china dairy sector20.0% - credit suisse

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12 January 2015

Asia Pacific/China

Equity Research

Food Producers

China Dairy Sector INITIATION

2015 outlook: Four trends

Figure 1: Valuation matrix—2015E P/E vs 2013 ROE

Mengniu

Yili

Bright DairyModern Dairy

Tingyi TsingtaoSunArt

Nestle

DanoneDean

Want Want

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

8 13 18 23 28

2015 P/E

2013 ROE

Source: Company data, Credit Suisse estimates

■ Four trends down the road. China's dairy consumption slowdown in 2014 was cyclical, in our view. We expect: (1) the 8-10% demand CAGR to continue over the next five years; (2) structural changes in the consumption behaviour (less flavoured milk, more UHT yoghurt and pasteurised milk; (3) firms to import UHT milk to play price arbitrage; and (4) to go vertical for

safety warranty.

■ Exposure to star products and earnings growth. Bright has the greatest exposure to UHT yoghurt—20% of total sales in 2013 and we expect it to contribute 36% of total sales (45% segment share) in 2016. Yili and Mengniu followed and launched similar products at end-2013, and are catching up very quickly. All three are distributing imported UHT in China, based either

an OEM (Yili and Bright) or distributing business model (Mengniu).

■ Pecking order. We prefer a downstream processor over upstream farming. (1) Yili (initiate with OUTPERFORM; Rmb40 TP) differentiates itself from

Mengniu on its higher profitability/ROE, management better motivated, and lower valuation multiple; (2) Bright (initiate with OUTPERFORM; Rmb24 TP) is to deliver a 46% earnings CAGR over 2014-16E, benefiting from its first-mover advantage in the rapid-growing UHT yoghurt segment; (3) Mengniu (upgrade to OUTPERFORM) attracts us with its strategic partnership, execution improvement and margin expansion story; and (4) without fundamental catalyst, Modern (upgrade to NEUTRAL) is a band-trading

stock on valuation.

Research Analysts

Kevin Yin

852 2101 7655

[email protected]

Contribution by:

Michael Shen

12 January 2015

China Dairy Sector 2

Focus tables and charts Figure 2: Industry demand model—market size and structure forecast

Sales value (Rmb mn) 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E CAGR

14-18E

Drinking milk products 116,640 126,622 139,560 162,306 179,457 196,687 204,392 215,498 228,486 241,948 254,208 5.6%

(1) Milk 59,956 62,451 67,010 76,077 83,208 89,959 100,324 113,769 128,780 143,949 157,601 12.0%

- UHT milk 47,965 49,961 53,408 60,162 65,017 68,767 72,893 77,995 83,455 89,297 95,548 7.0%

- UHT yoghurt - - 200 700 1,550 3,200 8,000 14,400 21,600 28,080 32,292 41.7%

- Pasteurized milk 11,991 12,490 13,402 15,215 16,642 17,992 19,431 21,374 23,725 26,572 29,761 11.2%

(2) Flavoured milk drinks 37,793 47,088 54,725 66,845 75,388 84,426 80,205 76,195 72,385 68,766 65,327 -5.0%

(3) Others 18,892 17,083 17,825 19,383 20,861 22,302 23,863 25,534 27,321 29,234 31,280 7.0%

Yoghurt 25,196 29,143 33,280 39,093 45,092 52,264 58,535 69,072 81,504 96,175 113,487 18.0%

IMF 32,516 41,352 50,943 61,952 75,241 91,178 98,472 108,319 119,151 131,066 144,173 10.0%

Ice cream 27,039 26,626 28,401 31,209 32,144 33,501 34,841 36,932 39,886 43,077 46,523 7.5%

Total 201,390 223,743 252,184 294,560 331,934 373,629 396,240 429,820 469,028 512,267 558,391 9.0%

Note: Historical by Euromonitor; forecast by CS; Source: Euromonitor, Credit Suisse estimates

Figure 3: Asian countries dairy consumption vs GDP per

capita in 2013

Figure 4: Cost structure of a typical online retailer selling

imported UHT milk

ChinaSGP

Japan

HK

Korea

10

20

30

40

50

60

70

80

0 10,000 20,000 30,000 40,000 50,000 60,000

Drinking milk consumptionvolume per capita

(Kg/preson)

GDP per capita (US$/preson)

1.2 (15%)

1.4 (17%)

0.8 (10%)

0.4 (5 %)

0

2

4

6

8

10

12

Rm

b8

/L

Rm

b12/L

Rmb/litre

Traif

VAT

Fulfilment

Ad & mkting

CIF

Breakeven price

Source: Euromonitor, Wind Source: Company data, Credit Suisse estimates

Figure 5: Valuation table Figure 6: Business model and financial matrix at a glance Rating Mktcap Trading Target Up- NP CAGR Trading

(US$ mn) price Price side 2014-16E 2015 P/E PEG 2015 P/E

Yili OP 14,123 28.9 40.0 39% 19% 24.0 1.2 17.3

Bright OP 3,513 18.6 24.0 29% 46% 36.0 0.8 27.9

Mengniu OP 8,285 33.4 40.0 20% 20% 26.0 1.2 21.7

Modern N 1,494 2.5 2.8 13% 8% 12.3 1.2 10.9

Target

Yili Mengniu Bright Modern

Establishment 1993 1999 1996 2006

Largest 11% mgmt 18% COFCO 54.6% Group 38.6% Yinmu

Mgmt holding 11% ~5% 4.54%

Distribution 2K+ POS, 2K+ POS, 700 POS, 70% to MN

Sales (Rmb mn) 47,454 43,357 16,179 3,289

- UHT yoghurt Just started Just started 20% ->36% (16) 0.0%

- Chilled yoghurt c12% c13% c10% 0.0%

- High-end UHT c8% c15% Just started 20.0%

- Powder c12% c8% c10% 0.0%

GP margin 28.6% 27.0% 34.9% 38.2%

Opex ratio 22.9% 23.3% 30.0% 6.5%

OP margin 5.5% 4.3% 4.2% 22.1%

Net margin 6.7% 3.8% 2.5% 14.6%

ROE 27.2% 11.7% 9.8% 8.9% Source: Note: price as of 9 January 2014; Source: the BLOOMBERG

PROFESSIONAL™ service, CS estimates; current price and TP in

Rmb

Note: 2013 financial numbers; Source: Company data, Credit Suisse

estimates

12 January 2015


Table of contents Focus tables and charts 2 Table of contents 3 2015 outlook: Four trends 4

8-10% CAGR to continue over the next five years 4 Structural changes in consumption behaviour 4 Importing UHT milk to play price arbitrage; go vertical to warrant product safety 4 Stock picks: Yili, Bright, Mengniu and Modern 4

Structural changes in consumption behaviour 10 Importing UHT milk to play price arbitrage; go vertical to warrant product safety 13

Go vertical to warrant product safety 16 Stock picks: Yili, Bright, Mengniu, and Modern 17 Global peer comparison 20 Inner Mongolia Yili Industrial Group (600887.SS / 600887 CH) 22

High margin and ROE; management incentive well aligned; attractive valuation 22 Focus charts and tables 23

Fast-growing high-margin product 24 Extensive and efficient distribution network 26

Strategic alliance with global peers 28 Management's personal interest aligned with share price performance 32 Upstream raw milk source management 34 Valuation 35 Major investment risks 35

Bright Dairy & Food Co., Ltd (600597.SS / 600597 CH) 41 UHT yoghurt to drive sales and margin expansion; a national player in the making 41

Focus charts and tables 42 Difference from Yili and Mengniu 43

First-mover advantage in UHT yoghurt… 45 …Yili and Mengniu are catching up 45 Low-temp products: A long way to go for China 46 Expanding out of East China is challenging, but Mosilian is a chance 47 Global alliance for milk powder and UHT milk 47 Valuation 49 Investment risks 49

China Mengniu Dairy (2319.HK / 2319 HK) 52 Apprehension of slowdown and earnings miss fairly discounted; upgrade to

OUTPERFORM 52 Focus charts and tables 53 China Modern Dairy Holdings Ltd (1117.HK / 1117 HK) 56

Close to the end of tunnel with low visibility; upgrade to NEUTRAL on attractive

valuation 56 Focus charts and tables 57

12 January 2015


2015 outlook: Four trends 8-10% CAGR to continue over the next five years

China's dairy consumption volume declined 1% YoY in 2014. The slowdown in 2014 was

cyclical, in our view. We attribute it to: (1) side-effects of the anti-corruption campaign, (2)

a lukewarm macro backdrop, and (3) 10-15% milk price inflation in 2013. This serves a low

comp base for 2015. For the next five years, we forecast China dairy demand will witness

an 8-10% CAGR, mainly driven by (1) penetration improvement, (2) more health-

conscious, (3) lifestyle changes, and (4) consumption upgrade.

Structural changes in consumption behaviour

We anticipate Chinese consumers to drink less UHT flavoured milk (accounting for 22%

of China's total dairy consumption, vs Japan's 3%, Singapore's 6% and Korea's 13%), but

more UHT yoghurt (a new and unique category; similar texture as chilled yoghurt, certain

nutrition level, no cold-chain bottleneck) and pasteurised milk (growing along with cold-

chain system development). Bright Dairy enjoys its first-mover advantage in UHT yoghurt

and pasteurised milk. Yili and Mengniu have been catching up rapidly.

