Tingyi Holding Group (322.HK)

0 3 - N O V - 2 0 0 8 B a s i c I n f o r m a t i o n Sector Consumer Tingyi Holding Group (322.HK) A dominate player in the world s largest market BUY Prev. Closed 8.10 52-week High 13.6 52-week Low 6.6 Target Price 10.61 Tingyi, headquart ered in Tianjin, is one of China s leading f ood and beverage players. The company s started its instant noodle segment in 1992, and expanded int o the bakery segment and beverage segment in 1996 which all owns the leading position in cert ain segments in China currently. Market Cap HK$ (Billion) 49.18 US$ (Billion) 6.35 Initiation with a Buy; target price of HK$10.61: We initiate Tingyi Holdings Group with a Buy recommendation and set up a target price of HK$10.61 which Shares outstanding 5,589 Mn implies a 23x 2009E EPS, based on our DCF analysis model. translates to 31.0% upside. Our target price P e r f o r m a n c e ( % ) Relative Absolute Pleasant outlook for instant noodle industry; China is the world s largest Index HSI 322.HK 1 month 20.0% 1.1% 3 month 31.9% (5.4%) 12 month 31.5% (21.4%) instant noodle consumer which accounts for more than one-third of global consumption in terms of volume. We believe the industry s organic growth of 10% per year to persist in the following 3-5 years due to (1) low per capita basis, (2) increasing demand from rural areas, and (3) rising quality attention to support ASP growth. P e r f o r m a n c e C h a r t s More healthy driven products in beverage market: Chinese beverage market size was roughly RMB 100bn in 2007 and grew at a CAGR of 20% over the past five 30% 0% 322 HK Equity HSI Index years. We noted that ready-to-drink tea (RTD tea), bottle water, and juice grew at a faster pace than carbonated drink as beverage buyers tend to pay more attention on their health. -30% Strong brand name, rich sales network, and impressive gross margin: -60% 02/22 04/07 05/22 07/06 08/20 10/04 With more than 10 years operation experience in China, Tingyi has enjoyed a splendid growth at a CAGR of 20%+ since 2001 in terms of both sales and net profits attributed to shareholders. We believe the growth to persist, thanks to its (1) dominant position in the world s largest market, (2) strong sales channel network, and (3) stable gross margin of 32-33% under restricted cost management. Top pick in Chinese F&B sector: Tingyi is our top pick among Chinese F&B Analyst: Sophie Fan (852)2105-1112 sector due to its largest economy of scale, dominant position in the market, better profitability, and strong management efficiency. We forecast the company s 2008 sales and net profits to grow 31.7% and 37.7% YoY, respectively. For 2009, we project sales to rise 23.8% YoY and net profit to increase 22.7%. sophie_fan@e-capital.com.hk

Investment Summary We initiate Tingyi Holdings Group with a Buy recommendation and set up a target price of HK$10.61 which implies a 23x 2009E EPS, based on our DCF analysis model. With more than 10 years operation experience in China, Tingyi has enjoyed a splendid growth at a CAGR of 20%+ since 2001 in terms of both sales and net profits attributed to shareholders. We believe the growth to persist thanks to following reasons. (1) A dominant position in the world s largest market. The company has a leading position in Chinese instant noodle and beverage markets supported by its high brand recognition. Currently, the company owns a 46.6% market share of Chinese instant noodle market. In terms of Tingyi s super product, ready-to-drink tea of beverage segment, it holds a market share of 41.3%. (2) Strong sales channel network. Tingyi has cultivated in its sales channel network by minimizing the number of layers between wholesalers and retail nodes which gives the company stronger pricing power and better understanding on customers consumption behavior. (3) Stable gross margin under restrict cost management. Though raw material price has flied since 2005, the company demonstrates its capability of cost management by maintaining gross margin at a stable and high level of roughly 32%. We forecast Tingyi s 2008 sales and net profits to grow 31.7% and 37.7% YoY, respectively. For 2009, we project sales to rise 23.8% YoY and net profit to increase 22.7%. Exhibit 1. Tingyi's sales and gross margin from 2002 to 2009E HK$ mn 6,000 5,000 4,000 3,000 2,000 1,000 0 2002 2003 2004 2005 2006 2007 2008E 2009E Sales (LHS) Gross Margin (RHS) % 40 32 24 16 8 0 Source: CMoney

