scale through Tingyi’s planned expansion 5% 2% of its water production network expansion, along with sustainably low sugar and PET-chip costs, to lead to 0% 0% gross-margin expansion of 1.5pp YoY to 32.2% for 2010 2011 2012 2013 2014E 2015E 2016E 2014, 0.1pp YoY to 32.3% for 2015, and 0.3pp YoY to Selling cost ratio (LHS) Operating margin (RHS) 32.6% for 2016. Source: Company, Daiwa forecasts

For the noodles segment, we expect to see gradual Tax. We forecast Tingyi’s reported effective tax rate to declines in promotion expenses for noodles and come down from 31.6% in 2013 to 28% in 2014 and product mix enhancements, which should bring about then to 27% in both 2015 and 2016. This reflects the a gross margin improvement to 29.5% for 2015 and fact that some of its loss-making subsidiaries (in

- 51 - China Packaged Food and Beverage Sector 25 June 2014

particular the Pepsi operation) reached breakeven in As we expect synergies with Pepsi’s China unit to 2013 and we expect some (eg, bakery units) to do so in materialise gradually and the instant noodle segment’s 2014-15E. As their losses are not eligible for tax net margin to rebound progressively, we forecast reductions, while loss-making, such businesses raised Tingyi’s ROE to improve to 17.3% in 2014, 20.1% in the company’s effective tax rate. 2015 and 20.3% in 2016, and expect the company to have a net cash position for 2015-16, with higher free Dividend. Tingyi has paid out 50% of its core profit cash flow. (reported net profit ex-valuation gain and other non- cash earnings) in the form of dividends over the past 5  Tingyi: net gearing and ROE years. We expect it to maintain its dividend payout 35% 40% ratio at 50% per year over 2014-16. 29.0% 30% 30%

25% 21.4% 20% Capex and cash flow 19.8% 20.1% 20.3% 20% 17.3% 10% We forecast the company’s capex to amount to 14.5% USD700m per year over 2014-16E, in the middle of its 15% 0% guidance range for 2014 of USD600m-800m and down 10% (10%) from USD896m in 2013. As Tingyi has already built a 5% (20%) strong production network in China, we believe its 0% (30%) upcoming capex will mainly be spent on new water 2010 2011 2012 2013 2014E 2015E 2016E production lines (for beverages) and modernising its ROE % (LHS) Net debt (cash)/equity % (RHS) noodle production facilities (to enhance both efficiency Source: Company, Daiwa forecasts and its product mix).

In 2Q14, Tingyi acquired 4 office buildings (under construction) from its parent Ting Hsin for a consideration of CNY2.48bn (USD406m). The buildings, located in the town of Hongqiao in Shanghai, will be used as Tingyi’s new headquarters, offices, research and development centre, education and training centre and related amenities for executive catering and accommodation. Tingyi’s declared purpose of moving its headquarters from Tianjin to Shanghai is to attract talent. The new location will also give the company closer ties with its business partners both domestically and overseas, as well as savings on transportation costs for staff and international business partners. The company plans to move to Hongqiao in 2015.

Despite the capex outlay, we expect Tingyi’s balance sheet to remain healthy and forecast the company’s free-cash flow to exceed USD700m each year over 2014-16 (2013: USD892m) after the above investments. In addition, we forecast its ROE to improve gradually over 2014-16, as shown in the following chart, from a trough level of 14.5% in 2013. Tingyi’s ROE has been dragged down substantially since 2012 due to the merger of part of its beverage business with that of Pepsi China, which has lower efficiency metrics than Tingyi, and intensified competition since 2012.

- 52 - China Packaged Food and Beverage Sector 25 June 2014

pricing power in 2H14 and 2015 as we believe its competitors lack the financial resources to continue price war and free gifts. In beverages, Tingyi looks well positioned to benefit from the trend of rising bottled water consumption in China given its nationwide presence, with the largest bottled water/beverage Valuation production network in China.

We have an Outperform (2) rating with a As shown below, our 2015-16 EPS forecasts are slightly above those of Bloomberg consensus. We expect its target price of HKD22.90, based on a 27x operating margin to exceed expectations as the 2015E PER and implying 9% upside company sees a continuous improvement in its pricing potential from the current share price. power for noodle products. Our revenue forecasts are largely in line with those of the consensus.

Sustainable valuation premium to  Tingyi: revenue and earnings trend and forecasts vs. consensus peers 2012 2013 2014E 2015E 2016E Revenue (USDm) 9,212 10,941 12,548 13,850 15,298 YoY (%) 17 19 15 10 10 We consider a PER method as the most appropriate Var. vs. consensus (%) n.a. n.a. 2 0 -2 way to value Tingyi, given its profile as a downstream Net profit (USDm) 369 394 527 689 785 food and beverage company with what we regard as YoY (%) -3 7 38 31 14 good earnings visibility and stability. Var. vs. consensus (%) n.a. n.a. -3 7 5 EPS (USD) 0.082 0.070 0.094 0.123 0.140 YoY (%) -3 7 34 31 14 To value Tingyi, we use the average of our 2014 and Var. vs. consensus (%) n.a. n.a. -1 7 5 2015 EPS forecasts and assign a target PER of 27x, Source: Bloomberg, Daiwa forecasts which is in line with the company’s past-5-year average trading PER. Our target PER also represents a 36%  Tingyi: 12-month forward PER bands premium to the major China food and beverage (x) companies’ average 2015E PER at current share prices 30 of 19.8x (based on the Bloomberg consensus EPS 25 forecasts, and on our forecasts for the companies we cover). In our view, the premium is justified by what we 20 see as Tingyi’s strong earnings-growth prospects for 15 2014-16 and leading market-share position and scale advantages over its peers. 10 5 Based on our EPS forecasts, Tingyi is trading currently Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 May-09 May-10 May-11 May-12 May-13 at PERs of 28.9x for 2014E and 22.1x for 2015E. We May-14 believe Tingyi deserve a re-rating from its current 322.HK 17 21 25 29 33 multiples as its operating margin gradually recovers. Source: Bloomberg For noodles, we believe Tingyi will gradually regain

 Tingyi and peers: valuation summary BB Mkt. cap Price Stock Δ % PER (x) EPS Growth (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) ROE(%) Name code Rating USDm 23-Jun-14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Average (Ex-Tingyi) 27.6 25.1 19.8 16.5 1 12 24 15 12.1 10.0 16 19 16 8.9 12.2 13.0 16.4 Source: Bloomberg,* Daiwa forecasts

- 53 - China Packaged Food and Beverage Sector 25 June 2014

Investment risks

Food safety issues We consider food safety issues to be the main risk to our positive investment view on Tingyi. As far as we are aware, Tingyi’s products have not been caught up in food safety concerns in recent years, and the company has invested significant sums in quality and safety control equipment to reduce such risks.