Importing UHT milk to play price arbitrage; go

vertical to warrant product safety

We estimate a mature sizeable retailer will break even for selling imported UHT milk in

China at Rmb12/L (vs Rmb18-21/L retail price for Mengniu/Yili's Deluxe/Satine). To cater

to market demand and play price arbitrage opportunity, the Top 3 all have expanded into

this new territory. Mengniu distributes Denmark-imported Arla-branded UHT milk,

leveraging its strategic shareholder Arla's strength. Yili and Bright use the OEM business

model. They sell the Italy/Australia-made UHT milk in China, with their own brand names

(Perfectlands and Pactum). In addition, all three have expanded into the upstream farming

business (either domestic or overseas). This is to secure consistent supply of quality raw

material and warrant product safety.

Stock picks: Yili, Bright, Mengniu and Modern

For 2015, we prefer downstream dairy processors (benefiting from a demand recovery

and low input cost) over upstream cow farming operators (raw milk price under

pressure on substitution effects of milk powder importing). The criteria for our pecking

order include: (1) growth momentum in both top and bottom lines; (2) growth quality

(profitability, ROE, and management quality); and (3) valuation multiple.

Yili differentiates itself from Mengniu as: (1) Yili has higher margin (6.7% net margin in

2013, vs Mengniu's 3.8%) and ROE (27%, vs Mengniu's 12%), on product mix, execution

and a 40 bp lower opex ratio; and (2) Yili's management is well motivated (the largest

shareholder with an 11% stake, vs Mengniu's ~5%, including 3.9% of old Mengniu

management). President Pan Gang and others bought 1.6% in July 2014 at Rmb24.81 (vs

the current price of Rmb30); and (3) Yili trades at 17x 2015E P/E or 16x ex-cash (vs

Mengniu's 22x and Bright's 27x).

We expect Bright to deliver a 46% earnings CAGR over 2014-16E, benefiting from its

first-mover advantage in UHT yoghurt/Mosilian—a unique star category with a 40-50% GP

margin. Mosilian sales surged a 115% CAGR over 2011-13, and we expect a 27% CAGR

over 2014-16 (a 40% market share and 36% sales contribution in 2016).

We like Mengniu for its margin expansion potential. We expect it to be driven through (1)

leveraging expertise from Danone, Arla, White Wave and Yashili; (2) execution

improvement (distribution reform to bear fruits); and (3) refining product portfolio.

Without meaningful fundamental catalyst, Modern is a band-trading stock on valuation.

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Figure 7: Peer comparison—Yili, Mengniu and Bright Dairy

Yili Mengniu Bright Dairy

Rmb mn 2010 2011 2012 2013 1H14 Rmb mn 2010 2011 2012 2013 1H14 Rmb mn 2010 2011 2012 2013 1H14

Revenue 29,545 37,266 41,736 47,454 27,096 Revenue 30,265 37,388 36,000 43,357 25,836 Revenue 9,299 11,576 13,630 16,179 9,794

- Liquid milk 20,985 26,933 32,271 37,116 20,709 - Liquid Milk 26,872 33,701 32,336 37,903 21,765 - Dairy products 8,995 11,092 13,052 15,412 9,316

- Milk powder 4,623 5,642 4,484 5,512 3,041 - Milk powder 282 428 493 2,431 2,083 ** Liquid milk N/A 8,481 9,888 11,620 7,220

- Ice cream 3,544 4,222 4,294 4,243 3,040 - Ice cream 3,112 3,259 3,171 3,023 1,988 ** Other dairy N/A 2,611 3,164 3,792 2,097

- Feedstock 393 469 687 583 305 - Others 305 484 579 767 478

Revenue mix 100% 100% 100% 100% 100% Revenue mix 100% 100% 100% 100% 100% Revenue mix 100% 100% 100% 100% 100%

- Liquid milk 71% 72% 77% 78% 76% - Liquid Milk 89% 90% 90% 87% 84% - Dairy products 97% 96% 96% 95% 95%

- Milk powder 16% 15% 11% 12% 11% - Milk powder 1% 1% 1% 6% 8% ** Liquid milk N/A 73% 73% 72% 74%

- Ice cream 12% 11% 10% 9% 11% - Ice cream 10% 9% 9% 7% 8% ** Other dairy N/A 23% 23% 23% 21%

- Feedstock 1% 1% 2% 1% 1% - Others 3% 4% 4% 5% 5%

Revenue YoY 22.0% 26.1% 12.0% 13.7% 13.6% Revenue YoY 17.7% 23.5% -3.7% 20.4% 25.0% Revenue YoY 20.5% 24.5% 17.7% 18.7% 32.1%

- Liquid milk 26.8% 28.3% 19.8% 15.0% 15.3% - Liquid Milk 18.2% 25.4% -4.1% 17.2% 19.2% - Dairy products 20.5% 23.3% 17.7% 18.1% 31.2%

- Milk powder 16.6% 22.1% -20.5% 22.9% 9.1% - Milk powder -2.5% 51.7% 15.2% 393.5% 361.7% ** Liquid milk N/A N/A 16.6% 17.5% 33.3%

- Ice cream 8.6% 19.1% 1.7% -1.2% 8.2% - Ice cream 15.9% 4.7% -2.7% -4.7% 1.7% ** Other dairy N/A N/A 21.2% 19.8% 24.5%

- Feedstock -7.7% 19.2% 46.4% -15.1% 2.4% - Others 21.3% 58.8% 19.5% 32.6% 52.8%

GP margin 30.2% 29.2% 29.6% 28.6% 33.2% GP margin 25.7% 25.7% 25.1% 27.0% 32.4% GP margin 35.5% 34.1% 35.5% 34.9% 35.0%

- Liquid milk 28.8% 26.5% 28.1% 26.1% 31.0% - Liquid milk 26.5% 26.1% 25.4% 26.0% 31.2% - Dairy products 35.5% 34.4% 36.2% 36.0% 36.2%

- Milk powder 39.0% 42.6% 39.5% 43.8% 45.9% - Milk powder 28.0% 29.0% 11.8% 52.0% 53.0% ** Liquid milk N/A 40.4% 43.3% 42.9% 42.4%

- Ice cream 29.2% 29.8% 32.3% 32.8% 36.9% - Ice cream 25.5% 22.0% 24.5% 24.5% 25.0% ** Other dairy N/A 15.0% 14.0% 15.0% 15.0%

- Feedstock 12.4% 13.7% 16.0% 11.3% 12.5% - Others 33.7% 28.3% 20.9% 12.1% 10.4%

GP mix 100% 100% 100% 100% 100% GP mix 100% 100% 100% 100% 100% GP mix 100% 100% 100% 100% 100%

- Liquid milk 68% 66% 74% 71% 72% - Liquid milk 89% 92% 88% 83% 81% - Dairy products 97% 97% 98% 98% 99%




SG&A/sales 28.1% 24.7% 25.2% 22.9% 24.6% SG&A/sales 20.3% 20.9% 21.6% 23.3% 28.7% SG&A/sales 31.4% 30.5% 30.9% 30.0% 30.9%

- Selling exp 22.9% 19.5% 18.5% 17.9% 19.1% - Selling exp 17.9% 17.9% 17.8% 18.8% 22.8% - Selling exp 28.5% 27.5% 27.7% 27.1% 28.2%

- Admin exp 5.1% 5.3% 6.7% 5.0% 5.4% - Admin exp 2.2% 2.5% 3.3% 3.7% 3.7% - Admin exp 2.9% 3.0% 3.2% 3.0% 2.7%

- Other exp 0.2% 0.5% 0.5% 0.8% 2.2%

OP 585 1,697 1,665 2,626 2,451 OP 1,909 2,070 1,513 1,852 1,221 OP 235 247 420 679 302

YoY -14.9% 190.1% -1.9% 57.7% 87.8% YoY 14.1% 13.7% -26.9% 22.3% 28.8% YoY 38.1% 5.1% 69.8% 61.8% 28.7%

OP margin 2.0% 4.5% 4.0% 5.5% 9.0% OP margin 6.3% 5.5% 4.2% 4.3% 4.7% OP margin 2.5% 2.1% 3.0% 4.2% 3.1%

Net earnings 777 1,809 1,717 3,187 2,293 Net earnings 1,237 1,589 1,257 1,631 1,049 Net earnings 194 238 311 406 209

YoY 20.0% 132.8% -5.1% 85.6% 31.9% YoY 4.3% 28.4% -20.9% 29.7% 39.9% YoY 58.7% 22.4% 30.9% 30.4% 41.5%

Net margin 2.6% 4.8% 4.1% 6.7% 8.4% Net margin 4.1% 4.3% 3.5% 3.8% 4.1% Net margin 2.0% 2.0% 2.3% 2.5% 2.1%

ROE 18.4% 30.0% 25.7% 27.2% ROE 13.5% 15.0% 10.5% 11.7% ROE 8.8% 9.9% 9.6% 9.8%

Source: Company data

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Figure 8: Valuation matrix—Global dairy comparison

EPS PEG Div

Company name Ticker Mkt cap Performance (%) P/E (x) EV/EBITDA (x) P/B (x) ROE (%) CAGR % yld

Reuters (US$ mn) 1M 3M 12M 2014 2015 2016 2014 2015 2014 2015 2014 2015 2014-16 2015 12MF

Global dairy products producers

Nestle NESN.VX 230,637 2% 6% 11% 21.5 19.9 18.4 12.2 12.4 3.4 3.3 19.1% 17.0% 8.2% 2.4 3.3%

Abbott ABT.N 70,487 3% 10% 16% 20.2 20.3 18.0 13.5 12.8 2.7 2.4 13.4% 12.6% 6.0% 3.4 2.2%

Danone DANO.PA 41,333 -3% 7% 7% 20.7 18.6 16.8 9.1 9.5 3.5 2.3 13.7% 14.6% 10.8% 1.7 3.0%

Mead Johnson MJN.N 20,615 1% 8% 20% 27.3 24.5 22.0 18.1 16.4 26.8 17.7 175% 91% 11.3% 2.2 1.7%