Investment Thesis The world s largest market Chinese instant noodles market - a stable industry organic growth of 10%. China is the world s largest instant noodle consumer. According to China Food Industry Association, Chinese instant noodle consumption accounts for more than one-third of global consumption in terms of volume. Total market size is worth approximately RMB 30bn per year. In this huge market, top three players, Master Kong, Hualong, and Uni-President, control 60% and 70% market shares by volume and value, respectively. Over the last decade, Chinese instant noodles market has grown at a GAGR of 10% annually. We believe the industry s organic growth of 10% per year to persist in the following 3-5 years due to three reasons. (1) Low per capita basis. Although China is the largest instant noodle consumer in the world, it only ranks at the fifth on a per capita basis. Annual instant noodles consumption per person is 20 packets in 2007 that we believe it still has plenty of room to grow compared to Japan s 80, Korea s 45, Taiwan s 44 packets, and Hong Kong s 43 packets. (2) Increasing demand from rural areas. Due to low penetration rate, we believe further instant noodle sales volume growth can be supported by rising demand from tier 2 and tier 3 cities. (3) Rising quality attention to support ASP growth. Though street concerns instant noodle market is likely to be saturated in urban areas, we believe buyers in tier 1 cities tend to shift consumption behavior from convenience attention to quality attention which leads to sustain sales value growth. Exhibit 2. Chinese instant noodles market shares Market share by volume (%) Market share by value (%) 2007 2006 2007 2006 Master Kong 34.5 32.5 47 43.3 Hualong 16.8 17.1 14.9 14.4 Uni-President 10.3 12.3 10.2 12.1 Bai-Xiang 9.1 10.6 6.7 7.7 Source: AcNielsen Chinese beverage market more healthy products driven. According to ACNielsen, Chinese beverage market size was roughly RMB 100bn in 2007 and grew at a CAGR of 20% over the past five years. We noted that ready-to-drink tea (RTD tea), bottle water, and juice grew at a faster pace than carbonated drink as beverage buyers tend to pay more attention on their health. In 2007, packing water comprised 53% of non-alcoholic beverage sales volume, carbonated drink 22%, juice 13%, RTD tea 12%, and others 1%.

Exhibit 3. Chinese beverage market breakdown in terms of products RTD tea 12% Others 1% Juice 13% Bottle water 52% Carbonated drink 22% Source: CMoney Tingyi currently has no plan to enter into carbonated drink market since that is dominated by global big names, such as Coca-cola (US) and Pepsi (US). Instead, the company is the market leader in RTD tea and bottle water segment with a market share of 53.3% and 19.9% by volume, respectively. We are positive on Chinese beverage market s future and foresee two key trends in this industry. (1) Rising ASP: We note that volume growth has dropped faster than value growth for all segments of the Chinese beverage market, according to the company s data. That is attributed to rising ASP supported by various new products launch, in our view. We expect this trend will continue and help beverage companies to improve their profitability. (2) Market consolidation:: According to ACNielsen, top players in Chinese beverage market keep grabbing market share from smaller players due to high brand recognition, aggressive marketing plan, and strong R&D team. We, thus, consider that big players such as Tingyi will be one of the key beneficiaries amid the trend of market consolidation. Exhibit 4. Chinese beverage market shares - RTD tea Market share by volume (%) Market share by value (%) 2007 2006 2007 2006 Master Kong 53.3 55.2 51.9 53.6 Uni-President 22.5 22.5 22.8 23.0 Wahaha 9.7 8.7 9.9 8.7 Coca Cola 5.3 5.5 5.6 5.9 Source: AcNielsen

