中国 : 日常消费品 ( 摘要 ) 证券研究报告乳业进入 新常态 ; 执行能力将推动表现分化 ; 首次覆盖 : 伊利评为买入

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1 2016 年 8 月 13 日 中国 : 日常消费品 证券研究报告乳业进入 新常态 ; 执行能力将推动表现分化 ; 首次覆盖 : 伊利评为买入 ( 摘要 ) 中国乳制品行业进入 新常态, 奶价依然低迷我们认为, 一度快速增长的中国乳制品行业进入了增速处于低个位数的 新常态 该市场中的高收入消费者已经达到饱和点, 目前一二线城市的消费量已经与日本和韩国相当 同时, 由于经济增长放缓 乳制品对于低收入人群而言并非一项日常消费品, 我们预计低端消费者需求将处于低位 我们预计到 2020 年乳制品销量年均复合增速将仅为 3%, 并基于此预计中国原奶价格将保持在人民币 3.4 元 / 公斤的低位 虽然我们预计全球供应过剩状况将在未来 18 个月恢复平衡 但是因为中国奶价较国际价格高 3, 所以我们认为进口也将对抑制国内价格产生一定影响 高附加值产品将推动增长 ; 酸奶将蓬勃发展在当前的低增速阶段, 我们预计企业盈利增长将来自于 :(1) 一二线城市消费者偏好转向功能性 高蛋白质产品 ;(2) 二三线城市乳制品消费量逐步增长 我们预计, 被越来越多消费者认为营养丰富且有助消化的酸奶将有优于所有其它品类的表现, 年均复合增速将达到两位数, 市场规模将增长至当前的近两倍, 达到 220 亿美元 总体而言, 我们预计到 2020 年中国乳制品行业利润池将增长至当前的 1.6 倍, 达到 58 亿美元 我们的观点与市场观点的不同之处 1: 我们预计中国乳制品行业将在更长时间内呈增长放缓态势 : 渗透率并不像看上去那样低, 乳制品仍然并非生活必需品 2: 功能性高蛋白质产品将引领增长 酸奶将是未来五年的亮点所在 3: 伊利的利润率扩张被低估 强大的品牌和分销实力推动产品结构改善 到 2020 年酸奶市场规模预计将增长至当前的两倍, 达到 220 亿美元 ASP CAGR Flavored Milk 13bn->12bn Dairy Market Size E (US$) E Ice Cream IMF 17bn-18bn UHT milk 13bn->17bn Pasteurized Yogurt, 12bn ->22bn 当前执行是关键 ; 首次覆盖乳业, 买入伊利, 卖出中国旺旺在竞争加剧 增速放缓的环境下, 执行能力将是能否赢得市场份额的关键所在 在这方面伊利股份 ( 买入 ) 表现优异 : 公司凭借扁平化的单层经销网络可更好地感应消费者需求变化 ; 公司拥有领先的产品线 有效的品牌运营和经验丰富的管理团队, 我们预计这些优势将带来行业领先的较高回报, 年预期每股盈利年均复合增速为 13% 我们预计公司将凭借高端产品赢得市场份额, 并认为股价尚未反映利润率大幅改善的潜力 (2018 年预期营业利润率上升 170 个基点 ) 我们认为中国旺旺 ( 卖出 ) 在这些行业趋势当中市场地位较薄弱, 其产品结构向较不健康的乳饮料倾斜 保守的营销和经销模式导致市场份额流失和盈利下降 我们还首次覆盖蒙牛乳业 光明乳业 合生元和现代牧业, 评级均为中性 Volume CAGR 资料来源 :Euromonitor 高盛全球投资研究 研究范围概览 首次覆盖 Ticker Company name Market Cap (USD mn) Target Price Rating Upside / Downside 2017E P/E SS Yili 17,387 Rmb 21.5 Buy 18% HK Biostime 1,644 HK$ 26.9 Neutral 14% HK Mengniu 5,770 HK$ 12.9 Neutral -3% HK CMD 620 HK$ 1.05 Neutral -5% SS Bright Dairy 2,856 Rmb 13.2 Neutral -11% HK Want Want 8,455 HK$ 4.2 Sell -15% 17.5 资料来源 : 彭博 高盛全球投资研究 未来可关注事件 2016 年二季度 / 中期业绩 :8 月中至 8 月底 * 全文翻译随后提供 廖绪发, CFA 执业证书编号 : S (21) xufa.liao@ghsl.cn 北京高华证券有限责任公司 北京高华证券有限责任公司及其关联机构与其研究报告所分析的企业存在业务关系, 并且继续寻求发展这些关系 因此, 投资者应当考虑到本公司可能存在可能影响本报告客观性的利益冲突, 不应视本报告为作出投资决策的唯一因素 有关分析师的申明和其他重要信息, 见信息披露附录, 或请与您的投资代表联系 北京高华证券有限责任公司 投资研究

