China Consumer Staples Sector

China Consumer Staples 26 January 2016

Switch focus to the small wonders

 With cost tailwinds likely to ease in 2016, we recommend focusing on fast-growing categories and premium products  We prefer small companies with revenue upside (“Davids”) over giants that can’t respond quickly to changing market dynamics (“Goliaths”) Anson Chan, CFA  Buy selectively: we like Vinda and upgrade UPCH to Buy (1); we (852) 2532 4350 downgrade Hengan, Tingyi and Fufeng to Hold (3) [email protected]

What's new: We are cutting 2016-17E EPS for 9 of the 12 China Key stock calls Consumer Staples companies by 2-33%. On our new numbers, the stocks New Prev. under Daiwa coverage are trading at PER discounts to international peers Uni-President China (220 HK) Rating Buy Underperform (16x 2016E PER vs. 21x), despite the peers having slower EPS growth Target 6.20 7.00 (9% vs. 16% for packaged food companies, per Bloomberg). We believe Upside p 19.2% this disparity indicates the risk of an EPS growth slowdown for the China Vinda International (3331 HK) players is priced in. In 2016E, we expect: 1) the revenue of most staples Rating Outperform Outperform players to slow further YoY from a relatively high base, and 2) gross-margin Target 14.30 17.40 expansion to slow as cost tailwinds ease. We remain Neutral on the sector. Upside p 10% Want Want China (151 HK) Rating Buy Buy What's the impact: Shift from big to small, old to new. We cut 2015- Target 7.30 8.50 17E revenue for 11 of the 12 companies by 1-14%, due mainly to: 1) shifts Upside p 47.2% in market share and channels, which often favour small players with new hit Hengan International Group (1044 HK) products and foreign brands, and 2) a high consumption base for items like Rating Hold Outperform beer and noodles, which means that market-share leaders can no longer Target 66.00 87.00 rely on their strengths (traditional distribution networks, dominant shares in Downside q 2.6% key categories), whereas small players are well placed because of their Tingyi Cayman Islands (322 HK) Rating Hold Outperform flexibility in product launches. For example, we forecast Vinda to see a Target 9.60 12.90 revenue CAGR of 23% over 2015-17 due to its increasing exposure to Upside p 5.8%

online channels, as well as acquisitions, vs. a flat (0%) CAGR for Hengan. Source: Daiwa forecasts

Cost tailwinds to subside: We still expect slight gross-margin expansion Daiwa’s China Staples Sector coverage for most of the staples downstream companies in 2016E (up <1pp YoY), Recommendation driven mainly by product-mix changes. Our growth forecasts are much The Davids Vinda Outperform (2) weaker than the surge seen in 2015E (2-4pp), as we believe some Modern Dairy Buy (1) commodity costs will rebound from a low base. At the same time, the weak Huishan Sell (5) CNY:USD will likely weigh on companies with large proportions of USD Uni-President China Buy (1) The Goliaths debt and/or imported raw materials. Hengan and Vinda have the most USD Hengan Hold (3) exposure in terms of their COGS (30-60%). Mengniu Hold (3) Tingyi Hold (3) Tsingtao Underperform (4) What we recommend: We like relatively small companies with the potential China Resources Beer Hold (3) for revenue growth on market-share gains and/or product-mix Fufeng Hold (3) improvements. Hence, we upgrade Uni-President China (UPCH) (220 HK, The Somewhere in betweens Want Want Buy (1) HKD5.20) to Buy (1), from Underperform (4); we also like Vinda (3331 HK, WH Group Outperform (2)

HKD13.0, Outperform [2]). Want Want (151 HK, HKD4.96, Buy [1]) is our Source: Daiwa sole Buy (1) among the large-cap staples companies (strong cash flow, share buyback support). Meanwhile, we downgrade Hengan (1044 HK, HKD67.75), Tingyi (322 HK, HKD9.07) and Fufeng (546 HK, HKD2.61) to Hold (3) on price competition and potentially slow volume growth.

How we differ: Our 2016-17E revenue and EPS are 1-9% and 2-39%, respectively, lower than consensus, reflecting our concern about market- share losses among the big players, and our bearish CNY assumptions.

See important disclosures, including any required research certifications, beginning on page 81

China Consumer Staples Sector: 26 January 2016

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 China Huishan Dairy Holdings 6863 HK 2.95 Sell Sell 1.87 1.60 16.9% 0.055 0.056 (1.9%) 0.073 0.088 (17.9%) China Mengniu Dairy 2319 HK 11.08 Hold Hold 11.70 14.50 (19.3%) 0.663 0.695 (4.5%) 0.636 0.752 (15.4%) China Modern Dairy Holdings 1117 HK 1.45 Buy Buy 3.00 3.30 (9.1%) 0.126 0.156 (19.5%) 0.172 0.214 (19.6%) China Resources Beer 291 HK 12.30 Hold Hold 12.40 13.40 (7.5%) 0.361 0.399 (9.6%) 0.530 0.517 2.5% Fufeng Group 546 HK 2.61 Hold Buy 2.55 5.00 (49.0%) 0.241 0.254 (5.0%) 0.260 0.348 (25.1%) Hengan International Group 1044 HK 67.75 Hold Outperform 66.00 87.00 (24.1%) 3.487 3.742 (6.8%) 3.675 4.195 (12.4%) Tingyi Cayman Islands 322 HK 9.07 Hold Outperform 9.60 12.90 (25.6%) 0.067 0.069 (3.9%) 0.069 0.079 (12.4%) Tsingtao Brewery 168 HK 28.80 Underperform Underperform 26.80 32.00 (16.3%) 1.211 1.305 (7.2%) 1.191 1.330 (10.4%) Uni-President China 220 HK 5.20 Buy Underperform 6.20 7.00 (11.4%) 0.195 0.197 (0.9%) 0.232 0.219 6.2% Vinda International 3331 HK 13.00 Outperform Outperform 14.30 17.40 (17.8%) 0.479 0.641 (25.3%) 0.570 0.851 (33.1%) Want Want China 151 HK 4.96 Buy Buy 7.30 8.50 (14.1%) 0.042 0.046 (9.7%) 0.050 0.054 (7.8%) WH Group 288 HK 4.40 Outperform Outperform 4.80 5.50 (12.7%) 0.042 0.041 1.8% 0.056 0.054 2.6% Source: Bloomberg, Daiwa forecasts

Daiwa’s China Staples Sector coverage: the Davids, the Goliaths, and the somewhere in-betweens Recommendation Product Revenue YoY% Gross profit margin % 2015E 2016E 2017E 2015E 2016E 2017E The Davids Vinda Outperform (2) Tissue paper and personal hygiene products 18.0% 31.0% 16.2% 31.5% 32.1% 32.1% Modern Dairy Buy (1) Raw milk and dairy products -0.9% 8.5% 7.8% 34.4% 35.5% 40.6% Huishan # Sell (5) Raw milk and dairy products 13.9% 24.3% 13.8% 57.5% 55.9% 56.5% Uni-President China Buy (1) Instant noodles and bottled drinks 5.1% 8.0% 4.9% 35.4% 36.2% 36.1% The Goliaths Hengan Hold (3) Tissue paper and personal hygiene products 2.0% -0.8% 1.1% 48.8% 49.5% 49.3% Mengniu Hold (3) Dairy products -1.9% 3.7% 2.5% 32.2% 31.2% 31.5% Tingyi Hold (3) Instant noodles and bottled drinks -9.4% 0.6% 2.5% 32.5% 32.3% 32.8% Tsingtao Underperform (4) Beer -3.3% -4.2% 1.4% 31.4% 32.0% 32.7% China Resources Beer Hold (3) Beer n.a. 3.8% 4.5% 34.6% 35.8% 36.4% Fufeng Hold (3) MSG 4.1% 9.4% 1.0% 16.2% 14.7% 15.5% The Somewhere in betweens Want Want Buy (1) Snacks, dairy products -6.5% 6.1% 6.9% 43.6% 43.9% 43.8% WH Group Outperform (2) Fresh and processed pork -1.0% 6.1% 5.4% 15.9% 15.6% 15.6%

Source: Daiwa forecasts Note: #FY16-18E numbers for Huishan as the company’s year-end is on 31 March

China Consumer Staples Sector: contribution of commodities to 2016E COGS (downstream) and revenue (upstream) (%) Snacks/ Industry dairy beverage Soft drinks and noodles Dairy products Brewery Personal-care products Packaged meat Company Want Want Tingyi UPC Mengniu Huishan Modern Dairy Tsingtao/CRB Hengan Vinda WH Group Locally sourced /sourced in non-USD currencies Palm oil <2 7 7

Flour <3 8 8

Sugar 5 5 5 3-5%

PET chips <5 30 30 <10 <5%

China: 7 0-80% Pork of COGS ~30% of Raw Milk <3 30-40 ~80% of revenue revenue Corn Feed: 70% of upstream operation

Sourced overseas

Milk powder 15% 10%

Wood pulp – short fibre ~10-15% 50-60% Wood pulp – long fibre

Source: Daiwa estimates

China Consumer Staples Sector: 26 January 2016

Table of contents

2016: the year when strengths become weaknesses ...... 4 Big players are likely to underperform this year...... 4 Prefer the Davids to the Goliaths ...... 10 Cost tailwinds to subside ...... 13 Cost trends turned neutral on gross margins ...... 13 Impact of CNY depreciation – mainly on the debt side ...... 18 Valuations and recommendations ...... 20 Rerating opportunity for selected stocks ...... 20 The Davids ...... 22 The Goliaths ...... 24 The somewhere in-betweens ...... 27 Risk ...... 28 Commodity prices – main risks, upside or downside ...... 28 Downside ...... 28

Company Section Uni-President China ...... 29 Vinda International ...... 33 Want Want China ...... 37 China Modern Dairy Holdings ...... 41 WH Group ...... 46 China Resources Beer ...... 50 Hengan International Group ...... 54 Tingyi Cayman Islands ...... 58 China Mengniu Dairy ...... 62 Fufeng Group ...... 66 Tsingtao Brewery ...... 70 China Huishan Dairy Holdings ...... 74

China Consumer Staples Sector: 26 January 2016

2016: the year when strengths become weaknesses

We believe a combination of consumers’ changing preferences and macro headwinds led to a slowdown in revenue growth (and in some cases declines in revenue) for the big China staples players in 2015, and we see this situation persisting into 2016.

Most staples categories Amid cost normalisation, we think promotions in commodity-like segments such as UHT in China have seen flat milk and bottled water will weigh on companies’ gross margins in 2016E. Hence, we prefer revenue, if not YoY the small players, which we see as more nimble and quicker to adapt to changes in the declines, since 2014 macro picture through product premiumisation and new business initiatives (eg, M&A and from a low revenue base). By contrast, we believe the big players will struggle to expand their top lines from a high base.

For example, we expect Modern Dairy’s gross margin to expand significantly over 2015- 17E despite its exposure to pricing risks, as we forecast an increasing revenue and profit contribution from its downstream operation.

We show below our coverage universe split into 3 groups: the big players (the Goliaths), the small players (the Davids), and then those in between. For the purposes of this report, ‘big’ means a company with a dominant or near-dominant market share and/or a national presence with its distribution network. Among the Goliaths, we note that, since 2014, revenue growth has turned negative or at best has been flat.

However, among the Davids, we see potential for even faster revenue growth and ASP hikes (vs. the Goliaths) on the back of improving penetration and expanding production/ distribution scale. We think the Davids have also shown more flexible sales and marketing strategies than the Goliaths, as evidenced by their accelerated revenue growth in 2015.

Our third group, those companies “somewhere in between”, are involved in a few sub- segments (some fast-growing, others slow-growing) or are the leading players in fragmented industries with low per-capita consumption.

Daiwa’s China Staples Sector coverage: the Davids, Goliaths, and somewhere in-betweens Recommendation Product Revenue YoY% Gross-profit margin % 2015E 2016E 2017E 2015E 2016E 2017E The Davids Vinda Outperform (2) Tissue paper and personal hygiene products 18.0% 31.0% 16.2% 31.5% 32.1% 32.1% Modern Dairy Buy (1) Raw milk and dairy products -0.9% 8.5% 7.8% 34.4% 35.5% 40.6% Huishan # Sell (5) Raw milk and dairy products 13.9% 24.3% 13.8% 57.5% 55.9% 56.5% Uni-President China Buy (1) Instant noodles and bottled drinks 5.1% 8.0% 4.9% 35.4% 36.2% 36.1% The Goliaths Hengan Hold (3) Tissue paper and personal hygiene products 2.0% -0.8% 1.1% 48.8% 49.5% 49.3% Mengniu Hold (3) Dairy products -1.9% 3.7% 2.5% 32.2% 31.2% 31.5% Tingyi Hold (3) Instant noodles and bottled drinks -9.4% 0.6% 2.5% 32.5% 32.3% 32.8% Tsingtao Underperform (4) Beer -3.3% -4.2% 1.4% 31.4% 32.0% 32.7% China Resources Beer Hold (3) Beer n.a. 3.8% 4.5% 34.6% 35.8% 36.4% Fufeng Hold (3) MSG 4.1% 9.4% 1.0% 16.2% 14.7% 15.5% The somewhere in betweens Want Want Buy (1) Snacks, dairy products -6.5% 6.1% 6.9% 43.6% 43.9% 43.8% WH Group Outperform (2) Fresh and processed pork -1.0% 6.1% 5.4% 15.9% 15.6% 15.6%

Source: Daiwa Note: #FY16-18E numbers for Huishan as the company’s year-end is on 31 March

Big players are likely to underperform this year Challenging conditions for big players to realise revenue growth In a fast-growing economy and consumer market like China, it is natural for the revenue growth of large companies with significant market shares (say, 25-50%) to track the revenue growth of the broader sector. At the same time, given the high bases for comparison, it becomes ever more difficult for giant companies to expand their revenue

China Consumer Staples Sector: 26 January 2016

bases. As we see it, the sector is now at a point where revenue momentum can no longer be driven by market-share gains or growth in per-capita consumption. Price cuts or promotions cannot contribute significant growth for most segments, in our view, due to the high base in 2015 the big companies are up against.

Revenue growth looks As illustrated in the exhibits below, China’s per capita consumption of items such as beer difficult for the big and noodles already exceeds the global average. Moreover, sales volumes in both players given a high categories have declined in each of the past 2 years. For other categories, including wine, base China’s per-capita consumption is still less than half of the global average. Indeed, even in the developed US market, wine consumption saw a 20% CAGR over 2013-15E.

Per capita consumption: China vs. global average China: industry sales growth by segment (2012-15) China Global average Japan US YoY% Wine (litre) 1.2 3.4 2.7 10.3 20 Beer (litre) 35.3 28.0 43.0 77.0 15 Noodles (packs) 31.7 14.7 43.3 13.3 Dairy (kg) 28.9 110.7 58.0 100.0 10 Snacks (USD) 40.4 54.5 n.a. 242.9 Tissue paper (kg) 4.7 4.5 15.0 22.0

(5)

(10) 2012 2013 2014 9M/1H15* Beer Noodles Juice-drinks Bottled tea Liquid milk

Source: Daiwa estimates, Bureau of Statistics, World Instant Noodles Association, AC Nielsen Source: Beer: Bureaus of Statistics, Others: AC Nielsen Note: *1H15 data for Juice/tea, 9M15 data for beer and noodles

In our view, the big players used to be able to leverage their scale to grow their revenue and profits rapidly. But now that consumption growth in key categories has slowed, and because consumer tastes in terms of products and purchase methods are changing, the Goliaths face an uphill struggle to realise the kind of revenue momentum they have seen in the past 5 years.

Below we highlight several changes that we believe will favour smaller or niche players, given their smaller revenue bases and greater flexibility to adapt to new market dynamics.

Changing battlefield Distribution channels According to China’s National Bureau of Statistics, online retail sales were up 35% YoY for the period January-November 2015, vs. a rise of 10.6% YoY for total retail sales. For the same period, sales of fast-moving consumer goods (FCMG), which we consider to comprise largely staples, grew slowly by below 5% YoY, on our estimates, albeit from a lower base.

According to a report by Bain & Co and Kanta Worldpanel, international consultancies with a focus on the consumer industry, overall FMCG revenue in China in 2014 was up 5.4% YoY and the rise was mainly price-driven. By contrast, online sales expanded by 38% YoY in the same year, which suggests that some consumers have shifted their buying from physical stores to online channels. Further, Bain forecasts the online segment to contribute 25% of FMCG sales in China by 2025E, which implies that online sales will grow 20% faster than offline sales on an annualised basis.

Although the offline segment looks set to remain the major retail channel for FMCG in the future (in developed economies like the UK and Korea, offline retail accounts for around 90% of FMCG revenue), online retail has become an important growth engine. In turn, FMCG products and staples companies are likely to continue increasing the resources and focus they devote to the online channel. By extension, we believe that companies’ existing

China Consumer Staples Sector: 26 January 2016

strengths in the traditional channel will be less effective in driving revenue growth and defending their market share going forward. Staples items now sold online in China include infant formula (>15% of total sales in China by channel) and nappies/diapers (>30%), relatively high-value products (per item) for which international brands tend to be the most popular. But we are also seeing rapid growth in online revenue for daily-use items such as tissue paper (less than 5% YoY growth by volume in hypermarket channels in 2015, vs. 20%-plus growth online, on our estimates).

We believe the disparity in sales growth between online and offline channels will continue, underlining the need for staples brands to expand their presence online. On our estimates, most of the staples companies under our coverage currently derive less than 3% of their revenue from online platforms. The one exception is Vinda, which derived 10% of its revenue from online retail channels in 1H15.

In 2016E, we believe revenue growth from online platforms for personal hygiene products will outpace that for other staples segments, since consumers seem to have adapted quickly to buying such products online.

FMCG: online market share by country China FMCG: market share by channel 35 100% 30 80% 25 60% 20

15 15 40%

10 20%

5 0% 1.6 2.2 2012 2013 2014 0 2012 2014 2025E Other Convenience store Grocery stores Hypermarket China France Korea UK Supermarkets and minimarts E-commerce Source: Kanta Worldpanel Source: Kanta Worldpanel

Demographics Chinese consumption Consumers are still price-sensitive, but many are now starting to consider food quality, power is still growing safety and taste when purchasing FMCGs. As shown below, the income levels of urban citizens increased by a 13% CAGR between 2004 and 2014 (10% on an inflation-adjusted base), showing real consumption power increased. Moreover, the dependency ratio also declined to 36% in 2014 from 41% in 2004 according to government statistics, meaning that the new consumption class (from students to working class) has more money than their parents did to spend on themselves.

China: income levels – 10 years ago vs now, adjusted for CPI Chine: no. of households by monthly income (CNY 000) CNY % 500 50,000 50 400 40,000 40 300 30,000 30

20,000 20 200

10,000 10 100 60 0 0 0 6 21

2014 2020E 2030E

2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2012 2013 2014 2000 Affluent (>23) Upper middle ( 12- 23) Annual salary of urban employee (inflation-adjusted) Middle ( 8 - 12) Emerging Middle ( 5 -8 ) Aspirant (2.8 - 5) Poor <2.8 Dependency ratio (RHS) Source: : Bureau of Statistics, Daiwa estimate Source: Boston Consulting Group report

China Consumer Staples Sector: 26 January 2016

New products can attract During 2H15, we met the managements of a number of consumer companies across new customers but also different segments – packaged food, beverages, sportswear distribution, personal care lead to cannibalisation products, etc. Many of them said they had developed a product mix and marketing strategies to target the top 20-30% of the household/income class. We note that Tingyi and UPCH launched new products in high-end categories in 2Q-4Q15 (at retail ASPs at least 20% above their mass-market products). Their new products have also focused on the value of nutrients and health (eg, MSG free instant noodles, sugar-free tea, nectars, etc).

Faster category shift and shorter product life cycle However, the life cycles for new products are becoming shorter, a trend that is particularly obvious for beverage products. Over the past 5 years, we have seen revenue growth for pear juice accelerate and then slow down (up 50% YoY in 2012, then flat/declining over 2013-15), the market size for milk tea almost double (revenue rising by 82% YoY for 2012, falling to 9% YoY in 2013), and revenue growth for room temperature yoghurt drinks rise by more than 100% pa over 2011-13, then slow to 35% in 2014. In other words, these new beverage categories experienced fast revenue growth within the first 2-3 years of launch, but most saw revenue growth slow significantly, or even reverse to a decline, thereafter.

For new beverage categories, it’s easier for newcomers and small players to compete against the big players as new and niche markets are fast-growing and have few historical price-reference points. We observe that, in the past 5 years, it has not usually been the No.1 player in the market that has launched a new niche product that has seen fast revenue growth. For example, milk tea and room-temperature yoghurt drinks were launched by 2nd or lower ranked players, like UPCH and Bright Dairy (600597 CH, not rated), with less than 20% nationwide market share.

We believe big players are less keen to launch new flavours for fear of them causing product cannibalisation (ie, leading to a sales shift among different divisions rather than gaining market share from competitors. For example, Mengniu’s sales growth for its premium UHT milk and room temperature yoghurt in 1H15 was largely offset by the sales decline for milk beverages as well as mass market UHT milk). Even if a big player launches a new product successfully and posts fast revenue growth initially, the impact on the company’s revenue and profit is likely to be lower than that for a small player due to the bigger company’s higher revenue base.

China: beverage consumption breakdown 2010 vs. 2012 vs. China: growth rates of various “start products” (2011-15) 2014 100% 3.5 200% 10.5 13.9 18 80% 17.8 15.4 150% 28.5 60% 23.6 22.1 100%

40% 50% 30.9 31.2 33.1 20% 0% 19.1 16.9 15.5 0% (50%) 2010 2012 2014 2011 2012 2013 2014 2015E RTD tea Bottled water Juice-drinks Hot-kid milk carbonated drinks Juice Milk tea Room-temperature yogurt Sportsdrink, herbal tea and others Laotan noodles Source: AC Nielsen, Tingyi Source: Companies, Daiwa estimates Note: Juice-drinks – estimated from Tingyi financials; Milk tea/Laotan noodles: from UPCH, Hot- kid milk – Want Want. Room-temperature yoghurt: Bright Dairy numbers

Price promotions not effective in driving bottom lines Price cuts offset volume Due to the distribution and production scale advantages of the Goliaths, they usually enjoy growth and lead to lower production costs (as a result of economies of scale, bulk purchases of raw materials, gross-margin pressure etc.) and are more keen on price cuts to promote sales volumes (reference Hengan’s reduction of its tissue paper prices in 2014; Tsingtao’s expansion in the mass-market segment since 2013 by selling more mid-to-low end sub-brand products). However, since

China Consumer Staples Sector: 26 January 2016

the beginning of 2015, price competition does not seem to have been such an effective tool for gaining market share, as evidenced by Hengan and Tsingtao’s YoY revenue declines in 1H15.

We believe that health consciousness, variety and image are now important factors determining consumer purchases, as affordability of FMCG items increases (supported by increasing income levels). Consumers seem willing to pay a premium if the products can provide value such as quality, safety (eg, personal hygiene products) or are purchased at high-profile locations (eg, entertainment clubs or high-end restaurants). Moreover, in some categories like the dairy segment, the number of brands available to Chinese consumers has expanded rapidly over the past 5 years due to dairy farms moving into downstream production, and foreign companies aggressively promoting their products in China (in particular through e-commerce). As a result, existing domestic players have not been able to grow their sales volumes by cutting prices because many competitors have followed the same strategy.

To follow are some trends we see in a variety of markets:

Rice crackers: in 1H15, Want Want’s rice cracker sales rose by 10% YoY, driven mainly by gift packs (up 41% YoY) and core brands (up 8% YoY); while revenue for the sub- brands, which are at least 30% cheaper than the core brands, was up only 5% YoY. We believe consumers continue to favour Want Want’s core brand products due to their better quality and brand image, in particular if they are purchased as gift items.

Dairy: for both Yili and Mengniu, their premium UHT milk products and star product sales exceeded their total revenue growth in 1H15. Those products’ ASPs are at least 50% above mass-market product prices, but they are perceived to have better nutrient value. According to Frost and Sullivan, high-end UHT milk retail sales in China will reach CNY89bn by 2017E, representing a 3-year CAGR of 21% (vs. 5% for mass-market products) and the revenue contribution of high-end UHT milk to the total UHT market will reach 45% in 2017E, from 31% at present.

Want Want: rice cracker sales YoY – sub-brands vs. core brands China: premium UHT milk sales vs. mass-market sales (1H15) YoY CNY bn 45% 300 40% 250 35% 200 107.2 30% 89 73.8 150 61.2 25% 50.6 34.6 41.7 100 29 20% 17.9 20.8 12.2 16.1 116 121.7 126.9 131.1 15% 50 92 97 103 109.7 64.9 71.3 76.1 78.9 10% 0

2009 2007 2008 2010 2011 2012 2013 2014

2016E 2017E 2018E 0% 2015E Mass market Premium Core brands Gift brands Sub-brands Source: Want Want Source: Frost and Sullivan

Brand loyalty has Bottled water: We believe Tingyi’s loss of bottled water market share since 1Q15 is become a more evidence of consumers’ increasing awareness of brand image and the difficulty of important factor in companies remaining competitive on price alone. According to AC Nielsen, Tingyi’s bottled beverage purchasing water market share slid by 2pp YoY in 1Q15, when it raised its bottled water retail ASP by decisions about 20% (from CNY1 for a 500ml bottle, the cheapest national brand we found in the market, to CNY1.2, in line with most peers, based on our estimates). Although Tingyi at the same time has increased the weight of its bottle to make it look more high-quality, and rebranded the product “Youyue” (meaning excellent and joy, in English), we believe Tingyi has long been regarded as a cheap brand in the eyes of consumers due to its below-peer pricing since launching its bottled-water product in 2004. In our view, it will take more effort on the part of the company to step up its advertising and marketing to build brand loyalty.

China Consumer Staples Sector: 26 January 2016

Tingyi: market share (%) and revenue (USDm) of bottled water segment USD m 500 22% 22% 25% 20% 19% 19% 400 18% 18% 20%

300 15%

200 10%

100 5%

0 0% 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Revenue Market share

Source: Company

International brands more attractive than local brands, mainly in personal- care products According to Kantar Worldpanel, most domestic players gained market share in major F&B categories in China in 2014. We believe that since 2014 domestic players have been, and are still, responding more quickly than international players to adapt to changes in local preferences and to accommodate the appetite of Chinese consumers. Exceptions include beer (which we believe is due to ABInBev’s successful penetration of the high-end market segment in China), instant noodles (from a low base) and chocolate (more imported goods available).

Foreign players though have gained market share in personal-care products, particularly facial and toilet tissue. Foreign brands also gained share in the baby diaper market in 2014, according to Euromonitor, while Hengan (the biggest domestic player) lost market share. The Japanese players seemed to take market share in sanitary napkins in 2014 (around 7%) albeit at a gradual pace – Unicharm’s market share was up 0.8pp YoY to 5.7% in volume terms, slightly faster than market leader Hengan.

We attribute the better performance of foreign brands in personal care products than in F&B items to: 1) their production technology and raw-material quality (Japanese brands in particular) being perceived as better than domestic peers’; consumers are more concerned about quality (convenience and hygiene) than prices in those products, and 2) lower logistical costs (smaller size and lower weight of diapers and sanitary napkins vs. F&B) which makes personal care products high-margin and frequently purchased products for e- commerce retail platforms. For staples companies to ride on that trend they would need to cooperate with strategic investors/JVs to introduce foreign products in China, in particular personal hygiene products.

We believe Vinda has been aggressively promoting its premium foreign brand, Tempo, after obtaining its licensing and distribution rights in China in 2013, while Hengan has not sought any international partnership yet. While both Davids and Goliaths can seek co- operation with international partners, there have been successful cases for Goliaths in the past 2 years (eg, both Tingyi and Tsingtao ended their co-operation with Japanese partners in 2015).

China Consumer Staples Sector: 26 January 2016

International brands: market-share changes (2014) Foreign brands are 3 2.1 1.8 1.6 1.6 2 1.3 1.2 1.2 gaining market share in 1 0.2 beer, chocolate and 0 (1) -0.1 -0.2 -0.3 -0.6 -0.6 instant noodles, as well (2) -0.9 -1 -1.1 -1.1 (3) -1.4 -1.7 -1.8 -2.4 as personal care (4) -2.8 -3.1 products (5) -3.8 -3.8

(6) -4.8

Milk

Beer

Juice

candy

Yogurt

Biscuits

Skincare

Shampoo

Chocolate

toothpaste

toothbrush

Bottledtea

Faciltissue

Toliettissue

bottledwater

Babydiapers

Chewinggum Infantformula

fabricsoftener

Personalwash

kitchencleaner

Instantnoodles

Hairconditioner

Color cosmecits

Fabricdetergents Carbonateddrinks Market share changes (%)

Source: Kanta Worldpanel

Prefer the Davids over the Goliaths In consideration of the above demographic and consumption pattern changes, we prefer the Davids (small players) to the Goliaths (big players) in most staples sub-segments, as we believe it is easier for the Davids to grow revenue (volume) from a low base compared with the Goliaths. In our view, it is difficult for Goliaths to leverage on their past strengths (eg, strong traditional channels, cost advantage, etc.) to grow revenue or expand gross margins, as many are already operating amid optimal conditions (in terms of utilization rates, cost reduction through bulk-purchases, etc.). We discuss below what Goliaths and Davids are doing.

The Goliaths’ strategy – co-operation with foreign players In our opinion, the Goliaths need to think about how to tap their existing assets (consumer bases, brands and networks) by finding new revenue sources, such as new product categories (through partnerships with foreign brands or in-house development), upgrading their existing products (for higher ASPs and gross margins) or engaging in more R&D in order to reduce costs. Some examples are shown below.

Tingyi formed JVs with a number of foreign players (Calibee, Wakado and Prima) in 2013 to launch snacks and other new products. Tingyi eyed the product development and brand recognition of those partners overseas and wanted to distribute such new products by leveraging on its own distribution network in China. However, all those JVs still contribute less than 2% of the company’s revenue at present based on our estimates, and Tingyi terminated one of the co-operation agreements (with Calibee) in 4Q15, as it had remained unprofitable for years and Calibee wanted to seek other opportunities to grow in China.

Tsingtao formed a JV with Suntory in 2013 to expand in eastern China. Suntory is responsible for production and Tsingtao for distribution and marketing. However, Suntory sold its stake in the JV to Tsingtao in 4Q15 after years of loss-making, leaving Tsingtao with the losses to deal with.

Mengniu formed a JV with strategic investor Danone in 2014 to develop yoghurt and other cold-chain products in China. We estimate Danone’s yoghurt products gained 1pp market share for Mengniu in 2015E and helped upgrade Mengniu’s production technology and brand recognition. In December 2015, Yashili (1230 HK, not rated), Mengniu’s infant formula subsidiary, also announced that it planned to acquire Danone’s infant formula business in China for HKD1.2bn. However, we are cautious on Mengniu’s co-operation with Danone in the infant formula business, as it is not an exclusive partnership. Danone is developing an imported and premium infant formula brand, Nutricia, on its own in China, and because of the non-exclusive nature of its partnership, Mengniu will not benefit from the fast growth of this high-end infant formula segment.

China Consumer Staples Sector: 26 January 2016

Want Want co-operated with Morinaga to launch pudding products in 1H15. We estimate the products contribute only about 0.5% of the company’s revenue at present, but this figure should expand further in 2016E.

The Davids’ strategy – niche products, new distribution channels The Davids and Goliaths Davids – based on our observations, the Davids are more flexible and quicker in terms of have to adopt different decision-making and responding to changes in the market. For example, in provinces or strategies — and we cities where there are no direct distributors of their products, the Davids can make use of believe the Davids stand the e-commerce channel without cannibalising the benefits of distributors, while big players a better chance of with national distributors may find it difficult to provide incentives for new (online) growth distributors to promote products without jeopardising existing distributors. The risk of cannibalization between old and new products is also lower for Davids due to their relatively smaller product portfolios.

Vinda has been the No.1 household paper brand on the e-commerce platform in China since mid-June 2015 (No. 3 in the total market). It has developed different packaging for its online platform to differentiate these items from its offline items. E-commerce transactions accounted for about 10% of its revenue in 1H15 (vs. <5% for its closest competitor, Hengan) and were profitable. Moreover, competitor Hengan has low exposure to e- commerce (3% of revenue in 2015E). With the acquisition impact, we expect Vinda’s revenue growth to rise at a 23% CAGR over 2015-17E, on our forecasts, due to its increasing exposure to online channels and acquisitions, vs. a flat (0%) CAGR for Hengan over the same period.

Modern Dairy was a late-comer to the China dairy downstream market, launching its own- branded products only in 2010 (pasteurized milk) on a small scale, followed by its first UHT product in 2013. To differentiate itself from market leaders like Mengniu and Yili, Modern Dairy focuses on premium products and selected regions only. The company also seldom uses TV commercials for advertising and promotions. Modern Dairy has around an 8% market share in the premium UHT milk market in China (AC Nielsen data in 3Q15), and its downstream net margin (of 12%) is higher than the large players’ (6-10%), thanks to its vertically-integrated model.

Vinda: revenue breakdown by channel Modern Dairy: revenue contribution from downstream 100% 1.6% CNY m 3.6% 5.1% 8.6% 9.8% 90% 3,000 40% 80% 35% 2,500 70% 30% 60% 2,000 25% 50% 1,500 20% 40% 15% 30% 1,000 20% 10% 500 10% 5% 0% 0 0% 1H13 2H13 1H14 2H14 1H15 2012 2013 2014 2015F 2016E 2017E Traditonal KA Corporate clients E-Commerce Downstream revenue as a ratio of total

Source: Company, Daiwa estimates Source: Company, Daiwa forecasts

Uni-President China (UPCH) regained market share in instant noodles in China (from around 11% in 2011 to ~18% in 2015E, according to AC Nielsen) through introducing new flavours and categories (eg, Laotan pickled vegetable noodles, Soup Daren brand, etc.) and had successfully turned the business around in 2H14. The company also launched a number of new beverages in 2014-15 targeting the high-end market and consumers in top- tier Chinese cities.