However, food safety issues, together with talk in the market about perceived food safety issues, could have an adverse effect on the company’s sales volume. We believe such risks are higher for the noodles segment than the beverage segment, as noodles come in a wide range of flavours and use numerous ingredients procured from many suppliers.

Further intensification of competition We assume that the promotion war in the China’s noodles market will ease gradually in 2015 and that Tingyi will continue to gain market share in all its segments. If its competitors do not stop their aggressive promotions or even offer further discounts in effort to drive revenue, Tingyi’s market share and operating margin could be lower than we expect currently for 2H14-16E.

Commodity price increases We forecast flour and palm oil to account for about 15% and 10%, respectively, of the company’s instant noodles production, and PET chips and sugar to represent about 60% and 10%, respectively, of its beverage segment’s COGS, in 2014. Its beverage production costs have been on a declining trend since 2013. Any rebound in sugar and PET chip costs could lead to gross margin erosion (in contrast with our forecasts for gross margin expansion for 2014-16).

M&A execution Tingyi has been active in acquisitions and joint ventures projects with international food and beverage companies since 1Q12, notably its deal with Pepsi in China and joint ventures for instant foods discussed in this report. Such expansion could divert management resources and lead to near-term net-margin pressure due to start-up expenses.

- 54 - China Packaged Food and Beverage Sector 25 June 2014

In 2003, Tingyi restructured its business units and sold just below 50% of its interest in the beverage business to 2 Japanese companies, Asahi Breweries (Not rated), a leading Japanese manufacturer of alcoholic beverages and soft drinks, and Itochu (Not rated), a trading company in Japan with offices in more than 80 Company background countries and operations covering a broad spectrum of industries (such as textile, machinery and utilities). Founded in 1992 and listed on the Hong Kong Stock Exchange in 1996, Tingyi is the world’s largest In 1Q12, Tingyi’s beverage unit was merged with Pepsi producer of instant noodles, and had a 56.4% market China, as discussed earlier in this report. As a result of share in China in terms of revenue for 2013. Its that merger, Tingyi currently owns 47.5% of its beverage unit, owned jointly with Pepsi and Asahi (as beverage operation. illustrated earlier in this report) has approximate shares of 52%, 26% and 24% of the China markets for ready-to-drink (RTD) tea, juice drinks and bottled water in terms of revenue in 2013.

As at the end of 2013, Tingyi had 566 sales offices and more than 600 production lines in 119 production centres throughout China.

Chairman Mr. Ing-chou Wei (with his family) and Sanyo Food are Tingyi’s major shareholders currently, with stakes of about 33% and 32%, respectively.

 Tingyi: current shareholding structure

Sanyo Food Ting Hsin Public 33% 32% Pepsi and 35% Itochu Tingyi (Cayman Island) Holding (322 HK)

35.4% 17.1% 47.5% 100%

Instant food business Beverage Intant noodles JV with Wakado: 45% JV with Prima: 60% JV with Calbee: 45% Bakery business: 100%

Source: Company

Development history Under the brand Master Kong, Tingyi developed its first instant noodles product, Noodles with Braised Beef, in 1992. Since then Tingyi has gradually developed another 3 classic instant noodles products, namely Noodles with Spicy Beef, Noodles with Stewed Mushroom and Chicken, and Noodles with Fresh Shrimp and Fish. These brands have been well received by consumers throughout China. The company also makes and sells different noodle flavours tailored to specific regions (which have proved popular, such as spicy flavours in Sichuan Province, Chinese-style soup- based flavours in Guangdong Province, etc.).

Tingyi subsequently entered the beverage and snack food markets in the Greater China region after 1995, and expanded its geographical coverage and distribution network to cover all areas of the country.

- 55 -

Consumer Staples / China 220 HK Consumer Staples / China 25 June 2014

Uni-President China

Uni-President China Target (HKD): 5.60 Downside: 3.4% 220 HK 23 Jun price (HKD): 5.80

Initiation: torn between growing earnings and market share 1 Buy 2 Outperform • We believe the stock’s outlook is clouded by a lack of new 3 Hold (initiation) products and limited visibility on noodle profit margins 4 Underperform • Recent right issue alleviates concern about stretched balance 5 Sell sheet; beverage earnings should cushion noodle losses • Initiating with Hold (3) rating and target price of HKD5.60, based on 30x 2014/15E EPS

How do we justify our view?

Steady profit from beverages. noodle segment will stage a We forecast its beverage revenue to turnaround in 2015. grow by 7-10 % YoY in 2014-16, on the back of market growth and ■ Risks product-mix upgrades. Assuming A lower-than-expected utilisation Anson Chan stable raw material costs, we forecast rate is the main downside risk to our (852) 2532 4350 a beverage operating margin of 5.8- call. Lower-than-expected selling [email protected] 5.9% over 2014-16, backed by our expenses are the main upside risk. expectation of an increased revenue Alison Law, CFA contribution from high-value items (852) 2532 4308 such as spring water and coffee. [email protected] Share price performance

