China Consumer Staples Sector

Transcription

1 China Consumer Staples 26 January 2016 China Consumer Staples Sector 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 ) Buy selectively: we like Vinda and upgrade UPCH to Buy (1); we downgrade Hengan, Tingyi and Fufeng to Hold (3) Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: We are cutting E EPS for 9 of the 12 China Consumer Staples companies by 2-33%. On our new numbers, the stocks under Daiwa coverage are trading at PER discounts to international peers (16x 2016E PER vs. 21x), despite the peers having slower EPS growth (9% vs. 16% for packaged food companies, per Bloomberg). We believe this disparity indicates the risk of an EPS growth slowdown for the China players is priced in. In 2016E, we expect: 1) the revenue of most staples players to slow further YoY from a relatively high base, and 2) gross-margin expansion to slow as cost tailwinds ease. We remain Neutral on the sector. What's the impact: Shift from big to small, old to new. We cut E revenue for 11 of the 12 companies by 1-14%, due mainly to: 1) shifts in market share and channels, which often favour small players with new hit products and foreign brands, and 2) a high consumption base for items like beer and noodles, which means that market-share leaders can no longer rely on their strengths (traditional distribution networks, dominant shares in key categories), whereas small players are well placed because of their flexibility in product launches. For example, we forecast Vinda to see a revenue CAGR of 23% over due to its increasing exposure to online channels, as well as acquisitions, vs. a flat (0%) CAGR for Hengan. Cost tailwinds to subside: We still expect slight gross-margin expansion for most of the staples downstream companies in 2016E (up <1pp YoY), driven mainly by product-mix changes. Our growth forecasts are much weaker than the surge seen in 2015E (2-4pp), as we believe some commodity costs will rebound from a low base. At the same time, the weak CNY:USD will likely weigh on companies with large proportions of USD debt and/or imported raw materials. Hengan and Vinda have the most USD exposure in terms of their COGS (30-60%). What we recommend: We like relatively small companies with the potential for revenue growth on market-share gains and/or product-mix improvements. Hence, we upgrade Uni-President China (UPCH) (220 HK, HKD5.20) to Buy (1), from Underperform (4); we also like Vinda (3331 HK, HKD13.0, Outperform [2]). Want Want (151 HK, HKD4.96, Buy [1]) is our 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. Key stock calls New Prev. Uni-President China (220 HK) Rating Buy Underperform Target Upside p 19.2% Vinda International (3331 HK) Rating Outperform Outperform Target Upside p 10% Want Want China (151 HK) Rating Buy Buy Target Upside p 47.2% Hengan International Group (1044 HK) Rating Hold Outperform Target Downside q 2.6% Tingyi Cayman Islands (322 HK) Rating Hold Outperform Target Upside p 5.8% Source: Daiwa forecasts Daiwa s China Staples Sector coverage Recommendation The Davids Vinda Outperform (2) Modern Dairy Buy (1) Huishan Sell (5) Uni-President China Buy (1) The Goliaths Hengan Hold (3) Mengniu Hold (3) Tingyi Hold (3) Tsingtao Underperform (4) China Resources Beer Hold (3) Fufeng Hold (3) The Somewhere in betweens Want Want Buy (1) WH Group Outperform (2) Source: Daiwa How we differ: Our E revenue and EPS are 1-9% and 2-39%, respectively, lower than consensus, reflecting our concern about marketshare losses among the big players, and our bearish CNY assumptions. See important disclosures, including any required research certifications, beginning on page 81

2 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 % (1.9%) (17.9%) China Mengniu Dairy 2319 HK Hold Hold (19.3%) (4.5%) (15.4%) China Modern Dairy Holdings 1117 HK 1.45 Buy Buy (9.1%) (19.5%) (19.6%) China Resources Beer 291 HK Hold Hold (7.5%) (9.6%) % Fufeng Group 546 HK 2.61 Hold Buy (49.0%) (5.0%) (25.1%) Hengan International Group 1044 HK Hold Outperform (24.1%) (6.8%) (12.4%) Tingyi Cayman Islands 322 HK 9.07 Hold Outperform (25.6%) (3.9%) (12.4%) Tsingtao Brewery 168 HK Underperform Underperform (16.3%) (7.2%) (10.4%) Uni-President China 220 HK 5.20 Buy Underperform (11.4%) (0.9%) % Vinda International 3331 HK Outperform Outperform (17.8%) (25.3%) (33.1%) Want Want China 151 HK 4.96 Buy Buy (14.1%) (9.7%) (7.8%) WH Group 288 HK 4.40 Outperform Outperform (12.7%) % %, 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) (%) Industry Snacks/ 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 % PET chips < <10 <5% Pork China: 70-80% of COGS Raw Milk < ~30% of revenue ~80% of revenue Corn Feed: 70% of upstream operation Sourced overseas Milk powder 15% 10% Wood pulp short fibre Wood pulp long fibre ~10-15% 50-60% Source: Daiwa estimates 2

3 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 Cost tailwinds to subside...13 Cost trends turned neutral on gross margins Impact of CNY depreciation mainly on the debt side Valuations and recommendations...20 Rerating opportunity for selected stocks The Davids The Goliaths The somewhere in-betweens Risk Commodity prices main risks, upside or downside Downside Company Section Uni-President China Vinda International Want Want China China Modern Dairy Holdings WH Group China Resources Beer Hengan International Group Tingyi Cayman Islands China Mengniu Dairy Fufeng Group Tsingtao Brewery China Huishan Dairy Holdings

4 China Consumer Staples Sector: 26 January : 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 Most staples categories in China have seen flat revenue, if not YoY declines, since 2014 Amid cost normalisation, we think promotions in commodity-like segments such as UHT milk and bottled water will weigh on companies gross margins in 2016E. Hence, we prefer the small players, which we see as more nimble and quicker to adapt to changes in the 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 E 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 Our third group, those companies somewhere in between, are involved in a few subsegments (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 4

5 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 difficult for the big players given a high base As illustrated in the exhibits below, China s per capita consumption of items such as beer and noodles already exceeds the global average. Moreover, sales volumes in both categories have declined in each of the past 2 years. For other categories, including wine, 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 E. Per capita consumption: China vs. global average China: industry sales growth by segment ( ) China Global average Japan US Wine (litre) Beer (litre) Noodles (packs) Dairy (kg) Snacks (USD) n.a Tissue paper (kg) YoY% (5) (10) M/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 5

6 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 100% 80% 60% 40% 20% E China France Korea UK Source: Kanta Worldpanel 0% Other Convenience store Grocery stores Hypermarket Supermarkets and minimarts E-commerce Source: Kanta Worldpanel Chinese consumption power is still growing Demographics Consumers are still price-sensitive, but many are now starting to consider food quality, 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 % , , , , , Annual salary of urban employee (inflation-adjusted) Dependency ratio (RHS) E 2030E Affluent (>23) Upper middle ( 12-23) Middle ( 8-12) Emerging Middle ( 5-8 ) Aspirant (2.8-5) Poor <2.8 Source: : Bureau of Statistics, Daiwa estimate Source: Boston Consulting Group report 6

7 China Consumer Staples Sector: 26 January 2016 New products can attract new customers but also lead to cannibalisation During 2H15, we met the managements of a number of consumer companies across different segments packaged food, beverages, sportswear distribution, personal care 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 ), 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 , then slow to 35% in 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 2 nd or lower ranked players, like UPCH and Bright Dairy ( 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 vs % % China: growth rates of various start products ( ) 200% 150% 60% % 40% % % RTD tea Bottled water carbonated drinks Juice Sportsdrink, herbal tea and others Source: AC Nielsen, Tingyi 50% 0% (50%) E Juice-drinks Milk tea Laotan noodles Hot-kid milk Room-temperature yogurt Source: Companies, Daiwa estimates Note: Juice-drinks estimated from Tingyi financials; Milk tea/laotan noodles: from UPCH, Hotkid milk Want Want. Room-temperature yoghurt: Bright Dairy numbers Price cuts offset volume growth and lead to gross-margin pressure Price promotions not effective in driving bottom lines Due to the distribution and production scale advantages of the Goliaths, they usually enjoy lower production costs (as a result of economies of scale, bulk purchases of raw materials, 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 7

8 E 2016E 2017E 2018E 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 subbrands, 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 (1H15) YoY 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Want Want Core brands Gift brands Sub-brands China: premium UHT milk sales vs. mass-market sales CNY bn Mass market Premium Source: Frost and Sullivan Brand loyalty has become a more important factor in beverage purchasing decisions Bottled water: We believe Tingyi s loss of bottled water market share since 1Q15 is evidence of consumers increasing awareness of brand image and the difficulty of companies remaining competitive on price alone. According to AC Nielsen, Tingyi s bottled water market share slid by 2pp YoY in 1Q15, when it raised its bottled water retail ASP by 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 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. 8

9 China Consumer Staples Sector: 26 January 2016 Tingyi: market share (%) and revenue (USDm) of bottled water segment USD m % 22% 20% % 18% 18% % 25% 20% 15% 10% 5% 0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Revenue Market share Source: Company 0% International brands more attractive than local brands, mainly in personalcare products According to Kantar Worldpanel, most domestic players gained market share in major F&B categories in China in 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 cooperation 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). 9

10 Toliet tissue Beer Hair conditioner Instant noodles Chewing gum Chocolate Carbonated drinks Facil tissue Shampoo Baby diapers Yogurt Milk Personal wash Fabric detergents Bottled tea toothbrush candy bottled water toothpaste kitchen cleaner Biscuits Juice Infant formula Color cosmecits fabric softener Skincare China Consumer Staples Sector: 26 January 2016 International brands: market-share changes (2014) Foreign brands are gaining market share in beer, chocolate and instant noodles, as well as personal care products (1) (2) (3) (4) (5) (6) 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. 10

11 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 and Goliaths have to adopt different strategies and we believe the Davids stand a better chance of growth The Davids strategy niche products, new distribution channels Davids based on our observations, the Davids are more flexible and quicker in terms of decision-making and responding to changes in the market. For example, in provinces or cities where there are no direct distributors of their products, the Davids can make use of the e-commerce channel without cannibalising the benefits of distributors, while big players with national distributors may find it difficult to provide incentives for new (online) 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 E, 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 ownbranded products only in 2010 (pasteurized milk) on a small scale, followed by its first UHT product in 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 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1.6% 3.6% 5.1% 8.6% 9.8% 1H13 2H13 1H14 2H14 1H15 Traditonal KA Corporate clients E-Commerce Source: Company, Daiwa estimates Modern Dairy: revenue contribution from downstream CNY m 3,000 2,500 2,000 1,500 1, F 2016E 2017E Downstream revenue as a ratio of total Source: Company, Daiwa forecasts 40% 35% 30% 25% 20% 15% 10% 5% 0% 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 targeting the high-end market and consumers in toptier 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 11

12 China Consumer Staples Sector: 26 January 2016 UPCH: products launched in the past 24 months 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). 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 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 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 12

13 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 E, 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 pp 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. Gross-margin expansion could slow in 2016E China Consumer Staples Sector: gross margins 60% 50% 43.6% 48.8% 58.6% 40% 30% 35.4% 32.6% 34.9% 30.9% 32.2% 31.5% 32.3% 20% 16.2% 16.9% 10% UPCH Want Want Tingyi WH Group CRB Tsingtao Mengniu Hengan Vinda Huishan Modern E 2017E Dairy Fufeng 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) (%) Industry Snacks/ 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 % PET chips < <10 <5% Pork China: 70-80% of COGS Raw Milk < ~30% of revenue ~80% of revenue Corn Feed: 70% of upstream operation Sourced overseas Milk powder 15% 10% Wood pulp short fibre Wood pulp long fibre ~10-15% 50-60% Source: Daiwa estimates 13

14 China Consumer Staples Sector: 26 January 2016 Downstream dairy players likely to see cost of milk rebound in 2016E Milk powder We believe the price of milk powder imported into China will bottom out in 1Q16 and gradually pick up throughout 2016E. In December 2015, Fonterra, the operator of the 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 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 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 international spot price (USD/tonne) 6,000 5,000 4,000 3,000 2,000 1,000 0 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 Jun-13 Apr-14 Feb-15 Dec-15 Import price Auction price Source: Global Dairy Trade, China Custom China: raw milk price CNY/kg Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Dec-15 National average CMD Huishan 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. 14

15 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 China Consumer Staples Sector: 26 January 2016 Palm oil prices: imported price of China (Tianjin port, LHS) CNY/m tonnes USD/m tonnes 11, , , , , , , ,000 0 M-09 M-10 J-11 N-11 A-12 J-13 A-14 F-15 N-15 "Malaysia" "Tianjin" China: wheat price CNY/m tonnes 3,500 3,000 2,500 2,000 1,500 1,000 Flour Wheat In 2016E, we expect the price of sugar to reverse its downtrend since 2013 Sugar We expect the price of sugar to increase by 5-10% YoY in 2016 in China due to the tighter supply. In December 2015, the Guangxi Provincial Government increased its guidance 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) CNY/m tonnes 13,000 12,000 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 Source: Wind PET (CNY/mt, LHS) Brent oil (USD/barrel, RHS) USD/Barrel China: global sugar price CNY/m tonnes USD/lb 9, ,000 7, , ,000 4, , ,000 1, Jan-08 Apr-09 Jul-10 Oct-11 Jan-13 Apr-14 Jul-15 Nanning Brazil 15

