2014: Price discipline in sight; Tingyi, UPC to Buy; Huishan to CL-Buy

Transcription

1 Equity Research 2014: Price discipline in sight; Tingyi, UPC to Buy; Huishan to CL-Buy Competition is king in year of weak sales and fading cost tailwind We believe competitive intensity will be the most important driver of China Staples earnings in 2014 against a backdrop of decelerating topline growth and abating raw material cost tailwinds. Directional changes in promotional spend will thus be crucial for margins this year. We upgrade Tingyi and UPC to Buy on positive OPM inflection as Beverage promotions ease. We expect Tingyi to pull promotions following recent stabilization of market share to restore profitability, and UPC to follow. This will drive accelerated EPS CAGR for both companies. Maintain out-of-consensus Sell on Hengan as intense competition is spilling from tissues and diapers into its key category sanitary napkins (>50% of OP). In 4Q13, Kimberly Clark staged a major re-launch of its fem care products targeting the same customer group as Hengan s Space-7. Fading raw material cost tailwind: In 2014E/2015E, we forecast that raw material costs will turn from deflationary to mildly inflationary, with our GS COGS Index to increase by 6 pp vs 1H13. Adding Huishan to CL-Buy as we expect the company to benefit most from raw milk price hikes and downstream premiumization, driving our 40% 2-yr EPS CAGR forecast. After recent pull back, Huishan is trading at 13.9X average 2014E/2015E P/E. Upgrade Tingyi and UPC to Buy: Beverages to drive margin rebound Tingyi s Beverage margins have contracted from 13% in 2008 to 5% in 2013E as a result of its aggressive market share defence. We think recent stabilization of RTD tea market share is likely to prompt Tingyi to pull Beverage promotions to restore profitability at a faster rate than appreciated by the market. We forecast Tingyi s Beverage margins to return to 11% by 2015E, driving 2-yr recurring EPS CAGR of 29% vs 17% in 2013E. We expect UPC to follow to restore prices and forecast its Beverage margins to bounce back from 4.4% in 2013E to 6.6% in 2015E, driving recurring 2-yr EPS CAGR of 43%, vs 42% decline in 2013E. Noodles competition will remain tough, but the upswing in Beverage margins will be enough to push both companies EPS CAGRs to 1st quartile vs Staples peers. At current average 2014E/2015E P/E of 22.8X for both Tingyi and UPC, we see re-rating opportunities to high 20s P/E. Upgrade both companies to Buy. KEY THEMES IN THIS REPORT 2014 Outlook: All about competition; selective on growth Latest China Staples trends: Growth deceleration continues, COGS tailwind to fade Tingyi, UPC: Beverages to drive positive OPM inflection in 2014, upgrade both to Buy RATING AND TARGET PRICE SUMMARY Rating 12 m TP Implied Company Ticker New Old New Old Crncy +/ % H Share Staples valuation framework Want Want 0151.HK Buy Buy HKD 37% UPC 0220.HK Buy Neutral HKD 27% Tingyi 0322.HK Buy Neutral HKD 26% Hengan 1044.HK Sell Sell HKD 1% Mengniu 2319.HK Neutral Neutral HKD 1% Tsingtao (H) 0168.HK Neutral Neutral HKD 17% CRE 0291.HK Neutral Neutral HKD 18% China Foods 0506.HK Neutral Neutral HKD 15% Other Staples stocks under coverage Huishan 6863.HK Buy* Buy HKD 35% Tsingtao (A) SS Buy Buy CNY 19% Greatview 0468.HK Neutral Neutral HKD 12% *The stock is on our Conviction List HOW WE DIFFER FROM CONSENSUS GS vs Consensus Company Ticker F13E F14E F15E Huishan 6863.HK 9% 6% 3% Want Want 0151.HK 4% 2% 7% UPC 0220.HK 37% 8% 10% Tingyi 0322.HK 1% 5% 10% Hengan 1044.HK 2% 12% 10% Mengniu 2319.HK 5% 4% 9% Tsingtao 0168.HK 10% 2% 4% CRE 0291.HK 10% 11% 5% China Foods 0506.HK 3% 105% 46% Greatview 0468.HK 3% 8% 10% Note: UPC, Tsingtao, CRE s Bloomberg consensus is a mix of core and non-core EPS. Our estimates are core EPS, excl. one-offs such as gains from asset sales. Source: Bloomberg, Datastream, Goldman Sachs Global Investment Research Revisions to earnings and 12-m target prices for our coverage We revise our FY13E-FY15E EPS by -10% to +13% and 12-m target prices by -14% to +35% for stocks under our coverage. Lisa Deng Goldman Sachs does and seeks to do business with lisa.deng@gs.com Goldman Sachs (Asia) L.L.C. Xiaochun Ni xiaochun.ni@gs.com Goldman Sachs (Asia) L.L.C. companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research