How we differ. Our 2014-16 (HKD) (%) revenue forecasts are 1-24% below 8.5 100 ■ Investment case 7.8 90 We initiate coverage of UPCH, the those of the Bloomberg consensus, 7.0 80 second-largest manufacturer of as we think UPCH lacks new star 6.3 70 instant noodles in China, with a products and could lose market 5.5 60 Hold (3) rating. share. Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Uni-Pres C (LHS) Relative to HSI (RHS) Noodle quandary. We expect ■ Catalysts UPCH to continue with its heavy We see little scope for upside in the 12-month range 5.56-8.17 promotion of Laotan (spicy and sour share price on a 6-month view. Market cap (USDbn) 3.23 vegetable flavour noodles) and While the likely scaling-back of 3m avg daily turnover (USDm) 3.99 promotions in 2015 should enhance Shares outstanding (m) 4,319 braised-beef products in 2014 before Major shareholder President Enterprise (1216.TT) (70.3%) winding down such activity in 2015 UPCH’s operating margin, the stock and deploying its financial resources may be derated if aggressive Financial summary (CNY) elsewhere. In turn, we forecast the discounts continue. Year to 31 Dec 14E 15E 16E operating margin for its noodles to Revenue (m) 24,943 26,671 28,113 remain negative in 2014 and recover ■ Valuation Operating profit (m) 601 976 1,193 We have a 6-month target price of Net profit (m) 502 756 928 mildly in 2015. On our forecasts, its Core EPS (fully-diluted) 0.127 0.175 0.215 noodle revenue growth should HKD5.60, based on a PER of 30x, EPS change (%) 2.3 38.2 22.7 decelerate to 2-3% YoY in 2015-16 the average of our 2014-15E EPS. Daiwa vs Cons. EPS (%) (23.6) (16.6) (0.7) (from 23%/8% in 2012/2013) and Our target multiple is at about 30% PER (x) 36.8 26.6 21.7 its market-share gains in the premium to the stock’s past-5-year Dividend yield (%) 0.5 1.1 1.4 average 12-month forward PER, as DPS 0.023 0.053 0.064 segment will come to an end. In our PBR (x) 1.8 1.7 1.6 view, there are no new products in we believe the recent rights issue EV/EBITDA (x) 12.5 9.7 8.3 the pipeline that will drive revenue will alleviate concerns about ROE (%) 5.2 6.6 7.6 to the same extent as Laotan. possible equity fundraising and the Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 72 China Packaged Food and Beverage Sector 25 June 2014

1 Buy How do we justify our view? 2 Outperform

3 Hold (initiation)  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  UPCH: reported and recurring net profit (CNYm) In 2013, UPCH’s recurring profit declined 49% YoY to 1,000 200% 174% CNY446m amid margin erosion, but its reported net 150% profit was up 6% YoY to CNY920m thanks to gains on 800 100% the disposal of 2 production plants and Want Want 600 China shares. We forecast its recurring profit to grow by 51% 50% 13%, 51% and 23% YoY in 2014-16, respectively. On our 400 13% 23% 0% forecasts, EPS growth will be slower, at 2% and 38% YoY for 2014-15, respectively, due to dilution from the 200 -40% -48% (50%) rights issue. We forecast revenue growth of 7%, 7% and 0 (100%) 5% YoY for 2014-16, respectively, down from 26% YoY 2011 2012 2013 2014E 2015E 2016E for 2012 and 9% YoY in 2013, as we believe the company Reported net profit (LHS) Recurring net profit (LHS) lacks promising new products and market growth is Recurring net profit YoY % (RHS) likely to slow. Source: Company, Daiwa forecasts

 Valuation  UPCH: 5-year 12-month forward PER bands The stock was rerated in 2011-12, likely due to the (HKD) success of UPCH’s new products (milk tea and Laotan 11 noodles). We do not foresee another rerating over our 10 investment horizon. Based on Bloomberg-consensus 9 forecasts, the stock is trading at a 5% discount to the 8 7 12M forward PER of Tingyi, its largest competitor in 6 China, versus an average discount of 22% over the past 5 5 years. The discount should narrow if, as we expect, 4 UPCH sees a turnaround in its operating margin for 3 noodles. Our target PER of 30x marks about 30% Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 premium to the stock’s past-5-year average, given our May-09 May-10 May-11 May-12 May-13 May-14 expectation of a gradual improvement in the balance 220 HK 9 18 27 36 45 sheet and operating margin on noodles. Source: Bloomberg

 Earnings revisions  UPCH: consensus EPS-forecast revisions (CNY)

The Bloomberg-consensus forecasts for 2014-15 EPS 0.500 have been revised down steadily since 2013 as a result of UPCH’s lower-than-expected interim and full-year 0.400 results, slowing market-share growth, and worsening balance sheet. Our EPS forecasts for 2014 and 2015 are 0.300 respectively 24% and 17% below those of the Bloomberg 0.200 consensus; we see further downside risk to the consensus forecasts as we believe UPCH lacks revenue- 0.100 growth drivers following the success in the market of its Laotan noodles and milk tea in 2010-13. 0.000 J-13 M-13 M-13 J-13 S-13 N-13 J-14 M-14 M-14 2014E 2015E Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales growth YoY - Instant noodles (6.0) 67.4 67.3 22.5 7.7 2.0 3.0 2.0 Sales growth YoY - Beverage (0.2) 27.0 21.5 30.2 8.9 9.8 8.9 7.0 Gross margin % - instant noodles 29.6 28.1 29.3 33.2 29.2 27.4 29.2 29.0 Gross margin % - beverage 42.9 34.1 29.8 35.6 35.8 35.8 35.9 36.5 Sellling and distribution expense ratio 28.3 26.1 25.4 28.2 29.3 28.3 27.4 26.9 (%) Advertising and promotion expense 13.3 11.3 10.0 13.0 12.3 11.5 11.1 10.8

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Instant noodles 2,120 3,549 5,936 7,270 7,826 7,979 8,220 8,386 Tea beverage 4,170 5,005 4,992 5,597 6,143 6,757 7,371 7,740 Other Revenue 2,818 4,037 6,047 8,539 9,328 10,206 11,080 11,988 Total Revenue 9,109 12,591 16,975 21,406 23,297 24,943 26,671 28,113 Other income 77 131 159 246 343 483 483 463 COGS (5,492) (8,548) (12,032) (14,004) (15,518) (16,803) (17,763) (18,596) SG&A (2,927) (3,616) (4,841) (6,766) (7,665) (8,022) (8,415) (8,787) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 767 558 261 882 458 601 976 1,193 Net-interest inc./(exp.) 47 55 95 64 99 (28) (66) (64) Assoc/forex/extraord./others 83 69 63 146 563 70 60 60 Pre-tax profit 896 682 419 1,091 1,120 643 970 1,190 Tax (192) (163) (84) (221) (200) (142) (213) (262) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 705 519 335 870 920 502 756 928 Net profit (adjusted) 705 519 335 870 446 502 756 928 EPS (reported)(CNY) 0.178 0.144 0.093 0.242 0.256 0.127 0.175 0.215 EPS (adjusted)(CNY) 0.178 0.144 0.093 0.242 0.124 0.127 0.175 0.215 EPS (adjusted fully-diluted)(CNY) 0.178 0.144 0.093 0.242 0.124 0.127 0.175 0.215 DPS (CNY) 0.098 0.043 0.026 0.048 0.051 0.023 0.053 0.064 EBIT 767 558 261 882 458 601 976 1,193 EBITDA 1,089 930 800 1,693 1,522 1,896 2,433 2,726