Yakult 2267.T 8,733 2% 17% 21% 47.0 42.6 36.3 16.7 16.3 3.8 3.6 8.4% 8.7% 13.9% 3.1 0.4%

Fonterra FSF.NZ 8,678 -4% -7% 3% 59.6 16.0 14.5 10.0 6.5 1.5 1.4 2.4% 10.0% 103.0% 0.2 5.3%

Meiji Foods 2269.T 7,224 8% 34% 70% 43.7 30.1 26.2 9.3 8.9 2.6 2.4 6.0% 8.7% 29.3% 1.0 0.9%

Parmalat PLT.MI 5,120 -1% -4% -4% 19.6 18.4 16.9 8.5 8.8 1.3 1.2 7.0% 6.9% 7.6% 2.4 1.7%

Vina Milk VNM.HM 4,612 -1% -10% -13% 15.9 14.1 12.9 11.9 10.2 4.8 4.1 32.2% 32.3% 11.1% 1.3 4.4%

Dean Foods DF.N 1,760 6% 47% 9% (204) 20.2 17.1 8.7 4.9 2.6 2.5 -1.4% 11.3% n.a. n.a. 1.6%

Dairy Crest DCG.L 971 -7% 24% -13% 11.7 12.3 11.4 5.7 5.8 (2.2) 2.4 -18.4% 19.2% 1.2% 10.4 4.6%

Morinaga Milk 2264.T 839 1% 14% 30% 20.6 20.8 18.1 2.9 3.5 0.8 0.8 4.1% 3.9% 6.7% 3.1 1.7%

Simple avg. 10.7 22.1 19.5 10.9 9.9 4.4 3.7 21.4% 19.4% 18.8% 0.6 2.4%

Weighted avg. 22.4 20.7 18.8 12.3 12.2 4.5 3.7 24.4% 19.3% 10.8% 2.1 2.9%

Chinese dairy products producers

Inner Mongolia Yili 600887.SS 14,123 3% 10% 15% 19.8 16.4 13.9 14.9 12.4 4.3 3.8 24.2% 25.3% 19.1% 0.9 2.0%

Mengniu Dairy 2319.HK 8,285 13% -1% -10% 24.6 20.1 16.9 13.1 11.0 2.5 2.3 11.5% 12.1% 20.7% 1.0 1.1%

Bright Dairy 600597.SS 3,513 6% 4% -18% 38.1 26.6 19.4 19.3 14.6 4.7 4.2 12.3% 16.5% 40.0% 0.7 1.7%

Sanyuan Daily 600429.SS 1,225 -2% -12% 17% 122.9 (215) n.a. n.a. n.a. n.a. n.a. 2.8% -1.0% n.a. n.a. n.a.

GX Royal Dairy 002329.SZ 1,194 0% 51% 139% 168.8 139.9 36.2 n.a. n.a. 7.9 7.0 11.0% 14.0% 116.0% 1.2 0.7%

Simple avg. 74.8 (2.4) 21.6 15.8 12.7 4.8 4.3 12.4% 13.4% 48.9% 1.5 1.4%

Weighted avg. 34.2 13.9 15.8 13.7 11.2 3.8 3.4 17.5% 18.8% 25.4% 1.3 1.6%

Chinese milk powder producers

Beingmate 002570.SZ 2,726 -1% -1% -13% 36.1 26.3 21.5 32.0 22.7 3.6 3.8 8.3% 11.9% 29.6% 0.9 n.a

Biostime International 1112.HK 1,268 5% -35% -76% 11.4 10.8 10.1 7.7 7.3 2.9 2.6 26.7% 25.6% 6.4% 1.7 n.a

Yashili 1230.HK 1,042 0% -19% -50% 18.2 16.3 13.6 13.3 10.1 2.1 1.9 11.3% 15.2% 15.7% 1.0 2.7%

Synutra SYUT.OQ 317 7% 18% -34% 6.1 4.9 n.a. 3.8 n.a. n.a. 59.6% n.a. n.a. n.a

Simple avg. 21.9 14.9 12.5 17.6 11.0 2.9 2.7 15.5% 28.1% 17.2% 1.3 2.7%

Weighted avg. 22.4 17.7 14.8 18.8 14.1 2.7 2.6 11.6% 17.0% 17.9% 1.3 0.5%

Chinese raw milk producers

Huishan 6863.HK 2,557 -1% -19% -50% 10.9 10.7 9.4 9.4 7.4 n.a. n.a. n.a n.a 7.3% 1.5 3.9%

China Modern Dairy 1117.HK 1,494 9% -29% -39% 9.0 8.3 7.2 5.9 5.7 1.4 1.2 16.6% 16.6% 11.7% 0.7 1.1%

YuanShengTai 1431.HK 418 9% -31% -64% 5.8 4.8 3.7 5.0 4.0 0.6 0.5 10.1% 10.1% 24.8% 0.2 0.0%

Xinjiang Western Animal 300106.SZ 338 -6% -13% -3% 46.6 34.5 n.a n.a. n.a. n.a. n.a. n.a n.a n.a. n.a. n.a

Simple avg. 18.1 14.6 6.8 6.7 5.7 1.0 0.9 13.4% 13.4% 14.6% 2.9 1.7%

Weighted avg. 12.4 11.1 7.6 7.3 6.1 0.5 0.4 6.0% 6.0% 12.4% 1.1 0.4%

Note: Share price as of 8 January 2015. Source: Reuters; Credit Suisse estimates

12 January 2015


8-10% CAGR to continue over the next five years We believe the dairy demand slowdown in 2014 was cyclical. The slowdown was mainly

due to: (1) side-effects of the anti-corruption campaign (less gifting, less non-cash staff

benefits); (2) a lukewarm macro backdrop; and (3) rapid dairy price inflation in 2013. The

consumption slowdown was witnessed across the board. Compared with the 9% decline in

instant noodle and a 4% decline in overall beverage, the 1% drop in dairy production

volume was relatively resilient.

From the long-term perspective, we believe China dairy consumption demand would

remain strong, driven by: (1) penetration improvement, (2) more health consciousness, (3)

lifestyle changes, and (4) consumption upgrade. We estimate an 8-10% volume CAGR

over the next five years.

Compared with the neighbouring Asian countries, China's lower dairy consumption per

capita suggests stellar sector demand potential in the long run.

■ In 2013, China's drinking milk consumption volume per capita amounted to 14.3 kg,

33% lower than Japan's 21.4 kg, 36% lower than HK's 22.4 kg, and 47% lower than

Korea's 27 kg.

■ In 2013, China's drinking milk consumption value per capita amounted to 23.3 kg, 62%

lower than HK's 61.7 kg, 64% lower than Japan's 63.9 kg, 66% lower than Korea's

69.2 kg.

Figure 9: Drinking milk consumption volume per capita

(Kg/person, 2013)

Figure 10: Drinking milk consumption value per capita

(US$/person, 2013)

27.0

22.421.4

14.3

0

5

10

15

20

25

30

Korea HK Japan China

Kg/person

69.2 63.9 61.7

23.3

0

10

20

30

40

50

60

70

80

Korea Japan HK China

US$/person

Source: Euromonitor Source: Euromonitor

Historical data suggest that, in addition to diet tradition/habits, dairy consumption volume

is positively correlated with the country's GDP per capita.

12 January 2015


Figure 11: Asian countries dairy consumption volume vs GDP per capita in 2013

ChinaSGP

Japan

HK

Korea

10

20

30

40

50

60

70

80

0 10,000 20,000 30,000 40,000 50,000 60,000

Drinking milk consumption volume

per capita (Kg/preson)

GDP per capita (US$/preson)

Source: Euromonitor, Wind

Figure 12: Industry demand model—sales value

Sales value (Rmb mn) 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

Drinking milk products 116,640 126,622 139,560 162,306 179,457 196,687 204,392 215,498 228,486 241,948 254,208

(1) Milk 59,956 62,451 67,010 76,077 83,208 89,959 100,324 113,769 128,780 143,949 157,601

- UHT milk 47,965 49,961 53,408 60,162 65,017 68,767 72,893 77,995 83,455 89,297 95,548

- UHT yoghurt - - 200 700 1,550 3,200 8,000 14,400 21,600 28,080 32,292

- Pasteurized milk 11,991 12,490 13,402 15,215 16,642 17,992 19,431 21,374 23,725 26,572 29,761

(2) Flavoured milk drinks 37,793 47,088 54,725 66,845 75,388 84,426 80,205 76,195 72,385 68,766 65,327

(3) Others 18,892 17,083 17,825 19,383 20,861 22,302 23,863 25,534 27,321 29,234 31,280

Yoghurt 25,196 29,143 33,280 39,093 45,092 52,264 58,535 69,072 81,504 96,175 113,487

IMF 32,516 41,352 50,943 61,952 75,241 91,178 98,472 108,319 119,151 131,066 144,173

Ice cream 27,039 26,626 28,401 31,209 32,144 33,501 34,841 36,932 39,886 43,077 46,523

Total 201,390 223,743 252,184 294,560 331,934 373,629 396,240 429,820 469,028 512,267 558,391

Note: Historical by Euromonitor; Forecast by CS; Source: Euromonitor, Credit Suisse estimates