Want Want has a strong record of product diversification (>600 SKUs of snack items, based on our estimates) and product development capability, such that it resembles a group of Davids rather than a big Goliath. We are confident that WW’s snack business can

China Consumer Staples Sector: 26 January 2016

still grow in volume terms as the market is still fragmented. According to Frost and Sullivan, the top-10 players only accounted for 30% of the market in 2014, while WW stood out at No. 1 with a 5% share. The market is divided up amongst the big and small Davids, each with its niche (eg, WW’s rice cracker is No.1 with a c70% market share).

UPCH: products launched in the past 24 months Beverage No. of flavours Suggested retail price Launch date What's special about the product? Xiaoming classmate tea 4 CNY 5 Mar-15 Special bottle design and cold-brewed Haizhiyen 3 CNY 5 Apr-14 Sea-salted low-sugar fruit juice Chinese mixed fruit drinks 2 CNY 5 May-15 Mixed Chinese fruit juice for health Nectars 3 n.a. Soon Nutritious and Western-style Asamu in little bottles 2 CNY 6 3Q15 Using chilled milk instead of milk powder Xiaoye milk tea 3 CNY 3 1H15 Targets primary and secondary students Noodles No. of flavours Suggested retail price Launch date What's special about the product? Champion 2 CNY 10-12 Nov-14 Soup Dairen 4 (2 more to come) CNY 8 Re-launched with new flavours 2 years ago Vege-light Noodles 3 CNY 5 Oct-15 Gemien 2 CNY 5 4Q14 Noodles No. of flavours Suggested retail price Launch date What's special about the product? Champion 2 CNY 10-12 Nov-14 Soup Dairen 4 (2 more to come) CNY 8 Re-launched with new flavours 2 years ago Vege-light Noodles 3 CNY 5 Oct-15

Source: Company, Daiwa

China Consumer Staples Sector: 26 January 2016

Cost tailwinds to subside Cost trends turned neutral on gross margins Most of the downstream staples companies that we cover are likely to see significant gross margin expansion over 2014-15E, on the back of lower raw-material costs. However, this trend could reverse in 2016E as the prices of some raw materials rebounded in 4Q15, and those of many others turned steady in 2H15. Furthermore, CNY depreciation against the USD is also likely to have a negative impact on the cost of imported raw materials (eg, wood pulp).

As shown in the following chart, we expect the gross margins of the downstream staples companies to have expanded by 1.3-3.4pp YoY for 2015E. For the upstream dairy farm and grain processing companies, we forecast their gross margins to have declined for the same period due to lower ASPs. For 2016E, we expect the gross margins for the upstream companies to change by only 1pp (plus or minus), mainly due to price promotions or product mix upgrades, rather than changing raw material costs. For the upstream companies, we expect a slight improvement in their gross margins due to a slight increase in ASP.

China Consumer Staples Sector: gross margins Gross-margin expansion 58.6% 60% could slow in 2016E 48.8% 50% 43.6%

40% 35.4% 34.9% 32.6% 30.9% 32.2% 31.5% 32.3% 30%

20% 16.2% 16.9%

10% UPCH Want Want Tingyi WH Group CRB Tsingtao Mengniu Hengan Vinda Huishan Modern Fufeng Dairy 2014 2015 2016E 2017E

Source: Company, Daiwa forecasts

Outlook for raw-material costs The following table shows the contribution to COGS of various raw materials for the consumer staples companies for 2015E. Most of the necessary raw materials can be sourced locally in China or the rest of Asia (not denominated in USDs and hence, are cushioned from the rising USD). The personal-care product companies have the highest exposure to imported raw materials.

China Consumer Staples Sector: contribution of commodities to 2016E COGS (downstream) and the revenue (upstream) (%) Snacks/ Industry dairy beverage Soft drinks and noodles Dairy products Brewery Personal-care products Packaged meat Company Want Want Tingyi UPC Mengniu Huishan Modern Dairy Tsingtao/CRB Hengan Vinda WH Group Locally sourced /sourced in non-USD currencies Palm oil <2 7 7

Flour <3 8 8

Sugar 5 5 5 3-5%

PET chips <5 30 30 <10 <5%

China: 70 -80% Pork of COGS ~30% of Raw Milk <3 30-40 ~80% of revenue revenue Corn Feed: 70% of upstream operation

Sourced overseas

Milk powder 15% 10%

Wood pulp – short fibre ~10-15% 50-60% Wood pulp – long fibre

Source: Daiwa estimates

China Consumer Staples Sector: 26 January 2016

Milk powder Downstream dairy We believe the price of milk powder imported into China will bottom out in 1Q16 and players likely to see cost gradually pick up throughout 2016E. In December 2015, Fonterra, the operator of the of milk rebound in 2016E largest dairy-product trading platform globally and the key co-operative for dairy farms in New Zealand, maintained its milk payout rate to its suppliers until May 2016 (at NZD4.6/kg). Fonterra expects the price of milk powder to rise in 2016 as the global glut dissipates and the China manufacturers (food processing companies and dairy beverage producers) start to purchase more after the milk powder inventory has normalised.

The milk powder spot price on the international market has risen by 42% from its trough of USD1,560/tonne in August 2015, while China’s powder import price (the actual cost for producers in China) declined by an average of 17% in 2015. As the import price at China customs typically lags the international spot price by 4-6 months due to transportation factors, we expect the powder price in China to be relatively low in 1H16 before trending up in 2H16.

Raw milk (China) According to the Ministry of Agriculture, the price of raw milk price increased by 3%QoQ for 4Q15 vs. September 2015. However, we now turn more cautious on the raw milk price outlook for 2016E, due to the declining feed cost, some of the large raw milk suppliers could lower their ASPs to expand their sales volume, implying pricing pressure in the industry. Moreover, despite the recent rebound in milk powder prices globally, the cost of milk powder is still near its past-5-year low globally. This means imported milk powder remains a cheap substitute for raw milk in 2016E. We assume a flat YoY raw milk ASP for Modern Dairy and Huishan Dairy in 2016E.

Milk powder prices: imported prices (at China Customs) and the China: raw milk price international spot price (USD/tonne) CNY/kg 6,000 5.5

5,000 5.0 4,000 4.5 3,000 4.0 2,000

1,000 3.5

0 3.0 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 Apr-14 Feb-15 Dec-15 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Dec-15 Import price Auction price National average CMD Huishan

Source: Global Dairy Trade, China Custom Source: Companies, Ministry of Agriculture

Palm oil and wheat/flour Ong Keng Wee, a plantation analyst at Daiwa’s alliance partner in Malaysia, Affin Hwang, forecasts an ASP for palm oil (in Malaysia) of MYR2,400/tonne for 2016E (+12% YoY), supported by a decline in inventory and possible lower production in 2016E. We believe the noodle players in China will be the key victims of the rising palm oil price in 2016E, as we estimate that palm oil accounts for about 15% of their COGS.

Wheat is another major cost item for the instant-noodle makers (~15% of COGS), and we expect the price of wheat to remain steady or increase slightly in 2016E, as the price the government pays is likely to remain stable, which should give farmers the incentive to produce wheat. Hence the noodle-makers are unlikely to make any cost saving when it comes to the wheat input cost for noodles, in our view.

China Consumer Staples Sector: 26 January 2016

Palm oil prices: imported price of China (Tianjin port, LHS) China: wheat price CNY/m tonnes USD/m tonnes CNY/m tonnes 11,000 1400 3,500

10,000 1200 3,000 9,000 1000 2,500 8,000 800 2,000 7,000 600 6,000 400 1,500

5,000 200 1,000

4,000 0

Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15

Dec-09 Dec-10 Aug-09 Aug-10 Aug-11 Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 M-09 M-10 J-11 N-11 A-12 J-13 A-14 F-15 N-15 Dec-08 "Malaysia" "Tianjin" Flour Wheat

Source: Bloomberg Source: Bloomberg

Sugar In 2016E, we expect the We expect the price of sugar to increase by 5-10% YoY in 2016 in China due to the tighter price of sugar to reverse supply. In December 2015, the Guangxi Provincial Government increased its guidance its downtrend since 2013 price for sugar cane, from CNY400/tonne for the 2014/15 harvest to CNY440/tonne for the 2015/16 harvest due to a decrease in acreage, implying lower production costs for cane sugar in China. On the international market, the price of sugar rose by 23% in 2H15 in Brazil, the largest exporter of sugar in the world. According to a USDA report released in November 2015, global sugar production for 2015/16 was forecast to decline by 3m tonnes, at 172m, with declines in Brazil, India, the EU, and Ukraine more than offsetting gains in Australia, Russia, and Turkey. The report projects consumption to reach a record 173m tonnes, pulling down the global inventory level by 4m tonnes to 40m tonnes in November 2016E.

PET chips According to data from Wind, the price of PET chips declined by 4% YoY in 4Q15 and 21% YoY for 2015 on average due to the weak price of crude oil, which should be positive for the gross margins of the beverage producers. However, as the PET chip price has almost reached its past-10-year trough of some CNY5,800 (in 2008; currently: CNY6,000/tonne), and given the strong USD, we don’t believe PET chip costs will decline by much in 2016E in China (in CNY terms). This, together with rising sugar costs, implies to us that there is limited room for the gross margins of the bottled-drink producers Tingyi and UPCH to expand this year.

China: PET-chip prices (vs. oil price) China: global sugar price CNY/m tonnes USD/Barrel CNY/m tonnes USD/lb 13,000 120 9,000 6 12,000 8,000 100 5 11,000 7,000 10,000 80 6,000 4 9,000 60 5,000 8,000 3 7,000 40 4,000 6,000 3,000 2 20 5,000 2,000 1 4,000 0 1,000

0 0

Jun-12 Jun-13 Jun-14 Jun-15

Mar-12 Mar-13 Mar-14 Mar-15

Dec-11 Dec-12 Dec-13 Dec-14

Sep-13 Sep-14 Sep-15 Sep-12 Jan-08 Apr-09 Jul-10 Oct-11 Jan-13 Apr-14 Jul-15 PET (CNY/mt, LHS) Brent oil (USD/barrel, RHS) Nanning Brazil

Source: Wind Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

Wood pulp – (short and long-fibre) Lower USD pulp costs Mercer Int. (Not rated), a global pulp supplier of wood pulp, and Hawkins Wright, a global offset by CNY research firm on forest, pulp and paper industry, offer the following insight into the global depreciation vs. USD supply outlook:

Softwood (northern bleached softwood kraft pulp [NBSK]): global capacity is expected to grow by 0.7m tpa in 2016E (<4% of total demand, based on our estimates), and according to Mercer, such growth is consistent with growth in demand. Wright forecasts softwood pulp demand to increase by 0.127m tpa over 2014-18, versus 0.19m tpa rises per year in capacity.

Hardwood (bleached hardwood kraft pulp [BHKP]): global capacity growth should be fast for 2016, at c. 3% on our estimates, but should match demand growth. Hawkins Wright forecasts hardwood pulp capacity to rise by 1.5m tpa over 2016E, versus demand growth of 1.38m tpa in 2015E.

Based on Bloomberg data, BHKP and NBSK pulp averaged USD803/tonne and USD832/tonne for 2H15, up 5% and down 5% YoY, respectively. We estimate normal wood pulp inventory for tissue producers is currently at about 4-6 months (including raw materials being shipped to China); and over 60% of the pulp used for tissue paper is NBSK. Hence, we expect pulp costs in 1H16 to be flat or decline slightly for wood pulp users in USD terms. However, if we take CNY depreciation into consideration (-4.5% against USD in 2015 per Bloomberg), wood pulp costs would remain flat YoY in terms of CNY in 1H16E, and risk rising in 2H16E.

Wood pulp prices USD/tonne 1,100 1,000 900 800 700 600 500 400 300 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 NBSK BHKP

Source: Bloomberg

Rice, corn and other grains (sourced in China) We believe prices of domestically sourced grains (corn, wheat, rice) will stop increasing or reverse their uptrends seen over the past 6 years as a result of changes to policies that used to support grain prices through government purchasing. For grains that are domestically produced and sourced in China (ie, corn, rice), prices have gone up slowly since 2009, supported by favourable policies. We believe the prices of major crops in China are supported by government incentives encouraging farmers to produce more. The China government has already cut its guaranteed purchase price for corn for the 2015/16 harvest period by c.11% YoY due to the high reserves level in the country. The government has also stated, that while it will continue to purchase wheat and rice in 2016, it hasn’t decided whether to continue to purchase corn or not.

Government purchase price of major grains in China (CNY/50kg 2015 2014 2013 2012 2011 2010 Corn 100 111-113 111-113 105-107 n.a. Wheat 118 118 112 102 93 86 Early rice 135 135 132 120 102 93 Later rice 138 138 135 125 107 97 Hard rice 155 155 150 140 126 103

Source: Ministry of Agriculture

China Consumer Staples Sector: 26 January 2016

We expect grain prices We estimate that grain prices in China are about 20% higher than international prices at to stay flat or decline in present (except soybean, whose imports accounted for over 60% of the consumption in the China in 2016E due to past 5 years) due to supportive government policies. We expect this gap to continue to policy changes trigger imports of grains into China or a reduction in domestic grain prices, in particular for corn. As shown below, international corn and wheat prices trended up in 4Q15, by 1% and 13% QoQ on average, based on Bloomberg data, respectively.

Corn price in the US spot market Corn price in China price USD/5000 bushel (CNY/m tonnes) 900 3,000 800 700 2,500 600 500 2,000 400 300 1,500 200 1,000 100

Oct-09 Apr-14

Jun-13 Jan-09 Jan-11 Jun-11 Jan-13 Jan-15 Jun-15

Mar-10 Mar-12

Aug-10 Nov-11 Aug-12 Nov-13 Sep-14 Nov-15

May-09

Jul-12 Jul-13 Jul-14 Jul-15

Jul-11 Heilongjiang Jilin Shandong

Oct-12 Apr-13 Oct-13 Apr-14 Apr-15 Apr-11 Oct-11 Apr-12 Oct-14 Oct-15

Jan-12 Jan-13 Jan-14 Jan-15 Jan-11 Source: Bloomberg Source: Bloomberg

Hogs and pork Any increase in the cost Hog inventory as of November 2015 was 388m heads in China, according to the Ministry of hogs and pork in of Agriculture (down 1% MoM, but down 10% YoY). The number of reproductive sows in 2016E will be lower than China declined to 38.3m heads in November 2015 (-12% YoY), implying that supply is we previously expected continuing to tighten. We expect pork prices to rise by less than 5% YoY on average in 2016E, due to the low base in 1H15 followed by a slight tightening of supply in 2H15-2016.

However, as of December 2015, the hog-corn cost ratio was already 8.6x, per the Ministry of Agriculture, near the high-end of the guidance range for hog raisers (6x-9x) as indicated by the government. If such a ratio rose above 9x the government may have to sell pork reserves to stabilise prices. Moreover, with the recent decline in corn costs (a major feed for hogs), we see limited upside for hog costs in 2016E. Hence we see limited upside to our hog and pork price forecast for in 2016.

China: pork and hog prices Hog-corn cost ratio CNY/kg (x) 30 10

25 9

8 20 2013 Ave. 2015 7 6.22 Ave, 6.55 15 6 10 5 2014 Ave, 5.50 5 4

J-08 J-08 D-08 J-09 D-09 J-10 D-10 J-11 D-11 J-12 D-12 J-13 D-13 J-14 N-14M-15N-15

Jan-15 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

Pork wholesale price Hog cost Jan-09

Sep-10 Sep-09 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15

May-15 May-10 May-11 May-12 May-13 May-14 May-09 Source: Wind, Bloomberg Source: CEIC

China Consumer Staples Sector: 26 January 2016

Impact of CNY depreciation – mainly on the debt side CNY depreciation Debt and financial costs – the key factor. Before 2014, most staples companies enjoyed against USD weighed low interest rates and the benefits of CNY appreciation against foreign currencies by using more on financial costs foreign debt (mainly USD or HKD). However, with the CNY starting to depreciate against than raw materials the USD in 1H15, most companies reported forex losses for that period. Most of them did not use derivatives to hedge against currency rate changes. To lessen the impact of CNY depreciation, some companies have already started replacing USD/HKD-debt with CNY- debt wherever possible:

In this report, we are revising down our 2016-17 EPS forecasts for 6 of the 12 companies we cover in the staples sector as a result of FX losses. We see companies with higher net gearing being slower to cut their USD/HKD debt to reduce FX losses, since they may not have sufficient resources to pay down their USD-debt quickly.

(1) Companies with net cash: Want Want and Hengan have the highest exposure to USD/HKD denominated debt (99-100%) among our coverage universe. They are in a net cash position, which enables them to pay down debt quickly if necessary. (2) Companies with net debt may have to raise CNY debt locally before settling their USD debt. Among the big caps, we expect Mengniu to work on replacing its non-CNY debt previously raised for acquisitions by leveraging on its relationship with COFCO Group (as an SOE) to secure more local debt in CNY and reduce its exposure to CNY. Also, for Tingyi, the debt borrowers (bond issuers) are Hong Kong entities (functional currency is HKD), so there is no mark-to-market loss for USD debt incurred by its Hong Kong entity. Translation losses on balance sheet items are debited to equity reserves, instead of the P&L. For Tingyi, we believe the FX loss in 2015 was due mainly to its EUR-denominated debt (for the purchase of machines), which is non- recurring in 2016E. Hence for both, we believe the impact of CNY depreciation in 2016-17E will not be higher than it likely was in 2015E. Vinda faces the biggest impact from further CNY depreciation due to its high gearing. However, we believe this factor has been priced in its recent share-price correction. (3) Some companies like Modern Dairy and Fufeng reported slight positive FX gains in 1H15, which we believe was due to non-CNY cash and other assets they have (eg, receivables). Going forward, we expect the impact of FX to be even smaller as they raise CNY-debt and reduce USD-denominated loans.

Exposure and impact of FX exchange rate changes on net profit USD/HKD USD/HKD HKD/USD net HKD/USD FX loss as % of debt as % debt as % cash as % debt as % Report. (m reporting pre-FX COGS % of total of book equity of equity of equity currency currency) net profit contribution 2014 2014 2014 2014 1H15 2015E 2016E 1H15 2015E 2016E in USD Tsingtao Brewery c.0% n.a. n.a. n.a. CNY 3.0 negligible -0.3 negligible <10% Fufeng 40% 26% 2% 24% CNY 5.5 negligible 1.1 negligible <10% UPCH 41% 19% 3% 17% CNY 1.7 negligible 0.2 negligible <10% Modern Dairy 41% 36% 5% 31% CNY 2.9 negligible 0.6 negligible <20% Mengniu 85% 39% 7% 32% CNY -22.0 -50 -50 -1.6 -1.9 -1.9 <10% Tingyi 87% 84% 4% 80% USD -49.2* -49 -50 -11* -12 -11 <10% Vinda 91% 82% 2% 80% HKD -30.0 -280 -300 -8 -37 -32 c.50% WH Group 97% 75% n.a. n.a. USD n.a. n.a. n.a. n.a. n.a. n.a. <50%. Want Want 99% 68% 2% 66% USD -0.9 -2 -5 -0.3 -0.3 -0.7 <20% Hengan 100% 85% 11% 74% HKD -139.0 -270 -240 -7 -6 -5 >30% Huishan Dairy 12% 7% 5% 2% CNY -124.6 negligible -13.8 negligible <10%

Source: Company, Daiwa estimates for 2015-16E Note: * for nine months ended Sep-15; # including impact from FX change in non USD/HKD currency exchange rate against CNY, 1due to its US operation

Revenue: CNY depreciation mainly weighs on companies that report in USD or HKD. Of the 6 companies we cover that report in USD or HKD, WH Group should be least impacted, as we estimate that over 50% of its revenue came from the US in 2015. We also estimate that about 25% of Vinda’s revenue comes from outside China (Hong Kong and ASEAN countries) after its acquisition of SCA’s pan-Asian hygiene products business in 1Q16.

China Consumer Staples Sector: 26 January 2016

Cost of production: Except wood pulp, soybean and milk powder, most raw materials used by staples companies in China are locally sourced. As such, a depreciating CNY is negative for the gross margins of users. But as discussed before, wood pulp prices have been trending down since 4Q15 on an abundant global supply, which we believe could help offset the pressure of a depreciating CNY. For milk powder, we also believe a weakening NZD against USD could help mitigate the pressure of increasing milk powder costs, as New Zealand accounts for more than 50% of the milk powder imported into China (in fact, the NZD has depreciated from NZD1:CNY4.8 a year ago to NZD1:CNY4.2 in January 2016).

China Consumer Staples Sector: 26 January 2016

Valuations and recommendations Rerating opportunity for selected stocks The China Consumer Staples sector has been derated since 2013 on the back of slowing revenue and earnings momentum. In 2015, the MSCI China Staples Index fell by 17.1%, vs. declines of 14.6% in the MSCI China and 8.2% in the HSI. Our coverage universe of downstream staples companies is trading currently at a 16x 2016E PER on a market-cap weighted average, based on our forecasts, and most are trading below their past-5-year 12-month-forward PER bands.

MSCI China Staples and MSCI China Indices (2015) The staples stocks have MSCI China Staples MSCI China 1,400 90 underperformed the 85 1,300 MSCI China for the past 2 80 1,200 years 75 1,100 70 65 1,000 60 900 55

800 50

Jul-14 Jul-15

Apr-14 Oct-14 Apr-15 Oct-15

Jan-14 Jun-14 Jan-15 Jun-15

Feb-15 Feb-14 Mar-14 Mar-15

Aug-14 Sep-14 Nov-14 Dec-14 Aug-15 Sep-15 Nov-15 Dec-15

May-14 May-15 MSCI China Staples MSCI China

Source: Bloomberg

China players already trading at discounts to international peers The China Consumer Staples stocks are currently trading at PER discounts to their international downstream peers. Based on the Bloomberg consensus forecasts, the China Consumer Staples stocks under our coverage are trading at 16x 2016E PER on average, vs. 21x for the main US and Europe F&B players. As a result of our now less favourable outlook for net-profit growth in 2016 in China due to a high base, macro headwinds, and CNY depreciation, we see little potential for a PER rerating of the Chinese players towards international peers’ valuations at this juncture. But at the same time, given that growth in nominal GDP and personal income in China eclipses the growth rates for most developed countries, as evidenced by the China players’ prospect of faster EPS growth in 2016E vs. their international peers, we also see limited room for a further derating.

Davids’ premium to Goliaths justified, in our view The Davids we highlighted in this report (Vinda, UPCH, etc) are trading at premiums to their peers (Hengan, Tingyi) in terms of PER. We believe these premiums are justified by the Davids’ higher prospective EPS growth in 2016-17E, on our forecasts, and their long- term revenue growth potential. The key rerating catalysts we see are: 1) M&A within the same industry/segment or strategic investments in new businesses, 2) successful new product launches, and 3) share buybacks or debt reductions.

The only exception is Modern Dairy, which is trading currently at a 7.1x 2016E PER, a significant discount to its peers Mengniu (15x) and Huishan (FY17E PER of 34x, March year end). We believe this discount is due to investors’ concerns about flat raw milk ASPs in 2016E. Nevertheless, we expect Modern Dairy shares to be rerated on the back of an increasing revenue and earnings contribution from its downstream operation, and gross- margin improvement from lower feed costs.

China Consumer Staples Sector: 26 January 2016

China Staples Sector: valuation comparison (as of 25 Jan 2016) Market Share Sales growth YoY EBIT margin cap price PER (X) EPS growth YoY (%) EV/EBITDA (%) (%) ROE Company Ticker Rating (USDm) (HKD) 2014 2015E 2016E 2017E 2014 15E 16E 17E 15E 16E 2014 15E 16E 2014 15E 16E 15E Food and beverage players Want Want China 151 HK Buy 8,174 4.96 13.7 15.4 12.7 11.5 -10 -11 21 10 9.1 7.4 -1 -6 6 20.6 20.9 23.5 27.1 Tingyi 322 HK Hold 6,512 9.07 16.4 17.6 16.9 15.4 1 -7 4 10 7.5 6.7 -6 -9 1 7.2 8.1 8.7 12.0 WH Group 288 HK Outperform 8,247 4.40 8.5 13.6 10.2 9.1 48 -37 34 12 6.6 5.7 98 -1 6 8.1 6.4 6.9 11.3 Mengniu Dairy 2319 HK Hold 5,516 11.08 14.8 13.5 14.7 13.2 32 9 -8 11 8.8 9.1 15 -2 4 5.1 6.4 5.7 11.5 Tsingtao Brewery 168 HK Underperform 4,988 28.80 15.5 19.3 20.4 19.2 13 -20 -6 6 8.5 8.9 3 -3 -4 6.6 6.3 6.0 10.3 China Resources Beer 291 HK Hold 3,818 12.30 n.a. 34.1 23.2 18.5 -chg +chg 47 25 5.8 12.8 16 -79 4 1.1 7.9 8.6 2.7 Uni-President China 220 HK Buy 2,880 5.20 129.1 21.6 18.9 17.0 -74 499 14 11 8.0 7.1 -3 5 8 0.9 4.4 5.2 7.5 Market cap. Weighted average 20.4 17.8 15.6 13.9 9 24 15 12 7.8 7.9 23 -11 4 8.7 9.6 10.3 13.4 Dairy farm operators Modern Dairy 1117 HK Buy 985 1.45 7.2 9.4 7.1 5.0 108 -23 31 41 5.5 6.4 53 -1 8 27.2 27.5 25.8 8.3 Huishan Dairy # 6863 HK Sell 5,095 2.95 43.0 43.5 34.4 29.6 -43 1 31 16 28.0 24.3 11 14 24 32.0 29.4 27.1 5.8 Market cap. Weighted average 37.2 38.0 29.9 25.6 -19 -3 31 20 24.3 21.4 18 12 21 31.2 29.1 26.9 6.2 Personal healthcare Hengan Int 1044 HK Hold 10,621 67.75 21.2 19.4 18.4 18.2 8 9 5 1 11.7 11.3 12 2 -1 24.1 25.1 25.7 23.5 Vinda Int 3331 HK Outperform 1,664 13.00 21.9 27.2 22.8 15.0 9 -19 19 52 11.9 10.9 17 18 31 10.5 10.5 10.1 8.9 Market cap. Weighted average 21.3 20.5 19.0 17.7 8 5 7 8 11.8 11.2 13 4 4 22.3 23.2 23.6 21.5 Others Fufeng 546 HK Hold 707 2.61 6.9 8.7 8.4 7.8 15 -21 4 8 4.6 4.4 -1 4 9 9.9 7.6 6.4 9.0

Source: Bloomberg, Daiwa forecasts Note: #FY15-18E numbers for Huishan are used as the company year-end is on 31 March;

International Staples Sector: valuation comparison (as of 22 January 2016) Bloomberg Mkt.Cap. Price PER (x) EPS Growth EV/EBITDA x Revenue YoY % EBIT margin Name Code LCY USDm 14 15E 16E 17E 14 15E 16E 17E 15E 16E 2014 15E 16E 15E 16E 16E

US major F&B players Kraft-Heinz KHC US USD 90,269 74.39 55.5 34.2 25.1 20.6 n.a. 62 36 22 18.3 16.3 n.a. -6 -1 15.1 19.9 23.7 Coca Cola KO US USD 182,918 42.06 26.0 21.1 20.5 19.1 -16 23 3 7 17.0 16.5 -2 -4 0 21.1 23.0 23.6 Pepsi PEP US USD 139,639 95.85 22.2 21.0 19.9 18.5 -1 6 5 8 12.9 12.5 0 -5 1 14.4 15.9 16.2 General Mills GIS US USD 32,830 55.33 27.4 19.3 18.1 17.0 -30 42 7 7 12.2 11.9 -2 -5 1 11.8 16.6 17.0 Mondelez MDLz US USD 66,109 41.6 32.2 23.4 20.8 18.7 -1 38 13 11 16.3 15.2 -3 -17 0 9.5 15.9 15.0 Kellogg K US USD 25,378 71.61 40.7 20.5 19.5 18.3 -65 99 5 6 13.6 13.2 -1 -7 -1 7.0 14.1 14.7 Nestle NSRGY US USD 226,472 71.03 n.a. 21.1 20.0 18.8 45 n.a. 5 7 n.a. n.a. -1 -1 3 11.9 15.8 16.3 Market cap. weighted average 22.2 22.7 20.7 18.9 6 22 9 9 11.0 10.4 -1 -5 1 14.5 18.0 18.8

Global Dairy companies Fonterra FCG NZ NZD 7,641 5.86 n.a. 13.6 12.2 11.3 190 n.a. 12 8 9.2 8.5 -15 6 13 4.3 7.1 n.a. Danone BN FP EUR 55,794 59.61 31.7 20.6 19.3 17.7 -22 54 7 9 12.4 11.8 -1 6 3 10.2 12.7 13.3 Mead Johnson MJN US USD 13,831 70.16 19.8 20.7 20.0 18.6 5 -5 5 8 13.5 13.5 5 -8 -2 22.4 23.7 23.9 ABBOTT ABT US USD 59,714 40.03 26.7 18.6 17.2 15.3 -11 44 10 11 12.3 11.5 3 1 5 12.8 18.4 19.6 Market cap. weighted average 26.5 19.4 18.1 16.4 -3 40 8 10 12.3 11.6 1 3 4 12.2 16.0 16.4

International hog processors TYSON FOODS-A TSN US USD 20,276 51.22 17.0 14.3 13.0 11.6 21 19 10 11 8.3 7.9 10 -4 2 5.2 6.2 6.5 SANDERSON FARMS SAFM US USD 1,750 77.54 8.1 14.4 13.3 15.9 -12 -43 8 -16 5.6 5.4 1 -3 9 12.0 7.2 5.2 PILGRIM'S PRIDE PPC US USD 5,526 21.66 7.9 7.9 10.8 12.3 30 1 -27 -12 4.8 6.3 2 -5 -1 14.0 13.7 9.9 HORMEL FOODS CRP HRL US USD 20,076 75.98 29.2 26.0 24.3 22.3 14 12 7 9 15.1 14.2 -1 4 4 11.5 12.3 12.8 INDUS BACHOC-B BACHOCOB MM MXN 2,164 66.55 10.2 9.4 12.1 11.5 93 9 -22 5 4.6 5.7 5 10 3 12.8 12.1 9.5 JBS JBSS3 BZ BRL 7,425 10.64 15.1 5.6 6.7 5.7 119 170 -15 17 5.2 4.2 30 37 26 6.5 6.4 6.2 Market cap. weighted average 19.6 16.5 15.9 14.8 35 33 1 8 9.7 9.3 8 5 6 9.0 9.3 9.1

Japanese player

ITOHAM FOODS INC 2284 JP JPY 1,304 625 11.5 20.9 19.7 17.6 143 -45 6 9 14.1 11.0 4 31 17 0.8 n.a. n.a. NH FOODS LTD 2282 JP JPY 3,719 2,163 14.2 15.5 14.5 13.4 25 -8 5 8 8.5 8.0 8 4 2 4.0 3.5 3.8 Market cap. weighted average 13.5 16.9 15.9 14.5 57 -18 6 8 10.0 8.8 7 11 6 3.1 2.6 2.8

International personal hygiene products 9

PROCTER & GAMBLE PG US USD 210,464 77.36 30.9 20.6 18.3 16.8 -22 50 13 12 13.3 12.7 -5 -13 3 15.5 21.5 22.3

KIMBERLY-CLARK KMB US USD 45,999 126.72 31.1 22.0 20.6 19.1 -22 42 7 9 13.4 12.8 1 -6 2 12.8 17.3 17.9

Sven ska Cellulosa AB SCAB SS SEK 20,083 244.4 26.0 19.9 18.3 17.2 19 30 9 24 11.3 10.3 12 11 4 9.9 11.2 11.6

KAO CORP 4452 JP JPY 24,610 5,793 37.0 30.5 24.8 22.7 24 21 23 8 11.8 11.0 7 5 4 9.5 10.8 11.9

UNICHARM CORP 8113 JP JPY 11,285 2,156.50 33.6 35.6 27.2 24.2 -18 -5 29 8 12.7 11.5 21 25 9 11.2 10.3 10.8

Market cap. weighted average 31.2 22.1 19.5 17.9 -15 43 13 9 13.1 12.4 -1 -8 3 14.1 19 19.8

Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

The Davids Uni-President China (220 HK, HKD5.20): New products shine - upgrading to Buy (1) We upgrade UPCH to In this report, we are upgrading our rating for UPCH to Buy (1), from Underperform (4), as Buy (1) we expect its revenue growth to resume (5-8% YoY in 2015-17E, after a 4% decline in 2014) on likely market-share gains in the noodle segment and an increasing revenue contribution from high-end beverage products. We believe UPCH can realise revenue growth more easily than its biggest competitor, Tingyi, by improving its market-penetration rate and focusing on high-value items. As a result of doing so, we expect its operating margin to expand by 0.7pp and 0.3pp in 2016-17E to 5.2% and 5.5%, respectively, on our forecasts, after a jump of 3.4pp in 2015E. UPCH’s share price is down by 27% from its 52- week peak and is now trading at 19x 2016E PER, below its past-3-year average 12-month- forward PER of 26x, which see as a good entry point. We have a new 12-month target price of HKD6.20 (from HKD7.00), which is based on a 2016E PER of 22.6x (UPCH’s average forward PER since its IPO in 2007).

