China infant formula -...

Please refer to page 68 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

CHINA

Inside

Turning sour, switch to mother’s milk 2

Valuation 4

Volume consumption to peak in 2017 8

Policy directed consolidation, price ceiling 13

Distribution channel revolution 18

Biostime 23

Yashili International 42

Mengniu 59

China infant formula stocks

Ticker Company Rating Price TP

Up/ Down

side

1112 HK Biostime UP 51.40 38.50 -25% 1230 HK Yashili UP 2.87 1.45 -50% Mkt Cap ADTV PER (x)

Company US$m US$m CY14E CY15E

Biostime 4,004 10.1 25.7 21.3 Yashili 1,318 2.2 34.4 29.8

Source: Bloomberg, Macquarie Research, June 2014; pricing date 10 June 2014

Analyst(s) Jamie Zhou, CFA +852 3922 1147 [email protected]

11 June 2014 Macquarie Capital Securities Limited

China infant formula Turning sour, switch to mother’s milk We initiate coverage on China’s infant formula sector with a cautious view and

Underperform ratings on Yashili and Biostime. A falling fertility rate and already

high market penetration (85%) would limit volume growth to barely a 5% CAGR

through 2018 before total consumption starts to decline, by our estimates. Recent

policy moves would further cap pricing power in an increasingly competitive

market as young Chinese parents bargain-hunt for imported brands online and

shy away from local brands such as Yashili. Nonetheless, a consumption upgrade

trend to the mid-to-high tier segment should create opportunities for brands, like

Biostime, that can continue to innovate.

2-child policy no silver bullet, volume CAGR to slow to 5%

We believe market excitement over a potential baby boom from relaxation of the

One Child Policy is overdone. Total formula consumption is likely to peak in 2018

while the volume CAGR would be barely 5%, and a mix shift would drive about

8% sales CAGR. Demographic expert Dr. Clint Laurent expects a temporary boost

of 3m new babies by 2017 would be insufficient to reverse a multi-decade falling

fertility profile. China’s fertility rate of 1.7 (already below the world average of 2.8),

compared to most developed Asian cities, indicates the rate could fall even further

(HK 1.3, Shanghai 0.7). Meanwhile, China’s formula penetration already reached

85% in 2013 and the government is promoting breastfeeding, hoping to raise the

low ratio from 16% (2012) to 50% by 2020.

Government investigation, competition cap pricing power

Beijing has been on the move over the past year to consolidate the fragmented

domestic infant formula industry. We believe the government’s end goal is to build

a strong domestic industry with high quality and safety standards to restore

Chinese consumers’ confidence in domestic infant formula. In the interim, policy

makers are concerned about the affordability of infant formula, with retail prices

double those of equivalent products overseas and in HK. Beijing has taken firm

measures against brands that are making excessive profits and this has sparked

price cuts. Coupled with intensifying competition, we see downside risks to the

high margins currently being earned (Biostime GM 65%, Yashili 53% (FY13).

Maternity, ecommerce rapidly eroding supermarket sales

The post-80s generation of convenience-seeking and tech-savvy consumers are

increasingly shopping at neighbourhood maternity shops and online. Infant

formula sales at supermarkets fell by 4% YoY in 2013, for the first time ever, and

companies that rely heavily on supermarket sales suffered market share loss

(Yashili). We expect this consumption habit shift to accelerate, particularly towards

ecommerce as parents bargain hunt for imported brands. The proliferation of

ecommerce has effectively lowered the entry barriers in lower-tier markets

previously dominated by local brands with offline distribution.

Earnings downside, 31% for Biostime, 60% for Yashili

We initiate on Biostime and Yashili with Underperform ratings. We believe the

market remains too optimistic: our FY14/15E forecasts are 16%/31% below

Consensus on Biostime and 55%/60% on Yashili; upcoming interim results should

catalyse Street downgrades. While we believe Biostime can maintain its market

leadership with the Adimil and O2O model, its valuation is rich at 26x/21x

FY14/15E PER. Yashili’s shares appear significantly overvalued at 34x/30x PER;

a 43% decline in FY14E earnings would mean its dividend is at risk.

Macquarie Research China infant formula

11 June 2014 2

Turning sour, switch to mother’s milk Volume consumption to peak in 2017E, opportunities exist in upgrade to mid-to-high tiers, driving 8% total market CAGR

Based on demographic expert Dr. Clint Laurent’s forecasts, we project China’s infant formula

consumption to grow at barely a 5% volume CAGR through 2018. With an expected

consumption upgrade from lower tier to mid- and high-tier categories, we expect the overall

market size to grow at a faster pace of 8% CAGR. Our cautious view on the industry growth

potential is mainly due to:

Relaxation of the one child policy, which will temporarily add up to 3m births, before

starting to decline in 2018E

Expectations of China’s fertility rate of 1.7 continuing to fall; HK/SG are at 1.3,

Shanghai is at 0.7

Infant formula consumption penetration already being high at 85% as of 2013

The Chinese government actively encouraging breastfeeding (16% in urban China vs.

world avg 37% in 2013) and banning hospitals from marketing infant formula products.

Fig 1 # of infants to peak with births in 2017 Fig 2 85% penetration, volume CAGR only 5%

Source: Global Demographics, Macquarie Research, June 2014 Source: Global demographics, Macquarie Research, June 2014

Consolidation, price investigation and competition to erode margins

Various policy measures have been announced in the past 12 months aimed at reforming the

infant formula industry. We believe the government’s goal is to build a strong domestic

industry with high quality and safety standards to restore Chinese consumers’ confidence in

local brands. In the domestic industry, the government has taken the following actions:

Strengthening safety standards, banning OEM production of infant formula

Increase accountability, requiring players to own or control their upstream milk sources

Eliminating weak, smaller players’ production licenses

As of June 2014, 82 out of 133 domestic infant formula makers have successfully

passed China FDA’s quality examination and have production permits renewed

In the interim, policy makers are concerned about the affordability of infant formula and have

taken measures against imported brands that are making excessive profits:

NDRC investigation of six brands over monopolistic pricing behaviour (reaping above-

normal profits), resulting in heavy penalties and price cuts (up to 20%)

Requiring all imported products to be packaged in final retail format with labels printed

in Chinese, thus banning the cheaper repackaging methods previously used

As of June 2014, 94 foreign infant formula brands have received import approval from

the General Administration of Quality Supervision, Inspection and Quarantine.

10

11

12

13

14

15

16

17

18

19

20

25

30

35

40

45

50

55

60

# of babies age 0-3 New birth

# of babies age 0-3 (million) # of new births

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

100

200

300

400

500

600

700

Market potential Market consumption

Infant formula volume (000 ton) Penetration %


11 June 2014 3

Local brands that rely on supermarket sales have lost market share

Infant formula sales at supermarkets dropped by 4% YoY in 2013, for the first time ever, and

companies that rely on significant sales from supermarkets suffered. Despite the overall

market still growing in the low-teens, sales of infant formula in supermarkets were largely flat

over the past three years. We expect the shift towards to maternity shops and ecommerce to

accelerate and that the beneficiaries will be those that can successfully capture this

consumption habit change.

The generation born after 1980 are typically technology-savvy and convenience seeking

consumers. They were the first to develop online shopping habits and when they have

babies, they are increasingly buying infant formula from two emerging channels (Fig 31):

Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barriers,

very fragmented. Early mover brands have secured an advantage in terms of shelf

space

Ecommerce: infant formula sold through China’s leading B2C sites, a brand driven

model where brand awareness attracts sales.

Fig 3 Selective growth opportunities in Mid-High Tier Fig 4 Sales shifting to maternity and ecommerce

Source: Nielsen, Global Demographics, Macquarie Research, June 2014 Source: Nielsen, June 2014

Biostime the rising star; Yashili the fallen angel

Between the two HK listed plays, Yashili has a higher reliance on supermarket (>60% of

sales) while Biostime‘s success was attributable to its early entry into maternity channels

(74% of sales), but it lacks in ecommerce which it plans to counter with its O2O sales model.

Fig 5 Biostime: a miracle infant formula growth story Fig 6 China infant formula top 12 players, Jan 2014

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014

13%

17% 18%

24%

17%

-8%

11% 11%

7%8%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Low Mid High Supreme Overall market

09-13 13-18E

Market growth (5-year CAGR)

44% 43%36%

33% 41%42%

23%16% 22%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013

Supermarkets Maternity stores Ecommerce

% of infant formula sales, China

0

1

2

3

4

5

6

7

8

9

2008 2009 2010 2011 2012 2013

Biostime Yashili Beingmate Mead Johnson (China)

Infant formula sales (RMB billion)

Mead Johnson,

14.5%

Wyeth, 13.3%

Beingmate, 8.5%

Biostime, 7.5%

Abbott, 7.0%Yili, 6.2%

Nestle, 4.4%

Yashili, 4.1%

Friso, 3.9%

Dumex, 3.6%

Feihe, 3.5%

Synutra, 3.2%

Others, 20.3%


11 June 2014 4

Valuation Our primary valuation is based on PER, which we then cross check against our DCF fair

valuation.

Biostime (Underperform) with HK$38.50/sh target, 16x FY15E PER

Our 12-month target price of HK$38.50/sh is based on 16x FY15E PER, the average of its

valuation since listing. We like the 34% ROE, strong FCF generation and consistent dividend

payout of 70%, however we are cautious on the rich valuation given we expect growth to slow

down significantly to just an 11% earnings CAGR for FY13-15E. Our FY14/15E earnings

forecasts are 16%/31% below Consensus. The founders’ lock-up expired on May 20th which

may also pose a sell-down overhang for the stock.

We cross-check with our DCF model, which suggest a fair valuation of HK$40/sh.

Yashili (Underperform) with HK$1.45/sh target, 15x FY15E PER

Our target price is based on 15x FY15E PER. Yashili’s profitability and return on capital have

fallen significantly (low teens EBIT margin and high single digit ROIC) since 1H13. Yashili has

been losing market share since the 2008 Melamine Crisis, particularly in Tier 1 & 2 cities, and

continues to be weak in two increasingly dominating channels: maternity and ecommerce.

Our Yashili DCF fair valuation is HK$1.29/sh. FCF turned negative in FY13 and with the

ongoing capex commitment with the New Zealand plant, we expect FCF to stay negative until

at least FY16. Prior to the takeover by Mengniu in Aug 2013, a special dividend representing

229% of FY13 NP was paid out to shareholders, which reduced the cash position by

RMB1bn. We believe the regular dividend is likely to be reduced significantly by 76% from

RMB11 cents in FY13 to just 3 cents in FY14.

Fig 7 Infant formula valuation comps

Price TP ∆ Mkt Cap PER (x) EV/EBITDA

(x)

EPS growth

(%) EBIT

margin ROE

(%)

Div yield

(%) P/Bk

Ticker Company Rec lc lc % US$m CY14E CY15E CY14E CY15E 13-15E CY13 CY13 CY13 FY13

1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 16.3 13.9 11.3 23.5 33.9 2.9 9.9 Biostime at TP 38.50 19.2 16.0 11.5 9.8 1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 19.3 14.4 -19.0 9.6 12.2 15.4 2.6 Yashili at TP 1.45 17.4 15.0 8.5 6.3 Infant formula pure-plays MJN US Mead Johnson NR 87.39 17,662 23.6 21.1 15.6 14.0 7.6 23.9 418.4 1.6 51.1 002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4 1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9 1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6 Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1 Diversified dairies 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8 600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5 NESN VX Nestlé NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5 BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2 FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4 Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0 China large cap staples 151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4 322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5 1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 168 HK Tsingtao Brewery NR 61.70 9,866 30.2 25.5 15.2 12.7 5.9 7.2 14.9 0.9 4.6 Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4 Pricing date 10 June 2014. Valuations and forecasts for non-rated stocks are from Bloomberg. Recommendation legend - OP: Outperform, N: Neutral, UP: Underperform, NR: not rated.

Source: Bloomberg, Macquarie Research, June 2014


11 June 2014 5

Among the listed dairy companies globally that have infant formula businesses in China, we

identify two baskets of comps:

Infant formula pure-plays

Biostime (1112.HK) – China based, premium products made in France, imported. #4

in market share (Jan 2014)

Yashili (1230.HK) – China based, imported ingredients from NZ. #8 in market share.

Mead Johnson (MJN.US) – U.S. based global infant formula maker, imported into

China. #1 market share holder in China

Beingmate (000257.CH) – China based infant formula maker, ingredients sourced

50/50 from domestic/imported sources. #3 in market share, highest among local

brands.

Diversified dairies

Mengniu (2319.HK) – China’s largest liquid milk maker, holds 68% stake in Yashili

Yili (600887.CH) – China’s largest liquid milk maker, #6 market share in infant formula

Nestlé (NESN.VX) – Global dairy giant, two brands in China: Wyeth (#2 market share)

and Nestlé (#7)

Danone (BN.FP) – Global dairy giant, owner of the Dumex brand (#10 in China)

Bright Dairy (600597.CH) – Shanghai based national diversified dairy, sells imported

infant formula, not a top 10 brand.

Fonterra (FSF.NZ) – Global dairy giant, sells imported powder in China, not a top 10.

We also examined Abbott Laboratories (ABT.US) whose Abbott brand of infant formula

commands 7% market share in China at the #5 spot. However, given that 70% of the listco’s

revenue is from the healthcare segment, we chose not to include it in the comps.


11 June 2014 6


With growth slowing, rising competition and government price caps, we believe infant formula

plays should trade at the low-end of their historical valuation range of 16-22x forward PER.

We think the price data over the past three years shows a fair representation of the infant

formula industry’s risks and opportunities.

The three domestic infant formula pure-plays were all were listed in late-2010/early-2011.

However, their forward valuations fluctuated greatly in 2013, due to three major industry

catalysts:

Positive: Mid-2013 Chinese government announces infant formula consolidation plans

Negative: July 2013 NDRC investigation which resulted in fines and price cuts

Positive: November 2013 relaxation of ‘One Child Policy’

Mead Johnson’s average forward PER is also a good proxy in our view, due to its global

diversification, which limits short term noise in the China market. MJN’s forward PER has

been steady in the range of 18x to 25.5x since mid 2009.

Fig 8 Biostime has traded on 16x PER on average Fig 9 Yashili has traded on 22x PER on average

Source: Bloomberg, Macquarie Research, June 2014 Source: Bloomberg, Macquarie Research, June 2014

Fig 10 Mead Johnson has traded on 22x PER on average

Fig 11 Beingmate has traded on 22x PER on average

Forward earnings are based on Bloomberg Consensus estimates. Forward earnings are based on Bloomberg Consensus estimates.


0

5

10

15

20

25

30

35

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

1112.HK forward PE ratio (x)

mean

-1 σ

+1 σ

0

10

20

30

40

50

60



mean

-1 σ

+1 σ

10

12

14

16

18

20

22

24

26

28

May-09 May-10 May-11 May-12 May-13 May-14

MJN.US forward PE ratio (x)

mean

-1 σ

+1 σ

5

10

15

20

25

30

35

40

May-11 May-12 May-13 May-14

002570.CH forward PE ratio (x)

mean

-1 σ

+1 σ


11 June 2014 7

Diversified dairies trading on lower valuation than infant formula

As a group, diversified dairies have been trading at a lower valuation than infant formula pure-

plays due to lower margins on the liquid milk business. The average EBIT margin of our

diversified dairies for FY13 was only 8% vs. 17% for infant formula pure-plays.

Most of the diversified dairies traded around 18x forward earnings on average over the past

five years. The exception is Mengniu, which traded on average at 25x PER. This is largely

due to a number of high profile M&A catalysts over the past few years (COFCO stake,

Danone JV and stake, Modern Dairy acquisition, Yashili acquisition, Arla partnership, White

Wave partnership).

Fig 12 Mengniu traded on 25x PER on average Fig 13 Yili traded on 17x PER on average

Forward earnings are based on Bloomberg Consensus estimates.


Fig 14 Nestlé traded on 18x PER on average Fig 15 Danone traded on 16x PER on average

Forward earnings are based on Bloomberg Consensus estimates. Forward earnings are based on Bloomberg Consensus estimates.


15

20

25

30

35

40



mean

-1 σ

+1 σ

5

10

15

20

25

30


600887.CH forward PE ratio (x)

mean

-1 σ

+1 σ

12

13

14

15

16

17

18

19

20

21

22


NESN.VX forward PE ratio (x)

mean

-1 σ

+1 σ

10

12

14

16

18

20

22


BN.FP forward PE ratio (x)

mean

-1 σ

+1 σ


11 June 2014 8

Volume consumption to peak in 2017 Opportunities exist in upgrade to mid-to-high tiers

Based on Dr. Clint Laurent’s demographic forecasts, we project China’s infant formula

consumption to grow at barely a 5% volume CAGR through 2018. With an expected

consumption upgrade from lower tier to mid- and high-tier categories, the overall market size

should grow at a faster pace of 8% CAGR.

Our cautious view on the industry growth potential is mainly due to:

The dismal outlook for the fertility rate despite relaxation of the one child policy

Infant formula consumption penetration being already high at 85% as of 2013

Limited upside to per-capita consumption as the government is actively encouraging

breastfeeding

Our volume forecasts are based on 2014 per-capita consumption of 11 kg/baby/year. The

typical infant formula consumption age for a baby is from 6 months to 2 years old. Upside

exists in wealthier families feeding infant formula to babies 2 years old and above.

Fig 16 # of infants to peak with births in 2017 Fig 17 Penetration of 85% in 2013 has little upside

Source: Global Demographics, Macquarie Research, June 2014 Source: Global Demographics, Macquarie Research, June 2014

10

11

12

13

14

15

16

17

18

19

20

25

30

35

40

45

50

55

60

# of babies age 0-3 New births

# of babies age 0-3 (million) # of new births

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

100

200

300

400

500

600

700

Market potential Market consumption

Infant formula volume (000 tonne) Penetration %


11 June 2014 9

Fig 18 Volume demand to peak in 2017 Fig 19 Upgrade trend to drive higher sales growth

Historical figures on market size and breakdown by tier from Euromonitor. Forecasts are Macquarie’s based on Global Demographics.

Tier breakdown by retail ASP for 900g can: Low: <RMB100, Mid: RMB100-200, High: RMB200-300, Supreme: >RMB300.

Source: Euromonitor, Global Demographics, Macquarie Research, June 2014


Out of the four price segments, we see Low Tier (below RMB100 per can) seeing the biggest

decline with an -8% market CAGR through 2018E. The Supreme Tier (above RMB300 per

can) market, which was the fastest growing in the past five years, is slowing down to just 7%

CAGR for the next five.

Selective opportunities still exist in the Mid- and High- tiers where growth could be sustained

above 10% CAGR. However, competition has already intensified within these segments.

Fig 20 Market growth to shift to Mid- to High- tiers Fig 21 Mid tier accounts for 42% of total market



0

100

200

300

400

500

600

700

Low Mid High Supreme

Infant formula volume (000 tonne)

0

20

40

60

80

100

120


Infant formula market size (RMB billion)

13%

17% 18%

24%

17%

-8%

11% 11%

7%8%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%


09-13 13-18E


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Breakdown of infant formula market by tier


11 June 2014 10

‘Two Child Policy’ to only temporarily boost births by 3m until 2017

To forecast the market growth potential for infant formula, we need to understand China’s

demographic profile on birth rates. We turned to demographic expert and the Founder of

Global Demographic Ltd, Dr. Clint Laurent, for clues on future birth trends.

In October 2013, the Chinese government relaxed the ‘One Child Policy’ such that if either of

a couple is a single child they are allowed to have a second baby. However, this is not the

first time the Policy was relaxed by the government; as early as 2002, families where both

spouses were a single child were already allowed to have two children.

Dr. Laurent sees the crucial distinction in the new policy definition changing from AND to OR

having a less profound impact on the birth rate than first meets the eye. Only 4.9 million urban

and 23 million rural women fall under the new definition who were not qualified under the old

one.

Those newly qualified must also satisfy the below conditions:

Is a Han Chinese and a single child herself

Already has a child

And if they are a rural Hukou, the first child is male (rural women with a daughter could

already have a second child)

Dr. Laurent calculates only 1.6m urban and 0.9m rural incremental births under the relaxed

rule. He expects the birth rate to rise from 14m as of 2012 to a peak of 18m in 2017 before

declining. At the max, he does not expect China’s total child bearing capacity to exceed 18

million. The maximum uplift of 3 million addition births per year would be insufficient to offset

what is otherwise a declining birth profile.

Fig 22 Relaxed rule to temporarily boost births up to 3m before falling again in 2018

Fig 23 More than half of the new births would be from rural families

Source: Global Demographics, Macquarie Research, June 2014 Source: Global Demographics, Macquarie Research, June 2014

0

2

4

6

8

10

12

14

16

18

20

2004

2006

2008

2010

2012

20

14

E

20

16

E

20

18

E

20

20

E

20

22

E

20

24

E

20

26

E

20

28

E

20

30

E

20

32

E

Births (old case) Births (new case)

# of births

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E

Urban Rural

# of births (million)


11 June 2014 11

Low fertility rate poised to drop further

According to the World Bank and China’s National Health and Family Planning Commission

(the government body that implements and oversees the ‘One Child Policy’), as of 2013

China’s fertility rate was 1.7 (births per woman), lower than 1.9 in the United States and far

below the global average of 2.8.

If developed Asian populations are any indication for China, fertility rates could go much lower

towards 1.1. Shanghai, as an extreme example, has a fertility rate of only 0.7 and ranks

globally the lowest.

Chinese fertility rates have been declining for the past five decades due partly to the one child

policy (1978) but also in recent decades to the decreasing propensity to have children,

particularly because of:

High urban property prices

High cost of raising a child (education, maternity, healthcare).