Figure 13: Industry demand model—sales value YoY

YoY growth 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

Drinking milk products 9% 10% 16% 11% 10% 3.9% 5.4% 6.0% 5.9% 5.1%

(1) Milk 4% 7% 14% 9% 8% 11.5% 13.4% 13.2% 11.8% 9.5%

- UHT milk 4% 7% 13% 8% 6% 6.0% 7.0% 7.0% 7.0% 7.0%

- UHT yoghurt 250% 121% 106% 150% 80.0% 50.0% 30.0% 15.0%

- Pasteurized milk 4% 7% 14% 9% 8% 8.0% 10.0% 11.0% 12.0% 12.0%

(2) Flavoured milk drinks 25% 16% 22% 13% 12% -5.0% -5.0% -5.0% -5.0% -5.0%

(3) Others -10% 4% 9% 8% 7% 7.0% 7.0% 7.0% 7.0% 7.0%

Yoghurt 16% 14% 17% 15% 16% 12.0% 18.0% 18.0% 18.0% 18.0%

IMF 27% 23% 22% 21% 21% 8.0% 10.0% 10.0% 10.0% 10.0%

Ice cream -2% 7% 10% 3% 4% 4.0% 6.0% 8.0% 8.0% 8.0%

Total 11% 13% 17% 13% 13% 6.1% 8.5% 9.1% 9.2% 9.0%


12 January 2015


Figure 14: Industry demand model—total sales breakdown

Total sales breakdown 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

Drinking milk products 58% 57% 55% 55% 54% 53% 52% 50% 49% 47% 46%

(1) Milk 30% 28% 27% 26% 25% 24% 25% 26% 27% 28% 28%

- UHT milk 24% 22% 21% 20% 20% 18% 18% 18% 18% 17% 17%

- UHT yoghurt 0% 0% 0% 0% 0% 1% 2% 3% 5% 5% 6%

- Pasteurized milk 6% 6% 5% 5% 5% 5% 5% 5% 5% 5% 5%

(2) Flavoured milk drinks 19% 21% 22% 23% 23% 23% 20% 18% 15% 13% 12%

(3) Others 9% 8% 7% 7% 6% 6% 6% 6% 6% 6% 6%

Yoghurt 13% 13% 13% 13% 14% 14% 15% 16% 17% 19% 20%

IMF 16% 18% 20% 21% 23% 24% 25% 25% 25% 26% 26%

Ice cream 13% 12% 11% 11% 10% 9% 9% 9% 9% 8% 8%

Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%


Figure 15: Industry demand model—milk sales breakdown

Milk sales breakdown 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

- UHT milk 80% 80% 80% 79% 78% 76% 73% 69% 65% 62% 61%

- UHT yoghurt 0% 0% 0% 1% 2% 4% 8% 13% 17% 20% 20%

- Pasteurized milk 20% 20% 20% 20% 20% 20% 19% 19% 18% 18% 19%

Sub-total milk 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%


12 January 2015


Structural changes in consumption behaviour Consumption of flavored milk (diluted milk with fruit and other flavor, made of fresh raw

milk or milk powder, mostly UHT milk) represents an extremely high portion of China's total

dairy consumption, which we believe is unsustainable.

■ Over 2008-13, China's flavored milk consumption saw a 15.3% CAGR (in sales

volume) and a 17.7% CAGR (in sales value).

■ In 2013, flavored milk consumption accounted for 22% of China's total dairy consumption

value, vs Korea's 13%, Singapore's 6%, Japan's 3%, and Hong Kong's 1%.

We attribute the extreme popularity of flavored milk in China to: (1) consumer behavior

and low health conscious level (more focusing on flavor than nutrition); (2) strong push by

all leading dairy brands (flavored milk has higher margins than plain milk); and (3) easy

logistics (require no cold chain support, no logistic bottlenecks).

Figure 16: China flavoured milk sales volume (2008-13) Figure 17: China flavoured milk sales value (2008-13)

4,194

5,236

6,299

7,2217,908

8,563

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

2008 2009 2010 2011 2012 2013

'000 Tonnes

36,804

46,061

53,746

65,801

74,279

83,261

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2008 2009 2010 2011 2012 2013

'000 Tonnes


Figure 18: Peer country comparison—flavoured milk consumption as % of total dairy

consumption value (2013)

1%

3%

6%

13%

22%

0%

5%

10%

15%

20%

25%

HK Japan SGP Korea China

Source: Euromonitor

12 January 2015


In the neighboring developed markets (where consumers share similar diet

tradition/habits), regular drinking milk and yoghurt play a more critical role on consumers'

dining tables.

■ Regular drinking milk accounted for 32% of total diary consumption value in Korea,

26% in Japan, and 18% in SGP, vs 24% in China in 2013.

■ Yoghurt accounted for 37% of total diary consumption value in Japan, 18% in Korea,

and 15% in SGP, vs 14% in China in 2013.

Following robust income growth, lifestyle changes, and rising health conscious level, we

expect Chinese consumers to gradually switch to pure milk and yoghurt from flavored milk.

■ Within the pure milk segment, UHT milk would continue to dominate the market,

benefiting from dietary habits and a lack of cold-chain system. However, consumers in

high-tier cities would switch to pasteurised milk from UHT products, in our view.

■ UHT yoghurt would grow very quickly in the next 3-5 years. Bright Dairy created UHT

yoghurt in 2009. It has similar texture as chilled yoghurt, offers certain nutrition and

requires no cold-chain support. All these features translated into strong sales growth.

Bright Dairy's UHT yoghurt sales size was Rmb3,220 mn in 2013, representing a

153% CAGR over 2010-13. Management targets Rmb6 bn in 2014 (85% YoY). Yili

and Mengniu followed Bright Dairy and launched their UHT yoghurt products at the

end of 2013.

■ We expect UHT yoghurt to gain market share from UHT flavor milk and UHT pure

milk. We estimate UHT yoghurt will see a 42% CAGR in the next 3-5 years,

representing 25% of China's total UHT consumption (vs currently 10%).

Figure 19: Peer country comparison—drinking milk

consumption as % of total dairy consumption value (2013)

Figure 20: Peer country comparison—Yoghurt

consumption as % of total dairy consumption value (2013)

4%

18%

24%26%

32%

0%

5%

10%

15%

20%

25%

30%

35%

HK SGP China Japan Korea

5%

14% 15%

18%

37%

0%

5%

10%

15%

20%

25%

30%

35%

40%

HK China SGP Korea Japan


12 January 2015


Figure 21: Peer country comparison—dairy consumption value mix (2013)

24%

14%

9%

24%22%

18%15%

18%

29%

6%

26%

37%

25%

3% 3%4% 5% 5%

75%

1%

32%

18%

24%

7%

13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Drinking milk Yoghurt Ice cream Infant formula Flavoured milk drinks

China SGP Japan HK Korea

Note: Hong Kong's extremely high consumption of IMF is mainly driven by mainland Chinese' consumption, leading to a distorted mix.

Source: Euromonitor

Figure 22: Sales exposure to UHT yoghurt Figure 23: UHT yoghurt segment market share

5,957

9,650

5,400 5,400

0%

5%

10%

15%

20%

25%

30%

35%

40%

0

2,000

4,000

6,000

8,000

10,000

12,000

Mosilian

(Bright)

Anmuxi

(Yili)

Chunzhen

(Mengniu)

2013 2016E

20%

36%

8% 9%

As % of

total salesSales ( Rmb mn)

100%

45%

25% 25%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2013 2016EMosilian (Bright) Anmuxi (Yili) Chunzhen (Mengniu)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

12 January 2015


Importing UHT milk to play price arbitrage; go vertical to warrant product safety Starting from 2013, German, French, Australian and New Zealand dairy companies

accelerated UHT milk exports into China, levering their idle capacity and low raw milk cost

in home markets, and benefiting strong demand in China.

Figure 24: Breakdown of China's UHT milk imports Figure 25: Breakdown of China's milk powder imports

Germany

40%

New

Zealand

20%

France

15%

Australia

12%

Others

13%

New

Zealand

80%

USA

6%

Australia

5%

France

2%

Others

9%

Source: CEIC, China Dairy Yearbook, Credit Suisse Source: CEIC, China Dairy Yearbook, Credit Suisse

With competitive pricing on the e-commerce platform (China online retailers bearing the

promotion cost and subsidising Chinese consumers), imported UHT milk rapidly gained

market shares from local peers. China UHT imports increased 92% YoY in 2013 (195,000

tonne) and 77% in 10M14. The total import volume looks still small, accounting for 1.4% of

total liquid milk consumption in China. But in the high-end liquid milk segment, it competes

badly with Mengniu's Delux and Yili's Satine. We estimate imported UHT accounts for 10-

20% of high-end milk consumption in China.

Figure 26: Imported liquid milk import volume and YoY

growth

Figure 27: Imported liquid milk volume as % of total liquid

milk production volume in China

8,330 14,371 17,117

43,067

101,693

194,807

273,907

69%

73%

19%

152%

136%

92% 77%

0%

20%

40%

60%

80%

100%

120%

140%

160%

-

50,000

100,000

150,000

200,000

250,000

300,000

2008 2009 2010 2011 2012 2013 10M14

Imported UHT volume YoY growth

Ton

0.06% 0.09% 0.09%

0.21%

0.47%

0.85%

1.41%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

2008 2009 2010 2011 2012 2013 10M14

Source: Wind Source: Wind

12 January 2015


We estimate nearly 50% of imported UHT milk is distributed through the e-commerce

platform in China. Yihaodian is the major online retailer, who accomplished nearly 40%

market share of online sales.

In high-tier cities, most online retailers scarify their profitability of selling imported UHT milk

to exchange for online traffic (for potential high-margin marketplace business). Online

selling prices range from Rmb10 to Rmb15 per litter, versus Rmb17-20 for Mengniu's

Delux and Yili's Satine in traditional hypermarkets. During some shopping events or

inventory clear-up days, the price could be as low as Rmb8-10 per litter (a 50% discount).

Considering 15% tariff and 17% VAT, we estimate Yihaodian's total import cost at Rmb10

per litter. Factoring in a 6-10% fulfilment cost and a 5% plus advertising/marketing

expense, we estimate Yihaodian is barely breakeven when it sells milk at Rmb12 per liter.