2 Table of contents 2014 outlook: All about competition; selective on growth 3 Latest China Staples trends: Growth deceleration continues 6 Upgrade Tingyi and UPC to Buy: Competition not over, but close to the end of a cycle 10 Beverages to lead margin rebound in 2014 for Tingyi and UPC 11 Noodles unit cost analysis suggests marketing flexibility available 15 Huishan (6863.HK): Positive data boosts conviction; to CL-Buy 24 Tingyi (0322.HK): Positive inflection on OP margins; up to Buy 30 UPC (0220.HK, Buy): Price restoration on the horizon; up to Buy 34 Want Want (0151.HK): Restructuring to bear fruit; maintain Buy 38 Hengan (1044.HK): Sanitary napkins feel the pressure; maintain Sell 46 Tsingtao ( SS, Buy; 0168.HK, Neutral): Price discounts fading 54 Summary of changes/risks for Neutral-rated stocks 60 Disclosure Appendix 61 The prices in this report are as of the market close of February 10, Exhibit 1: China Consumer Staples valuation comparison BBG Ticker Name Mkt Cap Last GS Target List Report Price EPS 13-15E PE PE PEG EV/EBITDA EV/EBITDA P/B Div Yield Div Yield ROA ROE ROE Close Rating Price Crncy Crncy 6M Chg CAGR CY13 CY14 2Yr CY13 CY14 CY14 CY13 CY14 CY13 CY13 CY14 US$m Price L.C. L.C. L.C. % % (X) (X) CAGR (X) (X) (X) % % % % % China Personal Care 1044 HK Hengan 13, Sell HKD HKD (5.0) HK Vinda 1, NC N/A HKD HKD Average 14, China NARTD/Packaged Food 322 HK Tingyi 14, Buy HKD USD HK Want Want China 17, Buy HKD USD (2.3) HK UPC 3, Buy 8.90 HKD CNY (0.6) HK China Foods Neutral 3.00 HKD HKD (15.6) nmf nmf nmf nmf (3.7) (11.2) (0.2) Average 35, China Alcohol 168 HK Tsingtao H-Share 9, Neutral HKD CNY (9.8) CH Tsingtao A-Share 9, Buy CNY CNY (1.5) HK China Foods Neutral 3.00 HKD HKD (15.6) nmf nmf nmf nmf (3.7) (11.2) (0.2) 291 HK CRE 6, Neutral HKD HKD (12.5) CH Beijing Yanjing 3, CS N/A CNY CNY nmf nmf CH Kweichow Moutai 22, Buy CNY CNY (23.1) CH Wuliangye 9, Neutral CNY CNY (22.4) CH Luzhou Laojiao 3, Neutral CNY CNY (22.0) CH Yantai Changyu 2, CS N/A CNY CNY (24.1) Average 68, China-Dairy 2319 HK China Mengniu 8, Neutral HKD CNY HK Huishan 4, CL Buy 3.60 HKD CNY nmf HK Modern Dairy 2, NC N/A HKD CNY CH Yili 12, CS N/A CNY CNY CH Bright Dairy 3, CS N/A CNY CNY (2.3) nmf nmf HK Yashili 1, NC N/A HKD CNY HK Biostime 5, NC N/A HKD CNY SYUT US Synutra NC N/A USD USD nmf nmf nmf nmf nmf nmf (12.7) nmf Average 40, China - Pork 1068 HK China Yurun 1, Neutral 4.60 HKD HKD (13.7) nmf nmf 9.2 nmf CH Shuanghui 16, NC N/A CNY CNY HK Dachan Food NC N/A HKD (10.0) nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf PFH SP People's Food nmf nmf NC N/A SGD nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf Average 18, China Packaging 468 Hk GA Pack Neutral 4.60 HKD CNY (12.5) HK COFCO Pack NC N/A HKD CNY nmf nmf HK Shenguan 1, NC N/A HKD CNY (0.9) CH Zhongfu NC N/A CNY CNY 19.4 nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf nmf CH Zi Jiang NC N/A CNY CNY nmf nmf nmf nmf nmf nmf TT Hon Chuan NC N/A TWD TWD (3.7) nmf nmf nmf nmf nmf nmf nmf nmf Average 4, *Stock is on our regional Conviction List. All target prices mentioned above are on a 12-m basis. CS = Coverage Suspended, NC = Not Covered. Huishan s 2013E-2015E EPS CAGR is calculated on calendar year basis here vs. its financial year-end on of March. Source: Bloomberg, Datastream, Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 2

3 2014 outlook: All about competition; selective on growth After a year of lackluster topline growth and intense competition in 2013, we believe that the key themes driving Staples performance in 2014 will again be centered on competitive intensity and access to growth. However, in 2014, we expect that the category sales growth disparity between early stage and later stage consumption categories will become even more pronounced, which will subsequently lead to increasingly divergent competitive intensity in the two segments. We reiterate Buy on Huishan and add it to CL; upgrade Tingyi and UPC to Buy from Neutral; maintain Want Want and Tsingtao (A) on Buy and Hengan on Sell. Exhibit 2 below conceptualizes our thinking behind the key themes influencing earnings growth for Staples in 2014 and where each of the stocks under our coverage is positioned. Exhibit 2: Conceptualizing key themes in Staples for 2014E Note: Direction of arrows indicate our expected trend for competitive intensity. Arrows pointing to the left indicate a reduction in competitive intensity. Arrows pointing to the right indicate an increase in competitive intensity. Source: Goldman Sachs Global Investment Research. We can broadly separate our Staples coverage into early stage and later stage companies based on the consumption categories that they are exposed to. We define a consumption category as either early stage or later stage based on China s per capita consumption maturity vs the rest of the developed world (i.e., US, UK, Japan). For example, we classify Instant Noodles as an early stage consumption category, as its per capita consumption in China of 3.3kg/pp in 2013 is already close to Japan s 4.2kg/pp. While Diapers is a later stage category as its per capita consumption is just at 15.4units/pp in 2013 vs US at 61units/pp. For early stage consumption categories such as instant noodles, beer, carbonated softdrinks, we expect topline growth in 2014 to remain soft as per capita consumption matures. However, industry profitability will likely improve driven by ongoing premiumization and consolidation, in our view. We could also expect to see higher incidences of M&A for companies that have a strong balance sheet in order to gain better access to growth. Goldman Sachs Global Investment Research 3