Fig 24 China’s fertility profile in structural decline, due to policy and declining propensity to have children

Fig 25 Developed Asian populations indicate China’s fertility has much downside

*2010 Census

Source: World Bank, Macquarie Research, June 2014 Source: World Bank, Macquarie Research, June 2014

This New York Times article illustrates the challenge for many families: sky high real estate

prices (home ownership is often a prerequisite for men to provide before marriage) and the

subsequent high cost of infant formula, medical expenses and education are putting many

young urban couples off from having children.

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

China U.S.

Births per woman

One Child Policy introduced

One Child Policy relaxed

0.7

1.7

1.3

1.1

1.3 1.3

1.4

1.9 1.9

1.6

1.9

0.5

1.0

1.5

2.0

Births per woman (2012)

http://www.nytimes.com/2014/02/26/world/asia/many-couples-in-china-will-pass-on-a-new-chance-for-a-second-child.html?_r=0


11 June 2014 12

Per-capita consumption capped by already low breastfeeding ratio

We think the current per-capita consumption of infant formula has very little upside due to the

already low breastfeeding ratio in China. The government has been taking proactive

measures to encourage breastfeeding.

The ratio of babies being exclusively breastfed (ie not given infant formula as well) for up to

six months old in China was only 28% as of 2013 vs. the world average of 39%. This is even

lower is for urban Chinese babies, where less than 16% are exclusively breastfed.

We see several reasons for this in urban China:

High female labour participation ratio

Lack of public or workplace nursery facilities

Aggressive promotion by infant formula makers, and in some instances illegal activities

taking place to promote infant formula (Sept 2013 CCTV’s uncovering of illegal bribes

given to hospital staff)

Fig 26 Breastfeeding ratio in Urban China is among the lowest in the world

Source: World Bank, National Health and Family Planning Commission, Macquarie Research, June 2014

Breastfeeding is now being encouraged in many countries around the world as extensive

research has proven the natural health benefits over artificial infant formula. During the first

six months after birth, the mother’s breast milk provides essential ingredients critical for the

infant’s immune system development that isn’t provided by infant formula substitutes.

Governments and institutions around the world have been advocating breastfeeding over

infant formula, through initiatives such as UNESCO/WHO’s 1992 Innocenti Declaration.

Chinese government taking action to increase breastfeeding ratio

The Chinese government recognizes the health benefits of breastfeeding and has been

taking action to increase the ratio:

To achieve a 50% breastfeeding ratio by 2020: set out by the ‘2020 China Children

Development Plan’ in 2011 (see official link in Chinese)

Ban on healthcare professional marketing and promoting breastfeeding

substitutes (infant formula): Following the Sept 2013 CCTV’s uncovering of illegal

sales practices by certain infant formula makers, the National Health and Family

Planning Commission set out a new regulation (see official link in Chinese)

67%

51%

28% 28%

16%

30%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

1998 2003 2008 2013

China average Urban China Rural China

% of new borns with exclusive breast feeding up to 6 months old

World average 39%

http://tv.cntv.cn/video/C10329/ba64e8796ca340cb96fa0156ba00cf85

http://tv.cntv.cn/video/C10329/ba64e8796ca340cb96fa0156ba00cf85

http://www.unicef.org/programme/breastfeeding/innocenti.htm

http://www.gov.cn/gongbao/content/2011/content_1927200.htm

http://www.gov.cn/jrzg/2013-09/17/content_2490399.htm


11 June 2014 13

Policy directed consolidation, price ceiling ‘Visible hand’ directing industry consolidation, capping prices

Various policy measures have been announced in the past 12 months aimed at reforming the

infant formula industry. We believe the government’s end goal is to build a strong domestic

industry with high quality and safety standards to restore Chinese consumers’ confidence in

domestic infant formula. In the interim, policy makers are concerned about the affordability of

infant formula and have taken measures against imported brands making excessive profits.

In the domestic infant formula industry, the Chinese government is taking the following steps:

Strengthening safety standards, banning OEM production of infant formula

Increasing accountability, requiring players to own or control their upstream milk

sources

Eliminating weak, smaller players’ production licenses

Establishing a list of national champion brands

Consolidating the industry from the current 200+ players to just 50

As of June 2014, 82 out of 133 domestic infant formula makers have successfully

passed the China FDA’s quality examination and had their production permits renewed

The government has also taken action against the imported infant formula brands:

NDRC investigation of six imported brands over monopolistic pricing behaviour

(reaping above-normal profits) which resulted in heavy penalties and price cuts of up

to 20%

Requiring all imported products to be packaged in final retail format with labels printed

in Chinese, thus banning the cheaper repackaging methods previously used

Banning hospital staff from marketing infant formula products

As of June 2014, 94 foreign infant formula brands have received import approval from

the General Administration of Quality Supervision, Inspection and Quarantine.


11 June 2014 14

Fig 27 Major policy announcements/events in the dairy industry over the past 12 months

Date Regulatory body Announcement, event and implication

May 2013 Premier Li Keqiang and the State Council

李克强总理、国务院 Exploring Options to Further Strengthening Quality and Safety of Infant Formula

June 2013 Ministry of Industry and Information Technology

工业和信息化部 Plan to Improve Infant formula Quality Standards, to Raise Public Consumer Confidence

June 2013 State Council and 9 ministries

国务院、九部委 Opinion on Further Strengthening Quality and Safety of Infant Formula, first major blueprint for industry consolidation

July 2013 National Development and Reform Commission

国家发展和改革委员会 Investigating six infant formula brands on violating Anti Monopoly Law, resulted in 5-20% price drop and hefty fines

August 2013 China Customs 中国海关总署 Fonterra’s contaminated whey powder incident prompted Chinese Customs to temporarily suspend imports. Fonterra later admit it was a false alarm

September 2013 China Central Television 中央电视台 Exposed certain global infant formula brands’ illegal bribes paid to hospital employees to promote sales of infant formula products

September 2013 National Health and Family Planning Commission

国家卫生和计划生育委员会 Ban on healthcare professional marketing and promoting breastfeeding substitutes (infant formula)

September 2013 China Dairy Industry Association

中国乳制品工业协会 Held new product launch conference. First batch of infant formula 'National Team' brands announced: Yili, Mengniu Yashily, Wonderful Sun, Feihe, Wissun, and Treasure of Plateau

September 2013 General Administration of Quality Supervision, Inspection and Quarantine

质量监督检验检疫总局 Guidelines on Strengthening the Management of Imported of Infant Formula, requiring all imported infant formula to be prepared in final retail packaging with Chinese labels on and after April 1, 2014

December 2013 China Food and Drug Administration

中国食品药品监督管理总局 Infant Formula Production License Examination Details, requiring all infant formula players to undergo strict re-examination under pharmaceutical standards in order to gain renewal of production licenses.

January 2014 China Dairy Industry Association

中国乳制品工业协会 Second batch of infant formula 'National Team' brands: Sanyuan, Beingmate, Yinqiao, Huishan, and Baiyue

May 2014 China Food and Drug Administration

中国食品药品监督管理总局 Report on Infant Formula Production License Examination: 82 of 133 domestic infant formula makers passed the test and had their licenses renewed while 51 failed or were postponed.

June 2014 General Administration of Quality Supervision, Inspection and Quarantine

质量监督检验检疫总局 94 foreign infant formula brands have received import approval, including Dumex, Abbott, Nestlé, Wyeth and Biostime

Source: Chinese government and its various ministries, Macquarie Research, June 2014


11 June 2014 15

State Council’s ‘Opinion’ marks the start of industry consolidation

On June 20, 2013, the State Council and its nine ministries, including the State Food and

Drug Administration and Ministry of Industries and Information Technology (MIIT), issued a

joint-communiqué, “Opinions on further strengthening the quality and safety of infant formula”.

The general aim of this policy announcement is to encourage domestic infant formula

producers to consolidate and strengthen supply chain quality control. Specifically, it called for

the following actions:

Producers of infant formulas to operate and control their own raw milk sources

Strengthen quality inspection throughout the supply chain

Consolidate processing industry and eliminate sub-standard players through production

license renewal starting May 2014

Ban repackaging or OEM production of infant formula

Strengthen and promote standardisation of scaled dairy farming

NDRC investigation of pricing power abuse and subsequent price cuts

On July 2, 2013, the National Development and Reform Commission (NDRC) launched an

investigation into six imported infant formula brands on the grounds of monopolistic pricing

behaviour. Prior to this, imported premium infant formulas were sold for RMB300-500/900g,

representing 50% more than equivalent products sold overseas and in the HK market.

NDRC announced in early August the results of its investigation: six infant formula brands

were found guilty of manipulating retail prices and were ordered to pay a total penalty of

RMB668m. Out of the six brands, Mead Johnson was ordered to pay the highest penalty of

RMB204m, however Biostime’s RMB163m penalty represented the most severe based on

percentage of sales.

Fig 28 NDRC investigation: hefty penalty, price cuts

Brand Company Penalty (% of sales) Company reaction

Biostime Biostime RMB163m (6%) 5-10% price reduction, 50% extra rewards for members Enfamil Mead Johnson RMB204m (4%) 10-20% price reduction Dumex Danone RMB172m (3%) 5-20% price reduction Similac Abbott RMB77m (3%) 4-12% price reduction Friso FrieslandCampina RMB48m (3%) 5% reduction Fonterra Fonterra RMB4m (3%) Wyeth Nestlé No penalty Average 11% reduction, max 20% Nestlé Nestlé No penalty Up to 20% reduction Beingmate Beingmate No penalty 5-20% price reduction Meiji Meiji No penalty

Source: NDRC, Company data, June 2014


11 June 2014 16

Policy and competition to drive infant formula prices, margins lower

We think the NDRC investigation was targeted squarely at the imported brands that have

been charging high prices and earning superior profitability on the back of Chinese

consumers’ concerns over domestic quality.

On the one hand, NDRC is buying time for the domestic players to consolidate and regain

market share. On the other hand, these price cuts should improve affordability for average

income families and thus ease one of the factors that have lowered young Chinese parents’

propensity to have children.

The latter has much larger implications for China’s looming demographic crisis, where the

ageing population has already started to shrink the size of the workforce. The last thing the

government would want to see is foreign brands benefitting excessively from Chinese

consumers’ long standing concerns over domestic food safety by reaping above-normal

profits. For details on China’s looming demographic crisis, please read Jake Lynch’s

Demographic Techtonics.

https://www.macquarieresearch.com/rp/d/r/p/_ODU0Mzk0?u=MTkxNDc

https://www.macquarieresearch.com/rp/d/r/p/_ODU0Mzk0?u=MTkxNDc


11 June 2014 17

Junlebao’s RMB130/can price war

The initial price cuts among major players in 2H2013 were just the beginning. New

competitors will likely further drive prices lower. Hebei based Junlebao (in which Mengniu

owns a 50% stake) surprised the industry in April 2014 by introducing a RMB130/can retail

price infant formula product (see the products on Junlebao’s own ecommerce site).

Fig 29 Junlebao’s RMB130/can, direct channel-only infant formula

Source: Company data, May 2014

Comparable products from most major brands retail for at least RMB200/can, and Junlebao’s

products are likely to be appealing to price sensitive consumers.

Different from traditional offline channels such as supermarkets or maternity shops,

Junlebao’s newly launched infant formula will be sold exclusively through direct channels

(telephone or online). In the chart below, we calculate two major cost components Junlebao

can eliminate: distributor costs and retail discounts.

Fig 30 Direct selling model cuts out middleman

Source: Macquarie Research, June 2014

Junlebao has expressed confidence in its unique selling model. We think Junlebao’s key

challenge will be the lack of brand awareness, given that this is its first infant formula product

launched. Without offline A&P, it may be difficult to gain meaningful market share in this

competitive industry.

Nevertheless, the Junlebao case indicates that industry players have already begun looking

for ways to undercut the already high prices to gain market share given the limited upside

potential from future ASP hikes.

0 50 100 150 200 250

Traditional

Direct selling

Ex-factory price VAT S&D cost Distributor discount Retail mark-up

RMB per 900g can of high grade infant formula

Retail price RMB130

RMB220

http://nf.junlebaoruye.com/Default.aspx


11 June 2014 18

Distribution channel revolution Local brands that rely on supermarkets have lost market share

Infant formula sales at supermarkets dropped by 4% YoY in 2013, for the first time ever, and

companies that have significant sales from supermarkets suffered. Despite the overall market

still growing in the low-teens, sales of infant formula in supermarkets were largely flat over the

past three years. We expect the shift towards maternity shops and ecommerce to accelerate

and the beneficiaries to be those that can successfully capture this consumption habit

change.


consumers. They were the first to develop online shopping habits and when they have babies

they are increasingly buying infant formula from two emerging channels:

Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barriers,

very fragmented. Early mover brands can secure an advantage in sales


model where brand awareness attracts sales.

Fig 31 Infant formula purchases are shifting from supermarkets to maternity shops and ecommerce

Fig 32 Supermarket sales on the decline, Ecommerce growing rapidly

Source: Nielsen, June 2014 Source: Nielsen, June 2014

44% 43%36%

33% 41%42%

23%16% 22%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013


% of infant formula sales, China

5%

-4%

36%

17%23%

60%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

2012 2013


Channel growth YoY


11 June 2014 19

Between the two HK listed plays, Yashili’s reliance on supermarket sales is the highest

(>60% of sales) while Biostime‘s success in recent years was attributable to its early-mover

entry into the maternity channels. However, Biostime lacks in terms of Ecommerce.

Fig 33 Biostime’s early move in maternity was instrumental to its success

Source: Nielsen, Company data, Macquarie Research, June 2014

23%

70%

43%26%

64%

36%

77%

30%

41% 74%

36%

42%

16% 22%

0%

20%

40%

60%

80%

100%

Biostime Yashili Industry Biostime Yashili Industry


2012 2013

% of infant formula sales


11 June 2014 20

Chinese consumers prefer imported brands

Hundreds of foreign brands have entered China’s infant formula market since the 2008

Melamine Scandal which killed six babies and caused thousands of others to fall sick.

Domestic brands that were once market leaders, such as Yashili, Synutra and Feihe, have all

conceded significant market share to companies such as Mead Johnson, Danone and Nestlé.

Fig 34 Infant formula market share, March 2012 Fig 35 Infant formula market share, January 2014

Source: Nielsen, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014

According to the Dairy Association of China, the infant formula market in China was evenly

split between domestic and foreign brands before the 2008 Melamine Scandal. As of 2013,

domestic brands’ total market share has dropped to below 40%, while in 1st tier cities

imported brands control more than 80% share.

The imported powder premiumisation drive came at the expense of domestic players. Not

only did domestic players lose market share to foreign ones, the industry actually became

more fragmented as a result.

We believe this consumer behaviour phenomenon that rapidly transformed the infant formula

industry was due to the following inter-related causes:

Imported infant formula’s ‘perceived’ superior quality assurance

The media’s negative portrayal of domestic infant formula following numerous

incidents, fuelling already high mistrust of domestic products

Rising outbound travel (including to Hong Kong) of Chinese citizens, increasing

access to and awareness of foreign brands

Strong marketing capability of foreign brands

Emergence of ecommerce, and specifically online maternity shops and overseas

group-buying sites

Consumers’ willingness to pay a premium for quality for their children, particularly

among the younger generation of Chinese parents (those born after 1980).

The only exception is Biostime, the Guangzhou based company which entered the infant

formula market only in the wake of the Melamine Incident, as it was able to capture significant

market share with its European sourced premium product positioning and innovative

membership sales strategy. As of January 2014, Biostime commanded 7.5% market share

and was the #4 player in the infant formula market and dominated the top spot in the supreme

segment (>RMB300/can ASP).

Mead Johnson,

13.8%

Wyeth, 9.8%

Beingmate, 9.6%

Abbott, 7.1%

Yili, 10.4%

Nestle, 4.0%Yashili, 5.1%

Dumex, 13.5%

Feihe, 4.6%

Synutra, 5.2%

Others, 16.9%

Mead Johnson,

14.5%

Wyeth, 13.3%

Beingmate, 8.5%

Biostime, 7.5%


Nestle, 4.4%

Yashili, 4.1%

Friso, 3.9%

Dumex, 3.6%

Feihe, 3.5%

Synutra, 3.2%

Others, 20.3%


11 June 2014 21

Lack of offline retail presence drives ecommerce sales

According to Alibaba’s IPO prospectus, China’s offline physical retail infrastructure lags

behind developed nations’, particularly in lower tier cities. Official statistics show that 19% of

Tier 1 & 2 urban consumers accounted for 41% of total retail sales in 2013, or three times

more on a per-capita basis. Ecommerce allows consumers in less developed regions to

‘leapfrog underdeveloped offline retail infrastructure’ to meet their consumption needs.

In the infant formula industry, this is demonstrated first in the lack of supermarkets in lower

tier cities, where much smaller maternity shops have found an opportunity to penetrate and

gain market share. More recently, ecommerce has allowed imported brands to penetrate

lower tier markets that they were previously unable to access due to traditional distribution

channels’ limitations.

Fig 36 China’s ecommerce market to grow at double digits, while penetration remains low

Fig 37 Under-developed offline retail presents opportunities for ecommerce to tap unmet demand

Source: Alibaba Prospectus (Euromonitor), June 2014 Source: Alibaba Prospectus (Euromonitor), June 2014

0%

2%

4%

6%

8%

10%

12%

14%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Ecommerce revenue Penetration

Total online sales (RMB billion)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

China U.S. U.K. Japan Germany

Retail space square meter per-capita


11 June 2014 22

Imported brands dominate ecommerce

Although two of the top five infant formula brands by sales are domestic companies

(Beingmate and Biostime), imported brands capture the top five spots in ecommerce with

60% market share.

Global brands with higher ‘perceived’ quality and strong A&P capabilities are highly

recognized by Chinese consumers. With the proliferation of social media and ecommerce,

consumers in lower tier cities can now conveniently make their purchases online.

Fig 38 Overall infant formula sales spread between domestic and imported brands

Fig 39 Imported brands dominate ecommerce

Source: Nielsen, Macquarie Research, June 2014 Source: iResearch, Macquarie Research, June 2014

Mead Johnson,

14.5%

Wyeth, 13.3%

Beingmate, 8.5%

Biostime, 7.5%


Nestle, 4.4%

Yashili, 4.1%

Friso, 3.9%

Dumex, 3.6%

Feihe, 3.5%

Synutra, 3.2%

Others, 20.3%

Infant formula (Jan 2014)

Mead Johnson

14.8%

Wyeth12.3%

Friso11.2%

Abbott11.0%

Dumex10.5%

Others40.2%

Ecommerce market share, infant formula (2013)


11 June 2014 23

HONG KONG

1112 HK Underperform

Price (at 13:45, 10 Jun 2014 GMT) HK$51.40

Valuation HK$ 40.01 - DCF (WACC 13.4%, beta 1.2, ERP 7.0%, RFR 5.0%, TGR 2.0%)

12-month target HK$ 38.50

Upside/Downside % -25.1

12-month TSR % -22.0

Volatility Index High

GICS sector Food, Beverage & Tobacco

Market cap HK$m 31,040

Market cap US$m 4,004

Free float % 25

30-day avg turnover US$m 6.3

Number shares on issue m 603.9

Investment fundamentals Year end 31 Dec 2013A 2014E 2015E 2016E

Revenue m 4,561.3 5,416.6 6,307.8 7,090.0 EBIT m 1,284.8 1,389.7 1,625.7 1,876.7 EBIT growth % 24.2 8.2 17.0 15.4 Reported profit m 820.7 987.3 1,189.6 1,364.5 Adjusted profit m 961.0 987.3 1,189.6 1,364.5 EPS rep Rmb 1.34 1.61 1.94 2.23 EPS rep growth % 10.3 20.3 20.5 14.7 EPS adj Rmb 1.57 1.61 1.94 2.23 EPS adj growth % 31.3 2.8 20.5 14.7 PER rep x 30.9 25.7 21.3 18.6 PER adj x 26.4 25.7 21.3 18.6 Total DPS Rmb 1.23 1.15 1.39 1.59 Total div yield % 3.0 2.8 3.4 3.9 ROA % 31.5 19.9 16.5 17.8 ROE % 39.7 36.6 38.3 38.3 EV/EBITDA x 18.3 16.3 13.9 12.0 Net debt/equity % -36.3 -37.1 -34.8 -36.3 P/BV x 9.9 8.6 7.5 6.5

Source: FactSet, Macquarie Research, June 2014

(all figures in Rmb unless noted, TP in HKD)



Biostime No longer the new kid on the block Initiating with Underperform, TP HK$38.50, 25% downside

We believe Biostime is China’s most extraordinary infant formula growth story in

recent years: born in the midst of the 2008 Melamine Scandal as the ‘new kid’ on

the block and through its premium positioning, innovative membership strategy,

unique supply chain and early mover advantage in capturing the rapid growth of

the maternity channel, it has quickly grown to become the #4 player with 7.6%

market share (2013). However, Biostime is facing challenges from muted industry

volume growth with falling fertility rates, limited pricing power from government-led

consolidation, and rising competition from proliferation of ecommerce. The stock is

expensive at a 26x/21x FY14/15E PER; our target HK$38.50 implies 16x FY15E

EPS, on par with the historical average. Founders’ lock-up expiration poses a sell-

down overhang on the stock.

Growth slows <20%, margins under pressure with mix shift

After an extraordinary streak (FY09-13 sales CAGR 69%), we project growth is

slowing to 19% in FY14. The July 2013 NDRC investigation has already reduced

firm-wide ASP by 1%. Margins will be under pressure; having dominated the

Supreme category (retail ASP >RMB300/can) with 55% market share, Biostime is

looking for growth in the high (RMB200-300) and mid-tier (RMB100-200). Mid/high

tier have lower margins (GM 56% and 62%) vs. Supreme (69%). We forecast OP

margin to drop by 160bps to 26.6%.

Market share scenario suggests downside is meaningful

While we believe Biostime can continue to maintain its market leadership with the

newly launched Adimil brand and the O2O sales model, with growth slowing faster

than expected, we see 16%/31% downside to Consensus estimates for

FY14/15E. Our base case scenario assumes Biostime 1) maintains market share

in the High Tier, 2) has a slight share loss in Supreme and 3) establishes a

presence in the Mid Tier. Our Bear Case suggests a further 8-15% earnings

decline should the company lose Supreme market share quicker than can be

offset with Adimil.