16 China Consumer Staples Sector: 26 January 2016 Lower USD pulp costs offset by CNY depreciation vs. USD Wood pulp (short and long-fibre) Mercer Int. (Not rated), a global pulp supplier of wood pulp, and Hawkins Wright, a global research firm on forest, pulp and paper industry, offer the following insight into the global 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 , 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, 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 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 Corn n.a. Wheat Early rice Later rice Hard rice Source: Ministry of Agriculture 16

17 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-09 May-09 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Jan-15 Jun-15 Nov-15 China Consumer Staples Sector: 26 January 2016 We expect grain prices to stay flat or decline in China in 2016E due to policy changes We estimate that grain prices in China are about 20% higher than international prices at present (except soybean, whose imports accounted for over 60% of the consumption in the past 5 years) due to supportive government policies. We expect this gap to continue to 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 USD/5000 bushel Corn price in China price (CNY/m tonnes) 3,000 2,500 2,000 1,500 1,000 Heilongjiang Jilin Shandong Any increase in the cost of hogs and pork in 2016E will be lower than we previously expected Hogs and pork Hog inventory as of November 2015 was 388m heads in China, according to the Ministry of Agriculture (down 1% MoM, but down 10% YoY). The number of reproductive sows in China declined to 38.3m heads in November 2015 (-12% YoY), implying that supply is 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 2H 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 China: pork and hog prices CNY/kg 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-15 N-15 Pork wholesale price Hog cost Source: Wind, Bloomberg Hog-corn cost ratio (x) Source: CEIC 2013 Ave Ave, Ave,

18 China Consumer Staples Sector: 26 January 2016 CNY depreciation against USD weighed more on financial costs than raw materials Impact of CNY depreciation mainly on the debt side Debt and financial costs the key factor. Before 2014, most staples companies enjoyed low interest rates and the benefits of CNY appreciation against foreign currencies by using foreign debt (mainly USD or HKD). However, with the CNY starting to depreciate against 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 CNYdebt wherever possible: In this report, we are revising down our 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 nonrecurring in 2016E. Hence for both, we believe the impact of CNY depreciation in E 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 debt as % of book equity HKD/USD cash as % of equity net HKD/USD debt as % of equity Report. currency FX loss (m reporting currency) as % of pre-fx net profit H E 2016E 1H E 2016E USD/HKD debt as % of total COGS % contribution 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 <10% Tingyi 87% 84% 4% 80% USD -49.2* * <10% Vinda 91% 82% 2% 80% HKD 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 <20% Hengan 100% 85% 11% 74% HKD >30% Huishan Dairy 12% 7% 5% 2% CNY negligible negligible <10% Source: Company, Daiwa estimates for E Note: * for nine months ended Sep-15; # including impact from FX change in non USD/HKD currency exchange rate against CNY, 1 due 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 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. 18

19 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). 19

20 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 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. The staples stocks have underperformed the MSCI China for the past 2 years MSCI China Staples and MSCI China Indices (2015) MSCI China Staples 1,400 1,300 1,200 1,100 1, MSCI China MSCI China Staples MSCI China 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 E, on our forecasts, and their longterm 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 grossmargin improvement from lower feed costs. 20

21 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) E 2016E 2017E E 16E 17E 15E 16E E 16E E 16E 15E Food and beverage players Want Want China 151 HK Buy 8, Tingyi 322 HK Hold 6, WH Group 288 HK Outperform 8, Mengniu Dairy 2319 HK Hold 5, Tsingtao Brewery 168 HK Underperform 4, China Resources Beer 291 HK Hold 3, n.a chg +chg Uni-President China 220 HK Buy 2, Market cap. Weighted average Dairy farm operators Modern Dairy 1117 HK Buy Huishan Dairy # 6863 HK Sell 5, Market cap. Weighted average Personal healthcare Hengan Int 1044 HK Hold 10, Vinda Int 3331 HK Outperform 1, Market cap. Weighted average Others Fufeng 546 HK Hold , 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 E 16E 15E 16E 16E US major F&B players Kraft-Heinz KHC US USD 90, n.a n.a Coca Cola KO US USD 182, Pepsi PEP US USD 139, General Mills GIS US USD 32, Mondelez MDLz US USD 66, Kellogg K US USD 25, Nestle NSRGY US USD 226, n.a n.a. 5 7 n.a. n.a Market cap. weighted average Global Dairy companies Fonterra FCG NZ NZD 7, n.a n.a n.a. Danone BN FP EUR 55, Mead Johnson MJN US USD 13, ABBOTT ABT US USD 59, Market cap. weighted average International hog processors TYSON FOODS-A TSN US USD 20, SANDERSON FARMS SAFM US USD 1, PILGRIM'S PRIDE PPC US USD 5, HORMEL FOODS CRP HRL US USD 20, INDUS BACHOC-B BACHOCOB MM MXN 2, JBS JBSS3 BZ BRL 7, Market cap. weighted average Japanese player ITOHAM FOODS INC 2284 JP JPY 1, n.a. n.a. NH FOODS LTD 2282 JP JPY 3,719 2, Market cap. weighted average International personal hygiene products 9 PROCTER & GAMBLE PG US USD 210, KIMBERLY-CLARK KMB US USD 45, Sven ska Cellulosa AB SCAB SS SEK 20, KAO CORP 4452 JP JPY 24,610 5, UNICHARM CORP 8113 JP JPY 11,285 2, Market cap. weighted average

22 China Consumer Staples Sector: 26 January 2016 We upgrade UPCH to Buy (1) The Davids Uni-President China (220 HK, HKD5.20): New products shine - upgrading to Buy (1) In this report, we are upgrading our rating for UPCH to Buy (1), from Underperform (4), as we expect its revenue growth to resume (5-8% YoY in E, 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 E 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-monthforward 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 E 2016E 2017E Revenue (CNY m) 23,329 22,488 23,642 25,524 26,783 YoY (%) Our forecast vs. consensus (%) n.a. n.a Net profit (CNY m) ,004 1,114 Net profit growth (%) EPS (CNY) EPS growth YoY (%) Operating margin 2.0% 0.9% 4.4% 5.2% 5.5% ROE 5.6% 1.3% 7.5% 8.3% 8.6% Source: Company, Daiwa forecasts UPCH: share price and past-7-year PER band chart (HKD) Jan-09 Mar-10 May-11 Jul-12 Sep-13 Nov-14 Jan HK 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 E 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 E 2016E 2017E Revenue (HKD m) 6,798 7,985 9,421 12,341 14,340 YoY (%) 13% 17% 18% 31% 16% Our forecast vs. consensus (%) n.a. n..a Net profit (HKD m) Net profit growth (%) 1% 9% EPS (HKD) Recurring EPS growth (%) 1% 9% -19% 19% 52% Operating margin ROE Source: Company, Daiwa forecasts Vinda: share price and past-5-year PER band chart HKD Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan HK 12x 15x 18x 21x 24x 22

23 Sep 13 Nov 13 Jan 14 Mar 14 May 14 Jul 14 Sep 14 Nov 14 Jan 15 Mar 15 May 15 Jul 15 Sep 15 Nov 15 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 China Consumer Staples Sector: 26 January 2016 We prefer Modern Dairy over Huishan Dairy among the upstream dairy companies China Modern Dairy (1117 HK, HKD1.45): Downstream expansion- reiterate Buy (1) We reiterate our Buy (1) call on Modern Dairy, with a new 12-month DCF-based target price of HKD3.00 (formerly HKD3.30). We expect Modern Dairy s earnings growth to recover in E after a 17% YoY decline in 2015E on the stabilisation of raw-milk 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 Year end Dec E 2016E 2017E Revenue (CNY m) 3,289 5,027 4,980 5,402 5,821 YoY (%) 62% 53% -1% 8% 8% Our forecast vs. consensus (%) n.a. n.a. 0% -4% -7% Net profit (CNY m) ,287 YoY (%) -28% 97% -14% 44% 41% Reported EPS YoY (%) -29% 108% -21% 37% 41% Operating margin 21.3% 27.2% 27.5% 25.8% 30.4% ROE (%) 6.8% 12.7% 8.3% 10.0% 12.7% Modern Dairy: share price and past-5-year PER band chart Source: Company, Daiwa forecasts 1117 HK 11x 15x 19x 23x 27x 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 SOTPbased 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 (Year-end Mar) FY14 FY15 FY16E FY17E FY18E Revenue (CNY m) 3,530 3,923 4,470 5,558 6,327 YoY growth (%) 38% 11% 14% 24% 14% vs consensus n.a. n.a. -2% -2% -5% Reported net profit (CNY m) 1, ,133 YoY growth (%) 32% -37% -3% 27% 16% Reported EPS (CNY) YoY growth (%) 17% -43% 1% 31% 16% ROE 13.1% 5.9% 5.8% 7.5% 8.1% Operating margin (%) 42.2% 32.0% 29.4% 27.1% 28.6% Huishan: share price and PER band since listing Source: Company, Daiwa forecasts 6863 HK 12x 16x 20x 24x 28x 23

24 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 China Consumer Staples Sector: 26 January 2016 We downgrade Tingyi and Hengan to Hold (3) on a slowdown in revenue momentum The Goliaths Tingyi (322 HK, HKD9.07): Too big to move- downgrading to Hold (3) In this report, we are downgrading our rating for Tingyi to Hold (3) from Outperform (2), as we see a risk of the company losing market share in the noodle and bottled water segments. We also expect revenue growth in its beverage business to remain slow at 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 E. We also expect net-profit growth to be slow, at a 6% CAGR in E, on a flat grossmargin 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 massmarket focus. In sum, we cut our E 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 E 2016E 2017E Revenue (USD m) 10,941 10,238 9,272 9,326 9,561 YoY % vs. consensus (%) n.a. n.a Recurring net profit (USD m) Profit growth YoY(%) EPS (USD) EPS growth YoY (%) Operating margin 6.7% 7.2% 8.1% 8.7% 8.9% ROE 14.5% 13.5% 12.0% 11.7% 12.0% Tingyi: share price and past-5-year PER band chart (HKD) Source: Company, Daiwa forecasts 322.HK 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 E 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 E 2016E 2017E Revenue (HKD m) 21,186 23,831 24,304 24,118 24,386 YoY (%) 14% 12% 2% -1% 1% Our forecast vs. consensus (%) n.a. n.a. -2% -10% -16% 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) Recurring EPS growth (%) 3% 8% 9% 5% 1% Operating margin 24.0% 24.1% 25.1% 25.7% 25.5% ROE 23.7% 22.9% 23.5% 22.8% 21.3% Source: Company, Daiwa forecasts Hengan: share price and past-8-year PER band chart (HKD) Aug 08 Aug 09 Aug 10 Aug 11 Aug 12 Aug 13 Aug 14 Aug HK 18x 21x 24x 27x 30x 24

25 China Consumer Staples Sector: 26 January 2016 We believe increasing selling expenses won t lead to rapid revenue growth for Mengniu Mengniu (2319 HK, HKD11.08): Competition remains stiff - maintaining Hold (3) We maintain our Hold (3) rating and remain cautious on Mengniu s revenue-growth prospects over E given the risks of: 1) market-share contraction in the premium milk segment, and 2) product cannibalisation On our revised-down revenue forecasts, as well as our concern that marketing expenses will increase, we cut our EPS forecasts by 5-15% over E. 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 E 2016E 2017E Revenue (CNY m) 43,357 50,049 49,103 50,942 52,203 YoY (%) 20% 15% -2% 4% 2% vs consensus (%) n.a. n.a. (3) (6) (11) Net profit (CNY m) 1,607 2,233 2,577 2,471 2,745 YoY (%) 16% 39% 15% -4% 11% EPS (CNY) YoY (%) 14% 32% 12% -4% 11% Operating margin 4.3% 5.1% 6.4% 5.7% 5.9% ROE (%) 11.6% 12.1% 11.5% 10.1% 10.4% Source: Company, Daiwa forecasts Mengniu: share price and past-5-year PER band chart (HKD) Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Mengniu 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 E EPS by 3-19%, assuming that CRB will acquire a minority stake in CR-Snow via bank financing in 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 E 2016E 2017E Revenue (HKD m) 146, ,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, ,282 1,606 YoY (%) n.a. n.a. n.a. 47% 25% EPS (HKD) 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: financials include CRB s non-beer business, which was disposed of in September

26 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 China Consumer Staples Sector: 26 January 2016 Huishan and Tsingtao remain our least preferred stocks Tsingtao Brewery (168 HK, HKD28.80, Underperform [4]): Still a market-share loser We are concerned: 1) that Tsingtao s market-share gains look to have come to an end in 2015E, while the other top-2 players gained market share during the period, and 2) about continuously declining industry sales (-5.7% in 9M15). Hence, we cut our revenue forecasts by 1-9% over E. 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 to almost 0% over E (on our forecasts). Accordingly, we reaffirm our Underperform (4) rating. Tsingtao: financial summary Key Financials FY15E 2016E 2017E Revenue (CNY m) 28,291 29,049 28,092 26,912 27,286 YoY 9.7% 2.7% -3.3% -4.2% 1.4% vs consensus n.a. n..a 2.1% -5.0% -7.0% 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% EPS (CNY) YoY 0.2% 13.2% -17.9% -1.6% 6.5% Operating margin % % 6.0% 6.5% ROE% % 9.4% 9.4% Tsingtao Brewery: share price and [past-5-year] PER band chart HKD Source: Company, Daiwa forecasts 168 HK 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 E 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 Valuation E 2016E 2017E Revenue (CNY m) 11,367 11,298 11,761 12,869 12,992 YoY Our forecast vs. consensus (%) n..a n..a Net profit (CNY m) YoY EPS (CNY) Recurring EPS growth (%) Operating margin (%) 8.1% 9.9% 7.6% 6.4% 6.8% ROE (%) 11.8% 12.3% 9.0% 9.0% 9.2% Fufeng: share price and past-5-year PER band (HKD) Source: Company, Daiwa forecasts 564.HK 3x 4.5x 6x 7.5x 9x 26