UPCH: financial summary UPCH: share price and past-7-year PER band chart 2013 2014 2015E 2016E 2017E (HKD) Revenue (CNY m) 23,329 22,488 23,642 25,524 26,783 10 YoY (%) 9 -4 5 8 5 Our forecast vs. consensus (%) n.a. n.a. 5 5 8 Net profit (CNY m) 446 127 844 1,004 1,114 8 Net profit growth (%) -48 -72 566 19 11 EPS (CNY) 0.12 0.03 0.20 0.23 0.26 6 EPS growth YoY (%) -48 -74 511 19 11 Operating margin 2.0% 0.9% 4.4% 5.2% 5.5% 4 ROE 5.6% 1.3% 7.5% 8.3% 8.6%

2 Jan-09 Mar-10 May-11 Jul-12 Sep-13 Nov-14 Jan-16 220 HK 16 20 24 28 32 Source: Company, Daiwa forecasts Source: Bloomberg

Vinda (3331 HK, HKD13.0): An emerging Asian play - reiterating Outperform (2) We reiterate our Outperform (2) rating on Vinda. We argue that the stock should be rerated on: 1) its transformation from a pure China tissue-paper manufacturer to a regional personal care product company following its acquisition of assets from its parent company, and 2) a solid revenue-growth outlook in China through ongoing market-share gains in the tissue-paper and incontinence-product segments. We believe the recent share-price correction was a result of foreign-exchange losses on the CNY depreciation. In this report we cut our 2015-17E EPS by 13-33%, due mainly to the forex losses. Our target price is now based on a 2016E PER of 25x (previously 20.4x), where we peg Vinda’s valuation to international peers’ (average: 20x 2016E PER) after its acquisition of the SCA Group’s hygiene operation, which we see turning it into a Pan-Asia business, and then apply a 25% premium due to our stronger EPS-growth forecast for Vinda vs. peers (including/excluding FX losses). We have a new 12-month target price of HKD14.30 (previously HKD17.40).

Vinda: financial summary Vinda: share price and past-5-year PER band chart 2013 2014 2015E 2016E 2017E HKD Revenue (HKD m) 6,798 7,985 9,421 12,341 14,340 25 YoY (%) 13% 17% 18% 31% 16% Our forecast vs. consensus (%) n.a. n..a -4 5 6 20 Net profit (HKD m) 543 593 478 609 979 Net profit growth (%) 1% 9% -19 27 61 15 EPS (HKD) 0.5434 0.5944 0.4787 0.5698 0.8670 10 Recurring EPS growth (%) 1% 9% -19% 19% 52% Operating margin 9.6 10.5 10.5 10.1 11.2 5 ROE 12.4 12.2 8.9 8.7 11.1

0 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 3331 HK 12x 15x 18x 21x 24x Source: Company, Daiwa forecasts Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

China Modern Dairy (1117 HK, HKD1.45): Downstream expansion- reiterate Buy (1) We prefer Modern Dairy We reiterate our Buy (1) call on Modern Dairy, with a new 12-month DCF-based target over Huishan Dairy price of HKD3.00 (formerly HKD3.30). We expect Modern Dairy’s earnings growth to among the upstream recover in 2016-17E after a 17% YoY decline in 2015E on the stabilisation of raw-milk dairy companies prices in China and rising imports of milk powder. The stock is trading currently at a 7x 2016E PER and a 0.7x 2016E PBR, on our forecasts, putting it at around a 54% discount to downstream peer Mengniu. Modern Dairy is on track to expand its downstream business, which is targeted to contribute 50% of the company’s revenue by 2020 (currently 25%), and progress on this front should support a rerating of the stock as a consumer brand company in our view. Moreover, we continue to favour Modern Dairy as a beneficiary of the long-term structural shortage of quality raw milk in China.

Modern Dairy: financial summary Modern Dairy: share price and past-5-year PER band chart Year end Dec 2013 2014 2015E 2016E 2017E 9 Revenue (CNY m) 3,289 5,027 4,980 5,402 5,821 8 YoY (%) 62% 53% -1% 8% 8% 7 Our forecast vs. consensus (%) n.a. n.a. 0% -4% -7% 6 Net profit (CNY m) 373 735 632 912 1,287 5 YoY (%) -28% 97% -14% 44% 41% 4 Reported EPS 0.077 0.160 0.126 0.172 0.243 3 YoY (%) -29% 108% -21% 37% 41% 2 Operating margin 21.3% 27.2% 27.5% 25.8% 30.4% 1 ROE (%) 6.8% 12.7% 8.3% 10.0% 12.7% 0

Jun11 Jun12 Jun13 Jun14 Jun15

Mar Mar 11 Mar 12 Mar 13 Mar 14 Mar 15

Dec11 Dec12 Dec13 Dec14 Dec15

Sep 11Sep Sep12 Sep13 Sep14 Sep15 1117 HK 11x 15x 19x 23x 27x

Source: Company, Daiwa forecasts Source: Bloomberg

Huishan (6863 HK, HKD2.95): More competition for downstream - reiterating Sell (5) We reiterate our Sell (5) rating on Huishan on valuation grounds. However, our SOTP- based 12-month target price rises to HKD1.87 from HKD1.60, due to a reduction in the number of shares outstanding after a share buyback in 2H15. The stock is now trading far above its peers’ average PER range of 3-7x (upstream) and 14-27x (downstream). We believe management’s share buybacks are the main reason for the stock’s increased PER multiple and we do not think that the company’s currently weak fundamentals justify such a hike. Nor do we consider the company’s share repurchases to be positive for its business development or balance sheet. We expect the downstream dairy industry in China to continue to see significant price competition and discounts across all segments (from premium-to-mass market), particularly for room-temperature products.

Huishan: financial summary Huishan: share price and PER band since listing (Year-end Mar) FY14 FY15 FY16E FY17E FY18E 6 Revenue (CNY m) 3,530 3,923 4,470 5,558 6,327 5 YoY growth (%) 38% 11% 14% 24% 14% vs consensus n.a. n.a. -2% -2% -5% 4 Reported net profit (CNY m) 1,249 790 768 977 1,133 3 YoY growth (%) 32% -37% -3% 27% 16% Reported EPS (CNY) 0.096 0.055 0.055 0.073 0.084 2 YoY growth (%) 17% -43% 1% 31% 16% 1 ROE 13.1% 5.9% 5.8% 7.5% 8.1% Operating margin (%) 42.2% 32.0% 29.4% 27.1% 28.6% 0

Jul 14Jul 15Jul

Jan 14Jan 15Jan

Mar 14 Mar 15

Nov 13 Nov 15 Nov Sep13 Sep14 Nov14 Sep15

May May 15 May 14 6863 HK 12x 16x 20x 24x 28x

Source: Company, Daiwa forecasts Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

The Goliaths Tingyi (322 HK, HKD9.07): Too big to move- downgrading to Hold (3) We downgrade Tingyi In this report, we are downgrading our rating for Tingyi to Hold (3) from Outperform (2), as and Hengan to Hold (3) we see a risk of the company losing market share in the noodle and bottled water on a slowdown in segments. We also expect revenue growth in its beverage business to remain slow at revenue momentum 1%/3% YoY in 2016/17E as the integration with Pepsi’s distribution system in China is progressing more slowly than we had expected. Hence, we forecast revenue growth for the beverage business to remain slow, at a 3% CAGR over 2016-17E.

We also expect net-profit growth to be slow, at a 6% CAGR in 2016-17E, on a flat gross- margin of 32-33%. We argue that, unlike UPCH, Tingyi will find it difficult to expand its gross margin via product-mix changes due to its large revenue base and previous mass- market focus. In sum, we cut our 2015-17E EPS by 4-16% and our 12-month target price from HKD12.90 to HKD9.60. We lower our target 2016E PER to 18x (from 21x), maintaining a 20% discount to Tingyi’s past-5-year average of 20%, on the back of the subdued earnings growth that we expect in the current year.

Tingyi: financial summary Tingyi: share price and past-5-year PER band chart 2013 2014 2015E 2016E 2017E (HKD) Revenue (USD m) 10,941 10,238 9,272 9,326 9,561 30 YoY % 19 -6 -9 1 3 vs. consensus (%) n.a. n.a. -1 -3 -5 25 Recurring net profit (USD m) 394 400 373 386 422 Profit growth YoY(%) 7 2 -7 3 9 20 EPS (USD) 0.070 0.072 0.067 0.069 0.075 EPS growth YoY (%) 7 2 -7 3 9 15 Operating margin 6.7% 7.2% 8.1% 8.7% 8.9% ROE 14.5% 13.5% 12.0% 11.7% 12.0% 10

Jul-14 Jul-15

Apr-11 Apr-12 Apr-13

Mar-14 Mar-15

Aug-13 Dec-13 Dec-10 Aug-11 Dec-11 Aug-12 Dec-12 Nov-14 Nov-15 322.HK 18 21 24 27 30

Source: Company, Daiwa forecasts Source: Bloomberg

Hengan (1044 HK, HKD67.75): Revenue expectations set too high, cutting to Hold (3) While we believe Hengan can maintain its No.1 position in the sanitary napkin market in China (it currently has about a 21-22% market share, on our estimates), we see its revenue growth being increasingly challenged by international brands, due to their growing penetration in lower-tier cities in China. As such, we downgrade Hengan to Hold (3) from Outperform (2) and cut our 12-month target price to HKD66 (from HKD87), based on a 2016E PER of 18x. We cut our 2015-17E EPS by 7-17% due to forex losses from CNY depreciation against the USD, as well as a potential decline in revenue.

Hengan: financial summary Hengan: share price and past-8-year PER band chart 2013 2014 2015E 2016E 2017E (HKD) Revenue (HKD m) 21,186 23,831 24,304 24,118 24,386 95 YoY (%) 14% 12% 2% -1% 1% Our forecast vs. consensus (%) n.a. n.a. -2% -10% -16% 75 Net profit (HKD m) 3,627 3,918 4,281 4,493 4,559 Recurring net profit growth (%) 3% 8% 9% 5% 1% EPS (HKD) 2.9473 3.1900 3.4873 3.6750 3.7287 55 Recurring EPS growth (%) 3% 8% 9% 5% 1% Operating margin 24.0% 24.1% 25.1% 25.7% 25.5% 35 ROE 23.7% 22.9% 23.5% 22.8% 21.3%

15 Aug 08 Aug 09 Aug 10 Aug 11 Aug 12 Aug 13 Aug 14 Aug 15 1044 HK 18x 21x

24x 27x 30x Source: Company, Daiwa forecasts Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

Mengniu (2319 HK, HKD11.08): Competition remains stiff - maintaining Hold (3) We believe increasing We maintain our Hold (3) rating and remain cautious on Mengniu’s revenue-growth selling expenses won’t prospects over 2016-17E given the risks of: 1) market-share contraction in the premium lead to rapid revenue milk segment, and 2) product cannibalisation On our revised-down revenue forecasts, as growth for Mengniu well as our concern that marketing expenses will increase, we cut our EPS forecasts by 5- 15% over 2015-17E. In turn, our 12-month target price falls to HKD11.70 (from HKD14.50), based on 2016E PER of 15.2x (was 16x). We now apply a bigger discount (from 15% to 20%) to the stock’s past-3-year average 12-month forward PER prior to 2013 (19x) to derive our target PER, as we see an increasing risk of market-share loss in the premium milk segment.

Mengniu: financial summary Mengniu: share price and past-5-year PER band chart 2013 2014 2015E 2016E 2017E (HKD) Revenue (CNY m) 43,357 50,049 49,103 50,942 52,203 25 YoY (%) 20% 15% -2% 4% 2% vs consensus (%) n.a. n.a. (3) (6) (11) 20 Net profit (CNY m) 1,607 2,233 2,577 2,471 2,745 YoY (%) 16% 39% 15% -4% 11% 15 EPS (CNY) 0.450 0.595 0.663 0.636 0.707 YoY (%) 14% 32% 12% -4% 11% Operating margin 4.3% 5.1% 6.4% 5.7% 5.9% 10 ROE (%) 11.6% 12.1% 11.5% 10.1% 10.4% 5 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Mengniu 13 17 21 25 29

Source: Company, Daiwa forecasts Source: Bloomberg

China Resources Beer (291 HK, HKD12.30, Hold [3]): Best-case scenario priced in CRB’s share price rose by 15% in 4Q15, which we believe fully prices in the earnings upside from the company’s planned acquisition of a 49% stake in the CR-Snow JV (subject to various conditions, eg, anti-trust approval by the China government for SABMiller’s merger with AB-InBev). In this report, we raise our 2016-17E EPS by 3-19%, assuming that CRB will acquire a minority stake in CR-Snow via bank financing in 2016.

We maintain our Hold (3) rating but lower our 12-month target price to HKD12.40 (from HKD13.40). We now value CRB at 23x 2016E PER (previously 26x 2016E), which marks a ca.15% premium to its closest peers’ (Tsingtao and Yanjing) average (20.2x), given our forecast for CRE to see faster EPS growth than its peers and its further potential earnings upside (via co-operation with an international peer, including strategic investment).

China Resources Beer: financial summary Key Financials 2013 2014 2015E 2016E 2017E Revenue (HKD m) 146,254 169,678 34,823 36,141 37,770 YoY 15.9% 16.0% -79.5% 3.8% 4.5% vs consensus n.a. n.a. n.a. -7.0% -8.7% Net profit (HKD m) 1,642 -794 874 1,282 1,606 YoY (%) n.a. n.a. n.a. 47% 25% EPS (HKD) 0.68 -0.33 0.36 0.53 0.66 YoY (%) n.a. n.a. n.a. 46.7% 25.2% ROE (%) 3.9% n.a. 2.7% 8.1% 9.6% Operating margin 3.5% 1.1% 7.9% 8.6% 10.0%

Source: Company, Daiwa forecasts; note: 2013-14 financials include CRB’s non-beer business, which was disposed of in September 2015

China Consumer Staples Sector: 26 January 2016

Tsingtao Brewery (168 HK, HKD28.80, Underperform [4]): Still a market-share loser Huishan and Tsingtao We are concerned: 1) that Tsingtao’s market-share gains look to have come to an end in remain our least 2015E, while the other top-2 players gained market share during the period, and 2) about preferred stocks continuously declining industry sales (-5.7% in 9M15). Hence, we cut our revenue forecasts by 1-9% over 2015-17E. Feeding in our lower EPS forecasts, we pare our 12- month TP to HKD26.80 (from HKD32.0). Our target PER of 19x (lowered from 20x) still marks a 10% discount to the stock’s past-3-year average 12-month forward PER, as Tsingtao’s EPS CAGR has declined from 8% for 2010-14 to almost 0% over 2015-17E (on our forecasts). Accordingly, we reaffirm our Underperform (4) rating.

Tsingtao: financial summary Tsingtao Brewery: share price and [past-5-year] PER band chart Key Financials 2013 2014 FY15E 2016E 2017E HKD Revenue (CNY m) 28,291 29,049 28,092 26,912 27,286 80 YoY 9.7% 2.7% -3.3% -4.2% 1.4% 70 vs consensus n.a. n..a 2.1% -5.0% -7.0% 60 Reported net profit (CNY m) 1,971 1,994 1,636 1,610 1,714 YoY 12.1% 1.1% -17.9% -1.6% 6.5% 50 EPS (CNY) 1.30 1.48 1.21 1.19 1.27 40 YoY 0.2% 13.2% -17.9% -1.6% 6.5% 30 Operating margin % 7.4 6.6 6.3% 6.0% 6.5% ROE% 13.3 13.6 10.3% 9.4% 9.4% 20

Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Oct-15 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

Jan-15 Jan-11 Jan-12 Jan-13 Jan-14 Jan-16 168 HK 18 21 24 27 30

Source: Company, Daiwa forecasts Source: Bloomberg

Fufeng (546 HK, HKD2.61): Price headwinds strengthening - downgrading to Hold (3) Given the product ASP declines, we are cutting: 1) Fufeng’s EPS forecasts over 2015-17E by 5-25%, and 2) our target PER from 12x to 9x (from the stock’s high end to the past-5- year average). Our new 12-month target price of HKD2.55 (previously HKD5.0) suggests limited upside; we have cut our target PER multiple from 12x to 9x as the product ASP uptrend looks to have come to an end and we believe Fufeng should now trade at its historical average PER (vs high-end when we had previously expected a product price upcycle). Hence, we downgrade our rating from Buy (1) to Hold (3). Shares are trading currently at a 8.5x 2016E PER. We believe the ASP and operating-profit margin decline for the xanthan gum business (10% of 2016E operating profit) has been priced in, while the shares will likely be supported by EPS growth at 8%/8% YoY over 2016/17E, respectively.

Fufeng: financial summary Fufeng: share price and past-5-year PER band Valuation 2013 2014 2015E 2016E 2017E (HKD) Revenue (CNY m) 11,367 11,298 11,761 12,869 12,992 10 YoY 2 -1 4 9 1 8 Our forecast vs. consensus (%) n..a n..a -1 -2 -6 Net profit (CNY m) 506 626 510 550 596 6 YoY 19 24 -19 8 8 4 EPS (CNY) 0.26 0.30 0.31 0.26 0.28 Recurring EPS growth (%) 5 16 -20 8 8 2 Operating margin (%) 8.1% 9.9% 7.6% 6.4% 6.8% ROE (%) 11.8% 12.3% 9.0% 9.0% 9.2% 0

Jul-09 Jul-14

Oct-15 Apr-08 Oct-10 Apr-13

Jan-12 Jun-12

Feb-09 Mar-11 Feb-14

Sep-13 Nov-07 Sep-08 Dec-09 Aug-11 Nov-12 Dec-14

May-10 May-15 564.HK 3x 4.5x 6x 7.5x 9x

Source: Company, Daiwa forecasts Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

The somewhere in-betweens Want Want (151 HK, HKD4.96, Buy [1])- Sales and earnings growth recovery in sight Want Want is our only We reiterate our Buy (1) rating on Want Want, but lower our 12-month target price to Buy-rated stock among HKD7.30 (set at 18.5x 2016E PER) from HKD8.50 (formerly 20x PER) after incorporating the big-cap staples downward revisions to our earnings of 8-10% over 2015-17E. Our target PER marks a names 20% discount to the stock’s past-5-year average 12-month forward PER, as we expect earnings growth to decelerate over 2015-17E vs the previous five years (15%). We forecast Want Want’s earnings growth to recover in 2016-17E as we expect revenue from its food business to see a 5% CAGR over 2015-17E, driven by new products and revenue growth in the snack segment. We prefer Want Want over the other large-cap China staples companies due to its stronger balance sheet and cash flow-supporting dividends and share buybacks (USD288m spent in 2015).

Want Want: financial summary Want Want: share price and past-5-year PER band 2013 2014 2015E 2016E 2017E (HKD) 14 Revenue (USD m) 3,818 3,775 3,532 3,748 4,008 YoY (%) 14% -1% -6% 6% 7% 12 Our forecast vs. consensus (%) n.a. n.a. -5.5% -3.0% -1.1% Net profit (USD m) 686 619 547 643 709 10 Recurring net profit growth (%) 24% -10% -12% 18% 10% 8 EPS (USD) 0.0519 0.0468 0.0416 0.0501 0.0552 Recurring EPS growth (%) 24% -10% -11% 20% 10% 6 Operating margin 23.1% 20.6% 20.9% 23.5% 24.3% 4 ROE 38.8% 31.0% 27.1% 29.5% 27.6%

2 Jan-11 Jul-11 Feb-12 Aug-12 Mar-13 Sep-13 Apr-14 Nov-14 May-15 Dec-15 151.HK 15x 18x 21x 24x 27x

Source: Company, Daiwa forecasts Source: Bloomberg

WH Group (288 HK, HKD4.40, Outperform [2]): Benefits from having a US brand On our forecasts, WH Group is trading at a 10x 2016E PER and we expect the company to deliver net-profit growth of 33% YoY for 2016. Its market cap now is almost equivalent to the market value of its 73% stake in Henan Shuanghui (000895 SZ, Not Rated). Hence, holders of the stock are effectively getting WH Group’s business outside China “for free”.

On our revised EPS forecasts and lower peer valuation benchmarks, we cut our 12-month target price to HKD4.80 from HKD5.50, based on a 2016E PER of 11x (previously 13.4x). Our target PER comprises 11.8x for the China operation (kept at a 20% discount to the peer average on slower prospective EPS growth) and a 10.2x PER for the US operation (in line with its US peers’ average).

WH Group: financial summary WH Group: share price and past-5-year PER band 2013 2014 2015E 2016E 2017E (HKD) 9 Revenue (USD m) 11,253 22,243 22,017 23,362 24,623 YoY (%) 80% 98% -1% 6% 5% 8 Our forecast vs. consensus (%) n.a. n.a. 1% 1% 2% 7 Net profit (USD m) -263 766 611 814 908 6 Reported net profit growth (%) 38% 66% -28% 33% 12% EPS (USD) 0.0452 0.0666 0.0417 0.0557 0.0621 5 Recurring EPS growth (%) 38% 48% -37% 33% 12% 4 Operating margin (%) 9.3 8.1 6.4 6.9 7.0 ROE(%) 25.0 22.8 11.3 13.5 13.4 3

Jul-15

Oct-14 Apr-15 Oct-15

Jan-15 Jun-15 Jan-16

Mar-15 Feb-15

Nov-14 Dec-14 Nov-15 Dec-15

Sep-14 Aug-14 Aug-15 Sep-15 May-15 288.HK 7x 8.5x 10x 11.5x 13x

Source: Company, Daiwa forecasts Source: Bloomberg

China Consumer Staples Sector: 26 January 2016

Risks Commodity prices – main risks, upside or downside As raw materials (including many types of agricultural products and packaging) account for over 80% of the COGS of the China staples 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 to China, and, hence, the companies are exposed to fluctuations in the global supply of these commodities.

We expect the gross margins of many of the staples companies we cover to expand slightly in 2016. Worse-than-expected depreciation of the CNY against USD, stronger global economy, or large rebound in the oil price could create unexpected cost pressures for the companies under our coverage. On the other hand, abundant supply of raw materials (ie, good harvest of grains) may lead to lower production costs and, hence, better gross margins for staple companies we covered.

Downside Product safety Food-safety hazards or negative talk in the market about the companies’ products could have an adverse effect on their sales volumes, causing the latter to fall below our current forecasts. Reports of food-safety issues, regardless of whether the China packaged food and beverage companies are responsible, could undermine their brand value and sales volumes.

Extreme weather changes A cooler-than-expected winter could be a slight positive for selected items (ie, noodles, meat). Also, a cooler-than-expected summer could dampen demand for bottled drinks. Heavy rainfall could curb outdoor activities, which in turn could weigh on demand and thus consumption of bottled drinks and packaged food.

Changes in regulations and price intervention Direct price interventions by the China Government could put pressure on ASPs and subsequently on the revenue of the packaged food and beverage companies. We believe the risk of this is greater for the instant-noodle players than for the other packaged-food segments, as instant noodles are a basic food item and any price hikes could create more public concern than a price increase for non-essential items such as snacks.

China Consumer Staples 26 January 2016

Uni-President China (220 HK) Uni-Presi dent Chi na

Target price: HKD6.20 (from HKD7.00)

Share price (25 Jan): HKD5.20 | Up/downside: +19.2%

Upgrading to Buy; new beverage products shine

 New beverage products to boost gross margins and market share Anson Chan, CFA (852) 2532 4350  Recent share price pull-back provides buying opportunity [email protected]  Upgrade to Buy (1) on market-share gains; TP now HKD6.20

What's new: After the recent pullback in the share price (-20% in 4Q15), Forecast revisions (%) we upgrade UPCH to Buy (1) from Underperform (4). During our recent Year to 31 Dec 15E 16E 17E retailer visits, we noted the increasing presence of UPCH’s new products, Revenue change (0.4) (0.1) 0.1 Net profit change (0.9) 6.2 17.6 in particular beverages. We expect the company’s earnings and revenue Core EPS (FD) change (0.9) 6.2 17.6 growth to outperform its peers in 2016E, as a result of its increasing Source: Daiwa forecasts contribution from new products, which carry high gross margins. Share price performance What's the impact: Adopting a diverse and differentiated approach to (HKD) (%) increase market share. UPCH was able to consistently gain market share 8.5 135 over 2012-15E (+1.7/2.9pp for noodles/juice drinks, to 18%/20%, 7.5 119 respectively) in those segments through product diversification. We expect 6.5 103 such a trend to continue to drive revenue growth over 2016-17E, despite 5.5 86 4.5 70 the sluggish industry outlook for beverages (as highlighted in our industry Jan-15 Apr-15 Jul-15 Oct-15 section), and this view was reaffirmed by our recent market research which Uni-Pres C (LHS) Relative to HSI (RHS) saw increasing presence of UPCH’s products in hypermarkets and convenience stores, including, small-bottles of milk tea (fresh-milk brewed 12-month range 4.98-8.13 to justify the higher ASPs), “vege-light” bow noodles, and sugar-free tea. Market cap (USDbn) 2.88 3m avg daily turnover (USDm) 3.27 EPS growth of 19-11% YoY for 2016-17E. We raise our EPS for 2016-17E by Shares outstanding (m) 4,319 Major shareholder Uni-President Enterprise (1216.TT) (70.3%) 6-18% after revising up our gross margin assumptions. We also lift our revenue forecasts for the beverage segment by 2%, as we believe UPCH will be able to Financial summary (CNY) regain market share in both the juice and bottled-tea segments (+0.5pp-1pp Year to 31 Dec 15E 16E 17E per year over 2016-17E). For noodles, we are cutting our revenue forecasts by Revenue (m) 23,642 25,524 26,783 1% as the market is still shrinking. But we expect UPCH’s gross margin to Operating profit (m) 1,042 1,334 1,465 Net profit (m) 844 1,004 1,114 reach 36% in 2016, and remain flat for 2017E, as the contribution of high- Core EPS (fully-diluted) 0.195 0.232 0.258 margin products rises while that for old products falls (vs. our previous forecast EPS change (%) 510.7 18.9 11.0 of a slight decline). As UPCH’s operating margin is thin (at 5.2% in 2016E, vs. Daiwa vs Cons. EPS (%) (2.8) (2.0) (7.6) PER (x) 22.5 18.9 17.0 8.7% for Tingyi), a 0.1pp improvement in the 2016 operating margin (led by Dividend yield (%) 0.9 1.1 1.2 gross margin expansion) would lift its reported net profit by 1.8% (and vice DPS 0.039 0.046 0.052 versa), on our estimates. As evidenced by the 1H15 results, such gross-margin PBR (x) 1.6 1.5 1.4 EV/EBITDA (x) 8.3 7.1 6.4 expansion was enough to offset the rise in selling expenses (for marketing new ROE (%) 7.5 8.3 8.6 products). Source: FactSet, Daiwa forecasts

What we recommend: We cut our 12-month TP to HKD6.20 (from HKD7.00) on a lower valuation benchmark, now based on a 22.6x 2016E PER (previously 26.5x for 2016E), in line with the company’s average since its IPO in 2007. Upgrade to Buy (1). Risk to our call: lower-than-expected new product revenue contribution.

How we differ: Our 2016-17 revenue forecasts are 2-8% above consensus as we are more optimistic on the revenue contribution from new products. Our 2015-17E EPS are below due to our lower expectations for the earnings contribution from the non-core business (Jinmailong JV).

See important disclosures, including any required research certifications, beginning on page 81

Uni-President China (220 HK): 26 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook UPCH: reported and recurring net profit, YoY %

We forecast UPCH’s net profit to rebound strongly by 1,200 566% 600% 566% YoY for 2015E (January-September 2015: +162% 500% 1,000 YoY) mainly on gross margin expansion, driven by lower 400% 800 raw-material costs (non-recurring in 2016-17E) and a 174% 300% product mix upgrade (long-term catalyst). We continue to 600 200% 19% 11% 100% see gross margin expansion as the key earnings catalyst 400 -40% -48% driving net profit to increase by 19% YoY for 2016E and -72% 0% 200 11% YoY for 2017E. (100%) 0 (200%) 2011 2012 2013 2014 2015E 2016E 2017E Reported net profit Recurring net profit

Reported net profit YoY % Source: Company, Daiwa forecasts

Valuation UPCH: 12-month forward PER bands since 2008 Over the past 5 years, UPCH has traded in a wide 12- (HKD) month forward PER range of 16-35x. Successful new 10 products were an important earnings and PER rerating catalyst in 2012-13. Our new target PER of 22.6x for 8 2016E is based on the company’s average valuation since 6 2007 (vs. its past-5-year average of 26.5x that we used previously), which we believe is more in line with the trough 4 valuation we saw in 2008-09. It also represents a premium to the Chinese staples companies’ average (16x), as 2 UPCH is one of the few staple stocks able to offer mid- Jan-09 Mar-10 May-11 Jul-12 Sep-13 Nov-14 Jan-16 teens EPS growth in 2016-17E, based on our estimates. 220 HK 16 20 24 28 32 Source: Bloomberg

Earnings revisions UPCH: Bloomberg consensus EPS forecasts UPCH’s 2016E consensus estimates trended up slightly in HKD 2H15, due we believe to the launch of more new products 0.300 and it successfully gaining greater product penetration, such as its Haizhiyen and Xiaoming classmates. We would 0.250 revisit our EPS forecasts if gross margin expansion from 0.200 new products launched was better than expected.

0.150

0.100 J-15 F-15 M-15 A-15 M-15 J-15 J-15 A-15 S-15 O-15 N-15 D-15 2015E 2016E

Source: Bloomberg

Uni-President China (220 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales growth YoY - Instant noodles 67.4 67.3 22.5 7.7 1.7 (2.4) 1.0 1.0 Sales growth YoY - Beverage 27.0 21.5 30.2 8.9 (7.6) 9.6 11.8 6.9 Gross margin % - instant noodles 28.1 29.3 33.2 29.2 28.7 31.9 31.5 30.8 Gross margin % - beverage 34.1 29.8 35.6 35.8 35.3 38.3 39.5 39.4 Sellling and distribution expense ratio 26.1 25.4 28.2 29.3 28.0 27.0 26.9 26.5 (%) Advertising and promotion expense 11.3 10.0 13.0 12.3 10.5 10.5 10.2 10.0

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Instant noodles 3,549 5,936 7,270 7,826 7,960 7,773 7,851 7,929 Tea beverage 5,005 4,992 5,597 6,143 5,526 5,293 5,561 5,728 Other Revenue 4,037 6,047 8,539 9,328 9,002 10,575 12,112 13,125 Total Revenue 12,591 16,975 21,406 23,297 22,488 23,642 25,524 26,783 Other income 131 159 246 343 167 167 167 167 COGS (8,548) (12,032) (14,004) (15,518) (15,179) (15,281) (16,277) (17,113) SG&A (3,616) (4,841) (6,766) (7,665) (7,263) (7,486) (8,079) (8,371) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 558 261 882 458 213 1,042 1,334 1,465 Net-interest inc./(exp.) 55 95 64 99 (42) 40 10 22 Assoc/forex/extraord./others 69 63 146 563 244 75 50 60 Pre-tax profit 682 419 1,091 1,120 415 1,157 1,394 1,547 Tax (163) (84) (221) (200) (129) (312) (390) (433) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 519 335 870 920 286 844 1,004 1,114 Net profit (adjusted) 519 312 856 446 127 844 1,004 1,114 EPS (reported)(CNY) 0.144 0.093 0.242 0.256 0.072 0.195 0.232 0.258 EPS (adjusted)(CNY) 0.144 0.087 0.238 0.124 0.032 0.195 0.232 0.258 EPS (adjusted fully-diluted)(CNY) 0.144 0.087 0.238 0.124 0.032 0.195 0.232 0.258 DPS (CNY) 0.043 0.026 0.048 0.051 0.013 0.039 0.046 0.052 EBIT 558 261 882 458 213 1,042 1,334 1,465 EBITDA 930 800 1,693 1,522 1,568 2,531 2,923 3,154

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 682 419 1,091 1,120 415 1,157 1,394 1,547 Depreciation and amortisation 372 538 811 1,064 1,355 1,489 1,589 1,689 Tax paid (157) 37 (202) (259) (210) (312) (390) (433) Change in working capital 197 503 646 (572) (142) (177) (41) (27) Other operational CF items (124) (135) (195) (188) (43) (115) (60) (82) Cash flow from operations 971 1,363 2,151 1,165 1,375 2,041 2,492 2,694 Capex (1,412) (4,162) (3,578) (4,746) (3,346) (2,000) (2,000) (2,000) Net (acquisitions)/disposals 0 0 0 950 520 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,412) (4,162) (3,578) (3,796) (2,826) (2,000) (2,000) (2,000) Change in debt 166 2,930 875 2,033 (168) 444 (780) (1,000) Net share issues/(repurchases) 0 0 0 0 2,665 0 0 0 Dividends paid (352) (156) (97) (171) (183) (57) (169) (201) Other financing CF items (354) (37) 470 55 (102) (70) (106) (73) Cash flow from financing (540) 2,738 1,247 1,917 2,212 316 (1,055) (1,274) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (981) (61) (180) (714) 762 358 (562) (580) Free cash flow (441) (2,799) (1,427) (3,581) (1,970) 41 492 694 Source: FactSet, Daiwa forecasts

Uni-President China (220 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 2,432 2,387 2,295 1,420 2,128 2,666 2,263 1,833 Inventory 1,139 1,274 1,285 1,514 1,129 1,256 1,338 1,407 Accounts receivable 401 513 513 548 487 512 553 581 Other current assets 429 443 824 1,026 1,343 1,343 1,343 1,343 Total current assets 4,402 4,617 4,917 4,508 5,088 5,778 5,498 5,164 Fixed assets 3,121 5,579 7,912 10,186 11,642 12,158 12,574 12,890 Goodwill & intangibles 11 8 7 17 29 29 29 29 Other non-current assets 2,047 3,533 3,704 4,258 4,506 4,506 4,506 4,506 Total assets 9,581 13,737 16,540 18,968 21,264 22,470 22,606 22,588 Short-term debt 166 1,584 409 902 1,556 2,000 2,000 2,000 Accounts payable 1,020 1,196 1,442 1,410 1,054 1,256 1,338 1,407 Other current liabilities 1,718 2,307 3,098 3,024 3,110 2,883 2,883 2,883 Total current liabilities 2,904 5,087 4,948 5,336 5,721 6,139 6,221 6,290 Long-term debt 0 1,512 3,562 5,102 4,280 4,280 3,500 2,500 Other non-current liabilities 17 328 358 388 427 427 427 427 Total liabilities 2,921 6,926 8,869 10,826 10,428 10,846 10,148 9,216 Share capital 34 34 34 34 40 40 40 40 Reserves/R.E./others 6,625 6,777 7,637 8,108 10,797 11,584 12,419 13,332 Shareholders' equity 6,660 6,811 7,671 8,142 10,837 11,624 12,459 13,372 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 9,581 13,737 16,540 18,968 21,264 22,470 22,606 22,588 EV 15,880 18,502 19,321 22,059 21,137 21,043 20,666 20,096 Net debt/(cash) (2,266) 709 1,675 4,584 3,708 3,614 3,237 2,667 BVPS (CNY) 1.850 1.892 2.131 2.262 2.509 2.691 2.884 3.096

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 38.2 34.8 26.1 8.8 (3.5) 5.1 8.0 4.9 EBITDA (YoY) (14.6) (14.0) 111.7 (10.1) 3.1 61.3 15.5 7.9 Operating profit (YoY) (27.2) (53.2) 237.4 (48.0) (53.5) 388.9 28.1 9.8 Net profit (YoY) (26.4) (39.9) 174.4 (47.9) (71.6) 566.2 18.9 11.0 Core EPS (fully-diluted) (YoY) (19.0) (39.9) 174.4 (47.9) (74.2) 510.7 18.9 11.0 Gross-profit margin 32.1 29.1 34.6 33.4 32.5 35.4 36.2 36.1 EBITDA margin 7.4 4.7 7.9 6.5 7.0 10.7 11.5 11.8 Operating-profit margin 4.4 1.5 4.1 2.0 0.9 4.4 5.2 5.5 Net profit margin 4.1 1.8 4.0 1.9 0.6 3.6 3.9 4.2 ROAE 7.9 4.6 11.8 5.6 1.3 7.5 8.3 8.6 ROAA 5.9 2.7 5.7 2.5 0.6 3.9 4.5 4.9 ROCE 8.4 3.1 8.2 3.6 1.4 6.0 7.4 8.2 ROIC 11.4 3.5 8.3 3.4 1.1 5.1 6.2 6.6 Net debt to equity n.a. 10.4 21.8 56.3 34.2 31.1 26.0 19.9 Effective tax rate 23.9 20.1 20.3 17.8 31.1 27.0 28.0 28.0 Accounts receivable (days) 9.8 9.8 8.7 8.3 8.4 7.7 7.6 7.7 Current ratio (x) 1.5 0.9 1.0 0.8 0.9 0.9 0.9 0.8 Net interest cover (x) n.a. n.a. n.a. n.a. 5.1 n.a. n.a. n.a. Net dividend payout 30.0 27.9 19.7 19.9 18.3 20.0 20.0 20.0 Free cash flow yield n.a. n.a. n.a. n.a. n.a. 0.2 2.6 3.7 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 17.9% market share (2014), according to AC Nielsen. In addition, it was the second-largest ready-to-drink tea brand (c.29% market share) and the largest milk tea brand (c.62%) in the domestic market in 2014.