O2O (online-to-offline): killing two birds with one stone

Biostime launched its O2O sales model (online ordering to offline home delivery

by member shops) in September 2013 and targets deriving 10% of its FY14

revenue from O2O. The initiative may at first appear as a defensive strategy

against rapidly rising ecommerce sales of imported infant formula brands (total

sales up 60% in 2013). We think Biostime is achieving two goals in one: 1)

offering consumers the convenience shopping experience of online/mobile and 2)

strengthening relationships with its most important offline partners, the maternity

shops, by sharing value chain profits with participating stores.

Mama100 monetisation with horizontal expansion

Biostime hopes to develop the Mama100 membership program into an

ecommerce ecosystem of maternity products. The Dec 2013 JV with Coco Health

may be a major step in penetrating the lucrative diapers market (penetration

remains low at 40%) which has a high cross-selling ratio (19%) to infant formula

sales. Biostime intends to make more horizontal acquisitions into other maternity-

related FMCG categories, and the newly issued RMB2.4bn CB puts it in a strong

balance sheet position to do so.


11 June 2014 24

Inside

Market share scenario: downside risk is

meaningful 25

Valuation 27

O2O: killing two birds with one stone 30

Mama100 monetisation 32

Management and corporate governance 33

Financials 36

1112 HK rel HSI performance



A miracle born in the midst of a crisis Company profile

Founded in Guanzhou in 1999, we believe Biostime is China’s most

extraordinary infant formula growth story in recent years: infant formula

products were launched in the midst of the 2008 Melamine Scandal and

through its innovative membership sales strategy, unique supply chain model

and early mover advantage in capturing the rapid growth of the maternity

channel, the company has quickly grown to become the #4 player, capturing

7.6% market share (2013). The company also sells a range of infant care,

probiotic supplements, infant food and nutritional products under the BM Care

brand. In September 2013, the company introduced the specialty function

infant formula brand Adimil.

Biostime pioneered the Supreme-tier category with the introduction of

>RMB300/can retail priced infant formula products and commanded 69%

market share in 2013. The company operates on a unique asset light supply

chain model with three key European OEM partners: Montaigu, Isigny

(Biostime owns 20% stake) in France and Arla in Denmark.

The company was successfully listed on the Stock Exchange of Hong Kong in

December 2010 under the ticker 1112.HK and raised HK$1.6bn in equity

capital. In February 2014, the company raised HK$3bn from the issuance of a

5-year zero-coupon convertible bond with a strike price of HK$90.84/sh.

Corporate governance and shareholding structure

Nine directors: two executive, four non-executive and three independent

Shareholding structure: 75% by co-founders (Biostime Pharmaceutical), 25%

free float. 5% potential dilution upon exercise of the 2019 Convertible Bond.

Auditor: Ernst & Young

Fig 1 Biostime’s extraordinary growth in infant formula since 2008


0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

Infant formula Others (probiotics, baby food) Infant formula market share

Revenue (RMB million) Market share %


11 June 2014 25

Market share scenario: downside risk is meaningful Defend share in Supreme, capture share in Mid and High Tiers

Biostime’s market share capture since the launching of infant formula in 2008 is remarkable.

It went from just 1.1% total market share in 2009 to 7.6% share in 2013. This was

accomplished with Biostime capturing significant growth opportunities in the Supreme and

High Tiers.

With a 17% CAGR over the past five years and we estimate slowing to just 8% over the next

five, Biostime recognizes it may be difficult for them to replicate their earlier success. Instead

they will focus on defending market share in Supreme, hoping to continue gaining incremental

share in High and launching Mid Tier products to enter the fastest growing segment.

Supreme tier (>RMB300/can): Biostime pioneered the segment and maintains a

dominate market share of 55% (2013). Increasing competition from Mead Johnson’s

new products in the segment poses the risk losing some market share

High tier (RMB200-300/can): Biostime’s biggest earnings contributor tier. Accounts for

60% of its revenue and it captured 12% market share as of 2013.

Mid tier (RMB100-200/can): Biostime previously didn’t want to be in this segment due

to the lower margins, 56% vs. 62% and 69% for High and Supreme tier, but this is

where we expect the market growth will be: low tier consumption upgrade to mid will

drive an 11% CAGR, in our view, and this tier accounts for 42% of total industry sales.

Fig 2 Biostime is competitively positioned in the remaining growth tiers

% of sales (2013) Biostime GP margin

Tier Price

RMB/can Industry Biostime Industry growth outlook Market share

(2013) Strategy FY13

Low <100 14% 0% Declining tier, consumers are upgrading to mid-to-high tiers

0.0% Not a target segment NA

Mid 100-200 42% 0% Bright spot in the industry, could continue to grow >10% CAGR

0.0% Entering 2014 with domestic produced Adimil (Retail ASP RMB180)

56%

High 200-300 39% 60% Bright spot in the industry, could continue to grow >10% CAGR, intensifying competition

11.8% Key driver for Biostime 62%

Supreme >300 5% 40% Slowing growth, but still has opportunities, 7% CAGR

55.4% Maintain market share, and ward off competition from Mead Johnson

69%

Source: Nielsen, Euromonitor, Company data, Macquarie Research, June 2014

Fig 3 Market growth to shift to Mid-to-High Tier Fig 4 Base case projection of market share by tier

Source: Nielsen, Global Demographics, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

13%

17% 18%

24%

17%

-8%

11% 11%

7%8%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%


09-13 13-18E


0%

10%

20%

30%

40%

50%

60%

2009 2010 2011 2012 2013 2014E 2015E 2016E

Mid High Supreme

Biostime market share


11 June 2014 26

Market share scenario analysis

We model three scenarios on Biostime’s market strategy. Our effective market share

calculation excludes the declining Low Tier, given that this is a market Biostime avoids.

Fig 5 Biostime’s market share scenario

Scenario Execution outcome 2013A 2014E 2015E 2016E

BASE CASE Mid Slight market entry success with Changsha Yingke produced RMB180/can Adimil 0.0% 0.8% 1.8% 2.3% High Intensifying competition in high-tier is countered by the market success of the

RMB250/can Adimil and thus the company maintains market share 11.8% 12.3% 12.3% 12.3%

Supreme lose some market share to Mead Johnson, but maintain >50% share 55.4% 53.4% 52.4% 51.4% Total market share 7.6% 8.2% 8.5% 8.8% Total market share (Ex-low tier) 8.8% 9.3% 9.6% 9.7% Effective market share gain/loss +0.7% +0.4% +0.3% +0.1% BULL CASE Mid Major breakthrough in capturing market share with new product introduction 0.0% 3.0% 6.0% 9.0% High O2O exceeds expectations, share gain from domestic players through Mama100 11.8% 13.3% 14.8% 16.3% Supreme Maintaining market share with the RMB350 Adimil 55.4% 55.4% 55.4% 55.4% Total market share 7.6% 9.6% 11.5% 13.5% Total market share (Ex-low tier) 8.8% 10.9% 13.0% 15.0% Effective market share gain/loss +2.1% +2.0% +2.1% BEAR CASE Mid Fail to meaningfully launch mid-end product 0.0% 0.3% 0.6% 0.9% High Losing market share due to competition, weak O2O, imported brands steal share from

Biostime through ecommerce 11.8% 10.8% 9.8% 8.8%

Supreme Little success with the more expensive Adimil, lose market share to Mead Johnson 55.4% 50.4% 45.4% 40.4% Total market share 7.6% 7.2% 6.6% 6.1% Total market share (Ex-low tier) 8.8% 8.2% 7.5% 6.8% Effective market share gain/loss -0.7% -0.7% -0.7%


Fig 6 Three scenarios on Biostime’s total market share change

Fig 7 Adj. EPS are 10-33% above Base case for Bull scenario and 8-21% below for Bear scenario

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Fig 8 Our bear case indicate a further downside of 8-21% on FY14-16 EPS

Adj. EPS RMB/sh % vs. base

2014E 2015E 2016E 2014E 2015E 2016E

Bull 1.78 2.34 2.96 10% 21% 33% Base 1.61 1.94 2.23 0% 0% 0% Bear 1.48 1.64 1.75 -8% -15% -21%


2.1% 2.0% 2.1%

2.6%

2.1%

0.7%0.4% 0.3%

0.1%

-0.7% -0.7% -0.7%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2011 2012 2013 2014E 2015E 2016E

Bull Base Bear

Change in Biostime market share (+/- %)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2011 2012 2013 2014E 2015E 2016E

Bull Base Bear

Adj. EPS


11 June 2014 27

Valuation Our primary valuation is based on a PER; we then cross check against our DCF fair

valuation.

Biostime (Underperform) with HK$38.50/sh target, 16x FY15E PER

Our 12-month target price of HK$38.50/sh is based on a 16x FY15E PER, the average of its

since-listing average valuation. We like the 34% ROE, strong FCF generation and consistent

dividend payout of 70%, however we are cautious on the rich valuation given we expect

growth to slow down significantly to just an 11% earnings CAGR. Our FY14/15E earnings

forecasts are 16%/31% below Consensus. Founders’ lock-up expired on May 20th which may

also pose a sell-down overhang on the stock.



(x)

EPS growth

(%) EBIT

margin ROE

(%)

Div yield

(%) P/Bk


1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 16.3 13.9 11.3 23.5 33.9 2.9 9.9 Biostime at TP 38.50 19.2 16.0 11.5 9.8 Infant formula pure-plays MJN US Mead Johnson NR 87.39 17,662 23.6 21.1 15.6 14.0 7.6 23.9 418.4 1.6 51.1 002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4 1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9 1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6 Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1 Diversified dairies 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8 600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5 NESN VX Nestlé NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5 BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2 FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4 Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0 China large cap staples 151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4 322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5 1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 168 HK Tsingtao Brewery NR 61.70 9,866 30.2 25.5 15.2 12.7 5.9 7.2 14.9 0.9 4.6 Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4 Price date June 10, 2014. Valuations and forecasts for non-rated stocks are from Bloomberg.

Recommendation legend - OP: Outperform, N: Neutral, UP: Underperform, NR: not rated.


With slowing growth, rising competition and government price caps, we believe infant formula

plays should trade at the low end of its historic valuation range of a 16-22x forward PER. We

think the price data over the past three years captures a fair representation of the infant

formula industry’s risks and opportunities.

The three domestic infant formula pure plays were all listed in late-2010/early-2011. However,

their forward valuations fluctuated greatly in 2013, due to three major industry catalysts:

Positive: Mid-2013 Chinese government announces infant formula consolidation plans

Negative: July 2013 NDRC investigation which resulted in fines and price cuts

Positive: November 2013 relaxation of ‘One Child Policy’

Mead Johnson’s average forward PER is also a good proxy, due to its global diversification

which limits short-term noise in the China market. MJN’s forward PER has been steady in the

range of 18x to 25.5x since mid-2009.


11 June 2014 28

Fig 10 Biostime forward PER band Fig 11 Currently trading on 23x forward PER


Mead Johnson the global comp, 18-25x PER range

We believe Mead Johnson is a good valuation comparable for Biostime, because:

31% of Mead Johnson’s FY13 revenue comes from China.

China contributed to 62% of Mead Johnson’s revenue growth over the past 4 years.

Both are market leaders gaining market share from the rest (Mead Johnson #1,

Biostime fast rising #4).

Both players command the highest margins among peers and have the highest ROIC.

Both players are leaders in product innovation and derive most of their profits from the

high-tier and supreme-tier infant formula category.

Both were investigated and fined by the NDRC in July 2013, hence they have a similar

policy risk profile (Mead Johnson received the highest absolute fine, Biostime the

highest in percentage of revenue).

However, we also note the crucial difference is brand awareness and channel exposure.

Mead Johnson is not only the #1 brand nationwide in China, but also the #1 in the fast

growing ecommerce channel, which is a competitive threat to Biostime. Thus, our target

valuation is 16x forward PER, a fair discount to MJN’s.

Fig 12 Mead Johnson trades on 21.8x PER on average Fig 13 Biostime’s margins more volatile

Forward earnings are based on Bloomberg Consensus estimates.


0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

Dec-10 Dec-11 Dec-12 Dec-13 Dec-14

Share price (HK$)

10x

20x

30x

0

5

10

15

20

25

30

35

40


Forward PE ratio (x)

mean

-1 σ

+1 σ

10

12

14

16

18

20

22

24

26

28


MJN.US forward PE ratio (x)

mean

-1 σ

+1 σ

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012 2013

Biostime Yashili Beingmate Mead Johnson

EBIT margin


11 June 2014 29

DCF fair value HK$40/sh

We cross check Biostime’s valuation using a DCF model. Our fair valuation is HK$40/sh.

We like the 40% ROE, strong FCF generation capabilities and consistent dividend payout of

70%, however we are cautious in the near term given 16%/31% FY14/15E earnings downside

from Consensus. Founders’ lock-up expired on May 20th which may also pose a sell-down

overhang on the stock.

Fig 14 Biostime cash flow projection

RMB million 12A 13A 14E 15E 16E 17E 18E 19E 20E

Sales 3,382 4,561 5,417 6,308 7,090 7,793 8,440 9,148 9,920 ... Growth 54% 35% 19% 16% 12% 10% 8% 8% 8% Gross Profit 2,229 2,975 3,460 3,943 4,408 4,817 5,188 5,592 6,031 ... GP Margin 66% 65% 64% 63% 62% 62% 61% 61% 61% EBITDA 1,075 1,199 1,482 1,868 2,136 2,392 2,642 2,918 3,106 … Margin 32% 26% 27% 30% 30% 31% 31% 32% 31% Less: Tax 244 345 367 419 448 518 442 509 565 Less: WC -115 167 -47 33 -40 33 -40 32 -41 Less: Capex 39 136 100 100 100 100 100 100 100 Less: Other 2 309 116 213 259 262 409 423 322 Free Cash Flow 905 243 946 1,103 1,369 1,479 1,731 1,855 2,160 ... FCF Growth -73% 290% 17% 24% 8% 17% 7% 16% PV of FCF 881 906 992 945 975 921 946

Source: Company data, Macquarie Research, June 2014

Fig 15 DCF valuation metrics

WACC DCF Valuation

Risk Free Rate 5.0% Sum of PV of FCF 6,565 Market Risk Premium 7.0% PV of Terminal Value (RMBm) 8,461 Equity Beta 1.2 Enterprise Value (RMBm) 15,025 Cost of Equity 13.4% Less: Net Debt -4,406

Cost of Debt (Pre-tax) 9.0% Market Cap (RMBm) 19,431 Cost of Debt (After tax) 6.8% No. of Ord shares (m), fully diluted 602

Target Debt weight 0.0% Terminal as % total 56% Target Equity weight 100.0% Foreign exchange (HKD/RMB) 1.24 Tax Rate 25% Market Cap (HKDm) 24,090

WACC 13.4% Terminal Growth 2.0% Value per share, HK$ $40.01



11 June 2014 30

O2O: killing two birds with one stone Proliferation of ecommerce threatening offline retail

Infant formula sales in supermarkets dropped by 4% for the first time in 2013, and companies

that had significant sales from supermarkets suffered. Despite the overall market still growing

at low-teens, sales of infant formula in super markets were largely flat over the past three

years. We expect the shift towards maternity shops and ecommerce to accelerate and

winners will be those that can successfully capture this change in consumption habits.

The generation born after 1980 is typically technology-savvy and convenience-seeking

consumers. They were the first to develop habits of shopping online, and when they have

babies, they are increasingly buying infant formula from two emerging channels:

Maternity shops: neighbourhood Mom & Pop baby product shops, low-entry barrier,

very fragmented. Early mover brands secure advantage in shelf space.

Ecommerce: infant formula sold through China’s leading B2C sites, a brand-driven

model where brand awareness attracts sales

Fig 16 Infant formula purchases are shifting from supermarkets to maternity shops and ecommerce


Source: Nielsen, June 2014 Source: Nielsen, June 2014

Biostime has been an early mover in the maternity channel and its phenomenal success in

recent years was attributable to its member store channel management system. However,

Biostime lacks in Ecommerce.

Fig 18 Biostime is strong in maternity channel, but negligible in ecommerce


20 21 20

1420 23

6

712

0

10

20

30

40

50

60

2008 2009 2010 2011 2012 2013


Retail sales value (RMB billion)

5%

-4%

36%

17%23%

60%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

2012 2013


Channel growth YoY

23%

70%

43%26%

64%

36%

77%

30%

41% 74%

36%

42%

16% 22%

0%

20%

40%

60%

80%

100%



2012 2013



11 June 2014 31

Proliferation of ecommerce threatening offline retail

Biostime launched its O2O sales model (online ordering to offline home delivery by member

shops) in September 2013 and targets deriving 10% of its FY14 revenue from O2O.

The initiative may at first appear as a defensive strategy against rapidly rising ecommerce

sales of imported infant formula brands (total sales up 60% in 2013). We think Biostime aims

to achieve two goals in one:

1) offering consumers the convenience shopping experience of online/mobile, and

2) strengthening relationships with its most important offline partners, the maternity shops, by

sharing value chain profits with participating stores.


11 June 2014 32

Mama100 monetisation Biostime’s success is instrumental to its ‘Mama100’ membership program, entailing a point

reward program and a mobile app with maternity social media functions. With 1.8m active

members as of Dec 2013, Biostime hopes to develop Mama100 to reach 3m active users by

2016 and become a powerful ecommerce ecosystem of maternity products.

To fully unlock the potential of Mama100, Biostime looks to:

Immediately: launching an O2O sales model allowing consumers to place orders

online/mobile and receive offline delivery from member shops.

Near future: expand into other infant FMCG categories that it currently doesn’t have a

significant presence. The company is searching for horizontal expansion M&A targets.

In the long run: Open Mama100 to third parties by charging a platform fee.

Fig 19 Mama100 active members to reach 3m by 2016 Fig 20 Already seeing strong cross-selling rates

Source: Company data, June 2014 Source: Company data, June 2014

Eyeing the lucrative yet underpenetrated diaper market

The Dec 2013 JV with Coco Health may be a major step in penetrating the lucrative diaper

market (penetration remains low at 47% vs. 85% for infant formula). Biostime intends to make

more horizontal acquisitions into other maternity-related FMCG categories, and the newly

issued RMB2.4bn CB puts it in a strong balance sheet position to do so.

Fig 21 Infant formula to reach 85% penetration Fig 22 Diaper penetration remains low at 40%

*based on 11kg/infant/year *based on three diapers per infant per day (conservative)

Source: Global Demographics, Nielsen, Macquarie Research, June 2014 Source: Euromonitor, CNHPIA, Macquarie Research, June 2014

0

500

1,000

1,500

2,000

2,500

3,000

2010 2011 2012 2013 2016E

Mama100 active members (000's)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

10

20

30

40

50

60

70

80

90

100

2009 2010 2011 2012 2013 2014E 2015E 2016E

Infant formula market (RMB billion) Penetration ratio*

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

10

20

30

40

50

60

70

80

90

100

2009 2010 2011 2012 2013 2014E 2015E 2016E

Baby diaper market (RMB billion) Penetration ratio*


11 June 2014 33

Management and corporate governance Strong shareholder return since IPO

Biostime was founded by Mr. Luo Fei and five co-founders, including his brother Luo Yun.

Collectively, the co-founders’ holding company ‘Biostime International’ owns 75% of listco

Biostime International with the remainder 25% as free float.

The company issued a HK$3bn 5-year zero coupon Convertible Bond with a conversion price

of HK$90.84/sh in February 2014. Upon full conversion, the CB will represent 5.36% of

enlarged shares outstanding.

Biostime Pharmaceutical entered into a voluntary lock-up for three years after the IPO. The

lock-up was further extended by three months after the 2019 CB issuance, and was expired

on May 20, 2014. Potential co-founder sell-down will pose an overhang on the shares.

Fig 23 Shareholding structure as of May 2014


Biostime International (1112.HK)

Biostime Pharmaceutical

Free Float

75% 25%

LUO Fei

28%

WU Xiong

26%

LUO Yun

20%

CHEN Fufang

20%

ZHANG Wenhui

10%

KONG Qingjuan

4%


11 June 2014 34

Fig 24 Biostime’s Corporate history and major events

Date Event Note

Aug 1999 Company founding Biostime Guangzhou was founded by Luo Fei and Luo Yun to engage in the research, development and production of probiotic supplement products

2002 Lallemand partnership Partnership with Lallemand to develop probiotic supplement products

2003 Biostime launch Biostime brand of probiotic supplement was formally launched in China

2006 Mama100 Established the Mama100 Membership Program to provide catered customer service, a membership points accumulation program, a monthly magazine subscription and other exclusive services

2008 Infant formula launch Launched infant formula product line from supplier Montaigu with high quality French source

2009 BM Care Registered and launched BM Care line of infant care products, including baby diapers

Dec 2010 IPO Raised HK$1.6bn through successful initial public offering on the Hong Kong Stock Exchange, listing under the stock code 1112

Nov 2011 Share option scheme Board approves share option scheme to motivate and retain senior management

Jun 2012 Arla partnership Biostime enters a 10-year financing and supply agreement with Arla Foods and provided DKK81.5 million of financing to expand infant formula production facilities

Jun 2012 CTO resignation Dr. Zhang Wenhui, the company's Chief Technology Officer, Executive Director and a shareholder of Biostime Pharmaceutical resigned and was redesignated as Non-executive Director

Jul 2013 Isigny investment Biostime invested EUR2.5m for a 20% stake in its infant formula OEM partner Isigny Sainte Mère. The fund will be used for Isigny's capacity expansion and R&D spend

Jul 2013 NDRC investigation Biostime was found guilty of NDRC's investigation on monopolistic pricing behavior. The company paid a total fine of RMB163m and cut prices on some of its prices up to 10%.