27 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 China Consumer Staples Sector: 26 January 2016 Want Want is our only Buy-rated stock among the big-cap staples names The somewhere in-betweens Want Want (151 HK, HKD4.96, Buy [1])- Sales and earnings growth recovery in sight We reiterate our Buy (1) rating on Want Want, but lower our 12-month target price to HKD7.30 (set at 18.5x 2016E PER) from HKD8.50 (formerly 20x PER) after incorporating downward revisions to our earnings of 8-10% over E. Our target PER marks a 20% discount to the stock s past-5-year average 12-month forward PER, as we expect earnings growth to decelerate over E vs the previous five years (15%). We forecast Want Want s earnings growth to recover in E as we expect revenue from its food business to see a 5% CAGR over E, 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 E 2016E 2017E Revenue (USD m) 3,818 3,775 3,532 3,748 4,008 YoY (%) 14% -1% -6% 6% 7% Our forecast vs. consensus (%) n.a. n.a. -5.5% -3.0% -1.1% Net profit (USD m) Recurring net profit growth (%) 24% -10% -12% 18% 10% EPS (USD) Recurring EPS growth (%) 24% -10% -11% 20% 10% Operating margin 23.1% 20.6% 20.9% 23.5% 24.3% ROE 38.8% 31.0% 27.1% 29.5% 27.6% Source: Company, Daiwa forecasts Want Want: share price and past-5-year PER band (HKD) Jan-11 Jul-11 Feb-12 Aug-12 Mar-13 Sep-13 Apr-14 Nov-14 May-15 Dec HK 15x 18x 21x 24x 27x 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 Its market cap now is almost equivalent to the market value of its 73% stake in Henan Shuanghui ( 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 E 2016E 2017E Revenue (USD m) 11,253 22,243 22,017 23,362 24,623 YoY (%) 80% 98% -1% 6% 5% Our forecast vs. consensus (%) n.a. n.a. 1% 1% 2% Net profit (USD m) Reported net profit growth (%) 38% 66% -28% 33% 12% EPS (USD) Recurring EPS growth (%) 38% 48% -37% 33% 12% Operating margin (%) ROE(%) WH Group: share price and past-5-year PER band (HKD) Source: Company, Daiwa forecasts 288.HK 7x 8.5x 10x 11.5x 13x 27

28 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 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. 28

29 Uni-Presi dent Chi na China Consumer Staples 26 January 2016 Uni-President China (220 HK) 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 Recent share price pull-back provides buying opportunity Upgrade to Buy (1) on market-share gains; TP now HKD6.20 Anson Chan, CFA (852) What's new: After the recent pullback in the share price (-20% in 4Q15), we upgrade UPCH to Buy (1) from Underperform (4). During our recent retailer visits, we noted the increasing presence of UPCH s new products, in particular beverages. We expect the company s earnings and revenue growth to outperform its peers in 2016E, as a result of its increasing contribution from new products, which carry high gross margins. What's the impact: Adopting a diverse and differentiated approach to increase market share. UPCH was able to consistently gain market share over E (+1.7/2.9pp for noodles/juice drinks, to 18%/20%, respectively) in those segments through product diversification. We expect such a trend to continue to drive revenue growth over E, despite the sluggish industry outlook for beverages (as highlighted in our industry section), and this view was reaffirmed by our recent market research which saw increasing presence of UPCH s products in hypermarkets and convenience stores, including, small-bottles of milk tea (fresh-milk brewed to justify the higher ASPs), vege-light bow noodles, and sugar-free tea. EPS growth of 19-11% YoY for E. We raise our EPS for E by 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 regain market share in both the juice and bottled-tea segments (+0.5pp-1pp per year over E). For noodles, we are cutting our revenue forecasts by 1% as the market is still shrinking. But we expect UPCH s gross margin to reach 36% in 2016, and remain flat for 2017E, as the contribution of highmargin products rises while that for old products falls (vs. our previous forecast of a slight decline). As UPCH s operating margin is thin (at 5.2% in 2016E, vs. 8.7% for Tingyi), a 0.1pp improvement in the 2016 operating margin (led by gross margin expansion) would lift its reported net profit by 1.8% (and vice versa), on our estimates. As evidenced by the 1H15 results, such gross-margin expansion was enough to offset the rise in selling expenses (for marketing new products). Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (0.4) (0.1) 0.1 Net profit change (0.9) Core EPS (FD) change (0.9) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Uni-Pres C (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 3.27 Shares outstanding (m) 4,319 Major shareholder President Enterprise (1216.TT) (70.3%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 23,642 25,524 26,783 Operating profit (m) 1,042 1,334 1,465 Net profit (m) 844 1,004 1,114 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) (2.8) (2.0) (7.6) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 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 Upgrade to Buy (1). Risk to our call: lower-than-expected new product revenue contribution. How we differ: Our revenue forecasts are 2-8% above consensus as we are more optimistic on the revenue contribution from new products. Our E 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

30 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 566% YoY for 2015E (January-September 2015: +162% YoY) mainly on gross margin expansion, driven by lower raw-material costs (non-recurring in E) and a product mix upgrade (long-term catalyst). We continue to see gross margin expansion as the key earnings catalyst driving net profit to increase by 19% YoY for 2016E and 11% YoY for 2017E. 1, % 1, % % -48% 19% 11% -72% E 2016E 2017E Reported net profit Recurring net profit Reported net profit YoY % Source: Company, Daiwa forecasts 600% 500% 400% 300% 200% 100% 0% (100%) (200%) Valuation UPCH: 12-month forward PER bands since 2008 Over the past 5 years, UPCH has traded in a wide 12- month forward PER range of 16-35x. Successful new products were an important earnings and PER rerating catalyst in Our new target PER of 22.6x for 2016E is based on the company s average valuation since 2007 (vs. its past-5-year average of 26.5x that we used previously), which we believe is more in line with the trough valuation we saw in It also represents a premium to the Chinese staples companies average (16x), as UPCH is one of the few staple stocks able to offer midteens EPS growth in E, based on our estimates. (HKD) Jan-09 Mar-10 May-11 Jul-12 Sep-13 Nov-14 Jan HK Earnings revisions UPCH s 2016E consensus estimates trended up slightly in 2H15, due we believe to the launch of more new products and it successfully gaining greater product penetration, such as its Haizhiyen and Xiaoming classmates. We would revisit our EPS forecasts if gross margin expansion from new products launched was better than expected. UPCH: Bloomberg consensus EPS forecasts HKD J-15 F-15 M-15 A-15 M-15 J-15 J-15 A-15 S-15 O-15 N-15 D E 2016E 30

31 Uni-President China (220 HK): 26 January 2016 Financial summary Key assumptions Sales growth YoY - Instant noodles (2.4) Sales growth YoY - Beverage (7.6) Gross margin % - instant noodles Gross margin % - beverage Sellling and distribution expense ratio (%) Advertising and promotion expense Profit and loss (CNYm) 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 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 Operating profit ,042 1,334 1,465 Net-interest inc./(exp.) (42) Assoc/forex/extraord./others Pre-tax profit ,091 1, ,157 1,394 1,547 Tax (163) (84) (221) (200) (129) (312) (390) (433) Min. int./pref. div./others Net profit (reported) ,004 1,114 Net profit (adjusted) ,004 1,114 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT ,042 1,334 1,465 EBITDA ,693 1,522 1,568 2,531 2,923 3,154 Cash flow (CNYm) Profit before tax ,091 1, ,157 1,394 1,547 Depreciation and amortisation ,064 1,355 1,489 1,589 1,689 Tax paid (157) 37 (202) (259) (210) (312) (390) (433) Change in working capital (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 Other investing CF items 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, ,033 (168) 444 (780) (1,000) Net share issues/(repurchases) , Dividends paid (352) (156) (97) (171) (183) (57) (169) (201) Other financing CF items (354) (37) (102) (70) (106) (73) Cash flow from financing (540) 2,738 1,247 1,917 2, (1,055) (1,274) Forex effect/others Change in cash (981) (61) (180) (714) (562) (580) Free cash flow (441) (2,799) (1,427) (3,581) (1,970) Source: FactSet, Daiwa forecasts 31

32 Uni-President China (220 HK): 26 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 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 Other current assets ,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 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, ,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 Total liabilities 2,921 6,926 8,869 10,826 10,428 10,846 10,148 9,216 Share capital 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 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) Key ratios (%) Sales (YoY) (3.5) EBITDA (YoY) (14.6) (14.0) (10.1) Operating profit (YoY) (27.2) (53.2) (48.0) (53.5) Net profit (YoY) (26.4) (39.9) (47.9) (71.6) Core EPS (fully-diluted) (YoY) (19.0) (39.9) (47.9) (74.2) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. 5.1 n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a. n.a. n.a. n.a. n.a 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

33 Vinda International Hong Kong Consumer Staples 26 January 2016 Vinda International (3331 HK) 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 Asia business acquisition likely to complete in 1Q16 and drive revenue Reiterate Outperform on valuation and stronger-than-peer EPS growth Anson Chan, CFA (852) What's new: We remain positive on Vinda s earnings growth prospects in view of its increasing sales of personal care products and expansion outside China. We estimate the pan-asian business being acquired will contribute c.10% of Vinda s revenue in 2016E (9 months contribution) and see the operating margin for this unit improving gradually as scale builds. We reiterate our Outperform (2) rating given: 1) the recent share-price weakness, which we think has priced in the impact of CNY depreciation against the USD, and 2) strong EPS growth in E despite our cuts. What's the impact: Emerging as an Asian play. Vinda is due to complete the acquisition of its parent s personal care product businesses in Malaysia, Singapore, Taiwan and Korea ( acquired business ) by March Thus, we are raising our E revenue by 9-14% (see our Memo, Acquisition of Pan-Asia business, 28 December 2015 for details). Due to a lack of 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 margin to be dragged down to 10% in 2016E ( E: 10.5%). However, we look for: 1) the operating margin for the China operations to still trend up slightly in 2016E (by 0.4pp YoY to 11%) on an increase in personal care product sales, and 2) the acquired business s operating margin to improve gradually as products sourced from China lead to lower production costs. Earnings cut due to CNY depreciation. We are revising down our 2015E revenue after a slight slowdown in tissue market revenue growth in China in 2H15E. However, we are cutting our E EPS by 13-33%, as we assume a: 1) FX loss of HKD m over E (17-36% of recurring net profit) due to CNY weakness (using Daiwa s USD/CNY rate of 7.5 by end-2016e), and 2) 13% EPS dilution from the new share issue for the acquisition. While Vinda is the most negatively impacted by CNY weakness in our coverage universe due to its USD debt exposure (>90% in 2015E), we believe its underlying growth remains robust, and hence forecast EPS growth of 19%/52% YoY for E, or 20%/30% YoY on an ex-fx impact basis. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (4.2) Net profit change (25.3) (28.3) (2.1) Core EPS (FD) change (25.3) (33.1) (13.4) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Vinda Intl (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 0.97 Shares outstanding (m) 998 Major shareholder SCA (51.4%) Financial summary (HKD) Year to 31 Dec 15E 16E 17E Revenue (m) 9,421 12,341 14,340 Operating profit (m) 990 1,242 1,605 Net profit (m) Core EPS (fully-diluted) EPS change (%) (19.5) Daiwa vs Cons. EPS (%) (22.9) (29.1) (10.9) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 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 E 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

34 Jan-15 Feb-15 Ma r-15 Apr-1 5 Ma y-15 Jun-15 Jul-1 5 Aug -15 Sep -15 Oct-1 5 Nov-15 Dec-15 Vinda International (3331 HK): 26 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We forecast Vinda s net profit to decline by 19.5% YoY for 2015E as we assume a HKD280m FX loss on the CNY s depreciation vs. the HKD. We look for EPS growth of 19% YoY for 2016E against net profit growth of 27.5% YoY, due to new share issue dilution as a result of its acquisition. Net profit growth will accelerate to 61% YoY for 2017E, on our forecasts, due to: 1) a reduction in FX losses, and 2) 16% YoY organic revenue growth on the back of increasing tissue sales and slight operating margin expansion. Our sensitivity analysis shows that a 1% depreciation in the CNY:USD exchange rate would lead to a 4% decline in the company s reported net profit for 2016E. Vinda: net profit and net-profit growth (HKDm) 1,200 1, (200) (400) E 2016E 2017E Reported profit FX loss YoY Source: Company, Daiwa forecasts 70% 60% 50 % 40% 30% 20 % 10% 0% (10%) (20%) (30%) Valuation Vinda: 12-month forward PER bands Vinda was rerated between September 2013 and September 2015 after Sweden s SCA became its major shareholder through Vinda acquiring SCA s personal care product business in China. We believe the recent shareprice drop already factors in the negative impact of CNY depreciation. We look for Vinda to be rerated over E as synergies with the acquired pan-asia business kick in, and penetration of Vinda/SCA s personal care products improves in China. We believe our target 2016E PER of 25x is undemanding given we forecast the company s EPS to grow at 35% CAGR over , including 19% YoY in Our target price also implies a 2017E PER of 16.5x, which is at a slight discount to the peers average of 18x. (HKD) Jan 1 1 Jan 1 2 Jan 1 3 Jan 1 4 Jan 1 5 Jan HK 12x 15x 18 x 21 x 24 x Earnings revisions Vinda: Bloomberg consensus EPS ( E) We see downside to the Bloomberg consensus EPS forecasts due to our higher FX loss assumptions from CNY depreciation (2015E: HKD280m; 2016E: HKD300m; 2017E: HKD200m). However, on an ex-fx loss basis, our forecasts call for earnings growth of 24%/20%/30% YoY over E driven by its acquisition of the Asian business and expansion of its tissue sales volume growth in China. (HKD) E 20 16E 34