2 Contents Our thesis in 6 charts 4 China dairy enters a new normal stage; milk price to remain weak 5 Slower growth for longer 5 Global milk price recovering in 2017, but China raw milk price to remain weak 7 Next growth driver: high protein, functional; Yogurt the bright spot 11 China profit pool to increase 1.6X by 2020 to Rmb5.8bn 11 Yogurt will be the bright spot 13 Execution is now the key: Yili stands out on distribution, branding 16 Products, branding, distribution, mgmt. comparison 16 Dairy 2020: Yili to gain market share in key product categories 24 Valuation: Yili our top pick, Want Want overvalued 29 Yili (Buy): A long-term stand-out leader; fastest sales/eps growth 33 Want Want (Sell): Weaker brand could lead to further sales drop 40 Mengniu (Neutral): Sales recovering, but margin drags earnings 46 Biostime (Neutral): Swisse offset by weak IMF; Policy the key focus 51 Bright Dairy (Neutral): Stalled sales, GPM expansion offset by ANP 57 CMD (Neutral): Weak upstream to persist, brand expansion slower 62 Appendix: China dairy overview 68 Disclosure Appendix 74 Prices as of August 9, 2016 close, unless otherwise stated. Gao Hua Securities acknowledges the role of Lincoln Kong, CFA, Joshua Lu and Kevin Li of Goldman Sachs in the preparation of this product. Comp Sheet (China and Global dairy) Price BBG Ticker Name Mkt Cap Last GS Target List Report EPS PE PE PEG EV/EBITDA EV/EBITDA P/B P/B Div Yield Div Yield ROE ROE Close Rating Price Crncy Crncy CAGR CY16 CY17 2Yr CY16 CY17 CY15 CY16E CY16E CY17E CY16E CY17 6M Chg Price L.C. L.C. L.C. % % (X) (X) CAGR (X) (X) (X) (X) % % % % US$m China Dairy CH Yili 16, Buy 21.5 CNY CNY HK Mengniu 6, Neutral 12.9 HKD CNY CH Bright Dairy 2, Neutral 13.2 CNY CNY HK Want Want China 8, Sell 4.2 HKD USD (5.2) (5.8) (2.9) HK Modern Dairy^ Neutral 1.05 HKD CNY (20.7) (14.4) (1.1) (7.1) (0.2) Average 35, China IMF 1112 HK Biostime 1, Neutral 26.9 HKD CNY HK Yashili 1, NC N/A HKD CNY (4.5) NA CH Beingmate 1, NC N/A CNY CNY NA Average 59, Global leaders BN FP Danone 50, NR N/A EUR EUR NESN VX Nestle 247, Sell 65.0 CHF CHF NA FSF NZ Fonterra 6, NC N/A NZD NZD (0.2) NA ALMARAI Almarai 11, Buy 72.0 SAR SAR AB CHR DC CHR Hansen 8, Neutral DKK EUR MJN US Mead Johnson 16, Neutral 96.0 USD USD NA NA (114.5) (101.9) 2269 JP Meiji 14,849 9,850.0 Neutral 12,000.0 JPY JPY Average 341, China F&B/FMCG 322 HK Tingyi 5, Neutral 6.4 HKD USD (12.5) (4.2) (5.8) HK UPC 3, Neutral 6.5 HKD CNY HK Tsingtao 5, Sell 24.3 HKD CNY (0.3) (1.2) (22.6) CH Kweichow Moutai 59, Buy CNY CNY HK Hengan 10, NC N/A HKD HKD (0.4) NA HK WH Group 11, Buy* 7.4 HKD USD Average 8, (0.2) ^ Excl. biological FV chg gain / (loss) *Conviction list, NC: Not Covered, NR: Not Rated. Source: Bloomberg, Goldman Sachs Global Investment Research 全球投资研究 2

3 PM Summary Slower growth for longer China s dairy industry was worth US$64bn in 2015, up from US$42bn in Although total per capita consumption is still low vs. DM countries (20kg vs. 200kg in the US), we think the market has entered a slower growth stage and we estimate only 3% volume CAGR over The slower growth is due to: 1) tier 1 and 2 cities already have similar penetration rates as Japan/Korea and 2) economic slowdown is impacting low-end consumer demand (dairy is not a staple for most low-end consumers). Our GS proprietary global dairy Supply and Demand model (including all major milk production and consumption countries globally) indicates a gradual recovery in the milk price in (GSe: New Zealand Whole Milk Power price to reach US$2,700/ton by end 2017, 3 increase from now) as milk output has started to slow in both NZ and the EU. In China, however, with the slower demand growth, our milk supply-demand model suggests the supply gap will be filled by higher imports (given a still large price gap), and therefore we see China raw milk prices remaining flat out to 2020 (GSe: around Rmb3.40/kg). Growth to come from value-added products, Yogurt to outperform With slower volume growth, we see growth coming from the shift in consumer preferences away from sweeter products like flavored milk towards functional, high protein products like probiotic yogurt. Within all dairy subcategories, we expect yogurt will outperform the rest and almost double in size by With further distribution expansion, we see low temp yogurt continuing to deliver mid-teen growth whereas we expect UHT yogurt to be more of a short-term product before gradually tapering off as distribution infrastructure improves and consumers shift to fresher, healthier products. In all, we expect the China dairy profit pool to grow 1.6X by 2020 to US$5.8bn over 2015, driven by growth in value-added products and margin improvement at dairy companies (due to the change in product mix). To capture the step change in the growth profile of the industry, we derive our 12-month target prices from our returns-based Director s Cut methodology (2017E EV/GCI vs. CROCI/WACC). Buy Yili on better execution; Sell Want Want We think a successful downstream expansion strategy is the key for dairy players to win market share. In this regard, Yili stands out. It has led on this front for the last three years, and we expect it to extend this leadership out to Yilli is best positioned in the higher growth categories and offers more targeted marketing to cater to young consumers. It also has a more comprehensive distribution network and a prudent, proven management team. We initiate with Buy and 12-month Rmb21.5. We expect it to deliver fastest 14% EPS CAGR and highest cash return of 27% over E vs. peers in an 8-15% range. In contrast, we think Want Want stands to lose market share and register negative growth as its product offerings of flavored milk and rice crackers are less innovative and positioned in declining categories. We expect -4% EPS (Rmb terms) CAGR over E. 全球投资研究 3

4 Our thesis in 6 charts Exhibit 1: China dairy market enter a new normal (slow low single digit growth) Exhibit 2: We expect China s raw milk price to stay low for the next three years China Raw milk supply excess/(shortage) 25% 2 15% 1 5% -5% -1 22% *LME: liquid milk equivalent Dairy consumption growth CAGR (LME) Source: USDA, dairy Association, Goldman Sachs Global Investment Research. 6% -8% E 2016E-20E Exhibit 3: We see yogurt registering the highest growth of all categories Forecasted dairy growth by category 2% 3% Total Supply Excess/(Shortage) China raw milk excess/ (shortage) incl. imports, K tons 6,000 4,000 2, ,000-4, Melamine Global Supply Shocks Source: DCANZ, Wind, Goldman Sachs Global Investment Research 4.03 Domestic Raw Milk Price (RMB/kg, RHS) Global Over supply Exhibit 4: We expect Yili to gain further market share in the yogurt category Yogurt market share (%) Global production cuts on lower prices 3.36 China domestic raw milk price, RMB/kgr E2017E2018E2019E2020E Yili Mengniu Bright Dairy E 2017E 2018E Source: Euromonitor, Goldman Sachs Global Investment Research Exhibit 5: Yili has been improving its product mix, bringing 330bps higher gross margin by 2018E Yili product mix and GPM Source: Euromonitor, Goldman Sachs Global Investment Research Exhibit 6: We expect Yili to show the highest EPS growth Company EPS CAGR Mid to low end products % sales High end products % sales GPM E 2017E 2018E Company EPS growth YoY Yili, 13% CAGR Mengniu, 6% Bright, 7% Want Want, -4% E 2017E 2018E 2019E 2020E Source: Goldman Sachs Global Investment Research. Source: Company data, Goldman Sachs Global Investment Research. 全球投资研究 4