Sept 2013 Adimil and O2O The company introduced the nutritional fortification brand of infant formula Adimil. At the same time, Biostime launched its Online-to-Offline (O2O) sales model.

Dec 2013 Changsha Yingke acquisition Acquired Changsha Yingke for RMB350m in cash. The acquired target will be used to manufacture lower-end Adimil infant formula products.

Jan 2014 Diaper JV Established a joint venture with Hangzhou Coco Healthcare to manufacture baby diapers. JV 60% owned by Coco, 40% by Biostime.

Feb 2014 2019 CB Issuance of HK$3.1bn 5-year zero-coupon Convertible Bond, conversion price HK$90.84/sh



11 June 2014 35

Fig 25 Biostime’s Board of Directors (as of April 2014)

Name Title Age Responsibilities and bio

Executive Directors

Mr. LUO Fei 罗飞 Chairman, CEO 50 Primarily responsible for overall strategies, planning & business development

Founded Biostime in 1999 and served as general manager since

Prior to 1999, Luo established Biohope, a personal care/household raw materials trading company

Graduated from South China University of Technology (1988) and EMBA from CEIBS (2008)

Ms. KONG Qingjuan 孔庆娟 COO 52 Appointed Executive Director in May 2010, mainly responsible for overall procurement, logistics, production, internal compliance & control

Prior to joining Biostime in 2000, Kong worked for hospitals and a bio-cosmetic company

Bachelor degree in medicine from Hebei Medical Institute (1985)

Non-executive Directors

Dr. ZHANG Wenhui 张文会 Non-executive director 49 Redesignated to Non-executive Director in June 2012

Was previously an executive director and Chief Technology Officer (2005-2012) in charge of R&D

Zhang was an assistant research professor of chemical engineering with University of Nebraska-Lincoln

Bachelor in biochemical engineering from East China University of Science and Technology (1985)

Master's in industry fermentation, doctorate in fermentation engineering from South China University of Technology (1988 and 1994)

Mr. WU Xiong 吴雄 Non-executive director 58 Appointed as Non-executive Director in May 2010

Was the general manager of Hainan Junjie Automobile (2000-2009)

and Haikou Market Properties Development (1997-2000)

and employed by the Administration of Industry and Commerce of Haikou City (1980-1997)

Graduated from Haikou No.1 Middle School (1975)

Mr. LUO Yun 罗云 Non-executive director 53 Elder brother of founding chairman Luo Fei

Appointed Non-executive Director in May 2010

Worked in various divisions of Biostime, including GM of Biostime Health & Nutrition (2009-2011), Mama100 membership center (1999-2009)

EMBA from Fudan University (2012)

Mr. CHEN Fufang 陈富芳 Non-executive director 50 Appointed Non-executive Director in May 2010

Bachelor's (1985) and master's (1988) in chemical fibre from South China University of Technology

Independent Non-executive Directors

Dr. NGAI Wai Fung 魏伟峰 INED, Chairman of Audit

52 Appointed INED in July 2010

MD of MNCOR Consulting, CEO of SWCS Corporate Services, VP of HK Institute of Chartered Secretaries

Hold directorships in: BaWang (1338.HK), Bosideng (3998.HK), China Coal Energy (1898.HK), CRCC (1186.HK), Juda (1329.HK), LDK Solar (LDK.US), Powerlong Real Estate (1238.HK), SANY Heavy (631.HK), SITC (1308.HK)

Mr. TAN Wee Seng 陈伟成 INED, Chairman of Remuneration

58 Appointed INED in July 2010

Hold directorships in: Xtep (1368.HK), Sa Sa (178.HK), CIFI Holdings (884.HK), ReneSola (SOL.US), CIFI (884.HK)

Also was a director of 7 Days (SVN.US) prior to delisting in July 2013 and was the Chairman for the delisting review committee

Prof. XIAO Baichun 萧柏春 INED 66 Appointed INED in July 2010

A professional and scholar in management science. Professor at Secton Hall University (1990-1999), Long Island University (1998-now)

Senior management

Mr. ZHAO Li 赵力 Chief Marketing Officer 45 Also General Manager of 'Parenting Power', one of the four brand project departments of Biostime

Joined Biostime in October 2004

Mr. Frank CAO Wenhui 曹文辉 Chief Financial Officer 36 Joined Biostime in March 2007

Previously a senior accountant with Mead Johnson (2005-2007)



11 June 2014 36

Financials Entering new era of slowing growth

After an extraordinary streak (FY09-13 revenue CAGR 69%), we expect growth to slow to

19% this year. The July 2013 NDRC investigation, which led to a 10% price drop on some

products, has reduced firm-wide ASP by 1%. We believe 1H14’s growth will stall to 15% due

to high YoY base.

Fig 26 FY14 revenue growth to slow to 19% Fig 27 Tough 1H14


Margins under pressure from mix-shift towards mid/high tiers

Margins will be under pressure as well; having already dominated the Supreme category

(retail ASP >RMB300/can) with 65% market share, Biostime is increasingly looking for growth

in the high (RMB200-300) and mid-tier (RMB100-200). Mid/high tier have lower margins (GM

56% and 62%) vs. Supreme (69%).

We forecast OP margin to drop by 160bps to 26.6%.

Fig 28 Mid/high tiers have lower GM than Supreme (FY14E)

Fig 29 Mix shift to lower blended infant formula GM


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

FY11 FY12 FY13 FY14E FY15E FY16E

Revenue (RMBm) YoY growth

0%

10%

20%

30%

40%

50%

60%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2H12 1H13 2H13 1H14E 2H14E 1H15E


56%

62%

69%

40%

45%

50%

55%

60%

65%

70%

75%

Mid High Supreme

Gross margin by tier

56%

58%

60%

62%

64%

66%

68%

70%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E

Mid High Supreme Blended GM (infant formula)

Infant formula revenue (RMBm) Blended GM


11 June 2014 37

Fig 30 Biostime - Annual P&L (Rmb m, except per share)

2011 2012 2013 2014E 2015E 2016E

Revenue 2,189 3,382 4,561 5,417 6,308 7,090 YoY growth 77% 54% 35% 19% 16% 12% Cost of sales 733 1,153 1,586 1,956 2,365 2,682 Gross profit 1,456 2,229 2,975 3,460 3,943 4,408 Gross margin 66.5% 65.9% 65.2% 63.9% 62.5% 62.2% Selling and distribution costs 709 1,078 1,513 1,860 2,085 2,273 Administrative expenses 82 117 177 210 232 258 Total SG&A 791 1,195 1,690 2,071 2,317 2,531 SG&A margin 36.1% 35.3% 37.1% 38.2% 36.7% 35.7% Operating profit 665 1,034 1,285 1,390 1,626 1,877 YoY growth 96% 55% 24% 8% 17% 15% Operating margin 30.4% 30.6% 28.2% 25.7% 25.8% 26.5% -2.5% Other income and gains 72 57 106 78 219 225 Other expenses -23 -39 -56 -66 -77 -86 NDRC fine -163 EBIT 714 1,053 1,173 1,401 1,768 2,015 EBIT margin 33% 31% 26% 26% 28% 28% Finance costs 2 11 30 115 120 Pre-tax profit 714 1,051 1,162 1,371 1,652 1,895 Income tax 187 307 341 384 463 531 Tax rate 26% 29% 29% 28% 28% 28% Net profit 527 743 821 987 1,190 1,365 Net margin 24% 22% 18% 18% 19% 19% Adjustments -163 0 0 0 Tax on adjustment -48 0 0 0 Adjusted profit 527 743 936 987 1,190 1,365 Adjusted margin 24% 22% 21% 18% 19% 19% YoY growth 98% 41% 26% 6% 20% 15% Adj EPS (diluted) 0.86 1.22 1.53 1.61 1.94 2.23 YoY growth 49% 41% 26% 6% 20% 15% Depreciation 13 22 26 80 101 121 EBITDA 727 1,075 1,199 1,482 1,868 2,136 EBITDA margin 33% 32% 26% 27% 30% 30%



11 June 2014 38

Fig 31 Biostime - Semi-annual P&L (Rmb m, except per share)

1H12 2H12 1H13 2H13 1H14E 2H14E 1H15E 2H15E

Revenue 1,363 2,019 2,061 2,500 2,367 3,050 2,756 3,552 YoY growth 57% 53% 51% 24% 15% 22% 16% 16% Cost of sales 469 684 692 894 855 1,101 1,033 1,332 Gross profit 894 1,335 1,370 1,606 1,512 1,948 1,723 2,221 Gross margin 65.6% 66.1% 66.4% 64.2% 63.9% 63.9% 62.5% 62.5% Selling and distribution costs 475 602 667 846 828 1,032 919 1,166 Administrative expenses 50 67 79 99 93 117 103 129 Total SG&A 525 669 746 944 922 1,149 1,022 1,296 SG&A margin 38.5% 33.2% 36.2% 37.8% 38.9% 37.7% 37.1% 36.5% Operating profit 368 666 624 661 590 799 701 925 YoY growth 62% 52% 69% -1% -5% 21% 19% 16% Operating margin 27.0% 33.0% 30.2% 26.4% 24.9% 26.2% 25.4% 26.0% Other income and gains 22 35 62 45 34 44 96 123 Other expenses -17 -22 -25 -31 -29 -37 -34 -43 NDRC fine -163 EBIT 373 680 498 675 595 806 763 1,005 EBIT margin 27% 34% 24% 27% 25% 26% 28% 28% Finance costs 0 2 4 7 13 17 50 65 Pre-tax profit 373 678 494 668 582 789 712 940 Income tax 99 209 196 145 168 216 202 261 Tax rate 27% 31% 40% 22% 29% 27% 28% 28% Net profit 274 469 298 523 415 573 510 679 Net margin 20% 23% 14% 21% 18% 19% 19% 19% Adjustments 0 0 -163 0 0 0 0 0 Tax on adjustment Adjusted profit 274 469 460 475 512 678 687 846 Adjusted margin 20% 23% 22% 19% 22% 22% 25% 24% YoY growth 40% 41% 68% 1% 11% 43% 34% 25% Adj EPS (diluted) 0.45 0.77 0.75 0.78 0.84 1.11 1.12 1.38 YoY growth 39% 41% 68% 1% 11% 43% 34% 25% Depreciation 10 12 13 13 35 45 44 57 EBITDA 384 692 511 689 631 851 807 1,061 EBITDA margin 28% 34% 25% 28% 27% 28% 29% 30%



11 June 2014 39

Fig 32 Biostime - Balance sheet (Rmb m)

2011 2012 2013 2014E 2015E 2016E

Inventories 297 523 972 968 1,377 1,283 Trade and bills receivables 10 0 15 3 18 6 Prepayments, deposits and other receivables 29 86 111 123 150 156 Due from a director 2 2 2 2 Derivative financial instrument 6 6 6 6 Loans receivable 13 27 27 27 27 Restricted cash 70 70 70 70 Cash and cash equivalents 1,814 1,669 1,663 6,364 6,561 6,840 Current assets 2,150 2,291 2,866 7,563 8,211 8,390 PP&E 59 77 322 496 596 696 Intangible assets 1 1 6 6 6 6 Deposits paid for PP&E 30 13 15 15 15 15 Time deposits 160 942 855 855 855 855 Deferred tax assets 36 79 124 218 415 Prepaid land lease payments 20 84 84 84 84 Goodwill 143 143 143 143 Bonds receivable 98 98 98 98 Loans receivable 110 85 85 85 85 Held-to-maturity investment 21 21 21 21 Non-current assets 288 1,242 1,754 1,804 2,122 2,419 Total assets 2,438 3,533 4,620 9,367 10,332 10,809 Trade payables 67 263 362 409 523 534 Other payables and accruals 265 444 720 715 1,020 948 Interest-bearing bank loan 271 751 2,883 2,993 3,047 Tax payable 83 156 213 6 Current liabilities 415 1,133 2,045 4,013 4,535 4,529 Deferred tax liabilities 45 77 60 60 60 60 2019 CB 2,411 2,411 2,411 Non-current liabilities 45 77 60 2,471 2,471 2,471 Total liabilities 461 1,211 2,104 6,484 7,007 7,001 Issued capital 5 5 5 5 5 5 Reserves 1,679 1,904 2,143 2,436 2,789 3,193 Proposed final dividend 293 414 367 442 532 611 Total equity 1,978 2,323 2,516 2,883 3,326 3,809 Total liabilities and equity 2,438 3,533 4,620 9,367 10,332 10,809



11 June 2014 40

Fig 33 Biostime - Cash flow (Rmb m)

2011 2012 2013 2014E 2015E 2016E

Profit before tax 714 1,051 1,162 1,371 1,652 1,895 Adjustments for: 2 27 12 82 46 65 Bank interest income -17 -43 -83 -78 -219 -225 Interest income from loans receivable -1 -5 Interest from guaranteed deposits -12 Finance costs 2 11 30 115 120 Depreciation 13 22 26 80 101 121 Changes in working capital: -77 115 -167 47 -33 40 Inventories -192 -226 -452 4 -409 94 Trade and bills receivables -5 9 -15 12 -15 12 Other receivables -4 -42 -1 -11 -27 -7 Amounts due from directors -2 Rental deposits -5 0 0 Trade and bills payables 1 196 99 47 114 11 Other payables and accruals 127 177 205 -5 304 -71 Due to a related company Gross operating cash flow 639 1,192 1,008 1,500 1,665 2,000 Tax paid -123 -245 -347 -384 -463 -531 Net Operating cash flow 516 947 660 1,116 1,203 1,469 Purchases of PP&E -39 -39 -136 -100 -100 -100 Proceeds from disposal of PP&E 0 0 0 Additions to intangible assets 0 0 -2 Acquisition of a subsidiary -280 -70 Increase in deposits paid for capex -21 -3 Held-to-maturity investment -21 Investment in bonds -123 -98 Repayment of loans receivable 1 9 Interest received 14 29 60 Principal guaranteed deposits 12 ST time deposits -324 -945 370 LT time deposits -160 -782 87 Restricted cash -70 Investing cash flow -529 -1,850 -81 -170 -100 -100 Proceeds from issue of shares 21 Share issue expenses -10 Shares for option scheme -57 -64 -64 -64 -64 New bank loans 271 645 2,132 111 54 Repayment of bank loans -165 CB 2,411 Interest paid -1 -9 -30 -115 -120 Dividends paid -180 -404 -622 -695 -837 -960 Financing cash flow -169 -192 -215 3,755 -906 -1,090 Increase/decrease in cash -182 -1,095 365 4,701 197 279 Period beginning cash 1,728 1,490 401 765 5,466 5,663 Foreign exchange -56 5 -1 Period end cash 1,490 401 765 5,466 5,663 5,942 Non-pledged time deposits (>3m) 324 1,269 898 898 898 898 Balance sheet cash 1,814 1,669 1,663 6,364 6,561 6,840 Free cash flow 456 905 243 946 1,103 1,369



11 June 2014 41

Biostime (1112 HK, Underperform, Target Price: HK$38.50) Interim Results 2H/13A 1H/14E 2H/14E 1H/15E Profit & Loss 2013A 2014E 2015E 2016E

Revenue m 2,500 2,367 3,050 2,756 Revenue m 4,561 5,417 6,308 7,090 Gross Profit m 1,606 1,512 1,948 1,723 Gross Profit m 2,975 3,460 3,943 4,408 Cost of Goods Sold m 894 855 1,101 1,033 Cost of Goods Sold m 1,586 1,956 2,365 2,682 EBITDA m 675 625 845 745 EBITDA m 1,311 1,470 1,726 1,998 Depreciation m 13 35 45 44 Depreciation m 26 80 101 121 Amortisation of Goodwill m 1 0 0 0 Amortisation of Goodwill m 1 0 0 0 Other Amortisation m 0 0 0 0 Other Amortisation m 0 0 0 0 EBIT m 661 590 799 701 EBIT m 1,285 1,390 1,626 1,877 Net Interest Income m 32 21 27 45 Net Interest Income m 72 48 103 105 Associates m 0 0 0 0 Associates m 0 0 0 0 Exceptionals m 6 0 0 0 Exceptionals m -139 0 0 0 Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Other Pre-Tax Income m -31 -29 -37 -34 Other Pre-Tax Income m -56 -66 -77 -86 Pre-Tax Profit m 668 582 789 712 Pre-Tax Profit m 1,162 1,371 1,652 1,895 Tax Expense m -145 -168 -216 -202 Tax Expense m -341 -384 -463 -531 Net Profit m 523 415 573 510 Net Profit m 821 987 1,190 1,365 Minority Interests m 0 0 0 0 Minority Interests m 0 0 0 0

Reported Earnings m 523 415 573 510 Reported Earnings m 821 987 1,190 1,365 Adjusted Earnings m 518 415 573 510 Adjusted Earnings m 961 987 1,190 1,365

EPS (rep) 0.85 0.68 0.93 0.83 EPS (rep) 1.34 1.61 1.94 2.23 EPS (adj) 0.85 0.68 0.93 0.83 EPS (adj) 1.57 1.61 1.94 2.23 EPS Growth yoy (adj) % 11.8 -6.4 10.5 23.1 EPS Growth (adj) % 31.3 2.8 20.5 14.7

PE (rep) x 30.9 25.7 21.3 18.6 PE (adj) x 26.4 25.7 21.3 18.6

EBITDA Margin % 27.0 26.4 27.7 27.0 Total DPS 1.23 1.15 1.39 1.59 EBIT Margin % 26.4 24.9 26.2 25.4 Total Div Yield % 3.0 2.8 3.4 3.9 Earnings Split % 53.9 42.0 58.0 42.9 Weighted Average Shares m 613 613 613 613 Revenue Growth % 23.8 14.8 22.0 16.4 Period End Shares m 602 602 602 602 EBIT Growth % -0.7 -5.3 20.9 18.7

Profit and Loss Ratios 2013A 2014E 2015E 2016E Cashflow Analysis 2013A 2014E 2015E 2016E

Revenue Growth % 34.9 18.8 16.5 12.4 EBITDA m 1,311 1,470 1,726 1,998 EBITDA Growth % 24.1 12.1 17.4 15.7 Tax Paid m -347 -384 -463 -531 EBIT Growth % 24.2 8.2 17.0 15.4 Chgs in Working Cap m 117 -47 33 -40 Gross Profit Margin % 65.2 63.9 62.5 62.2 Net Interest Paid m -11 -30 -115 -120 EBITDA Margin % 28.7 27.1 27.4 28.2 Other m -409 107 21 162 EBIT Margin % 28.2 25.7 25.8 26.5 Operating Cashflow m 660 1,116 1,203 1,469 Net Profit Margin % 21.1 18.2 18.9 19.2 Acquisitions m -280 -70 0 0 Payout Ratio % 78.6 71.6 71.6 71.6 Capex m -136 -100 -100 -100 EV/EBITDA x 18.3 16.3 13.9 12.0 Asset Sales m 0 0 0 0 EV/EBIT x 18.7 17.3 14.8 12.8 Other m 335 -0 0 0

Investing Cashflow m -81 -170 -100 -100 Balance Sheet Ratios Dividend (Ordinary) m -622 -695 -837 -960 ROE % 39.7 36.6 38.3 38.3 Equity Raised m 0 0 0 0 ROA % 31.5 19.9 16.5 17.8 Debt Movements m 480 2,132 111 54 ROIC % 98.2 62.4 64.5 62.3 Other m -73 -94 -179 -184 Net Debt/Equity % -36.3 -37.1 -34.8 -36.3 Financing Cashflow m -215 1,343 -906 -1,090 Interest Cover x nmf nmf nmf nmf Price/Book x 9.9 8.6 7.5 6.5 Net Chg in Cash/Debt m 364 2,289 197 279 Book Value per Share 4.2 4.8 5.5 6.3

Free Cashflow m 525 1,016 1,103 1,369

Balance Sheet 2013A 2014E 2015E 2016E Cash m 1,663 6,364 6,561 6,840 Receivables m 15 3 18 6 Inventories m 972 968 1,377 1,283 Investments m 27 27 27 27 Fixed Assets m 322 496 596 696 Intangibles m 143 143 143 143 Other Assets m 1,478 1,365 1,610 1,814 Total Assets m 4,620 9,367 10,332 10,809 Payables m 362 409 523 534 Short Term Debt m 751 2,883 2,993 3,047 Long Term Debt m 0 0 0 0 Provisions m 213 6 0 0 Other Liabilities m 780 3,186 3,491 3,419 Total Liabilities m 2,104 6,484 7,007 7,001 Shareholders' Funds m 2,516 2,883 3,326 3,809 Minority Interests m 0 0 0 0 Other m 0 0 0 0 Total S/H Equity m 2,516 2,883 3,326 3,809 Total Liab & S/H Funds m 4,620 9,367 10,332 10,809

All figures in Rmb unless noted. Source: Company data, Macquarie Research, June 2014


11 June 2014 42

HONG KONG



Valuation HK$ 1.29 - DCF (WACC 13.2%, beta 1.4, ERP 7.0%, RFR 5.0%, TGR 2.0%)




Volatility Index High




Free float % 12


Number shares on issue m 3,559


Revenue m 3,890.0 3,738.8 4,173.0 4,572.4 EBIT m 467.2 279.3 354.8 425.3 EBIT growth % -13.0 -40.2 27.0 19.9 Reported profit m 437.6 240.3 277.9 325.2 Adjusted profit m 423.1 240.3 277.9 325.2 EPS rep Rmb 0.12 0.07 0.08 0.09 EPS rep growth % -7.1 -45.1 15.6 17.0 EPS adj Rmb 0.12 0.07 0.08 0.09 EPS adj growth % -5.7 -43.3 15.6 17.0 PER rep x 18.9 34.4 29.8 25.4 PER adj x 19.5 34.4 29.8 25.4 Total DPS Rmb 0.40 0.03 0.03 0.04 Total div yield % 17.1 1.2 1.4 1.6 ROA % 9.3 6.0 6.8 7.6 ROE % 11.8 7.6 8.3 9.2 EV/EBITDA x 13.8 19.3 14.4 12.0 Net debt/equity % -19.6 2.8 7.1 1.0 P/BV x 2.6 2.5 2.4 2.3





Yashili International Between a rock and a hard place Initiate with Underperform, HK$1.45 target, 50% downside

We initiate coverage of Yashili with an Underperform rating and a target price of

HK$1.45/sh, which implies 50% downside. With sales declines in 4Q13, we see

multiyear headwinds for Yashili and significant earnings downside. We forecast

FY14 EPS to fall by 43% and only to rebound by 16% in FY15E, which is 55%

and 60% below consensus estimates. With lower visibility of a turnaround and

negative FCF until at least the end of FY15, we see a high probability of a

dividend cut.