4 In the specific case of our upgrade of Tingyi and UPC to Buy from Neutral, even though we expect slowing top-line growth for both companies as Beverage and Noodles growth becomes mature in China, we expect a rebound in operating margins as we expect reduction in promotional intensity to be the key positive catalyst for the stocks. For later stage consumption categories, we forecast more attractive topline growth in 2014E helped by consumers trading up and recent policy reforms. However, competition will likely intensify as large numbers of competitors enter the market, which could lead to margin erosion. We see personal care categories such as diapers and tissues and more recently sanitary napkins as particularly susceptible to this and hence we maintain our out-of-consensus Sell on Hengan due to earnings risk. We continue to like Huishan and WW as both companies have access to high growth categories and enjoy moderate competition. For these two companies, we believe that company-specific execution would be the focus. We note that Want Want s new product launches (albeit small) are doing well and that it has increased its milk beverage ASP by 5%-8% in October 2013 to combat rising milk powder costs, which reflects its strong pricing power. For Huishan, we reiterate Buy and add it to our CL. Recent positive news such as being selected as part of the second batch of national champions for Infant Formula by the Dairy Association of China, as well as continued escalation of raw milk prices into January 2014 provide added support to our forecast of 40% EPS CAGR in 2013E-2015E. Our valuation framework Exhibit 3 below shows the key valuation framework that we apply to our Staples coverage. We use P/E as our primary valuation methodology as back-testing suggests that it generates the highest alpha. Our valuation framework has been consistently applied since we adopted it in 2H12 and has not changed in this report. We roll forward the valuation period for all 11 of our stocks on Exhibit 3 by 6 months from CY2014E to average CY2014E/CY2015E. For our core, branded FMCG (Fast Moving Consumer Goods) stocks, i.e., Tingyi, Hengan and Want Want, we value the stocks on a relative basis based on each company s 2-yr EPS CAGR and CROCI rank vs its Staples peers. We apply a 20% P/E premium or discount (unchanged) to our sector target average P/E of 24.0X (unchanged) to companies that rank in the first quartile or fourth quartile of EPS CAGR. Moreover, we also apply another 15% premium or 5% discount (both unchanged) to our sector target average P/E of 24.0X to companies which are either in the first or fourth quartile for CROCI. For example, Want Want, which has 3 rd quartile EPS CAGR but first quartile CROCI relative to its Staples peers, will receive a 15% P/E premium to our target sector average of 24.0X, resulting in a P/E valuation multiple of 27.6X. Our target sector average of 24.0X is in-line with the sector s P/E average from For beer companies (Tsingtao and beer business of CRE), we use EV/EBITDA as our primary valuation methodology as these companies tend to be cash rich and depreciation policies can vary greatly among them. Since we value CRE s beer business using EV/ EBITDA and retail business using P/E, with reference to peers, we value CRE on SOTP basis. Companies that we cover but have a higher commoditized component are not included in this framework, e.g., Huishan given its upstream dairy farming exposure. For Huishan, we use PE-SOTP valuation, with reference to its closes peers China Modern Dairy and Mengniu. For Greatview, we value based on a 20% discount to historical average P/E given a 20% fall in our forecast CROCI for the stock due to margin squeeze. For China Foods, we value the company on a SOTP-P/B basis given the company s forecast loss in 2013E/2014E. Goldman Sachs Global Investment Research 4

5 Exhibit 3: Our stock calls for 2014: Top pick Huishan (add to CL-Buy), Tingyi and UPC (upgrade to Buy from Neutral), Want Want (maintain Buy), and Hengan (maintain Sell) Ratings Target price Valuation multiples EPS growth CROCI Company New Old Chg New Old Chg CP Implied Up/Dow nside Target multiple Prem/Disc Applied Old Multiple E CAGR Rank Premium Applied 2014E Rank Theoretical Prem/Disc Within valuation framework Mengniu Neutral Neutral % % 24.0X 0% 24.0X 27% 3 0% 11% 3 0% 0% Want Want Buy Buy % % 27.6X 15% 27.6X 24% 3 0% 38% 1 15% 15% Hengan Sell Sell % % 22.8X 5% 22.8X 13% 4 20% 23% 1 15% 5% Tingyi Buy Neutral % % * 28.8X 20% 24.0X 29% 1 20% 15% 2 0% 20% CRE Neutral Neutral % % ** 28.8X SOTP 33.5X 28% 2 0% 6% 4 5% 5% Tsingtao (H) Neutral Neutral % % 15.0X EV/EBITDA 15.0X 23% 4 20% 14% 2 0% 20% UPC Buy Neutral % % 28.8X 20% 28.8X 43% 1 20% 9% 3 0% 20% China Foods Neutral Neutral % % ^^ 1.4X SOTP P/B 1.4X nmf nmf 0% 5% 4 5% 5% 24.0X 24.0X 27% 15% Outside of valuation framework Tsingtao (A) Buy Buy % % 15.0X EV/EBITDA 15.0X 23% N/A N/A 14% N/A N/A N/A Greatview Neutral Neutral % % *** 12.0X 20% vs hist. avg P/E 15.5X 22% N/A N/A 17% N/A N/A N/A Huishan CL Buy Buy % % ^ 18.5X SOTP P/E 19.5X 40% N/A N/A 18% N/A N/A N/A * We increase Tingyi's P/E multiple from 24x to 28.8x as the company's 2 yr EPS CAGR moves into 1st quartile ** We value CRE on a SOTP valuation methodology (Beer using EV/EBITDA, Retail using P/E), the Target and Old Muliples shown above are implied P/E multiples based on our SOTP valuation. *** We reduced the P/E multiple from 15.5x to 12.0x as the company's average 2014/15E CROCI is expected to be 20% below historical average. ^ We value Huishan on P/E based SOTP, with reference to its closest peers China Modern Dairy and Mengniu. The Target and Old multiples shown above are implied P/E multiples based on our SOTP valuation. ^^ We value China Foods on SOTP P/B basis as we expect the company to be in loss in 2013 and 2014 with low earnings visibility. Premium Applied Source: Datastream, Goldman Sachs Global Investment Research. Exhibit 4: Our 2013E-2015E forecasts are generally below Bloomberg consensus forecasts except for Tingyi GS forecasts vs consensus Currency CY2013E EPS CY2014E EPS CY2015E EPS GS vs Consensus Company Ticker New Old Chg % New Old Chg % New Old Chg % F13E F14E F15E Want Want 0151.HK USD % % % 4% 2% 7% Tingyi 0322.HK USD % % % 1% 5% 10% UPC 0220.HK RMB % % % ^ 37% 8% 10% Hengan 1044.HK HKD % % % 2% 12% 10% Mengniu 2319.HK RMB % % % 5% 4% 9% China Foods 0506.HK HKD % % % * 3% 105% 46% CRE 0291.HK HKD % % % 10% 11% 5% Tsingtao 0168.HK RMB % % % ^ 10% 2% 4% Huishan 6863.HK RMB % % % 9% 6% 3% Greatview 0468.Hk RMB % % % 3% 8% 10% Sector Average ^ Consensus forecasts for UPC and Tsingtao in 2013E is a mix of pre one off and post one off estimates by brokers. Gse is pre one off's * We are less optimistic vs street on ability to turnaround Wine business in a short time. Note: All EPS above is shown on calendarized basis. All companies within our coverage are December year end, except for Huishan, which is a March year end. Source: Bloomberg, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 5