Exhibit 5. Chinese beverage market shares - Diluted juice Market share by volume (%) Market share by value (%) 2007 2006 2007 2006 Coca Cola 25.9 21.0 29.6 24.5 Uni-President 25.7 31.5 24.3 29.2 Master Kong 18.1 18.8 16.5 17.1 Hui Yuan 8.8 8.1 7.5 7.7 Wahaha 2.7 4.0 2.6 3.8 Source: AcNielsen Exhibit 6. Chinese beverage market shares - Bottle water Market share by volume (%) Market share by value (%) 2007 2006 2007 2006 Master Kong 19.9 12.7 18.6 12.4 Wahaha 14.6 14.5 16.2 15.9 Farmer's Spring 10.2 10.2 11.0 10.7 Yi Bao 8.4 7.0 10.8 9.0 Coca Cola 5.0 6.3 4.5 5.7 Run Tian 3.2 3.1 2.8 2.7 Robust 2.4 3.3 2.4 3.3 Source: AcNielsen Tingyi s core competitive advantages Tingyi has enjoyed a splendid growth at a CAGR of 20%+ since 2001 in terms of both sales and net profits attributed to shareholders. We view brand name and sales channels are the company s core competitive advantages The most popular brand name Master Kong. Tingyi markets almost all the products under its own Master Kong brand. Master Kong are ranked as the most popular F&B brand name in China with instant noodles, RTD tea, and bottle water market share of 34.5%, 53.3%, and 19.9%, respectively. Meanwhile, low-end packet noodles are sold under another own Fu Man Duo brand which is established to heighten the entry barrier of low-end instant noodles market. We are positive on Tingyi s since the company owns the most popular brand name in the world s largest market and is likely to continue grabbing market share from smaller players supported by its high brand recognition, large economy of scale, solid R&D team and, strong financial support in the future. Solid distribution network. Tingyi owns 535 sales offices, 82 warehouses, 5,999 wholesalers, and 68,717 direct retailers nationwide as at the end of 2007 that is the richest distribution network among all F&B players in China. In order to have better control over the end retail nodes, Tingyi has worked hard on minimizing the layers of wholesalers in the supply chain. First, the company requires its salespeople to accompany its wholesaler clients to take

orders from end-retailers. Second, the company has devoted itself to penetrate into tier 2 to tier 3 cities which has larger growth potential. The rich distribution network and control power over end retailer give the company stronger pricing power and better understanding on customers consumption behavior. Impressive gross margin Though raw material price has flied since 2005, the company demonstrates its capability of cost management by maintaining gross margin at a stable and high level of roughly 32%. In 1H08, gross margin of instant noodles, beverages, and bakery business increased 1.9 ppts, 0.54 ppts, and 1.1 ppts, to 26.0%, 38.9%, and 38.3%, respectively. Management indicated the improving numbers are supported by better product mix and restricted cost control. We estimate that 2008 and 2009 gross margin will maintain at the health level of 32.86% and 32.60%, respectively. Exhibit 7. Tingyi s major raw material price trends RMB/Ton 12000 10000 8000 6000 4000 2000 0 1Q/02 1Q/03 1Q/04 1Q/05 1Q/06 1Q/07 1Q/08 PET Resin:60% of PET drink cost Flour:12-18% of noodle cost Palm Oil:12-15% of noodle cost Sugar 10% of PET drink cost Source: CMoney; CSC Securities Why Master Kong? Tingyi vs. Uni-President China In China, Uni-President China (220.HK; UPC) is the only one F&B player which has the same product lines (instant noodles and beverage) with Tingyi. We, thus, refer to UPC in our peer comparison. Larger economy scale; larger market share. For 1H08, Tingyi achieved sales of HK$16bn which was 3 times larger than UPC. In terms of market share, Tingyi stands at No. 1 ranking in instant noodles, RTD tea, and bottle water segments which enjoy market share of 34.5%, 53.3%, and 19.9% which is significantly higher than UPC s 10.3%, 22.5%