Sales plummet on combination of unfavourable factors

Revenue went from 29% YoY growth in 1H13 to -12% in 2H13, with the decline

largely in 4Q. Poor sales were hit by three main negatives: 1) Fonterra’s false

alarm whey powder incident in August, which harmed brand reputation (Yashili is

branded as 100% from New Zealand), 2) NDRC investigation led to industry wide

price cuts and sales promotions, 3) the State Council’s industry consolidation

order to eliminate weak players led to inventory dumping at heavy discounts. YTD

sales have not improved much from 4Q due to price adjustment impact and a

stabilized 2H14 remains a hope at this point.

Channel trouble: weak in maternity, minimal in ecommerce

We think Yashili’s real trouble lies in its channel exposure. Yashili is a latecomer

to two of the increasingly dominant sales channels that convenience-seeking

young Chinese parents buy their infant formula from: maternity shops and

ecommerce. 64% of Yashili’s FY13 sales came from supermarkets, which saw a

3% yoy decline in total infant formula sales. Yashili remains weak in maternity

stores with revenue of RMB43k/store, far below Biostime’s RMB183k/store. More

threatening to Yashili’s home game in the lower tier markets is the proliferation of

ecommerce allowing global brands to leapfrog into previously underpenetrated

markets; total sales of infant formula online jumped >60% in 2013. Yashili is

introducing a points and membership sales system; however, we doubt it can

generate a meaningful turnaround this year.

55-60% EPS downside, negative FCF risks dividend cut

FCF turned negative in FY13 and with the ongoing capex commitment with the

New Zealand plant, we expect FCF to stay negative until at least FY16. Prior to

Mengniu’s takeover, a special dividend representing 229% of FY13 NP was paid

out to shareholders, which reduced the cash position by RMB1bn. We forecast

the regular year-end dividend payout will likely to be cut by 76% from RMB11

cents in FY13 to just RMB3 cents in FY14E.

Management turnover to pose further operational risks

The majority of Yashili’s directors and executive team has been replaced with

Mengniu/COFCO’s and only two members of the founding Zhang family remain

with the Board, with total effective stake reduced from 51% to just 9% after the

takeover deal. Share options granted to the company’s long-serving senior

management team were cancelled without immediate plan of a new one. At its

FY13 results briefing, Mengniu continued to reiterate keeping Yashili largely

autonomous while looking to exert control via the Board. We see increasing risks

of further management turmoil that could disrupt already weak sales trends before

Mengniu can fully install its team on board.


11 June 2014 43

Inside

Valuation 44

Yashili’s multi-year struggle 47

Management and corporate governance 50

Financials 53

1230 HK rel HSI performance



A fallen angel and its former glory Company profile

Headquartered in Chaozhou, Guangdong Province, Yashili was founded in

1998 by the Zhang family. The company manufactures and sells infant

formula products under the Yashili and Scient brands, as well as soymilk

powder, cereal, rice flour and milk powder for adults and teenagers.

Yashili used to command leading market share in infant formula sales in

China with 100% of its raw milk sourced domestically. After the 2008 Chinese

Melamine Scandal of tainted milk products that killed six infants and sickened

thousands, the company made a successful and swift shift to New Zealand

sources and began to brand as such. However, due to rising competition from

imported infant formula from global brands in China, the company lost

significant market share and retreated to a lower-tier market focus.

In March 2008, Carlyle invested RMB650m in the company for a 17% stake.

The company successfully listed on the Stock Exchange of Hong Kong in

October 2010 under the ticker ‘1230.HK’ and raised HK$2.4bn. In August

2013, Mengniu (2319.HK) acquired a 68% stake in Yashili at HK$3.50/sh.

Corporate governance and shareholding structure

The Board is comprised of nine directors – three executive, three non-

executive and three independent. Five of the nine directors are/were

Mengniu/COFCO related, including non-executive Chairwoman Sun Yiping,

who is Mengniu’s incumbent CEO.

As of April 2014, Yashili is owned 68% by Mengniu, 9% by Zhang

International, 6% by Temasek, 5% by Hopu and the remainder by public free

float.

The company changed its auditor from KPMG to Ernst & Young in 2014 to

align with Mengniu’s auditor.

Fig 1 Melamine aftermath: from China’s #1 infant formula brand to #8

Source: Nielsen, Company data, Macquarie Research, June 2014.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0

1,000

2,000

3,000

4,000

5,000

2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

Infant formula Others (nutrition, baby food) Infant formula market share

Revenue (RMB million) Market share %


11 June 2014 44

Valuation Our primary valuation is based on PER; we then cross check against our DCF fair valuation.

Yashili (Underperform) with HK$1.45/sh target, 15x FY15E PER

Our 12-month target price on is based on 15x FY15E PER. Yashili’s profitability and return on

capital have fallen significantly (low-teens EBIT margin and high-single-digit ROIC). Yashili

have been losing market share, particularly in Tier 1 & 2 cities and continues to be weak in

two increasingly dominating infant formula channels: maternity and ecommerce.



(x)

EPS growth

(%) EBIT

margin ROE

(%)

Div yield

(%) P/Bk


1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 19.3 14.4 -19.0 9.6 12.2 15.4 2.6 Yashili at TP 1.45 17.4 15.0 8.5 6.3 Infant formula pure-plays MJN US Mead Johnson NR 87.39 17,662 23.6 21.1 15.6 14.0 7.6 23.9 418.4 1.6 51.1 002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4 1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9 1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6 Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1 Diversified dairies 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8 600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5 NESN VX Nestlé NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5 BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2 FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4 Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0 China large cap staples 151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4 322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5 1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1 2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7 168 HK Tsingtao Brewery NR 61.70 9,866 30.2 25.5 15.2 12.7 5.9 7.2 14.9 0.9 4.6 Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4

Price date June 10, 2014. Valuations and forecasts for non-rated stocks are from Bloomberg. Recommendation legend - OP: Outperform, N: Neutral, UP: Underperform, NR: not rated.


Among listed dairy companies globally that have infant formula business in China, we identify

two baskets of comps:


Diversified dairies

Diversified dairies trading on lower valuation than infant formula

As a group, Diversified dairies trade at a lower valuation to Infant formula pure-plays due to

lower margin on liquid milk business. The average EBIT margin for our Diversified dairies for

FY13 was only 8% vs. 17% for infant formula pure-plays.

Most of the diversified dairies traded around 18x forward earnings on average over the past

five years. The exception is Mengniu, which traded, on average, at 24x PER. This is largely

due to a number of high profile M&A catalysts over the past few years (COFCO stake,

Danone JV and stake, Modern Dairy acquisition, Yashili acquisition, Arla partnership, White

Wave partnership).


11 June 2014 45

Fig 3 Yashili currently trading on 37x forward PER Fig 4 3.0x trailing P/Bk


We believe Yashili’s forward multiple should be trading at discount to the diversified dairies at

18x PER, a discount to its infant formula pure play:

Yashili’s profitability and return on capital have fallen to levels more comparable to

Diversified dairies

Yashili have been losing market share, particularly in Tier 1 & 2 cities

Yashili is weak in maternity channel and non-existent on ecommerce, two increasingly

dominating channels for infant products

Fig 5 Yashili's margins fallen to diversified dairies’ levels

Fig 6 So has the return on capital

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Bloomberg, Company data, Macquarie Research, June 2014

0

10

20

30

40

50

60


Forward PE ratio (x)

mean

-1 σ

+1 σ

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14

Trailing P/Bk ratio (x)

mean

-1 σ

+1 σ

0%

5%

10%

15%

20%

25%

2008 2009 2010 2011 2012 2013

IMF pure-plays Diversified dairies Yashili

EBIT margin

0%

10%

20%

30%

40%

50%

60%

70%

2008 2009 2010 2011 2012 2013

IMF pure-plays Diversified dairies Yashili

ROIC


11 June 2014 46

DCF fair value HK$1.29/sh

Our Yashili DCF fair valuation is HK$1.29/sh. FCF turned negative in FY13 and with the

ongoing capex commitment with the New Zealand plant, we expect FCF to stay negative until

at least FY16.

Prior to Mengniu’s takeover, a special dividend representing 229% of FY13 NP was paid out

to shareholders, which reduced cash position by RMB1bn. We believe regular dividend will

likely to be cut by 76% from RMB11 cents in FY13 to just RMB3 cents in FY14E.

We use equity beta of 1.4 to factor in the increasing uncertainty in sales trend and margin

visibility.

Fig 7 Yashili cash flow projection

RMB million 12A 13A 14E 15E 16E 17E 18E 19E 20E

Sales 3,655 3,890 3,739 4,173 4,572 4,896 5,096 5,295 5,490 ... Growth 24% 6% -4% 12% 10% 7% 4% 4% 4% Gross Profit 1,962 2,080 1,916 2,139 2,321 2,461 2,535 2,608 2,677 ... GP Margin 54% 53% 51% 51% 51% 50% 50% 49% 49% EBITDA 619 553 395 529 635 700 756 814 874 … Margin 17% 14% 11% 13% 14% 14% 15% 15% 16% Less: Tax 127 196 80 93 108 124 138 152 167 Less: WC -242 257 109 -42 20 -48 16 -50 14 Less: Capex 208 255 800 500 137 147 153 159 165 Less: Other -38 -40 0 0 0 0 0 0 0 Free Cash Flow 564 -114 -594 -22 370 477 449 553 528 ... FCF Growth -120% 420% -96% -1785% 29% -6% 23% -4% PV of FCF -554 -18 269 306 255 277 234


Fig 8 DCF valuation metrics

WACC DCF Valuation

Risk Free Rate 5.0% Sum of PV of FCF 769 Market Risk Premium 7.0% PV of Terminal Value (RMBm) 2,134 Equity Beta 1.4 Enterprise Value (RMBm) 2,904 Cost of Equity 14.8% Less: Net Debt -801

Cost of Debt (Pre-tax) 9.0% Market Cap (RMBm) 3,705 Cost of Debt (After tax) 6.8% No. of Ord shares (m), fully diluted 3,559

Target Debt weight 20.0% Terminal as % total 74% Target Equity weight 80.0% Foreign exchange (HKD/RMB) 1.24 Tax Rate 25% Market Cap (HKDm) 4,593

WACC 13.2% Terminal Growth 2.0% Value per share, HK$ $1.29



11 June 2014 47

Yashili’s multi-year struggle An uphill battle since 2008

Prior to the 2008 melamine scandal, Yashili was a 100% domestic infant formula maker

sourcing from local upstream suppliers. In the wake of the scandal, Yashili swiftly changed

milk sources to overseas (mainly to New Zealand’s Fonterra) and rebranded its products as

containing ‘imported ingredients’ to lift consumer perception of its quality. Although ingredient

mixing and packaging remained in China, Yashili is the only ‘domestic’ brand that has 100%

of its raw milk sourced from overseas, in contrast to other major domestic players such as Yili

and Beingmate.

However, the last six years have been anything but smooth sailing for domestic infant formula

players, due to consumers’ lack of trust in domestic brands’ quality. The milk powder market

in China was evenly split between domestic and foreign brands before 2008. As of 2013,

domestic brands’ total market share has dropped to below 40%, while in first-tier cities

imported brands enjoy a market share of more than 80%.

Yashili’s growth was mainly driven by its strong lower-tier distribution channel of its mid-range

products, while premium and top-tier city sales continue to shrink.

Fig 9 Yashili's growth is mainly from lower-tier cities Fig 10 Low contribution from Premium segment

Source: Company data, Macquarie Research, July 2013 Source: Company data, Macquarie Research, July 2013

Mengniu’s opportunity

Yashili currently operates a 50,000 ton/year processing capacity in China. It is investing in a

new 50,000 ton plant in New Zealand that is expected to commence production of premium

products by the end of 2014.

In addition to providing a solid footing into the milk powder segment which Mengniu lacks, we

see the following synergies of this combination:

Top-tier market penetration: Mengniu could help Yashili in opening up top-tier cities

where it has been losing market share. Mengniu has strong relationships with its

distributors and key accounts while Yashili has simple product offerings that do not

overlap much with Mengniu’s own.

Raw material procurement: Yashili could benefit from Mengniu and COFCO from

higher collective negotiation power of the combined platform.

Technology partnership with Arla to develop premium products: Mengniu’s JV

partner and major shareholder Arla Foods will work together with Yashili in improving

its technology and develop premium products (Scient).

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010 2011 2012 2013

First-tier Second-tier Third-tier and others

Formula sales (RMB million)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 2010 2011 2012 2013

Mid-high end formula (Yashili) Premium formula (Scient) Others

% of EBIT


11 June 2014 48

Chinese consumers prefer imported brands

Hundreds of foreign brands have entered Chinese infant formula markets since the 2008

Melamine Scandal which killed six and sickened thousands of babies. Domestic brands that

were once market leaders, such as Yashili, Synutra and Feihe have all conceded significant

market share to companies such as Mead Johnson, Danone and Nestlé.

Fig 11 Infant formula market share, March 2012 Fig 12 Infant formula market share, January 2014

Source: Nielsen, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014

According to the Dairy Association of China, the infant formula market in China was evenly

split between domestic and foreign brands before the 2008 Melamine Scandal. As of 2013,

domestic brands’ total market share has likely dropped to below 40%, while in 1st tier cities

imported brands controlled more than 80% share.

The imported powder premiumisation drive came at the expense of domestic players. Not

only did the domestic players lose market share to foreign companies, the industry actually

became more fragmented as a result.

We believe this consumer behaviour phenomenon that rapidly transformed the infant formula

industry was due to the following inter-related causes:

Imported infant formula carries ‘perceived’ superior quality assurance

Media negatively portrayed domestic infant formula following numerous incidents,

fuelling already high mistrust on domestic products

Rising outbound travel (including to Hong Kong) of Chinese citizens increases access

to and awareness of foreign brands

Strong marketing capability of foreign brands

Emergence of ecommerce, and specifically online maternity shops and overseas

group-buying sites

Consumer willingness to pay a premium for quality for their children, particularly for the

younger generation of Chinese parents (those that are born after 1980).

Mead Johnson,

13.8%

Wyeth, 9.8%

Beingmate, 9.6%

Abbott, 7.1%

Yili, 10.4%

Nestle, 4.0%Yashili, 5.1%

Dumex, 13.5%

Feihe, 4.6%

Synutra, 5.2%

Others, 16.9%

Mead Johnson,

14.5%

Wyeth, 13.3%

Beingmate, 8.5%

Biostime, 7.5%


Nestle, 4.4%

Yashili, 4.1%

Friso, 3.9%

Dumex, 3.6%

Feihe, 3.5%

Synutra, 3.2%

Others, 20.3%


11 June 2014 49

Yashili’s channel trouble: late in maternity, minimal in ecommerce

Infant formula sales in supermarkets dropped by 4% for the first time in 2013, and companies

such as Yashili that had significant sales from supermarkets suffered. Despite overall market

still growing at low-teens, sales of infant formula in super markets were largely flat over the

past three years. We expect the shift towards to maternity shops and ecommerce to

accelerate and winners will be those that can successfully capture this consumption habit

change.


consumers. They were the first to develop habits of shopping online and when they have

babies, they are increasingly buying infant formula from two emerging channels:

Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barrier,

very fragmented. Early mover brands secure advantage in sales


model where brand awareness attracts sales

Fig 13 Per maternity store sales far below Biostime’s


Source: Company data, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014

Yashili had strong reliance on supermarket with >60% of sales coming from them. As of

FY13, Yashili had minimal existence in ecommerce, recording less than 1% of sales online.

Fig 15 Yashili’s reliance on supermarkets hurt its market share


0

20

40

60

80

100

120

140

160

180

200

2011 2012 2013

Yashili Biostime

Revenue per maternity shop (000's RMB/store/year)

5%

-4%

36%

17%23%

60%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

2012 2013


Channel growth YoY

23%

70%

43%26%

64%

36%

77%

30%

41% 74%

36%

42%

16% 22%

0%

20%

40%

60%

80%

100%



2012 2013



11 June 2014 50

Management and corporate governance Zhang brothers cashed out from Mengniu takeover, special dividend

Mengniu acquired an 89% stake in Yashili in August 2013. Following a share placement in

November 2013 to Temasek and Hopu, Mengniu (2319.HK) now controls 68% effective stake

in Yashili (1230.HK).

From the deal, Zhang International (holding co of the founding Zhang siblings) have cashed

out ~HK$5.3bn/US$680m and retained only 8.6% effective stake in Yashili post completion of

the deal. Prior to the takeover, Zhang International held 51.3% stake in Yashili and approved

a RMB1bn special dividend payout in June 2013.

Yashili’s financials have been consolidated into Mengniu’s from September 2013. According

to Mengniu, Yashili will continue to be managed independently for the first two years (though

Mengniu will exert control through the Board) but the aim is to have Yashili eventually

consolidated into Mengniu’s platform.

Fig 16 Shareholding structure as of May 2014


Fig 17 Yashili’s Corporate history and major events

Date Event Note

Mar 1998 Company founding Yashili was founded by twelve shareholders including the six Zhang brothers and their respective spouses

2002 Scient launch Yashili launched the Scient premium infant formula brand

Mar 2008 Carlyle investment Carlyle invested RMB649.7 million for 17% stake in the company

Sept 2008 Melamine Crisis Nationwide milk safety scandal prompted Yashili recalled and wrote off RMB787m worth of goods

2009 Shift to New Zealand source In the wake of the 2008 Melamine Crisis, Yashili shifted 100% of its raw milk powder from domestic sources to New Zealand

Oct 2010 IPO Successfully listed on Hong Kong Stock Exchange, raising HKD2.4bn

June 2013 Special dividend Company paid special dividend of RMB1bn to shareholders, representing ~214% payout ratio on FY12 reported net profit of RMB470m

Aug 2013 Mengniu acquires majority stake Mengniu acquired 68% effective stake in Yashili for HK$3.50/sh from the founding brothers and Carlyle Mengniu replaces Yashili’s board with its own directors

Sept 2013 ‘National brand’ Yashili’s ‘Ambery’ (安贝慧) brand was selected by CDIA as the first batch of the so-called

‘National brand’ of infant formula

Dec 2013 Change of auditor KPMG was replaced by Ernst & Young as the company’s auditor


China MengniuInternational (unlisted)

Yashili International(1230.HK)

Zhang InternationalMengniu Dairy

(2319.HK)

Temasek Hopu Free Float

89% 11%

77% 6% 5% 12%


11 June 2014 51

Fig 18 Yashili’s Board of Directors (as of May 2014)

Name Title Age Responsibilities and bio

Executive Directors

Mr. ZHANG Lidian 张利钿 CEO and Executive director

49 Founding brother of Yashili

Ceased to be the Executive Chairman as of July 2013

Mr. LI Dongming 李东明 Executive director 44 Appointed ED on July 24, 2013

Joined from COFCO with 20 years of M&A experience

Mr. ZHANG Yanpeng 张雁鹏 Executive director 37 General Manager of Scient

Joined Yashili in 2003

Nephew of Zhang Lidian

Non-executive Directors

Ms. SUN Yiping 孙伊萍 Non-executive director, Chairman of the Board, Chairman of Nomination

47 Appointed NED, Chairman on July 24, 2013.

CEO of Mengniu since April 2012, Yashili's controlling parent company

Previously with COFCO Group since 1993 and served in management of COFCO's Coca Cola and property businesses

Over 20 years of experience in FMCG and real estate

Bachelor's and Master's from China Agricultural University

Mr. BAI Ying 白瑛 Non-executive director 43 Appointed NED on June 6, 2014

Executive Director of Mengniu since 2008, in charge of its UHT division

Mr. WU Jingshui 吴景水 Non-executive director 48 Appointed NED on July 2013

Was previously the CFO of Mengniu (2010-2013)

Independent Non-executive Directors

Mr. Ben MOK Wai Bun 莫卫斌 INED, Chairman of Remuneration

65 Appointed on November 15, 2013

Executive director of Max Sun Enterprises

Consultant for COFCO Coca-Cola

Mr. CHENG Shoutai 程守太 INED 46 Appointed on November 15, 2013

Chief partner of Tahota Law Firm, qualified lawyer

Mr. Conway LEE Kong Wai

李港卫 INED, Chairman of Audit

59 Appointed on November 15, 2013

Was a partner of Ernst & Young

Source: Company data, Macquarie Research, July 2013


11 June 2014 52

Board and potential senior management shake-ups

Board and senior management shake-ups over the next year could result in sales channel

disruption before Mengniu fully integrates Yashili into its platform.

Senior management sell-down: Zhang International (Yashili’s executive directors

who are also siblings) sold down its 51% stake in Yashili to just 11% in the deal.

Board has been replaced: After Mengniu’s acquisition, only two out of 11 directors on

Yashili’s old Board stayed. Mengniu replaced the rest with its own or COFCO’s

personnel, including Mengniu CEO Sun Yiping herself as the Non-Executive

Chairman.

Share options have been cancelled: share option scheme that was put in place to

incentivise management through 2015 has been cancelled as part of the Mengniu

takeover. These options were granted to 181 employees of Yashili, and represented

~1.5% of total shares outstanding. Eight out of the nine senior management

personnel listed below were part of the scheme; the cancellation will effectively

eliminate their stake in the company. Many of these key senior management

personnel have been with Yashili for significant period of their careers.