5 China dairy enters a new normal stage; milk price to remain weak We see China dairy industry growth having entered a new normal stage and expect low single digit volume growth over the next 3-4 years. Per capita diary penetration for high tier cities is already comparable with levels in Japan and Korea level and in our view therefore has reached equilibrium. On the other hand, demand in lower tier cities are more a function of economic growth as dairy is not yet a staple among lower-income Chinese. With the slower demand, we see the China raw milk price remaining weak even though we expect the global S/D backdrop to gradually recover. In light of this, we are cautious on upstream dairy farming companies. As the industry shift from high growth to low growth, we see the earning growth driver for dairy companies also changing. It is more difficult for companies to grow if they simply expand their distribution network or push new products into existing channels. Going forward we think execution will be the key to winning market share, Yili stands out with strong results in the past years. Slower growth for longer China dairy: double digit volume growth before 2014, but subdued in past 2 years The China dairy market has grown nine-fold in the past 15 years with a total addressable market of US$64bn currently. Before 2014, dairy demand growth average 12% for more than 10 years, with Yili and Mengniu growing their sales six-fold. Exhibit 7: China dairy market enter a slow growth stage Exhibit 8: China dairy market volume comparable with US/W. Europe 25% 2 22% Dairy consumption growth CAGR (LME) 40,000 35,000 30,000 Total Dairy Market Volume ('000 Tonnes) 34,205 27,386 15% 1 5% -5% -1 6% 2% 3% -8% E 2016E-20E 25,000 20,000 15,000 10,000 5,000 0 Western Europe 19,347 3,964 1,419 USA China Japan S. Korea Source: Euromonitor Source: Euromonitor Per capita comparison not always correct, high tier city consumption already on par with overseas peers Compared with US/EU, China s per capita consumption is low (roughly 20kg per person vs. 200kg in the US). Among staples categories, dairy is also one of the least penetrated at only avg. 22% of US/EU level. However, in light of their different dietary habits, we think US/EU s dairy consumption is not a good comparable for China and think Japan/Korea are better benchmarks. Exhibit 10 shows that for liquid milk (fresh + UHT milk), China per capita is about 46% of the Japan/Korea avg. and if we include the flavored milk, then China is already 76%. This is higher than the relative penetration for RTD tea or instant noodles. 全球投资研究 5

6 Looking at per capita by different tier cities, more developed regions and tier 1 cities are closer to Japan/Korea already. This suggests that high tier city consumers have developed the milk drinking appetite and future volume growth may be more muted. (Exhibit 11) Exhibit 9: China per capita consumption of dairy still has large gap vs US/EU level China per Capita consumption vs US/West Europe Exhibit 10: but smaller vs Japan/Korea China per Capita consumption vs Japan/Korea 0 Volume per capita as % of US/W.Europe volume per capita Volume per capita as % of Japan/Korea volume per capita Milk Formula 1 92% Milk Formula 1 24 Flavoured2 Milk 234% Flavoured 2 Milk 276% Yoghurt 3 Yoghurt 3 45% 51% Liquid + Flavoured 4 Milk 32% Liquid + Flavoured 4 Milk 76% Liquid Milk 5 (Fresh+UHT) 18% Liquid Milk 5 (Fresh+UHT) 46% Source: Euromonitor, Goldman Sachs Global Investment Research Source: Euromonitor, Goldman Sachs Global Investment Research Exhibit 11: Urban China s liquid LME consumption is closer to Japan than to Rural China Liquid milk per capita, Urban and Rural Exhibit 12: East/South China (wealthier regions) have similar dairy consumption vs Japan/Korea Per capita by region Liquid Milk Equivalent per capita (kg) 38 Kg/Capita Dairy per capita consumption by region Yoghurt/Sour Milk Milk Flavored Milk 31kg 26kg 39kg 34kg kg Urban China Rural China Japan 0 Northwest Southwest Mid China North and N/E East China South China Japan Korea Source: Goldman Sachs Global Investment Research Source: Euromonitor We expect weak volume demand: Economy and high ASP impact low-end demand We see the main reasons that demand has been weak for past 2 years are: 1) Dairy not yet a staple for lower-end consumers: Chinese consumers tastes have diverged as income growth has diverged. While for higher income consumer we may see continued trade-up, lower income consumers are more deeply affected by the overall slowdown in income growth. Dairy is still not a staple product for many Chinese families, and so if the economy slows, many may switch to inexpensive alternatives (eg: soy milk etc.) 全球投资研究 6