and less than 2%, respectively. Exhibit 8. Peer comparison - Tingyi vs. UPC (numbers as of 1H08) HK$ mn Tingyi Holdings Uni-President China 1H08 Sales 15,984.2 5,716.7 YoY (%) 36.4 13.1 1H08 Profits attributed to shareholders 995.3 240.8 YoY (%) 33.2-18.4 Gross margin (%) 32.9 34.3 Operating margin (%) 10.9 6.0 ROE (%) 11.8 3.8 Source: CMoney; CSC Securities Higher operating profit margin secured by austere cost control. Compared to UPC which main product is beverage with sales contribution of 75%, Tingyi has less sales contribution from beverage products of 50% which carry higher gross margin than instant noodles (gross margin of beverage and instant noodles are roughly 38% and 28%, respectively, according to management). UPC, thus, possesses higher gross margin than Tingyi by approximately 1-2 ppts. However, we noted that Tingyi has a better operating margin of 10.9% than UPC s 6%, which supported by lower administration expenses, depreciations, and finance costs. This demonstrates that Tingyi has better capability of cost control and working efficiency. Better ROE. Over the past 3 years, Tingyi s ROE of 15-18% has performed better than UPC s 8-10%. Tingyi has had no growth in equity during this period while UPC s equity has increased by 20%. In 1H08, Tingyi s capital is HK$8.3bn, which is 129% larger than UPC s HK$6.4bn. On the other hand, Tingyi s net profit has been 4 times higher than UPC. This implies that Tingyi has better profitability and management efficiency than peers. Exhibit 9. ROE of Tingyi vs. UPC % 20 16 12 8 4 0 2005 2006 2007 1H08 Tingyi Holdings Uni-President China Source: CMoney; CSC Securities

For the reasons above, we are of the opinion that investors who are interested in the China F&B industry should keep an eye on Tingyi. Company Overview Started in 1992 and listed in 1996, Tingyi Holdings is one of the leading instant noodles and beverage manufacturers in China. Major shareholders are Ting Hsin Holdings Corp. and Sanyo Foods Co. which each holds a 33.2% stake of Tingyi. The former one is a holding entity which controlled by Tingyi s founder Wei family and the latter one is a major Japanese instant noodle manufacturer. Instant noodle business main growth driver. In 1H08, turnover for the instant noodle business was US$982mn, increased by 49.4% from last year and representing 47.94% of the group s total turnover. Instant noodle business remains to be the major growth driver of the company, especially on high margin products. Turnover of high-end noodles grew by 55.49% over the same period of last year where growth rate is impressively higher than the company s overall sales growth of 36.36%. Master Kong gained 62.6% and 68.1% market share respectively for container noodles and high-end packet noodle. We expect instant noodle sales to grow 38.16% and 30.28% YoY in 2008 and 2009, respectively, Beverage business slowing growth. In 1H08, beverage business presented a YoY sales growth of 25.19% to US$942mn which accounted for 46.02% of the group s total sales. Management indicated that slowing growth was due to change in the purchasing structure of consumers, abnormal weather, and intensified competition. We forecast 2008 and 2009 sales of beverage business will increase 24.64% and 18.40% YoY, respectively. Gross margin will maintain at a relatively high level of 38-39% compared to the company s overall gross margin of 32-33%. Beverage business yet to take off. The turnover of the bakery business in the first half of the year amounted to US$67mn, an increase of 42.99% YoY and made up 3.31$ of total sales. We attributed the strong growth to its low base and consider that there is no sign showing that the business is going to take off due to fierce competition from global big names such as Kraft. Valuation Initiation with a Buy; target price of HK$10.61. We initiate Tingyi with a Buy rating and a target price of HK$10.61, based on the DCF valuation since it is more comfortable to reflect the company s stable operation. Our assumption of DCF analysis is a WACC of 10.07% and terminal growth rate of 3% which is along with industry average.