Fig 19 Mengniu/COFCO have replaced the board with its directors

Board before Mengniu acquisition (June 2013) Board after Mengniu acquisition (November 2013)

Executive directors Executive directors ZHANG Lidian Chairman Zhang Brother >>> ZHANG Lidian Executive director/CEO Yashili ZHANG Yanpeng ED, GM of Scient Zhang Nephew >>> ZHANG Yanpeng Executive director Yashili ZHANG Likun ED, Sales & Marketing Zhang Brother ZHANG Liming ED, Finance Zhang Brother ZHANG Libo ED, Administration Zhang Brother LI Dongming Executive director COFCO Non-executive directors Non-executive directors CHANG Herman NED Carlyle ZHANG Chi NED Carlyle SUN Yiping Non-executive Chairman Mengniu's CEO BAI Ying NED Mengniu’s ED WU Jingshui NED Ex-CFO of Mengniu Independent Non-executive Directors Independent Non-executive Directors YU Shimao INED Independent CHEN Yongquan INED Independent WONG Samuel INED Independent LIU Jinting INED Independent Ben MOK Wai Bun INED ex-COFCO CHENG Shoutai INED Independent Conway LEE Kong Wai INED Independent


Fig 20 Yashili Board and Senior Management prior to the Mengniu acquisition

Yashili stake Part of option scheme? Name Position Age Note Before After

Board of Directors ZHANG Lidian ED, CEO 49 Co-founder, Zhang sibling 9.2% 1.8% Yes ZHANG Yanpeng ED, GM of Scient 37 Zhang’s nephew Yes Senior management WU Dinian VP, Sales and Marketing 45 Served Yashili since 2001 (13 years), previously with

Tingyi Yes

WU Xiaonan GM of Investment, Legal 40 Joined in 2008 with legal background Yes XIE Xunpeng GM of Sales and Marketing 42 Served Yashili since 1993 (21 years) Yes PAN Jingzhi Assistant to President 38 Served Yashili since 1996 (18 years) Yes WEN Jieping CFO 37 Joined in 2011 Yes CHEN Xiaohong GM of External Affairs 39 Served Yashili since 1997 (17 years) Yes TONG Chengfu GM of R&D 47 Served Yashili since 2000, previously with Weiquan

(14 years) Yes

LI Mengchun GM of QC 41 Served Yashili since 2004 (10 years) Yes JIANG Weijian Finance Controller 34 Joined in 2008 with accounting background



11 June 2014 53

Financials Sales plummeting on combination of unfavourable factors

Revenue dropped from 29% YoY growth in 1H13 to -12% in 2H13, with the decline largely in

4Q. Poor sales were hit by three main negatives:

Fonterra’s false alarm whey powder incident in August harmed brand reputation

(Yashili is branded as 100% from New Zealand);

NDRC investigation led to industry wide price cuts and sales promotions;

The State Council’s industry consolidation order to eliminate weak players led to

inventory dumping at heavy discounts.

YTD sales have not improved much from 4Q due to price adjustment impact; a stabilized

2H14 remains the company’s hope at this point.

Fig 21 Sales plunged in 2H13 Fig 22 Hoping for a recovery in 2H14


-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

0

500

1,000

1,500

2,000

2,500

2H12 1H13 2H13 1H14E 2H14E 1H15E


-10%

-5%

0%

5%

10%

15%

20%

25%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

FY11 FY12 FY13 FY14E FY15E FY16E



11 June 2014 54

Fig 23 Yashili - Annual P&L

2011 2012 2013 FY14E FY15E FY16E

Turnover 2,958 3,655 3,890 3,739 4,173 4,572 YoY change 0% 24% 6% -4% 12% 10% Cost of sales 1,420 1,693 1,810 1,822 2,034 2,252 Gross profit 1,538 1,962 2,080 1,916 2,139 2,321 ...GP margin 52.0% 53.7% 53.5% 51.3% 51.3% 50.8% Selling and distribution expenses 1,062 1,223 1,394 1,411 1,544 1,646 Administrative expenses 185 202 219 226 240 249 Total SG&A 1,247 1,425 1,613 1,637 1,784 1,895 SG&A ratio 42.2% 39.0% 41.5% 43.8% 42.8% 41.5% Operating profit 291 537 467 279 355 425 Operating margin 9.8% 14.7% 12.0% 7.5% 8.5% 9.3% Other revenue 29 38 26 Other net loss 0 0 -1 Other expenses -6 -15 -11 EBIT 313 559 482 279 355 425 EBIT margin 10.6% 15.3% 12.4% 7.5% 8.5% 9.3% Finance income 65 90 108 49 35 42 Finance costs -3 -3 -13 -8 -19 -34 Profit before taxation 375 646 577 320 370 434 Income tax expenses 67 176 137 80 93 108 Tax rate 18% 27% 24% 25% 25% 25% Net profit 308 470 439 240 278 325 Net margin 10% 13% 11% 6% 7% 7% Minority interests 2 2 2 Net profit attributable 306 468 438 240 278 325 Adjustments 22 23 15 0 0 0 Adjusted profit attributable 284 446 423 240 278 325 Adjusted NP margin 9.6% 12.2% 10.9% 6.4% 6.7% 7.1% YoY change -37.3% 56.9% -5.1% -43.2% 15.6% 17.0% Adjusted EPS (basic) 0.081 0.127 0.119 0.068 0.078 0.091 Adjusted EPS (diluted) 0.080 0.125 0.118 0.067 0.078 0.091 YoY change -45.6% 57.2% -5.7% -43.3% 15.6% 17.0% EBITDA 370 619 553 395 529 635 EBITDA margin 12.5% 16.9% 14.2% 10.6% 12.7% 13.9%



11 June 2014 55

Fig 24 Yashili - Semi-annual P&L

1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15

Turnover 1,689 1,966 2,153 1,737 2,002 1,737 2,240 1,933 YoY change 17% 30% 27% -12% -7% 0% 12% 11% Cost of sales 772 921 961 849 973 849 1,089 945 Gross profit 917 1,045 1,192 888 1,028 888 1,151 988 ...GP margin 54.3% 53.1% 55.4% 51.1% 51.4% 51.1% 51.4% 51.1% Selling and distribution expenses

566 657 712 682 755 656 834 710

Administrative expenses 98 104 114 105 121 105 129 111 Total SG&A 664 761 826 787 876 761 963 821 SG&A ratio 39.3% 38.7% 38.4% 45.3% 43.8% 43.8% 43.0% 42.5% Operating profit 253 284 366 101 152 127 188 167 Operating margin 15.0% 14.4% 17.0% 5.8% 7.6% 7.3% 8.4% 8.6% Other revenue 19 19 11 16 Other net loss 0 0 0 0 Other expenses -13 -2 -3 -7 EBIT 259 301 373 109 152 127 188 167 EBIT margin 15.3% 15.3% 17.3% 6.3% 7.6% 7.3% 8.4% 8.6% Finance income 48 42 42 67 27 22 19 16 Finance costs -1 -2 -4 -10 -4 -4 -11 -9 Profit before taxation 306 341 411 166 175 146 197 174 Income tax expenses 86 90 115 22 44 36 49 43 Tax rate 28% 26% 28% 13% 25% 25% 25% 25% Net profit 220 251 295 144 131 109 147 130 Net margin 13% 13% 14% 8% 7% 6% 7% 7% Minority interests 1 1 2 0 Net profit attributable 219 250 294 144 131 109 147 130 Adjustments 6 17 7 8 0 0 0 0 Adjusted profit attributable 213 233 287 136 131 109 147 130 Adjusted NP margin 12.6% 11.8% 13.3% 7.8% 6.5% 6.3% 6.6% 6.7% YoY change 34.6% -41.5% -54.3% -19.8% 12.5% 19.3% Adjusted EPS (basic) 0.060 0.066 0.081 0.038 0.037 0.031 0.041 0.037 Adjusted EPS (diluted) 0.060 0.065 0.080 0.038 0.037 0.031 0.041 0.036 YoY change 33.9% -41.9% -54.4% -19.8% 12.5% 19.3% EBITDA 294 325 406 147 216 179 284 245 EBITDA margin 17.4% 16.5% 18.8% 8.5% 10.8% 10.3% 12.7% 12.7%



11 June 2014 56

Fig 25 Yashili - Balance sheet

2011 2012 2013 FY14E FY15E FY16E

Inventories 578 653 886 891 1,070 1,039 Trade and bills receivables 52 27 32 Prepayments and other receivables 138 136 171 212 229 230 Amounts due from related parties 2 1 Income tax recoverable Other investments Restricted bank deposits 72 300 42 42 42 42 Short-term bank deposits 612 199 199 199 199 Other investments 180 200 445 445 445 445 Cash and equivalents 2,582 2,073 611 199 414 324 Total current assets 3,604 4,001 2,387 1,988 2,399 2,278 Property, plant and equipment 730 744 1,195 1,880 2,207 2,297 Intangible assets 5 4 6 6 6 6 Investment properties 76 112 116 116 116 116 Lease prepayments 133 130 216 216 216 216 Deferred tax assets 77 80 85 92 127 170 Prepayments for PP&E 11 184 54 54 54 54 Pledged deposits 150 150 150 150 Other non-current assets 7 8 7 7 7 7 Long-term bank deposits 306 300 300 300 300 Total non-current assets 1,040 1,569 2,130 2,822 3,184 3,316 Total assets 4,644 5,570 4,517 4,811 5,582 5,594 Trade and other payables 720 1,029 1,140 1,044 1,282 1,231 Loans and borrowings 31 331 154 374 655 554 Amounts due to related parties 2 2 Income tax payables 53 89 41 Provision for sales return Total current liabilities 806 1,451 1,335 1,418 1,937 1,785 Loans and borrowings 47 114 200 169 Deferred income 31 19 12 12 12 12 Deferred tax liabilities 3 18 13 13 13 13 Amounts due to related parties Total non-current liabilities 33 37 72 139 224 194 Total liabilities 840 1,488 1,407 1,556 2,162 1,978 Capital 301 303 306 306 306 306 Reserves 3,501 3,776 2,804 2,949 3,115 3,310 Minority interests 1 3 0 Shareholders' equity 3,804 4,082 3,110 3,254 3,421 3,616 Total liabilities and equity 4,644 5,570 4,517 4,811 5,582 5,594



11 June 2014 57

Fig 26 Yashili - Cash flow

2011 2012 2013 FY14E FY15E FY16E

Profit before tax 375 646 577 320 370 434 Adjustments: 42 11 16 75 158 202 Depreciation and amortisation 79 82 86 116 174 210 Loss on disposal of PP&E 0 0 1 Impairment for PP&E 6 -1 Write-down of inventories 3 0 0 Share-based transactions 20 8 6 Interest income -44 -43 -54 -49 -35 -42 Interest expense 3 3 13 8 19 34 Foreign exchange difference, net -11 Gains on other investments -18 -47 -24 Change in working capital: 123 242 -257 -109 42 -20 Inventories -190 -75 -233 -5 -180 32 Trade receivables 140 26 -5 -9 -17 -1 Other receivables -36 3 -55 Pledged deposits -6 0 -5 0 0 0 Payables 231 300 48 -96 238 -51 Deferred income -12 -12 -7 0 0 0 Amounts due to related parties -3 0 0 0 Gross operating cash flow 541 899 337 286 571 615 Income tax paid -82 -127 -196 -80 -93 -108 Operating cash flow 458 772 141 206 478 507 Interest received 44 26 33 Acquisition of PP&E -107 -208 -255 -800 -500 -137 Proceed from PP&E disposal 1 3 5 Proceeds from sales of other investments

173 1,396 2,763

Receipts of other bank deposits 1,208 Payment of other bank deposits -903 -789 Acquisition of intangible assets 0 -1 -4 Acquisition of land use right -91 -11 Acquisition of non-current assets -5 -4 -125 Acquisition of other investments -335 -1,369 -2,984 Deposit for performance bond related to land use right

-11

Other effect from investing activities -1 5 Investing cash flow -229 -1,145 -168 -800 -500 -137 Proceeds from share issued for exercise share option

31

Payment for repurchase of shares -16 Proceeds from loans 36 361 615 287 367 -132 Repayments of bank loans -163 -62 -742 Receipts of pledged deposits -24 66 495 Payment of pledged deposits -293 -384 Acquisition of minority interests -28 Interest paid -3 -3 -5 -8 -19 -34 Dividends paid -235 -200 -1,408 -96 -111 -130 Dividend of prior year paid to non-controlling shareholder

-20

Financing cash flow -404 -130 -1,445 182 236 -296 Change in cash -175 -503 -1,472 -412 215 73 Cash year beginning 2,759 2,582 2,073 611 199 414 Effect of exchange rate changes -3 -5 10 Cash year end 2,582 2,073 611 199 414 487 Free cash flow 352 564 -114 -594 -22 370



11 June 2014 58

Yashili International (1230 HK, Underperform, Target Price: HK$1.45) Interim Results 2H/13A 1H/14E 2H/14E 1H/15E Profit & Loss 2013A 2014E 2015E 2016E

Revenue m 1,737 2,002 1,737 2,240 Revenue m 3,890 3,739 4,173 4,572 Gross Profit m 888 1,028 888 1,151 Gross Profit m 2,080 1,916 2,139 2,321 Cost of Goods Sold m 849 973 849 1,089 Cost of Goods Sold m 1,810 1,822 2,034 2,252 EBITDA m 147 216 179 284 EBITDA m 553 395 529 635 Depreciation m 38 64 52 96 Depreciation m 74 116 174 210 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 8 0 0 0 Other Amortisation m 12 0 0 0 EBIT m 101 152 127 188 EBIT m 467 279 355 425 Net Interest Income m 57 23 18 9 Net Interest Income m 95 41 16 8 Associates m 0 0 0 0 Associates m 0 0 0 0 Exceptionals m 8 0 0 0 Exceptionals m 15 0 0 0 Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Pre-Tax Profit m 166 175 146 197 Pre-Tax Profit m 577 320 370 434 Tax Expense m -22 -44 -36 -49 Tax Expense m -137 -80 -93 -108 Net Profit m 144 131 109 147 Net Profit m 439 240 278 325 Minority Interests m 0 0 0 0 Minority Interests m -2 0 0 0

Reported Earnings m 144 131 109 147 Reported Earnings m 438 240 278 325 Adjusted Earnings m 136 131 109 147 Adjusted Earnings m 423 240 278 325

EPS (rep) fen 4.0 3.7 3.1 4.1 EPS (rep) fen 12.2 6.7 7.8 9.1 EPS (adj) fen 3.8 3.7 3.1 4.1 EPS (adj) fen 11.8 6.7 7.8 9.1 EPS Growth yoy (adj) % -41.9 -54.4 -19.8 12.5 EPS Growth (adj) % -5.7 -43.3 15.6 17.0

PE (rep) x 18.9 34.4 29.8 25.4 PE (adj) x 19.5 34.4 29.8 25.4

EBITDA Margin % 8.5 10.8 10.3 12.7 Total DPS fen 39.6 2.7 3.1 3.7 EBIT Margin % 5.8 7.6 7.3 8.4 Total Div Yield % 17.1 1.2 1.4 1.6 Earnings Split % 32.2 54.5 45.5 53.1 Weighted Average Shares m 3,579 3,582 3,582 3,582 Revenue Growth % -11.6 -7.0 0.0 11.9 Period End Shares m 3,559 3,559 3,559 3,559 EBIT Growth % -64.3 -58.5 25.7 23.7


Revenue Growth % 6.4 -3.9 11.6 9.6 EBITDA m 553 395 529 635 EBITDA Growth % -10.6 -28.5 33.8 20.2 Tax Paid m -196 -80 -93 -108 EBIT Growth % -13.0 -40.2 27.0 19.9 Chgs in Working Cap m -321 -109 42 -20 Gross Profit Margin % 53.5 51.3 51.3 50.8 Net Interest Paid m -95 -41 -16 -8 EBITDA Margin % 14.2 10.6 12.7 13.9 Other m 200 41 16 8 EBIT Margin % 12.0 7.5 8.5 9.3 Operating Cashflow m 141 206 478 507 Net Profit Margin % 10.9 6.4 6.7 7.1 Acquisitions m -2,984 0 0 0 Payout Ratio % 334.5 40.3 40.3 40.3 Capex m -255 -800 -500 -137 EV/EBITDA x 13.8 19.3 14.4 12.0 Asset Sales m 5 0 0 0 EV/EBIT x 16.3 27.3 21.5 17.9 Other m 3,065 0 0 0

Investing Cashflow m -168 -800 -500 -137 Balance Sheet Ratios Dividend (Ordinary) m -1,408 -96 -111 -130 ROE % 11.8 7.6 8.3 9.2 Equity Raised m 31 0 0 0 ROA % 9.3 6.0 6.8 7.6 Debt Movements m -127 287 367 -132 ROIC % 20.6 8.4 8.0 8.7 Other m 59 -8 -19 -34 Net Debt/Equity % -19.6 2.8 7.1 1.0 Financing Cashflow m -1,445 182 236 -296 Interest Cover x nmf nmf nmf nmf Price/Book x 2.6 2.5 2.4 2.3 Net Chg in Cash/Debt m -1,462 -412 215 73 Book Value per Share 0.9 0.9 1.0 1.0

Free Cashflow m -114 -594 -22 370

Balance Sheet 2013A 2014E 2015E 2016E Cash m 810 398 613 686 Receivables m 32 0 0 0 Inventories m 886 891 1,070 1,039 Investments m 1,010 1,010 1,010 1,010 Fixed Assets m 1,250 1,935 2,261 2,188 Intangibles m 6 6 6 6 Other Assets m 522 570 622 665 Total Assets m 4,517 4,811 5,582 5,594 Payables m 1,140 1,044 1,282 1,231 Short Term Debt m 154 374 655 554 Long Term Debt m 47 114 200 169 Provisions m 13 13 13 13 Other Liabilities m 53 12 12 12 Total Liabilities m 1,407 1,556 2,162 1,978 Shareholders' Funds m 3,110 3,254 3,421 3,616 Minority Interests m 0 0 0 0 Other m 0 0 0 0 Total S/H Equity m 3,110 3,254 3,421 3,616 Total Liab & S/H Funds m 4,517 4,811 5,582 5,594



11 June 2014 59

HONG KONG



Valuation HK$ 27.90 - Sum of Parts




Volatility Index Low




Free float % 34


Number shares on issue m 1,958


Revenue m 43,357 50,569 57,243 63,928 EBIT m 1,990 2,558 2,956 3,514 EBIT growth % 25.1 28.6 15.6 18.9 Reported profit m 1,631 1,992 2,382 2,860 Adjusted profit m 1,746 1,992 2,382 2,860 EPS rep Rmb 0.90 1.02 1.20 1.44 EPS rep growth % 26.0 13.7 17.7 20.1 EPS adj Rmb 0.96 1.02 1.20 1.44 EPS adj growth % 26.4 6.2 17.9 20.1 PER rep x 34.2 30.1 25.5 21.3 PER adj x 32.0 30.1 25.5 21.3 Total DPS Rmb 0.20 0.23 0.28 0.66 Total div yield % 0.7 0.8 0.9 2.2 ROA % 6.5 6.3 6.7 7.1 ROE % 12.6 10.4 9.6 10.1 EV/EBITDA x 18.2 14.9 12.6 10.6 Net debt/equity % 26.0 3.9 -3.2 -2.6 P/BV x 3.7 2.6 2.2 2.0

2319 HK rel HSI performance, & rec history

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.





Mengniu Overvalued for its intrinsic worth Event

We incorporate our negative outlook from our Yashili initiation and lower our

Mengniu forecasts by 6%/13% for FY14/15E. We cut our TP by 30% to

HK$27.90/sh based on our new sum-of-parts valuation and downgrade the

stock from Neutral to Underperform. Current market cap implies that

Mengniu’s core business is overvalued at 33x/28x PER vs. large cap staples’

27x/22x.

Two new threats have changed our view on the stock: 1) imminent and

significant downward earnings risks on Yashili (our forecasts are 55-60%

below consensus), and 2) emerging threat of imported UHT milk, which could

potentially erode Milk Deluxe’s long-term competitiveness and profitability.

Impact

Yashili plummeting on multiple woes, 55-60% earnings downside:

Mengniu’s 68%-controlled infant formula subsidiary Yashili (1230.HK, UP) is

having the worst combination of fortune: positioned unattractively in the soon-

to-be ex-growth infant formula industry as a lower-tier city player with majority

exposure in the declining supermarket channels. Yashili is now risking losing

more market share to imported brands as the proliferation of e-commerce

lowers the entry barrier to its lower-tier city stronghold. Profits already fell 42%

in 2H13 and will further decline by 43% in FY14 on our forecasts. These

negatives are the main drivers of our 6%/13% earnings downgrade on

Mengniu, where our forecasts are now 8%/14% below Street consensus.

Import invasion! 13% of premium UHT market to come from imports: We

see competitive risks from imported UHT in the long run, as it’s been selling at

least 25% cheaper than Mengniu’s. Growing at 126% CAGR 2010-13 and

hitting fresh records in April 2014, imports should account for 13% of the

premium UHT market in 2014. This market is currently dominated by

Mengniu’s Milk Deluxe (~50% share), Mengniu’s single biggest earnings

contributor (~24% of GP). But the risks are not imminent, given much is

parallel imports sold mostly through ecommerce that remains confined to just

Tier 1 cities.

Earnings and target price revision

Lower FY14/15E EPS by 6%/13% to reflect significant weakness in Yashili’s

earnings contribution. Cut TP by 30% to HK$27.9/sh on SOTP valuation.

Price catalyst

12-month price target: HK$27.90 based on a Sum of Parts methodology.