7 We run an affordability analysis on major milk products (Exhibit 14). This indicates that compared to US, liquid milk/yogurt is still a relatively expensive products for Chinese s hourly earnings, especially for the urban mass (annual income of US$2,500-4,000.) Additionally, spending on food is already over indexed in China vs. other developed countries, and so as income grow, the incremental money spent on food will be proportionally less than overall income growth. 2) High-tier city close to saturation: Although overall per capita consumption still has growth potential, urban consumption, especially in tier 1 cities has already reached a similar level as in Japan, and so we think the incremental volume growth there will be more subdued. In conclusion, we see China dairy demand growth to be slower for longer at about 3.5% volume CAGR over E. Exhibit 13: Tier 2 and below cities have seen higher growth in disposable income and have greater spending power Per capita income by tier city Urban Tier 1 Tier 2 Tier 3 and Below Rural Population (mn) Urban avg. disp. Income/cap (RMB) 31, , , , , yr CAGR 8.8% 9.7% 7.7% 10.7% Spending Power (RMB bn) 3, , , ,158.1 Source: Wind Exhibit 14: For China Urban Mass, many yogurts remain expensive Affordability analysis Source: Euromonitor, Goldman Sachs Global Investment Research Global milk price recovering in 2017, but China raw milk price to remain weak The global milk price (often referred to the New Zealand Whole Milk Powder [WMP] auction price) has corrected since peaking in mid-2013 and has remained at the weak US$2,000/ton level in past year. The down cycle is being driven by weaker-than-expected China demand over and accelerating production in the EU as the milk quota was lifted. The current milk price of US$2,100/ton is already below NZ farmers all-in cash cost of US$2,700/ton as well as Europe s milk cost. Our GS proprietary supply-demand model (includes the detail production, consumption forecast for the major exporting/importing countries, NZ, EU, US, China, Brazil, etc.) suggests that: The EU will see 3% production growth in 2016, as since the milk quota was lifted in Apr 2015, many farmers reared new heifers, and these have only become milkable in the past 6 months. With the still lackluster EU domestic consumption, this will lead to higher 全球投资研究 7

8 export volume for EU in From 2017 we estimate EU farmers will slow their pace production with flat growth, given the milk price is not high enough to cover their production costs. NZ has set a target to reduce milk production by 3-4% in 2016/17 season, on top of the 2% decline last season. The US is also reducing export volume as domestic demand is stronger than expected. Net net, for 2016 we expect the exports from these three major markets combined will still grow at just over 4% in 2016 but then gradually taper off in (Exhibit 16). For , we think the oversupply issue will gradually balance out starting in 2017, driving consumption and production from major countries at a similar 1.2% CAGR. Exhibit 15: We forecast that milk powder prices will reach US$2,700 by 2017E, driven by gradual S/D balancing Milk powder price and Global Production/Consumption forecast US$/ton 6,000 5,000 4,000 NZ Global Dairy Trade Wholemilk Powder Auction Price (US$/ton) Over Supply: - NZ returns to good weather - Europe quota lifted April 15 - Reaction to high prices Demand shocks: - China austerity measure, economy slows, de-stocking - Russia shut imports from August 2014 Moderate reduction in supply: - NZ cutting supply on lower prices - Europe still seeing supply growth - China modern farms slow supply - Lower oil, corn costs Still weak demand: - China demand remains slow but de-stocking largely finished 3, E: US$2, E :US$3, E: 2,300 2,000 Supply shortage: 1, NZ Drought - Europe Quota - China cow disease and culling on high crop cost Robst Demand: - Robust China demand, stock-piling - Russia 2nd largest importer in cheese globally Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 Nov-17 Feb-18 May-18 Aug-18 Nov-18 mn tons Global Milk Production 5-Yr CAGR Production (mn tons) yr Production CAGR 2.8% % % 1.5% 1.2% % % % % % EU US Russia Brazil China NZ Japan Top 7 mn tons Global Milk Consumption 5-yr CAGR Incremental Consumption (mn tons, LHS) yr Consumption CAGR (RHS) % 3.5% % % 1.4% % 1.1% % % 0.4% 0.5% EU US Russia Brazil China Japan Top 6 Source: USDA, DCANZ, Goldman Sachs Global Investment Research 全球投资研究 8

9 Global milk price to recover: Although China demand has not yet picked up, with the more radical supply side reduction, we estimate NZ WMP price will slowly recover starting 2H16 and reach US$2,700/ton by the end of 2017 (NZ farmer s breakeven point). Exhibit 16: We expect exports from EU/US/NZ to grow at 4% for 2016E then taper off to 0.9% in 2018E Export growth by EU/US/NZ Exhibit 17: China s raw milk continues to trade at a premium against Global milk prices China raw milk price vs. Global Dairy Export Market (3 major exporters) China raw milk price (Rmb/Kg) Mn Tonnes EU US NZ yoy growth % % 18% 16% 14% 12% 1 8% NZ WMP equivalent price (auction only) NZ WMP equivalent price (auction plus transport, VAT) % 5.4% 2.1% 3.3% % 0.9% 6% 4% 2% E 2017E 2018E -2% Source: Goldman Sachs Global Investment Research, DCANZ Source: Bloomberg China milk prices to flat line For China, given demand has been weaker than expected in the past 2 years, milk oversupply has driven excess inventory and a lower milk price (down 2 from peaks). Our China supplydemand model estimates currently there s about 3.3mn tons of liquid milk equivalent inventory in the market, vs. China s annual demand of 37-38mn ton. The excessive inventory is mostly poured into milk powder format so it can be stored for more than 18 months. Milk price has also been in a down cycle since 1H14 due to the industry oversupply. Following the smaller farmers exiting market last year, in 2016 we have started to see large scale farmers also sharply slowing down the dairy farm expansion and are having trouble selling raw milk. (China Modern dairy poured about 11% of its milk production into milk powder in 1H16). Therefore, we estimate in 2016 domestic supply will be reduced by 1.3%. However, due to higher feed cost and land prices, China raw milk price has consistently been much higher than global prices. Currently it s still running at 55% premium to global prices (Exhibit 17, including all transport, tariff expenses), thus we see the imports will continue to be strong and sufficient to fill the China supply gap. (Exhibit 18) This will drive China raw milk price to be lower for longer at around Rmb /kg level, in our view. We are cautious about upstream dairy companies, as they will continue to have very tight cash margin and will need to more aggressively expand into the branded milk market to earn cash flow. 全球投资研究 9