6 Latest China Staples trends: Growth deceleration continues The latest Nielsen FMCG growth trends indicate that Staples growth continued to decelerate into 4Q2013. November 2013 FMCG growth was 5.5%, below the rolling 12-m average growth of 6.7% and FY12 average of 14.9%. Food growth was 5.3% (rolling 12-m average 6.3%) vs non-food growth of 5.9% (rolling 12-m average 7.5%). For the rolling 12 months to November 2013, beverages grew 9.5%, while other foods, which includes instant noodles, grew just 2%. Within non-food category, personal care grew 9.0%. Exhibit 5: China total FMCG sales growth fell to 5.5% in November 2013 from average of 6.7% for the rolling 12 months to November 2013 Nielsen monthly sales growth for total FMCG, food and non-food groups in China 40.0 Total FMCG Food Non Food Monthly Category Growth (YoY %) (10.0) (20.0) Sep 11 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Source: Nielsen. Exhibit 6: Within food, beverage sales growth in November 2013 fell to 6.4% vs 9.5% in the rolling 12 months to November 2013 Nielsen monthly food sub-category growth Exhibit 7: Within non-food, personal care sales growth in November 2013 fell to 5.8% vs 9.0% in the rolling 12 months to November 2013 Nielsen monthly non-food sub-category growth Impulse food Beverage Dairy food Other food Household Personal Care 50 Insect Control Hair Products Monthly Category Growth (YoY %) Sep 11 Nov 11 Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 Sep 13 Nov 13 Monthly Category Growth (YoY %) Sep 11 Nov 11 Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 Sep 13 Nov 13 Source: Nielsen. Source: Nielsen. Goldman Sachs Global Investment Research 6

7 Premiumization remained a core growth driver, accounting for the larger portion of category growth for Liquid Milk, Confectionery, Infant Milk Formula. While heavy competition drove price erosions for RTD tea, CSD (both due to upsizing in 2013 without increasing prices) and Facial Tissues. Exhibit 8: Food sub-category value growth, rolling 12 months to November 2013 Exhibit 9: ASP growth contributed to a significant portion of category growth for most food categories Nov 2013 Food Category Growth (MAT, YoY %) Nov 13 ASP growth (MAT, YoY %) Nov 13 Volume growth (MAT, YoY %) (5.0) (10.0) (3.2) (2.2) (1.3) (1.6) (6.1) Source: Nielsen. Source: Nielsen. Exhibit 10: Personal care sub-category value growth, rolling 12 months to November 2013 Exhibit 11: ASP growth was still high in sanitary napkins, but price erosion obvious for facial tissues Nov 2013 Non Food Category Growth (MAT, YoY %) Nov 13 ASP growth (MAT, YoY %) Nov 13 Volume growth (MAT, YoY %) Facial Tissue 2.8 Bathroom Tissue 4.7 Diaper Sanitary Protection (5.7) Facial Tissue 3.0 (0.2) Bathroom Tissue Diaper 8.5 (1.1) Sanitary Protection Source: Nielsen. Source: Nielsen. Increasing growth divergence between early stage and later stage consumption categories Exhibit 12 shows the Nielsen average rolling 12-month average category growth for early stage and later stage consumption categories. Both the early stage and later stage consumption categories saw topline growth slow through 2013, although early stage categories slowed more aggressively relative to later stage categories. That is, average category sales for early stage categories slowed by 6.3 pp to 3.7% in November 2013, vs 10.0% in January 2013, while later stage categories slowed by just 2 pp, from 13.4% to 11.4%. Euromonitor expects this diverging trend to continue through 2017 (Exhibit 13). As category growth shifts gears, ASP is likely to become an increasingly important component of category growth, in our view (Exhibits 14 and 15), particularly for early stage categories. Goldman Sachs Global Investment Research 7

8 In E, we project that volume growth for early stage categories will slow from 9.4% to 5.0%, while ASP growth will be 4.8%, accounting for approximately half of the total category growth as consumer trading up continues. For later stage categories, although slower than the past 5 years, volume growth of 12.7% in E is still respectable, and an increasing ASP growth of 3.1% will push total category growth to close to 15% CAGR. Exhibit 12: Growth discrepancy of early stage vs late stage Staples categories have been increasingly pronounced per Nielsen Nielsen rolling 12-m average category sales Exhibit 13: Euromonitor forecasts also support our expectation that growth disparity between the two groups will widen over the next several years Early stage consumption categories Late stage consumption categories Early Stage Consumption Categories Later Stage Consumption Categories % % 14.0% 15.5% 12.1% 13.5% 16.5% 12.1% 17.3% 14.2% 14.5% 15.0% 16.9% 15.4% 15.9% 15.4% % 10.6% 10.2% 10.9% % 8.5% 9.3% 9.1% 9.2% 0.0 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Early stage: biscuits, liquid milk, instant noodles, consumer packed oils, carbonates, fruit/vegetable juice, RTD tea, bathroom tissue, sanitary protection. Later stage: milk formula, sugar confectionery, chocolate confectionery, flavored milk drinks, yoghurt and sour milk products, sweet and savory snacks, bottled water, RTD coffee, sports and energy drinks, Asian specialty drinks, nappies/diapers/pants, facial tissue. Source: Nielsen. 5.0% E 2015E 2016E 2017E Note: The growth rates between Nielsen and Euromonitor are slightly different as Nielsen s data is relatively more modern trade skewed, while Euromonitor covers all channels. Source: Euromonitor. Exhibit 14: Forecast ASP vs volume growth for early stage consumption categories in E vs Exhibit 15: Forecast ASP vs volume growth for later stage consumption categories in E vs Volume Growth ASP Growth Volume Growth ASP Growth '07 '12 CAGR 9.4% 5.1% '07 '12 CAGR 17.1% 1.6% '12 '17 CAGR 5.0% 4.8% '12 '17 CAGR 12.7% 3.1% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% Source: Euromonitor. Source: Euromonitor. Goldman Sachs Global Investment Research 8