Hong Kong Consumer Staples 26 January 2016

(3331 HK) Vinda International Vinda International

Target price: HKD14.30 (from HKD17.40) Share price (25 Jan): HKD13.00 | Up/downside: +10.0%

Look beyond CNY issues; emerging Asian play

 EPS and TP cut after building in higher FX loss assumptions Anson Chan, CFA (852) 2532 4350  Asia business acquisition likely to complete in 1Q16 and drive revenue [email protected]  Reiterate Outperform on valuation and stronger-than-peer EPS growth

What's new: We remain positive on Vinda’s earnings growth prospects in Forecast revisions (%) view of its increasing sales of personal care products and expansion Year to 31 Dec 15E 16E 17E outside China. We estimate the pan-Asian business being acquired will Revenue change (4.2) 9.0 13.6 Net profit change (25.3) (28.3) (2.1) contribute c.10% of Vinda’s revenue in 2016E (9 months’ contribution) and Core EPS (FD) change (25.3) (33.1) (13.4) see the operating margin for this unit improving gradually as scale builds. Source: Daiwa forecasts We reiterate our Outperform (2) rating given: 1) the recent share-price weakness, which we think has priced in the impact of CNY depreciation Share price performance against the USD, and 2) strong EPS growth in 2016-17E despite our cuts. (HKD) (%) 20 170 What's the impact: Emerging as an Asian play. Vinda is due to complete 17 153 the acquisition of its parent’s personal care product businesses in Malaysia, 15 135 13 118

Singapore, Taiwan and Korea (“acquired business”) by March 2016. Thus, 11 100 we are raising our 2016-17E revenue by 9-14% (see our Memo, Acquisition Jan-15 Apr-15 Jul-15 Oct-15 of Pan-Asia business, 28 December 2015 for details). Due to a lack of Vinda Intl (LHS) Relative to HSI (RHS) economies of scale, the acquired business’s operating margin was 5.7% in 9M15, vs. 9.7% for Vinda. As such, we expect Vinda’s reported operating 12-month range 11.80-19.32 margin to be dragged down to 10% in 2016E (2014-15E: 10.5%). However, Market cap (USDbn) 1.66 we look for: 1) the operating margin for the China operations to still trend 3m avg daily turnover (USDm) 0.97 Shares outstanding (m) 998 up slightly in 2016E (by 0.4pp YoY to 11%) on an increase in personal care Major shareholder SCA (51.4%) product sales, and 2) the acquired business’s operating margin to improve gradually as products sourced from China lead to lower production costs. Financial summary (HKD) Year to 31 Dec 15E 16E 17E Earnings cut due to CNY depreciation. We are revising down our 2015E Revenue (m) 9,421 12,341 14,340 revenue after a slight slowdown in tissue market revenue growth in China Operating profit (m) 990 1,242 1,605 Net profit (m) 478 609 979 in 2H15E. However, we are cutting our 2016-17E EPS by 13-33%, as we Core EPS (fully-diluted) 0.479 0.570 0.867 assume a: 1) FX loss of HKD200-300m over 2015-17E (17-36% of EPS change (%) (19.5) 19.0 52.2 recurring net profit) due to CNY weakness (using Daiwa’s USD/CNY rate of Daiwa vs Cons. EPS (%) (22.9) (29.1) (10.9) 7.5 by end-2016E), and 2) 13% EPS dilution from the new share issue for PER (x) 27.2 22.8 15.0 Dividend yield (%) 1.5 1.5 2.0 the acquisition. While Vinda is the most negatively impacted by CNY DPS 0.190 0.201 0.261 weakness in our coverage universe due to its USD debt exposure (>90% in PBR (x) 2.3 1.7 1.6 2015E), we believe its underlying growth remains robust, and hence EV/EBITDA (x) 11.9 10.9 8.7 ROE (%) 8.9 8.7 11.1 forecast EPS growth of 19%/52% YoY for 2016-17E, or 20%/30% YoY on Source: FactSet, Daiwa forecasts an ex-FX impact basis.

What we recommend: We reaffirm our Outperform (2) rating, but cut our 12-month TP to HKD14.30 from HKD17.40, now based on a 25x 2016E PER (vs. 20.4x before). After the acquisition of its parent’s Asian business, we now peg Vinda’s valuation to international peers’ (average 20x 2016E PER), and apply a 25% premium for its better EPS-growth profile (2016E: 19% vs. 9% for peers). Key risk: a surge in pulp or selling expenses.

How we differ: Our 2016-17E EPS are 11-29% below consensus, which we attribute to Daiwa’s more bearish view on the CNY/USD exchange rate.

See important disclosures, including any required research certifications, beginning on page 81

Vinda International (3331 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Vinda: net profit and net-profit growth We forecast Vinda’s net profit to decline by 19.5% YoY for (HKDm) 2015E as we assume a HKD280m FX loss on the CNY’s 1,200 70% 1,000 60% depreciation vs. the HKD. We look for EPS growth of 19% 50% 800 YoY for 2016E against net profit growth of 27.5% YoY, due 40% to new share issue dilution as a result of its acquisition. Net 600 30% profit growth will accelerate to 61% YoY for 2017E, on our 400 20% 200 10% forecasts, due to: 1) a reduction in FX losses, and 2) 16% 0% 0 YoY organic revenue growth on the back of increasing (10%) (200) tissue sales and slight operating margin expansion. Our (20%) (400) (30%) sensitivity analysis shows that a 1% depreciation in the 2011 2012 2013 2014 2015E 2016E 2017E CNY:USD exchange rate would lead to a 4% decline in the Reported profit FX loss YoY company’s reported net profit for 2016E. Source: Company, Daiwa forecasts

Valuation Vinda: 12-month forward PER bands Vinda was rerated between September 2013 and (HKD) 25 September 2015 after Sweden’s SCA became its major shareholder through Vinda acquiring SCA’s personal care 20 product business in China. We believe the recent share- 15 price drop already factors in the negative impact of CNY depreciation. We look for Vinda to be rerated over 2016- 10 17E as synergies with the acquired pan-Asia business kick 5 in, and penetration of Vinda/SCA’s personal care products improves in China. We believe our target 2016E PER of 0 25x is undemanding given we forecast the company’s EPS Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 3331 HK 12x 15x to grow at 35% CAGR over 2015-17, including 19% YoY in 18x 21x 24x 2016. Our target price also implies a 2017E PER of 16.5x, Source: Bloomberg which is at a slight discount to the peers’ average of 18x.

Earnings revisions Vinda: Bloomberg consensus EPS (2015-16E) We see downside to the Bloomberg consensus 2015-16 (HKD) EPS forecasts due to our higher FX loss assumptions from 1.0 CNY depreciation (2015E: HKD280m; 2016E: HKD300m; 0.9 2017E: HKD200m). However, on an ex-FX loss basis, our 0.8 forecasts call for earnings growth of 24%/20%/30% YoY 0.7 over 2015-17E driven by its acquisition of the Asian 0.6 business and expansion of its tissue sales volume growth 0.5 in China. 0.4

0.3

Jul-15

Apr-15 Oct-15

Jan-15 Jun-15

Mar-15 Feb-15

Aug-15 Sep-15 Nov-15 Dec-15 May-15 2015E 2016E

Source: Bloomberg

Vinda International (3331 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Volume YoY % 26 19 27 14 15 15 8 8 ASP YoY % 2.2 10.9 (0.2) (0.7) 0.4 0.2 2.5 2.2 Selling cost ratio % 12.4 12.1 12.8 13.9 14.9 15.3 16.2 16.0 Wood pulp cost change YoY % 34 (2) (12) 8 (2) (1) (2) 0

Profit and loss (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Toilet roll 2,201 2,926 3,669 3,970 4,293 4,568 4,568 4,796 Other tissue papers 1,401 1,839 2,355 2,828 3,577 4,503 5,478 6,290 Other Revenue 0 0 0 0 115 350 2,295 3,254 Total Revenue 3,602 4,765 6,024 6,798 7,985 9,421 12,341 14,340 Other income 22 18 55 40 91 60 60 60 COGS (2,540) (3,469) (4,169) (4,826) (5,577) (6,458) (8,384) (9,739) SG&A (626) (814) (1,138) (1,317) (1,661) (2,034) (2,775) (3,057) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 458 501 772 694 839 990 1,242 1,605 Net-interest inc./(exp.) (3) 19 (41) (57) (79) (116) (171) (165) Assoc/forex/extraord./others 6 2 (12) 35 (23) (280) (300) (200) Pre-tax profit 460 522 719 672 737 594 771 1,239 Tax (91) (116) (182) (130) (144) (116) (162) (260) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 369 406 537 543 593 478 609 979 Net profit (adjusted) 369 406 537 543 593 478 609 979 EPS (reported)(HKD) 0.394 0.432 0.537 0.543 0.594 0.479 0.570 0.867 EPS (adjusted)(HKD) 0.394 0.432 0.537 0.543 0.594 0.479 0.570 0.867 EPS (adjusted fully-diluted)(HKD) 0.394 0.432 0.537 0.543 0.594 0.479 0.570 0.867 DPS (HKD) 0.118 0.120 0.156 0.156 0.160 0.190 0.201 0.261 EBIT 458 501 772 694 839 990 1,242 1,605 EBITDA 588 664 972 968 1,218 1,436 1,754 2,184

Cash flow (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 460 522 719 672 737 594 771 1,239 Depreciation and amortisation 130 163 200 274 379 446 512 579 Tax paid (101) (140) (217) (205) (44) (116) (162) (260) Change in working capital (339) (150) (15) (1) (53) (363) (488) (332) Other operational CF items (3) (21) 53 81 82 115 171 165 Cash flow from operations 147 373 740 821 1,100 676 804 1,391 Capex (473) (833) (1,264) (1,386) (1,009) (1,000) (1,000) (1,000) Net (acquisitions)/disposals 1 7 36 (21) (1,366) 0 (3,776) 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (472) (826) (1,228) (1,407) (2,375) (1,000) (4,776) (1,000) Change in debt 224 882 114 653 1,727 144 2,002 0 Net share issues/(repurchases) 33 5 531 (9) 0 (9) 2,077 0 Dividends paid (112) (112) (130) (161) (148) (189) (227) (295) Other financing CF items 212 (77) (17) 34 (299) (43) (47) (96) Cash flow from financing 357 697 498 517 1,281 (97) 3,805 (391) Forex effect/others (6) (4) (4) (62) 18 280 300 200 Change in cash 27 241 5 (131) 24 (141) 133 200 Free cash flow (326) (460) (525) (565) 91 (324) (196) 391 Source: FactSet, Daiwa forecasts

Vinda International (3331 HK): 26 January 2016

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 390 716 760 693 722 486 472 581 Inventory 1,322 1,372 1,447 1,643 2,029 2,350 3,051 3,544 Accounts receivable 647 939 1,116 1,286 1,524 1,888 2,472 2,873 Other current assets 1 43 42 41 62 90 90 90 Total current assets 2,359 3,071 3,365 3,663 4,336 4,813 6,085 7,087 Fixed assets 2,273 3,022 3,987 5,102 5,902 6,478 9,795 10,238 Goodwill & intangibles 11 10 13 21 1,400 1,400 1,400 1,400 Other non-current assets 248 360 458 586 565 565 1,535 1,535 Total assets 4,891 6,464 7,823 9,373 12,203 13,257 18,815 20,260 Short-term debt 557 801 1,219 1,032 1,556 1,700 2,000 2,000 Accounts payable 980 1,210 1,423 1,820 2,309 2,674 3,472 4,033 Other current liabilities 64 69 91 58 154 139 139 139 Total current liabilities 1,601 2,080 2,733 2,911 4,020 4,514 5,611 6,173 Long-term debt 530 1,169 865 1,705 2,909 2,909 4,611 4,611 Other non-current liabilities 72 76 105 110 194 194 194 194 Total liabilities 2,203 3,325 3,704 4,726 7,122 7,616 10,416 10,977 Share capital 94 94 100 100 100 100 100 100 Reserves/R.E./others 2,594 3,045 4,019 4,547 4,981 5,541 8,299 9,184 Shareholders' equity 2,688 3,139 4,119 4,647 5,081 5,641 8,399 9,284 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 4,891 6,464 7,823 9,373 12,203 13,257 18,815 20,260 EV 13,677 14,173 14,207 14,932 16,722 17,102 19,117 19,009 Net debt/(cash) 698 1,254 1,325 2,044 3,743 4,123 6,139 6,030 BVPS (HKD) 2.870 3.345 4.121 4.654 5.089 5.650 7.438 8.221

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 29.8 32.3 26.4 12.8 17.5 18.0 31.0 16.2 EBITDA (YoY) (8.6) 13.0 46.3 (0.4) 25.8 17.9 22.2 24.5 Operating profit (YoY) (12.2) 9.5 53.9 (10.1) 20.9 18.0 25.4 29.2 Net profit (YoY) (7.3) 10.0 32.3 1.1 9.3 (19.5) 27.5 60.7 Core EPS (fully-diluted) (YoY) (10.5) 9.8 24.2 1.2 9.4 (19.5) 19.0 52.2 Gross-profit margin 29.5 27.2 30.8 29.0 30.2 31.5 32.1 32.1 EBITDA margin 16.3 13.9 16.1 14.2 15.3 15.2 14.2 15.2 Operating-profit margin 12.7 10.5 12.8 10.2 10.5 10.5 10.1 11.2 Net profit margin 10.2 8.5 8.9 8.0 7.4 5.1 4.9 6.8 ROAE 15.5 13.9 14.8 12.4 12.2 8.9 8.7 11.1 ROAA 8.6 7.1 7.5 6.3 5.5 3.8 3.8 5.0 ROCE 13.6 11.3 13.6 10.2 9.9 10.0 9.8 10.4 ROIC 12.3 10.0 11.7 9.2 8.7 8.6 8.1 8.5 Net debt to equity 26.0 40.0 32.2 44.0 73.7 73.1 73.1 65.0 Effective tax rate 19.8 22.3 25.3 19.3 19.5 19.5 21.0 21.0 Accounts receivable (days) 53.5 60.8 62.3 64.5 64.2 66.1 64.5 68.0 Current ratio (x) 1.5 1.5 1.2 1.3 1.1 1.1 1.1 1.1 Net interest cover (x) 139.2 n.a. 19.0 12.2 10.6 8.5 7.3 9.7 Net dividend payout 30.0 27.7 29.0 28.7 26.9 39.6 35.3 30.1 Free cash flow yield n.a. n.a. n.a. n.a. 0.7 n.a. n.a. 3.0 Source: FactSet, Daiwa forecasts

Company profile

Vinda is the 3rd-largest tissue paper brand in China, with a market share of approximately 13% in 2014, according to AC Nielsen. Its major products include toilet rolls, box tissues, handkerchiefs, and soft-pack tissues.

China Consumer Staples 26 January 2016

Want Want China (151 HK) Want Want Chi na

Target price: HKD7.30 (from HKD8.50) Share price (25 Jan): HKD4.96 | Up/downside: +47.1%

Revenue and earnings growth recovery in sight

 Remains our only Buy among big-caps due to strong balance sheet Anson Chan, CFA (852) 2532 4350  Focus on snacks segment to support pricing power [email protected]  EPS growth to resume in 2016-17E; reiterate Buy (1) rating

What's new: Unlike other dairy processors, Want Want’s milk-powder cost Forecast revisions (%) trend should remain favourable in 1H16 as it uses up its reserves of low- Year to 31 Dec 15E 16E 17E cost inventory, whose unit cost we estimate is still c.20% below the current Revenue change (5.5) (4.5) (4.4) Net profit change (9.4) (8.8) (10.1) milk powder spot price on the international market. Moreover, we expect Core EPS (FD) change (9.7) (7.8) (9.1) the ASP of Want Want’s rice crackers to continue to rise due to product-mix Source: Daiwa forecasts adjustments (with the company planning more seasonal products/festive items), and we see Want Want maintaining its strategy of avoiding price Share price performance competition to protect its brand and pricing power. Reiterate Buy (1) rating. (HKD) (%) 9.5 105 What's the impact: Gross margin poised to improve. We are cutting our 8.3 95 2015-17E EPS by 8-10%: 1) as we expect FX losses over 2015-17 due to 7.0 85 CNY depreciation against the USD, and 2) after revising down our 2015- 5.8 75 4.5 65 17E revenue by 4-5% on rising competition in the dairy industry. That said, Jan-15 Apr-15 Jul-15 Oct-15 we look for Want Want’s revenue growth to resume in 2016-17E at 6-7% Want Want (LHS) Relative to HSI (RHS) YoY (vs. a 1-6% YoY decline in 2014 and 2015) on the new products launched in 2014-15E continuing to gain market share, and a recovery in 12-month range 4.79-9.32 revenue growth for snacks in 2016E. This, coupled with lower raw-material Market cap (USDbn) 8.18 costs, should see the gross margin improve slightly by 0.3pp to around 3m avg daily turnover (USDm) 16.45 44% for 2016E, after a 3.4pp YoY jump in 2015E. Shares outstanding (m) 12,855 Major shareholder Eng-meng Tsai (48.0%)

Still our top pick. We still prefer Want Want over the other big-cap staple Financial summary (USD) companies due to: 1) our expectation that its EPS growth will resume in Year to 31 Dec 15E 16E 17E 2016-17E, and 2) its stronger balance sheet and cash flow, and 3) our Revenue (m) 3,532 3,748 4,008 preference for the snacks segment over other key food & beverage Operating profit (m) 739 880 974 Net profit (m) 547 643 709 categories due to its potentially relatively faster segment revenue growth. Core EPS (fully-diluted) 0.042 0.050 0.055 EPS change (%) (11.1) 20.2 10.3 What we recommend: We trim our 12-month target price to HKD7.30 Daiwa vs Cons. EPS (%) (9.5) 2.2 8.2 PER (x) 15.3 12.7 11.5 (from HKD8.50), which is now based on an 18.5x 2016E PER (from 20x) Dividend yield (%) 3.0 3.9 4.3 post our EPS revisions. Our target PER is based on a 20% discount to the DPS 0.019 0.025 0.028 stock’s past-5-year average 12-month forward PER (now 23.2x vs. 25x PBR (x) 4.1 3.4 3.0 EV/EBITDA (x) 9.1 7.4 6.4 previously with the same 20% discount), as we expect a slowdown in dairy ROE (%) 27.1 29.5 27.6 market growth over 2015-17E vs. the previous 5 years. However, we see Source: FactSet, Daiwa forecasts continuous share buybacks, armed with its FCF of USD550m/year over 2016-17E (it spent c.USD288m in 2015) as a potential catalyst. With EPS growth heading back towards positive territory in 2016-17E, we reaffirm our Buy (1) call. The key risk: a surge in promotion costs.

How we differ: Our 2015E EPS is 11% below consensus due to our lower dairy revenue assumptions. We are more optimistic on Want Want’s dry food business (rice crackers, snacks) in 2016-17E and beyond, given the low per-capita consumption base in China, as evidenced by our above- consensus 2016-17 EPS forecasts.

See important disclosures, including any required research certifications, beginning on page 81

Want Want China (151 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Want Want: net profit net-profit growth We forecast Want Want’s net profit to recover to 18% YoY (USDm) 800 40% and 10% YoY in 2016-17E, after 2 consecutive years of 700 decline. The key drivers would be: 1) a recovery in revenue 32% 30% 600 24% to a 6% CAGR over 2015-17E (-7% in 2015E) supported 20% 500 by snacks segment growth, and 2) slight operating margin 17% 18% 10% expansion from a higher contribution from high-margin new 400 10% 300 products and streamlining of the sales team (completed in 0% 200 2H15). -10% (10%) 100 -12% 0 (20%) 2011 2012 2013 2014E 2015E 2016E 2017E Net profit (LHS) YoY (RHS)

Source: Company, Daiwa forecasts

Valuation Want Want: 12-month forward PER bands Want Want is trading near the low-end of its past 5-year (HKD) 14 12M forward PER band (15-28x). It has the strongest free 12 cash flow and balance sheet among the staples companies we cover, which could support share buybacks (it spent 10 USD288m in 2015 on buying shares back). We expect 8 Want Want to rerate towards its past-5-year average PER 6 of 23x as earnings growth gradually resumes from 2016E. 4

2 Jan-11 Jul-11 Feb-12 Aug-12 Mar-13 Sep-13 Apr-14 Nov-14 May-15 Dec-15 151.HK 15x 18x 21x 24x 27x

Source: Bloomberg

Earnings revisions Want Want: 2015-16E Bloomberg EPS consensus The Bloomberg-consensus 2015-16 EPS forecasts for (USD) Want Want trended down in 2015 on a slowdown in 0.08 revenue momentum, in particular for dairy beverages. 0.07 However, we expect earnings growth to recover on 0.07 improving snacks revenue growth as a result of the new 0.06 0.06 products launched in 2014-15. Our 2016E EPS is 2% 0.05 above the Bloomberg-consensus forecasts. 0.05

0.04

Jul 15Jul

Apr Apr 15 Oct Oct 15

Jan 15Jan 15Jun

Feb Feb 15 Mar 15

Nov15 Dec15

Aug15 Sep15 May 15 2015E 2016E

Source: Bloomberg

Want Want China (151 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales growth YoY - rice crackers 34.3 30.0 (0.6) 12.0 (10.8) 8.2 6.6 7.5 Sales growth YoY - beverages 33.8 30.6 22.6 17.0 (0.3) (14.1) 2.5 3.4 Sales growth YoY - snacks 22.0 36.1 14.8 8.4 7.0 (3.6) 12.4 12.5 Gross margin % - rice crackers 40.8 37.6 39.0 40.8 39.9 41.9 42.6 43.3 Gross margin % - beverages 34.6 33.4 39.5 41.3 38.4 43.7 44.1 43.5 Gross margin % - snacks 40.7 34.5 40.4 43.0 44.9 45.2 44.8 44.9

Profit and loss (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Rice crackers 629 817 812 910 812 879 937 1,007 Beverages 1,067 1,394 1,709 1,999 1,993 1,712 1,755 1,815 Other Revenue 548 736 838 909 970 941 1,056 1,186 Total Revenue 2,244 2,947 3,359 3,818 3,775 3,532 3,748 4,008 Other income 41 61 46 78 73 73 73 73 COGS (1,400) (1,922) (2,031) (2,232) (2,256) (1,991) (2,104) (2,251) SG&A (447) (564) (664) (781) (816) (875) (837) (856) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 439 522 711 883 777 739 880 974 Net-interest inc./(exp.) 4 16 38 49 53 45 21 26 Assoc/forex/extraord./others 0 0 1 2 (1) (1) (1) (1) Pre-tax profit 443 538 749 934 830 782 900 1,000 Tax (84) (119) (195) (247) (210) (235) (257) (290) Min. int./pref. div./others 0 0 0 (1) (1) (1) (1) (1) Net profit (reported) 359 420 554 686 619 547 643 709 Net profit (adjusted) 359 420 554 686 619 547 643 709 EPS (reported)(USD) 0.027 0.032 0.042 0.052 0.047 0.042 0.050 0.055 EPS (adjusted)(USD) 0.027 0.032 0.042 0.052 0.047 0.042 0.050 0.055 EPS (adjusted fully-diluted)(USD) 0.027 0.032 0.042 0.052 0.047 0.042 0.050 0.055 DPS (USD) 0.023 0.020 0.029 0.035 0.024 0.019 0.025 0.028 EBIT 439 522 711 883 777 739 880 974 EBITDA 500 596 798 988 899 876 1,029 1,133

Cash flow (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 443 538 749 934 830 782 900 1,000 Depreciation and amortisation 61 74 88 105 122 137 148 158 Tax paid (72) (82) (186) (222) (210) (235) (257) (290) Change in working capital (16) 54 (14) 191 (418) 181 (24) 6 Other operational CF items (4) (16) (38) (50) (53) (44) (20) (25) Cash flow from operations 412 568 598 958 271 822 749 849 Capex (171) (224) (243) (273) (354) (250) (200) (200) 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 (171) (224) (243) (273) (354) (250) (200) (200) Change in debt 287 381 (22) 255 158 (272) 0 0 Net share issues/(repurchases) (8) 0 0 (5) (38) (290) (14) 0 Dividends paid (317) (259) (299) (419) (460) (295) (272) (333) Other financing CF items (4) 67 26 49 12 15 37 28 Cash flow from financing (41) 189 (294) (121) (327) (843) (249) (305) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 200 533 61 564 (410) (271) 300 344 Free cash flow 241 345 355 685 (83) 572 549 649 Source: FactSet, Daiwa forecasts

Want Want China (151 HK): 26 January 2016

Financial summary continued … Balance sheet (USDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 906 1,437 1,499 2,060 1,650 1,381 1,686 2,035 Inventory 339 410 461 534 667 436 490 524 Accounts receivable 101 160 166 164 132 124 131 140 Other current assets 107 96 142 152 140 140 140 140 Total current assets 1,454 2,103 2,268 2,911 2,589 2,081 2,447 2,839 Fixed assets 758 891 1,046 1,236 1,448 1,564 1,620 1,665 Goodwill & intangibles 1 1 1 1 1 1 1 1 Other non-current assets 77 128 146 201 246 246 246 246 Total assets 2,290 3,123 3,461 4,348 4,284 3,892 4,313 4,751 Short-term debt 294 775 350 410 518 246 246 246 Accounts payable 184 211 231 281 197 200 211 226 Other current liabilities 386 531 599 823 578 516 543 577 Total current liabilities 864 1,517 1,181 1,515 1,293 962 1,000 1,049 Long-term debt 350 250 653 847 898 898 898 898 Other non-current liabilities 0 24 24 34 35 35 35 35 Total liabilities 1,214 1,791 1,858 2,396 2,226 1,895 1,932 1,981 Share capital 264 264 265 265 264 264 264 264 Reserves/R.E./others 809 1,065 1,331 1,679 1,786 1,725 2,109 2,498 Shareholders' equity 1,073 1,330 1,595 1,943 2,050 1,989 2,373 2,762 Minority interests 3 3 8 9 8 8 8 8 Total equity & liabilities 2,290 3,123 3,461 4,348 4,284 3,892 4,313 4,751 EV 7,924 7,774 7,693 7,384 7,952 7,949 7,644 7,295 Net debt/(cash) (262) (413) (496) (802) (234) (237) (542) (891) BVPS (USD) 0.081 0.101 0.121 0.147 0.155 0.155 0.185 0.215

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 31.2 31.3 14.0 13.7 (1.1) (6.5) 6.1 6.9 EBITDA (YoY) 22.7 19.3 33.9 23.8 (9.1) (2.6) 17.5 10.1 Operating profit (YoY) 23.4 19.0 36.0 24.3 (12.0) (4.9) 19.2 10.7 Net profit (YoY) 14.5 16.9 32.0 23.8 (9.8) (11.6) 17.6 10.3 Core EPS (fully-diluted) (YoY) 14.5 16.9 31.9 23.7 (9.7) (11.1) 20.2 10.3 Gross-profit margin 37.6 34.8 39.5 41.5 40.2 43.6 43.9 43.8 EBITDA margin 22.3 20.2 23.8 25.9 23.8 24.8 27.4 28.3 Operating-profit margin 19.6 17.7 21.2 23.1 20.6 20.9 23.5 24.3 Net profit margin 16.0 14.2 16.5 18.0 16.4 15.5 17.1 17.7 ROAE 34.8 34.9 37.9 38.8 31.0 27.1 29.5 27.6 ROAA 17.7 15.5 16.8 17.6 14.3 13.4 15.7 15.6 ROCE 28.6 25.6 28.6 30.4 23.2 22.3 26.4 26.2 ROIC 48.8 47.0 51.9 57.5 39.0 28.8 35.0 37.2 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 19.0 22.0 26.0 26.5 25.3 30.0 28.5 29.0 Accounts receivable (days) 14.2 16.2 17.7 15.8 14.3 13.2 12.4 12.4 Current ratio (x) 1.7 1.4 1.9 1.9 2.0 2.2 2.4 2.7 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 83.2 61.6 68.3 67.1 51.6 46.1 50.2 50.1 Free cash flow yield 2.9 4.2 4.3 8.4 n.a. 7.0 6.7 7.9 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.

China Consumer Staples 26 January 2016

China Modern Dairy Holdings (1117 HK) China M odern Dair y H ol dings

Target price: HKD3.00 (from HKD3.30) Share price (25 Jan): HKD1.45 | Up/downside: +106.8%

Downstream expansion to offset upstream weakness

 EPS forecasts lowered after profit warning in December 2015 Anson Chan, CFA (852) 2532 4350  But expect a long-term rerating as downstream contribution rises [email protected]  Reiterate Buy (1); target price cut to HKD3.0

What's new: We are now more conservative on the outlook for raw-milk Forecast revisions (%) prices in 2016, but see CMD as a beneficiary of a long-term structural Year to 31 Dec 15E 16E 17E shortage of high-quality raw milk in China. Also, the company stands to Revenue change (2.2) (12.6) (13.9) Net profit change (19.5) (19.6) (19.6) benefit significantly from a rise in downstream revenue. Reiterate Buy (1). Core EPS (FD) change (19.5) (19.6) (19.6)

Source: Daiwa forecasts What's the impact: Downstream: ambitious but feasible target. Management targets downstream revenue to contribute 50% to total Share price performance revenue by 2020, vs. 25% in 2015E. We believe this goal is achievable and (HKD) (%) would be highly profitable given it focuses on premium products. CMD’s 3.3 125 market share in the premium UHT milk segment in China already rose to 2.8 111 8% in 3Q15 (+2.9pp YoY). By adding new products and focusing on brand 2.3 98 building (highlighting its high quality and 100% in-house raw-milk source), 1.7 84 1.2 70 we believe a 24% revenue CAGR is achievable over 2015-17E. Jan-15 Apr-15 Jul-15 Oct-15

CMDH (LHS) Relative to HSI (RHS) Lower feed costs could largely offset raw-milk-price pressure. With declining feed costs, some large competitors may lower their ASPs to boost 12-month range 1.40-3.28 sales volume, driving pricing pressure in the industry. Moreover, despite the Market cap (USDbn) 0.98 recent rebound in milk-powder prices globally (+42% YoY in the 1st week of 3m avg daily turnover (USDm) 2.26 December, from a trough of USD1,560/tonne in August 2015, as per Shares outstanding (m) 5,298 Major shareholder Mengniu (28.0%) Fonterra, the dominant producer/exporter of milk powder in New Zealand), milk-powder prices are still near a 5-year low globally. This implies imported Financial summary (CNY) milk powder could remain a cheap substitute for liquid raw milk in 2016E. Year to 31 Dec 15E 16E 17E But lower feed (mainly corn) costs, could see CMD’s gross margin improve Revenue (m) 4,980 5,402 5,821 by 1.1pp YoY in 2016E, despite our revised forecast for flat raw-milk prices Operating profit (m) 1,368 1,392 1,771 Net profit (m) 632 912 1,287 (previously a 3% YoY rise per year) over 2016-17E. Core EPS (fully-diluted) 0.126 0.172 0.243 EPS change (%) (21.3) 37.0 41.1 What we recommend: We cut our 2015E EPS by 20% due to a higher- Daiwa vs Cons. EPS (%) (18.4) (5.4) 19.7 PER (x) 9.7 7.1 5.0 than-expected loss from the revaluation of biological assets announced in Dividend yield (%) 0.8 0.8 0.8 the profit warning issued in December 2015. We also cut our 2016-17E DPS 0.010 0.010 0.010 EPS by 20% each after lowering our raw-milk-price assumptions to flat PBR (x) 0.7 0.7 0.6 EV/EBITDA (x) 5.7 6.4 5.0 (from 3-4% rises previously). (See Takeaways from conference call on ROE (%) 8.3 10.0 12.7 2015 profit warning, 21 December 2015.) We lower our 12-month SOTP- Source: FactSet, Daiwa forecasts based target price to HKD3.0 (from HKD 3.30). We now value the upstream business (dairy farms) at HKD2.30 (previously HKD2.60) using a DCF model, and the downstream business at HKD0.70, based on a 15x 2016E PER (unchanged and in line with the average of its China peers). We reiterate our Buy (1) rating. Key risks: an unexpected outbreak of bovine disease and/or a surge in feed costs.