10 Exhibit 18: We still see a glut of supply in China s milk market in 2016E China S/D (including imports) Exhibit 19: We expect China s inventory surplus to persist China raw milk price and Inventory surplus 50,000 45,000 40,000 35,000 30,000 China domestic production Imported Milk (Liquid+Milk Powder) China total demand Raw Milk Equivalent consumption (K tons) 55,000 Melamine 2015 total supply 39mn ton: 33.8mn domestic production + 5.2mn ton Imports 2015 total demand: 37mn tons RME Total Supply Excess/(Shortage) China raw milk excess/ (shortage) incl. imports, K tons 6,000 4,000 2,000 Melamine Domestic Raw Milk Price (RMB/kg, RHS) Global Over supply China domestic raw milk price, RMB/kgr ,000 20,000 15,000 10, , Global Supply Shocks Global production cuts on lower prices , E 2017E 2018E 2019E 2020E -4, E2017E2018E2019E2020E 2.00 Source: China dairy Association, Goldman Sachs Global Investment Research Source: China dairy Association, Goldman Sachs Global Investment Research Exhibit 20: We expect a milk supply excess up until 2020E, but only less than half of the current surplus China supply-demand model China S/D model CAGR Total supply (K ton) 35,821 34,333 33,380 34,995 37,768 35,916 39,844 39,000 39,428 40,626 41,872 43,700 45,151 yoy growth 1.2% -4.2% -2.8% 4.8% 7.9% -4.9% 10.9% -2.1% 1.1% % 4.4% 3.3% 3. Total demand (K ton) 34,563 30,263 32,466 34,112 36,256 37,560 36,441 37,196 38,280 39,582 41,022 42,445 43,989 yoy growth -2.3% -12.4% 7.3% 5.1% 6.3% 3.6% % 2.9% 3.4% 3.6% 3.5% 3.6% 3.4% Supply Excess/(Shortage) 1,258 4, ,512 (1,645) 3,403 1,804 1,147 1, ,256 1,162 Estimated Inventory 1,256 5,328 4,983 1,796 2,395 (132) 1,758 5,207 2,951 2,191 1,893 2,105 2,417 *Inventory: 2yr cumulative basis, due to majority of inventory are in milk powder format and can last for 18 months. Source: China Dairy Association, Goldman Sachs Global Investment Research. 全球投资研究 10

11 Next growth driver: high protein, functional; Yogurt the bright spot China profit pool to increase 1.6X by 2020 to Rmb5.8bn If we look at the liquid milk equivalent (LME) i.e. transfer each dairy product to LME based on its contents then we see penetration in China is actually still low at 16kg per person per year vs. Japan 38kg (excluding cheese). This is because of the much higher portion of flavored milk consumption in China vs. other countries. Therefore, we see future growth potential may not come from the dairy volume growth, but from consumers shifting between dairy categories chiefly from demand for higher protein, functional products. Going forward, we see demand drivers varying between different tiered cities. Tier 1 and 2: per capita demand near saturation, growth will mainly come from product premiumization and consumers shifting to more value-added products (Yogurt etc.) Tier 3-4: per capita demand still has room to grow, future growth will depend on increased frequency in milk drinking and awareness of healthier products (shift from flavored milk to UHT milk and yogurt) County and Rural areas: very limited per capita dairy demand currently, future growth depend on development of milk drinking habits and income growth (beneficial products could still be basic UHT milk and UHT yogurt) Exhibit 21: 2 of China s dairy consumption is flavored milk China dairy Per cap Consumption (LME) Exhibit 22: In contrast Japan consumes a lot less flavored milk Japan dairy Per cap Consumption (LME) China per capita consumption breakdown Japan per capita consumption breakdown Yoghurt and Sour Milk, 29.7%, 5kg/cap Total LME per Cap: 16 Flavoured Milk, 21.4%, 4kg/cap Yoghurt and Sour Milk, 33.2%, 13kg/cap Flavoured Milk, 1.4%, 1kg/cap Total LME per cap: 38 Milk, 65.3%, 25kg/cap Milk, 48.9%, 8kg/cap Source: Euromonitor Source: Euromonitor Profit pool to increase on product mix; high protein products drive increase We estimate China s dairy total profit pool is about US$3.6bn in 2015, implying c.6% industry avg. margin. For , we see the total industry size growing at 6.6% CAGR to US$82bn, driven by 3% volume CAGR and 2% ASP growth. With consumers preference for value added products, we see company margins also increasing from mid-single digit to high single digit, driving the overall profit pool to increase 1.6X to US$5.8bn in As we mentioned earlier, we see consumers, especially the high tier city consumers, will prefer more functional and high protein content products. In the past 2 years, yogurt has been the fastest growth category, and we see this trend continuing. 全球投资研究 11

12 Exhibit 23: We forecast Yogurt to be the fastest growing category with double digit volume growth, driving the China profit pool to increase by 1.6X by 2020 Market size, volume, profit pool forecast by category Source: Euromonitor, Goldman Sachs Global Investment Research. 全球投资研究 12

13 By subcategory, we see the yogurt segment nearly doubling its market size to US$22bn in 2020, driven by strong volume growth. UHT milk will continue to be the dominant liquid milk product given its convenience and consumers established drinking habits; hence we see the similar volume growth as the industry average and expect roughly US$17bn in annual sales by On the other hand, we see flavored milk and IMF as the two categories that will shrink over next few years. China s flavored milk penetration is already one of highest in the world, and with the increasing awareness of healthy and less sweet preference, we expect the size of flavored milk to shrink by 1.3%. For IMF, China is among the world s largest market with annual sales of US$16bn in This is due to per baby penetration is on par with world average and average IMF product ASP is 5 above the EU/NZ level. For the next 5 years, we see IMF pricing remaining under pressure with the proliferation of online and cross border channels. Absolute ASP for IMF products, especially premium products will decline yoy, in our view; however this will be partially offset by the product mix upgrade, driving about 1% ASP fall yoy to The impact from the removal of the one child policy, initiated in 2016 will start to kick in from the end of year, however given the trend of number of new births and increasing promotion of breast feeding, we expect IMF volume growth to be more muted in the next 5 years at low single digits. Yogurt will be the bright spot In beverages, we have seen a clear trend of consumers moving to healthier, less-sweet and functional products. In the past two years, Sports drink and Water recorded mid-to-high single digit growth vs. Carbonates and RTD tea posting negative growth. We expect a similar trend in dairy products. Specifically, yogurt in China is usually considered a healthier product, and beneficial to health. In China, the perception of yogurt is different from Western style or Greek yogurt. In China, low temp yogurt (Exhibit 24, fourth column) is what consumers typically perceive as real Yogurt, which is usually the drinkable yogurt. It generally has higher sugar content than Greek yogurt. In the past few years, hot categories have been 1) Drinking yogurt and 2) UHT yogurt. The former has been led by Japanese brand Yakult and promoted as good for digestion, while the latter became very popular only from 2014, led by Bright Dairy, Yili and Mengniu products, advertised as high nutrition and easy to carry yogurt. As it is stored and consumed at room temperature, UHT yogurt can be rapidly and easily distributed into lower tier cities and has gained popularity as the big dairy companies aggressively promote them. Similar to beverages, we expect consumers to gradually turn to less-sweet and more functional products, i.e. move towards the low temp yogurt or the Western style yogurt (eg: Bright Dairy introduced a plain yogurt last year called Rushi ) Thus, we expect low temp yogurt to record rapid 13% sales CAGR for E, but for yogurt drinks to show limited growth as consumers switch. 全球投资研究 13