9 Raw material outlook returns to mildly inflationary, tailwind comes to an end In 2012 through 1H13, most Staples companies enjoyed lower raw materials costs including large falls in palm oil, sugar, PET prices and NZ milk powder (2012 only). As we are expecting a mild rebound in raw material prices in 2014E/2015E, we do not expect that companies can cushion their earnings any longer. As such, competition will become a more important force in determining earnings growth in 2014E/2015E, in our view. We forecast the average COGS base for the three large staples companies (Tingyi, Want Want and Hengan) to rise by 6pp in 2014E/2015E. This will be driven by still elevated NZ milk powder prices, mild inflation in palm oil, sugar, rice and flour, partially offset by continued fall of PET prices as our Global Macro Research team forecasts another 9% fall in Brent Crude Oil prices in 2014E. Contrary to the market, we also forecast pulp prices to remain stable in 2014E (as opposed to a mild drop) as our Latin American Paper Analyst Marcelo Aguiar believes that a tighter demand/supply due to delays and more than anticipated complexity in new capacity ramp up will support prices. Exhibit 16: We forecast average COGS to be stable in 2014E-2015E, but the raw material cost tailwind that helped prop up earnings growth in 2012 and 1H13 is likely to end 50% Staples' gross margin vs. raw material price index Want Want Hengan Tingyi Average raw material price index (RHS) % Raw material Hengan % Want Want % 30% Tingyi % 80 20% 1H08 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13E 1H14E 2H14E 2015E 70 Source: Bloomberg, WIND, Datastream, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 9

10 Upgrade Tingyi and UPC to Buy: Competition not over, but close to the end of a cycle The Edgeworth pricing cycle theory 1 advocates that in a market with highly homogenous products, firms undercut each other successively to increase their market share (price war phase) until the war becomes too costly, at which point some firm increases its price. The other firms quickly follow, after which price cutting begins again. The market price thus evolves in cycles. The rivalry between Tingyi and UPC is far from over, but we believe that the current cycle is drawing to a close. We upgrade both Tingyi and UPC from Neutral to Buy on improving EPS growth and CROCI outlook driven by margin recovery. We forecast Tingyi and UPC s 2-yr EPS CAGR will accelerate to 29%/43% in E vs 17%/-42% in 2013E. At current P/E of 22.8X average 2014E/2015E EPS for both companies, we see rerating opportunities to high 20s P/E given first quartile growth vs Staples peers. We believe beverages will lead margin recovery for both Tingyi and UPC in Recent stabilization of Beverage market share will prompt Tingyi to pull promotions to restore margins at a rate underappreciated by the market, in our view. As UPC has generally been a price follower, we expect the company too will restore pricing, driving margin upside for both companies. As Beverage growth has been driven more by product innovations in the past 2 years, we expect that both Tingyi and UPC will be more focused on developing new products in We are already seeing this in the market, including Tingyi s recent launch of its milk and coffee blend beverage selling at RMB3.80/500ml bottle, more than 2X the price of a RMB2.20/600ml bottle of RTD tea, on a per litre basis. Consequently, we forecast that Tingyi s Beverage OP margin will rebound from 4.9% in 2013E to 10.8% in 2015E, while UPC s Beverage OP margin will rebound from 4.4% in 2013E to 6.6% in 2015E. Noodles will remain tough as UPC has recently extended its sausage promotions to Tingyi s flagship braised beef noodles. However, we do not expect this to materially worsen from 2013E as our instant noodles unit cost analysis suggests that both companies have the flexibility to shift promotional focus between different flavors. Moreover, we are also seeing a pull-back in above the line advertising spend to fund the more direct, priceled promotions. We expect the Noodles price-war to end by 2015E as: 1) Tingyi s dominant market share in braised beef noodles will be hard to challenge. Former No.2 competitor Hualong attempted to push for market share in this category via its premium label Jinmailang in The product added a free egg to its braised beef flavored bowl noodles and emphasized its superior quality noodles at competitive prices. Despite some initial success, it was not sustained and Hualong has been losing share in recent years; 2) second consecutive year of losses, tight cash flow will necessitate UPC to pull back promotions. Our instant noodles unit cost analysis calculates that UPC and Tingyi have each spent an additional RMB0.19/unit and RMB0.26/unit of COGS on promotions in 2013E compared with Given ex-factory price of just RMB1.29/unit and RMB1.57/unit respectively, this implies that aggressive competition has cost both companies 15%- 17% in GP margin. That is, all the raw material cost savings and more, have been reinvested back into the market for competition. If just 25% of this were to be restored, we think both Tingyi and UPC will enjoy an incremental 3-4 pp noodles OP margin. We forecast that Tingyi s Noodles margins will fall from 9.7% in 2013E to 9.25% in 2015E due to added competition in Braised Beef Noodles; while UPC s will improve from - 2.5% to -0.6% in 2015E due to reduced competition in Lao Tan Noodles. 1 A theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles, Maskin and Tirole, 1988 Goldman Sachs Global Investment Research 10