The target price implies a 23.1x 2009E PE and a PEG of 1.02x which is above the average of peer group s 14.2x 2009E PE. We believe Tingyi deserves a valuation premium due to its (1) dominant position in the world s largest F&B market, (2) solid sales channel network which leads to a stronger pricing power and R&D capability of new product development, (3) better financial management among peers. We forecast the company s 2008 sales and net profits to grow 31.7% and 37.7% YoY, respectively. For 2009, we project sales to rise 23.8% YoY and net profit to increase 22.7%. Our target price translates to 31.0% upside. We recommend investors to accumulate the stock on weakness. Exhibit 10. DCF sensitivity analysis of target price Target price (HK$) Terminal growth rate Source: CSC Securities WACC 9.07% 9.57% 10.07% 10.57% 11.07% 2.00% 10.91 10.59 10.28 9.98 9.69 2.50% 11.08 10.75 10.44 10.13 9.84 3.00% 11.26 10.93 10.61 10.30 10.01 3.50% 11.46 11.12 10.80 10.48 10.18 4.00% 11.67 11.33 11.00 10.68 10.37 Exhibit 11. Peer group comparison in terms of valuation Share price PE EV/EBITDA Stock code Company name (10/31) 2008E 2009E 2008E 2009E 322.HK Tingyi 8.10 21.64 17.63 8.83 7.23 220.HK Uni-President China 1.65 10.61 7.09 1.92 1.57 168.HK Tsingtao Brewery 13.54 22.30 17.78 11.48 9.78 151.Hk Want-want 2.89 18.57 14.86 13.51 10.58 2319.HK China Mengniu 7.35 34.82 15.35 10.05 6.13 1068.Hk Yurun Food 9.00 12.02 10.17 10.90 8.38 1216.TT Uni-President 28.00 17.13 15.44 40.76 37.09 1201.TT Wei Chuan 15.65 13.32 10.30 -- -- 2897.JP Nissin 2785 16.01 17.20 7.30 6.88 2503.JP Kirin 1067 8.79 16.61 7.16 6.67 Average 17.52 14.24 12.43 10.48 Source: Bloomberg; CSC Securities

Table Income Statement (US$ MN except EPS) 2005 2006 2007 2008E 2009E Revenue 1,846 2,332 3,215 4,233 5,240 Gross Margin 578 752 1,016 1,391 1,708 Operating Profit 180 230 309 460 556 Pretax Income 188 237 317 460 561 Net Income 124 149 195 268 329 EPS 0.022 0.027 0.035 0.048 0.059 Growth (%).Of Revenue 25.82 26.34 37.90 31.65 23.78.Of Gross Margin 42.88 30.14 34.97 36.99 22.80.Of Operating Profit (39.27) 27.41 34.49 48.74 20.81.Of Pretax I ncome (36.59) 25.97 34.01 44.96 21.90.Of Net Income (56.87) 20.56 30.83 37.65 22.74 Ratio (%).Of Gross Margin 31.33 32.27 31.58 32.86 32.60.Of Operating Profit 9.78 9.86 9.62 10.86 10.60.Of Pretax I ncome 10.18 10.15 9.87 10.86 10.70.Of Net Income 6.69 6.39 6.06 6.34 6.28 SOURCE: Tingyi, CSC Securities estimates Table Balance Sheet (US$ MN ) 2005 2006 2007 2008E 2009E Inventory 102 112 155 202 250 Current Asset 418 478 647 863 1,135 Total Asset 1,549 1,840 2,334 2,992 3,728 Current Liabilit y 485 696 925 1,416 1,965 Total Liability 677 927 1,307 1,931 2,617 Equity 872 913 1,028 1,061 1,111 Solvency Liability Ratio (%) 43.70 50.37 55.98 64.54 70.20 Debt -to-equit y Ratio 17.49 29.35 38.77 53.48 62.12 SOURCE: Tingyi 1 T h i s p u b l i c a t i o n i s i s s u e d b y C S C S e c u r i t i e