14 Exhibit 24: Consumer taste shifts towards less sweet, functional products we see similar trends for Beverage and Milk Beverage and dairy products Comparison Source: Company data, Goldman Sachs Global Investment Research. UHT yogurt grew from a niche product in 2012 to an Rmb20bn market in 2015, due to the products being easy to carry and perceived as healthy (although there s no active Lactobacillus in UHT yogurt). The product caters to new demand in locations that lack sophisticated cold chain logistics and replaces some of the flavored milk and yogurt drink demand, in our view. Bright Dairy is the leader of this category with star products Momchilian, followed by Yili and Mengniu. UHT yogurt is a new product category and many people are worried about the lifecycle of the product. However, we note consumer purchase frequency of this product has only reached 5 of that for Want Want s Hot kid milk, which at its peak in 2013 was the best-selling single SKU dairy product in China. Therefore we think UHT yogurt growth has another 1-2 years of rapid growth ahead. That said as consumers start to realize the difference between UHT and low temp yogurt, as well as with development of logistics in low tier cities, we expect UHT yogurt growth to taper off and be outpaced by low temp yogurt. 全球投资研究 14

15 Exhibit 25: UHT yogurt not yet near the purchase frequency of Hot Kid Milk during its peak in 2013 Purchase frequency Exhibit 26: Liquid milk has seen higher growth in lower tier cities Liquid milk growth by category Products Hot Kid Milk UHT Yoghurt UHT Yoghurt Year E Sales Value (Rmb bn) ASP (RMB/L) Sales Packs (bn) Typical consumers 5-15 yrs 15-35yrs 15-35yrs 6. Frequency (Pack/person/yr) % 4.1% Liquid milk growth yoy by tier 7.5% 6.1% 4.3% 2.8% 6.9% 6.3% Tier 1 Tier 2 Tier 3 Tier 4 and below Source: Euromonitor, Company data. Source: Nielsen. Exhibit 27: We forecast low temp yogurt to take share from UHT yogurt and yogurt drink shares post 2016 Yogurt market breakdown by type Exhibit 28: We expect low temp/uht yogurt to grow 13%/8% four-year CAGR, respectively 4 year CAGR by Category Low temp Yogurt Yogurt Drinks UHT yogurt UHT yogurt Yogurt drink Low temp yogurt 10 Flavor milk UHT milk E 2017E 2018E 2019E 2020E % 23% 1 13% 7% 8% 3% 2% 6% -1% E 2016E-2020E Source: Company data, Goldman Sachs Global Investment Research Source: Goldman Sachs Global Investment Research 全球投资研究 15

16 Execution is now the key: Yili stands out on distribution, branding Since the melamine incident, China consumers demand for quality milk has increased substantially. Yili and Mengniu s premium UHT milk products all gained market share with strong growth after that event. However, in past two years, China dairy demand has been weaker than expected and posted subdued volume growth. But upstream dairy supply is still growing rapidly, leading to high milk inventory in the market and increasing competition. Mengniu saw greater challenge to its growth and its stock price corrected as much as 5 during As the China dairy market has now entered a slower growth stage, individual companies performances have diverged more and more. The future growth and market share dynamics depend on each company s specific strategy on product offering, marketing and branding and their effective execution. We compare in detail the 4 downstream branded dairy companies and conclude that Yili as industry leader is set to extend its leading position and gain further market share in most categories. Products, branding, distribution, mgmt. comparison #1: Products: Yili and Mengniu better exposed to high-growth categories Yili and Mengniu, as leading national players, have key products in most categories. They both have more than 5 of their sales in the higher growth UHT milk and yogurt, with the rest in milk beverage and milk powder. Both companies have been gaining market share in the yogurt category. In comparison, Want Want s sales are more skewed to flavored milk sales, accounting for 5 with the rest rick crackers or snacks. Therefore Want Want s dairy sales are under significant pressure as the flavored milk market continues to shrink and the company faces more competition from Yili/Mengniu s children s milk products. Bright Dairy is a more of a regional player focusing on East China and pasteurized milk. In the past 3 years it has successfully launched and led the UHT yogurt market with its star product Momchilovtsi. However, as competition intensifies in the UHT yogurt market, we see Bright s growth coming under pressure from its dependence on a single SKU product. (We estimate in 2016 Yili s UHT yogurt Ambrosial will surpass the scale of Bright Dairy s UHT yogurt sales). 全球投资研究 16

17 Exhibit 29: Yili has outperformed Mengniu in the past two year slow growth period Yili and Mengniu : Expansion Mengniu: expanded liquid milk / yogurt facilities aggressively and increased promotion (sponsor 'Super Girl'), surpassed Yili in size in 2007 Yili: Chairman Pan stepped in and gradually built each region's networkflat distribution and high control on retail end (ZhiWang plan in 2006) : Melamine Mengniu, Yili both hit but recovered quickly in 2009 Mengniu: COFCO invested, Founder mgmt team gradually left the company : Demand for quality Premium milk stands out as consumers demand safety and quality Yili: outperform on sales/margin due to strong premium products, higher brand investment Mengniu: focus on growing size after COFCO and new mgmt came in; Acquired IMF, invest in upstream farming and JV with Danone : Divergent consumer, Slower growth Yili: cater well to the changing consumers demand; invest in the brand Mengniu: hit by high inventory and slowing demand, started to increase direct control of the distribution network 60,000 50,000 Rmb mn Yili Mengniu Sales 60,360 49,027 40,000 30,000 20,000 10,000 8,735 7, Yili OPM Mengniu OPM OPM 7.9% % 5.2% Index to 100 as of July 2004 Stock Performance Yili, 12X : Mr. Pan elected Yili Chairman/CEO mid 2008: Melamine 2009 July: COFCO invested in Mengniu 2012 Apr: Mengniu changed CEO to Ms. Sun Mengniu, 6X Source: Company data, Bloomberg, Goldman Sachs Global Investment Research. 全球投资研究 17