35 Vinda International (3331 HK): 26 January 2016 Financial summary Key assumptions Volume YoY % ASP YoY % (0.2) (0.7) Selling cost ratio % Wood pulp cost change YoY % 34 (2) (12) 8 (2) (1) (2) 0 Profit and loss (HKDm) 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 ,295 3,254 Total Revenue 3,602 4,765 6,024 6,798 7,985 9,421 12,341 14,340 Other income 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 Operating profit ,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 ,239 Tax (91) (116) (182) (130) (144) (116) (162) (260) Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(hkd) EPS (adjusted)(hkd) EPS (adjusted fully-diluted)(hkd) DPS (HKD) EBIT ,242 1,605 EBITDA ,218 1,436 1,754 2,184 Cash flow (HKDm) Profit before tax ,239 Depreciation and amortisation 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) Cash flow from operations , ,391 Capex (473) (833) (1,264) (1,386) (1,009) (1,000) (1,000) (1,000) Net (acquisitions)/disposals (21) (1,366) 0 (3,776) 0 Other investing CF items Cash flow from investing (472) (826) (1,228) (1,407) (2,375) (1,000) (4,776) (1,000) Change in debt , ,002 0 Net share issues/(repurchases) (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 ,281 (97) 3,805 (391) Forex effect/others (6) (4) (4) (62) Change in cash (131) 24 (141) Free cash flow (326) (460) (525) (565) 91 (324) (196) 391 Source: FactSet, Daiwa forecasts 35

36 Vinda International (3331 HK): 26 January 2016 Financial summary continued Balance sheet (HKDm) As at 31 Dec E 2016E 2017E Cash & short-term investment Inventory 1,322 1,372 1,447 1,643 2,029 2,350 3,051 3,544 Accounts receivable ,116 1,286 1,524 1,888 2,472 2,873 Other current assets 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 ,400 1,400 1,400 1,400 Other non-current assets ,535 1,535 Total assets 4,891 6,464 7,823 9,373 12,203 13,257 18,815 20,260 Short-term debt ,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 Total current liabilities 1,601 2,080 2,733 2,911 4,020 4,514 5,611 6,173 Long-term debt 530 1, ,705 2,909 2,909 4,611 4,611 Other non-current liabilities Total liabilities 2,203 3,325 3,704 4,726 7,122 7,616 10,416 10,977 Share capital 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 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) Key ratios (%) Sales (YoY) EBITDA (YoY) (8.6) (0.4) Operating profit (YoY) (12.2) (10.1) Net profit (YoY) (7.3) (19.5) Core EPS (fully-diluted) (YoY) (10.5) (19.5) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a Net dividend payout 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. 36

37 Want Want Chi na China Consumer Staples 26 January 2016 Want Want China (151 HK) 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 Focus on snacks segment to support pricing power EPS growth to resume in E; reiterate Buy (1) rating Anson Chan, CFA (852) What's new: Unlike other dairy processors, Want Want s milk-powder cost trend should remain favourable in 1H16 as it uses up its reserves of lowcost inventory, whose unit cost we estimate is still c.20% below the current milk powder spot price on the international market. Moreover, we expect the ASP of Want Want s rice crackers to continue to rise due to product-mix adjustments (with the company planning more seasonal products/festive items), and we see Want Want maintaining its strategy of avoiding price competition to protect its brand and pricing power. Reiterate Buy (1) rating. What's the impact: Gross margin poised to improve. We are cutting our E EPS by 8-10%: 1) as we expect FX losses over due to CNY depreciation against the USD, and 2) after revising down our E revenue by 4-5% on rising competition in the dairy industry. That said, we look for Want Want s revenue growth to resume in E at 6-7% YoY (vs. a 1-6% YoY decline in 2014 and 2015) on the new products launched in E continuing to gain market share, and a recovery in revenue growth for snacks in 2016E. This, coupled with lower raw-material costs, should see the gross margin improve slightly by 0.3pp to around 44% for 2016E, after a 3.4pp YoY jump in 2015E. Still our top pick. We still prefer Want Want over the other big-cap staple companies due to: 1) our expectation that its EPS growth will resume in E, and 2) its stronger balance sheet and cash flow, and 3) our preference for the snacks segment over other key food & beverage categories due to its potentially relatively faster segment revenue growth. What we recommend: We trim our 12-month target price to HKD7.30 (from HKD8.50), which is now based on an 18.5x 2016E PER (from 20x) post our EPS revisions. Our target PER is based on a 20% discount to the stock s past-5-year average 12-month forward PER (now 23.2x vs. 25x previously with the same 20% discount), as we expect a slowdown in dairy market growth over E vs. the previous 5 years. However, we see continuous share buybacks, armed with its FCF of USD550m/year over E (it spent c.usd288m in 2015) as a potential catalyst. With EPS growth heading back towards positive territory in E, we reaffirm our Buy (1) call. The key risk: a surge in promotion costs. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (5.5) (4.5) (4.4) Net profit change (9.4) (8.8) (10.1) Core EPS (FD) change (9.7) (7.8) (9.1) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Want Want (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 12,855 Major shareholder Eng-meng Tsai (48.0%) Financial summary (USD) Year to 31 Dec 15E 16E 17E Revenue (m) 3,532 3,748 4,008 Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) (11.1) Daiwa vs Cons. EPS (%) (9.5) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 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 E and beyond, given the low per-capita consumption base in China, as evidenced by our aboveconsensus EPS forecasts. See important disclosures, including any required research certifications, beginning on page 81

38 Jan 15 Feb 15 Mar 15 Apr 15 May 15 Jun 15 Jul 15 Aug 15 Sep 15 Oct 15 Nov 15 Dec 15 Want Want China (151 HK): 26 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We forecast Want Want s net profit to recover to 18% YoY and 10% YoY in E, after 2 consecutive years of decline. The key drivers would be: 1) a recovery in revenue to a 6% CAGR over E (-7% in 2015E) supported by snacks segment growth, and 2) slight operating margin expansion from a higher contribution from high-margin new products and streamlining of the sales team (completed in 2H15). Want Want: net profit net-profit growth (USDm) % 32% Source: Company, Daiwa forecasts 24% -10% -12% 18% E 2015E 2016E 2017E Net profit (LHS) YoY (RHS) 40% 30% 20% 10% 10% 0% (10%) (20%) Valuation Want Want is trading near the low-end of its past 5-year 12M forward PER band (15-28x). It has the strongest free cash flow and balance sheet among the staples companies we cover, which could support share buybacks (it spent USD288m in 2015 on buying shares back). We expect Want Want to rerate towards its past-5-year average PER of 23x as earnings growth gradually resumes from 2016E. Want Want: 12-month forward PER bands (HKD) Jan-11 Jul-11 Feb-12 Aug-12 Mar-13 Sep-13 Apr-14 Nov-14 May-15 Dec HK 15x 18x 21x 24x 27x Earnings revisions Want Want: E Bloomberg EPS consensus The Bloomberg-consensus EPS forecasts for Want Want trended down in 2015 on a slowdown in revenue momentum, in particular for dairy beverages. However, we expect earnings growth to recover on improving snacks revenue growth as a result of the new products launched in Our 2016E EPS is 2% above the Bloomberg-consensus forecasts. (USD) E 2016E 38

39 Want Want China (151 HK): 26 January 2016 Financial summary Key assumptions Sales growth YoY - rice crackers (0.6) 12.0 (10.8) Sales growth YoY - beverages (0.3) (14.1) Sales growth YoY - snacks (3.6) Gross margin % - rice crackers Gross margin % - beverages Gross margin % - snacks Profit and loss (USDm) Rice crackers ,007 Beverages 1,067 1,394 1,709 1,999 1,993 1,712 1,755 1,815 Other Revenue ,056 1,186 Total Revenue 2,244 2,947 3,359 3,818 3,775 3,532 3,748 4,008 Other income 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 Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others (1) (1) (1) (1) Pre-tax profit ,000 Tax (84) (119) (195) (247) (210) (235) (257) (290) Min. int./pref. div./others (1) (1) (1) (1) (1) Net profit (reported) Net profit (adjusted) EPS (reported)(usd) EPS (adjusted)(usd) EPS (adjusted fully-diluted)(usd) DPS (USD) EBIT EBITDA ,029 1,133 Cash flow (USDm) Profit before tax ,000 Depreciation and amortisation 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 Capex (171) (224) (243) (273) (354) (250) (200) (200) Net (acquisitions)/disposals Other investing CF items Cash flow from investing (171) (224) (243) (273) (354) (250) (200) (200) Change in debt (22) (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) Cash flow from financing (41) 189 (294) (121) (327) (843) (249) (305) Forex effect/others Change in cash (410) (271) Free cash flow (83) Source: FactSet, Daiwa forecasts 39

40 Want Want China (151 HK): 26 January 2016 Financial summary continued Balance sheet (USDm) As at 31 Dec E 2016E 2017E Cash & short-term investment 906 1,437 1,499 2,060 1,650 1,381 1,686 2,035 Inventory Accounts receivable Other current assets Total current assets 1,454 2,103 2,268 2,911 2,589 2,081 2,447 2,839 Fixed assets ,046 1,236 1,448 1,564 1,620 1,665 Goodwill & intangibles Other non-current assets Total assets 2,290 3,123 3,461 4,348 4,284 3,892 4,313 4,751 Short-term debt Accounts payable Other current liabilities Total current liabilities 864 1,517 1,181 1,515 1, ,000 1,049 Long-term debt Other non-current liabilities Total liabilities 1,214 1,791 1,858 2,396 2,226 1,895 1,932 1,981 Share capital 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 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) Key ratios (%) Sales (YoY) (1.1) (6.5) EBITDA (YoY) (9.1) (2.6) Operating profit (YoY) (12.0) (4.9) Net profit (YoY) (9.8) (11.6) Core EPS (fully-diluted) (YoY) (9.7) (11.1) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a 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. 40

41 China M odern Dair y H ol dings China Consumer Staples 26 January 2016 China Modern Dairy Holdings (1117 HK) Target price: HKD3.00 (from HKD3.30) Share price (25 Jan): HKD1.45 Up/downside: % Downstream expansion to offset upstream weakness EPS forecasts lowered after profit warning in December 2015 But expect a long-term rerating as downstream contribution rises Reiterate Buy (1); target price cut to HKD3.0 Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: We are now more conservative on the outlook for raw-milk prices in 2016, but see CMD as a beneficiary of a long-term structural shortage of high-quality raw milk in China. Also, the company stands to benefit significantly from a rise in downstream revenue. Reiterate Buy (1). What's the impact: Downstream: ambitious but feasible target. Management targets downstream revenue to contribute 50% to total revenue by 2020, vs. 25% in 2015E. We believe this goal is achievable and would be highly profitable given it focuses on premium products. CMD s market share in the premium UHT milk segment in China already rose to 8% in 3Q15 (+2.9pp YoY). By adding new products and focusing on brand building (highlighting its high quality and 100% in-house raw-milk source), we believe a 24% revenue CAGR is achievable over E. Lower feed costs could largely offset raw-milk-price pressure. With declining feed costs, some large competitors may lower their ASPs to boost sales volume, driving pricing pressure in the industry. Moreover, despite the recent rebound in milk-powder prices globally (+42% YoY in the 1st week of December, from a trough of USD1,560/tonne in August 2015, as per 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 milk powder could remain a cheap substitute for liquid raw milk in 2016E. But lower feed (mainly corn) costs, could see CMD s gross margin improve by 1.1pp YoY in 2016E, despite our revised forecast for flat raw-milk prices (previously a 3% YoY rise per year) over E. What we recommend: We cut our 2015E EPS by 20% due to a higherthan-expected loss from the revaluation of biological assets announced in the profit warning issued in December We also cut our E EPS by 20% each after lowering our raw-milk-price assumptions to flat (from 3-4% rises previously). (See Takeaways from conference call on 2015 profit warning, 21 December 2015.) We lower our 12-month SOTPbased 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (2.2) (12.6) (13.9) Net profit change (19.5) (19.6) (19.6) Core EPS (FD) change (19.5) (19.6) (19.6) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 CMDH (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 2.26 Shares outstanding (m) 5,298 Major shareholder Mengniu (28.0%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 4,980 5,402 5,821 Operating profit (m) 1,368 1,392 1,771 Net profit (m) ,287 Core EPS (fully-diluted) EPS change (%) (21.3) Daiwa vs Cons. EPS (%) (18.4) (5.4) 19.7 PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E 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