11 Beverages to lead margin rebound in 2014 for Tingyi and UPC Tingyi s beverage OPM has dropped from 13% in 2008 to 5% in 2013E due to aggressive market share defence. This is below the usual level of 10%-15% EBIT margin that is achievable by Beverage companies with dominant market share within a certain country. As such, we believe that the recent stabilization in RTD tea market share will prompt Tingyi to pull promotions to restore profitability to a more desirable level. From Exhibits 17, we see that Tingyi s volume market share in RTD tea has rebounded from Mar/April 2013, while UPC and third competitor Wahaha have lost market share. We think UPC s loss of market share could be attributed to: 1) significant slowdown of its flagship Asamu milk tea sales (Exhibit 19) as the usual high growth cycle for an IT product only lasts for c.2-3yrs; and 2) loss of market share in the RTD tea excl. milk tea category as Tingyi has upsized its RTD tea beverages from 500ml to 600ml without increasing prices since beginning of However, we believe that UPC is unlikely to pursue a price war with Tingyi given its tight cash flow and the need to fund another RMB4bn capex in 2014E. Since Tingyi has already successfully defended its RTD tea market share in the face of UPC s slow-down in milk tea, we do not see further motivation for Tingyi to extend its pricing discounts in a slowing category. In fact, we believe that there is good reason for Tingyi to pull back its promotions in beverages in order to drive margin recovery. In addition, we forecast PET prices to fall further in 2014E/2015E as our Global Macro Research team is looking for another 9% drop in Brent Crude Oil prices in This should lift Tingyi and UPC s margins further, in our view. Exhibit 17: Tingyi sees a rebound in volume market share of RTD tea beverages Nielsen RTD tea volume market share Exhibit 18: We are beginning to see a rebound in RTD tea ASP from July/August 2013 Nielsen RTD tea ASP trend TINGYI UPC WAHAHA TINGYI UPC WAHAHA Volume Mkt Share (%) 60% 50% 40% 30% 20% 10% 0% Sep Oct11 Nov Dec11 Jan Feb12 Mar Apr12 May Jun12 Jul Aug12 Sep Oct12 Nov Dec12 Jan Feb13 Mar Apr13 May Jun % 28.4% 7.4% Sep Oct13 Jul Aug13 $1.05 $1.00 $0.95 $0.90 $0.85 $0.80 $0.75 $ Jul Aug12 May Jun12 Mar Apr12 Jan Feb12 Nov Dec11 Sep Oct Mar Apr13 Jan Feb13 Nov Dec12 Sep Oct Sep Oct13 Jul Aug13 May Jun13 Source: Nielsen. Source: Nielsen. Goldman Sachs Global Investment Research 11

12 Exhibit 19: UPC s flagship product Asamu milk tea is seeing visible topline slowdown, relieving market share pressure for Tingyi RTD tea growth MARKET TINGYI UPC ASAMU Milk Tea 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 10% 20% 78.0% 63.4% 42.5% 49.7% 26.3% 16.2% 10.7% Sept Oct13 Jul Aug13 May Jun13 Mar Apr13 Jan Feb13 Nov Dec12 Sep Oct12 Source: Nielsen. PepsiCo-Tingyi alliance likely to boost margins further from 2014E We forecast a small profit contribution (4%/6% to group profits in 2014E/2015E) for the PepsiCo-Tingyi alliance, which will further add to our margin recovery thesis for Tingyi. Since formation of the alliance in 2Q12, Tingyi s management has been targeting to turn PepsiCo s losses in China to break-even by Given management s confirmation of a profitable quarter in 2Q13 and a solid performance by Beverages in 3Q13, it appears that this has come to fruition. From 2014E, we expect the PepsiCo alliance to contribute a small profit to Tingyi s beverage business as continued merging of production facilities, end POS and coolers, gradual merging of sales team etc. will gradually drive the Pepsi business towards Tingyi s NPAT margin target of 8%. With the recent appointment of Mr Ko Yuen-Yat to take over from Mr Chu Wah-Hui to head Tingyi s Beverage division, we believe that Tingyi is onto its 2 nd stage of integration. In the first stage, Mr Chu, a former President of PepsiCo China, was appointed to facilitate the integration of the two businesses and to rebuild PepsiCo. In this second phase of integration, the focus could be to maximize synergistic benefits and drive the beverage business forward as a coherent, operational unit for Tingyi. In 2014E/2015E, we forecast the Pepsi business to contribute US$1.79bn and US$1.89bn to Tingyi s top-line and US$23mn (4% of group) and US$45mn (6% of group) to net profit after minority interest. Goldman Sachs Global Investment Research 12

13 Exhibit 20: We forecast that PepsiCo could contribute US$45mn net profit post minority interest or 6% uplift to group profits by 2015E 2012E 2013E 2014E 2015E Consolidated from 2Q12 USD mn Sales 1,607 1,685 1,790 1,892 GP EBIT NPAT CBL's share at 78% % interest % of group reported NPAT 4% 6% USD % Growth Sales 4.9% 6.2% 5.7% GP 8.4% 9.7% 9.0% EBIT nmf nmf 91.5% NPAT nmf nmf 97.9% USD % Margin GP 31.0% 32.0% 33.0% EBIT 0.7% 3.7% 6.7% NPAT 0.4% 3.4% 6.4% Note: CBL is PepsiCo s share of Pepsi s Chinese Bottlers i.e. PepsiCo only owns 78% of total Pepsi bottlers in China. Source: Company data, Goldman Sachs Global Investment Research. Exhibits 21 and 22 show our margin recovery projections for both Tingyi s and UPC s beverage businesses. Exhibit 21: We expect Tingyi s Beverage OPM to rebound due to: 1) continued fall in raw material prices; 2) recovering top-line and PepsiCo driving improved operating leverage; 3) a pull-back in promotional intensity Tingyi s beverage EBIT margin trend vs market share Tingyi RTD tea market share (LHS) Tingyi Beverage EBIT Margin (RHS) 70% 60% 50% 13.3% 13.4% 13.2% One More Bottle campaign drove large increase in market share, but higher raw material costs more than halved OP margins RTD tea category slow-down, PepsiCo merger and intensified competition against UPC's milk tea drove margins down fruther. We expect resumption of market share gains, lower raw material costs, PepsiCo profits, pull back in competition with UPC will drive margin rebound. 17.5% 15.0% 12.5% 40% 11.1% 10.8% 10.0% 30% 9.2% 8.6% 7.5% 20% 5.4% 4.9% 5.0% 10% 3.8% 2.5% 0% E 2014E 2015E 0.0% Source: Nielsen, Company data, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 13