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 896 682 419 1,091 1,120 643 970 1,190 Depreciation and amortisation 323 372 538 811 1,064 1,295 1,457 1,532 Tax paid (192) (157) 37 (202) (259) (142) (213) (262) Change in working capital 122 197 503 646 (572) (323) (54) (45) Other operational CF items (130) (124) (135) (195) (188) (42) 6 4 Cash flow from operations 1,019 971 1,363 2,151 1,165 1,432 2,166 2,419 Capex (580) (1,412) (4,162) (3,578) (4,746) (4,500) (2,000) (1,000) Net (acquisitions)/disposals (120) 0 0 0 950 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (700) (1,412) (4,162) (3,578) (3,796) (4,500) (2,000) (1,000) Change in debt (9) 166 2,930 875 2,033 1,496 0 (300) Net share issues/(repurchases) 0 0 0 0 0 2,665 0 0 Dividends paid (172) (352) (156) (97) (171) (183) (100) (227) Other financing CF items (59) (354) (37) 470 55 (94) (132) (129) Cash flow from financing (239) (540) 2,738 1,247 1,917 3,885 (232) (656) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 80 (981) (61) (180) (714) 817 (66) 763 Free cash flow 439 (441) (2,799) (1,427) (3,581) (3,068) 166 1,419 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 3,384 2,432 2,387 2,295 1,420 2,367 2,421 3,303 Inventory 688 1,139 1,274 1,285 1,514 1,611 1,703 1,783 Accounts receivable 273 401 513 513 548 586 627 660 Other current assets 147 429 443 824 1,026 1,026 1,026 1,026 Total current assets 4,493 4,402 4,617 4,917 4,508 5,590 5,777 6,773 Fixed assets 2,174 3,121 5,579 7,912 10,186 13,397 13,945 13,418 Goodwill & intangibles 13 11 8 7 17 17 17 17 Other non-current assets 1,474 2,047 3,533 3,704 4,258 4,258 4,258 4,258 Total assets 8,154 9,581 13,737 16,540 18,968 23,261 23,996 24,465 Short-term debt 0 166 1,584 409 902 2,000 2,000 1,700 Accounts payable 507 1,020 1,196 1,442 1,410 1,381 1,460 1,528 Other current liabilities 1,172 1,718 2,307 3,098 3,024 2,866 2,866 2,866 Total current liabilities 1,680 2,904 5,087 4,948 5,336 6,247 6,326 6,094 Long-term debt 0 0 1,512 3,562 5,102 5,500 5,500 5,500 Other non-current liabilities 20 17 328 358 388 388 388 388 Total liabilities 1,700 2,921 6,926 8,869 10,826 12,135 12,214 11,982 Share capital 3434343434414141 Reserves/R.E./others 6,420 6,625 6,777 7,637 8,108 11,085 11,741 12,442 Shareholders' equity 6,454 6,660 6,811 7,671 8,142 11,126 11,782 12,483 Minority interests 00000000 Total equity & liabilities 8,154 9,581 13,737 16,540 18,968 23,261 23,996 24,465 EV 16,003 17,030 19,652 20,471 23,209 23,758 23,704 22,521 Net debt/(cash) (3,384) (2,266) 709 1,675 4,584 5,133 5,079 3,897 BVPS (CNY) 1.793 1.850 1.892 2.131 2.262 2.576 2.728 2.890

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) (1.4) 38.2 34.8 26.1 8.8 7.1 6.9 5.4 EBITDA (YoY) 23.9 (14.6) (14.0) 111.7 (10.1) 24.6 28.3 12.0 Operating profit (YoY) 47.6 (27.2) (53.2) 237.4 (48.0) 31.3 62.2 22.3 Net profit (YoY) 105.0 (26.4) (35.5) 159.7 (48.7) 12.5 50.7 22.7 Core EPS (fully-diluted) (YoY) 105.0 (19.0) (35.5) 159.7 (48.7) 2.3 38.2 22.7 Gross-profit margin 39.7 32.1 29.1 34.6 33.4 32.6 33.4 33.9 EBITDA margin 12.0 7.4 4.7 7.9 6.5 7.6 9.1 9.7 Operating-profit margin 8.4 4.4 1.5 4.1 2.0 2.4 3.7 4.2 Net profit margin 7.7 4.1 2.0 4.1 1.9 2.0 2.8 3.3 ROAE 11.6 7.9 5.0 12.0 5.6 5.2 6.6 7.6 ROAA 9.2 5.9 2.9 5.7 2.5 2.4 3.2 3.8 ROCE 12.6 8.4 3.1 8.2 3.6 3.7 5.1 6.1 ROIC 21.8 11.4 3.5 8.3 3.4 3.2 4.6 5.6 Net debt to equity net cash net cash 10.4 21.8 56.3 46.1 43.1 31.2 Effective tax rate 21.4 23.9 20.1 20.3 17.8 22.0 22.0 22.0 Accounts receivable (days) 9.9 9.8 9.8 8.7 8.3 8.3 8.3 8.4 Current ratio (x) 2.7 1.5 0.9 1.0 0.8 0.9 0.9 1.1 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. 21.4 14.8 18.8 Net dividend payout 55.0 30.0 27.9 19.7 19.9 18.3 30.0 30.0 Free cash flow yield 2.2 n.a. n.a. n.a. n.a. n.a. 0.8 7.0 Source: FactSet, Daiwa forecasts

 Company profile Listed in Hong Kong in 2007, Uni-President China (UPCH) is the second-largest instant-noodle manufacturer in China, with a 17.2% market share (2013), according to AC Nielsen. In addition, it was the second-largest ready-to-drink tea brand (24.6% market share) and the largest milk tea brand (60%) in the domestic market in 2013.