How we differ: Our 2015-16E EPS are 5-18% below consensus due to our higher revaluation-loss forecasts from biological asset revaluation. Our 2017E EPS is 20% above consensus as we are more optimistic than the market on CMD’s downstream expansion.

See important disclosures, including any required research certifications, beginning on page 81

China Modern Dairy Holdings (1117 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Modern Dairy: net profit and cash earnings and YoY%

We forecast CMD’s net profit to decline by 19% YoY for ((CNYm)) 2015 due to a CNY400m loss from the revaluation of 1,400 120% 108% biological assets (2014: CNY330m). On fewer revaluation 1,200 100% losses and an increasing revenue contribution from its 1,000 80% 60% downstream operation, we look for reported net-profit 800 44% 41% 40% growth to recover to 44% YoY and 41% YoY for 2016E and 600 34% 2017E, respectively. 20% 400 0% 200 -19% -20% -28% 0 -40% 2012 2013 2014 2015E 2016E 2017E Reported net profit (LHS) Reported profit YoY (RHS, %)

Source: Company, Daiwa forecast

Valuation Modern Dairy: 12-month-forward PER

Modern Dairy stock is trading currently at a PER of 7.1x for (HKD) 2016E, compared to its closet peer, China Huishan’s 34x 10 FY17E (fiscal year ending March 2017) (both on our EPS 8 forecasts). Yet, we believe Modern Dairy’s execution risk 6 for expansion is lower than Huishan’s. We believe the 4 recent sell-off of Modern Dairy shares has already priced our flat raw-milk-price outlook and we believe Modern 2 Dairy deserves a rerating if its downstream business 0

successfully expands in revenue and maintains a high

Jun 12 Jun Jun 11Jun 13Jun 14Jun 15Jun

Mar Mar 11 Mar 13 Mar Mar 12 Mar 14 Mar 15

Sep 12Sep Dec11 Dec12 Sep13 Dec13 Sep14 Dec14 Sep15 Dec15 gross margin (>22%). Sep11 1117 HK 11x 15x 19x 23x 27x Source: Bloomberg

Earnings revisions Modern Dairy: Bloomberg consensus EPS (2015-16E)

We see downside risk to the street’s 2015E EPS as some (HKD) analysts may have not factored in the profit warning 0.35 announced recently. The Bloomberg-consensus 2015-16E 0.30 EPS forecasts trended down in 2015 on increasing losses from the revaluation of biological assets. 0.25 0.20

0.15

0.10

Apr Apr 15 Oct 15

Jun 15Jun

Feb Feb 15

Dec 15 Dec Dec14 Aug15 2015E 2016E

Source: Bloomberg

China Modern Dairy Holdings (1117 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Milk Yield (tonne/cow/year) 7.8 7.8 8.0 8.4 8.9 9.1 8.9 8.7 Sales volume of raw milk (tonnes) 201,958 366,656 496,979 679,722 931,334 930,284 1,007,953 1,052,848 Raw milk ASP (CNY/kg) 3.9 3.8 4.1 4.6 5.0 4.4 4.2 4.2 Number of cows 87,496 128,759 176,264 186,838 201,507 210,537 213,296 219,329

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Raw milk 782 1,384 1,971 2,968 4,194 3,327 3,319 3,325 Self-own brand 0 7 64 321 833 1,620 2,045 2,454 Other Revenue 0 0 0 0 0 33 38 42 Total Revenue 782 1,392 2,035 3,289 5,027 4,980 5,402 5,821 Other income 56 127 124 70 40 55 55 55 COGS (587) (1,065) (1,531) (2,412) (3,161) (3,268) (3,486) (3,460) SG&A (53) (45) (94) (246) (541) (398) (580) (645) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 198 409 533 701 1,365 1,368 1,392 1,771 Net-interest inc./(exp.) (47) (60) (101) (208) (266) (293) (302) (296) Assoc/forex/extraord./others 62 50 105 (83) (329) (390) (100) (100) Pre-tax profit 214 399 537 410 770 685 990 1,375 Tax (0) 0 (3) (11) (7) (25) (50) (60) Min. int./pref. div./others (50) (10) (14) (26) (28) (28) (28) (28) Net profit (reported) 163 389 520 373 735 632 912 1,287 Net profit (adjusted) 163 389 520 373 778 632 912 1,287 EPS (reported)(CNY) 0.040 0.080 0.107 0.077 0.151 0.126 0.172 0.243 EPS (adjusted)(CNY) 0.040 0.080 0.107 0.077 0.160 0.126 0.172 0.243 EPS (adjusted fully-diluted)(CNY) 0.040 0.080 0.107 0.077 0.160 0.126 0.172 0.243 DPS (CNY) 0.000 0.000 0.000 0.000 0.010 0.010 0.010 0.010 EBIT 198 409 533 701 1,365 1,368 1,392 1,771 EBITDA 202 428 573 997 2,096 2,014 1,756 2,153

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 214 399 537 410 770 685 990 1,375 Depreciation and amortisation 67 95 135 169 226 246 265 282 Tax paid (0) (0) (8) (11) (7) (25) (50) (60) Change in working capital (3) 253 177 (441) (309) 148 196 280 Other operational CF items (8) (45) 131 291 594 683 402 396 Cash flow from operations 269 701 972 419 1,274 1,737 1,802 2,274 Capex (1,498) (2,258) (2,271) (1,960) (1,785) (1,341) (1,193) (1,346) Net (acquisitions)/disposals 0 (14) 0 (78) 0 (1,583) 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,498) (2,272) (2,271) (2,038) (1,785) (2,925) (1,193) (1,346) Change in debt (212) 680 1,104 1,641 839 212 0 (400) Net share issues/(repurchases) 2,876 0 0 0 0 1,583 0 0 Dividends paid 0 0 0 0 0 (48) (48) (48) Other financing CF items (953) (137) (44) 201 42 (732) (432) (426) Cash flow from financing 1,711 544 1,061 1,842 881 1,016 (480) (874) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 482 (1,027) (238) 222 370 (172) 130 54 Free cash flow (1,229) (1,557) (1,299) (1,542) (511) 396 609 927 Source: FactSet, Daiwa forecasts

China Modern Dairy Holdings (1117 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 2,069 1,017 470 800 1,170 1,008 1,138 1,192 Inventory 319 338 440 691 641 606 639 642 Accounts receivable 132 211 283 545 827 909 1,000 1,100 Other current assets 1 2 2 2 2 2 2 2 Total current assets 2,521 1,568 1,195 2,037 2,639 2,525 2,779 2,936 Fixed assets 1,924 2,660 3,583 4,033 4,458 5,040 4,925 4,793 Goodwill & intangibles 310 310 310 310 310 310 310 310 Other non-current assets 2,256 3,378 5,070 6,114 6,804 8,912 9,967 11,176 Total assets 7,011 7,916 10,159 12,494 14,211 16,788 17,982 19,215 Short-term debt 559 510 1,666 2,989 2,958 2,800 2,800 2,400 Accounts payable 206 354 716 813 842 926 1,112 1,334 Other current liabilities 316 397 706 681 575 687 822 983 Total current liabilities 1,081 1,261 3,089 4,483 4,376 4,414 4,734 4,717 Long-term debt 1,176 1,693 1,641 1,960 2,829 3,200 3,200 3,200 Other non-current liabilities 188 73 100 190 350 341 341 341 Total liabilities 2,445 3,028 4,830 6,633 7,555 7,955 8,274 8,258 Share capital 415 413 415 415 415 415 415 415 Reserves/R.E./others 4,096 4,415 4,822 5,328 6,096 8,263 9,127 10,367 Shareholders' equity 4,511 4,828 5,237 5,743 6,510 8,678 9,542 10,781 Minority interests 56 61 92 118 146 156 166 176 Total equity & liabilities 7,011 7,916 10,159 12,494 14,211 16,788 17,982 19,215 EV 6,212 7,724 9,393 10,664 11,046 11,429 11,310 10,866 Net debt/(cash) (333) 1,186 2,837 4,149 4,618 4,992 4,862 4,408 BVPS (CNY) 0.940 1.006 1.091 1.191 1.351 1.638 1.801 2.035

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. 78.0 46.2 61.7 52.8 (0.9) 8.5 7.8 EBITDA (YoY) n.a. 111.9 34.0 73.9 110.4 (3.9) (12.8) 22.6 Operating profit (YoY) n.a. 106.8 30.4 31.5 94.6 0.2 1.7 27.3 Net profit (YoY) n.a. 138.0 33.6 (28.2) 108.4 (18.7) 44.2 41.1 Core EPS (fully-diluted) (YoY) n.a. 102.9 33.6 (28.5) 108.4 (21.3) 37.0 41.1 Gross-profit margin 24.9 23.5 24.7 26.7 37.1 34.4 35.5 40.6 EBITDA margin 25.8 30.7 28.2 30.3 41.7 40.4 32.5 37.0 Operating-profit margin 25.3 29.4 26.2 21.3 27.2 27.5 25.8 30.4 Net profit margin 20.9 28.0 25.5 11.4 15.5 12.7 16.9 22.1 ROAE 7.2 8.3 10.3 6.8 12.7 8.3 10.0 12.7 ROAA 4.7 5.2 5.8 3.3 5.8 4.1 5.2 6.9 ROCE 6.3 6.1 6.8 7.2 11.7 10.0 9.1 11.0 ROIC 4.7 7.9 7.4 7.5 12.7 10.5 9.3 11.3 Net debt to equity n.a. 24.6 54.2 72.2 70.9 57.5 51.0 40.9 Effective tax rate 0.0 0.0 0.6 2.6 1.0 3.6 5.1 4.4 Accounts receivable (days) 30.8 44.9 44.3 45.9 49.8 63.6 64.5 65.9 Current ratio (x) 2.3 1.2 0.4 0.5 0.6 0.6 0.6 0.6 Net interest cover (x) 4.2 6.8 5.3 3.4 5.1 4.7 4.6 6.0 Net dividend payout 0.0 0.0 0.0 0.0 6.6 8.0 5.8 4.1 Free cash flow yield n.a. n.a. n.a. n.a. n.a. 6.1 9.4 14.3 Source: FactSet, Daiwa forecasts

Company profile

China Modern Dairy (CMD) is the largest dairy-farm operator in China and the first in the country to operate large-scale dairy farms (herd size: 10,000 heads). More than 70% of its raw milk is sold to Mengniu, while the remainder is sold to regional milk-powder producers, and as fresh milk under CMD’s own brand. A group of individual shareholders (including management) and Mengniu own 31% and 28% of CMD, respectively.

China Modern Dairy Holdings (1117 HK): 26 January 2016

CMD: DCF sensitivity Key assumption for our DCF calculation Equity Value Assumptions (%)

Discount NPV of Enterprise Equity Per Share Equity Beta (X) Terminal growth rate 0 Rate FCF (CNY m) Value (CNY m) Value (CNY m) (HKD) Equity risk premium Cost of debt 7.8 5.6% 26,923 29,990 25,372 5.70 Risk free rate Debt-weighting 40 6.6% 22,380 25,448 20,830 4.68 Cost of equity WACC* 9.6

7.6% 19,079 22,147 17,529 3.94 8.6% 16,580 19,648 15,030 3.38 9.6% 14,681 17,749 13,131 3.00 10.6% 13,063 16,131 11,513 2.59 11.6% 11,784 14,852 10,234 2.30 12.6% 10,720 13,788 9,170 2.06 13.6% 9,823 12,891 8,273 1.86

Source: Daiwa estimates Source: Daiwa estimates

CMD: DCF valuation of upstream business 2015F 2016F 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F 2026F 2027F 2028F 2029F 2030F >FY2031E Milk volume (000 tons) 930 1,066 1,176 1,209 1,230 1,245 1,264 1,284 1,306 1,313 1,320 1,328 1,335 1,343 1,350 1,357 ASP (CNY/kg) 4.40 4.20 4.28 4.33 4.37 4.41 4.46 4.50 4.55 4.59 4.64 4.69 4.73 4.78 4.83 4.88 Sales of milk (CNY mil) 4,947 4,476 5,036 5,231 5,376 5,497 5,633 5,783 5,938 6,031 6,125 6,221 6,318 6,417 6,518 6,614 EBIT (CNY mil) 1,368 1,392 1,771 1,591 1,613 1,654 1,701 1,754 1,777 1,801 1,825 1,850 1,874 1,899 1,925 1,948 EBITDA (CNY mil) 1,614 1,656 2,053 1,890 1,931 1,988 2,053 2,123 2,165 2,206 2,248 2,289 2,332 2,374 2,417 2,458 Terminal Value Interest and tax expenses -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 -318 Capex (CNY mil) -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 -350 Cashflow (CNY mil) 946 988 1,385 1,222 1,262 1,320 1,385 1,455 1,497 1,538 1,579 1,621 1,663 1,706 1,749 1,790 18,602 Discount factor 1.096 1.202 1.317 1.444 1.583 1.735 1.902 2.085 2.286 2.506 2.747 3.011 3.300 3.618 3.966 4.347 4.766 Discounted FCF 862.5 822.4 1051.4 846.4 797.5 760.8 728.2 697.9 654.8 613.9 575.1 538.5 504.0 471.5 441.0 411.6 3903.4 Total discounted FCF (from 2015F onward) 14,681 NAV/share (CNY) 1.90 Net cash as of 2014 -4,618 Total value 10,063 NAV/share (HK$) 2.30

Source: Daiwa estimates

Hong Kong Consumer Staples 26 January 2016

WH Group (288 HK) WH Group

Target price: HKD4.80 (from HKD5.50) Share price (25 Jan): HKD4.40 | Up/downside: +9.0%

Benefits from having a US brand

 Raising core 2016-17E EPS on higher ASP but lower sales volume Anson Chan, CFA (852) 2532 4350  Smithfield operation trading at 3.1x 2016E PER at current share price [email protected]  Reaffirm Outperform (2) rating; 33% YoY EPS growth for 2016E

What's new: We are positive on WH Group starting operations of its new Forecast revisions (%) American-style packaged-meat factory in Zhengzhou in December 2015, Year to 31 Dec 15E 16E 17E producing American and Smithfield branded cold-chain products that carry Revenue change (3.7) (4.7) (5.3) Net profit change 1.8 2.6 1.2 a higher ASP vs. its Chinese products. This product-mix upgrade should Core EPS (FD) change 1.8 2.6 1.2 bode well for the company. Reiterate Outperform (2) rating. Source: Daiwa forecasts

What's the impact: Commodity cost trends look favourable in China, Share price performance but mixed in the US: as we highlighted in the sector portion of this report, (HKD) (%) we see limited upside to hog costs in 2016E due to lower corn (feed) costs 6.5 130 in China. But for the US, the upstream segment’s margins may remain 5.8 120 volatile due to commodity cost changes (grain and hog prices), and 5.0 110 Smithfield plans to diversify the risk by increasing its export business, in 4.3 100 3.5 90 particular to China (+40% YoY for 9M15). Jan-15 Apr-15 Jul-15 Oct-15

WH Group (LHS) Relative to HSI (RHS) Get the US operation for free: Shuanghui, WH Group’s major operating subsidiary in China, is now trading at a 10x 2016E PER (Bloomberg 12-month range 3.84-6.06 consensus), implying that WH Group’s 73% stake translates into HKD3.7 Market cap (USDbn) 8.25 per WH Group share. This means Smithfield, WH Group’s US operation 3m avg daily turnover (USDm) 9.48 expected to contribute c.50% of its 2015E operating profit, accounts for Shares outstanding (m) 14,620 Major shareholder Management (34.0%) only about USD873m in WH Group’s current market cap (vs. the USD4.5bn

WH Group paid for it in 2013). Financial summary (USD) Year to 31 Dec 15E 16E 17E Sluggish demand in 2H15 is likely temporary: For 2015-17E, we are Revenue (m) 22,017 23,362 24,623 cutting revenue by 4-5%, as we lower our packaged-meat sales volume Operating profit (m) 1,412 1,623 1,733 Net profit (m) 611 814 908 assumption by 6-10% for both China and the US, due to the sluggish Core EPS (fully-diluted) 0.042 0.056 0.062 demand we saw in 2H15E. But we now expect a slight increase in its EPS change (%) (37.4) 33.4 11.6 packaged-meat ASP (+5% YoY in China and 2% in the US in 2016E, vs. Daiwa vs Cons. EPS (%) (21.3) (5.7) (7.3) PER (x) 13.5 10.2 9.1 flat previously) on the product mix improvement. Hence, we are revising up Dividend yield (%) 2.8 3.6 4.0 our EPS for the company by 1-3% for the same period. DPS 0.016 0.021 0.023 PBR (x) 1.5 1.3 1.2 EV/EBITDA (x) 6.6 5.7 5.0 What we recommend: We cut our 12-month TP to HKD4.80 from ROE (%) 11.3 13.5 13.4 HKD5.50, now based on a 2016E PER of 11x (was 13.4x), to bring it in line Source: FactSet, Daiwa forecasts with its peers. Our target PER comprises 11.8x for the China operation (kept at a 20% discount to peers’ average on its lower operating margin vs Valuation of WH Group’s business other staple companies) and 10.2x PER for the US operation (in line with USD m its US peers’ average). The key risk: unexpected hedging losses for the US Market cap of Shuanghui (000895.SS) (25 Jan 16) 9,206 WH's stake (%) 73.3 operation. WH's stake worth 6,744 WH Group's market cap 8,284 How we differ: Our 2015-17E EPS are 6-21% below consensus as we Smithfield's valuation (USD m) 1,549 Implied 2016E PER for Smithfield (x) 3.1 assume the absence of gains from the revaluation of its biological assets. Source: Bloomberg, Daiwa estimates

See important disclosures, including any required research certifications, beginning on page 81

WH Group (288 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook WH Group: Net profit (USD m) and YoY (%) We forecast WH Group’s net profit to decline by 28% YoY (USDm) (% ) in 2015E due to an absence of gains from the revaluation 1,500 1,300 90% of its agriculture produce at its US hog-raising operation 1,100 66% 70% (2014: about USD 300m). We expect net profit growth to 900 50% resume in 2016-17E, on a recovery in the company’s sales 700 38% 33% volume growth in both China and the US through its 500 30% 300 12% 10% improved packaged-meat product mix. 100 -10% (100) (300) -28% -30% 2011 2012 2013 2014 2015E 2016E 2017E Reported net profit (LHS) Recurring net profit (LHS) Reported net profit YoY % Source: Company, Daiwa forecasts

Valuation WH Group: 12-month forward PER bands since listing The stock is now trading at 2016E PER of 10x, which looks (HKD) 9 attractive to us compared with the other major China staples companies (trading at an average 2016E PER of 8 18x on our forecasts). In our view, WH Group’s discount to 7 its peers has priced in the risks of: 1) volatile hedging gains 6 or losses in its agriculture product future contracts for its 5 US hog production business, and 2) potential share sales 4 by some financial investors after their lock-ups expire (6-12 3

months after the August 2014 IPO).

Jul-15

Oct-14 Apr-15 Oct-15

Jan-15 Jan-16 Jun-15

Feb-15 Mar-15

Aug-14 Sep-14 Nov-14 Dec-14 Aug-15 Sep-15 Dec-15 Nov-15 May-15 288.HK 7x 8.5x

10x 11.5x 13x Source: Bloomberg

Earnings revisions WH Group: Bloomberg 2015 and 2016 consensus EPS (USD) The Bloomberg consensus 2015-16E EPS forecasts for (USD) WH Group have trended down since 2015 due to rising 0.075 pork prices. While our 2015-17 forecasts are below the 0.070 consensus, due to the likely absence of revaluation gains, 0.065 we would see an upside risk to our EPS numbers if pork costs in China were to rise by less than we expect due to 0.060 lower feed costs. 0.055

0.050

Jul15

Jan 15Jan

Mar15

Sep15 Nov15 May 15

2015E 2016E

Source: Bloomberg

WH Group (288 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Packaged meat revenue YoY - China n.a. n.a. 16.3 12.0 (0.9) (8.5) 11.9 12.2 (%)

Packaged meat revenue YoY - U.S. (%) n.a. n.a. n.a. n.a. 14.3 (2.2) 4.0 3.0

Fresh meat revenue YoY - China (%) n.a. n.a. 15.5 24.4 5.4 8.5 12.4 10.2 Fresh meat revenue YoY - U.S. (%) n.a. n.a. n.a. n.a. 20.5 5.0 1.0 1.0 Operating margin - China (%) n.a. 5.8 9.8 10.6 11.8 10.9 10.8 10.8 Operating margin - U.S. (%) n.a. n.a. n.a. 2.4 6.0 5.9 5.5 5.5

Profit and loss (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Hog production 0 14 13 191 252 435 478 461 Fresh pork 0 2,095 2,419 4,543 9,368 9,861 10,413 10,939 Other Revenue 0 3,346 3,811 6,519 12,623 11,721 12,471 13,223 Total Revenue 0 5,455 6,243 11,253 22,243 22,017 23,362 24,623 Other income n.a. 132 105 167 843 88 168 178 COGS n.a. (4,902) (5,272) (9,480) (18,979) (18,525) (19,719) (20,782) SG&A n.a. (356) (454) (874) (2,269) (2,120) (2,140) (2,238) Other op.expenses n.a. (15) (8) (787) (110) (48) (48) (48) Operating profit 0 314 614 279 1,728 1,412 1,623 1,733 Net-interest inc./(exp.) 0 (57) (15) (120) (371) (216) (171) (139) Assoc/forex/extraord./others n.a. 2 3 3 63 12 0 0 Pre-tax profit 0 259 602 162 1,420 1,208 1,452 1,593 Tax n.a. (71) (134) (229) (448) (406) (429) (456) Min. int./pref. div./others n.a. (59) (143) (196) (206) (191) (210) (230) Net profit (reported) 0 129 325 (263) 766 611 814 908 Net profit (adjusted) 0 129 367 508 844 611 814 908 EPS (reported)(USD) n.a. 0.011 0.029 (0.023) 0.060 0.042 0.056 0.062 EPS (adjusted)(USD) n.a. 0.011 0.033 0.045 0.067 0.042 0.056 0.062 EPS (adjusted fully-diluted)(USD) n.a. 0.011 0.033 0.045 0.067 0.042 0.056 0.062 DPS (USD) n.a. 0.000 0.000 0.000 0.000 0.016 0.021 0.023 EBIT 0 314 656 1,050 1,806 1,412 1,623 1,733 EBITDA 0 402 769 1,223 2,165 1,795 2,031 2,160

Cash flow (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 0 259 602 162 1,420 1,208 1,452 1,593 Depreciation and amortisation n.a. 88 113 173 359 383 408 428 Tax paid n.a. (101) (126) (250) (476) (406) (429) (456) Change in working capital n.a. 5 57 (48) 327 (147) (253) (276) Other operational CF items n.a. 55 20 53 (419) 204 111 79 Cash flow from operations 0 306 666 90 1,211 1,242 1,289 1,368 Capex n.a. (309) (151) (295) (699) (500) (500) (300) Net (acquisitions)/disposals n.a. (40) (16) (4,678) (10) (10) (10) (10) Other investing CF items n.a. 0 0 0 0 0 0 0 Cash flow from investing 0 (349) (167) (4,973) (709) (510) (510) (310) Change in debt n.a. 864 (670) 7,238 (2,762) (1,000) (700) (500) Net share issues/(repurchases) n.a. 0 0 0 2,284 0 0 0 Dividends paid n.a. (38) (105) (90) 0 (235) (300) (333) Other financing CF items n.a. 59 312 (2,636) (127) (215) (196) (169) Cash flow from financing 0 885 (463) 4,512 (605) (1,450) (1,196) (1,003) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 0 842 36 (371) (103) (718) (417) 56 Free cash flow 0 (3) 515 (205) 512 742 789 1,068 Source: FactSet, Daiwa forecasts

WH Group (288 HK): 26 January 2016

Financial summary continued … Balance sheet (USDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 0 1,032 796 1,083 1,209 965 764 1,053 Inventory n.a. 529 328 1,808 1,900 2,090 2,299 2,529 Accounts receivable n.a. 38 50 870 845 887 932 978 Other current assets n.a. 104 96 1,406 1,420 1,420 1,420 1,420 Total current assets 0 1,703 1,270 5,167 5,374 5,362 5,415 5,980 Fixed assets n.a. 1,387 1,411 4,132 4,582 4,699 4,791 4,663 Goodwill & intangibles n.a. 565 566 3,615 3,561 3,561 3,561 3,561 Other non-current assets n.a. 227 250 1,242 1,203 871 881 891 Total assets 0 3,882 3,497 14,156 14,720 14,493 14,648 15,095 Short-term debt n.a. 855 164 760 719 719 719 719 Accounts payable n.a. 300 225 851 850 935 935 935 Other current liabilities n.a. 464 399 1,211 1,553 1,553 1,553 1,553 Total current liabilities 0 1,619 788 2,822 3,122 3,207 3,207 3,207 Long-term debt n.a. 9 30 6,672 3,951 2,951 2,251 1,751 Other non-current liabilities n.a. 121 129 1,524 1,597 1,597 1,597 1,597 Total liabilities 0 1,749 947 11,018 8,670 7,755 7,055 6,555 Share capital 0 1 1 1 1 1 1 1 Reserves/R.E./others n.a. 1,547 1,788 2,269 5,129 5,676 6,376 7,154 Shareholders' equity 0 1,548 1,789 2,270 5,130 5,677 6,377 7,155 Minority interests n.a. 585 761 868 920 1,061 1,216 1,386 Total equity & liabilities 0 3,882 3,497 14,156 14,720 14,493 14,648 15,096 EV n.a. 8,644 8,386 14,941 12,102 11,829 11,485 10,866 Net debt/(cash) n.a. (168) (602) 6,349 3,461 2,705 2,206 1,417 BVPS (USD) n.a. 0.138 0.159 0.202 0.350 0.388 0.436 0.489

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. n.a. 14.4 80.2 97.7 (1.0) 6.1 5.4 EBITDA (YoY) n.a. n.a. 91.3 59.0 77.0 (17.1) 13.2 6.4 Operating profit (YoY) n.a. n.a. 108.9 60.1 72.0 (21.8) 15.0 6.7 Net profit (YoY) n.a. n.a. 184.5 38.4 66.1 (27.6) 33.1 11.6 Core EPS (fully-diluted) (YoY) n.a. n.a. 184.5 38.4 47.6 (37.4) 33.4 11.6 Gross-profit margin n.a. 10.1 15.6 15.8 14.7 15.9 15.6 15.6 EBITDA margin n.a. 7.4 12.3 10.9 9.7 8.2 8.7 8.8 Operating-profit margin n.a. 5.8 10.5 9.3 8.1 6.4 6.9 7.0 Net profit margin n.a. 2.4 5.9 4.5 3.8 2.8 3.5 3.7 ROAE n.a. 16.7 22.0 25.0 22.8 11.3 13.5 13.4 ROAA n.a. 6.6 9.9 5.8 5.8 4.2 5.6 6.1 ROCE n.a. 21.0 22.9 15.8 17.0 13.4 15.5 16.1 ROIC n.a. 23.2 24.4 (2.0) 12.5 9.9 11.9 12.5 Net debt to equity n.a. n.a. n.a. 279.7 67.5 47.6 34.6 19.8 Effective tax rate n.a. 27.4 22.3 141.4 31.5 33.6 29.5 28.6 Accounts receivable (days) n.a. 1.3 2.6 14.9 14.1 14.4 14.2 14.2 Current ratio (x) n.a. 1.1 1.6 1.8 1.7 1.7 1.7 1.9 Net interest cover (x) n.a. 5.5 43.7 8.8 4.9 6.5 9.5 12.4 Net dividend payout n.a. 0.0 0.0 n.a. 0.0 38.4 36.9 36.7 Free cash flow yield 0.0 n.a. 6.2 n.a. 6.2 9.0 9.6 12.9 Source: FactSet, Daiwa forecasts

Company profile

WH Group is the largest pork-processing company in the world, and has the largest market share in pork processing in China and the US, which together account for 60% of global pork consumption. It is also a leader in key markets in Europe. The company raises and slaughters hogs, and produces fresh pork and packaged-meat products. It also owns the largest cold-chain logistics network in China. Its brands include Shuanghui, Smithfield, Farmland, Eckrich, and Armour.

China Consumer Staples 26 January 2016

(291 HK) China Resources Beer China R esources Beer

Target price: HKD12.40 (from HKD13.40) Share price (25 Jan): HKD12.30 | Up/downside: +0.8%

Best-case scenario looks priced in

 Forecasts raised on prospect of CRB acquiring stake in CR-Snow JV Anson Chan, CFA (852) 2532 4350  CRB continues to gain market share [email protected]  Maintain Hold (3) as acquisition seems to have been priced in

What's new: Acquisition already priced in? According to a Hong Kong Forecast revisions (%) Economic Journal report in December 2015, China Resources Beer (CRB) Year to 31 Dec 15E 16E 17E (the former China Resources Enterprise) is seeking an investment bank to Revenue change (4.7) (6.5) (6.2) Net profit change (9.6) 2.5 18.9 act as a financial advisor to assist in the acquisition of the remaining 49% Core EPS (FD) change (9.6) 2.5 18.9 stake in the CR-Snow JV, a venture between CRB and UK-based Source: Daiwa forecasts SABMiller. Assuming SABMiller merges with Anheuser-Busch InBev, it is likely SABMiller would sell its 49% holding in the CR-Snow JV (CRB has a Share price performance

51% stake already) (also see What if AB-InBev merges with SABMiller, 17 (HKD) (%) September 2015). We would see this scenario playing out in mid-2016. We 26 160 keep our Hold (3) rating on CRB as we believe its valuation is fair. 23 138 19 115

16 93

What's the impact: Key assumptions for a stake acquisition. We are 12 70 revising up our 2016-17E EPS by 3-19% assuming: 1) the acquisition is Jan-15 Apr-15 Jul-15 Oct-15 done at a c.22x 2016E PER (our target PER for CRB) and is fully funded by China Reso (LHS) Relative to HSI (RHS) bank financing at an interest rate of 4% per year, and 2) CRB maintains its ASP and market-share gains over 2016-17E without the support of 12-month range 12.30-25.80 SABMiller (we see this as a likely scenario, as CRB has accumulated a lot Market cap (USDbn) 3.82 of technology and production experience from SABMiller over the past 20 3m avg daily turnover (USDm) 10.03 Shares outstanding (m) 2,421 years, while its sales team has been run independently). Arguably the only Major shareholder CRNC (51.9%) negative would be the subsequent increase in net gearing (which we estimate would reach 239% by end-2016, vs. 65% if the acquisition does Financial summary (HKD) not go ahead). Year to 31 Dec 15E 16E 17E Revenue (m) 34,823 36,141 37,770 Another scenario: 1) If CRB does not go ahead with the stake acquisition, Operating profit (m) 2,746 3,116 3,760 Net profit (m) 874 1,282 1,606 we estimate its net profit would still grow by 16% YoY for 2016, driven by Core EPS (fully-diluted) 0.361 0.530 0.663 market-share gains. We expect the beer market to continue to shrink in EPS change (%) n.a. 46.7 25.2 2016 (-5.7% in volume in 11M15), but believe CRB will still report flat sales Daiwa vs Cons. EPS (%) (10.0) 17.9 29.0 PER (x) 34.1 23.2 18.5 volume. 2) After acquiring the stake from SABMiller, we would not rule out Dividend yield (%) 100.0 0.4 0.9 the possibility of CRB seeking co-operation with another international brand DPS 12.300 0.054 0.116 to expand its share of China’s high-end beer market. PBR (x) 1.9 1.8 1.7 EV/EBITDA (x) 5.8 12.8 11.3 ROE (%) 2.7 8.1 9.6 What we recommend: We maintain our Hold (3) rating and lower our 12- Source: FactSet, Daiwa forecasts month TP to HKD12.4 (from HKD13.4). We now value CRB at a 23x 2016E PER (previously 26x for 2016E). We continue to set our target PER at a c.15% premium to the 20x average of its closest peers, due to CRB’s faster EPS growth and potential for further earnings upside. Nevertheless, we are cutting 2015-17E revenue and 2015E EPS due to the likelihood of a further slowdown in industry volume. The key upside and downside risks to our call: better or worse-than-expected product-mix upgrades.

How we differ: Our 2016-17E EPS are 18-29% above the Bloomberg consensus as we factor in the earnings enhancement from an acquisition of the CR-Snow JV minority stake and higher operating-margin assumptions.

See important disclosures, including any required research certifications, beginning on page 81

China Resources Beer (291 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook CRB: net profit and net-profit growth

We now forecast CRB’s net profit to increase by 47% YoY (HKDm) for 2016 and 25% YoY for 2017, assuming its acquisition of 1,800 60% the remaining stake in CR-Snow JV goes ahead. The 1,600 47% 50% 1,400 40% acquisition would almost double CRB’s profit-after tax (as 1,200 30% 25% its stake in the JV would increase from 51% to 100%, and 1,000 20% 15% the JV owns all CRB’s beer business in China). Even if the 800 10% 600 0% acquisition does not proceed, we forecast CRB’s net profit 400 (10%) to increase by 16% YoY for 2016 and 15% YoY for 2017, 200 -19% (20%) driven by product-mix upgrades that would drive up the 0 (30%) 2013 2014 2015E 2016E 2017E operating margin by 0.7pp and 1.4pp, respectively. Net profit (LHS) YoY (RHS)

Source: Company, Daiwa forecasts

Valuation CRB: 12-month forward PER band CRB’s valuation has been rerated since April 2015 after the (HKD) former China Resources Enterprise announced plans to 50 dispose of its non-beer businesses pay a special dividend 40 and rename the company China Resources Beer (all 30 completed in September 2015). Going forward, we believe 20 CRB should trade at a premium to its pre-restructuring valuation due to its now higher earnings visibility through 10 focusing on the beer business only. 0

Jul 13 Jul Jul 11Jul 12Jul 14Jul 15Jul

Apr Apr 11 Oct 15 Oct Oct 11 Apr 12 Oct 12 Apr 13 Oct 13 Apr 14 Oct 14 Apr 15

Jan 11Jan 12Jan 13Jan 14Jan 15Jan 16Jan Our target valuation is now based on a 15% premium to 291.HK 15x 20x peers’ average, based on CRB’s expected operating- 25x 30x 35x margin expansion over 2016-17 and No.1 position in Source: Bloomberg China’s competitive beer market.