18 Exhibit 30: Yili and Mengniu has biggest exposure to Yogurt Sales by product type (2015) Sales Exposure by Category UHT Milk Milk Beverage Yogurt IMF Others Past. Milk % 18% 4% 8% 27% 51% 37% % 2 26% % 42% 49% 37% 1 Yili Mengniu Want Want Bright Source: Company data. #2: Branding: more effective and targeted branding crucial for young consumers For dairy products, typical consumers are children/ students for flavored milk and teenagers or millennials for yogurt etc. Hence we think marketing and branding aimed at younger consumers will become more important for dairy companies. From 2013, we have seen increasing number of dairy companies investing in the popular TV or entertainment programs. Yili, starting from 2014, has greatly increased its A&P expenses as they promote their star products. Its A&P ratio reached 12% in 2015 and we expect it to continue to rise over E vs. Mengniu s 8-9% and Want Want and Bright at less than 4%. Yili has invested in television programs with higher viewership (avg. 3.0 rating vs. Mengniu s 1.5) and has greater presence on social media (sponsoring online video program and engaging in WeChat events). Also Yili spends about 6 more on advertising and roughly Rmb1bn on TV sponsorship each year. This has translated into higher sales growth for the last two years (Exhibit 34). Want Want on the other hand, spent less than 4% of sales on A&P, as it relies rely more on distributors effort to push products. In our opinion this puts them at a disadvantage to win market share. 全球投资研究 18

19 Exhibit 31: Yili s higher spending on A&P has led to higher incremental sales growth A&P comparison Exhibit 32: Most of Yili s selling expenses are advertising 2015 Yili vs Mengniu Selling Expenses Breakdown A&P as % of Sales Yili, 13.6% Mengniu, 8.9% Want Want, 3.6% Bright, 3.6% E 2017E 2018E Yili Selling Expenses Breakdown Rmb mn Yili Mengniu 8,000 7,276 7,000 6,000 5,000 4,085 4,000 3,139 2,994 3,000 2,183 2,310 2,000 1, Salary Advertising Transportation Rental Others Source: Company data, Goldman Sachs Global Investment Research Source: Company data Exhibit 33: Yili sponsored TV programs have had higher ratings than Mengniu s TV program sponsorship Exhibit 34: Yili s higher ANP spending has led to higher sales growth vs Mengniu Yili/Mengniu A&P ratio vs Abs. sales increase Rmb mn 1,400 1,200 A&P expenses on TV program sponsorship Rating pts. Mengniu Yili Mengniu ratings (RHS) Yili ratings (RHS) % 14% A&P as % of Sales vs Abs. Sales increase Yili Abs Sales Increase Mengniu Abs. Sales Increase Yili Mengniu Rmb mn 10,000 Yili, 13.7% 8,000 1, % 6, % 6% Mengniu, 8.9% 4,000 2, % % E 2017E 2018E -2,000 Source: tvtv.hk Source: Company data, Goldman Sachs Global Investment Research 全球投资研究 19

20 Exhibit 35: Yili sponsored TV shows are some of the most popular ones in China Yili, Mengniu and Bright Dairy sponsor list 2015 TV Sponsorship Company 2015 TV Shows Dates on Air Brand Expense (rmb mn) Avg. Ratings Mengniu 花儿与少年 (Flower and Teenager) April - July 2015 ZhenGuoLi 蒙面歌王 (Hidden Singer) July - Sep 2015 Just Yogurt N/A 1.10 偶像来了 (Here Comes Idol) Aug- Oct 2015 Just Yogurt 十二道鋒味 (Nicolas Tse Show) Aug- Oct 2015 Mengniu N/A 1.00 全员加速中 (Full Speed) Nov Present Just Yogurt Mengniu Total Yili 最强大脑 2 (Largest Brain 2) Jan - March 2015 Satine 奔跑吧兄弟 2 (Running Man 2) April - July 2015 Ambrosial 爸爸去那兒 3 (Dad, where to? 3) July - Oct 2015 QQ Star 奇葩说 2 (QiPa Shuo 2) June - Present GuLiDuo Yili Total TV Sponsorship Company 2016 TV Shows Dates on Air Brand Expense (rmb mn) Avg. Ratings Mengniu 2016 超级女声 (Super Voice) March - Present SuanSuanRu 150 N/A 全员加速中 2(Full Speed 2) April - Present Just Yogurt 我是模王 (I am MoWang) Apr-16 Yoyi C 80 N/A 迪士尼神奇之旅 (Disney Land) May-16 Future Star Mengniu Total Yili 我是歌手 4 (I am Singer 4) Jan - April 2016 Satine 奔跑吧兄弟 4 (Running Man 4) April - July 2016 Yili 挑战者联盟 2 (Challenger's Leauge 2) Summer 2016 ChangYi 里约奥运会 中国骄傲 (Rio Olympics)Summer 2016 Yili 175 N/A Yili Total 1, Bright Dairy 极限挑战 2 (Extreme Challenge) April-June 2016 Momchilovtsi N/A N/A Source: tvtv.hk #3: Distribution: Yili has flat distribution network and better control of the retail end Both Yili and Mengniu have national production facilities and distribution networks, so they can roll out the new products more quickly than the regional players. By comparison, Yili employs a lot more sales people than Mengniu (Exhibit 36, 3 more) as it has a flat one-tier distribution network. Its sales person contacts their tier 1 distributor and then the distributor directly reaches out to the retail end. They have 8K plus distributors, whereas Mengniu and other peers have less than 5K. Under this network, Yili will be able to more efficiently adapt to the changes at the retail end and get up-to-date information from consumers. 全球投资研究 20