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noodles) in 2H12, we believe this will have less impact on UPCH’s revenue given: 1) competitors quickly launched similar products, meaning that UPCH did not establish first-mover advantage, and 2) braised beef noodles are not so different from existing products. In our view, Laotan noodles, mixed with pickled cabbage, Noodles — torn have a distinctive spicy and sour flavour that consumers embraced, whereas braised beef flavour was between growing seen not as a product upgrade but rather as an incremental change. earnings and market share  UPCH: Laotan and braised beef noodles

We believe that UPCH risks losing market share if it discontinues discounts and promotional gifts for its star products. Its operating margin on noodles is likely to Source: Company remain negative this year. In our view, UPCH has launched few new products in the year-to-date. According to the management, it has No new revenue drivers on the extended the free sausage promotion from Laotan and horizon braised beef noodles to roasted beef flavour noodles, a product it has sold for many years but which has a UPCH’s noodle division recorded losses in most years market share of only 10% (vs. 90% for Tingyi). As the between 2004 and 2010. However, after it eliminated company has limited financial resources to promote loss-making low-end products and upgraded its product new products, we believe it has little scope to launch mix in 2008, its profitability in the noodle segment products in 2014, even if it has successfully developed began to improve. Underpinned by its launch of Laotan them. noodles in 2010, the company’s noodle revenue saw a CAGR of 51% between 2009 and 2012. However, growth Moreover, we believe it has become more difficult to in its noodle sales slowed significantly in 2013 as devise and establish distinctive new products in the competitors launched similar products and some market, as competitors now react quickly by launching consumers shifted to other flavours. similar offerings. For example, Tingyi launched its version of Laotan noodles in 2012, almost 3 years after  UPCH: noodle revenue and contribution from Laotan UPCH introduced its version. However, Tingyi (CNYm) launched its braised beef flavour noodles in 4Q12, just 9,000 70% 64% 65% 65% 64% 65% 2 quarters after UPCH had done the same. 8,000 61% 60% 7,000 50% In our view, the risk for Uni-President is that launching 6,000 42% 5,000 40% new noodle products may not be economically prudent if it does not first attain economies of scale. 4,000 30% 3,000 20% 2,000 Aggressive promotions set to continue 10% 1,000 As competitors have launched similar products, 0 0% 2010 2011 2012 2013 2014E 2015E 2016E UPCH’s domestic market share in the Laotan category Revenue (LHS) Laotan as % of segment's revenue (RHS) has gone from 100% to 50-60% currently, on our estimates. To defend its market share and drive sales of Source: Company, Daiwa forecasts its latest products, UPCH began offering a free sausage with every bowl of Laotan and braised beef noodles in We estimate that Laotan currently contributes about 2H12. As a result, its operating margin in the noodle 65% of UPCH’s revenue in the noodle segment. segment declined from 5.2% in 1H12 to 1.2% in 2H12, Although the company followed up on the success of and turned negative in 2013. Laotan with a new star product (braised beef flavour

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UPCH scaled back its promotions in 1Q13 but resumed  UPCH: market share and gross margin in noodle segment (%) them soon after in the face of aggressive promotional 20.0 34 17.2 17.2 17.0 16.7 activity and product launches by competitors. 15.8 32 According to AC Nielsen, the company gained 1.4pp of 13.3 33.2 15.0 market share in the noodle segment in 2013. However, 30 9.5 we believe such promotions won’t be as effective in 28 29.3 29.2 29.2 10.0 winning market share in 2014, as growth in the market 29.0 26 28.1 seems to be shifting from UPCH’s star products to new 27.4 flavours offered by rivals. 24 5.0 22 In 2H13, the company’s noodle revenue growth 20 0.0 decelerated to 5% YoY, from 10% YoY in 1H13, while its 2010 2011 2012 2013 2014E 2015E 2016E competitor Tingyi’s revenue growth accelerated to 12% Gross margin (LHS) Market share (RHS) YoY, from 6% YoY. Hence, we assume that UPCH will Source: Company, AC Nielsen, Daiwa forecasts maintain its market share throughout 2014 by continuing with its aggressive promotions and free gifts.

 UPCH: operating loss and margin in the noodle segment (CNYm) 300 225 4% 3% 200 165 2% 100 43 13 1% 0 0% (1%) (100) (2%) (200) -143 (3%) (300) (4%) -266 2011 2012 2013 2014E 2015E 2016E

Operating profit (LHS) Operating margin (RHS)

Source: Company, Daiwa forecasts

Gross margin forecast to remain under pressure We estimate the free sausage promotion has increased UPCH’s production cost for a bowl of noodles by 7-10% and hence has a 2-3pp impact on its gross margin in the segment. Factoring in other marketing campaign expenses as well, we forecast UPCH’s operating loss in the noodle segment to widen to CNY266m in 2014, from CNY143m in 2013.

Assuming that UPCH stops offering free sausages and scales back its other promotional expenses, we forecast its operating margin in the noodle segment to turn slightly positive in 2015. The risk is that the curtailment of promotional activity puts downward pressure on UPCH’s market share and leads to a slowdown in revenue growth.

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 UPCH: sea-salted lemonade, sugar-free tea, and high-end milk tea

Beverages – steady outlook for revenue and margins

The launch of innovative new beverages should help maintain a steady operating margin in the segment of 6%. We forecast a beverage revenue CAGR of 9% for 2013- 16E.