Figure 28: Cost structure of a typical online retailer selling imported UHT milk

1.2 (15%)

1.4 (17%)

0.8 (10%)

0.4 (5 %)

0

2

4

6

8

10

12

Rm

b8

/L

Rm

b1

2/L

Rmb/litre

Traiff

VAT

Fulfilmentexp

Ad & mkting exp

CIF

Breakeven price

Source: Credit Suisse estimates

To cater to domestic needs and play global price arbitrage, local dairy companies started

building strategic alliances with the international partners. This creates a cannibalisation

effect with their existing high-end UHT milk products, but helps on overall sales growth.

■ Mengniu (equity investment model): In 2012, Mengniu partnered up with Arla

Foods, a leading dairy company in Demark. Arla Foods is now a strategic shareholder

of Mengniu with a 5.3% stake. In September 2013, Mengniu introduced UHT organic

UHT milk in Shanghai, branded with "Arla". E-commerce platforms are the major

distribution channel.

■ Yili (OEM model): In November 2013, Yili established a strategic partnership with

Sterilgarda Alimenti, the largest dairy company in Italy. In September 2014, Yili

announced it would launch imported UHT product in China, under the brand name of

Perfectlands (a newly created name by Yili). Perfectlands is mainly distributed through

the e-commerce platform, and is priced higher than other imported UHT milk.

■ Bright Dairy (OEM model): In April 2014, Bright Dairy signed a strategic agreement

with Pactum Dairy Group (PDG), a leading Australia dairy company. Based on the

agreement, Bright imports PDG's UHT milk product from Australia, and then

distributes products in China under the brand name of U+. U+ is priced at the high end

of the retail price range on the e-commerce platform.

12 January 2015


Figure 29: Imported UHT whole milk price comparison

Brand name Company/

product origin

Package

size

Retail price

(Rmb)

Equivalent price

(Rmb/L)

Price/avg.-1

Oldenburger Nordmilch

(made in Germany) 1L 10.9 10.9 -28.1%

Arla Mengniu

(made in Denmark) 1L 12.9 12.9 -14.9%

Devondale Murray Goulburn

(made in Australia) 1L 13.9 13.9 -8.4%

Lactel Lactalis

(made in France) 200ml*24 23.9 16.5 8.8%

Anchor Fonterra

(made in New Zealand)

1L 16.9 16.9 11.4%

U+ Bright Dairy

(made in Australia) 250ml*10 49.8 19.9 31.2%

Perfectlands Yili

(made in Italy) 1L*4 95.2 23.8 56.9%

Average 15.2

Note: Listing price as of 23 Dec 2014 at Yihaodian; Source: Credit Suisse

Figure 30: Imported UHT whole milk equivalent price

10.9

12.913.9

16.5 16.9

19.9

23.8

0

5

10

15

20

25

Oldenburger(Nordmilch's)

Arla(Introduced by

Mengniu)

Devondale(Murray Goulburn's)

Lactel(Lactalis')

Anchor(Fonterra's)

U+(Bright dairy's)

Perfectlands(Yili's)

Rmb/L

Source: Yihaodian; Note: price as at 23 December 2014

12 January 2015


Go vertical to warrant product safety

Vertical integration is a common business model for most dairy companies in mature

markets. The purpose is for dairy processing companies to secure quality raw milk supply

and hence warrant the quality and consistency of finished dairy products.

After the sector-wide melamine scandal in September 2008, Chinese dairy companies

have started to invest more in the upstream farming business.

■ Mengniu was the IPO cornerstone investor of CMD and YST. Currently, Mengniu

owns a 28% equity stake in CMD and 4.4% in YST. Mengniu also signed off-take

contracts with CMD and Shengmu to lock raw milk supply. In addition, Mengniu builds

dairy farms on its own.

■ Yili was the IPO cornerstone investor of Huishan, investing Rmb310 mn in September

2013. It currently holds a 1.1% stake in Huishan.

In addition to that, Yili invested Rmb3.1 bn to develop the world's largest dairy base in

New Zealand.

Phase I: In April 2013, Yili bought the 100% stake of Oceania Dairy Limited and

started to build a new infant milk formula production project. The total investment

amounts to Rmb1,103 mn for a total capacity of 47,000 tonne.

Phase II: In November 2014, Yili invested another Rmb2,000 mn on four different

projects, namely NZ milk powder project (Rmb1,005 mn), NZ Infant milk formula

packaging project (Rmb332 mn), NZ raw milk processing project (Rmb201 mn), and

NZ UHT milk project (Rmb462 mn). The capacity of milk powder is up to 56,000 tonne.

The NZ dairy production base (total investment over Rmb3 bn) cover 380,000 sq m,

with the ability to process 1,400 tonne raw milk per day. It will be the largest dairy base

in the world, with function from processing, production to packaging. The Phase I IMF

project has already started to work with the ability to process 215,000 tonne each year

under full operation. Currently Yili has signed a purchasing contract with 47 local dairy

farmers to meet the production capacity.

Figure 31: Summary of Yili's projects in New Zealand

Investment time Project name Investment value

(Rmb mn)

Capacity

(ton)

Construction period

(month)

Phase 1: 2013 April IMF project 1,103 47,000 Operational now

Phase 2: 2014 Nov Milk powder project 1,005 56,000 19

Phase 2: 2014 Nov IMF packaging project 332 N/A 34

Phase 2: 2014 Nov Raw milk processing project 201 N/A 22

Phase 2: 2014 Nov UHT milk project 462 N/A 22

Total 3,103 380k sqm; 1,400 ton

raw milk output/day

Source: Credit Suisse research

■ Bright Dairy teamed up with RRJ Capital (a PE fund focusing on Asian consumer

space) for its upstream dairy farming business. In February 2014, RRJ Capital

invested Rmb1,525 mn cash for a 45% stake in Bright Holstan (an entity managing all

dairy farms, farms under construction and farm related business of Bright Dairy).

Bright Dairy owns the remaining 55% stake. The partnership helps Bright Dairy more

effectively develop upstream farming business with an easier financial burden.

12 January 2015


Stock picks: Yili, Bright, Mengniu, and Modern For 2015, we prefer downstream dairy processors (benefiting from the demand

recovery and low input cost) over upstream cow farming operators (raw milk price

under pressure on substitution effect of milk powder importing).

The criteria for our pecking order include:

(1) growth momentum in both top and bottom lines;

(2) growth quality (profitability, ROE, and management quality);

(3) valuation multiple.

Our pecking order is:

■ Yili differentiates itself from Mengniu as: (1) Yili has higher margin (6.7% net margin

in 2013, vs Mengiu's 3.8%) and ROE (27%, vs Mengniu's 12%), on product mix,

execution and a 40 bp lower opex ratio; and (2) Yili's management is well motivated

(the largest shareholder with an 11% stake, vs Mengniu's ~5%, including 3.9% of old

Mengniu management). President Pan Gang and others bought 1.6% in July 2014 at

Rmb24.81 (vs current price of Rmb30); and (3) Yili trades at 17x 2015E P/E or 16x

ex-cash (vs Mengniu's 21.7x and Bright's 27.5x).

■ We expect Bright to deliver a 46% earnings CAGR over 2014-16, benefiting from its

first-mover advantage in UHT yoghurt/Mosilian—a unique star category with a 40-50%

GP margin. Mosilian sales surged a 115% CAGR over 2011-13, and we expect a 27%

CAGR over 2014-16E (a 40% market share and 36% sales contribution in 2016).

■ We like Mengniu for its margin expansion potential. We expect it to be driven through

(1) leveraging expertise from Danone, Arla, White Wave and Yashili; (2) execution

improvement (distribution reform to bear fruits) and (3) refining product portfolio.

■ Without meaningful fundamental catalyst, Modern is a band-trading stock on

valuation.

Figure 32: Valuation table Figure 33: Business model and financial matrix at a

glance Rating Mktcap Trading Target Up- NP CAGR Trading

(US$ mn) price Price side 2014-16E 2015 P/E PEG 2015 P/E

Yili OP 14,123 28.9 40.0 39% 19% 24.0 1.2 17.3

Bright OP 3,513 18.6 24.0 29% 46% 36.0 0.8 27.9

Mengniu OP 8,285 33.4 40.0 20% 20% 26.0 1.2 21.7

Modern N 1,494 2.5 2.8 13% 8% 12.3 1.2 10.9

Target

Yili Mengniu Bright Modern

Establishment 1993 1999 1996 2006

Largest 11% mgmt 18% COFCO 54.6% Group 38.6% Yinmu

Mgmt holding 11% ~5% 4.54%

Distribution 2K+ POS, 2K+ POS, 700 POS, 70% to MN

Sales (Rmb mn) 47,454 43,357 16,179 3,289

- UHT yoghurt Just started Just started 20% ->36% (16) 0.0%

- Chilled yoghurt c12% c13% c10% 0.0%

- High-end UHT c8% c15% Just started 20.0%

- Powder c12% c8% c10% 0.0%

GP margin 28.6% 27.0% 34.9% 38.2%

Opex ratio 22.9% 23.3% 30.0% 6.5%

OP margin 5.5% 4.3% 4.2% 22.1%

Net margin 6.7% 3.8% 2.5% 14.6%

ROE 27.2% 11.7% 9.8% 8.9% Source: Note: price as of 9 Jan 2014; Source: Bloomberg, CS

estimates; closing price and TP are in Rmb

Note: 2013 financial numbers; Source: Company data, Credit Suisse

estimates

12 J

an

uary

201

5

Ch

ina D

airy

Sec

tor

18

Figure 34: Valuation matrix—Global dairy comparison

EPS PEG Div

Company name Ticker Mkt cap Performance (%) P/E (x) EV/EBITDA (x) P/B (x) ROE (%) CAGR % yld