Catalyst: Yashili’s interim results in August should catalyse consensus

earnings downgrades

Action and recommendation

Mengniu has completed a handful of high-profile acquisitions over the past 12

months (Yashili, CMD, Danone, Arla) that firmly solidifies its lead in the

Chinese dairy industry. However, delivering only 13% ROE and low-teens

organic growth, Mengniu’s core business appears overvalued at 33x/28x

FY14/15E PER. We suggest investors take profits and revisit later.


11 June 2014 60

Sum-of-the-parts valuation target price: HK$27.90/share

We change our valuation methodology from PER to sum-of-parts, considering that Mengniu holds

stake in three listed companies under our coverage:

Yashili (1230.HK, UP) – 68% stake, consolidated financials,

China Modern Dairy (1117.HK, OP) – 28% stake, associate income, and

YuanShengTai Dairy Farm (1431.HK, OP) – 4.2% stake, associate income.

We take our target valuation on Yashili, Modern Dairy and YuanShengTai as proxy for fair value for

Mengniu’s stakes’ worth. We then assign a 20x FY15E PER target valuation on Mengniu’s core

business, average of Large Cap China consumer staples comp and global dairy comp groups. We

derive a total equity valuation of HK$60.8bn or HK$27.90/sh target price.

Fig 1 SOTP valuation: HK$27.90/sh

Segment Methodology

(FY15 PER) Macquarie target

valuation Mengniu stake

Attributable equity valuation

(RMBm)

Yashili (1230.HK) 15.0x 4,163 68% 2,831 Modern Dairy (1117.HK) 15.0x 19,822 28% 5,550 YST Dairy (1431.HK) 13.5x 4,351 4% 183 Mengniu's core biz 20.0x 35,488 100% 35,488 Total equity valuation (RMBm) 44,052 CNYHKD 1.2398 # of shares 1,957 Per share price (HK$/sh) 27.90


Reasons for higher valuation on Mengniu’s core business

Strong market leadership in premium liquid milk, particularly in high end with Milk Deluxe brand

Strongest among peers in upstream raw milk, 96% sourced from scaled farms; ownership stakes

in Mengniu, YST, Fuyuan Farming

Danone joint venture on chilled dairy products could have upside on new product introduction in

FY15 and beyond

International partnership with Arla and White Wave to pave way for further international

opportunities

Reasons for lower valuation on Mengniu’s core business

Yashili is struggling with declining sales and falling market share, our forecasts are ~60% below

Consensus

Core business growing at only low-teens organic rate while delivering just 13% ROE

Fig 2 Current market caps imply Mengniu’s core-biz is overvalued on 33x/28x earnings

Current market cap (RMB million) Mengniu stake

Attributable equity value (RMB million)

Yashili 8,233 68% 5,599 Modern Dairy 13,229 28% 3,704 YST Dairy 4,285 4.2% 180 Mengniu 60,054 60,054 Implied Mengniu core-biz valuation 50,571 Mengniu core-biz (Macquarie forecasts) FY14E FY15E Adj. net profit (RMBm) 1,527 1,774 Implied PER (x) 33.1x 28.5x Market cap as of closing price of June 10, 2014

Source: Bloomberg, Company data, Macquarie Research, June 2014


11 June 2014 61

Fig 3 Mengniu (2319.HK) 13% ROE, 12% growth vs. comps trading on 20-21% ROE, 17-20% EPS CAGR

Price TP ∆ Mkt Cap PER (x) EV/EBITDA (x)

EPS growth

(%) ROE

(%)

Div yield

(%) PEG P/Bk

Ticker Company Rec lc lc % US$m CY14E CY15E CY14E CY15E 13-15E CY13 CY13 CY14E FY13

2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 12.6 0.7 2.5 3.7 Mengniu at TP 27.90 22.1 18.7 11.0 9.4 1.9 China large cap consumer staples 151 HK Want Want OP 10.68 13.00 22% 18,200 23.4 20.2 15.8 13.4 15.4 37.9 2.9 1.5 9.5 322 HK Tingyi OP 22.20 24.40 10% 16,027 32.9 27.2 11.8 10.4 19.7 16.0 1.5 1.7 5.5 1044 HK Hengan N 83.50 84.00 1% 13,254 23.1 19.3 16.5 13.6 23.3 25.2 2.6 1.0 6.1 168 HK Tsingtao Brewery NR 61.05 9,836 30.0 25.3 15.3 12.8 6.1 14.9 0.9 4.9 4.6 Average 27.0 22.5 14.3 12.1 16.9 20.9 1.7 1.6 5.3 China dairy comps 1117 HK CMD OP 3.21 5.12 60% 1,999 12.5 9.6 11.5 8.8 48.6 16.2 0.8 0.3 2.2 1431 HK YST OP 1.38 2.73 98% 696 9.8 7.2 5.3 3.9 41.0 10.4 0.0 0.2 1.2 151 HK Want Want OP 10.68 13.00 22% 18,200 23.4 20.2 15.8 13.4 15.4 37.9 2.9 1.5 9.5 1112 HK Biostime UP 51.00 38.50 -25% 3,971 25.5 21.2 15.6 13.3 11.3 33.9 2.9 2.3 9.9 1230 HK Yashili UP 3.19 1.45 -55% 1,464 38.3 33.1 21.1 15.8 -19.0 12.2 15.4 NA NA 6863 HK Huishan NR 1.86 3,457 12.6 9.5 9.4 7.5 NA 16.7 0.0 NA NA 600887 CH Yili NR 31.32 10,229 14.1 11.9 8.2 NA 20.6 20.1 2.0 0.7 3.7 600597 CH Bright NR 16.79 3,287 21.9 18.2 NA NA 30.1 12.8 1.5 0.7 4.7 002570 CH Beingmate NR 13.53 2,212 14.0 NA 8.4 NA 27.0 16.8 1.9 0.5 3.5 Average 17.0 13.8 10.4 8.8 20.8 19.0 2.8 1.1 3.8 ex-A Share 17.4 13.6 11.2 8.8 18.2 20.0 3.2 1.4 3.7 Global dairy comps FSF NZ Fonterra N 6.08 6.65 9% 8,221 36.0 22.0 12.0 9.8 -31.3 3.5 2.1 NA 1.5 SML NZ Synlait N 3.25 4.00 23% 402 16.2 16.4 9.5 8.5 35.0 21.5 0.0 0.5 5.0 NESN VX Nestlé NR 70.45 252,869 20.2 18.8 13.7 12.7 5.4 16.2 3.3 3.7 3.6 BN FP Danone NR 54.26 47,437 19.6 17.8 12.2 11.1 7.0 12.4 2.8 2.8 3.2 MJN US Mead Johnson NR 89.68 18,124 24.2 21.7 16.0 14.4 7.6 418.4 1.6 3.2 52.4 DF US Dean Foods NR 17.06 1,595 31.3 16.7 7.9 6.5 -74.9 151.8 0.0 NA 2.4 SAP CN Saputo NR 58.33 10,436 18.8 17.4 12.1 11.4 7.7 23.2 1.5 2.4 4.4 PLT IM Parmalat NR 2.50 6,207 21.0 19.7 7.9 7.3 -2.0 7.3 1.2 NA 1.5 2269 JP Meiji Dairies NR 6,750 5,032 19.0 18.2 7.4 7.0 20.0 6.9 1.4 0.9 1.6 2264 JP Morinaga Milk NR 398 987 17.2 NA NA NA 2.5 5.1 1.9 6.9 0.8 2270 JP Megmilk Snow NR 1,324 915 13.9 12.1 6.4 5.9 -25.0 6.3 2.2 NA 0.8 Average 20.1 17.6 9.7 8.7 -4.4 61.1 1.6 1.5 1.8 Price date June 10, 2014. Valuations and forecasts for non-rated stocks are from Bloomberg. Recommendation legend - OP: Outperform, N: Neutral, UP: Underperform, NR: not rated.


Fig 4 Mengniu trading on blended 28x Forward PER Fig 5 One standard deviation above its 5-year mean


15

20

25

30

35

40

45

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14

Share price (HK$)

20x

25x

30x

15

20

25

30

35

40



mean

-1 σ

+1 σ


11 June 2014 62

Fig 6 Mengniu trading at premium to its biggest competitor Yili (600887.CH, not rated)

Fig 7 Current premium of 77% at three-year high

Forward estimates on Yili based on Bloomberg consensus.


Fig 8 Mengniu and Yashili are the most expensive dairy stocks with the lowest earnings growth

Fig 9 ROE also among the lowest within the dairy sector


-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

5

10

15

20

25

30

35

Jun 2011 Jun 2012 Jun 2013 Jun 2014

Mengniu premium Mengniu Yili

Mengniu premium over YiliForward PER (x)

-20%

0%

20%

40%

60%

80%

Jun 2011 Jun 2012 Jun 2013 Jun 2014

Mengniu 's valuation premium over Yili

average 29%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

- 10.0 20.0 30.0 40.0

Mengniu

CMD

YST

Want Want

Biostime

Yashili

Yili

Bright

Beingmate

FY14E PER (x)

EP

S C

AG

R F

Y13-1

5E

Avg 17x PER

Avg 21% EPS CAGR

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0.0 10.0 20.0 30.0 40.0

Mengniu

CMD

YST

Want Want

Biostime

Yashili

Yili

Bright

BeingmatePri

ce-t

o-b

oo

k (F

Y13)

ROE% (FY13)

Avg 19% ROE

Avg 5x P/Bk


11 June 2014 63

Fig 10 Breakdown of Macquarie Mengniu NP forecast

Fig 11 Breakdown of Consensus Mengniu NP forecast

Source: Company data, Macquarie Research, June 2014 Source: Bloomberg, Macquarie Research, June 2014

Fig 12 Attribution of Macquarie Mengniu NP forecast

Fig 13 Attribution of Consensus Mengniu NP forecast

Source: Company data, Macquarie Research, June 2014 Source: Bloomberg, Macquarie Research, June 2014

Fig 14 Our Yashili Adj. NP forecasts are 55-60% below Street consensus

Fig 15 Yashili earnings downside accounts for majority of our below consensus view on Mengniu

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Bloomberg, Company data, Macquarie Research, June 2014

1,556 1,385 1,521 1,5271,774

129 16318996 283

39220

26

0

500

1,000

1,500

2,000

2,500

3,000

3,500

FY11 FY12 FY13 FY14E FY15E

Mengniu core biz Yashili CMD YST

Net profit (RMBm)

1,556 1,385 1,521 1,5001,871

129 348

447

96259

33319

25

0

500

1,000

1,500

2,000

2,500

3,000

3,500



Net profit (RMBm)

100% 100%87%

77% 74%

7%

8% 8%

6%

14% 16%

1% 1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Breakdown of NP

100% 100%87%

71% 70%

7%

16% 17%

6%

12% 12%

1% 1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Breakdown of NP

2%

-5%

-55%-60%

9%

18%

1% 4%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

FY14E FY15E


Adj. NP Macquarie vs. Street (+/- %)

-350

-300

-250

-200

-150

-100

-50

0

-400

-350

-300

-250

-200

-150

-100

-50

0

50

100

FY14E FY15E

Mengniu core biz Yashili CMD

YST Mengniu Adj. NP

Adj. NP Macquarie vs. Street (RMBm) Mengniu blended (RMBm)


11 June 2014 64

Imported UHT invasion, 126% volume CAGR

We see competitive risks from imported UHT, which has been selling for at least 25% cheaper than

Mengniu’s.

After a few rounds of price hikes in 2013 (Mengniu raised Milk Deluxe ASP three times), China’s

retail price of premium UHT milk has now reached above RMB22/litre. The high prices have attracted

many importers to reap profits.

According to a study done by China Dairy Industry Association, most of the imported UHT have been

selling competitively at RMB16/litre to capture market share from domestic brands such as

Mengniu’s Milk Deluxe and Yili’s Satine.

In the below cost structure breakdown, everyone along the value chain (parallel importers, retailers,

distributors) can all make decent 10-15% profits off imported UHT milk.

Fig 16 Premium UHT’s value chain profit distribution: Milk Deluxe vs. imported UHT

Source: CDIA, Company data, Macquarie Research, June 2014

Yihaodian’s Guinness World Record

In March, China’s largest FMCG e-tailer YHD.com (51% controlled by Walmart) broke the Guinness

World Record selling 30 ocean containers of milk in less than 53 minutes. This is followed only by

YHD.com stepping up the game again on May 29th, topping its own record by selling 100 ocean

containers of milk within 51.5 minutes.

Fig 17 Imported UHT priced competitively at RMB16/L vs. domestic premium UHT selling for >RMB20/L

Fig 18 YHD.com broke Guinness record in March: selling 30 ocean containers of UHT milk in 53 minutes

Source: Macquarie Research, June 2014 Source: Yihaodian.com, June 2014

0.00 5.00 10.00 15.00 20.00 25.00

Milk Deluxe

Parallel imports

RMB per Litre of premium UHT

Consumers buy at RMB16 on Yihaodian.com

RMB22 in supermarket

cost, insurance and freight (CIF)

raw material cost

tariff & VAT

SG&AMengniu's

profitdistributor mark-up

retail mark-up

retail mark-up

distributor mark-up

http://www.scmp.com/news/china-insider/article/1452543/milk-flies-e-commerce-shelves-site-sets-new-guiness-world-record


11 June 2014 65

126% volume CAGR and setting fresh highs

According to China Customs’ trade data, total UHT import volume jumped from barely 7k tons in

2010 to 143k tons in 2013, registering a 126% CAGR. Latest data shows that total imports hit

another record high in April 2014 at 26k tons imported in just one month (annualises to >300k ton or

doubling 2013’s).

Fig 19 Import UHT hitting fresh high in April 2014 Fig 20 Half of the imports are from Germany

Source: China Customs, Macquarie Research, June 2014 Source: China Customs, Macquarie Research, June 2014

To account for 13% of premium UHT market

Compared with total liquid milk consumption volume of 26m tons, total imports of 130k ton is barely

meaningful, representing just 50bps. However, if we narrow down to just premium UHT (we estimate

~2m tons consumption in 2013 and growing at 9% per annum), the imported numbers then become

meaningful: up from <1% in 2010 to 7.3% in 2013 and could reach 13% in 2014.

Fig 21 Import accounted for an insignificant 0.5% of total liquid milk volume

Fig 22 But is becoming an increasingly meaningful portion of premium UHT, to rise to 13% in 2014

Macquarie forecast of 9% total volume growth in 2014 *Macquarie estimate based on 8% volume share in 2013.

Source: China Custom, MOA, Macquarie Research, June 2014 Source: China Custom, MOA, Macquarie Research, June 2014

0

5

10

15

20

25

30

35

2010 2011 2012 2013 2014

UHT milk Other liquid milk

Monthly liquid milk import (000 ton)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014

Germany New Zealand France Australia Rest of world

0.0% 0.0% 0.0%

0.1%

0.3%

0.5%

1.0%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

0

5

10

15

20

25

30

35

2008 2009 2010 2011 2012 2013 2014E

Total liquid milk Imported UHT % imported

Liquid milk volume (million ton) % imported

0.6% 0.8% 0.6%

1.8%

4.2%

7.3%

13.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2008 2009 2010 2011 2012 2013 2014E

Premium UHT Imported UHT % imported

Premium UHT volume* (million ton) % imported


11 June 2014 66

Milk Deluxe beware

We are seeing competitive risks which could structurally limit Mengniu’s long-term pricing power.

The premium UHT market was created by Mengniu with the successful introduction of Milk Deluxe in

2006. The market to date remains dominated by Mengniu’s Milk Deluxe (~50% market share). Milk

Deluxe is also Mengniu’s single biggest earnings contributor (~24% of FY13’s GP).

Fig 23 Mengniu currently controls 50% of the premium UHT market with Milk Deluxe brand

Fig 24 Milk Deluxe is a major earnings driver for Mengniu

Source: MOFCOM, Euromonitor, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

But the threat is not imminent…

According to our channel checks:

Most UHT milk is sourced through parallel imports (third party import/wholesale agents)

78% sold on e-commerce sites, YHD.com remains largely a Shanghai/Beijing platform

Importers lack comprehensive distribution to compete head to head against Mengniu and Yili

Imported milk’s quality is being disputed:

Foreign milk not necessarily from premium raw milk sources compared with Mengniu’s Milk

Deluxe, which only sources from the highest quality upstream raw milk (e.g. Modern Dairy)

6-8 weeks’ ocean freight time + 3-4 weeks China custom inspection and quarantine means 3-4

months of shelf life would’ve been expired

Imported UHT is given one year total shelf-life, where domestic brands typically put conservatively

6-9 months on the packaging

But Tier-1 city consumers will still buy imported UHT, because:

They are foreign

They are cheaper

Milk Deluxe (Mengniu)

50%

Satine (Yili)30%

Others20%

Approximate market share of premiumUHT

Milk Deluxe (Premium

UHT)

24%

Other star brands

30%

Rest of Mengniu

46%

Approximate breakdown of Mengniu's GP (2013)


11 June 2014 67

China Mengniu Dairy Company (2319 HK, Underperform, Target Price: HK$27.90) Interim Results 2H/13A 1H/14E 2H/14E 1H/15E Profit & Loss 2013A 2014E 2015E 2016E

Revenue m 22,689 24,779 25,790 28,049 Revenue m 43,357 50,569 57,243 63,928 Gross Profit m 6,178 7,111 7,219 8,027 Gross Profit m 11,697 14,331 16,173 17,882 Cost of Goods Sold m 16,511 17,667 18,571 20,022 Cost of Goods Sold m 31,660 36,238 41,070 46,046 EBITDA m 1,659 1,867 2,163 2,180 EBITDA m 3,193 4,030 4,704 5,582 Depreciation m 589 721 750 856 Depreciation m 1,202 1,471 1,747 2,067 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 0 0 0 0 Other Amortisation m 0 0 0 0 EBIT m 1,070 1,146 1,412 1,324 EBIT m 1,990 2,558 2,956 3,514 Net Interest Income m 100 -37 -38 13 Net Interest Income m 199 -75 28 64 Associates m 124 142 160 197 Associates m 154 302 419 537 Exceptionals m -126 0 0 0 Exceptionals m -138 0 0 0 Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Pre-Tax Profit m 1,168 1,251 1,534 1,534 Pre-Tax Profit m 2,205 2,786 3,403 4,115 Tax Expense m -181 -247 -265 -329 Tax Expense m -367 -513 -686 -866 Net Profit m 987 1,004 1,269 1,205 Net Profit m 1,838 2,273 2,717 3,249 Minority Interests m -118 -142 -139 -168 Minority Interests m -207 -280 -335 -389

Reported Earnings m 869 862 1,130 1,038 Reported Earnings m 1,631 1,992 2,382 2,860 Adjusted Earnings m 974 862 1,130 1,038 Adjusted Earnings m 1,746 1,992 2,382 2,860

EPS (rep) 0.47 0.45 0.57 0.52 EPS (rep) 0.90 1.02 1.20 1.44 EPS (adj) 0.53 0.45 0.57 0.52 EPS (adj) 0.96 1.02 1.20 1.44 EPS Growth yoy (adj) % 50.9 3.7 8.2 16.6 EPS Growth (adj) % 26.4 6.2 17.9 20.1

PE (rep) x 34.2 30.1 25.5 21.3 PE (adj) x 32.0 30.1 25.5 21.3

EBITDA Margin % 7.3 7.5 8.4 7.8 Total DPS 0.20 0.23 0.28 0.66 EBIT Margin % 4.7 4.6 5.5 4.7 Total Div Yield % 0.7 0.8 0.9 2.2 Earnings Split % 55.8 43.3 56.7 43.6 Weighted Average Shares m 1,820 1,956 1,987 1,987 Revenue Growth % 28.0 19.9 13.7 13.2 Period End Shares m 1,835 1,957 1,957 1,957 EBIT Growth % 59.1 24.5 32.0 15.5


Revenue Growth % 20.2 16.6 13.2 11.7 EBITDA m 3,193 4,030 4,704 5,582 EBITDA Growth % 22.8 26.2 16.7 18.7 Tax Paid m -367 -513 -686 -866 EBIT Growth % 25.1 28.6 15.6 18.9 Chgs in Working Cap m 517 -971 775 -1,065 Gross Profit Margin % 27.0 28.3 28.3 28.0 Net Interest Paid m 199 -75 28 64 EBITDA Margin % 7.4 8.0 8.2 8.7 Other m -258 30 176 256 EBIT Margin % 4.6 5.1 5.2 5.5 Operating Cashflow m 3,284 2,501 4,996 3,970 Net Profit Margin % 4.0 3.9 4.2 4.5 Acquisitions m -7,592 0 0 0 Payout Ratio % 20.9 22.8 23.2 46.1 Capex m -2,846 -2,125 -2,370 -2,484 EV/EBITDA x 18.2 14.9 12.6 10.6 Asset Sales m 28 0 0 0 EV/EBIT x 28.4 22.6 19.2 16.0 Other m -4,858 0 0 0

Investing Cashflow m -15,269 -2,125 -2,370 -2,484 Balance Sheet Ratios Dividend (Ordinary) m -385 -545 -652 -1,559 ROE % 12.6 10.4 9.6 10.1 Equity Raised m 2,005 3,867 0 0 ROA % 6.5 6.3 6.7 7.1 Debt Movements m 7,880 -7,822 -271 -248 ROIC % 21.0 9.2 8.8 9.5 Other m 2,831 -0 0 0 Net Debt/Equity % 26.0 3.9 -3.2 -2.6 Financing Cashflow m 12,331 -4,500 -923 -1,808 Interest Cover x nmf 34.2 nmf nmf Price/Book x 3.7 2.6 2.2 2.0 Net Chg in Cash/Debt m 9,008 3,369 9,198 7,173 Book Value per Share 8.4 11.7 13.7 15.3

Free Cashflow m 438 376 2,626 1,486

Balance Sheet 2013A 2014E 2015E 2016E Cash m 7,102 2,977 4,680 4,359 Receivables m 3,240 3,959 4,275 4,965 Inventories m 2,577 3,380 3,821 4,757 Investments m 0 0 0 0 Fixed Assets m 11,608 13,984 16,323 18,772 Intangibles m 5,695 5,695 5,695 5,125 Other Assets m 10,119 11,226 12,395 13,565 Total Assets m 40,339 41,220 47,190 51,542 Payables m 9,217 10,096 11,932 12,795 Short Term Debt m 8,554 748 491 257 Long Term Debt m 3,236 3,236 3,236 3,236 Provisions m 235 274 310 346 Other Liabilities m 1,087 1,031 1,182 1,345 Total Liabilities m 22,328 15,384 17,151 17,979 Shareholders' Funds m 15,361 22,906 26,774 29,909 Minority Interests m 2,650 2,931 3,265 3,654 Other m 0 0 0 0 Total S/H Equity m 18,011 25,836 30,039 33,563 Total Liab & S/H Funds m 40,339 41,221 47,190 51,542



11 June 2014 68

Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie First South - South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 31 March 2014

AU/NZ Asia RSA USA CA EUR Outperform 51.32% 60.23% 41.25% 40.21% 58.52% 48.74% (for US coverage by MCUSA, 8.21% of stocks followed are investment banking clients)

Neutral 34.54% 24.97% 40.00% 53.19% 35.56% 32.77% (for US coverage by MCUSA, 6.67% of stocks followed are investment banking clients)

Underperform 14.14% 14.80% 18.75% 6.60% 5.92% 18.49% (for US coverage by MCUSA, 0.00% of stocks followed are investment banking clients)

Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.