42 Dec 14 Feb 15 Apr 15 Jun 15 Aug 15 Oct 15 Dec 15 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 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 2015 due to a CNY400m loss from the revaluation of biological assets (2014: CNY330m). On fewer revaluation losses and an increasing revenue contribution from its downstream operation, we look for reported net-profit growth to recover to 44% YoY and 41% YoY for 2016E and 2017E, respectively. ((CNYm)) 1,400 1,200 1, % 108% 100% 80% 60% 34% 44% 41% 40% 20% 0% -28% -19% -20% -40% E 2016E 2017E Reported net profit (LHS) Reported profit YoY (RHS, %) Source: Company, Daiwa forecast Valuation Modern Dairy stock is trading currently at a PER of 7.1x for 2016E, compared to its closet peer, China Huishan s 34x FY17E (fiscal year ending March 2017) (both on our EPS forecasts). Yet, we believe Modern Dairy s execution risk for expansion is lower than Huishan s. We believe the recent sell-off of Modern Dairy shares has already priced our flat raw-milk-price outlook and we believe Modern Dairy deserves a rerating if its downstream business successfully expands in revenue and maintains a high gross margin (>22%). Modern Dairy: 12-month-forward PER (HKD) HK 11x 15x 19x 23x 27x Earnings revisions We see downside risk to the street s 2015E EPS as some analysts may have not factored in the profit warning announced recently. The Bloomberg-consensus E EPS forecasts trended down in 2015 on increasing losses from the revaluation of biological assets. Modern Dairy: Bloomberg consensus EPS ( E) (HKD) E 2016E 42

43 China Modern Dairy Holdings (1117 HK): 26 January 2016 Financial summary Key assumptions Milk Yield (tonne/cow/year) Sales volume of raw milk (tonnes) 201, , , , , ,284 1,007,953 1,052,848 Raw milk ASP (CNY/kg) Number of cows 87, , , , , , , ,329 Profit and loss (CNYm) Raw milk 782 1,384 1,971 2,968 4,194 3,327 3,319 3,325 Self-own brand ,620 2,045 2,454 Other Revenue Total Revenue 782 1,392 2,035 3,289 5,027 4,980 5,402 5,821 Other income 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 Operating profit ,365 1,368 1,392 1,771 Net-interest inc./(exp.) (47) (60) (101) (208) (266) (293) (302) (296) Assoc/forex/extraord./others (83) (329) (390) (100) (100) Pre-tax profit ,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) ,287 Net profit (adjusted) ,287 EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT ,365 1,368 1,392 1,771 EBITDA ,096 2,014 1,756 2,153 Cash flow (CNYm) Profit before tax ,375 Depreciation and amortisation Tax paid (0) (0) (8) (11) (7) (25) (50) (60) Change in working capital (3) (441) (309) Other operational CF items (8) (45) Cash flow from operations ,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 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, (400) Net share issues/(repurchases) 2, , Dividends paid (48) (48) (48) Other financing CF items (953) (137) (44) (732) (432) (426) Cash flow from financing 1, ,061 1, ,016 (480) (874) Forex effect/others Change in cash 482 (1,027) (238) (172) Free cash flow (1,229) (1,557) (1,299) (1,542) (511) Source: FactSet, Daiwa forecasts 43

44 China Modern Dairy Holdings (1117 HK): 26 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment 2,069 1, ,170 1,008 1,138 1,192 Inventory Accounts receivable ,000 1,100 Other current assets 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 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 ,666 2,989 2,958 2,800 2,800 2,400 Accounts payable ,112 1,334 Other current liabilities 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 Total liabilities 2,445 3,028 4,830 6,633 7,555 7,955 8,274 8,258 Share capital 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 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) Key ratios (%) Sales (YoY) n.a (0.9) EBITDA (YoY) n.a (3.9) (12.8) 22.6 Operating profit (YoY) n.a Net profit (YoY) n.a (28.2) (18.7) Core EPS (fully-diluted) (YoY) n.a (28.5) (21.3) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) Net dividend payout Free cash flow yield n.a. n.a. n.a. n.a. n.a 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. 44

45 China Modern Dairy Holdings (1117 HK): 26 January 2016 CMD: DCF sensitivity Equity Value Discount NPV of Enterprise Equity Per Share Rate FCF (CNY m) Value (CNY m) Value (CNY m) (HKD) 5.6% 26,923 29,990 25, % 22,380 25,448 20, % 19,079 22,147 17, % 16,580 19,648 15, % 14,681 17,749 13, % 13,063 16,131 11, % 11,784 14,852 10, % 10,720 13,788 9, % 9,823 12,891 8, Source: Daiwa estimates Key assumption for our DCF calculation Assumptions (%) Equity Beta (X) Terminal growth rate 0 Equity risk premium Cost of debt 7.8 Risk free rate Debt-weighting 40 Cost of equity WACC* 9.6 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) 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 Capex (CNY mil) Cashflow (CNY mil) ,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 Discounted FCF Total discounted FCF (from 2015F onward) 14,681 NAV/share (CNY) 1.90 Net cash as of ,618 Total value 10,063 NAV/share (HK$) 2.30 Source: Daiwa estimates 45

46 WH Group Hong Kong Consumer Staples 26 January 2016 WH Group (288 HK) 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 E EPS on higher ASP but lower sales volume Smithfield operation trading at 3.1x 2016E PER at current share price Reaffirm Outperform (2) rating; 33% YoY EPS growth for 2016E Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: We are positive on WH Group starting operations of its new American-style packaged-meat factory in Zhengzhou in December 2015, producing American and Smithfield branded cold-chain products that carry a higher ASP vs. its Chinese products. This product-mix upgrade should bode well for the company. Reiterate Outperform (2) rating. What's the impact: Commodity cost trends look favourable in China, but mixed in the US: as we highlighted in the sector portion of this report, we see limited upside to hog costs in 2016E due to lower corn (feed) costs in China. But for the US, the upstream segment s margins may remain volatile due to commodity cost changes (grain and hog prices), and Smithfield plans to diversify the risk by increasing its export business, in particular to China (+40% YoY for 9M15). Get the US operation for free: Shuanghui, WH Group s major operating subsidiary in China, is now trading at a 10x 2016E PER (Bloomberg consensus), implying that WH Group s 73% stake translates into HKD3.7 per WH Group share. This means Smithfield, WH Group s US operation expected to contribute c.50% of its 2015E operating profit, accounts for only about USD873m in WH Group s current market cap (vs. the USD4.5bn WH Group paid for it in 2013). Sluggish demand in 2H15 is likely temporary: For E, we are cutting revenue by 4-5%, as we lower our packaged-meat sales volume assumption by 6-10% for both China and the US, due to the sluggish demand we saw in 2H15E. But we now expect a slight increase in its packaged-meat ASP (+5% YoY in China and 2% in the US in 2016E, vs. flat previously) on the product mix improvement. Hence, we are revising up our EPS for the company by 1-3% for the same period. What we recommend: We cut our 12-month TP to HKD4.80 from HKD5.50, now based on a 2016E PER of 11x (was 13.4x), to bring it in line 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 other staple companies) and 10.2x PER for the US operation (in line with its US peers average). The key risk: unexpected hedging losses for the US operation. How we differ: Our E EPS are 6-21% below consensus as we assume the absence of gains from the revaluation of its biological assets. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (3.7) (4.7) (5.3) Net profit change Core EPS (FD) change Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 WH Group (LHS) Source: FactSet, Daiwa forecasts Valuation of WH Group s business USD m Market cap of Shuanghui ( SS) (25 Jan 16) 9,206 WH's stake (%) 73.3 WH's stake worth 6,744 WH Group's market cap 8,284 Smithfield's valuation (USD m) 1,549 Implied 2016E PER for Smithfield (x) 3.1, Daiwa estimates Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 9.48 Shares outstanding (m) 14,620 Major shareholder Management (34.0%) Financial summary (USD) Year to 31 Dec 15E 16E 17E Revenue (m) 22,017 23,362 24,623 Operating profit (m) 1,412 1,623 1,733 Net profit (m) Core EPS (fully-diluted) EPS change (%) (37.4) Daiwa vs Cons. EPS (%) (21.3) (5.7) (7.3) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) See important disclosures, including any required research certifications, beginning on page 81

47 Jan 1 5 Ma r 1 5 Ma y 15 Jul 15 Sep 15 Nov 15 Aug -14 Sep -14 Oct-1 4 Nov-14 Dec-14 Jan-15 Feb-15 Ma r-15 Apr-1 5 Ma y-15 Jun-15 Jul-1 5 Aug -15 Sep -15 Oct-1 5 Nov-15 Dec-15 Jan-16 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 in 2015E due to an absence of gains from the revaluation of its agriculture produce at its US hog-raising operation (2014: about USD 300m). We expect net profit growth to resume in E, on a recovery in the company s sales volume growth in both China and the US through its improved packaged-meat product mix. (USDm) (% ) 1,5 00 1,3 00 1, (100) (300) Source: Company, Daiwa forecasts 38% 66% -28% 33% E 20 16E 20 17E Reported net profit (LHS) Reported net profit Y oy % Recurring net profit (LHS) 90 % 70 % 50 % 30 % 12% 10 % -10% -30% Valuation WH Group: 12-month forward PER bands since listing The stock is now trading at 2016E PER of 10x, which looks attractive to us compared with the other major China staples companies (trading at an average 2016E PER of 18x on our forecasts). In our view, WH Group s discount to its peers has priced in the risks of: 1) volatile hedging gains or losses in its agriculture product future contracts for its US hog production business, and 2) potential share sales by some financial investors after their lock-ups expire (6-12 months after the August 2014 IPO). (HKD) HK 7x 8.5 x 10 x 11.5x 13 x Earnings revisions The Bloomberg consensus E EPS forecasts for WH Group have trended down since 2015 due to rising pork prices. While our forecasts are below the consensus, due to the likely absence of revaluation gains, 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 lower feed costs. WH Group: Bloomberg 2015 and 2016 consensus EPS (USD) (USD) E 20 16E 47

48 WH Group (288 HK): 26 January 2016 Financial summary Key assumptions Packaged meat revenue YoY - China (%) n.a. n.a (0.9) (8.5) Packaged meat revenue YoY - U.S. (%) n.a. n.a. n.a. n.a (2.2) Fresh meat revenue YoY - China (%) n.a. n.a Fresh meat revenue YoY - U.S. (%) n.a. n.a. n.a. n.a Operating margin - China (%) n.a Operating margin - U.S. (%) n.a. n.a. n.a Profit and loss (USDm) Hog production 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 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 ,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 Pre-tax profit ,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) (263) Net profit (adjusted) EPS (reported)(usd) n.a (0.023) EPS (adjusted)(usd) n.a EPS (adjusted fully-diluted)(usd) n.a DPS (USD) n.a EBIT ,050 1,806 1,412 1,623 1,733 EBITDA ,223 2,165 1,795 2,031 2,160 Cash flow (USDm) Profit before tax ,420 1,208 1,452 1,593 Depreciation and amortisation n.a Tax paid n.a. (101) (126) (250) (476) (406) (429) (456) Change in working capital n.a (48) 327 (147) (253) (276) Other operational CF items n.a (419) Cash flow from operations ,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 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 , Dividends paid n.a. (38) (105) (90) 0 (235) (300) (333) Other financing CF items n.a (2,636) (127) (215) (196) (169) Cash flow from financing (463) 4,512 (605) (1,450) (1,196) (1,003) Forex effect/others Change in cash (371) (103) (718) (417) 56 Free cash flow 0 (3) 515 (205) ,068 Source: FactSet, Daiwa forecasts 48

49 WH Group (288 HK): 26 January 2016 Financial summary continued Balance sheet (USDm) As at 31 Dec E 2016E 2017E Cash & short-term investment 0 1, ,083 1, ,053 Inventory n.a ,808 1,900 2,090 2,299 2,529 Accounts receivable n.a Other current assets n.a ,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 ,615 3,561 3,561 3,561 3,561 Other non-current assets n.a ,242 1, Total assets 0 3,882 3,497 14,156 14,720 14,493 14,648 15,095 Short-term debt n.a Accounts payable n.a Other current liabilities n.a ,211 1,553 1,553 1,553 1,553 Total current liabilities 0 1, ,822 3,122 3,207 3,207 3,207 Long-term debt n.a ,672 3,951 2,951 2,251 1,751 Other non-current liabilities n.a ,524 1,597 1,597 1,597 1,597 Total liabilities 0 1, ,018 8,670 7,755 7,055 6,555 Share capital 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 ,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 Key ratios (%) Sales (YoY) n.a. n.a (1.0) EBITDA (YoY) n.a. n.a (17.1) Operating profit (YoY) n.a. n.a (21.8) Net profit (YoY) n.a. n.a (27.6) Core EPS (fully-diluted) (YoY) n.a. n.a (37.4) Gross-profit margin n.a EBITDA margin n.a Operating-profit margin n.a Net profit margin n.a ROAE n.a ROAA n.a ROCE n.a ROIC n.a (2.0) Net debt to equity n.a. n.a. n.a Effective tax rate n.a Accounts receivable (days) n.a Current ratio (x) n.a Net interest cover (x) n.a Net dividend payout n.a n.a Free cash flow yield 0.0 n.a. 6.2 n.a 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. 49