Reuters (US$ mn) 1M 3M 12M 2014 2015 2016 2014 2015 2014 2015 2014 2015 2014-16 2015 12MF

Global dairy products producers

Nestle NESN.VX 230,637 2% 6% 11% 21.5 19.9 18.4 12.2 12.4 3.4 3.3 19.1% 17.0% 8.2% 2.4 3.3%

Abbott ABT.N 70,487 3% 10% 16% 20.2 20.3 18.0 13.5 12.8 2.7 2.4 13.4% 12.6% 6.0% 3.4 2.2%

Danone DANO.PA 41,333 -3% 7% 7% 20.7 18.6 16.8 9.1 9.5 3.5 2.3 13.7% 14.6% 10.8% 1.7 3.0%

Mead Johnson MJN.N 20,615 1% 8% 20% 27.3 24.5 22.0 18.1 16.4 26.8 17.7 175% 91% 11.3% 2.2 1.7%

Yakult 2267.T 8,733 2% 17% 21% 47.0 42.6 36.3 16.7 16.3 3.8 3.6 8.4% 8.7% 13.9% 3.1 0.4%

Fonterra FSF.NZ 8,678 -4% -7% 3% 59.6 16.0 14.5 10.0 6.5 1.5 1.4 2.4% 10.0% 103.0% 0.2 5.3%

Meiji Foods 2269.T 7,224 8% 34% 70% 43.7 30.1 26.2 9.3 8.9 2.6 2.4 6.0% 8.7% 29.3% 1.0 0.9%

Parmalat PLT.MI 5,120 -1% -4% -4% 19.6 18.4 16.9 8.5 8.8 1.3 1.2 7.0% 6.9% 7.6% 2.4 1.7%

Vina Milk VNM.HM 4,612 -1% -10% -13% 15.9 14.1 12.9 11.9 10.2 4.8 4.1 32.2% 32.3% 11.1% 1.3 4.4%

Dean Foods DF.N 1,760 6% 47% 9% (204) 20.2 17.1 8.7 4.9 2.6 2.5 -1.4% 11.3% n.a. n.a. 1.6%

Dairy Crest DCG.L 971 -7% 24% -13% 11.7 12.3 11.4 5.7 5.8 (2.2) 2.4 -18.4% 19.2% 1.2% 10.4 4.6%

Morinaga Milk 2264.T 839 1% 14% 30% 20.6 20.8 18.1 2.9 3.5 0.8 0.8 4.1% 3.9% 6.7% 3.1 1.7%

Simple avg. 10.7 22.1 19.5 10.9 9.9 4.4 3.7 21.4% 19.4% 18.8% 0.6 2.4%

Weighted avg. 22.4 20.7 18.8 12.3 12.2 4.5 3.7 24.4% 19.3% 10.8% 2.1 2.9%

Chinese dairy products producers

Inner Mongolia Yili 600887.SS 14,123 3% 10% 15% 19.8 16.4 13.9 14.9 12.4 4.3 3.8 24.2% 25.3% 19.1% 0.9 2.0%

Mengniu Dairy 2319.HK 8,285 13% -1% -10% 24.6 20.1 16.9 13.1 11.0 2.5 2.3 11.5% 12.1% 20.7% 1.0 1.1%

Bright Dairy 600597.SS 3,513 6% 4% -18% 38.1 26.6 19.4 19.3 14.6 4.7 4.2 12.3% 16.5% 40.0% 0.7 1.7%

Sanyuan Daily 600429.SS 1,225 -2% -12% 17% 122.9 (215) n.a. n.a. n.a. n.a. n.a. 2.8% -1.0% n.a. n.a. n.a.

GX Royal Dairy 002329.SZ 1,194 0% 51% 139% 168.8 139.9 36.2 n.a. n.a. 7.9 7.0 11.0% 14.0% 116.0% 1.2 0.7%

Simple avg. 74.8 (2.4) 21.6 15.8 12.7 4.8 4.3 12.4% 13.4% 48.9% 1.5 1.4%

Weighted avg. 34.2 13.9 15.8 13.7 11.2 3.8 3.4 17.5% 18.8% 25.4% 1.3 1.6%

Chinese milk powder producers

Beingmate 002570.SZ 2,726 -1% -1% -13% 36.1 26.3 21.5 32.0 22.7 3.6 3.8 8.3% 11.9% 29.6% 0.9 n.a

Biostime International 1112.HK 1,268 5% -35% -76% 11.4 10.8 10.1 7.7 7.3 2.9 2.6 26.7% 25.6% 6.4% 1.7 n.a

Yashili 1230.HK 1,042 0% -19% -50% 18.2 16.3 13.6 13.3 10.1 2.1 1.9 11.3% 15.2% 15.7% 1.0 2.7%

Synutra SYUT.OQ 317 7% 18% -34% 6.1 4.9 n.a. 3.8 n.a. n.a. 59.6% n.a. n.a. n.a

Simple avg. 21.9 14.9 12.5 17.6 11.0 2.9 2.7 15.5% 28.1% 17.2% 1.3 2.7%

Weighted avg. 22.4 17.7 14.8 18.8 14.1 2.7 2.6 11.6% 17.0% 17.9% 1.3 0.5%

Chinese raw milk producers

Huishan 6863.HK 2,557 -1% -19% -50% 10.9 10.7 9.4 9.4 7.4 n.a. n.a. n.a n.a 7.3% 1.5 3.9%

China Modern Dairy 1117.HK 1,494 9% -29% -39% 9.0 8.3 7.2 5.9 5.7 1.4 1.2 16.6% 16.6% 11.7% 0.7 1.1%

YuanShengTai 1431.HK 418 9% -31% -64% 5.8 4.8 3.7 5.0 4.0 0.6 0.5 10.1% 10.1% 24.8% 0.2 0.0%

Xinjiang Western Animal 300106.SZ 338 -6% -13% -3% 46.6 34.5 n.a n.a. n.a. n.a. n.a. n.a n.a n.a. n.a. n.a

Simple avg. 18.1 14.6 6.8 6.7 5.7 1.0 0.9 13.4% 13.4% 14.6% 2.9 1.7%

Weighted avg. 12.4 11.1 7.6 7.3 6.1 0.5 0.4 6.0% 6.0% 12.4% 1.1 0.4%

Note: Share price as of 8st Jan, 2015. Source: Reuters; Credit Suisse estimates

12 J

an

uary

201

5

Ch

ina D

airy

Sec

tor

19

Figure 35: Peer comparison—Yili, Mengniu and Bright Dairy

Yili Mengniu Bright Dairy

Rmb mn 2010 2011 2012 2013 1H14 Rmb mn 2010 2011 2012 2013 1H14 Rmb mn 2010 2011 2012 2013 1H14

Revenue 29,545 37,266 41,736 47,454 27,096 Revenue 30,265 37,388 36,000 43,357 25,836 Revenue 9,299 11,576 13,630 16,179 9,794

- Liquid milk 20,985 26,933 32,271 37,116 20,709 - Liquid Milk 26,872 33,701 32,336 37,903 21,765 - Dairy products 8,995 11,092 13,052 15,412 9,316

- Milk powder 4,623 5,642 4,484 5,512 3,041 - Milk powder 282 428 493 2,431 2,083 ** Liquid milk N/A 8,481 9,888 11,620 7,220

- Ice cream 3,544 4,222 4,294 4,243 3,040 - Ice cream 3,112 3,259 3,171 3,023 1,988 ** Other dairy N/A 2,611 3,164 3,792 2,097

- Feedstock 393 469 687 583 305 - Others 305 484 579 767 478

Revenue mix 100% 100% 100% 100% 100% Revenue mix 100% 100% 100% 100% 100% Revenue mix 100% 100% 100% 100% 100%

- Liquid milk 71% 72% 77% 78% 76% - Liquid Milk 89% 90% 90% 87% 84% - Dairy products 97% 96% 96% 95% 95%




Revenue YoY 22.0% 26.1% 12.0% 13.7% 13.6% Revenue YoY 17.7% 23.5% -3.7% 20.4% 25.0% Revenue YoY 20.5% 24.5% 17.7% 18.7% 32.1%

- Liquid milk 26.8% 28.3% 19.8% 15.0% 15.3% - Liquid Milk 18.2% 25.4% -4.1% 17.2% 19.2% - Dairy products 20.5% 23.3% 17.7% 18.1% 31.2%

- Milk powder 16.6% 22.1% -20.5% 22.9% 9.1% - Milk powder -2.5% 51.7% 15.2% 393.5% 361.7% ** Liquid milk N/A N/A 16.6% 17.5% 33.3%

- Ice cream 8.6% 19.1% 1.7% -1.2% 8.2% - Ice cream 15.9% 4.7% -2.7% -4.7% 1.7% ** Other dairy N/A N/A 21.2% 19.8% 24.5%

- Feedstock -7.7% 19.2% 46.4% -15.1% 2.4% - Others 21.3% 58.8% 19.5% 32.6% 52.8%

GP margin 30.2% 29.2% 29.6% 28.6% 33.2% GP margin 25.7% 25.7% 25.1% 27.0% 32.4% GP margin 35.5% 34.1% 35.5% 34.9% 35.0%

- Liquid milk 28.8% 26.5% 28.1% 26.1% 31.0% - Liquid milk 26.5% 26.1% 25.4% 26.0% 31.2% - Dairy products 35.5% 34.4% 36.2% 36.0% 36.2%