Earnings revisions CRB: Bloomberg consensus 2015-16E EPS

Our 2016-17E EPS are far above those of the Bloomberg (HKD) consensus as we have factored in the impact of the 0.55 prospective acquisition. We expect the consensus to revise 0.50 0.45 up its EPS forecast for the company if the acquisition takes 0.40 place. But we do believe the street’s EPS forecasts already 0.35 factor in a potential rise in ASPs over 2016-17 due to the 0.30 company’s ongoing product-mix upgrades. 0.25 0.20

0.15

Jul 15Jul 15Jul

Oct Oct 15 Oct 15 Oct 15

Jun 15Jun 15Jun 16Jan

Aug15 Aug15 Sep15 Sep15 Nov15 Nov15 Dec15 Dec15

May 15 May 15 2015E 2016E

Source: Bloomberg

China Resources Beer (291 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Beer sales volume YoY (%) 10.9 10.3 3.9 10.2 1.0 (1.8) 0.0 0.0 Beer ASP (YoY %) 2.9 12.4 1.2 6.2 4.0 2.8 3.8 4.5 Beer EBITDA margin (%) 14.59 13.10 13.63 13.45 12.62 12.82 13.93 14.51 Sales volume contribution fromhigh-end 20.8 25.0 28.4 36.0 40.3 43.5 47.9 53.2 products

Profit and loss (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Retail 55,140 70,088 83,506 95,174 109,500 n.a. n.a. n.a. Beer 21,535 26,689 28,064 32,835 34,482 34,823 36,141 37,770 Other Revenue 10,053 13,387 14,666 18,245 25,696 n.a. n.a. n.a. Total Revenue 86,728 110,164 126,236 146,254 169,678 34,823 36,141 37,770 Other income 1,976 1,683 2,041 2,381 2,836 436 643 959 COGS (64,404) (82,807) (95,835) (108,881) (127,233) (22,763) (23,188) (24,016) SG&A (19,919) (24,524) (27,894) (34,697) (43,483) (9,750) (10,481) (10,953) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 4,381 4,516 4,548 5,057 1,798 2,746 3,116 3,760 Net-interest inc./(exp.) (175) (224) (361) (304) (526) (294) (335) (1,530) Assoc/forex/extraord./others 806 1,134 2,466 293 569 (4,400) 0 0 Pre-tax profit 5,012 5,426 6,653 5,046 1,841 (1,948) 2,780 2,230 Tax (1,395) (1,375) (1,631) (1,894) (1,550) (736) (751) (624) Min. int./pref. div./others (965) (1,038) (1,077) (1,244) (452) (843) (747) 0 Net profit (reported) 2,652 3,013 3,945 1,908 (161) (3,526) 1,282 1,606 Net profit (adjusted) 1,873 1,889 1,527 1,642 (794) 874 1,282 1,606 EPS (reported)(HKD) 1.106 1.256 1.644 0.794 (0.067) (1.456) 0.530 0.663 EPS (adjusted)(HKD) 0.781 0.787 0.636 0.683 (0.331) 0.361 0.530 0.663 EPS (adjusted fully-diluted)(HKD) 0.781 0.787 0.636 0.683 (0.331) 0.361 0.530 0.663 DPS (HKD) 0.520 0.470 0.300 0.270 0.270 12.300 0.054 0.116 EBIT 4,381 4,516 4,548 5,057 1,798 2,746 3,116 3,760 EBITDA 6,946 7,393 7,840 8,946 6,681 9,366 5,336 5,980

Cash flow (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 5,012 5,426 6,653 5,046 1,841 (1,948) 2,780 2,230 Depreciation and amortisation 2,565 2,877 3,292 3,889 4,883 2,220 2,220 2,220 Tax paid (991) (1,680) (1,683) (2,047) (1,636) (736) (751) (624) Change in working capital 1,575 2,233 3,775 4,850 4,147 (600) (407) (432) Other operational CF items (1,182) (829) (3,098) (958) (8,091) 294 335 1,530 Cash flow from operations 6,979 8,027 8,939 10,780 1,144 (770) 4,178 4,923 Capex (4,037) (7,097) (9,505) (7,204) (7,900) (2,438) (2,168) (2,077) Net (acquisitions)/disposals 3,747 (1,541) 990 (4,308) 109 30,000 (29,000) 0 Other investing CF items 360 401 (2,386) 1,671 1,199 0 0 0 Cash flow from investing 70 (8,237) (10,901) (9,841) (6,592) 27,562 (31,168) (2,077) Change in debt 86 3,049 1,363 4,685 6,194 n.a. n.a. n.a. Net share issues/(repurchases) 26 11 21 18 0 0 0 0 Dividends paid (1,175) (1,271) (1,128) (673) (649) (29,520) (175) (256) Other financing CF items (392) 2,909 (522) (39) (650) (3,556) (1,490) (1,854) Cash flow from financing (1,455) 4,698 (266) 3,991 4,895 (33,076) (1,665) (2,110) Forex effect/others (51) (303) (23) 265 0 0 0 0 Change in cash 5,543 4,185 (2,251) 5,195 (553) (6,283) (28,655) 736 Free cash flow 2,942 930 (566) 3,576 (6,756) (3,207) 2,010 2,846 Source: FactSet, Daiwa forecasts

China Resources Beer (291 HK): 26 January 2016

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 14,305 18,514 16,396 21,536 20,834 4,104 2,449 3,184 Inventory 15,626 20,715 21,242 25,021 27,690 9,170 9,341 9,675 Accounts receivable 6,843 11,534 13,744 16,428 16,555 1,952 2,187 2,286 Other current assets 46 51 125 251 157 72 72 72 Total current assets 36,820 50,814 51,507 63,236 65,236 15,298 14,049 15,217 Fixed assets 41,443 50,240 56,971 69,117 88,060 26,739 26,687 26,544 Goodwill & intangibles 9,873 11,065 15,243 19,990 23,364 10,708 24,664 24,664 Other non-current assets 1,266 1,530 3,767 2,946 4,704 17,483 17,483 17,483 Total assets 89,402 113,649 127,488 155,289 181,364 70,228 82,883 83,908 Short-term debt 4,151 7,092 4,374 3,357 9,025 4,050 4,050 4,050 Accounts payable 32,476 45,487 53,104 69,178 76,260 24,311 24,311 24,311 Other current liabilities 871 618 706 1,155 1,069 190 190 190 Total current liabilities 37,498 53,197 58,184 73,690 86,354 28,551 28,551 28,551 Long-term debt 8,158 8,442 13,352 19,346 19,872 10,000 37,000 37,000 Other non-current liabilities 1,148 1,538 2,168 2,642 5,515 1,158 1,158 1,158 Total liabilities 46,804 63,177 73,704 95,678 111,741 39,709 66,709 66,709 Share capital 2,396 2,399 2,399 2,399 2,399 2,402 2,402 2,402 Reserves/R.E./others 29,727 35,440 38,343 41,674 46,348 13,073 13,772 14,798 Shareholders' equity 32,123 37,839 40,742 44,073 48,747 15,475 16,174 17,200 Minority interests 10,475 12,633 13,042 15,538 20,876 15,044 0 0 Total equity & liabilities 89,402 113,649 127,488 155,289 181,364 70,228 82,883 83,909 EV 37,886 39,004 43,766 46,100 57,340 54,773 68,384 67,649 Net debt/(cash) (1,996) (2,980) 1,330 1,167 8,063 9,946 38,601 37,866 BVPS (HKD) 13.366 15.770 16.969 18.348 20.294 6.391 6.680 7.103

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 35.2 27.0 14.6 15.9 16.0 (79.5) 3.8 4.5 EBITDA (YoY) 28.8 6.4 6.0 14.1 (25.3) 40.2 (43.0) 12.1 Operating profit (YoY) 49.6 3.1 0.7 11.2 (64.4) 52.7 13.5 20.7 Net profit (YoY) 47.2 0.9 (19.2) 7.5 n.a. n.a. 46.7 25.2 Core EPS (fully-diluted) (YoY) 46.8 0.8 (19.2) 7.4 n.a. n.a. 46.7 25.2 Gross-profit margin 25.7 24.8 24.1 25.6 25.0 34.6 35.8 36.4 EBITDA margin 8.0 6.7 6.2 6.1 3.9 26.9 14.8 15.8 Operating-profit margin 5.1 4.1 3.6 3.5 1.1 7.9 8.6 10.0 Net profit margin 2.2 1.7 1.2 1.1 (0.5) 2.5 3.5 4.3 ROAE 6.5 5.4 3.9 3.9 n.a. 2.7 8.1 9.6 ROAA 2.3 1.9 1.3 1.2 n.a. 0.7 1.7 1.9 ROCE 8.5 7.5 6.6 6.6 2.0 3.8 6.1 6.5 ROIC 8.1 7.7 6.7 5.5 0.4 4.6 4.8 4.9 Net debt to equity n.a. n.a. 3.3 2.6 16.5 64.3 238.7 220.2 Effective tax rate 27.8 25.3 24.5 37.5 84.2 n.a. 27.0 28.0 Accounts receivable (days) 25.4 30.4 36.5 37.6 35.5 97.0 20.9 21.6 Current ratio (x) 1.0 1.0 0.9 0.9 0.8 0.5 0.5 0.5 Net interest cover (x) 25.0 20.2 12.6 16.6 3.4 9.3 9.3 2.5 Net dividend payout 47.0 37.4 18.3 34.0 n.a. n.a. 10.2 17.5 Free cash flow yield 9.9 3.1 n.a. 12.0 n.a. n.a. 6.7 9.6 Source: FactSet, Daiwa forecasts

Company profile

China Resources Beer is a subsidiary of China Resources National Corporation (CRNC), a state- owned enterprise. The company’s 51%-owned joint venture with SABMiller, CRE-Snow, is the largest beer maker in China with a 23% market share by volume for 2014.

Hong Kong Consumer Staples 26 January 2016

Hengan International Group (1044 HK)

Heng an Inter national Gr oup

Target price: HKD66.00 (from HKD87.00) Share price (25 Jan): HKD67.75 | Up/downside: -2.5%

Revenue expectations set too high

 Increasingly challenged in disposable diapers, sanitary napkin markets Anson Chan, CFA (852) 2532 4350  Cutting 2015-17E EPS by 7-17% on lower sales, forex losses [email protected]  Downgrading rating and TP; share-price downside looks limited

What's new: As highlighted in our industry section: 1) foreign brands Forecast revisions (%) continue to gain share in China’s personal hygiene product market, and 2) Year to 31 Dec 15E 16E 17E revenue from the e-commerce channel has been growing quicker than that Revenue change (2.1) (7.5) (11.1) Net profit change (6.9) (12.8) (17.1) from traditional channels. We believe Hengan will be a victim of such Core EPS (FD) change (6.8) (12.4) (16.6) trends. However, as the stock is already trading near its trough valuation Source: Daiwa forecasts since 2008, we see limited downside to its share price at the current level. Downgrade to Hold (3) from Outperform (2). Share price performance

(HKD) (%) What's the impact: Personal care products. While we believe Hengan will 105 115 maintain its No.1 position in China’s sanitary napkin market (21-22% market 95 109 share, on our estimates), we see its growth prospects being increasingly 85 103 75 96 challenged as international brands deepen their market presence in lower-tier 65 90 cities. Hengan has become less competitive on price relative to Japan brands Jan-15 Apr-15 Jul-15 Oct-15 given import tariff reductions and increased cross-border purchases. At the Hengan (LHS) Relative to HSI (RHS) same time, we believe its modest presence in online channels (c3% of total revenue for 2014) will weigh on its revenue-growth prospects. As such, we cut 12-month range 65.05-100.10 2015-17E revenue for diapers and sanitary napkins by 11-15% and now Market cap (USDbn) 10.63 assume no volume growth in these segments. 3m avg daily turnover (USDm) 23.79 Shares outstanding (m) 1,223

Major shareholder Sze Man Bok (18.6%) Tissue paper: In 1H15, Hengan reported a 2% YoY decline in revenue in the tissue paper segment. Going forward, we expect increasing headwinds Financial summary (HKD) and price competition. Hengan has little exposure to the e-commerce Year to 31 Dec 15E 16E 17E channel, where tissue paper sales are expanding rapidly (20%-plus YoY in Revenue (m) 24,304 24,118 24,386 2015E for Hengan’s closest domestic competitor, Vinda (3331 HK, Operating profit (m) 6,111 6,202 6,210 Net profit (m) 4,281 4,493 4,559 HKD13.00, Outperform [2]). Also, since most players are aggressively Core EPS (fully-diluted) 3.487 3.675 3.729 cutting prices and going for market share, we think Hengan is unlikely to EPS change (%) 9.3 5.4 1.5 raise product ASPs in 2015-17E. Our revised forecasts call for only 1% per Daiwa vs Cons. EPS (%) 2.2 (2.5) (10.7) year growth in sales volume for Hengan in this segment over 2016-17E. PER (x) 19.4 18.4 18.2 Dividend yield (%) 3.0 3.2 3.3 DPS 2.042 2.148 2.214 What we recommend: We cut 2015-17E EPS by 7-17% after factoring in: PBR (x) 4.4 4.0 3.7 1) lower revenue forecasts assuming Hengan fails to gain further market EV/EBITDA (x) 11.7 11.3 10.9 ROE (%) 23.5 22.8 21.3 share, and 2) higher financial costs associated with its HKD debt due to Source: FactSet, Daiwa forecasts CNY depreciation. In turn, we lower our TP to HKD66, from HKD87, based on a target PER of 18x (previously 20x) applied to our revised 2016E EPS. Our target PER marks a slight discount to international peers’ average (20x) given Hengan’s slower EPS growth prospects for 2016E (5% vs. 13% ([Bloomberg consensus for peers]). We downgrade our rating to Hold (3), from Outperform (2). The main upside risk to our call: product-mix upgrades. The main downside risk: a further surge in raw-material costs.

How we differ: Our 2016-17E EPS estimates are 3-11% below the Bloomberg consensus, likely as we are more bearish on Hengan’s revenue outlook in the sanitary napkin segment.

See important disclosures, including any required research certifications, beginning on page 81

Hengan International Group (1044 HK): 26 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Hengan: net profit and net-profit growth We forecast Hengan’s net profit growth to slow significantly (HKDm) from 9% YoY in 2015E to 5% YoY in 2016E and 2% YoY in 5,000 40% 35% 2017E, on revenue growth of -1% and 1% YoY in 2016- 4,000 30% 17E, with tissue paper likely to be the only segment to 3,000 record growth. Also, we assume forex losses of HKD150m 25% 2,000 20% and HKD120m, respectively, as part of its financial costs, in 15% 2015-16E due to the CNY’s depreciation against HKD. 1,000 10% Favourable petrochem costs should support a slight rise in 0 5% Hengan’s gross margin in 2016E, but the impact is likely to (1,000) 0% be tempered by the increased revenue contribution of 2011 2012 2013 2014 2015E 2016E 2017E tissue paper, on which the operating margin is relatively Net profit (HKD m) Forex gain / loss YoY % low. Source: Company, Daiwa forecasts

Valuation Hengan: 12-month forward PER band The stock is trading currently at an 18x 2016E PER on our (HKD) EPS forecast, near the bottom of its PER band since 2008. 95 We see the risk of a further derating in the long term, since we expect EPS growth to decelerate again in 2017E 75 However, that risk may not eventuate in 2016 following the 55 recent sell-off and as the potential disposal of non-core businesses could boost investors’ confidence in 35 management. Hence, we see limited valuation downside in 2016E. 15 Aug 08 Aug 09 Aug 10 Aug 11 Aug 12 Aug 13 Aug 14 Aug 15 1044 HK 18x 21x 24x 27x 30x Source: Bloomberg

Earnings revisions Hengan: Bloomberg consensus EPS (2015-16E) The Bloomberg-consensus 2015E and 2016E EPS (HKD) forecasts for Hengan have trended down slowly since 4.6 4.4 2015, and we see further downside to the market’s 4.2 forecasts on the back of lower-than-expected revenue 4.0 growth. 3.8 3.6 Our 2016E EPS is 3% below that of the consensus. 3.4 3.2

3.0

Jul-15

Apr-15 Oct-15 Oct-15

Jan-15 Jan-15 Jun-15

Feb-15 Mar-15 Mar-15

Aug-15 Aug-15 Sep-15 Nov-15 Dec-15

May-15 May-15 2015E 2016E

Source: Bloomberg

Hengan International Group (1044 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sanitary napkin volume YoY 10 64 16 12 18 0 0 0 Diapers volume YoY 13 10 (4) 3 (4) (3) (1) (1) Tissue paper volume YoY 33 26 25 12 8 0 (1) 0 Sanitary napkin ASP YoY 0.0 1.5 3.1 7.1 6.6 3.0 0.0 0.0 Diapers ASP YoY 0.0 1.5 3.1 5.8 9.5 2.0 2.0 0.0 Tissue paper ASP change YoY 3.2 4.1 (8.7) (0.0) (1.9) 0.0 2.0 2.0

Profit and loss (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sanitary napkins 3,170 4,114 4,915 5,898 7,428 7,651 7,651 7,651 Diposable diapers 2,447 2,723 2,685 2,938 3,095 3,062 3,092 3,061 Other Revenue 7,815 10,213 10,923 12,350 13,308 13,592 13,375 13,675 Total Revenue 13,432 17,051 18,524 21,186 23,831 24,304 24,118 24,386 Other income 249 456 565 776 1,164 880 859 834 COGS (7,487) (10,250) (10,209) (11,627) (12,843) (12,443) (12,186) (12,363) SG&A (3,194) (3,963) (4,139) (5,248) (6,402) (6,630) (6,589) (6,648) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 3,000 3,294 4,741 5,088 5,750 6,111 6,202 6,210 Net-interest inc./(exp.) 39 (38) (202) (72) (407) (483) (277) (98) Assoc/forex/extraord./others 0 0 0 185 (130) (150) (120) 0 Pre-tax profit 3,038 3,255 4,539 5,201 5,213 5,478 5,805 6,112 Tax (552) (570) (1,001) (1,245) (1,369) (1,407) (1,481) (1,528) Min. int./pref. div./others (48) (37) (19) (50) (58) (60) (70) (75) Net profit (reported) 2,438 2,649 3,519 3,906 3,785 4,011 4,253 4,509 Net profit (adjusted) 2,370 2,605 3,531 3,627 3,918 4,281 4,493 4,559 EPS (reported)(HKD) 2.000 2.156 2.861 3.174 3.082 3.267 3.479 3.688 EPS (adjusted)(HKD) 1.944 2.120 2.871 2.947 3.190 3.487 3.675 3.729 EPS (adjusted fully-diluted)(HKD) 1.944 2.120 2.871 2.947 3.190 3.487 3.675 3.729 DPS (HKD) 1.305 1.350 1.700 1.850 1.994 2.042 2.148 2.214 EBIT 3,000 3,294 4,741 5,088 5,750 6,111 6,202 6,210 EBITDA 3,384 3,727 5,291 5,791 6,505 6,969 7,153 7,254

Cash flow (HKDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 3,038 3,255 4,539 5,201 5,213 5,478 5,805 6,112 Depreciation and amortisation 385 433 550 703 755 858 951 1,044 Tax paid (552) (570) (1,001) (1,245) (1,369) (1,407) (1,481) (1,528) Change in working capital (1,099) 221 (1,046) (809) 488 48 107 19 Other operational CF items (39) 38 202 72 407 483 277 98 Cash flow from operations 1,733 3,378 3,244 3,922 5,494 5,460 5,659 5,745 Capex (1,117) (2,428) (2,469) (1,407) (1,696) (1,400) (1,400) (1,400) Net (acquisitions)/disposals 0 0 0 13 257 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,117) (2,428) (2,469) (1,395) (1,438) (1,400) (1,400) (1,400) Change in debt 2,582 1,906 4,009 8,192 1,135 0 (5,000) (5,000) Net share issues/(repurchases) 123 120 0 103 (546) (471) (52) 0 Dividends paid (1,466) (1,594) (1,844) (2,216) (4,368) (2,571) (2,548) (2,657) Other financing CF items (72) (148) (240) (364) (640) (648) (452) (315) Cash flow from financing 1,167 284 1,926 5,714 (4,418) (3,690) (8,052) (7,971) Forex effect/others (68) (44) 12 (279) 132 270 240 50 Change in cash 1,716 1,190 2,713 7,962 (230) 640 (3,553) (3,576) Free cash flow 617 950 775 2,515 3,798 4,060 4,259 4,345 Source: FactSet, Daiwa forecasts

Hengan International Group (1044 HK): 26 January 2016

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 6,048 8,327 9,607 19,624 21,336 21,995 18,308 14,735 Inventory 2,760 2,934 3,831 4,386 3,695 3,580 3,506 3,557 Accounts receivable 1,396 1,893 1,870 2,184 2,455 2,504 2,485 2,512 Other current assets 546 590 883 1,127 1,220 1,281 1,345 1,412 Total current assets 10,750 13,744 16,191 27,321 28,706 29,360 25,643 22,216 Fixed assets 5,184 7,257 9,117 9,832 10,245 10,729 11,120 11,417 Goodwill & intangibles 607 601 591 581 357 357 357 357 Other non-current assets 2,036 1,717 3,306 2,456 3,269 3,369 3,469 3,569 Total assets 18,577 23,319 29,205 40,190 42,577 43,814 40,588 37,558 Short-term debt 3,815 6,815 7,441 13,233 15,164 15,164 10,164 5,164 Accounts payable 1,319 1,881 1,803 2,097 2,300 2,228 2,182 2,214 Other current liabilities 943 1,316 1,578 1,585 1,522 1,637 1,761 1,894 Total current liabilities 6,077 10,012 10,821 16,915 18,986 19,029 14,107 9,272 Long-term debt 1,497 404 3,787 6,187 5,390 5,390 5,390 5,390 Other non-current liabilities 178 185 188 170 138 138 138 138 Total liabilities 7,752 10,600 14,797 23,272 24,514 24,557 19,635 14,800 Share capital 122 123 123 123 122 118 117 117 Reserves/R.E./others 10,381 12,219 13,955 16,410 17,515 18,713 20,411 22,215 Shareholders' equity 10,503 12,341 14,078 16,534 17,638 18,831 20,528 22,332 Minority interests 322 377 330 385 425 425 425 425 Total equity & liabilities 18,577 23,319 29,205 40,190 42,578 43,814 40,589 37,558 EV 82,429 82,112 84,794 83,024 82,487 81,828 80,515 79,088 Net debt/(cash) (736) (1,108) 1,621 (204) (782) (1,441) (2,754) (4,180) BVPS (HKD) 8.614 10.042 11.455 13.427 14.350 15.400 16.801 18.277

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 24.0 26.9 8.6 14.4 12.5 2.0 (0.8) 1.1 EBITDA (YoY) 15.0 10.1 42.0 9.4 12.3 7.1 2.6 1.4 Operating profit (YoY) 15.3 9.8 43.9 7.3 13.0 6.3 1.5 0.1 Net profit (YoY) 11.5 9.9 35.6 2.7 8.0 9.3 5.0 1.5 Core EPS (fully-diluted) (YoY) 5.2 9.1 35.4 2.7 8.2 9.3 5.4 1.5 Gross-profit margin 44.3 39.9 44.9 45.1 46.1 48.8 49.5 49.3 EBITDA margin 25.2 21.9 28.6 27.3 27.3 28.7 29.7 29.7 Operating-profit margin 22.3 19.3 25.6 24.0 24.1 25.1 25.7 25.5 Net profit margin 17.6 15.3 19.1 17.1 16.4 17.6 18.6 18.7 ROAE 24.3 22.8 26.7 23.7 22.9 23.5 22.8 21.3 ROAA 14.5 12.4 13.4 10.5 9.5 9.9 10.6 11.7 ROCE 21.3 18.3 20.8 16.4 15.3 15.6 16.3 17.8 ROIC 27.8 25.0 26.7 23.6 24.9 25.9 25.7 25.3 Net debt to equity n.a. n.a. 11.5 n.a. n.a. n.a. n.a. n.a. Effective tax rate 18.2 17.5 22.1 23.9 26.3 25.7 25.5 25.0 Accounts receivable (days) 31.0 35.2 37.1 34.9 35.5 37.2 37.7 37.4 Current ratio (x) 1.8 1.4 1.5 1.6 1.5 1.5 1.8 2.4 Net interest cover (x) n.a. 85.8 23.5 70.3 14.1 12.6 22.4 63.7 Net dividend payout 65.3 62.6 59.4 58.3 64.7 62.5 61.7 60.0 Free cash flow yield 0.7 1.1 0.9 3.0 4.6 4.9 5.1 5.2 Source: FactSet, Daiwa forecasts

Company profile

Hengan International Group (Hengan) is the largest supplier of sanitary napkins and household tissue paper in China in terms of sales, with market shares of around 10.9% and 11.4%, respectively, in 2013 according to Euromonitor. Hengan also produces diapers (for babies and adults) and snack products.

China Consumer Staples 26 January 2016

Tingyi Cayman Islands (322 HK)

Tingyi Cayman Isl ands

Target price: HKD9.60 (from HKD12.90) Share price (25 Jan): HKD9.07 | Up/downside: +5.8%

Too big to move; downgrading to Hold

 Noodle sales volume under pressure in the near term due to price hike Anson Chan, CFA (852) 2532 4350  Beverage segment to resume earnings growth on new products [email protected]  Downgrading to Hold (3); cut TP to HKD9.6; 2015-17E EPS lowered

What's new: Given our concerns on Tingyi’s product mix changes since Forecast revisions (%) October 2015 and the likely negative impact on both its market share and Year to 31 Dec 15E 16E 17E long-term revenue outlook as a local Goliath, we downgrade the stock to Revenue change (1.4) (3.7) (5.3) Net profit change (3.9) (12.4) (16.3) Hold (3) from Outperform (2). For 2016, we do not see much potential Core EPS (FD) change (3.9) (12.4) (16.3) downside for its share price, and would advise investors to sit on the stock Source: Daiwa forecasts for now. Share price performance

What's the impact: Risk of noodle market-share loss: In Oct 2015, Tingyi (HKD) (%) adjusted its product mix (content upgrade + ASP hike) for noodles. Unlike other 20 110 price hikes over the past 5 years, none of its major competitors has followed 17 98 14 85 suit. Hence, Tingyi may lose market share among price sensitive consumers 11 73 and in the traditional channels. We expect its noodle business revenue to fall 8 60 by 11%/2% YoY in 2015/16E (previously: 10%/+3%), with a 1pp decline in the Jan-15 Apr-15 Jul-15 Oct-15 gross margin over 2015-17E on growing raw-material costs and a lower-than- Tingyi Hdg (LHS) Relative to HSI (RHS) expected utilisation rate (previously: 2pp gross-margin expansion). 12-month range 8.89-19.74 New beverage products: Assuming a revenue decline in the bottled-water Market cap (USDbn) 6.52 business but increasing revenue contribution from functional drinks (ie, 3m avg daily turnover (USDm) 11.16 Shares outstanding (m) 5,600 vitamin drinks), we cut our revenue-growth forecast to 3% per year over Major shareholder Wei Ing-chou (33.8%) 2016-17E (from 4%), after a 9% YoY decline in 2015E. We expect: 1) negative impact from termination benefits due to layoffs at the Pepsi unit Financial summary (USD) lingering into 2016E as Tingyi will need to restructure this division further to Year to 31 Dec 15E 16E 17E drive long-term revenue, and 2) sugar costs to rebound in 2016E, Revenue (m) 9,272 9,326 9,561 impacting COGS. Accordingly, we expect Tingyi’s gross margin to be flat Operating profit (m) 750 807 851 Net profit (m) 373 386 422 over 2016-17E despite product-mix upgrades. Core EPS (fully-diluted) 0.067 0.069 0.075 EPS change (%) (6.8) 3.4 9.5 Cutting 2015-17E EPS by 4-16%, on: 1) a 1-5% cut in our revenue forecasts Daiwa vs Cons. EPS (%) (0.5) (11.7) (11.2) PER (x) 17.5 16.9 15.4 on our concern of market-share loss in the noodles segment, 2) FX losses of Dividend yield (%) 2.9 3.0 3.2 USD50m in 2016E (accounting for 13% of 2016E net profit) due to the CNY DPS 0.033 0.034 0.038 depreciation vs. the USD, and 3) gross-margin erosion from rising palm oil PBR (x) 2.0 1.9 1.8 prices and a falling utilisation rate for the noodles segment. EV/EBITDA (x) 7.4 6.7 6.2 ROE (%) 12.0 11.7 12.0

Source: FactSet, Daiwa forecasts What we recommend: We cut our 12-month TP to HKD9.60 from HKD12.9 on our 2016 EPS revisions. We also lower our 2016E target PER to 18x from 21x, as we now assign a slight discount to Tingyi’s target valuation vs. the average of its international peers, on the back of its likely lower earnings growth. Key upside risk: new product revenue contribution exceeding our expectations; key downside risks: food safety issues.

How we differ: Our 2016-17E EPS are 11-12% below consensus as we expect Tingyi’s revenue to miss market expectations due to market-share loss in the noodles segment.

See important disclosures, including any required research certifications, beginning on page 81

Tingyi Cayman Islands (322 HK): 26 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Tingyi: net profit (USDm) and YoY (%) We expect Tingyi’s net profit only grow by 3% and 10% (USDm) YoY over 2016-17E, mainly driven by operating-margin 500 15% 400 expansion in the beverage unit from cost savings (absence 9.5% 10% of termination-benefit expenses and operating leverage in 300 6.7% the Pepsi unit). For the noodles business (about 70% of 5% 200 3.4% 1.6% net profit over 2015-17E), we expect a 13% YoY net-profit 0% 100 decline in 2015E, then forecast it to remain flat over 2016- -2.9% 17 on market-share losses. We believe the beverage 0 (5%) -6.8% segment’s gross margin will be largely steady YoY in (100) (10%) 2016E as product-mix upgrades could offset the increase 2012 2013 2014 2015E 2016E 2017E in sugar costs. We expect the ASP hike in the noodle Noodles Beverage Others Recurring profit growth YoY % segment to offset the increased flour and palm oil costs as Source: Company, Daiwa forecasts well as the lower utilisation rate due to falling sales volume.

Valuation Tingyi: 12-month forward PER bands since 2008 The stock is currently trading at 17x 2016E PER. We see (HKD) the risk of a major derating of the stock in the long run as 25 we expect Tingyi’s EPS growth to be structurally lower 20 compared to the past. But this risk may have already been factored in by the market after the recent sell-off. Thus, we 15 see limited downside to the share price from current levels, 10 as: 1) we expect EPS growth to recover to 6% CAGR over 2016-17E after declining in 2015E, and 2) the stock is 5

already trading near its trough valuation, seen in 2008.