50 China R esources Beer China Consumer Staples 26 January 2016 China Resources Beer (291 HK) 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 CRB continues to gain market share Maintain Hold (3) as acquisition seems to have been priced in Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: Acquisition already priced in? According to a Hong Kong Economic Journal report in December 2015, China Resources Beer (CRB) (the former China Resources Enterprise) is seeking an investment bank to act as a financial advisor to assist in the acquisition of the remaining 49% stake in the CR-Snow JV, a venture between CRB and UK-based 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 51% stake already) (also see What if AB-InBev merges with SABMiller, 17 September 2015). We would see this scenario playing out in mid We keep our Hold (3) rating on CRB as we believe its valuation is fair. What's the impact: Key assumptions for a stake acquisition. We are revising up our E EPS by 3-19% assuming: 1) the acquisition is done at a c.22x 2016E PER (our target PER for CRB) and is fully funded by bank financing at an interest rate of 4% per year, and 2) CRB maintains its ASP and market-share gains over E without the support of SABMiller (we see this as a likely scenario, as CRB has accumulated a lot of technology and production experience from SABMiller over the past 20 years, while its sales team has been run independently). Arguably the only negative would be the subsequent increase in net gearing (which we estimate would reach 239% by end-2016, vs. 65% if the acquisition does not go ahead). Another scenario: 1) If CRB does not go ahead with the stake acquisition, we estimate its net profit would still grow by 16% YoY for 2016, driven by market-share gains. We expect the beer market to continue to shrink in 2016 (-5.7% in volume in 11M15), but believe CRB will still report flat sales volume. 2) After acquiring the stake from SABMiller, we would not rule out the possibility of CRB seeking co-operation with another international brand to expand its share of China s high-end beer market. What we recommend: We maintain our Hold (3) rating and lower our 12- 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 E 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (4.7) (6.5) (6.2) Net profit change (9.6) Core EPS (FD) change (9.6) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 China Reso (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 2,421 Major shareholder CRNC (51.9%) Financial summary (HKD) Year to 31 Dec 15E 16E 17E Revenue (m) 34,823 36,141 37,770 Operating profit (m) 2,746 3,116 3,760 Net profit (m) 874 1,282 1,606 Core EPS (fully-diluted) EPS change (%) n.a Daiwa vs Cons. EPS (%) (10.0) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E 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

51 May 15 May 15 Jun 15 Jun 15 Jul 15 Jul 15 Aug 15 Aug 15 Sep 15 Sep 15 Oct 15 Oct 15 Oct 15 Nov 15 Nov 15 Dec 15 Dec 15 Jan 16 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 China Resources Beer (291 HK): 26 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We now forecast CRB s net profit to increase by 47% YoY for 2016 and 25% YoY for 2017, assuming its acquisition of the remaining stake in CR-Snow JV goes ahead. The acquisition would almost double CRB s profit-after tax (as its stake in the JV would increase from 51% to 100%, and the JV owns all CRB s beer business in China). Even if the acquisition does not proceed, we forecast CRB s net profit to increase by 16% YoY for 2016 and 15% YoY for 2017, driven by product-mix upgrades that would drive up the operating margin by 0.7pp and 1.4pp, respectively. CRB: net profit and net-profit growth (HKDm) 1,800 1,600 1,400 1,200 1, Source: Company, Daiwa forecasts -19% 15% 47% E 2016E 2017E Net profit (LHS) YoY (RHS) 25% 60% 50% 40% 30% 20% 10% 0% (10%) (20%) (30%) Valuation CRB s valuation has been rerated since April 2015 after the former China Resources Enterprise announced plans to dispose of its non-beer businesses pay a special dividend and rename the company China Resources Beer (all completed in September 2015). Going forward, we believe CRB should trade at a premium to its pre-restructuring valuation due to its now higher earnings visibility through focusing on the beer business only. CRB: 12-month forward PER band (HKD) Our target valuation is now based on a 15% premium to peers average, based on CRB s expected operatingmargin expansion over and No.1 position in China s competitive beer market. 291.HK 15x 20x 25x 30x 35x Earnings revisions CRB: Bloomberg consensus E EPS Our E EPS are far above those of the Bloomberg consensus as we have factored in the impact of the prospective acquisition. We expect the consensus to revise up its EPS forecast for the company if the acquisition takes place. But we do believe the street s EPS forecasts already factor in a potential rise in ASPs over due to the company s ongoing product-mix upgrades. (HKD) E 2016E 51

52 China Resources Beer (291 HK): 26 January 2016 Financial summary Key assumptions Beer sales volume YoY (%) (1.8) Beer ASP (YoY %) Beer EBITDA margin (%) Sales volume contribution fromhigh-end products Profit and loss (HKDm) Retail 55,140 70,088 83,506 95, ,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, , , , ,678 34,823 36,141 37,770 Other income 1,976 1,683 2,041 2,381 2, 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 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, (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) (0.067) (1.456) EPS (adjusted)(hkd) (0.331) EPS (adjusted fully-diluted)(hkd) (0.331) DPS (HKD) 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) 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) ,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) ,000 (29,000) 0 Other investing CF items (2,386) 1,671 1, 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) 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) Change in cash 5,543 4,185 (2,251) 5,195 (553) (6,283) (28,655) 736 Free cash flow 2, (566) 3,576 (6,756) (3,207) 2,010 2,846 Source: FactSet, Daiwa forecasts 52

53 China Resources Beer (291 HK): 26 January 2016 Financial summary continued Balance sheet (HKDm) As at 31 Dec E 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 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, , , , ,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 ,155 1, 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, ,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, Total equity & liabilities 89, , , , ,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) Key ratios (%) Sales (YoY) (79.5) EBITDA (YoY) (25.3) 40.2 (43.0) 12.1 Operating profit (YoY) (64.4) Net profit (YoY) (19.2) 7.5 n.a. n.a Core EPS (fully-diluted) (YoY) (19.2) 7.4 n.a. n.a Gross-profit margin EBITDA margin Operating-profit margin Net profit margin (0.5) ROAE n.a ROAA n.a ROCE ROIC Net debt to equity n.a. n.a Effective tax rate n.a Accounts receivable (days) Current ratio (x) Net interest cover (x) Net dividend payout n.a. n.a Free cash flow yield n.a n.a. n.a Source: FactSet, Daiwa forecasts Company profile China Resources Beer is a subsidiary of China Resources National Corporation (CRNC), a stateowned 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

54 Heng an Inter national Gr oup Hong Kong Consumer Staples 26 January 2016 Hengan International Group (1044 HK) 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 Cutting E EPS by 7-17% on lower sales, forex losses Downgrading rating and TP; share-price downside looks limited Anson Chan, CFA (852) What's new: As highlighted in our industry section: 1) foreign brands continue to gain share in China s personal hygiene product market, and 2) revenue from the e-commerce channel has been growing quicker than that from traditional channels. We believe Hengan will be a victim of such trends. However, as the stock is already trading near its trough valuation since 2008, we see limited downside to its share price at the current level. Downgrade to Hold (3) from Outperform (2). What's the impact: Personal care products. While we believe Hengan will maintain its No.1 position in China s sanitary napkin market (21-22% market share, on our estimates), we see its growth prospects being increasingly challenged as international brands deepen their market presence in lower-tier cities. Hengan has become less competitive on price relative to Japan brands given import tariff reductions and increased cross-border purchases. At the 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 E revenue for diapers and sanitary napkins by 11-15% and now assume no volume growth in these segments. Tissue paper: In 1H15, Hengan reported a 2% YoY decline in revenue in the tissue paper segment. Going forward, we expect increasing headwinds and price competition. Hengan has little exposure to the e-commerce channel, where tissue paper sales are expanding rapidly (20%-plus YoY in 2015E for Hengan s closest domestic competitor, Vinda (3331 HK, HKD13.00, Outperform [2]). Also, since most players are aggressively cutting prices and going for market share, we think Hengan is unlikely to raise product ASPs in E. Our revised forecasts call for only 1% per year growth in sales volume for Hengan in this segment over E. What we recommend: We cut E EPS by 7-17% after factoring in: 1) lower revenue forecasts assuming Hengan fails to gain further market share, and 2) higher financial costs associated with its HKD debt due to 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (2.1) (7.5) (11.1) Net profit change (6.9) (12.8) (17.1) Core EPS (FD) change (6.8) (12.4) (16.6) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Hengan (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 1,223 Major shareholder Sze Man Bok (18.6%) Financial summary (HKD) Year to 31 Dec 15E 16E 17E Revenue (m) 24,304 24,118 24,386 Operating profit (m) 6,111 6,202 6,210 Net profit (m) 4,281 4,493 4,559 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) 2.2 (2.5) (10.7) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E 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

55 Jan-15 Jan-15 Feb-15 Ma r-15 Ma r-15 Apr-1 5 Ma y-15 Ma y-15 Jun-15 Jul-1 5 Aug -15 Aug -15 Sep -15 Oct-1 5 Oct-1 5 Nov-15 Dec-15 Hengan International Group (1044 HK): 26 January 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook We forecast Hengan s net profit growth to slow significantly from 9% YoY in 2015E to 5% YoY in 2016E and 2% YoY in 2017E, on revenue growth of -1% and 1% YoY in E, with tissue paper likely to be the only segment to record growth. Also, we assume forex losses of HKD150m and HKD120m, respectively, as part of its financial costs, in E due to the CNY s depreciation against HKD. Favourable petrochem costs should support a slight rise in Hengan s gross margin in 2016E, but the impact is likely to be tempered by the increased revenue contribution of tissue paper, on which the operating margin is relatively low. Hengan: net profit and net-profit growth (HKDm) 5, % 4, % 30 % 3, % 2, % 1, % 10 % 0 5% (1,000 ) 0% E 20 16E 20 17E Net profit (HKD m) Fore x gain / loss YoY % Source: Company, Daiwa forecasts Valuation The stock is trading currently at an 18x 2016E PER on our EPS forecast, near the bottom of its PER band since We see the risk of a further derating in the long term, since we expect EPS growth to decelerate again in 2017E However, that risk may not eventuate in 2016 following the recent sell-off and as the potential disposal of non-core businesses could boost investors confidence in management. Hence, we see limited valuation downside in 2016E. Hengan: 12-month forward PER band (HKD) Aug 08 Aug 09 Aug 10 Aug 11 Aug 12 Aug 13 Aug 14 Aug HK 18x 21x 24 x 27 x 30 x Earnings revisions Hengan: Bloomberg consensus EPS ( E) The Bloomberg-consensus 2015E and 2016E EPS forecasts for Hengan have trended down slowly since 2015, and we see further downside to the market s forecasts on the back of lower-than-expected revenue growth. Our 2016E EPS is 3% below that of the consensus. (HKD) E 20 16E 55

56 Hengan International Group (1044 HK): 26 January 2016 Financial summary Key assumptions Sanitary napkin volume YoY Diapers volume YoY (4) 3 (4) (3) (1) (1) Tissue paper volume YoY (1) 0 Sanitary napkin ASP YoY Diapers ASP YoY Tissue paper ASP change YoY (8.7) (0.0) (1.9) Profit and loss (HKDm) 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 , 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 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 (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) EPS (adjusted)(hkd) EPS (adjusted fully-diluted)(hkd) DPS (HKD) 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) Profit before tax 3,038 3,255 4,539 5,201 5,213 5,478 5,805 6,112 Depreciation and amortisation ,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) Other operational CF items (39) 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 Other investing CF items 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) (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, ,926 5,714 (4,418) (3,690) (8,052) (7,971) Forex effect/others (68) (44) 12 (279) Change in cash 1,716 1,190 2,713 7,962 (230) 640 (3,553) (3,576) Free cash flow ,515 3,798 4,060 4,259 4,345 Source: FactSet, Daiwa forecasts 56

57 Hengan International Group (1044 HK): 26 January 2016 Financial summary continued Balance sheet (HKDm) As at 31 Dec E 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 ,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 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, ,787 6,187 5,390 5,390 5,390 5,390 Other non-current liabilities Total liabilities 7,752 10,600 14,797 23,272 24,514 24,557 19,635 14,800 Share capital 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 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) Key ratios (%) Sales (YoY) (0.8) 1.1 EBITDA (YoY) Operating profit (YoY) Net profit (YoY) Core EPS (fully-diluted) (YoY) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a. n.a n.a. n.a. n.a. n.a. n.a. Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a Net dividend payout Free cash flow yield 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. 57

58 Tingyi Cayman Isl ands China Consumer Staples 26 January 2016 Tingyi Cayman Islands (322 HK) 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 Beverage segment to resume earnings growth on new products Downgrading to Hold (3); cut TP to HKD9.6; E EPS lowered Anson Chan, CFA (852) What's new: Given our concerns on Tingyi s product mix changes since October 2015 and the likely negative impact on both its market share and long-term revenue outlook as a local Goliath, we downgrade the stock to Hold (3) from Outperform (2). For 2016, we do not see much potential downside for its share price, and would advise investors to sit on the stock for now. What's the impact: Risk of noodle market-share loss: In Oct 2015, Tingyi adjusted its product mix (content upgrade + ASP hike) for noodles. Unlike other price hikes over the past 5 years, none of its major competitors has followed suit. Hence, Tingyi may lose market share among price sensitive consumers and in the traditional channels. We expect its noodle business revenue to fall by 11%/2% YoY in 2015/16E (previously: 10%/+3%), with a 1pp decline in the gross margin over E on growing raw-material costs and a lower-thanexpected utilisation rate (previously: 2pp gross-margin expansion). New beverage products: Assuming a revenue decline in the bottled-water business but increasing revenue contribution from functional drinks (ie, vitamin drinks), we cut our revenue-growth forecast to 3% per year over E (from 4%), after a 9% YoY decline in 2015E. We expect: 1) negative impact from termination benefits due to layoffs at the Pepsi unit lingering into 2016E as Tingyi will need to restructure this division further to drive long-term revenue, and 2) sugar costs to rebound in 2016E, impacting COGS. Accordingly, we expect Tingyi s gross margin to be flat over E despite product-mix upgrades. Cutting E EPS by 4-16%, on: 1) a 1-5% cut in our revenue forecasts on our concern of market-share loss in the noodles segment, 2) FX losses of USD50m in 2016E (accounting for 13% of 2016E net profit) due to the CNY depreciation vs. the USD, and 3) gross-margin erosion from rising palm oil prices and a falling utilisation rate for the noodles segment. 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (1.4) (3.7) (5.3) Net profit change (3.9) (12.4) (16.3) Core EPS (FD) change (3.9) (12.4) (16.3) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Tingyi Hdg (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 5,600 Major shareholder Wei Ing-chou (33.8%) Financial summary (USD) Year to 31 Dec 15E 16E 17E Revenue (m) 9,272 9,326 9,561 Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) (6.8) Daiwa vs Cons. EPS (%) (0.5) (11.7) (11.2) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E 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