Strong R&D capability

We believe UPCH has a sound track record of launching differentiated beverages that build its market share and broaden its customer base. In 2009, for example, it launched a milk tea (Asamu brand) in a market formerly dominated by Japan players. The product saw a 78% CAGR in revenue in 2009-13 and by

2013 had a 62% share of the milk-tea segment. Source: Company

Compared with international brands, we think UPCH Going high-end has stronger brand recognition and a broader To drive its profit margin in the beverage segment, distribution network in China, which is reflected in the UPCH is focusing on launching high-end products. In company’s market share nationally. 2H13, it introduced a new milk tea brand (CITEA),

which has a retail ASP of CNY8 per 500ml bottle, The company plans to launch 8-10 new beverage stock- compared with CNY3.5-4 for the Asamu brand. keeping units (SKUs) each year. We are particularly Moreover, it intends to exit the mass-market bottled positive on the prospects for its recently launched sea- water segment (retail ASP: CNY1 per bottle) and shift salt lemonade product, which we expect to help it to its attention to the high-margin spring water segment. sustain 5% pa growth in revenue in the juice segment, even assuming no growth in the overall market over Across the market as a whole, we expect other high- 2014-16. margin products, such as coffee, to see faster revenue growth than other products, given a low base currently in terms of revenue and per-capita consumption.

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 UPCH: high-margin beverage portfolio  Revenue growth and operating margin of beverage business 25,000 8% 7.2% 7% 20,000 5.8% 5.9% 5.8%6% 5.5% 5.6% 15,000 5% 4% 10,000 3% 2.1% 2% 5,000 1% 0 0% Source: Company 2010 2011 2012 2013 2014E 2015E 2016E Revenue (LHS) Milk tea as % of segmetn's revenue We forecast UPCH’s beverage revenue to grow by 10% Source: Company, Daiwa forecasts YoY in 2014, 9% YoY in 2015, and 7% YoY in 2016. These growth rates are well below the 30% YoY growth in beverage revenue recorded in 2012, given that Investing in production capacity market growth is slowing and the company has little exposure to fast-growing categories such as functional to maximise economies of scale drinks and mass-market bottled water. Production plants Considering its brand equity and ability to charge high- UPCH has been investing significantly in its production end prices for some products, we forecast UPCH’s facilities since 2010, and the number of its plants has operating margin in the beverage segment to remain at increased from 13 in 2011 to 28 in 2013. Its goal is to 5.8-5.9% over 2014-16. realise economies of scale more effectively while reducing logistics costs by cutting the distance between  Revenue growth by segment and proportion of milk tea plants and markets. (CNYm) (%) 20,000 40 18,000 However, as a result of this initiative, we see a risk to 16,000 30 30 profit margins in the near term if the company cannot 14,000 27 12,000 utilise its new capacity and maintain its utilisation rate 10,000 22 20 (2013: 60%-70% for beverages, 60% for noodles). We 8,000 6,000 assume that over 2014-16 UPCH will reduce its ratio of 9 10 9 10 4,000 7 outsourced production in order to maintain its 2,000 utilisation rate. 0 0 2009 2010 2011 2012 2013 2014E 2015E 2016E Others Milk tea Juice Drinks Bottled tea YoY % (RHS) Milk tea as % of segmetn's revenue Source: Company, Daiwa forecasts

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 UPCH: production expansion from 13 plants in 2011 to 28 in 2013

Source: Company

Distribution Reflecting UPCH’s brand recognition, and the popularity of its beverages, the company’s products’ penetration of modern retail channels (hypermarkets, supermarkets and convenience store chains) is high and comparable to that of major international and domestic players. Its products are also widely available in urban areas.

However, despite its status as the second-largest instant noodle player in China, we believe the penetration of UPCH products in terms of distribution is less than that of market leader Tingyi. We attribute the company’s weakness in this regard to the following factors: 1) its less efficient product distribution, particularly in northern and north-eastern China, where it has only 4 plants currently, which makes delivery of products to rural areas and lower-tier cities more costly, 2) its less extensive product portfolio compared with Tingyi, which is therefore better placed to meet retailers’ demand for a wide variety of products, and 3) its relative lack of financial and human resources, given its smaller scale at present.

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Gross-margin trends Assuming further product-mix upgrades and an increase in its in-house production, we forecast UPCH to maintain a gross margin on beverages of more than 35% over 2013-16. For the noodle operation, we expect Financials the gross margin in 2014 to decline by 1.8pp YoY (from 29.2% in 2013) as heavy promotional activity continues. However, we expect the free sausage gift to We forecast UPCH’s reported net profit to come to an end in 2015, as UPCH needs to return to grow by 13%, 51% and 23% YoY in 2014- profitability within the segment and strengthen its cash flow. 16, respectively. Following its rights issue in June 2014, we expect net gearing to  UPCH: gross margin by segment (%) decline to 46% in 2014, from 56% in 2013. 36.5 38 35.6 35.8 35.8 35.9 36 34.1 34 ROE likely to remain weak 32 29.8 33.2 30 UPCH’s recurring net profit fell by 48% YoY in 2013, 28 29.3 29.2 29.2 29.0 26 28.1 due largely to its operating loss in the noodle segment. 27.4 We forecast its recurring net profit to grow by 13% YoY 24 for 2014, 51% YoY for 2015, and 23% YoY for 2016. 22 20 2010 2011 2012 2013 2014E 2015E 2016E Despite the rapid increase in its net gearing, from 22% Instant noodles Beverage in 2012 to 56% in 2013, we forecast the company’s ROE to remain subdued, at 5.2-7.6% over our forecast Source: Company, Daiwa forecasts horizon, given our expectation of weak operating margins, particularly for noodles. Our forecast for a Operating margin and selling expenses sharp YoY increase in its net profit for 2015 reflects our UPCH’s operating margin has come under pressure in assumption that UPCH will cut promotional expenses recent years in the face of keen competition in the for the noodle business. noodle market. Assuming its free cash flow remains weak over 2014-16, we expect UPCH to maintain its  UPCH: ROE and net profit full-year advertising expenses at CNY2.9-3bn over the (CNYm) same period; such expenses as a proportion of overall 1,000 14% revenue should fall from 12.3% in 2013 to 11.5% in 12.0% 12% 2014 and 11.1% in 2015. 800 10% 600 On our forecasts, the selling expense ratio will improve 7.9% 7.6%8% 6.6% from 29.3% in 2013 to 28.3% in 2014 and 27.4% in 400 5.6% 6% 5.0% 5.2% 2015 as the company’s production is gradually built up. 4% 200 2%  UPCH: operating margin and selling expense ratio 0 0% 8,000 0 2010 2011 2012 2013 2014E 2015E 2016E 4.4% 7,000 4.2% 4.1% 0 Reported net profit (LHS) Exceptional item (LHS) ROE (RHS) 6,000 3.7% Source: Company, Daiwa forecasts 5,000 0 4,000 2.4% 3,000 2.0% 0 1.5% 2,000 0 1,000 0 0 2010 2011 2012 2013 2014E 2015E 2016E Advertising expenses (LHS) Other selling expenses (LHS) Operating margin (RHS) Source: Company, Daiwa forecasts

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Tax. We forecast UPCH’s effective tax rate to be 22% over 2014-16E, versus 18% in 2013. Its effective tax rate is lower than the standard tax rate for China enterprises (25%), as some of its subsidiaries enjoy favourable tax treatment as part of the government’s efforts to support the development of the country’s western regions.