Analyst certification: The views expressed in this research accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd ABN 94 122 169 279 (AFSL No. 318062) (MGL) and its related entities (the Macquarie Group) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclaimers: Macquarie Securities (Australia) Ltd; Macquarie Capital (Europe) Ltd; Macquarie Capital Markets Canada Ltd; Macquarie Capital Markets North America Ltd; Macquarie Capital (USA) Inc; Macquarie Capital Securities Ltd and its Taiwan branch; Macquarie Capital Securities (Singapore) Pte Ltd; Macquarie Securities (NZ) Ltd; Macquarie First South Securities (Pty) Limited; Macquarie Capital Securities (India) Pvt Ltd; Macquarie Capital Securities (Malaysia) Sdn Bhd; Macquarie Securities Korea Limited and Macquarie Securities (Thailand) Ltd are not authorized deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia), and their obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 (MBL) or MGL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any of the above mentioned entities. MGL provides a guarantee to the Monetary Authority of Singapore in respect of the obligations and liabilities of Macquarie Capital Securities (Singapore) Pte Ltd for up to SGD 35 million. This research has been prepared for the general use of the wholesale clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient you must not use or disclose the information in this research in any way. If you received it in error, please tell us immediately by return e-mail and delete the document. We do not guarantee the integrity of any e-mails or attached files and are not responsible for any changes made to them by any other person. MGL has established and implemented a conflicts policy at group level (which may be revised and updated from time to time) (the "Conflicts Policy") pursuant to regulatory requirements (including the FCA Rules) which sets out how we must seek to identify and manage all material conflicts of interest. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. In preparing this research, we did not take into account your investment objectives, financial situation or particular needs. Macquarie salespeople, traders and other professionals may provide oral or written market commentary or trading strategies to our clients that reflect opinions which are contrary to the opinions expressed in this research. Macquarie Research produces a variety of research products including, but not limited to, fundamental analysis, macro-economic analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research, whether as a result of differing time horizons, methodologies, or otherwise. Before making an investment decision on the basis of this research, you need to consider, with or without the assistance of an adviser, whether the advice is appropriate in light of your particular investment needs, objectives and financial circumstances. There are risks involved in securities trading. The price of securities can and does fluctuate, and an individual security may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international stock market or economic conditions, which may adversely affect the value of the investment. This research is based on information obtained from sources believed to be reliable but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. Clients should contact analysts at, and execute transactions through, a Macquarie Group entity in their home jurisdiction unless governing law permits otherwise. The date and timestamp for above share price and market cap is the closed price of the price date. #CLOSE is the final price at which the security is traded in the relevant exchange on the date indicated. Country-specific disclaimers: Australia: In Australia, research is issued and distributed by Macquarie Securities (Australia) Ltd (AFSL No. 238947), a participating organisation of the Australian Securities Exchange. New Zealand: In New Zealand, research is issued and distributed by Macquarie Securities (NZ) Ltd, a NZX Firm. Canada: In Canada, research is prepared, approved and distributed by Macquarie Capital Markets Canada Ltd, a participating organisation of the Toronto Stock Exchange, TSX Venture Exchange & Montréal Exchange. Macquarie Capital Markets North America Ltd., which is a registered broker-dealer and member of FINRA, accepts responsibility for the contents of reports issued by Macquarie Capital Markets Canada Ltd in the United States and sent to US persons. Any US person wishing to effect transactions in the securities described in the reports issued by Macquarie Capital Markets Canada Ltd should do so with Macquarie Capital Markets North America Ltd. The Research Distribution Policy of Macquarie Capital Markets Canada Ltd is to allow all clients that are entitled to have equal access to our research. United Kingdom: In the United Kingdom, research is issued and


11 June 2014 69

distributed by Macquarie Capital (Europe) Ltd, which is authorised and regulated by the Financial Conduct Authority (No. 193905). Germany: In Germany, this research is issued and/or distributed by Macquarie Capital (Europe) Limited, Niederlassung Deutschland, which is authorised and regulated by the UK Financial Conduct Authority (No. 193905). and in Germany by BaFin. France: In France, research is issued and distributed by Macquarie Capital (Europe) Ltd, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority (No. 193905). Hong Kong & Mainland China: In Hong Kong, research is issued and distributed by Macquarie Capital Securities Ltd, which is licensed and regulated by the Securities and Futures Commission. In Mainland China, Macquarie Securities (Australia) Limited Shanghai Representative Office only engages in non-business operational activities excluding issuing and distributing research. Only non-A share research is distributed into Mainland China by Macquarie Capital Securities Ltd. Japan: In Japan, research is issued and distributed by Macquarie Capital Securities (Japan) Limited, a member of the Tokyo Stock Exchange, Inc. and Osaka Securities Exchange Co. Ltd (Financial Instruments Firm, Kanto Financial Bureau (kin-sho) No. 231, a member of Japan Securities Dealers Association and The Financial Futures Association of Japan and Japan Investment Advisers Association). India: In India,

research is issued and distributed by Macquarie Capital Securities (India) Pvt Ltd. (CIN: U67120MH1995PTC089592), 92, Level 9, 2 North Avenue, Maker Maxity, Bandra Kurla Complex, Bandra (East), Mumbai – 400 051, India, which is a SEBI registered Stock Broker having membership with National Stock Exchange of India Limited (INB231246738) and Bombay Stock Exchange Limited (INB011246734). Malaysia: In Malaysia, research is issued and distributed by Macquarie Capital Securities (Malaysia) Sdn. Bhd. (Company registration number: 463469-W) which is a Participating Organisation of Bursa Malaysia Berhad and a holder of Capital Markets Services License issued by the Securities Commission. Taiwan: In Taiwan, research is issued and distributed by Macquarie Capital Securities Ltd, Taiwan Branch, which is licensed and regulated by the Financial Supervisory Commission. No portion of the report may be reproduced or quoted by the press or any other person without authorisation from Macquarie. Nothing in this research shall be construed as a solicitation to buy or sell any security or product. Research Associate(s) in this report who are registered as Clerks only assist in the preparation of research and are not engaged in writing the research. Thailand: In Thailand, research is produced with the contribution of Kasikorn Securities Public Company Limited, issued and distributed by Macquarie Securities (Thailand) Ltd. Macquarie Securities (Thailand) Ltd. is a licensed securities company that is authorized by the Ministry of Finance, regulated by the Securities and Exchange Commission of Thailand and is an exchange member of the Stock Exchange of Thailand. Macquarie Securities (Thailand) Limited and Kasikorn Securities Public Company Limited have entered into an exclusive strategic alliance agreement to broaden and deepen the scope of services provided to each parties respective clients. The strategic alliance does not constitute a joint venture. The Thai Institute of Directors Association has disclosed the Corporate Governance Report of Thai Listed Companies made pursuant to the policy of the Securities and Exchange Commission of Thailand. Macquarie Securities (Thailand) Ltd does not endorse the result of the Corporate Governance Report of Thai Listed Companies but this Report can be accessed at: http://www.thai-iod.com/en/publications.asp?type=4. South Korea: In South Korea, unless otherwise stated, research is prepared, issued and distributed by Macquarie Securities Korea Limited, which is regulated by the Financial Supervisory Services. Information on analysts in MSKL is disclosed at http://dis.kofia.or.kr/fs/dis2/fundMgr/DISFundMgrAnalystPop.jsp?companyCd2=A03053&pageDiv=02. South Africa: In South Africa, research is issued and distributed by Macquarie First South Securities (Pty) Limited, a member of the JSE Limited. Singapore: In Singapore, research is issued and distributed by Macquarie Capital Securities (Singapore) Pte Ltd (Company Registration Number: 198702912C), a Capital Markets Services license holder under the Securities and Futures Act to deal in securities and provide custodial services in Singapore. Pursuant to the Financial Advisers (Amendment) Regulations 2005, Macquarie Capital Securities (Singapore) Pte Ltd is exempt from complying with sections 25, 27 and 36 of the Financial Advisers Act. All Singapore-based recipients of research produced by Macquarie Capital (Europe) Limited, Macquarie Capital Markets Canada Ltd, Macquarie First South Securities (Pty) Limited and Macquarie Capital (USA) Inc. represent and warrant that they are institutional investors as defined in the Securities and Futures Act. United States: In the United States, research is issued and distributed by Macquarie Capital (USA) Inc., which is a registered broker-dealer and member of FINRA. Macquarie Capital (USA) Inc, accepts responsibility for the content of each research report prepared by one of its non-US affiliates when the research report is distributed in the United States by Macquarie Capital (USA) Inc. Macquarie Capital (USA) Inc.’s affiliate’s analysts are not registered as research analysts with FINRA, may not be associated persons of Macquarie Capital (USA) Inc., and therefore may not be subject to FINRA rule restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. Information regarding futures is provided for reference purposes only and is not a solicitation for purchases or sales of futures. Any persons receiving this report directly from Macquarie Capital (USA) Inc. and wishing to effect a transaction in any security described herein should do so with Macquarie Capital (USA) Inc. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures, or contact your registered representative at 1-888-MAC-STOCK, or write to the Supervisory Analysts, Research Department, Macquarie Securities, 125 W.55th Street, New York, NY 10019. © Macquarie Group

Auckland Tel: (649) 377 6433

Jakarta Tel: (62 21) 515 1818

Mumbai Tel: (91 22) 6653 3000

Singapore Tel: (65) 6601 1111

Bangkok Tel: (662) 694 7999

Johannesburg Tel: (2711) 583 2000

Munich Tel: (089) 2444 31800

Sydney Tel: (612) 8232 9555

Calgary Tel: (1 403) 218 6650

Kuala Lumpur Tel: (60 3) 2059 8833

New York Tel: (1 212) 231 2500

Taipei Tel: (886 2) 2734 7500

Denver Tel: (303) 952 2800

London Tel: (44 20) 3037 2000

Paris Tel: (33 1) 7842 3823

Tokyo Tel: (81 3) 3512 7900

Frankfurt Tel: (069) 509 578 000

Manila Tel: (63 2) 857 0888

Perth Tel: (618) 9224 0888

Toronto Tel: (1 416) 848 3500

Geneva Tel: (41) 22 818 7777

Melbourne Tel: (613) 9635 8139

Seoul Tel: (82 2) 3705 8500

Hong Kong Tel: (852) 2823 3588

Montreal Tel: (1 514) 925 2850

Shanghai Tel: (86 21) 6841 3355

Available to clients on the world wide web at www.macquarieresearch.com and through Thomson Financial, FactSet, Reuters, Bloomberg, and CapitalIQ.

http://www.thai-iod.com/en/publications.asp?type=4

http://www.thai-iod.com/en/publications.asp?type=4

http://dis.kofia.or.kr/fs/dis2/fundMgr/DISFundMgrAnalystPop.jsp?companyCd2=A03053&pageDiv=02

Asia Research Head of Equity Research

John O’Connell (Global – Head) (612) 8232 7544

Peter Redhead (Asia – Head) (852) 3922 4836

Automobiles/Auto Parts

Janet Lewis (China) (852) 3922 5417

Zhixuan Lin (China) (8621) 2412 9006

Amit Mishra (India) (9122) 6720 4084

Michael Sohn (Korea) (82 2) 3705 8644

Banks and Non-Bank Financials

Ismael Pili (Asia, Hong Kong, China) (852) 3922 4774

Jian Li (China, Hong Kong) (852) 3922 3579

Matthew Smith (China) (8621) 2412 9022

Suresh Ganapathy (India) (9122) 6720 4078

Nicolaos Oentung (Indonesia) (6221) 2598 8366

Alastair Macdonald (Japan) (813) 3512 7476

Chan Hwang (Korea) (822) 3705 8643

Gilbert Lopez (Philippines) (632) 857 0892

Dexter Hsu (Taiwan) (8862) 2734 7530

Passakorn Linmaneechote (Thailand) (662) 694 7728

Conglomerates

Gilbert Lopez (Philippines) (632) 857 0892

Consumer and Gaming

Gary Pinge (Asia) (852) 3922 3557

Linda Huang (China, Hong Kong) (852) 3922 4068

Jamie Zhou (China, Hong Kong) (852) 3922 1147

Elaine Lai (Hong Kong) (852) 3922 4749

Amit Mishra (India) (9122) 6720 4084

Lyall Taylor (Indonesia) (6221) 2598 8489

Toby Williams (Japan) (813) 3512 7392

HongSuk Na (Korea) (822) 3705 8678

Alex Pomento (Philippines) (632) 857 0899

Somesh Agarwal (Singapore) (65) 6601 0840

Best Waiyanont (Thailand) (662) 694 7993

Emerging Leaders

Jake Lynch (China, Asia) (8621) 2412 9007

Michael Newman (Japan) (813) 3512 7920

Kwang Cho (Korea) (822) 3705 4953

Industrials

Janet Lewis (Asia) (852) 3922 5417

Patrick Dai (China) (8621) 2412 9082

Saiyi He (China) (852) 3922 3585

Inderjeetsingh Bhatia (India) (9122) 6720 4087

Andy Lesmana (Indonesia) (6221) 2598 8398

Kenjin Hotta (Japan) (813) 3512 7871

Sunaina Dhanuka (Malaysia) (603) 2059 8993

Somesh Agarwal (Singapore) (65) 6601 0840

David Gambrill (Thailand) (662) 694 7753

Insurance

Scott Russell (Asia, Japan) (852) 3922 3567

Jian Li (China, Hong Kong) (852) 3922 3579


Software and Internet

David Gibson (Asia) (813) 3512 7880

Jiong Shao (China, Hong Kong) (852) 3922 3566

Steve Zhang (China, Hong Kong) (852) 3922 3578

George Meng (China, Hong Kong) (852) 3922 4128

Nitin Mohta (India) (9122) 6720 4090

Nathan Ramler (Japan) (813) 3512 7875

Prem Jearajasingam (Malaysia) (603) 2059 8989

Oil, Gas and Petrochemicals

James Hubbard (Asia) (852) 3922 1226

Aditya Suresh (Hong Kong, China) (852) 3922 1265

Abhishek Agarwal (India) (9122) 6720 4079

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669


Trevor Buchinski (Thailand) (662) 694 7829

Pharmaceuticals and Healthcare

Abhishek Singhal (India) (9122) 6720 4086

Joseph Quinn (Taiwan) (8862) 2734 7519

Property

Tuck Yin Soong (Asia, Singapore) (65) 6601 0838

David Ng (China, Hong Kong) (852) 3922 1291

Raymond Liu (China, Hong Kong) (852) 3922 3629

Kai Tan (China) (852) 3922 3720

Abhishek Bhandari (India) (9122) 6720 4088

Andy Lesmana (Indonesia) (6221) 2598 8398

William Montgomery (Japan) (813) 3512 7864


RJ Aguirre (Philippines) (632) 857 0890

Brandon Lee (Singapore) (65) 6601 0024

Corinne Jian (Taiwan) (8862) 2734 7522

David Liao (Taiwan) (8862) 2734 7518

Patti Tomaitrichitr (Thailand) (662) 694 7727

Resources / Metals and Mining

Matty Zhao (China) (852) 3922 1293

Hefei Deng (China) (852) 3922 1136

Rakesh Arora (India) (9122) 6720 4093

Riaz Hyder (Indonesia) (6221) 2598 8486

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669

David Liao (Taiwan) (8862) 2734 7518

Technology

Jeffrey Su (Asia, Taiwan) (8862) 2734 7512

Steve Zhang (China, Hong Kong) (852) 3922 3578

Nitin Mohta (India) (9122) 6720 4090

Claudio Aritomi (Japan) (813) 3512 7858

Damian Thong (Japan) (813) 3512 7877

David Gibson (Japan) (813) 3512 7880

George Chang (Japan) (813) 3512 7854

Daniel Kim (Korea) (822) 3705 8641

Soyun Shin (Korea) (822) 3705 8659

Ellen Tseng (Taiwan) (8862) 2734 7524

Tammy Lai (Taiwan) (8862) 2734 7525

Telecoms

Nathan Ramler (Asia, Japan) (813) 3512 7875

Danny Chu (China, Hong Kong) (852) 3922 4762

Riaz Hyder (Indonesia) (6221) 2598 8486

Eugene Jung (Korea) (822) 3705 8686

Prem Jearajasingam (Malaysia, Singapore) (603) 2059 8989

Piyachat Ratanasuvan (Thailand) (662) 694 7982

Transport & Infrastructure

Janet Lewis (Asia) (852) 3922 5417

Andrew Lee (Asia) (852) 3922 1167

Nicholas Cunningham (Japan) (813) 3512 6044


Corinne Jian (Taiwan) (8862) 2734 7522

Utilities & Renewables

Gary Chiu (Asia) (852) 3922 1435

Alan Hon (Hong Kong) (852) 3922 3589

Inderjeetsingh Bhatia (India) (9122) 6720 4087

Prem Jearajasingam (Malaysia) (603) 2059 8989

Commodities

Colin Hamilton (Global) (4420) 3037 4061

Jim Lennon (4420) 3037 4271

Matthew Turner (4420) 3037 4340

Graeme Train (8621) 2412 9035

Angela Bi (8621) 2412 9086

Rakesh Arora (9122) 6720 4093

Economics

Peter Eadon-Clarke (Asia, Japan) (813) 3512 7850

Richard Gibbs (Australia) (612) 8232 3935

Larry Hu (China, Hong Kong) (852) 3922 3778

Tanvee Gupta Jain (India) (9122) 6720 4355

Quantitative / CPG

Gurvinder Brar (Global) (4420) 3037 4036

Josh Holcroft (Asia). (852) 3922 1279

Burke Lau (Asia) (852) 3922 5494

Suni Kim (Japan) (813) 3512 7569

Tim Sharp (Hong Kong) (852) 3922 1318

Strategy/Country

Viktor Shvets (Asia) (852) 3922 3883

Chetan Seth (Asia) (852) 3922 4769

Joshua van Lin (Asia Micro) (852) 3922 1425

Peter Eadon-Clarke (Japan) (813) 3512 7850

David Ng (China, Hong Kong) (852) 3922 1291

Jiong Shao (China) (852) 3922 3566

Rakesh Arora (India) (9122) 6720 4093

Nicolaos Oentung (Indonesia) (6121) 2598 8366


Yeonzon Yeow (Malaysia) (603) 2059 8982

Alex Pomento (Philippines) (632) 857 0899

Conrad Werner (Singapore) (65) 6601 0182

David Gambrill (Thailand) (662) 694 7753 Find our research at Macquarie: www.macquarie.com.au/research Thomson: www.thomson.com/financial Reuters: www.knowledge.reuters.com Bloomberg: MAC GO Factset: http://www.factset.com/home.aspx CapitalIQ www.capitaliq.com Email [email protected] for access

Asia Sales Regional Heads of Sales

Robin Black (Asia) (852) 3922 2074

Chris Gray (ASEAN) (65) 6601 0288 Peter Slater (Boston) (1 617) 598 2502

Jeffrey Shiu (China & Hong Kong) (852) 3922 2061 Thomas Renz (Geneva) (41) 22 818 7712 Bharat Rawla (India) (9122) 6720 4100

Jurgan Usman (Indonesia) (6221) 515 1555 Miki Edelman (Japan) (813) 3512 7857 John Jay Lee (Korea) (822) 3705 9988

Ruben Boopalan (Malaysia) (603) 2059 8888 Gino C Rojas (Philippines) (632) 857 0861 Eric Roles (New York) (1 212) 231 2559

Regional Heads of Sales cont’d

Paul Colaco (San Francisco) (1 415) 762 5003

Erica Wang (Taiwan) (8862) 2734 7586 Angus Kent (Thailand) (662) 694 7601 Julien Roux (UK/Europe) (44) 20 3037 4867

Sean Alexander (Generalist) (852) 3922 2101

Regional Head of Distribution

Justin Crawford (Asia) (852) 3922 2065

Sales Trading

Adam Zaki (Asia) (852) 3922 2002

Phil Sellaroli (Japan) (813) 3512 7837 Kenneth Cheung (Singapore) (65) 6601 0288

Sales Trading cont’d

Mike Keen (UK/Europe) (44) 20 3037 4905

Chris Reale (New York) (1 212) 231 2555 Marc Rosa (New York) (1 212) 231 2555 Stanley Dunda (Indonesia) (6221) 515 1555

Suhaida Samsudin (Malaysia) (603) 2059 8888 Michael Santos (Philippines) (632) 857 0813 Isaac Huang (Taiwan) (8862) 2734 7582

Dominic Shore (Thailand) (662) 694 7707

China infant formula -...

Documents

Transcript of China infant formula -...