Jul-14 Jul-15

Apr-09 Apr-10 Apr-11 Apr-12 Apr-13

Jan-08

Mar-14 Mar-15

Aug-08 Dec-08 Aug-09 Dec-09 Aug-10 Dec-10 Aug-11 Dec-11 Aug-12 Dec-12 Dec-13 Nov-15 Aug-13 Nov-14 May-08 322.HK 18 21 24 27 30 Source: Bloomberg

Earnings revisions Tingyi: Bloomberg consensus EPS forecast (2015-16E) Although the Bloomberg consensus EPS estimates for (USD) 2015-16 have continued to trend down over the past 12 0.12 months due the results for the past 3 quarters missing 0.11 0.10 consensus expectations, we still see downside risk to 0.09 consensus revenue estimates for 2016-17. We would 0.08 consider making further revenue cuts if new products in the 0.07 beverage segment failed to drive revenue growth. 0.06 0.05

0.04

Jul-15

Apr-15 Apr-15 Oct-15 Oct-15

Jan-15 Jun-15 Jun-15 Jan-15

Mar-15 Feb-15

Sep-15 Nov-15 Dec-15 Dec-15 Aug-15 Aug-15 May-15

2015E 2016E Source: Bloomberg

Tingyi Cayman Islands (322 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales growth YoY - instant noodles 27.0 22.5 10.2 9.4 (4.5) (10.7) (2.2) 1.4 Sales growth YoY - beverages 38.9 13.2 23.3 27.1 (7.5) (8.7) 2.7 3.1 Gross margin % - instant noodles 28.8 27.2 30.0 29.2 28.3 29.9 29.3 28.9 Gross margin % - beverages 28.5 25.7 29.6 30.8 31.9 34.0 33.9 35.1 Sellling and distribution expense ratio 16.8 16.8 20.3 21.1 20.9 20.1 20.2 20.6 (%)

Profit and loss (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Instant noodles 2,932 3,592 3,960 4,332 4,138 3,697 3,614 3,666 Beverage 3,532 3,999 4,931 6,268 5,800 5,294 5,435 5,605 Other Revenue 218 266 321 341 300 281 276 289 Total Revenue 6,681 7,857 9,212 10,941 10,238 9,272 9,326 9,561 Other income 46 131 255 201 209 160 180 180 COGS (4,782) (5,770) (6,457) (7,631) (7,120) (6,257) (6,316) (6,424) SG&A (1,247) (1,512) (2,164) (2,663) (2,438) (2,206) (2,213) (2,296) Other op.expenses (92) (73) (75) (118) (156) (220) (170) (170) Operating profit 606 633 771 730 733 750 807 851 Net-interest inc./(exp.) (7) (9) (33) (37) (47) (75) (92) (61) Assoc/forex/extraord./others 147 39 94 30 7 11 11 11 Pre-tax profit 747 663 832 723 694 686 726 801 Tax (134) (163) (228) (229) (209) (213) (211) (224) Min. int./pref. div./others (136) (80) (145) (86) (84) (100) (130) (154) Net profit (reported) 477 420 460 409 400 373 386 422 Net profit (adjusted) 340 380 369 394 400 373 386 422 EPS (reported)(USD) 0.085 0.075 0.082 0.073 0.072 0.067 0.069 0.075 EPS (adjusted)(USD) 0.061 0.068 0.066 0.070 0.072 0.067 0.069 0.075 EPS (adjusted fully-diluted)(USD) 0.061 0.068 0.066 0.070 0.072 0.067 0.069 0.075 DPS (USD) 0.043 0.038 0.032 0.035 0.036 0.033 0.034 0.038 EBIT 606 633 771 730 733 750 807 851 EBITDA 810 911 1,092 1,118 1,186 1,213 1,313 1,385

Cash flow (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 747 663 832 723 694 686 726 801 Depreciation and amortisation 203 278 321 388 452 463 506 535 Tax paid (96) (130) (138) 386 (223) (232) (194) (191) Change in working capital 215 464 (158) 273 284 (354) (185) 18 Other operational CF items (1,050) 4 25 18 38 63 81 50 Cash flow from operations 19 1,279 882 1,788 1,245 626 935 1,212 Capex (966) (1,349) (882) (896) (1,100) (600) (550) (550) Net (acquisitions)/disposals 0 0 0 0 (380) 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (966) (1,349) (882) (896) (1,480) (600) (550) (550) Change in debt 299 616 234 192 952 (382) (447) 0 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (192) (239) (210) (180) (197) (200) (187) (193) Other financing CF items 93 (38) (85) 57 47 (113) (142) (121) Cash flow from financing 201 339 (61) 69 802 (696) (776) (314) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (746) 269 (60) 961 568 (669) (391) 348 Free cash flow (947) (70) 1 892 145 26 385 662 Source: FactSet, Daiwa forecasts

Tingyi Cayman Islands (322 HK): 26 January 2016

Financial summary continued … Balance sheet (USDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 893 600 838 1,250 1,183 765 608 979 Inventory 310 313 478 481 387 340 343 349 Accounts receivable 128 155 233 260 238 211 208 209 Other current assets 357 368 419 419 535 535 535 535 Total current assets 1,688 1,436 1,968 2,410 2,343 1,851 1,694 2,073 Fixed assets 2,923 4,030 5,002 5,485 5,860 6,382 6,406 6,403 Goodwill & intangibles 0 0 29 28 27 27 27 27 Other non-current assets 281 343 474 501 976 557 557 557 Total assets 4,891 5,809 7,473 8,424 9,206 8,817 8,685 9,061 Short-term debt 457 701 500 1,017 1,382 1,000 800 800 Accounts payable 1,084 974 1,043 1,252 896 787 795 809 Other current liabilities 687 753 1,252 1,357 1,358 1,209 1,219 1,238 Total current liabilities 2,228 2,428 2,795 3,625 3,636 2,996 2,814 2,846 Long-term debt 177 549 985 660 1,247 1,247 1,000 1,000 Other non-current liabilities 117 145 197 213 227 246 265 286 Total liabilities 2,522 3,123 3,976 4,498 5,110 4,489 4,079 4,133 Share capital 27 28 28 28 28 28 28 28 Reserves/R.E./others 1,794 2,072 2,523 2,852 3,006 3,179 3,378 3,607 Shareholders' equity 1,821 2,100 2,551 2,880 3,034 3,207 3,406 3,635 Minority interests 548 587 946 1,046 1,062 1,122 1,200 1,293 Total equity & liabilities 4,891 5,809 7,473 8,424 9,206 8,817 8,685 9,061 EV 6,811 7,759 8,031 7,886 8,924 9,020 8,809 8,530 Net debt/(cash) (259) 650 647 426 1,446 1,482 1,192 821 BVPS (USD) 0.326 0.376 0.457 0.515 0.542 0.573 0.608 0.649

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 31.5 17.6 17.2 18.8 (6.4) (9.4) 0.6 2.5 EBITDA (YoY) (2.8) 12.5 19.9 2.3 6.1 2.3 8.3 5.5 Operating profit (YoY) (3.5) 4.4 21.8 (5.3) 0.5 2.2 7.7 5.4 Net profit (YoY) (11.3) 11.9 (2.9) 6.7 1.6 (6.8) 3.4 9.5 Core EPS (fully-diluted) (YoY) (11.3) 11.9 (2.9) 6.6 1.5 (6.8) 3.4 9.5 Gross-profit margin 28.4 26.6 29.9 30.3 30.5 32.5 32.3 32.8 EBITDA margin 12.1 11.6 11.9 10.2 11.6 13.1 14.1 14.5 Operating-profit margin 9.1 8.1 8.4 6.7 7.2 8.1 8.7 8.9 Net profit margin 5.1 4.8 4.0 3.6 3.9 4.0 4.1 4.4 ROAE 20.7 19.4 15.9 14.5 13.5 12.0 11.7 12.0 ROAA 8.2 7.1 5.6 5.0 4.5 4.1 4.4 4.8 ROCE 23.1 18.2 17.3 13.8 11.9 11.3 12.4 13.0 ROIC 26.0 17.5 15.0 11.7 10.4 9.1 9.9 10.6 Net debt to equity n.a. 31.0 25.3 14.8 47.7 46.2 35.0 22.6 Effective tax rate 18.0 24.6 27.4 31.6 30.1 31.0 29.0 28.0 Accounts receivable (days) 6.6 6.6 7.7 8.2 8.9 8.9 8.2 8.0 Current ratio (x) 0.8 0.6 0.7 0.7 0.6 0.6 0.6 0.7 Net interest cover (x) 93.1 67.6 23.6 19.5 15.6 10.0 8.8 13.9 Net dividend payout 50.0 50.0 39.2 48.2 49.9 50.0 50.0 50.0 Free cash flow yield n.a. n.a. 0.0 13.7 2.2 0.4 5.9 10.1 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% market share in China (in terms of revenue for 2014). The company’s beverage unit, owned jointly with Pepsi and Asahi Group, has shares of 55%, 27% and 21% of the China markets for ready-to-drink (RTD) tea, juice drinks and bottled water, respectively, by revenue, for 2014.

China Consumer Staples 26 January 2016

China Mengniu Dairy (2319 HK) China M eng niu D air y

Target price: HKD11.70 (from HKD14.50) Share price (25 Jan): HKD11.08 | Up/downside: +5.5%

Competition remains stiff

 Cutting 2015-17E EPS by 5-15% on higher selling cost, slower revenue Anson Chan, CFA (852) 2532 4350  Limited share price downside as trading near 2011-15 low PER [email protected]  Hence, we maintain Hold (3) on valuation grounds

What's new: We recently visited the food retailers and learned that Forecast revisions (%) Mengniu’s dominant position in the premium UHT milk market is now being Year to 31 Dec 15E 16E 17E challenged by the small players that can differentiate themselves from Revenue change (1.0) (1.2) (1.6) Net profit change (4.5) (15.4) (15.2) Mengniu in terms of the origins of the milk that they sell (100% in-house Core EPS (FD) change (4.5) (15.4) (15.2) made raw milk or sourced overseas). We maintain our Hold (3) as Source: Daiwa forecasts competition remains fierce in the dairy downstream market. Share price performance What's the impact: Key concerns: 1) Internal product cannibalisation. (HKD) (%) We are concerned that the rapidly growing demand for Mengniu’s yogurt 23 125 products (+74% YoY revenue growth for 1H15) will continue to take sales 20 113 volume away from its premium milk business, due to the substitution effect. 17 100 And, we now expect more new rivals in the UHT segments (imported 13 88 10 75 substitutes and UHT yogurt in particular). Accordingly, for 2015E, we Jan-15 Apr-15 Jul-15 Oct-15 estimate that Mengniu’s share of the premium milk market was 50% (vs. CMD (LHS) Relative to HSI (RHS) our estimate of 55% for 2014) and that the revenue growth of its Milk

Deluxe (premium UHT milk) is likely to have decelerated by 5-10% YoY for 12-month range 10.80-22.60 2015E (vs. c.20% for 2014). 2) Infant formula: Mengniu recently injected Market cap (USDbn) 5.52 its Oushi Mengniu infant formula business into its subsidiary, Yashili. And 3m avg daily turnover (USDm) 22.14 subject to shareholder approval, we expect it to acquire Danone’s infant Shares outstanding (m) 3,883 Major shareholder COFCO (16.3%) formula brand in China, Dumex, in 1H16E. But we are concerned that

Yashili’s weak online distribution will not improve after the acquisition, and Financial summary (CNY) that the brand will continue to lose market share to foreign brands and face Year to 31 Dec 15E 16E 17E increasing selling costs in 2016E. Revenue (m) 49,103 50,942 52,203 Operating profit (m) 3,122 2,908 3,105 Net profit (m) 2,577 2,471 2,745 Cutting 2015-17E EPS by 5-15%. 1) Due to the loss of market share in the Core EPS (fully-diluted) 0.663 0.636 0.707 premium milk segment, we are cutting our 2015-17E revenue by 1-2%. We EPS change (%) 11.6 (4.1) 11.1 still expect selling costs, as a percentage of revenue, to remain high, at 21- Daiwa vs Cons. EPS (%) 2.9 (9.9) (14.1) PER (x) 14.1 14.7 13.2 21.5% over 2016-17E (previous forecast: 20%) due to the lower revenue Dividend yield (%) 1.4 1.3 1.4 base and price promotions for new products, 2) on ASP pressure, we DPS 0.128 0.121 0.135 expect Mengniu’s gross margin to decline by 1pp for 2016E, to 31.2%. PBR (x) 1.6 1.4 1.3 EV/EBITDA (x) 9.1 9.2 8.3

ROE (%) 11.5 10.1 10.4 What we recommend: Given our lower EPS forecasts, we are cutting our Source: FactSet, Daiwa forecasts 12-month TP to HKD11.70 from HKD14.50, based on a 2016E PER of 15.2x (previously 16x). We now assign a bigger discount (20%, from 15%) to the stock’s 2011-13 average 12-month forward PER (19x; excluding the impact of M&A, as we see an increasing risk of further market-share losses in the premium milk market. Our Hold (3) rating stands. The key upside risk: further reduction in selling costs; the key downside risk: rebound in the milk cost.

How we differ: Unlike the market, we prefer the upstream dairy-farm operators to the downstream players like Mengniu, due to the structural shortage of quality and safe raw milk in China.

See important disclosures, including any required research certifications, beginning on page 81

China Mengniu Dairy (2319 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Mengniu: net profit and YoY growth Reflecting the structural slowdown in China’s dairy market (CNYm) and the more intense competition, we expect Mengniu’s 3,000 50% revenue growth to recover only slightly, to 4% and 3% for 2,500 39% 40% 30% 2016-17E, respectively, versus a decline of 2% for 2015E. 2,000 28% But this will likely come at the expense of rising selling 20% 1,500 16% 15% expenses and price promotions. Hence, we expect the 11%10% 1,000 EBITDA margin to decline to 8.8% for 2016E, from 9.3% 0% -4% for 2015E. We forecast EPS to decline by 4% YoY for 500 -10% -13% 2016E, before rebounding to 11% YoY growth for 2017E on 0 -20% a slight improvement in operating leverage. 2011 2012 2013 2014E 2015E 2016E 2017E Net profit (LHS) YoY (RHS)

Source: Company, Daiwa forecasts

Valuation Mengniu: past-5-year 12-month forward PER bands The stock is trading currently at a 2016E PER of 15x. This (HKD) 25 is in line with the average of its major China food and beverage peers, on our forecasts. We believe the stock is 20 fairly valued given what we see as its lacklustre revenue outlook. We would need to see successful M&A activity in 15 its infant formula business and a successful product-mix upgrade in order for the stock to be rerated. However, as 10 the stock is already trading near the low-end of its past-5- year 12-month forward PER (13x), we see limited potential 5 share-price downside. Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Mengniu 13 17 21 25 29 Source: Bloomberg

Earnings revisions Mengniu: Bloomberg 2015-16E EPS forecasts

Our 2015 EPS forecast is in line with that of the Bloomberg (HKD) consensus but our 2016 and 2017 EPS forecasts are 10% 1.10 and 14% below, as we have built in the intensifying 1.00 competition and slower domestic dairy market revenue 0.90 growth. We would also see downside to our and the 0.80 street’s EPS forecasts if Mengniu’s infant formula business 0.70 were to turn loss-making in 2016-17E, after acquiring Dumex. 0.60

0.50

Jul 15Jul

Oct Oct 15 Apr Apr 15

Jan 15 Jan 15 Jun Jan 16Jan

Mar Mar 15

Feb 15

Aug15 Sep15 Nov15 Dec15 May 15 2015E 2016E

Source:: Bloomberg

China Mengniu Dairy (2319 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales growth YoY % - Liquid Milk n.a. 25 (4) 17 14 (1) 3 3 Sales growth YoY %- Infant formula n.a. n.a. n.a. 6 82 (11) 11 2 ASP hike % n.a. 3.2 2.0 4.5 9.5 (2.0) (1.8) (1.2) SG&A cost ratio % n.a. 20.9 20.5 22.5 25.0 25.6 25.1 25.1

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Liquid Milk 26,872 33,701 32,336 37,903 43,036 42,800 44,250 45,369 Ice-cream 3,112 3,259 3,171 3,023 2,716 2,444 2,444 2,493 Other Revenue 282 428 572 2,431 4,297 3,859 4,248 4,341 Total Revenue 30,265 37,388 36,079 43,357 50,049 49,103 50,942 52,203 Other income 193 296 249 289 449 347 217 217 COGS (22,479) (27,796) (27,050) (31,660) (34,616) (33,303) (35,034) (35,782) SG&A (6,465) (7,805) (7,398) (9,774) (12,505) (12,570) (12,787) (13,103) Other op.expenses n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Operating profit 1,455 1,896 1,687 1,852 2,665 3,122 2,908 3,105 Net-interest inc./(exp.) 43 112 179 199 208 75 121 132 Assoc/forex/extraord./others 40 52 (53) 154 160 162 247 385 Pre-tax profit 1,538 2,061 1,813 2,205 3,032 3,359 3,276 3,622 Tax (182) (276) (245) (367) (459) (605) (590) (652) Min. int./pref. div./others (119) (195) (186) (231) (340) (178) (216) (225) Net profit (reported) 1,237 1,589 1,382 1,607 2,233 2,577 2,471 2,745 Net profit (adjusted) 1,237 1,589 1,382 1,607 2,233 2,577 2,471 2,745 EPS (reported)(CNY) 0.356 0.454 0.395 0.450 0.595 0.663 0.636 0.707 EPS (adjusted)(CNY) 0.356 0.454 0.395 0.450 0.595 0.663 0.636 0.707 EPS (adjusted fully-diluted)(CNY) 0.356 0.454 0.395 0.450 0.595 0.663 0.636 0.707 DPS (CNY) 0.080 0.099 0.080 0.101 0.141 0.128 0.121 0.135 EBIT 1,455 1,896 1,687 1,852 2,547 3,122 2,908 3,105 EBITDA 2,168 2,760 2,728 3,069 3,956 4,552 4,463 4,784

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 1,538 2,061 1,813 2,205 3,032 3,359 3,276 3,622 Depreciation and amortisation 713 864 1,041 1,218 1,291 1,430 1,555 1,680 Tax paid (49) (218) (285) (307) (351) (605) (590) (652) Change in working capital 193 300 (133) (1,106) (910) (551) (225) (35) Other operational CF items (83) (164) (126) (353) (485) (237) (368) (517) Cash flow from operations 2,312 2,842 2,310 1,656 2,578 3,396 3,648 4,098 Capex (1,426) (2,696) (2,267) (3,101) (2,906) (2,500) (2,500) (2,500) Net (acquisitions)/disposals 0 0 0 (9,495) (372) (2,506) 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,426) (2,696) (2,267) (12,597) (3,278) (5,006) (2,500) (2,500) Change in debt 60 (184) (58) 11,191 (1,847) (1,986) (497) (487) Net share issues/(repurchases) 0 0 0 0 4,089 0 0 0 Dividends paid (245) (278) (350) (283) (367) (548) (497) (471) Other financing CF items (282) 317 (127) 1,466 (4,198) 995 (230) (225) Cash flow from financing (467) (145) (535) 12,374 (2,323) (1,539) (1,224) (1,183) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 419 1 (492) 1,434 (3,023) (3,149) (76) 415 Free cash flow 886 146 43 (1,445) (329) 896 1,148 1,598 Source: FactSet, Daiwa forecasts

China Mengniu Dairy (2319 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 6,800 6,801 6,230 7,663 4,902 1,753 1,677 2,092 Inventory 1,176 1,685 1,420 2,577 4,342 4,178 4,395 4,489 Accounts receivable 575 836 801 754 1,148 1,915 2,185 2,240 Other current assets 1,112 1,064 1,310 5,327 9,940 9,940 9,940 9,940 Total current assets 9,664 10,387 9,761 16,321 20,333 17,786 18,197 18,760 Fixed assets 5,915 7,694 8,489 10,522 11,697 12,810 13,798 14,661 Goodwill & intangibles 1,158 1,292 1,516 8,356 8,508 9,708 9,708 9,708 Other non-current assets 568 829 1,225 5,140 6,542 6,684 6,911 7,276 Total assets 17,306 20,202 20,991 40,339 47,081 46,989 48,615 50,406 Short-term debt 691 657 599 8,554 4,479 3,000 3,000 3,000 Accounts payable 3,548 3,685 3,679 4,761 4,992 5,043 5,305 5,418 Other current liabilities 1,999 2,885 2,703 4,748 4,880 4,880 4,880 4,880 Total current liabilities 6,238 7,226 6,981 18,063 14,351 12,923 13,185 13,298 Long-term debt 150 0 0 3,236 5,464 4,957 4,460 3,972 Other non-current liabilities 700 927 938 1,029 2,773 2,773 2,773 2,773 Total liabilities 7,088 8,153 7,919 22,328 22,588 20,653 20,418 20,043 Share capital 357 362 362 724 392 392 392 392 Reserves/R.E./others 9,401 11,109 12,081 14,637 21,097 23,031 24,888 27,044 Shareholders' equity 9,758 11,471 12,443 15,361 21,489 23,424 25,280 27,436 Minority interests 459 578 629 2,650 3,003 2,912 2,918 2,926 Total equity & liabilities 17,306 20,202 20,991 40,339 47,081 46,989 48,615 50,406 EV 30,735 30,629 31,269 40,283 40,553 41,483 40,840 39,581 Net debt/(cash) (5,959) (6,145) (5,631) 4,126 5,041 6,204 5,783 4,880 BVPS (CNY) 2.809 3.245 3.520 4.219 5.534 6.032 6.510 7.065

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 17.7 23.5 (3.5) 20.2 15.4 (1.9) 3.7 2.5 EBITDA (YoY) 9.6 27.3 (1.1) 12.5 28.9 15.1 (2.0) 7.2 Operating profit (YoY) 131.8 30.3 (11.0) 9.8 37.5 22.6 (6.9) 6.8 Net profit (YoY) 180.9 28.4 (13.0) 16.3 39.0 15.4 (4.1) 11.1 Core EPS (fully-diluted) (YoY) 164.7 27.5 (13.0) 13.9 32.3 11.6 (4.1) 11.1 Gross-profit margin 25.7 25.7 25.0 27.0 30.8 32.2 31.2 31.5 EBITDA margin 7.2 7.4 7.6 7.1 7.9 9.3 8.8 9.2 Operating-profit margin 4.8 5.1 4.7 4.3 5.1 6.4 5.7 5.9 Net profit margin 4.1 4.3 3.8 3.7 4.5 5.2 4.9 5.3 ROAE 13.5 15.0 11.6 11.6 12.1 11.5 10.1 10.4 ROAA 7.9 8.5 6.7 5.2 5.1 5.5 5.2 5.5 ROCE 14.0 16.0 12.8 8.5 7.9 9.1 8.3 8.5 ROIC 33.9 32.3 21.9 10.4 8.8 8.2 7.2 7.4 Net debt to equity n.a. n.a. n.a. 26.9 23.5 26.5 22.9 17.8 Effective tax rate 11.8 13.4 13.5 16.6 15.1 18.0 18.0 18.0 Accounts receivable (days) 7.0 6.9 8.3 6.5 6.9 11.4 14.7 15.5 Current ratio (x) 1.5 1.4 1.4 0.9 1.4 1.4 1.4 1.4 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 22.5 21.8 20.3 22.4 23.8 19.3 19.0 19.1 Free cash flow yield 2.4 0.4 0.1 n.a. n.a. 2.5 3.2 4.4 Source: FactSet, Daiwa forecasts

Company profile

Established in Inner Mongolia in 1999, China Mengniu Dairy (Mengniu) is controlled by COFCO group, a state-owned food conglomerate. Mengniu focuses on the production of UHT milk, milk beverages and ice cream. It is China’s largest maker of liquid milk products by revenue, with about a 28% market share in 2013, according to AC Nielsen.

Hong Kong Materials 26 January 2016

Fufeng Group (546 HK)

Fufeng Group

Target price: HKD2.55 (from HKD5.00) Share price (25 Jan): HKD2.61 | Up/downside: -2.2%

Price headwinds strengthening

 Weak oil and commodity prices putting pressure on ASP Anson Chan, CFA (852) 2532 4350  Hence, we cut our 2015-17E EPS; but limited share price downside [email protected]  Downgrading to Hold (3); cutting EPS by 5-25%, TP to HKD2.55

What's new: On the back of the decline in input costs in 2H15, the price of Forecast revisions (%) Fufeng’s MSG fell by 8% HoH for 2H15 and we expect a further fall of 10% Year to 31 Dec 15E 16E 17E for 2016E. Weak oil prices are also likely to weigh on Fufeng’s ASPs. Revenue change (1.5) (5.4) (5.4) Net profit change (12.7) (32.0) (31.5)

Core EPS (FD) change (5.0) (25.1) (24.3) What's the impact: Pricing pressure intensifying: 1) for September- Source: Daiwa forecasts October 2015, Fufeng’s MSG price fell by c.10%. We believe the big players like Fufeng have cut their ASPs due to the lower corn cost, with the Share price performance aim of pushing competitors out of the market. We are cutting cut our MSG (HKD) (%) ASP assumptions by 2% for 2015E and 8% for 2016-17E. We now forecast 7.0 155 the unit gross profit of its MSG to stay at c.CNY800/tonne (last trough was 5.9 136 4.8 118 in 2013), as we think Fufeng has a scale advantage (previous forecast: a 3.6 99 rise of c.CNY 220/tonne for 2016E). We expect the MSG price to fall in line 2.5 80 with corn costs in 2016E, driven by policy changes (see the sector portion Jan-15 Apr-15 Jul-15 Oct-15 of this report), 2) the price of the company’s xanthan gum (XG) fell by 30% Fufeng Gp (LHS) Relative to HSI (RHS)

YoY for 2H15, on weakening demand from oil drilling (XG is used as a mud additive). Accordingly, we estimate Fufeng’s XG price would be 12-month range 2.53-6.71 CNY13,000/tonne for 2016E, down 14% YoY. But potential XG price Market cap (USDbn) 0.70 downside looks limited as: 1) demand from the food-processing segment 3m avg daily turnover (USDm) 1.57 Shares outstanding (m) 2,113 (accounting for c.40 -45% of total revenue) is steady, and 2) we believe the Major shareholder Li Xue Chun (46.2%) current price is close to the cash cost level of its domestic peers. Financial summary (CNY) Earnings CAGR of 8% for 2015-17E (previously: 22%): We cut our Year to 31 Dec 15E 16E 17E 2015-17E core EPS for Fufeng by 5-25%, due to the falling prices for XG Revenue (m) 11,761 12,869 12,992 and MSG. But we raise our MSG sales volume forecasts by an average of Operating profit (m) 892 818 889 Net profit (m) 510 550 596 13% for 2016-17E, as Fufeng plans to enhance its production lines in Inner Core EPS (fully-diluted) 0.241 0.260 0.282 Mongolia and northeast China, with new technology improving the yield EPS change (%) (19.5) 7.9 8.4 and leading to cost reductions. We also expect financial cost savings of Daiwa vs Cons. EPS (%) (22.2) (36.5) (38.7) PER (x) 9.1 8.5 7.8 CNY118m for 2016E on lower debt and because it replaced some bank Dividend yield (%) 3.8 3.3 3.5 loans with domestic bonds issued in November 2015. DPS 0.084 0.072 0.078 PBR (x) 0.8 0.7 0.7 What we recommend: Given our revised EPS forecasts, we are cutting EV/EBITDA (x) 4.7 4.4 3.7 ROE (%) 9.0 9.0 9.2 our 12-month TP to HKD2.55 (from HKD5.0). We also cut our target PER to Source: FactSet, Daiwa forecasts 9x, from 12x, on the falling ASP trend, and believe the shares should trade at their past-5-year average PER of 9x (vs. high end of the range when we thought the product price upcycle was ongoing). However, we still forecast Fufeng’s recurring EPS to grow by 8% YoY for each of 2016-17E, on sales volume growth and lower financial costs, and the shares are trading at 0.7x 2016E PBR, which we see as attractive. We downgrade our rating to Hold (3), from Buy (1). The main upside/downside risks: rising/falling ASPs for its key products, in particular MSG.

How we differ: Our 2015-17E EPS are 22-39% below the Bloomberg consensus on our lower ASP assumptions.

See important disclosures, including any required research certifications, beginning on page 81

Fufeng Group (546 HK): 26 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Fufeng: net profit and recurring profit (CNYm) and YoY % We forecast a core EPS CAGR of 8% over 2015-17E on 700 30% the back of lower financial costs as well as growth in MSG 600 20% sales. In our model, we have factored in a 10% decline in 500 10% 0% the price of MSG and a 13% decline in the price of its XG 400 in 2016E. MSG and its by-products should together (10%) 300 account for more than 80% of Fufeng’s operating profit in (20%) 2016-17E, and our sensitivity analysis shows that a 200 (30%) CNY100 increase in the price of the company’s MSG 100 (40%) would lead to a 14% increase in its net profit. 0 (50%) 2011 2012 2013 2014 2015E 2016E 2017E Reported net profit (CNY m) Recurring profit (CNY m)

Recurring profit YoY% Source: Company, Daiwa forecasts

Valuation Fufeng: 12-month forward PER bands In 2015, the stock was derated from a 12x 12-month (HKD) forward PER to 9x amid falling product ASPs. It is 10 currently trading at 9x 2016E PER, on our estimates, 8 which is close to the middle of its past-5-year 12-month 6 forward PER range of 6-12x. We believe this reflects the 4 product pricing pressure that we anticipate for 2016E, as 2 well as the more favourable corn cost outlook. Hence, we

recommend waiting for product ASPs to recover (ie, after 0 Jul-14

2017E) before revisiting the stock. Jul-09

Apr-08 Oct-10 Apr-13 Oct-15

Jan-12 Jun-12

Mar-11 Feb-09 Feb-14

Nov-12 Dec-14 Nov-07 Sep-08 Dec-09 Aug-11 Sep-13

May-10 May-15 564.HK 6x 7.5x 9x 10.5x 12x

Source: Bloomberg

Earnings revisions Fufeng: Bloomberg consensus EPS (HKD) The 2015-16 Bloomberg consensus EPS forecasts for (HKD) Fufeng have trended down since the company missed the 0.75 0.70 consensus expectations for 1H15. We see further 0.65 downside to the 2016-17E consensus EPS forecasts, as 0.60 we are cautious on the company’s MSG and XG prices. 0.55 0.50 0.45 0.40 0.35

0.30

Jul-15 Jul-15

Apr-15 Oct-15 Oct-15

Jan-15 Jan-15 Jun-15

Feb-15 Mar-15 Mar-15

Dec-15 Nov-15 Dec-15

Aug-15 Sep-15

May-15 May-15 2015E 2016E

Source: Bloomberg

Fufeng Group (546 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E MSG price (CNY/tonne) 7,903 7,984 7,134 6,307 6,495 6,650 6,000 6,000 Xanthan gum price (CNY/tonne) 19,579 18,222 20,392 25,254 20,607 15,000 13,000 13,000 Corn price (CNY/tonne) 1,741 1,978 2,015 1,798 1,875 1,819 1,637 1,605 Sales volume - MSG (000 tonnes) 493 616 945 1,003 926 927 1,077 1,077 Sales volume - Xanthan gum (000 35 46 52 58 65 58 55 55 tonnes) GPM - MSG segment (%) 22.7 16.1 11.4 12.6 14.6 14.6 13.8 14.6 GPM - Xanthan gum (%) 38.8 36.2 46.0 58.3 52.7 36.1 30.8 31.6

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E MSG segment 5,350 7,024 9,539 9,114 8,605 9,481 10,376 10,499 Xanthan gum segment 682 836 1,066 1,454 1,348 870 715 715 Other Revenue 385 539 507 798 1,344 1,410 1,778 1,778 Total Revenue 6,416 8,399 11,112 11,367 11,298 11,761 12,869 12,992 Other income 111 118 145 153 193 215 223 228 COGS (4,851) (6,880) (9,474) (9,267) (9,131) (9,853) (10,975) (10,979) SG&A (550) (795) (1,011) (1,252) (1,165) (1,157) (1,217) (1,261) Other op.expenses (22) (64) (37) (76) (75) (75) (82) (90) Operating profit 1,104 778 735 925 1,120 892 818 889 Net-interest inc./(exp.) (32) (62) (245) (290) (346) (265) (147) (167) Assoc/forex/extraord./others 0 0 0 0 0 162 0 0 Pre-tax profit 1,071 716 490 635 774 789 671 722 Tax (105) (112) (64) (129) (148) (142) (121) (126) Min. int./pref. div./others 0 0 0 0 0 0 0 0 Net profit (reported) 966 604 427 506 626 647 550 596 Net profit (adjusted) 966 604 427 506 626 510 550 596 EPS (reported)(CNY) 0.582 0.352 0.248 0.259 0.300 0.308 0.262 0.284 EPS (adjusted)(CNY) 0.582 0.352 0.248 0.259 0.300 0.243 0.262 0.284 EPS (adjusted fully-diluted)(CNY) 0.582 0.352 0.248 0.259 0.300 0.241 0.260 0.282 DPS (CNY) 0.227 0.106 0.000 0.047 0.059 0.084 0.072 0.078 EBIT 1,104 778 735 925 1,120 892 818 889 EBITDA 1,358 1,146 1,268 1,623 1,840 1,693 1,664 1,770

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 1,071 716 490 635 774 789 671 722 Depreciation and amortisation 254 368 533 698 719 801 846 881 Tax paid (125) (96) (71) (129) (148) (142) (121) (126) Change in working capital 427 (576) (170) (240) 500 (565) 383 (39) Other operational CF items 32 62 245 290 346 265 147 167 Cash flow from operations 1,659 474 1,028 1,255 2,192 1,148 1,926 1,605 Capex (1,912) (2,419) (1,800) (1,180) (2,363) (900) (900) (500) Net (acquisitions)/disposals 0 0 0 0 613 299 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,912) (2,419) (1,800) (1,180) (1,749) (601) (900) (500) Change in debt 938 2,012 904 24 39 (300) (724) (913) Net share issues/(repurchases) 0 0 0 493 0 77 0 0 Dividends paid (379) (358) (42) (33) (116) (137) (220) (152) Other financing CF items (32) (62) (245) (290) (346) (265) (147) (167) Cash flow from financing 527 1,592 618 194 (423) (625) (1,091) (1,232) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 274 (353) (154) 269 19 (79) (65) (127) Free cash flow (253) (1,945) (772) 75 (171) 248 1,026 1,105 Source: FactSet, Daiwa forecasts

Fufeng Group (546 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 915 614 550 862 962 883 818 691 Inventory 711 1,180 1,415 1,517 1,946 2,705 2,574 2,598 Accounts receivable 817 1,739 2,340 2,069 1,452 1,511 1,654 1,669 Other current assets 0 0 0 0 0 0 0 0 Total current assets 2,443 3,533 4,305 4,449 4,359 5,100 5,046 4,959 Fixed assets 4,088 6,032 7,259 7,576 7,470 7,283 7,349 6,980 Goodwill & intangibles 0 0 0 0 0 0 0 0 Other non-current assets 190 294 407 595 1,865 1,853 1,840 1,828 Total assets 6,720 9,859 11,971 12,619 13,694 14,235 14,235 13,767 Short-term debt 555 704 2,408 1,168 813 813 813 500 Accounts payable 1,839 2,631 3,304 2,891 3,203 3,457 3,850 3,852 Other current liabilities 31 54 47 52 51 51 51 51 Total current liabilities 2,425 3,388 5,759 4,111 4,067 4,320 4,714 4,403 Long-term debt 981 2,844 2,045 3,309 3,702 3,402 2,679 2,079 Other non-current liabilities 169 220 372 380 556 556 556 556 Total liabilities 3,575 6,453 8,176 7,800 8,325 8,279 7,948 7,037 Share capital 174 174 176 204 205 205 205 205 Reserves/R.E./others 2,971 3,233 3,619 4,615 5,164 5,751 6,081 6,525 Shareholders' equity 3,145 3,407 3,795 4,819 5,369 5,956 6,286 6,730 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 6,720 9,859 11,971 12,619 13,694 14,235 14,235 13,767 EV 5,280 7,593 8,561 8,274 8,213 7,991 7,332 6,546 Net debt/(cash) 621 2,934 3,902 3,615 3,554 3,333 2,674 1,887 BVPS (CNY) 1.895 1.982 2.180 2.306 2.570 2.819 2.976 3.186

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 38.5 30.9 32.3 2.3 (0.6) 4.1 9.4 1.0 EBITDA (YoY) 9.3 (15.6) 10.6 28.0 13.3 (8.0) (1.7) 6.4 Operating profit (YoY) 5.2 (29.5) (5.5) 25.8 21.1 (20.4) (8.4) 8.7 Net profit (YoY) 4.1 (37.5) (29.4) 18.7 23.8 (18.6) 7.9 8.4 Core EPS (fully-diluted) (YoY) 4.1 (39.6) (29.4) 4.5 15.6 (19.5) 7.9 8.4 Gross-profit margin 24.4 18.1 14.7 18.5 19.2 16.2 14.7 15.5 EBITDA margin 21.2 13.6 11.4 14.3 16.3 14.4 12.9 13.6 Operating-profit margin 17.2 9.3 6.6 8.1 9.9 7.6 6.4 6.8 Net profit margin 15.1 7.2 3.8 4.5 5.5 4.3 4.3 4.6 ROAE 34.9 18.4 11.8 11.8 12.3 9.0 9.0 9.2 ROAA 17.6 7.3 3.9 4.1 4.8 3.7 3.9 4.3 ROCE 28.8 13.4 9.7 10.5 11.7 8.9 8.2 9.3 ROIC 31.2 13.0 9.1 9.1 10.4 8.0 7.3 8.3 Net debt to equity 19.8 86.1 102.8 75.0 66.2 56.0 42.5 28.0 Effective tax rate 9.8 15.7 13.0 20.3 19.1 18.0 18.0 17.5 Accounts receivable (days) 42.8 55.5 67.0 70.8 56.9 46.0 44.9 46.7 Current ratio (x) 1.0 1.0 0.7 1.1 1.1 1.2 1.1 1.1 Net interest cover (x) 34.1 12.6 3.0 3.2 3.2 3.4 5.6 5.3 Net dividend payout 39.0 30.3 0.0 18.3 19.7 27.3 27.5 27.4 Free cash flow yield n.a. n.a. n.a. 1.6 n.a. 5.3 22.0 23.7 Source: FactSet, Daiwa forecasts

Company profile

Fufeng is the largest producer of MSG and xanthan gum in China, with an approx. 45% share of the former market and over 50% of the latter for 2014. Corn is the company’s major raw material, accounting for about 60% of its COGS for 2014. Its production plants are located in Inner Mongolia, Xinjiang and Shaanxi.