Dividend. We expect UPCH to maintain a 30% payout ratio (of recurring net profit) over 2015-16E.

Free cash flow remains negative, gearing to improve slowly On 12 May 2014, UPCH announced a rights issue (one share issued at HKD4.56 per share for every 5 shares held). The company’s major shareholder, Uni- President Enterprises, has taken up the rights issue, and we expect UPCH to realise total proceeds of CNY2.7bn before the end of June.

However, as UPCH has budgeted CNY4.5bn of capex for 2014, we expect its net gearing to remain high, at 43-46% over 2014-15, due to weak free cash flow.

 Net gearing and free cash flow 2,000 60% 56.3% 1,000 50% 46.1% 43.1% 0 40%

(1,000) 31.2%30%

(2,000) 21.8% 20%

(3,000) 10.4% 10%

(4,000) 0.0% 0% 2010 2011 2012 2013 2014E 2015E 2016E

Free cashflow (LHS) Net gearing (RHS)

Source: Company, Daiwa forecasts

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 UPCH: 12-month forward PER bands (HKD) 11 10 9 8 Valuation 7 6 5 We initiate coverage of UPCH with a 4 3 Hold (3) rating and a target price of Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 HKD5.60, based on 30x the average of May-09 May-10 May-11 May-12 May-13 May-14 our 2014-15E EPS forecasts. Implied 220 HK 9 18 27 36 45 Source: Bloomberg downside stands at 3%. UPCH has traded at a discount to its major competitor, Tingyi, for much of the past 5 years. The discount Risk of further equity fundraising narrowed gradually between 2009 and 2012 before has receded becoming a premium for around 1 year beginning in mid-2012, as UPCH closed the market-share gap To value UPCH, we use the average of our 2014-15 EPS between it and Tingyi and expanded its operating-profit forecasts and assign a target PER of 30x, which is margin. In addition, its earnings growth exceeded that of about 30% above the stock’s past-5-year average Tingyi in 2011-12, albeit from a lower base. multiple. The premium is in line with the average at which UPCH has traded in 2012, when it reported a However, we believe the stock’s discount to Tingyi will 160% YoY increase in reported EPS. We believe UPCH narrow in 2H14 and 2015 if, as we expect, UPCH has the potential to trade at similar premium again, catches up with its rival in terms of its operating given the significant improvement in EPS growth margin and improves its balance sheet. expected for 2015-16E. We believe the 30% premium is justified by: 1) the recent rights issue, which should Tingyi’s operating margin has been higher than alleviate investors’ concerns on further equity fund UPCH’s since 2009 (for Tingyi it has ranged from 6.7- raising, the proceeds of which will be used to reduce 9.1%, and for UPCH it has ranged from 2-4.4%) due to the company’s net gearing (we forecast it to drop from the latter’s lack of economies of scale. We see the 56% for 2013 to 46% for 2014), and 2) the turnaround potential over the long term for UPCH’s margin to that we expect in its operating margin for the noodle improve if its economies of scale improve. segment in 2015.  UPCH: 12-month forward PER discount (premium) to Tingyi (%)  UPCH: revenue and earnings trend and our forecasts vs. consensus 80 2012 2013 2014E 2015E 2016E 60 Revenue (CNYm) 21,406 23,297 24,943 26,671 28,113 40 YoY (%) 26 9 7 7 5 Var. vs. consensus (%) n.a. n.a. -5 -10 -13 20 Recurring net profit (CNYm) 870 446 502 756 928 0 YoY (%) 160 -48 13 51 23 Var. vs. consensus (%) n.a. n.a. -23 -4 0 (20) EPS (CNY) 0.24 0.12 0.13 0.18 0.22 (40) YoY (%) 160 -49 2 38 23 Var. vs. consensus (%) n.a. n.a. -23 -17 0 (60) Source: Bloomberg, Daiwa forecasts (80) J-09 J-09 J-10 J-10 J-11 J-11 J-12 J-12 J-13 J-13 J-14 A-09 A-10 A-11 A-12 A-13 A-14 O-09 O-10 O-11 O-12 O-13

Source: Bloomberg, Daiwa

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 UPCH and peers: valuation summary Bloomberg Daiwa Mkt. cap Share price Stock Δ % PER (x) EPS change (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) ROE (%) Company code rating (USDm) 23-June-14 3M 1M 2013 2014e 2015e 2016e 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Average (ex-UPCH) 27.7 24.1 19.2 16.2 -1.8 16.1 23.1 13.6 12.1 10.0 16.7 20.1 16.3 9.4 12.8 13.6 18.0 Source: Bloomberg,* Daiwa forecasts

- 68 - China Packaged Food and Beverage Sector 25 June 2014

brand and the largest milk-tea brand, with market Investment catalysts and risks shares of 24.6% and 60%, respectively, in 2013.