14 Exhibit 22: We expect UPC s Beverage OPM to rebound due to: 1) continued fall in raw material prices; 2) increased new plant utilization; 3) a pull-back in promotional intensity UPC s beverage EBIT margin trend vs market share UPC RTD tea market share (LHS) UPC Beverage EBIT Margin (RHS) 35% 30% Significant drop in raw material costs Significant increase in raw material costs Significant growth of milk tea, driving positive operating leverage We expect market share expansion plateaus. Pull back in promotions and further falls in PET prices drive margin expansion. 17.5% 15.0% 25% 13.4% 12.5% 20% 10.7% 11.1% 10.0% 15% 7.5% 10% 6.8% 7.2% 5.5% 4.4% 5.3% 6.6% 5.0% 5% 2.5% 0% E 2014E 2015E 2.1% 0.0% Source: Nielsen, Company data, Goldman Sachs Global Investment Research. Exhibit 23: We forecast Tingyi s underlying organic beverage margins excl. PepsiCo will rebound to 10.3%/12.2% in 2014E/2015E Tingyi s underlying beverage margins, excl. PepsiCo 50% Organic GPM Organic OPM Organic Opex/Sales % 45.9% 40% 30% 33.5% 34.6% 41.1% 33.9% 32.6% 40.7% 38.1% 39.6% 35.8% 40.1% 36.9% 36.8% 36.2% 36.9% 28.5% 29.5% 31.1% 32.9% 34.5% 25.7% 20% 25.4% 23.6% 23.4% 23.0% 25.8% 19.3% 20.3% 23.5% 24.6% 22.6% 22.2% 10% 0% -1.1% 7.2% 13.3% 2.6% 3.8% 14.7% 13.3% 13.4% 13.2% 11.1% 9.2% 5.4% 6.0% 6.5% 10.3% 12.2% We forecast margin recovery due to positive mix; lower raw material costs; positive operating leverage; pull-back in promotions vs UPC -10% E 2014E 2015E Source: Company data, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 14

15 Noodles unit cost analysis suggests marketing flexibility available Sausage promotions have dominated instant noodles headlines in 2013 on being the primary promotional tool in Tingyi and UPC s fight for market share. In the past month, UPC has further extended its sausage promotion onto Tingyi s flagship braised beef noodles. But how much does a sausage cost and what will this mean for margins? Exhibit 24: UPC s braised beef noodles the latest flavor to include sausage promotions Which categories have now become part of the sausage promotion? Tingyi UPC Lao Tan Lu Rou Braised Beef egg flakes Note: Crosses indicate that the free sausage promotional offer applies to this flavor s bowl noodles Source: Goldman Sachs Global Investment Research. This section attempts to conduct an in-depth study in per-unit cost associated with producing and marketing a unit of instant noodles in China in order to assess the strategic options available to both companies in the price-war. Methodology In Exhibits and below, we have attempted to estimate the per unit cost of instant noodles for both Tingyi and UPC. Each of the companies disclose instant noodles segment sales, GPM and OPM. Using total market volume sales disclosed by the World Instant Noodles Association (WINA) and applying Euromonitor s estimated volume market share for UPC and Tingyi, we have derived the annual noodles volumes for both companies used to calculate our per unit cost. For COGS, we use 2010 as a base for the basic raw materials required for instant noodles production, before the current cycle of price-war escalated in Indexing this base for changes in spot raw material prices, such as the fall in palm oil prices in 2012 and 2013, we calculate the cost base for these same raw materials in The difference between this and our forecast 2013 COGS is assumed to be the additional COGS added in for promotional purposes due to intensified competition e.g. sausage, sauce sachets etc. For the different components of SG&A, we have estimated the components of Admin expense, Transport and Salaries, with reference to group expense ratios. The remaining SG&A costs are assumed to be advertising and promotions. Conclusion Noodles competition will remain tough in 2014E, but we believe that the noodles price-war will draw to a close by 2015E. 2010: Exhibits 25 and 26 attempt to break down the unit production and marketing cost for instant noodles for Tingyi and UPC in We note that: 1) Tingyi has a higher ex-factory price of RMB1.28/unit compared with UPC s RMB1.08/unit. This would suggest that Tingyi, with 3X more volumes sales vs UPC, enjoys better bargaining power in the market. 2) Tingyi incurs higher per unit cost of production than UPC. A plausible explanation of this is that Tingyi follows a diversified approach vs UPC s focused approach. It appears that economies of scale have allowed UPC to drive a lower per unit cost compared with even the most dominant company in the market. Goldman Sachs Global Investment Research 15

16 Exhibit 25: At the height of raw material costs in 2010, we estimate that it took UPC RMB0.62 worth of raw materials to produce 1 unit of instant noodles GS estimate of COGS breakdown for UPC in 2010E Rmb/Unit Basic raw materials Ex-factory Price Sausage promotion Additional Raw materials Other COGS Promotions Transpor tation 0.06 Other Selling Exp (incl. salaries) Admin 0.03 Operating Profit Source: Euromonitor, Goldman Sachs Global Investment Research. Exhibit 26: while it took Tingyi RMB0.73/unit GS estimate of Tingyi s Instant Noodles average per unit cost 2010 Rmb/Unit Basic raw materials Exfactory 1.28 Sausage promotion Additional Raw materials - - Other COGS Promotions 0.07 Transpor tation 0.05 Other Selling Exp (incl. salaries) 0.08 Admin 0.02 Operating Profit Source: Euromonitor, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 16