21 Exhibit 36: Yili is more directly involved in each POS, vs Mengniu s distributor driven model Yili vs Mengniu sales employees (2015) Exhibit 37: Want Want still has limited exposure in modern trade channel vs. other large staples companies Sales by channels (2015) # of Employees Total employees Sales employees 70,000 60,000 57,971 50,000 39,683 40,000 30,000 20,000 15,604 11,905 10,000 5,372 1,834 0 Yili Mengniu Bright Dairy Traditional channel Modern trade Online and others 95% 45% 5 55% 45% WW Mengniu Yili Tingyi UPC Source: Company data Source: Company data, Goldman Sachs Global Investment Research. With its wider distribution system, Yili has greater presence in lower tier cities and traditional channels than Mengniu. Mengniu, due to its relatively higher exposure in tier 1 and 2 cities, will face more intense competition vs. upstream dairy players or import player on the premium UHT milk side. This is because smaller, newer players usually have fewer resources to distribute products into low tier city and therefore focus on premium end products. In past 12 months, Mengniu has also started to reform its distribution network by increasing the portion of direct selling and simplifying its layers of distributors. We think this will take time to have a material impact on the company. Want Want has been in China since the early 1990s and hence is well penetrated into traditional channels. However, it is having difficulty penetrating into new channels such as supermarkets or convenience stores in the past decade. More than 9 of its sales still come through traditional channels as they want to protect their distributor margin. However this makes Want Want less effective in launching new products or catering to young consumers, in our view. Exhibit 38: Yili has greater premium milk market share in tier 3 and below cities Market share in different tier cities Exhibit 39: Mengniu has a greater share in offline channels than Yili Market share by channels (%) Yili Mengniu Tier 1 Tier 2 Tier 3 Tier 4 and below (%) Yili Mengniu Hypermarket Supermarket Small Convenience supermarket store Brick and Mortar Source: Modern Dairy. Source: Modern Dairy. 全球投资研究 21

22 Exhibit 40: Greater competition in the premium UHT market Yili and upstream players are catching up Premium UHT milk sales (ex-factory level) Rmb mn Yili JinDian Mengniu Milk Deluxe Modern Dairy Shengmu 18,000 16,000 14,000 12,000 10,000 8, ,533 1,656 1,502 8,136 Shengmu:134% cagr Modern Dairy:116% cagr Mengniu: 11% cagr 6,000 4,000 6,550 4,877 5,706 Yili: 37% cagr 2,000 3, Source: Company data, Goldman Sachs Global Investment Research. #4: Management team: Yili more prudent and incentivized management. team Both Yili and Mengniu have explicit mgmt. incentive scheme through either share awards or share options. For Yili, as much as 3 of annual incremental earnings growth can be allocated to the mgmt. team. This compares to Want Want and Bright which have share incentive plan in place but none has been awarded since it began. Yili mgmt. has been with the company for more than 10 years and has deep experience in the industry. The team has focused on both growth and returns, and subsequently in our view Yili has proven prudent in its capex expansion. It has also focused more on organic expansion rather than M&A, which could potentially dilute company value. Exhibit 41: Yili provides a comprehensive performance linked incentive scheme Incentive schemes and remuneration comparison Company Yili Mengniu Want Want Bright Share Award Scheme Share Award Scheme - 3 of incremental Adopted in 2013 Discretionary Bonus Share Award Scheme Type of Incentives increase in net income Share Option Scheme ended in 2013 Share Option Scheme Share Option Scheme - no options have been granted since adoption Total Remuneration (2015) 5,148 3,439 3,828 1,325 Sales (2015) RMB mn 59,863 49,027 23,407 20,385 Remuneration as % of Sales (2015) 8.6% % 6.5% 2015 Average Employees 59,178 38,100 52,000 4,459 Average Monthly Remuneration RMB' Source: Company data 全球投资研究 22

23 Exhibit 42: Yili has one of the highest free floats of all China dairy companies, while mgmt. still holds nearly 8% Share ownership of each company Dairy Companies Ownership Structure Yili Hohhot Investment, 7.5% China Security Fund, 3. China Securities Finance, 4.3% Founder Gang Pan, 3.9% Other Executives, 4.1% Mengniu Sun Yi Ping*(CEO), 0.4% COFCO Dairy Invst. (JV of COFCO, Arla, Danone), 31.5% Public Investors, 68.1% Public Investors, 77.2% Want Want Bright Dairy Public Investors, 40.2% Tsai Eng Meng (Chairman), 49.8% Public Investors, 43.6% Bright Food Group, 54.4% JPMORGAN, 5. IWATSUKA CONFECTIONE RY, 5. Source: Bloomberg Compared with China and Global dairy companies, Yili has the highest CROCI (26%) due to its high asset turnover. It deploys a light asset model due to years of prudence on capex and working capital. Over , Yili s CROCI grew from 15% to 26% on the back of 7 increase in Gross Cash Invested (GCI). Most of the incremental capital growth has come from PPE investment or organic capacity expansion. We expect Yili to retain its high CROCI of c.27% over E. This compares to Mengniu s 3X higher GCI, which mainly come from higher intangibles and working capital, as the company made a series of acquisitions in last 3 years and also saw inventory levels go up due to milk oversupply. Exhibit 43: Yili has highest CROCI among of peers, mainly driven by higher asset turnover 2015 CROCI breakdown comparison 2015 CROCI Breakdown Comparison CROCI Asset Turnover EBITDA Margin Cash Conversion 3 4.0x 25% 26% 22% 3.5x 2 8% 0.9x 11.2% 8% 0.7x 15% 1.0x 3.0x 2.5x 15% 1 5% 6% 0.6x 17.2% 0.6x 0.8x 9.8% 1.0x 2.3x 0.8x 8.3% 1.2x 28.7% 1.1x 7.4% 2.0x 2.0x 1.5x 1.0x 0.5x Danone Meiji Yili Mengniu Want Want Bright 0.0x Source: Company data, Goldman Sachs Global Investment Research 全球投资研究 23