59 Jan-15 Jan-15 Feb-15 Ma r-15 Apr-1 5 Apr-1 5 Ma y-15 Jun-15 Jun-15 Jul-1 5 Aug -15 Aug -15 Sep -15 Oct-1 5 Oct-1 5 Nov-15 Dec-15 Dec-15 Jan-08 Ma y-08 Aug -08 Dec-08 Apr-0 9 Aug -09 Dec-09 Apr-1 0 Aug -10 Dec-10 Apr-1 1 Aug -11 Dec-11 Apr-1 2 Aug -12 Dec-12 Apr-1 3 Aug -13 Dec-13 Ma r-14 Jul-1 4 Nov-14 Ma r-15 Jul-1 5 Nov-15 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% YoY over E, mainly driven by operating-margin expansion in the beverage unit from cost savings (absence of termination-benefit expenses and operating leverage in the Pepsi unit). For the noodles business (about 70% of net profit over E), we expect a 13% YoY net-profit decline in 2015E, then forecast it to remain flat over on market-share losses. We believe the beverage segment s gross margin will be largely steady YoY in 2016E as product-mix upgrades could offset the increase in sugar costs. We expect the ASP hike in the noodle segment to offset the increased flour and palm oil costs as well as the lower utilisation rate due to falling sales volume. (USDm) % % 10 % % 5% % 1.6% 0% % 0 (5%) -6.8% (100) (10%) E 20 16E 20 17E Noodles Beverage Others Recurring profit growth YoY % Source: Company, Daiwa forecasts Valuation Tingyi: 12-month forward PER bands since 2008 The stock is currently trading at 17x 2016E PER. We see the risk of a major derating of the stock in the long run as we expect Tingyi s EPS growth to be structurally lower compared to the past. But this risk may have already been factored in by the market after the recent sell-off. Thus, we see limited downside to the share price from current levels, as: 1) we expect EPS growth to recover to 6% CAGR over E after declining in 2015E, and 2) the stock is already trading near its trough valuation, seen in (HKD) HK Earnings revisions Tingyi: Bloomberg consensus EPS forecast ( E) Although the Bloomberg consensus EPS estimates for have continued to trend down over the past 12 months due the results for the past 3 quarters missing consensus expectations, we still see downside risk to consensus revenue estimates for We would consider making further revenue cuts if new products in the beverage segment failed to drive revenue growth. (USD) E 2016E 59

60 Tingyi Cayman Islands (322 HK): 26 January 2016 Financial summary Key assumptions Sales growth YoY - instant noodles (4.5) (10.7) (2.2) 1.4 Sales growth YoY - beverages (7.5) (8.7) Gross margin % - instant noodles Gross margin % - beverages Sellling and distribution expense ratio (%) Profit and loss (USDm) 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 Total Revenue 6,681 7,857 9,212 10,941 10,238 9,272 9,326 9,561 Other income 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 Net-interest inc./(exp.) (7) (9) (33) (37) (47) (75) (92) (61) Assoc/forex/extraord./others Pre-tax profit 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) Net profit (adjusted) EPS (reported)(usd) EPS (adjusted)(usd) EPS (adjusted fully-diluted)(usd) DPS (USD) EBIT EBITDA ,092 1,118 1,186 1,213 1,313 1,385 Cash flow (USDm) Profit before tax Depreciation and amortisation Tax paid (96) (130) (138) 386 (223) (232) (194) (191) Change in working capital (158) (354) (185) 18 Other operational CF items (1,050) Cash flow from operations 19 1, ,788 1, ,212 Capex (966) (1,349) (882) (896) (1,100) (600) (550) (550) Net (acquisitions)/disposals (380) Other investing CF items Cash flow from investing (966) (1,349) (882) (896) (1,480) (600) (550) (550) Change in debt (382) (447) 0 Net share issues/(repurchases) Dividends paid (192) (239) (210) (180) (197) (200) (187) (193) Other financing CF items 93 (38) (85) (113) (142) (121) Cash flow from financing (61) (696) (776) (314) Forex effect/others Change in cash (746) 269 (60) (669) (391) 348 Free cash flow (947) (70) Source: FactSet, Daiwa forecasts 60

61 Tingyi Cayman Islands (322 HK): 26 January 2016 Financial summary continued Balance sheet (USDm) As at 31 Dec E 2016E 2017E Cash & short-term investment ,250 1, Inventory Accounts receivable Other current assets 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 Other non-current assets Total assets 4,891 5,809 7,473 8,424 9,206 8,817 8,685 9,061 Short-term debt ,017 1,382 1, Accounts payable 1, ,043 1, Other current liabilities ,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 ,247 1,247 1,000 1,000 Other non-current liabilities Total liabilities 2,522 3,123 3,976 4,498 5,110 4,489 4,079 4,133 Share capital 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 ,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) ,446 1,482 1, BVPS (USD) Key ratios (%) Sales (YoY) (6.4) (9.4) EBITDA (YoY) (2.8) Operating profit (YoY) (3.5) (5.3) Net profit (YoY) (11.3) 11.9 (2.9) (6.8) Core EPS (fully-diluted) (YoY) (11.3) 11.9 (2.9) (6.8) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) Net dividend payout Free cash flow yield n.a. n.a 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

62 China M eng niu D air y China Consumer Staples 26 January 2016 China Mengniu Dairy (2319 HK) Target price: HKD11.70 (from HKD14.50) Share price (25 Jan): HKD11.08 Up/downside: +5.5% Competition remains stiff Cutting E EPS by 5-15% on higher selling cost, slower revenue Limited share price downside as trading near low PER Hence, we maintain Hold (3) on valuation grounds Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: We recently visited the food retailers and learned that Mengniu s dominant position in the premium UHT milk market is now being challenged by the small players that can differentiate themselves from Mengniu in terms of the origins of the milk that they sell (100% in-house made raw milk or sourced overseas). We maintain our Hold (3) as competition remains fierce in the dairy downstream market. What's the impact: Key concerns: 1) Internal product cannibalisation. We are concerned that the rapidly growing demand for Mengniu s yogurt products (+74% YoY revenue growth for 1H15) will continue to take sales volume away from its premium milk business, due to the substitution effect. And, we now expect more new rivals in the UHT segments (imported substitutes and UHT yogurt in particular). Accordingly, for 2015E, we estimate that Mengniu s share of the premium milk market was 50% (vs. 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 2015E (vs. c.20% for 2014). 2) Infant formula: Mengniu recently injected its Oushi Mengniu infant formula business into its subsidiary, Yashili. And subject to shareholder approval, we expect it to acquire Danone s infant formula brand in China, Dumex, in 1H16E. But we are concerned that Yashili s weak online distribution will not improve after the acquisition, and that the brand will continue to lose market share to foreign brands and face increasing selling costs in 2016E. Cutting E EPS by 5-15%. 1) Due to the loss of market share in the premium milk segment, we are cutting our E revenue by 1-2%. We still expect selling costs, as a percentage of revenue, to remain high, at % over E (previous forecast: 20%) due to the lower revenue base and price promotions for new products, 2) on ASP pressure, we expect Mengniu s gross margin to decline by 1pp for 2016E, to 31.2%. What we recommend: Given our lower EPS forecasts, we are cutting our 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 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (1.0) (1.2) (1.6) Net profit change (4.5) (15.4) (15.2) Core EPS (FD) change (4.5) (15.4) (15.2) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 CMD (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) Shares outstanding (m) 3,883 Major shareholder COFCO (16.3%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E 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 Core EPS (fully-diluted) EPS change (%) 11.6 (4.1) 11.1 Daiwa vs Cons. EPS (%) 2.9 (9.9) (14.1) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 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

63 Jan 15 Feb 15 Mar 15 Apr 15 May 15 Jun 15 Jul 15 Aug 15 Sep 15 Oct 15 Nov 15 Dec 15 Jan 16 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 and the more intense competition, we expect Mengniu s revenue growth to recover only slightly, to 4% and 3% for E, respectively, versus a decline of 2% for 2015E. But this will likely come at the expense of rising selling expenses and price promotions. Hence, we expect the EBITDA margin to decline to 8.8% for 2016E, from 9.3% for 2015E. We forecast EPS to decline by 4% YoY for 2016E, before rebounding to 11% YoY growth for 2017E on a slight improvement in operating leverage. (CNYm) 3,000 2,500 2,000 1,500 1, % 39% 40% 28% 30% 20% 16% 15% 11% 10% 0% -4% -10% -13% -20% E 2015E 2016E 2017E Net profit (LHS) YoY (RHS) Source: Company, Daiwa forecasts Valuation The stock is trading currently at a 2016E PER of 15x. This is in line with the average of its major China food and beverage peers, on our forecasts. We believe the stock is fairly valued given what we see as its lacklustre revenue outlook. We would need to see successful M&A activity in its infant formula business and a successful product-mix upgrade in order for the stock to be rerated. However, as the stock is already trading near the low-end of its past-5- year 12-month forward PER (13x), we see limited potential share-price downside. Mengniu: past-5-year 12-month forward PER bands (HKD) Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Mengniu Earnings revisions Mengniu: Bloomberg E EPS forecasts Our 2015 EPS forecast is in line with that of the Bloomberg consensus but our 2016 and 2017 EPS forecasts are 10% and 14% below, as we have built in the intensifying competition and slower domestic dairy market revenue growth. We would also see downside to our and the street s EPS forecasts if Mengniu s infant formula business were to turn loss-making in E, after acquiring Dumex. (HKD) E 2016E Source:: Bloomberg 63

64 China Mengniu Dairy (2319 HK): 26 January 2016 Financial summary Key assumptions Sales growth YoY % - Liquid Milk n.a. 25 (4) (1) 3 3 Sales growth YoY %- Infant formula n.a. n.a. n.a (11) 11 2 ASP hike % n.a (2.0) (1.8) (1.2) SG&A cost ratio % n.a Profit and loss (CNYm) 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 ,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 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.) Assoc/forex/extraord./others (53) 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) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) 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) Profit before tax 1,538 2,061 1,813 2,205 3,032 3,359 3,276 3,622 Depreciation and amortisation ,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 (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 (9,495) (372) (2,506) 0 0 Other investing CF items 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) , 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 Change in cash (492) 1,434 (3,023) (3,149) (76) 415 Free cash flow (1,445) (329) 896 1,148 1,598 Source: FactSet, Daiwa forecasts 64

65 China Mengniu Dairy (2319 HK): 26 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 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 ,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 ,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 ,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 ,236 5,464 4,957 4,460 3,972 Other non-current liabilities ,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 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 ,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) Key ratios (%) Sales (YoY) (3.5) (1.9) EBITDA (YoY) (1.1) (2.0) 7.2 Operating profit (YoY) (11.0) (6.9) 6.8 Net profit (YoY) (13.0) (4.1) 11.1 Core EPS (fully-diluted) (YoY) (13.0) (4.1) 11.1 Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a. n.a. n.a Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a. n.a 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. 65

66 Fufeng Group Hong Kong Materials 26 January 2016 Fufeng Group (546 HK) 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 Hence, we cut our E EPS; but limited share price downside Downgrading to Hold (3); cutting EPS by 5-25%, TP to HKD2.55 Anson Chan, CFA (852) What's new: On the back of the decline in input costs in 2H15, the price of Fufeng s MSG fell by 8% HoH for 2H15 and we expect a further fall of 10% for 2016E. Weak oil prices are also likely to weigh on Fufeng s ASPs. What's the impact: Pricing pressure intensifying: 1) for September- 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 aim of pushing competitors out of the market. We are cutting cut our MSG ASP assumptions by 2% for 2015E and 8% for E. We now forecast the unit gross profit of its MSG to stay at c.cny800/tonne (last trough was in 2013), as we think Fufeng has a scale advantage (previous forecast: a rise of c.cny 220/tonne for 2016E). We expect the MSG price to fall in line with corn costs in 2016E, driven by policy changes (see the sector portion of this report), 2) the price of the company s xanthan gum (XG) fell by 30% 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 CNY13,000/tonne for 2016E, down 14% YoY. But potential XG price downside looks limited as: 1) demand from the food-processing segment (accounting for c.40-45% of total revenue) is steady, and 2) we believe the current price is close to the cash cost level of its domestic peers. Earnings CAGR of 8% for E (previously: 22%): We cut our E core EPS for Fufeng by 5-25%, due to the falling prices for XG and MSG. But we raise our MSG sales volume forecasts by an average of 13% for E, as Fufeng plans to enhance its production lines in Inner Mongolia and northeast China, with new technology improving the yield and leading to cost reductions. We also expect financial cost savings of CNY118m for 2016E on lower debt and because it replaced some bank loans with domestic bonds issued in November What we recommend: Given our revised EPS forecasts, we are cutting our 12-month TP to HKD2.55 (from HKD5.0). We also cut our target PER to 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 E, 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. Forecast revisions (%) Year to 31 Dec 15E 16E 17E 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) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Fufeng Gp (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 1.57 Shares outstanding (m) 2,113 Major shareholder Li Xue Chun (46.2%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 11,761 12,869 12,992 Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) (19.5) Daiwa vs Cons. EPS (%) (22.2) (36.5) (38.7) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our E 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