- Milk powder 39.0% 42.6% 39.5% 43.8% 45.9% - Milk powder 28.0% 29.0% 11.8% 52.0% 53.0% ** Liquid milk N/A 40.4% 43.3% 42.9% 42.4%

- Ice cream 29.2% 29.8% 32.3% 32.8% 36.9% - Ice cream 25.5% 22.0% 24.5% 24.5% 25.0% ** Other dairy N/A 15.0% 14.0% 15.0% 15.0%

- Feedstock 12.4% 13.7% 16.0% 11.3% 12.5% - Others 33.7% 28.3% 20.9% 12.1% 10.4%

GP mix 100% 100% 100% 100% 100% GP mix 100% 100% 100% 100% 100% GP mix 100% 100% 100% 100% 100%

- Liquid milk 68% 66% 74% 71% 72% - Liquid milk 89% 92% 88% 83% 81% - Dairy products 97% 97% 98% 98% 99%




SG&A/sales 28.1% 24.7% 25.2% 22.9% 24.6% SG&A/sales 20.3% 20.9% 21.6% 23.3% 28.7% SG&A/sales 31.4% 30.5% 30.9% 30.0% 30.9%

- Selling exp 22.9% 19.5% 18.5% 17.9% 19.1% - Selling exp 17.9% 17.9% 17.8% 18.8% 22.8% - Selling exp 28.5% 27.5% 27.7% 27.1% 28.2%

- Admin exp 5.1% 5.3% 6.7% 5.0% 5.4% - Admin exp 2.2% 2.5% 3.3% 3.7% 3.7% - Admin exp 2.9% 3.0% 3.2% 3.0% 2.7%

- Other exp 0.2% 0.5% 0.5% 0.8% 2.2%

OP 585 1,697 1,665 2,626 2,451 OP 1,909 2,070 1,513 1,852 1,221 OP 235 247 420 679 302

YoY -14.9% 190.1% -1.9% 57.7% 87.8% YoY 14.1% 13.7% -26.9% 22.3% 28.8% YoY 38.1% 5.1% 69.8% 61.8% 28.7%

OP margin 2.0% 4.5% 4.0% 5.5% 9.0% OP margin 6.3% 5.5% 4.2% 4.3% 4.7% OP margin 2.5% 2.1% 3.0% 4.2% 3.1%

Net earnings 777 1,809 1,717 3,187 2,293 Net earnings 1,237 1,589 1,257 1,631 1,049 Net earnings 194 238 311 406 209

YoY 20.0% 132.8% -5.1% 85.6% 31.9% YoY 4.3% 28.4% -20.9% 29.7% 39.9% YoY 58.7% 22.4% 30.9% 30.4% 41.5%

Net margin 2.6% 4.8% 4.1% 6.7% 8.4% Net margin 4.1% 4.3% 3.5% 3.8% 4.1% Net margin 2.0% 2.0% 2.3% 2.5% 2.1%

ROE 18.4% 30.0% 25.7% 27.2% ROE 13.5% 15.0% 10.5% 11.7% ROE 8.8% 9.9% 9.6% 9.8%


12 January 2015


Global peer comparison Figure 36: Peer comparison—business model, sales size and breakdown, and brands

Company Business model Brief introduction Sales and margin Sales breakdown Key brands

Fonterra

(NZ-based)

Dairy cooperative;

vertical integrated

(farming and

processing); listed in

NZ, market cap of

US$9 bn

Fonterra is the largest global milk processor

and dairy products exporter in the world. It

is a cooperatively-owned company and

owned by more than 10,000 New Zealand

farmers and public shareholders. Its milk

powder export accounts for above 60% of

China's total imports. Its dairy product

exports account for above 30% of world's

total exports.

FY12/6 sales of

NZ$19.8 bn

(US$16 bn), net

margin of 3%.

By geography:

Asia (ex-China)

29%, Australia

12%, China 10%,

NZ 10%, US 7%,

Europe 6%

Anchor,

Anmum and

Anlene

Friesland

Campina

(Netherland-

based)

Dairy cooperative;

vertical integrated

(farming and

processing); "from

grass to glass"

Friesland Campina is based in the

Netherlands, operating both upstream and

downstream dairy business. Together with

its member dairy farmers, it supplies dairy

products to both individual and professional

consumers in over 100 countries. It has

offices in 28 countries and 19,946

employees.

2012 sales of €10.3

bn (US$13.7 bn),

with net margin of

2.7%

By category: dairy

57%, cream,

cheese & butter

24%, ingredients

19%; By

geography:

Europe 59%, Asia

& Oceania 26%,

US & Africa 15%

Dutch Lady,

Friso, Fristi,

Fruttis, and

Campina

Arla Foods

(Denmark-

based)

Dairy cooperative;

vertical integrated

(farming and

processing)

Arla Foods is a cooperative owned by dairy

farmers in Denmark, Sweden, Germany,

UK, Luxemburg and Belgium. It is the

seventh largest dairy company with

production plants in 12 countries, sales

offices in 30+ countries, and 18k+

employees

2012 sales of

DKK63 bn

(US$11.2 bn), milk

10.4 bn kg, net

margin of 3%

By category: fresh

dairy 42%, cheese

25%, butter 14%,

others 19%; by

geography: UK

22%, Sweden

19% and Denmark

11%;

Arla &

Cravendale

(milk & cream),

Lurpak (butter)

and Castello

(cheese)

Dairy Farmers

of America

(US-based)

Dairy cooperative;

vertical integrated

(farming and

processing); "from

farm to table"

DFA (HQ in Kansas City) is a national milk

marketing cooperative. It is owned by and

serves nearly 13,000 dairy farmer members

(1.8 mn cows, 9K + farms in 48 states).

DFA buys raw milk from its members and

sells dairy products, food components,

ingredients, and shelf-stable dairy products

to wholesale buyers. 31 DFA-owned plants.

2010 net sales of

US$9.8 bn (30% of

total US raw milk);

marketed 63 bn

pounds (28.6 mn t)

of fluid milk in 2011

31 plants

throughout the

US

Borden®

Cheese, Cache

Valley®

Cheese,

Keller’s®

Creamery

Butter, Plugrá®

Butter,

Breakstone’s®

Butter, Kemps®

and Guida’s

Dairy

China

Mengniu

(China-based)

Mainly on

processing; secure

quality raw milk

supply through

minority equity

investment;

HK-listed; market

cap of US$7-8 bn

Established in 1999, Mengniu is the largest

liquid milk producer in China with a market

share of 25.4% in 2013, according to

Nielsen. In 2013, 94% raw milk was

sourced from scaled farms; of which, 20%

are self-built/operated/equity investment

and 74% with farms through cooperation.

Mengniu has an 80:20 JV with Danone,

65% stake in Yahsili, strategic partnership

with Arla, 28% interest in CMD and plans to

build a JV with CMD for pasteurised milk

production.

2013 sales of

Rmb43 bn, 7.7 mn

tons of capacity of

dairy products,

27.3% GP margin,

5.1% EBIT margin,

3.8% net margin

UHT 49%, milk

beverage 23%,

yoghurt 12.4%,

ice cream 7.7%,

Infant and dairy

products 8.1% in

1H14

UHT: Mengniu,

Milk Deluxe,

Future Star;

Milk beverage:

Fruit Milk Drink,

Suan Suan Ru,

Youyi C;

Yoghurt:

Champion,

Future Star; Ice

cream: Deluxe,

Ice+; Milk

powder:

Mengniu ARLA

Dean Foods

(US-based)

Processors of fluid

milk marketed under

more than 50 local

and regional dairy

brands and private

labels. US-listed,

market cap

~US$1.4bn.

Dean Foods is an American food and

beverage company that specialises in dairy

products. Dean Foods has 100 facilities

located in 35 American states as well as

five manufacturing plants in the countries of

Belgium, France, the United Kingdom, and

the Netherlands. Dean Food’s market share

in US fluid milk is 35.7% by volume.

2013 sales of

US$9bn, 2.8mn

gallons of fluid milk,

21% GP margin,

2.5% operating

margin, and 8.9%

ROIC.

Fluid milk: 73%;

Ice Cream: 9%;

Fresh cream: 3%;

ESL &

creamers:3%;

Cultured: 4%;

Others 7%. (2013)

US: Dean’s,

McArthur Dairy,

Garlick Farms,

Land Lakes,

Mayfield Dairy

Farms, Alta

Dena;

International:

TruMoo

12 January 2015


Figure 37: Peer comparison—business model, sales size and breakdown, and brands

Company Business model Brief introduction Sales and margin Sales breakdown Key brands

Agropur

(Canada-

based)

Dairy cooperative;

vertical integrated

(farming and

processing)

Founded in 1938, The Agropur cooperative

is the largest Canadian dairy company with

annualised sales of US$3 bn and a volume

of 2.7 bn litres). It has 3,615 shareholders

and 5,700 employees in 27 plants and

numerous distribution centres and offices

across Canada, the US and Argentina.

Agropur is the co-owner of Ultima Foods

with Agrifoods Intl Cooperative Ltd. Ultima

Foods markets yoghurt in Canada under

the Yoplait brand.

2012 sales of

US$3.8 bn

Fresh milk,

cheese, yoghurt,

butter

Québon, Oka,

Sealtest,

Natural, Island

Farms, Yoplait,

La Lacteo,

Trega and

Schrœder

Prairie Farms

Dairy (US-

based)

Dairy cooperative;

vertical integrated

(farming and

processing); US-

based

Founded in 1938, Prairie Farms (HQ in

Illinois) receives milk from 743 producers,

operates 24 plants, and produces dairy

products through 13 JV plants. In 2008, it

produced 1.4 bn pounds of milk, averaging

1.873 mn pounds per farm. It expanded

largely through M&A and JV with various

dairy cooperatives, producers, and

manufacturers.