Upside risks Its parent company, Uni-President Enterprise (1216 Earlier-than-expected reductions in budget TT, TWD52.8, Outperform [2]), which has a 70% stake, for aggressive promotions and capex is one of the largest food and beverage producers in Taiwan. We forecast UPCH’s advertising and promotion expenditure (as a percentage of revenue) to decline UPCH’s major beverage products include RTD tea, from 12.3% in 2013 to 11-12% in 2014-16. We also note juice, milk tea, coffee and bottled spring water. As of 31 the company has budgeted for CNY4.5bn in capex for December 2013, UPCH owned 28 plants in 25 2014 for expansion, which is well below our forecast for provinces in China. its operating cash flow of CNY1.4bn. If these expenses were to decline, investors’ concerns about UPCH’s  UPCH: shareholding structure stretched balance sheet would likely be alleviated. Public shareholders Uni-President Enterprises (1216.TT) Downside risks 30% Nissin Hualong Foods 70% Product concentration For 2013, we estimate that Laotan contributed about Uni-President China (220.HK) 60% of the company’s revenue in the noodle segment, while milk tea accounted for about 30% of its beverage revenue. A sudden shift in consumers’ preferences or 0.5% - 15% 40% food-safety issues affecting the noodle or beverage Beverage Instant noodles Wondersun Dairy, Andre Juice Jinmailang JV segments could have a big impact on UPCH, given it (8259.HK). etc has a less diverse product range than the other major

F&B players. Source: Company

Decline in utilisation rate  UPCH: revenue breakdown by segment (2013) UPCH has expanded its production capacity rapidly in Others 1.4% recent years, particularly for beverages. According to Other beverage 20.4% management, it had capacity utilisation rates of only Instant noodles 60% for beverages and 60-70% for noodles in 2013. If 33.6% sales volumes were to fall below the company’s expectations, we believe the decline in its utilisation rate would have a bigger impact on UPCH than its rivals in terms of operating leverage. Juice 18.3% Commodity prices We forecast flour and palm oil to account for 15% and RTD tea 26.4% 10%, respectively, of UPCH’s COGS for noodles in Source: Company 2014. As for beverages, we forecast PET chips and sugar to account for 60% and 10%, respectively, of the Among its best-known products are More brand juices, company’s COGS in the segment in 2014. Beverage Iced brand and Unif Green Tea in the RTD tea production costs have been declining since 2013, and a segment, and Lai Yi Tong (來一桶), Unif-100 (統一100) rebound in sugar and/or PET chip costs could lead to 巧麵館 gross-margin erosion for the company. and Qiaom Mian Guan ( ) instant noodles.

In addition to its core businesses, UPCH has invested Company background in various F&B enterprises, including the Jinmailang Beverage joint venture, and holds minority stakes in Listed in Hong Kong in 2007, UPCH is the second- Andre Juice (08259 HK, Not rated) and Wondersun largest instant-noodle manufacturer in China, with a Dairy (not listed). 17.2% market share in 2013, according to AC Nielsen. It is also the second-largest ready-to-drink (RTD) tea

- 69 - China Packaged Food and Beverage Sector 25 June 2014

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Deputy Head of Asia Pacific Research Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Rohan DALZIELL (852) 2848 4938 [email protected] Shipbuilding; Steel Regional Head of Product Management Jun Yong BANG (82) 2 787 9168 [email protected] Kevin LAI (852) 2848 4926 [email protected] Tyres; Chemicals Deputy Head of Regional Economics; Macro Economics (Regional) Mike OH (82) 2 787 9179 [email protected] Christie CHIEN (852) 2848 4482 [email protected] Capital Goods (Construction and Machinery) Macro Economics (Taiwan) Sang Hee PARK (82) 2 787 9165 [email protected] Jonas KAN (852) 2848 4439 [email protected] Consumer/Retail Head of Hong Kong Research; Head of Hong Kong and China Property Thomas Y KWON (82) 2 787 9181 [email protected] Jerry YANG (852) 2773 8842 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Banking (Taiwan); Insurance (Taiwan and China) Leon QI (852) 2532 4381 [email protected] TAIWAN Banking (Hong Kong, China); Broker (China) Mark CHANG (886) 2 8758 6245 [email protected] Alison LAW (852) 2532 4308 [email protected] Head of Taiwan Research Head of Regional Consumer; Consumer (Hong Kong/China); Gaming and Leisure Steven TSENG (886) 2 8758 6252 [email protected] (Hong Kong, China) IT/Technology Hardware (PC Hardware) Jamie SOO (852) 2773 8529 [email protected] Christine WANG (886) 2 8758 6249 [email protected] Consumer (Hong Kong/China) IT/Technology Hardware (Automation); Cement; Consumer Anson CHAN (852) 2532 4350 [email protected] Kylie HUANG (886) 2 8758 6248 [email protected] Consumer (Hong Kong/China) IT/Technology Hardware (Handsets and Components) Eric CHEN (852) 2773 8702 [email protected] Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) INDIA Lynn CHENG (852) 2773 8822 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] IT/Electronics (Semiconductor) Head of India Research; Strategy; Banking/Finance Felix LAM (852) 2532 4341 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Materials (Hong Kong, China); Cement and Building Materials (China, Capital Goods; Utilities Taiwan); Property (China)

Dennis IP (852) 2848 4068 [email protected] SINGAPORE Power; Utilities; Renewables and Environment (Hong Kong/China) Adrian LOH (65) 6499 6548 [email protected] John CHOI (852) 2773 8730 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China) China); Capital Goods (Singapore) Jackson YU (852) 2848 4976 [email protected] Benjamin LIM (65) 6321 3086 [email protected] Small/Mid Cap (Regional) Oil and Gas (ASEAN and China); Capital Goods (Singapore) Joey CHEN (852) 2848 4483 [email protected] Angeline LOH (65) 6499 6570 [email protected] Steel (China) Banking/Finance, Consumer/Retail Kelvin LAU (852) 2848 4467 [email protected] David LUM (65) 6329 2102 [email protected] Head of Transportation (Hong Kong, China); Transportation (Regional) Property and REITs Jibo MA (852) 2848 4489 [email protected] Evon TAN (65) 6499 6546 [email protected] Head of Custom Products Group; Custom Products Group Property and REITs Thomas HO (852) 2773 8716 [email protected] Ramakrishna MARUVADA (65) 6499 6543 [email protected] Custom Products Group Head of ASEAN & India Telecommunications; Telecommunications (China, ASEAN & India) Jame OSMAN (65) 6321 3092 [email protected] Telecom (ASEAN & India); Pharmaceuticals and Healthcare (Singapore)

- 70 - China Packaged Food and Beverage Sector 25 June 2014

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- 71 - China Packaged Food and Beverage Sector 25 June 2014

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Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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