s ( H K ) L i m i t e d ( C S C S L ), a l i c e n s e d c o r p o r a t i o n t o c a r r y o n T y p e 1, 2 & 4 r e g u l a t e d a c t i v i t i e s u n d e r S e c u r i t i e s a n d F u t u r e s O r d i n a n c e ( C A P. 5 7 1 ) i n H o n g K o n g, f o r s o p h i s t i c a t e d i n v e s t o r s w h o u n d e r s t a n d t h e m e a n i n g o f r i s k s i n i n v e s t m e n t s a n d i s p r o d u c e d s o l e l y f o r i n f o r m a t i o n p u r p o s e s a n d s h o u l d n o t b e c o n s t r u e d a s a n o f f e r t o b u y o r s e l l a n y s e c u r i t i e s o r c o m m o d i t i e s. I n v e s t o r s m u s t m a k e t h e i r o w n d e t e r m i n a t i o n i n r e l a t i o n t o t h e a p p r o p r i a t e n e s s o f a n i n v e s t m e n t i n a n y s e c u r i t i e s r e f e r r e d t o h e r e i n b a s e o n t h e l e g a l, t a x, a c c o u n t i n g c o n s i d e r a t i o n s a n d i n v e s t m e n t s t r a t e g y a p p l i c a b l e t o s u c h i n v e s t o r s. T h e i n f o r m a t i o n, o p i n i o n s, a n d p r o j e c t i o n s c o n t a i n e d i n t h i s r e p o r t a r e b a s e d u p o n s o u r c e s b e l i e v e d t o b e r e l i a b l e, b u t t h e y h a v e n o t b e e n i n d e p e n d e n t l y v e r i f i e d. N e i t h e r C S C S L, n o r a n y o f t h e c o m p a n i e s o f t h e C a p i t a l C o m p a n y, n o r a n y i n d i v i d u a l c o n n e c t e d w i t h t h e C o m p a n y s h a l l a c c e p t r e s p o n s i b i l i t y o r l i a b i l i t y f o r a n y l o s s o c c a s i o n e d b y r e l i a n c e p l a c e d u p o n t h e c o n t e n t s h e r e o f. T h e i n f o r m a t i o n a n d o p i n i o n c o n t a i n e d i n t h i s r e p o r t a r e s u b j e c t t o c h a n g e w i t h o u t n o t i c e. T h e C a p i t a l C o m p a n y o f w h i c h C S C S L i s m e m b e r, a n d / o r t h e i r a f f i l i a t e d c o m p a n i e s a n d / o r d i r e c t o r s, r e p r e s e n t a t i v e s, e m p l o y e e s o r o f f i c e r s a s s u c h, m a y f r o m t i m e t o t i m e p e r f o r m i n v e s t m e n t, a d v i s o r y, o r o t h e r s e r v i c e s f o r t h e c o m p a n i e s m e n t i o n e d i n t h i s p u b l i c a t i o n, a n d w h e r e t h e a p p l i c a b l e l a w p e r m i t s, t h e a b o v e - m e n t i o n e d e n t i t i e s o r i n d i v i d u a l s m a y h a v e u s e d t h e r e s e a r c h m a t e r i a l s b e f o r e p u b l i c a t i o n o r m a y h a v e p o s i t i o n s ( a s p r i n c i p a l o r o t h e r w i s e ) i n, o r o t h e r w i s e b e m a t e r i a l l y i n t e r e s t e d i n, a n y o f t h e s e c u r i t i e s m e n t i o n e d h e r e i n. T h i s r e p o r t m a y n o t b e r e p r o d u c e d, d i s t r i b u t e d o r p u b l i s h e d i n a n y m e d i u m f o r a n y p u r p o s e w i t h o u t p r i o r w r i t t e n a p p r o v a l.