China Consumer Staples 26 January 2016

Tsingtao Brewery (168 HK) Tsingtao Brewer y

Target price: HKD26.80 (from HKD32.00) Share price (25 Jan): HKD28.80 | Up/downside: -6.9%

Still a market-share loser

 Revenue to continue to contract in 2016E on industry decline Anson Chan, CFA (852) 2532 4350  ROE continuing to decline on inefficient use of net cash [email protected]  Reiterate Underperform (4); cutting TP on lower EPS forecasts

What's new: We believe Tsingtao will remain a victim of market-share Forecast revisions (%) losses to international brands in the premium beer segment in China in Year to 31 Dec 15E 16E 17E 2016E. Similar to other Goliaths, Tsingtao is finding it hard to grow its Revenue change (1.4) (7.6) (8.6) Net profit change (7.2) (10.4) (4.8) revenue from a high per capita base of beer consumption in China. Hence, Core EPS (FD) change (7.2) (10.4) (4.8) we reiterate our Underperform (4) rating. Source: Daiwa forecasts

What's the impact: Risks losing further market share amid weak Share price performance industry outlook. We see rising competition for Tsingtao beer from other (HKD) (%) alcoholic drinks, such as wine (imported volume +42% YoY in China in 60 100 2015E) and Chinese liquor (+7% YoY in sales volume for 9M15). Beer 51 91 industry sales in China also face pressure given a high base, with per 43 83 capita consumption in China currently at c. 37 litres a year, in line with the 34 74 25 65 global average and accounting for c. 80% of alcohol consumption in China. Jan-15 Apr-15 Jul-15 Oct-15

In 2016E, we expect continued weak demand for beer (for 11M15, industry Tsingtao B (LHS) Relative to HSI (RHS) output volume declined by 5.7% YoY). We are concerned that Tsingtao’s market share stopped growing for 9M15 (flat YoY at 19.6%, still the second- 12-month range 28.80-56.75 largest player in China), while the other top-3 players gained market share. Market cap (USDbn) 4.99 Tsingtao lost ground in the high-end segment in 2015E to its main 3m avg daily turnover (USDm) 7.90 competitor, AB-InBev, and we think this loss could widen in 2016E as we Shares outstanding (m) 1,351 Major shareholder Tsingtao Brewery Grp (30.5%) see a lack of product differentiation and marketing strategy.

Financial summary (CNY) Sitting on its cash. We estimate Tsingtao was sitting on net cash of Year to 31 Dec 15E 16E 17E CNY6.2bn as at end-December 2015 (vs. CNY6bn as at end-December Revenue (m) 28,092 26,912 27,286 2014), and we forecast its ROE to slide from 13.6% in 2014 to 10.3%/9.4% Operating profit (m) 1,758 1,628 1,761 Net profit (m) 1,636 1,610 1,714 for 2015/16E, respectively. We believe Tsingtao is finding it hard to identify Core EPS (fully-diluted) 1.211 1.191 1.269 meaningful acquisition targets at a reasonable price or those that could EPS change (%) (17.9) (1.6) 6.5 boost EPS, as the other A-share and H-share-listed beer companies are Daiwa vs Cons. EPS (%) (1.3) (7.2) (6.4) PER (x) 20.1 20.4 19.2 trading at PERs of 25-29x for 2016E, based on the Bloomberg consensus, Dividend yield (%) 1.6 1.5 1.6 vs Tsingtao’s 20x. DPS 0.386 0.357 0.381 PBR (x) 2.0 1.9 1.7 EV/EBITDA (x) 8.9 9.0 8.1 What we recommend: We reiterate our Underperform (4) rating, and cut ROE (%) 10.3 9.4 9.4 our 2015-17E revenue by 1-9% as we expect its sales volume to decline. Source: FactSet, Daiwa forecasts And to reflect its higher selling expenses needed to keep up with its competitors, we are also cutting our 2015-17E EPS by 5-10%. Accordingly, we cut our 12-month TP to HKD26.80 from HKD32, based on a 2016E PER of 19x (formerly 20x). Our target PER is still at a 10% discount to the stock’s past-3-year average 12-month forward PER, as Tsingtao’s EPS CAGR has declined from 8% for 2010-14 to 2% over 2015-17E. The main risks to our rating: price hikes and EPS-accretive M&A.

How we differ: Our revised 2016-17 revenue forecasts are 4 -7% below the Bloomberg consensus as we assume lower ASPs than other analysts. Hence our 2016-17E EPS estimates are 6-7% below the consensus.

See important disclosures, including any required research certifications, beginning on page 81

Tsingtao Brewery (168 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Tsingtao: reported net profit and change YoY (%) We forecast Tsingtao’s recurring net profit to decline by CNY m 2,500 15% 18% and 2% YoY for 2015-16E, respectively, on a decline 13% 10% in sales volume, at a CAGR of 6%, and less non-operating 2,000 6% financing income over the same period. We expect a slight 5% 2% rebound in 2017E net profit (+6% YoY) on a higher ASP 1,500 0% 0% -2% due to product mix upgrades and flat sales volume. 1,000 (5%)

(10%) 500 (15%) -18% 0 (20%) 2012 2013 2014 2015E 2016E 2017E Recurring net profit one-off gain YoY

Source: Company, Daiwa forecasts

Valuation Tsingtao: 12-month forward PER bands We believe Tsingtao’s previously strong valuation was HKD supported by its frequent M&A activity and continuous ASP 80 hikes, both of which have ground to a halt. Our target price 70 is based on a 2016E PER of 19x, a 10% discount to 60 Tsingtao’s past-5-year average. This discount is the same 50 as the discount seen in 2012, when its operating-profit 40 margin also came under pressure due to competition. 30

Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Oct-15 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

Jan-15 Jan-11 Jan-12 Jan-13 Jan-14 Jan-16 168 HK 18 21 24 27 30

Source: Bloomberg

Earnings revisions Tsingtao: Bloomberg-consensus EPS-forecast revisions The Bloomberg-consensus EPS forecasts for 2015-16 HKD have trended down since the beginning of 2015 as industry 3.0 2.8 sales volume growth has been slowing QoQ. Our EPS 2.6 forecasts are marginally lower than the consensus for 2.4 2015E, 7% lower for 2016E, and 6% lower for 2017E, as 2.2 2.0 we are less optimistic on Tsingtao’s sales-volume growth 1.8 outlook due to it still losing market share in the premium 1.6 segment. 1.4 1.2 1.0 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 2015E 2016E

Source: Bloomberg

Tsingtao Brewery (168 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales volume growth YoY - Principal 22.9 18.0 14.7 7.5 4.9 0.0 (4.0) (5.0) brand Sales volume growth YoY - Other (1.8) 0.0 (1.2) 15.8 14.0 15.0 6.0 4.0 brands Average selling price (CNY / tonne) 3,005.2 3,088.8 3,187.5 3,204.8 3,191.6 3,164.4 3,212.4 3,271.6 Gross margin % 35.2 33.3 31.6 32.0 30.9 31.4 32.0 32.7 Sellling and distribution expense ratio 19.7 19.1 19.1 19.8 19.6 19.7 20.5 20.8 (%)

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Beer 19,614 22,790 25,318 27,767 28,599 27,642 26,462 26,836 others 284 368 463 524 450 450 450 450 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 19,898 23,158 25,782 28,291 29,049 28,092 26,912 27,286 Other income 0 0 0 0 0 0 0 0 COGS (12,898) (15,441) (17,635) (19,236) (20,082) (19,283) (18,294) (18,373) SG&A (4,997) (5,599) (6,200) (7,183) (7,045) (6,951) (6,991) (7,152) Other op.expenses (72) (17) (1) (2) 4 (100) 0 0 Operating profit 1,931 2,101 1,945 1,870 1,926 1,758 1,628 1,761 Net-interest inc./(exp.) (5) 36 178 251 335 176 171 180 Assoc/forex/extraord./others 125 301 360 543 426 323 419 419 Pre-tax profit 2,051 2,438 2,483 2,665 2,687 2,257 2,217 2,359 Tax (539) (657) (639) (692) (663) (601) (588) (625) Min. int./pref. div./others (64) (60) (86) (2) (29) (20) (20) (20) Net profit (reported) 1,448 1,721 1,758 1,971 1,994 1,636 1,610 1,714 Net profit (adjusted) 1,448 1,721 1,758 1,761 1,994 1,636 1,610 1,714 EPS (reported)(CNY) 1.072 1.274 1.301 1.459 1.476 1.211 1.191 1.269 EPS (adjusted)(CNY) 1.072 1.274 1.301 1.304 1.476 1.211 1.191 1.269 EPS (adjusted fully-diluted)(CNY) 1.072 1.274 1.301 1.304 1.476 1.211 1.191 1.269 DPS (CNY) 0.180 0.260 0.400 0.450 0.442 0.386 0.357 0.381 EBIT 1,931 2,101 1,945 2,080 1,926 1,758 1,628 1,761 EBITDA 2,612 2,816 2,790 2,757 2,859 2,799 2,768 3,001

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 2,051 2,438 2,483 2,665 2,687 2,257 2,217 2,359 Depreciation and amortisation 681 715 845 887 933 1,040 1,140 1,240 Tax paid (586) (485) (981) (930) (780) (601) (588) (625) Change in working capital 1,098 (5) 643 1,311 (641) 75 14 (6) Other operational CF items (5) (41) (193) (261) (359) (191) (186) (195) Cash flow from operations 3,239 2,622 2,797 3,672 1,839 2,580 2,598 2,773 Capex (1,103) (2,442) (2,382) (2,036) (1,943) (2,000) (2,000) (2,000) Net (acquisitions)/disposals (340) (1,769) 0 0 (350) 0 0 0 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,444) (4,210) (2,382) (2,036) (2,293) (2,000) (2,000) (2,000) Change in debt 91 480 61 (109) (1,466) (3) 0 0 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (216) (244) (351) (540) (608) (597) (521) (483) Other financing CF items 687 (6) 930 604 384 275 421 371 Cash flow from financing 562 230 639 (45) (1,690) (325) (100) (112) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 2,357 (1,358) 1,054 1,590 (2,143) 255 498 661 Free cash flow 2,135 180 415 1,635 (103) 580 598 773 Source: FactSet, Daiwa forecasts

Tsingtao Brewery (168 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 7,598 6,108 7,118 8,532 6,389 6,640 6,933 7,399 Inventory 1,942 2,718 2,360 2,535 2,487 2,598 2,463 2,474 Accounts receivable 341 574 316 553 530 513 491 498 Other current assets 13 184 348 655 946 946 946 946 Total current assets 9,895 9,583 10,142 12,274 10,352 10,697 10,833 11,316 Fixed assets 5,794 7,829 9,032 9,252 10,189 11,148 12,008 12,767 Goodwill & intangibles 1,442 3,460 3,628 3,613 4,088 4,088 4,088 4,088 Other non-current assets 647 761 859 2,225 2,376 2,376 2,376 2,376 Total assets 17,777 21,634 23,661 27,365 27,004 28,309 29,304 30,547 Short-term debt 196 163 150 1,898 435 435 435 435 Accounts payable 1,333 1,746 2,075 2,845 2,586 2,754 2,611 2,622 Other current liabilities 4,486 5,247 5,110 6,370 6,208 6,208 6,208 6,208 Total current liabilities 6,016 7,156 7,336 11,114 9,228 9,397 9,253 9,265 Long-term debt 1,275 1,789 1,862 5 3 0 0 0 Other non-current liabilities 766 1,412 1,680 2,372 2,486 2,486 2,486 2,486 Total liabilities 8,057 10,357 10,878 13,491 11,717 11,882 11,739 11,750 Share capital 1,351 1,351 1,351 1,351 1,351 1,351 1,351 1,351 Reserves/R.E./others 8,252 9,759 11,117 12,670 14,037 15,176 16,265 17,496 Shareholders' equity 9,603 11,110 12,468 14,021 15,388 16,527 17,616 18,847 Minority interests 117 166 315 (147) (100) (100) (50) (50) Total equity & liabilities 17,777 21,634 23,661 27,364 27,004 28,309 29,304 30,547 EV 26,707 28,728 27,908 24,815 25,282 25,028 24,785 24,320 Net debt/(cash) (6,126) (4,156) (5,106) (6,629) (5,951) (6,206) (6,499) (6,964) BVPS (CNY) 7.108 8.224 9.229 10.378 11.390 12.233 13.039 13.950

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 10.4 16.4 11.3 9.7 2.7 (3.3) (4.2) 1.4 EBITDA (YoY) 15.6 7.8 (0.9) (1.2) 3.7 (2.1) (1.1) 8.4 Operating profit (YoY) 17.5 8.8 (7.4) 6.9 (7.4) (8.7) (7.4) 8.2 Net profit (YoY) 22.5 18.8 2.1 0.2 13.2 (17.9) (1.6) 6.5 Core EPS (fully-diluted) (YoY) 25.7 18.8 2.1 0.2 13.2 (17.9) (1.6) 6.5 Gross-profit margin 35.2 33.3 31.6 32.0 30.9 31.4 32.0 32.7 EBITDA margin 13.1 12.2 10.8 9.7 9.8 10.0 10.3 11.0 Operating-profit margin 9.7 9.1 7.5 7.4 6.6 6.3 6.0 6.5 Net profit margin 7.3 7.4 6.8 6.2 6.9 5.8 6.0 6.3 ROAE 16.1 16.6 14.9 13.3 13.6 10.3 9.4 9.4 ROAA 8.9 8.7 7.8 6.9 7.3 5.9 5.6 5.7 ROCE 18.3 17.2 13.9 13.6 12.2 10.8 9.3 9.5 ROIC 34.8 28.6 19.5 18.6 17.5 13.2 11.2 11.3 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 26.3 27.0 25.7 26.0 24.7 26.6 26.5 26.5 Accounts receivable (days) 6.6 7.2 6.3 5.6 6.8 6.8 6.8 6.6 Current ratio (x) 1.6 1.3 1.4 1.1 1.1 1.1 1.2 1.2 Net interest cover (x) 396.3 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 16.8 20.4 30.7 30.8 29.9 31.8 30.0 30.0 Free cash flow yield 6.5 0.5 1.3 5.0 n.a. 1.8 1.8 2.4 Source: FactSet, Daiwa forecasts

Company profile

Listed in 1993, Tsingtao Brewery (Tsingtao) is the second-largest beer maker in China, with a 18.6% market share for 2014. The company dates back to 1903, when the Qingdao Joint-stock Company of the German Beer Company was established. It has more than 60 plants at present. Tsingtao Brewery Group, a state-owned company, owns about 31% of the company. Tsingtao sells products under the Tsingtao, Yinmai, Laoshan, Sanshui, and Hans brands.

China Consumer Staples 26 January 2016

China Huishan Dairy Holdings (6863 HK) China H uishan D airy Hol dings

Target price: HKD1.87 (from HKD1.60) Share price (25 Jan): HKD2.95 | Up/downside: -36.6%

More competition for downstream

 Cost advantage diminishing on expansion outside home turf Anson Chan, CFA (852) 2532 4350  Pricing pressure leading to our FY16-18E EPS cuts of 2-18% [email protected]  Reiterating Sell (5) on high net gearing, stretched valuation

What's new: As Huishan is still a small player in the liquid milk market of Forecast revisions (%) China (~2% in 1H15, on our estimates), we expect increasing marketing Year to 31 Mar 16E 17E 18E expenses and discounts in 2016E as it attempts to gain market share. We Revenue change (1.0) (1.6) (2.8) Net profit change (1.9) (17.9) (18.1) are also bearish on Huishan’s ambitions in the infant formula business Core EPS (FD) change (1.9) (17.9) (18.1) through a JV with FrieslandCampania, which targets to launch new infant Source: Daiwa forecasts formula products in 2H16E. As discussed in our sector note, we foresee increasing competition from foreign competitors that are much stronger Share price performance than Huishan in e-commerce channels and the mass-market segment. On (HKD) (%) stretched valuation, we reiterate Sell [5]. 3.1 300 2.6 238 What's the impact: Due to more promotional discounts among peers in 2.1 175 the UHT milk industry at retail channels, we cut our FY16-18E revenue 1.7 113 1.2 50 estimates by 1-3%. We also expect Huishan’s cost advantage over other Jan-15 Apr-15 Jul-15 Oct-15 major dairy farms due to in-house feed production to diminish due to: 1) a CHDH (LHS) Relative to HSI (RHS) falling corn price in China (the feed costs of peers should fall), and 2)

Huishan’s move to expand in Eastern China in 2H16E, where land costs 12-month range 1.23-3.01 are higher than in its home turf of Liaoning province. We expect Huishan’s Market cap (USDbn) 5.10 free cashflow to remain negative over FY16-17E and net gearing to go up 3m avg daily turnover (USDm) 7.04 to 61-67% (also includes the impact of the aggressive share buybacks in Shares outstanding (m) 13,473 Major shareholder Yang Kai (70.7%) 2015). Factoring in the cuts to our revenue forecasts, increasing financial costs, and valuation losses from biological assets (crops and cows), we Financial summary (CNY) revise down our FY16-18E EPS by 2-18%. Year to 31 Mar 16E 17E 18E Revenue (m) 4,470 5,558 6,327 What we recommend: We raise our valuation for the upstream business Operating profit (m) 1,314 1,508 1,807 Net profit (m) 768 977 1,133 to HKD1.77 from HKD1.50 (DCF-based) by using new WACC assumptions Core EPS (fully-diluted) 0.055 0.073 0.084 based on the latest data. We value the downstream business at HKD0.1 EPS change (%) 0.8 31.2 15.9 per share (unchanged), based on 12x FY16E PER. We also raise our Daiwa vs Cons. EPS (%) (12.3) (16.6) (5.5) PER (x) 45.1 34.4 29.6 SOTP-based 12-month TP from HKD1.60 to HKD1.87, due to the reduced Dividend yield (%) 0.5 0.6 0.7 number of shares outstanding after share buyback in 2H15. The stock is DPS 0.013 0.015 0.017 now trading far above its peers’ PER range of 3-7x (upstream) and 14-27x PBR (x) 2.7 2.5 2.3 EV/EBITDA (x) 28.8 24.3 20.7 (downstream), and we don’t think the company’s currently weak ROE (%) 5.8 7.5 8.1 fundamentals justify the prevailing valuation (45x FY16E and 34x FY17E Source: FactSet, Daiwa forecasts PER on 1%/31% YoY EPS growth). Hence, we reiterate our Sell (5) rating on Huishan. The key risk to our call: a strong rebound in raw milk prices.

How we differ: Our FY16-18E EPS forecasts are 6-17% below the Bloomberg consensus due to Huishan’s increasing marketing expenses and higher feed costs as it expands into Eastern China.

See important disclosures, including any required research certifications, beginning on page 81

China Huishan Dairy Holdings (6863 HK): 26 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Huishan: Net profit and YoY growth

We forecast EPS growth for Huishan of 1% YoY for FY16E, (CNYm) 31% YoY for FY17E and 16% YoY for FY18E. Although we 1,400 120% 111% expect sales volume to see a 21% CAGR over FY15-18E, 1,200 100% 80% on an increasing number of milkable cows, we believe 1,000 60% sales volume growth will be offset by a decline in the raw 800 40% 32% 27% milk price (-10% YoY in FY16E, flat over FY17-18E) and 600 16% 20% 0% increased marketing and feed costs as Huishan expands in 400 -3% Eastern China. (20%) 200 -37% (40%) 0 (60%) FY13 FY14 FY15 FY16E FY17E FY18E Net profit (LHS) Net profit YoY (RHS)

Source: Company, Daiwa forecast

Valuation Huishan: 12M forward PER band since listing Huishan is trading currently at a PER of 34x for FY17E (HKD) based on our EPS forecasts), which we believe has only 6 been boosted by the share repurchase undertaken in 5 2H15. The stock is trading at a significant premium to its 4 downstream peers, such as China Mengniu Dairy. We see 3 long-term derating potential for Huishan due to an increase 2 in marketing expenses to drive market-share gains, and a 1

diminishing cost advantage when the company expands 0 Jul 14 Jul

outside its home turf (Northeastern China) in 2H16. 15Jul

Jan 14Jan 15Jan

Mar Mar 14 Mar Mar 15

Sep 15Sep 15 Nov Sep13 Nov13 Sep14 Nov14

May May 14 May 15 6863 HK 12x 16x 20x 24x 28x

Source: Bloomberg

Earnings revisions Huishan: Bloomberg consensus FY16-17E EPS forecast We believe the recent slight upward revisions to the (HKD) consensus FY17E EPS estimate, which is likely due to 0.30 anticipation of an increasing downstream revenue 0.25 contribution through expansion, is not justified. 0.20

Our FY16-18E EPS is 6-17% below the consensus due to 0.15 our concerns over Huishan’s increasing marketing 0.10 expenses. 0.05

0.00 Jul 14 Sep 14 Nov 14 Jan 15 Mar 15 May 15 Jul 15 Sep 15 Nov 15 FY16 FY17

Source: Bloomberg

China Huishan Dairy Holdings (6863 HK): 26 January 2016

Financial summary Key assumptions Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Milk Yield (tonne/cow/year) 8.70 8.60 9.10 9.00 9.10 8.52 8.72 8.74 Sales volume of Milk (tonnes) 57,381 213,920 352,411 482,428 577,071 742,574 947,801 1,071,201 ASP of raw milk (CNY/kg) 4.30 4.45 4.51 5.04 4.87 4.40 4.40 4.40 Number of cows (heads) 55,570 90,254 112,778 144,191 180,331 194,920 219,447 242,825 Upstream gross margin (%) 42.7 48.5 58.7 62.0 56.1 51.7 53.5 55.1

Profit and loss (CNYm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Raw Milk 244 672 681 989 1,028 1,006 1,057 1,109 Processed milk 15 564 1,707 2,288 2,422 2,847 3,269 3,986 Other Revenue 115 97 165 254 473 617 1,233 1,231 Total Revenue 374 1,333 2,552 3,530 3,923 4,470 5,558 6,327 Other income 0 0 0 0 0 0 0 0 COGS (231) (732) (1,105) (1,162) (1,440) (1,898) (2,452) (2,752) SG&A (33) (54) (197) (562) (935) (1,078) (1,358) (1,488) Other op.expenses (24) (52) (69) (315) (293) (180) (240) (280) Operating profit 87 495 1,181 1,491 1,255 1,314 1,508 1,807 Net-interest inc./(exp.) (57) (103) (142) (206) (323) (623) (565) (621) Assoc/forex/extraord./others 297 67 (28) 9 (83) 123 103 90 Pre-tax profit 327 459 1,012 1,294 850 814 1,046 1,276 Tax 0 (11) (67) (45) (60) (46) (69) (113) Min. int./pref. div./others 0 0 0 0 0 0 0 (30) Net profit (reported) 327 448 945 1,249 790 768 977 1,133 Net profit (adjusted) 327 448 945 1,249 790 768 977 1,133 EPS (reported)(CNY) 0.028 0.039 0.082 0.096 0.055 0.055 0.073 0.084 EPS (adjusted)(CNY) 0.028 0.039 0.082 0.096 0.055 0.055 0.073 0.084 EPS (adjusted fully-diluted)(CNY) 0.028 0.039 0.082 0.096 0.055 0.055 0.073 0.084 DPS (CNY) 0.000 0.000 0.000 0.022 0.015 0.013 0.015 0.017 EBIT 87 495 1,181 1,491 1,255 1,314 1,508 1,807 EBITDA 406 611 1,181 1,654 1,361 1,435 1,748 2,086

Cash flow (CNYm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 327 459 1,012 1,294 850 814 1,046 1,276 Depreciation and amortisation 24 37 69 163 222 180 240 280 Tax paid 0 (9) (96) (45) (60) (46) (69) (113) Change in working capital (64) (128) 191 (710) (237) 27 (139) 421 Other operational CF items 52 101 139 204 322 643 575 631 Cash flow from operations 340 460 1,315 906 1,097 1,618 1,653 2,494 Capex (1,921) (1,744) (1,541) (5,503) (5,491) (3,304) (2,170) (2,350) Net (acquisitions)/disposals 26 8 57 23 2 713 23 38 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing (1,895) (1,737) (1,485) (5,480) (5,489) (2,591) (2,147) (2,312) Change in debt 0 137 732 3,309 1,687 2,000 600 600 Net share issues/(repurchases) 243 0 907 5,816 (141) (1,673) 0 0 Dividends paid 0 0 0 0 (311) (219) (169) (197) Other financing CF items (122) 1,801 (1,383) (85) 481 (60) (565) (621) Cash flow from financing 121 1,938 257 9,040 1,716 48 (135) (218) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (1,435) 661 87 4,466 (2,676) (925) (629) (36) Free cash flow (1,581) (1,284) (227) (4,597) (4,394) (1,686) (517) 144 Source: FactSet, Daiwa forecasts

China Huishan Dairy Holdings (6863 HK): 26 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 48 513 826 5,363 3,138 2,272 1,643 1,607 Inventory 203 413 447 915 1,582 1,776 2,002 1,955 Accounts receivable 138 148 173 220 271 325 390 468 Other current assets 1,585 582 696 784 2,817 1,012 1,012 1,012 Total current assets 1,974 1,655 2,141 7,283 7,807 5,385 5,046 5,041 Fixed assets 1,844 2,840 3,637 5,337 7,322 8,730 9,278 9,786 Goodwill & intangibles 384 418 1,453 3,975 3,824 3,836 3,848 3,860 Other non-current assets 1,305 2,278 3,280 4,425 5,382 7,066 8,413 9,925 Total assets 5,507 7,190 10,511 21,020 24,334 25,016 26,585 28,612 Short-term debt 182 362 909 1,641 2,867 3,367 3,967 4,567 Accounts payable 470 524 910 738 1,401 1,682 1,838 2,290 Other current liabilities 2,313 3,280 473 540 986 579 574 574 Total current liabilities 2,965 4,166 2,292 2,919 5,254 5,628 6,379 7,431 Long-term debt 1,961 1,917 2,103 4,679 5,140 6,640 6,640 6,640 Other non-current liabilities 193 224 233 227 255 107 107 107 Total liabilities 5,119 6,307 4,628 7,825 10,649 12,376 13,127 14,178 Share capital 0 0 0 1,143 1,143 1,143 1,143 1,143 Reserves/R.E./others 388 882 5,883 12,053 12,544 11,499 12,317 13,262 Shareholders' equity 388 882 5,883 13,195 13,686 12,642 13,459 14,405 Minority interests 0 0 0 0 (1) (1) (1) 29 Total equity & liabilities 5,507 7,190 10,511 21,020 24,334 25,016 26,585 28,612 EV 35,671 35,342 35,762 34,534 38,444 41,310 42,539 43,205 Net debt/(cash) 2,095 1,766 2,186 958 4,869 7,735 8,964 9,600 BVPS (CNY) 0.034 0.077 0.512 0.916 0.956 0.938 0.999 1.069

Key ratios (%) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) n.a. 256.3 91.5 38.3 11.1 13.9 24.3 13.8 EBITDA (YoY) n.a. 50.5 93.5 40.0 (17.7) 5.5 21.8 19.4 Operating profit (YoY) n.a. 470.3 138.5 26.2 (15.8) 4.7 14.8 19.8 Net profit (YoY) n.a. 36.9 110.8 32.2 (36.8) (2.7) 27.2 15.9 Core EPS (fully-diluted) (YoY) n.a. 36.9 110.8 17.1 (43.1) 0.8 31.2 15.9 Gross-profit margin 38.4 45.1 56.7 67.1 63.3 57.5 55.9 56.5 EBITDA margin 108.5 45.8 46.3 46.8 34.7 32.1 31.4 33.0 Operating-profit margin 23.2 37.2 46.3 42.2 32.0 29.4 27.1 28.6 Net profit margin 87.5 33.6 37.0 35.4 20.1 17.2 17.6 17.9 ROAE 168.7 70.6 27.9 13.1 5.9 5.8 7.5 8.1 ROAA 11.9 7.1 10.7 7.9 3.5 3.1 3.8 4.1 ROCE 6.9 17.4 19.6 10.5 6.1 5.9 6.5 7.3 ROIC 3.5 18.8 20.6 13.0 7.1 6.4 6.6 7.1 Net debt to equity 539.8 200.2 37.2 7.3 35.6 61.2 66.6 66.6 Effective tax rate 0.0 2.3 6.6 3.5 7.1 5.6 6.6 8.9 Accounts receivable (days) 67.5 39.2 22.9 20.3 22.9 24.3 23.5 24.8 Current ratio (x) 0.7 0.4 0.9 2.5 1.5 1.0 0.8 0.7 Net interest cover (x) 1.5 4.8 8.3 7.2 3.9 2.1 2.7 2.9 Net dividend payout 0.0 0.0 0.0 22.4 27.9 22.8 20.2 20.2 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0.4 Source: FactSet, Daiwa forecasts

Company profile

China Huishan Dairy (Huishan) is the second-largest dairy-farm operator in China and is based in Liaoning Province, northeastern China. The company supplies raw milk to third-party dairy processors, as well as produces fresh milk and UHT dairy products under its own brand, Huishan.

China Huishan Dairy Holdings (6863 HK): 26 January 2016

Valuation

Huishan: valuation sensitivity to discount rate Huishan: key DCF assumptions Equity Value Beta (X) 0.522 Terminal growth rate 0

Discount NPV of Enterprise Equity Per Share Equity risk premium 12.96 Cost of debt 6 Rate FCF (CNY m) Value (CNY m) Value (CNY m) (HKD) Risk free rate 2.94 Debt-weighting 44.9 4.0% 55,132 56,384 51,515 4.59 Cost of equity 9.7 WACC* 8.0

5.0% 42,948 44,200 39,330 3.50 6.0% 34,856 36,108 31,239 2.78 7.0% 29,099 30,351 25,481 2.27 8.0% 24,797 26,049 21,180 1.89 9.0% 21,465 22,717 17,848 1.59 10.0% 18,811 20,063 15,193 1.35 11.0% 16,648 17,900 13,031 1.16 12.0% 14,855 16,107 11,237 1.00

Source: Daiwa estimates Source: Daiwa estimates

Huishan: DCF valuation of upstream business FY16F FY17F FY18F FY19F FY20F FY21F FY22F FY23F FY24F FY25F EBIT (CNY m) 471 797 2,511 3,030 3,182 3,211 3,177 3,152 3,152 3,170 Depreciation(CNY m) 150 210 250 270 290 303 315 328 341 354 EBITDA (CNY m) 621 1,007 2,761 3,300 3,472 3,514 3,492 3,480 3,493 3,523 Capex (CNY m) -1,266 -800 -800 -808 -500 -505 -510 -515 -520 -526 Cashflow (CNY m) -1,040 -222 1,507 2,129 2,609 2,646 2,619 2,601 2,609 2,635 Discount factor 1.080 1.166 1.260 1.360 1.469 1.587 1.714 1.851 1.999 2.159 Discounted FCF -962.5 -190.0 1196.6 1564.8 1775.5 1667.3 1528.2 1405.4 1305.3 1220.4 FY26F FY27F FY28F FY29F FY30F FY31F FY32F FY33F FY34F >FY35E EBIT (CNY m) 3,192 3,209 3,222 3,231 3,238 3,243 3,245 3,245 3,243 Depreciation(CNY m) 367 380 394 407 421 435 157 160 163 Terminal EBITDA (CNY m) 3,559 3,589 3,616 3,639 3,659 3,677 3,402 3,405 3,406 Value Capex (CNY m) -531 -536 -541 -547 -552 -558 -563 -569 -575 Cashflow (CNY m) 2,665 2,690 2,711 2,729 2,743 2,756 2,476 2,473 2,468 30,855 Discount factor 2.332 2.518 2.720 2.937 3.172 3.426 3.700 3.996 4.316 4.661 Discounted FCF 1142.8 1068.3 996.9 929.0 864.9 804.6 669.1 618.9 572.0 6619.9 Total discounted FCF (from FY16E onward) 24,797 NAV/share (CNY) 1.48 Net cash as of FY15 -4,869 Total value 19,9289 NAV/share (HK$) 1.77

Source: Daiwa estimates

China Huishan Dairy Holdings (6863 HK): 26 January 2016

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The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 63.9% Hold** 21.3% Sell*** 14.8% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 December 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

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