67 Jan-15 Jan-15 Feb-15 Mar-15 Mar-15 Apr-15 May-15 May-15 Jun-15 Jul-15 Jul-15 Aug-15 Sep-15 Oct-15 Oct-15 Nov-15 Dec-15 Dec-15 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 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 E on the back of lower financial costs as well as growth in MSG sales. In our model, we have factored in a 10% decline in the price of MSG and a 13% decline in the price of its XG in 2016E. MSG and its by-products should together account for more than 80% of Fufeng s operating profit in E, and our sensitivity analysis shows that a CNY100 increase in the price of the company s MSG would lead to a 14% increase in its net profit E 2016E 2017E Reported net profit (CNY m) Recurring profit (CNY m) Recurring profit YoY% Source: Company, Daiwa forecasts 30% 20% 10% 0% (10%) (20%) (30%) (40%) (50%) Valuation Fufeng: 12-month forward PER bands In 2015, the stock was derated from a 12x 12-month forward PER to 9x amid falling product ASPs. It is currently trading at 9x 2016E PER, on our estimates, which is close to the middle of its past-5-year 12-month forward PER range of 6-12x. We believe this reflects the product pricing pressure that we anticipate for 2016E, as well as the more favourable corn cost outlook. Hence, we recommend waiting for product ASPs to recover (ie, after 2017E) before revisiting the stock. (HKD) HK 6x 7.5x 9x 10.5x 12x Earnings revisions Fufeng: Bloomberg consensus EPS (HKD) The Bloomberg consensus EPS forecasts for Fufeng have trended down since the company missed the consensus expectations for 1H15. We see further downside to the E consensus EPS forecasts, as we are cautious on the company s MSG and XG prices. (HKD) E 2016E 67

68 Fufeng Group (546 HK): 26 January 2016 Financial summary Key assumptions 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) , ,077 1,077 Sales volume - Xanthan gum (000 tonnes) GPM - MSG segment (%) GPM - Xanthan gum (%) Profit and loss (CNYm) MSG segment 5,350 7,024 9,539 9,114 8,605 9,481 10,376 10,499 Xanthan gum segment ,066 1,454 1, Other Revenue ,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 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, , Net-interest inc./(exp.) (32) (62) (245) (290) (346) (265) (147) (167) Assoc/forex/extraord./others Pre-tax profit 1, Tax (105) (112) (64) (129) (148) (142) (121) (126) Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(cny) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) EBIT 1, , EBITDA 1,358 1,146 1,268 1,623 1,840 1,693 1,664 1,770 Cash flow (CNYm) Profit before tax 1, Depreciation and amortisation 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 Cash flow from operations 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 Other investing CF items Cash flow from investing (1,912) (2,419) (1,800) (1,180) (1,749) (601) (900) (500) Change in debt 938 2, (300) (724) (913) Net share issues/(repurchases) 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, (423) (625) (1,091) (1,232) Forex effect/others Change in cash 274 (353) (154) (79) (65) (127) Free cash flow (253) (1,945) (772) 75 (171) 248 1,026 1,105 Source: FactSet, Daiwa forecasts 68

69 Fufeng Group (546 HK): 26 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 2016E 2017E Cash & short-term investment 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 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 Other non-current assets ,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 ,408 1, Accounts payable 1,839 2,631 3,304 2,891 3,203 3,457 3,850 3,852 Other current liabilities 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 Total liabilities 3,575 6,453 8,176 7,800 8,325 8,279 7,948 7,037 Share capital 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 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) Key ratios (%) Sales (YoY) (0.6) EBITDA (YoY) 9.3 (15.6) (8.0) (1.7) 6.4 Operating profit (YoY) 5.2 (29.5) (5.5) (20.4) (8.4) 8.7 Net profit (YoY) 4.1 (37.5) (29.4) (18.6) Core EPS (fully-diluted) (YoY) 4.1 (39.6) (29.4) (19.5) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) Net dividend payout Free cash flow yield n.a. n.a. n.a. 1.6 n.a 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 Corn is the company s major raw material, accounting for about 60% of its COGS for Its production plants are located in Inner Mongolia, Xinjiang and Shaanxi. 69

70 Tsingtao Brewer y China Consumer Staples 26 January 2016 Tsingtao Brewery (168 HK) 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 ROE continuing to decline on inefficient use of net cash Reiterate Underperform (4); cutting TP on lower EPS forecasts Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: We believe Tsingtao will remain a victim of market-share losses to international brands in the premium beer segment in China in 2016E. Similar to other Goliaths, Tsingtao is finding it hard to grow its revenue from a high per capita base of beer consumption in China. Hence, we reiterate our Underperform (4) rating. What's the impact: Risks losing further market share amid weak industry outlook. We see rising competition for Tsingtao beer from other alcoholic drinks, such as wine (imported volume +42% YoY in China in 2015E) and Chinese liquor (+7% YoY in sales volume for 9M15). Beer industry sales in China also face pressure given a high base, with per capita consumption in China currently at c. 37 litres a year, in line with the global average and accounting for c. 80% of alcohol consumption in China. In 2016E, we expect continued weak demand for beer (for 11M15, industry 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 secondlargest player in China), while the other top-3 players gained market share. Tsingtao lost ground in the high-end segment in 2015E to its main competitor, AB-InBev, and we think this loss could widen in 2016E as we see a lack of product differentiation and marketing strategy. Sitting on its cash. We estimate Tsingtao was sitting on net cash of CNY6.2bn as at end-december 2015 (vs. CNY6bn as at end-december 2014), and we forecast its ROE to slide from 13.6% in 2014 to 10.3%/9.4% for 2015/16E, respectively. We believe Tsingtao is finding it hard to identify meaningful acquisition targets at a reasonable price or those that could boost EPS, as the other A-share and H-share-listed beer companies are trading at PERs of 25-29x for 2016E, based on the Bloomberg consensus, vs Tsingtao s 20x. What we recommend: We reiterate our Underperform (4) rating, and cut our E revenue by 1-9% as we expect its sales volume to decline. And to reflect its higher selling expenses needed to keep up with its competitors, we are also cutting our E 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 to 2% over E. The main risks to our rating: price hikes and EPS-accretive M&A. Forecast revisions (%) Year to 31 Dec 15E 16E 17E Revenue change (1.4) (7.6) (8.6) Net profit change (7.2) (10.4) (4.8) Core EPS (FD) change (7.2) (10.4) (4.8) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 Tsingtao B (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 7.90 Shares outstanding (m) 1,351 Major shareholder Tsingtao Brewery Grp (30.5%) Financial summary (CNY) Year to 31 Dec 15E 16E 17E Revenue (m) 28,092 26,912 27,286 Operating profit (m) 1,758 1,628 1,761 Net profit (m) 1,636 1,610 1,714 Core EPS (fully-diluted) EPS change (%) (17.9) (1.6) 6.5 Daiwa vs Cons. EPS (%) (1.3) (7.2) (6.4) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) How we differ: Our revised revenue forecasts are 4-7% below the Bloomberg consensus as we assume lower ASPs than other analysts. Hence our E EPS estimates are 6-7% below the consensus. See important disclosures, including any required research certifications, beginning on page 81

71 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 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 18% and 2% YoY for E, respectively, on a decline in sales volume, at a CAGR of 6%, and less non-operating financing income over the same period. We expect a slight rebound in 2017E net profit (+6% YoY) on a higher ASP due to product mix upgrades and flat sales volume. CNY m 2,500 13% 15% 2,000 6% 10% 5% 1,500 2% 0% -2% 0% 1,000 (5%) (10%) 500 (15%) 0-18% (20%) E 2016E 2017E Recurring net profit one-off gain YoY Source: Company, Daiwa forecasts Valuation We believe Tsingtao s previously strong valuation was supported by its frequent M&A activity and continuous ASP hikes, both of which have ground to a halt. Our target price is based on a 2016E PER of 19x, a 10% discount to Tsingtao s past-5-year average. This discount is the same as the discount seen in 2012, when its operating-profit margin also came under pressure due to competition. Tsingtao: 12-month forward PER bands HKD HK Earnings revisions The Bloomberg-consensus EPS forecasts for have trended down since the beginning of 2015 as industry sales volume growth has been slowing QoQ. Our EPS forecasts are marginally lower than the consensus for 2015E, 7% lower for 2016E, and 6% lower for 2017E, as we are less optimistic on Tsingtao s sales-volume growth outlook due to it still losing market share in the premium segment. Tsingtao: Bloomberg-consensus EPS-forecast revisions HKD Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov E 2016E 71

72 Tsingtao Brewery (168 HK): 26 January 2016 Financial summary Key assumptions Sales volume growth YoY - Principal brand (4.0) (5.0) Sales volume growth YoY - Other brands (1.8) 0.0 (1.2) Average selling price (CNY / tonne) 3, , , , , , , ,271.6 Gross margin % Sellling and distribution expense ratio (%) Profit and loss (CNYm) Beer 19,614 22,790 25,318 27,767 28,599 27,642 26,462 26,836 others Other Revenue Total Revenue 19,898 23,158 25,782 28,291 29,049 28,092 26,912 27,286 Other income 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) Assoc/forex/extraord./others 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) EPS (adjusted)(cny) EPS (adjusted fully-diluted)(cny) DPS (CNY) 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) Profit before tax 2,051 2,438 2,483 2,665 2,687 2,257 2,217 2,359 Depreciation and amortisation ,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) (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) Other investing CF items Cash flow from investing (1,444) (4,210) (2,382) (2,036) (2,293) (2,000) (2,000) (2,000) Change in debt (109) (1,466) (3) 0 0 Net share issues/(repurchases) Dividends paid (216) (244) (351) (540) (608) (597) (521) (483) Other financing CF items 687 (6) Cash flow from financing (45) (1,690) (325) (100) (112) Forex effect/others Change in cash 2,357 (1,358) 1,054 1,590 (2,143) Free cash flow 2, ,635 (103) Source: FactSet, Daiwa forecasts 72

73 Tsingtao Brewery (168 HK): 26 January 2016 Financial summary continued Balance sheet (CNYm) As at 31 Dec E 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 Other current assets 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 ,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 , 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, 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 (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) Key ratios (%) Sales (YoY) (3.3) (4.2) 1.4 EBITDA (YoY) (0.9) (1.2) 3.7 (2.1) (1.1) 8.4 Operating profit (YoY) (7.4) 6.9 (7.4) (8.7) (7.4) 8.2 Net profit (YoY) (17.9) (1.6) 6.5 Core EPS (fully-diluted) (YoY) (17.9) (1.6) 6.5 Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout Free cash flow yield n.a 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 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. 73

74 China H uishan D airy Hol dings China Consumer Staples 26 January 2016 China Huishan Dairy Holdings (6863 HK) 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 Pricing pressure leading to our FY16-18E EPS cuts of 2-18% Reiterating Sell (5) on high net gearing, stretched valuation Anson Chan, CFA (852) anson.chan@hk.daiwacm.com What's new: As Huishan is still a small player in the liquid milk market of China (~2% in 1H15, on our estimates), we expect increasing marketing expenses and discounts in 2016E as it attempts to gain market share. We are also bearish on Huishan s ambitions in the infant formula business through a JV with FrieslandCampania, which targets to launch new infant formula products in 2H16E. As discussed in our sector note, we foresee increasing competition from foreign competitors that are much stronger than Huishan in e-commerce channels and the mass-market segment. On stretched valuation, we reiterate Sell [5]. What's the impact: Due to more promotional discounts among peers in the UHT milk industry at retail channels, we cut our FY16-18E revenue estimates by 1-3%. We also expect Huishan s cost advantage over other major dairy farms due to in-house feed production to diminish due to: 1) a 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 are higher than in its home turf of Liaoning province. We expect Huishan s free cashflow to remain negative over FY16-17E and net gearing to go up to 61-67% (also includes the impact of the aggressive share buybacks in 2015). Factoring in the cuts to our revenue forecasts, increasing financial costs, and valuation losses from biological assets (crops and cows), we revise down our FY16-18E EPS by 2-18%. What we recommend: We raise our valuation for the upstream business to HKD1.77 from HKD1.50 (DCF-based) by using new WACC assumptions based on the latest data. We value the downstream business at HKD0.1 per share (unchanged), based on 12x FY16E PER. We also raise our SOTP-based 12-month TP from HKD1.60 to HKD1.87, due to the reduced number of shares outstanding after share buyback in 2H15. The stock is now trading far above its peers PER range of 3-7x (upstream) and 14-27x (downstream), and we don t think the company s currently weak fundamentals justify the prevailing valuation (45x FY16E and 34x FY17E 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. Forecast revisions (%) Year to 31 Mar 16E 17E 18E Revenue change (1.0) (1.6) (2.8) Net profit change (1.9) (17.9) (18.1) Core EPS (FD) change (1.9) (17.9) (18.1) Source: Daiwa forecasts Share price performance (HKD) (%) Jan-15 Apr-15 Jul-15 Oct-15 CHDH (LHS) Source: FactSet, Daiwa forecasts Relative to HSI (RHS) 12-month range Market cap (USDbn) m avg daily turnover (USDm) 7.04 Shares outstanding (m) 13,473 Major shareholder Yang Kai (70.7%) Financial summary (CNY) Year to 31 Mar 16E 17E 18E Revenue (m) 4,470 5,558 6,327 Operating profit (m) 1,314 1,508 1,807 Net profit (m) ,133 Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) (12.3) (16.6) (5.5) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 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