17 2013E: Exhibit 27 to Exhibit 28 shows our estimate for how the unit costs have evolved for Tingyi and UPC by 2013E. Most notably, the raw material cost per unit should have declined substantially given the market price corrections for palm oil and flour during this period. However, since per unit COGS in 2013E has actually not improved vs 2010, we assume that the difference between our estimate of the raw materials per unit in 2013E (assuming the same base as 2010) vs the actual raw material costs incurred to be the additional ingredients added to intensify consumer promotions. For example, as seen in Exhibit 25, we calculated that UPC s base instant noodles cost RMB0.62/unit in basic raw materials to produce. While by 2013E, given the large drops in flour and palm oil prices, this should be close to RMB0.54/unit. However, we calculate that UPC s per unit raw material cost has actually increased to RMB0.73/unit. We believe that the additional RMB0.19/unit can be attributed to additional promotions such as the sausage promotion, pickled vegetables, and sauce sachets. Interestingly, this shows that Tingyi has invested higher per unit COGS for promotions (RMB0.26/unit) vs UPC (RMB0.19/unit), but is able to better leverage its brand promotional expense spending only RMB0.10/unit vs UPC s RMB0.18/unit. The total market investments in 2013E for Tingyi and UPC in instant noodles are similar, at RMB0.36/unit and RMB0.37/unit, respectively. With already such a high level of market investment, we believe that things are unlikely to get materially worse. Instead, Tingyi and UPC can moderate some of its investments in the Lao Tan category growth given its noticeable slow-down and re-direct to defending/grow in new categories without incurring significant additional marketing spend. That is, we believe that Tingyi has a higher degree of flexibility with its marketing budget than perceived by the market. Exhibit 27: By 2013E, raw materials per unit have fallen to just RMB0.54, while additional promotional material has cost UPC an incremental RMB0.19/unit to COGS GS estimate of COGS breakdown for UPC in 2013E Rmb/Unit Basic raw materials Ex-factory Price 1.29 Sausage promotion 0.12 Additional Raw materials 0.07 Other COGS Promotions 0.18 Transpor tation 0.06 Other Selling Exp (incl. salaries) 0.14 Admin 0.04 Operating Profit Source: Euromonitor, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 17

18 Exhibit 28: By 2013E, raw materials per unit has fallen to just RMB0.63, while additional promotional material has cost Tingyi an incremental RMB0.26/unit to COGS Tingyi instant noodles per unit cost 2013E RMB/Unit Basic raw materials Exfactory Sausage promotion 0.04 Additional Raw materials Other COGS Promotions 0.10 Transpor tation 0.06 Other Selling Exp (incl. salaries) Admin 0.05 Operating Profit Source: Euromonitor, Goldman Sachs Global Investment Research. 2014E-2015E: With UPC s Lao Tan noodle growth visibly slowing in 2013E and Tingyi appearing to have successfully defended its market share, we ponder the next steps for these two companies. Competitive behavior in an oligopoly is often complex because pricing decisions are made in a highly interdependent environment. Studies on Edgeworth Price Cycles illustrate that in a market of homogeneous goods where customers are price sensitive (as is the case for Instant Noodles), one vendor s actions to undercut another will be quickly matched. Undercutting will continue until the war becomes too costly when one competitor will restore prices. Everyone will follow as quickly as possible, and the cycle repeats. Exhibit 29: Both companies have continued to gain share in instant noodles at the expense of smaller companies Nielsen Volume Market Share Instant Noodles Exhibit 30: UPC s instant noodles growth has slowed in 1H13 due to slowdown of Lao Tan Noodles Instant Noodles sales growth YoY (%) - Tingyi, Market, UPC Instant Noodles Volume Market Share (%) Jun-06 Tingyi Uni-President Huafong Hualong White Elephant Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun % 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% Tingyi UPC Market 67.4% 67.3% 22.5% 10.6% 10.4% -7.8% -6.0% 10.4% 15.2% 14.6% 8.0% H13 Source: Company data, Nielsen. Source: Company data. Goldman Sachs Global Investment Research 18

19 If we look at Tingyi and UPC, we believe that this price-war will hit its peak in 2014 and pricing will be restored by This is because we forecast that after its loss in 2013E, UPC will sustain a second year of loss (albeit smaller) in 2014E by targeting Tingyi s flagship product Braised Beef Noodles, with little success in gaining market share. UPC s balance sheet will be further stretched in 2014E by a high capex budget of RMB4bn and rising palm oil costs, driving negative free cash flow will be in the vicinity of RMB2.2bn in 2014E. This implies that the company may be required to take on further debt, continue to resell fixed assets back to its sister companies, consider issuing equity or a combination of all three. If we assume that the company will resolve its cash needs via debt, the net gearing for UPC in 2014E would potentially be 67%. By 2015E, a combination of slowing topline and raw material inflation is likely to spell an end to this round of price war, in our view, as companies realize that it is detrimental to the industry profit pool and will begin to pull back on promotions. In the meantime, we think the intense competition is likely to marginalize smaller companies further, such as Hualong and Baixiang, which do not have the financial might to keep up, leading to a further market share gain for incumbents. Exhibit 31: In 2014, we expect UPC to direct a higher portion of its promotional budget to below-the-line direct price promotions, partially funded by a reduction in above the line brand spend, in our view. Total promotional spend will be slightly lower at RMB0.35/unit vs RMB0.37/unit in 2013E GSE UPC Instant Noodles per unit cost 2014E 1.40 Rmb/Unit 1.20 Basic raw materials Exfactory 1.29 Sausage promotion 0.13 Additional Raw materials 0.07 Other COGS Promotions Transport ation 0.05 Other Selling Exp (incl. salaries) Admin Operating Profit Source: Euromonitor, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 19