FY2007-08 sale of

US$2.9 bn

Cheese, butter,

ice cream, sour

cream, cottage

cheese, various

dips, yoghurt, and

fluid milk. It

produces and

sells juices,

flavoured drinks,

and pre-made

iced tea

Prairie Farms;

North Star; Kids

China

Huishan

Dairy

(China-based)

Vertical integrated

(plantation, farming

and processing);

China-based

Commenced farming operation in 2009, HS

is the second largest cow farm operator in

China (50 farms, herd size of 112,851, raw

milk of 352,411 tonne, and yield of 9.1

tonne in FY13/3). In 2012, HS used 60%

raw milk to produce liquid milk and powder,

while the remainder was sold to Mengniu

and Yili. HS is the largest liquid milk

producer in Northeastern China (mainly

Liaoning & Jilin) with market share of

13.7%.

FY2013/3 sales of

Rmb2.553 bn

(US$412 mn), 54%

overall GPM, 59%

farming GPM; 45%

OP margin; 37.2%

net margin

Raw milk 27%,

liquid milk 67%,

milk powder 3%

and grain 3%

Dr Fresh (fresh

milk, 10% of

total); Jersey

Queen,

Nature's Farm

and Huishan

(UHT, 32%);

Colostrum, Ten

Days, Huishan

(yoghurt, 44%);

Wonderful (milk

beverage, 14%)

China Modern

Dairy (China-

based)

Mainly on farming,

gradually expanding

into processing; HK-

listed, market cap of

US$1.6 bn

Commenced farming operation in 2006,

CMD is the largest cow farm operator (22

mega farms, herd size of 176,300, raw milk

of 567,021 tons, and yield of 8.23 tonne in

FY13/6). Based on the ten-year off-take

contract, CMD should sell at least 70% raw

milk to Mengniu, and keep or sell the

remaining 30% to third parties (excluding

Yili).

FY2013/6 sales of

Rmb2.481 bn

(US$400 mn),

567,021 tons of raw

milk, 8.23 ton yield,

33.2% GP margin,

27.3% cash

EBITDA margin,

13.1% reported net

margin

Raw milk to

Mengniu 82%; raw

milk to others

15%; premium

UHT milk 3%

Modern Dairy

(premium UHT

milk)

Yili Mainly on

processing; secure

quality raw milk

supply through

global plants

investment;

China-listed; market

cap of US$13.6 bn

Established in 1993, Yili is the largest dairy

products in China. The core operating

business includes liquid milk, ice cream and

milk formula. Yili is the leading player in the

room-temperature products market and

leverage on its extensive distribution

network in China.

2013 sales of

Rmb48 bn, 28.7%

GP margin, 6.3%

EBIT margin, 6.7%

net margin

Liquid milk 76%,

milk powder 11%,

ice cream 11%,

Feed stock 1%

UHT: Satine,

QQ star,

Anmuxi; Yogurt :

Changqin,; Milk

powder: Pro-

kido, Tofer; Ice

cream: Qiaolezi,

Ice factory

Bright dairy Mainly on

processing; secure

quality raw milk

supply through

global partner

alliance ;

China-listed; market

cap of US$7-8 bn

Established in 1996, Bright dairy is the

largest pasteurized milk manufacture in

China. It specialises in the manufacture of

dairy products in Shanghai and East China.

The company is the first player to initiative

room-temperature yoghurt, Mosilian, which

is the key growth driver of the company.

2013 sales of

Rmb16 bn, 34.7%

GP margin, 4.7%

EBIT margin, 2.5%

net margin

Liquid milk 72%,

other dairy

products 23%,

commercial retail

5%

UHT:

Mosilian,U+;

Pasteurized

milk: Youbei;

Yoghurt:

Changyou,

Rushi; Milk

powder: Pure

Canterbury

Source: Company data, Fonterra, Friesland Campina, Arla Foods, Dairy Farmers of America, China Mengniu, Agropur, Prairie Farms Dairy,

Huishan, China Modern Dairy, Yili, Bright dairy, Credit Suisse

12 January 2015


Asia Pacific / China

(Consumer Staples CN (Asia))

Inner Mongolia Yili Industrial Group (600887.SS / 600887 CH)

INITIATION

High margin and ROE; management incentive

well aligned; attractive valuation

■ Initiate coverage with OUTPERFORM. Established in 1993, Yili is the

largest dairy company in China (a 20% market share in 2013, before

Mengniu's 19% and Bright Dairy's 8%), and the second-largest liquid milk

producer in China (a 23% market share in 2013, after Mengniu's 25.4%). We

forecast Yili's earnings will see a 19.4% CAGR over 2014-16, on a sales

CAGR of 12%.

■ Superior profitability and ROE. Yili and Mengniu share a similar business

model. Yili has higher profitability (a 6.7% net margin in 2013, vs Mengniu's

3.8%) and ROE (27% in 2013, vs Mengniu's 12%). We attribute the gap to:

(1) product mix (Yili has 12% sales exposure to high-margin IMF, vs

Mengniu's 6%); (2) product pricing (Yili's ice cream GP margin 32.8% vs

Mengniu's 24.5%); and (3) operating efficiency (Yili's opex/sales ratio of

22.9% was 40 bp lower than Mengniu and 710 bp lower than Bright).

■ Management well motivated. In July 2014, President Pan Gang and three

other management members bought 48.8 mn shares (1.6%) from the

secondary market at Rmb24.81 (vs the current share price of around

Rmb30). Top management is the largest shareholder of Yili, with an 11%

stake. This compares with Jinniu/Yinniu (old Mengniu)'s ownership of 3.9%

and CEO Sun Yiping's 0.43% (assuming all restricted reward share vested).

Management's personal interest is closely aligned with the share price,

favouring minority shareholders.

■ Our target price of Rmb40 is based on 24x 2015E P/E (implying 1.2x

PEG). Yili trades at 17x 2015E P/E (low-end of historical forward P/E band)

and 0.9x PEG. This also compares with Mengniu's 21.7x, Bright's 27x,

Tingyi'x 22x, UPC's 30.5x, Want Want's 20.6x, Hengan's 21.2x, Sunart's 18x

and Tsingtao's 24.5x. The investment risks include food safety, competition

and inflation.

Share price performance

0

100

200

300

0

20

40

11-Jan-13 11-Jan-14

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the

Shanghai Shenzhen CSI300 index which closed at 3559.26 on

09/01/15

On 09/01/15 the spot exchange rate was Rmb6.21/US$1

Performance Over 1M 3M 12M Absolute (%) 1.7 8.5 12.6 — Relative (%) -3.8 -1.3 0.1 —

Financial and valuation metrics

Year 12/13A 12/14E 12/15E 12/16E Revenue (Rmb mn) 47,778.9 54,407.5 60,794.8 67,880.8 EBITDA (Rmb mn) 3,768.7 5,780.5 7,096.1 8,232.5 EBIT (Rmb mn) 2,626.0 4,432.9 5,580.9 6,570.1 Net profit (Rmb mn) 3,187.3 4,165.2 5,102.5 5,938.0 EPS (CS adj.) (Rmb) 1.04 1.36 1.67 1.94 Change from previous EPS (%) n.a. Consensus EPS (Rmb) n.a. 1.45 1.76 2.07 EPS growth (%) 85.6 30.7 22.5 16.4 P/E (x) 27.1 20.7 16.9 14.5 Dividend yield (%) 1.9 1.9 2.4 2.8 EV/EBITDA (x) 21.8 14.0 11.1 9.3 P/B (x) 5.3 4.6 4.0 3.4 ROE (%) 27.2 24.0 25.3 25.3 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

Rating OUTPERFORM* Price (09 Jan 15, Rmb) 28.15 Target price (Rmb) 40.00¹ Upside/downside (%) 42.1 Mkt cap (Rmb mn) 86,262 (US$ 13,900) Enterprise value (Rmb mn) 81,201 Number of shares (mn) 3,064.37 Free float (%) 98.2 52-week price range 29.9 - 20.9 ADTO - 6M (US$ mn) 229.7

*Stock ratings are relative to the coverage universe in each

analyst's or each team's respective sector.

¹Target price is for 12 months.

Research Analysts

Kevin Yin

852 2101 7655

[email protected]

12 January 2015


Focus charts and tables Figure 38: 2013 Yili sales revenue mix Figure 39: Yili high-end products sales contribution

- Liquid milk78%

- Milk powder and other dairy

products12%

- Ice cream product

9%

- Feedstock1%

QQ star (QQ星)

15%

Satine (金典)

8%

Pro-Kido(金领冠)

4%

Qiaolezi (巧乐兹)

3%

Other high-end products

5%

Other products65%

Source: Company data Source: Credit Suisse estimates

Figure 40: OP margin comparison-Yili and Mengniu Figure 41: China raw milk price

2.0%

4.5%4.0%

5.5%

9.0%

6.3%

5.5%

4.2% 4.3%4.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

2010 2011 2012 2013 1H14

Yili OP margin Mengniu OP margin

1.50

2.00

2.50

3.00

3.50

4.00

4.50

Jan-

06

Jun-

06

Nov

-06

Apr

-07

Sep

-07

Feb-

08

Jul-0

8

Dec

-08

May

-09

Oct

-09

Mar

-10

Aug

-10

Jan-

11

Jun-

11

Nov

-11

Apr

-12

Sep

-12

Feb-

13

Jul-1

3

Dec

-13

May

-14

Oct

-14

(Rmb/kg)

Source: Company data Source: Wind

Figure 42: Yili—forward P/E (standard deviation) Figure 43: Yili—12M forward P/E band

0

20

40

60

80

100

'09 '10 '11 '12 '13 '14

P/E mean -1std

+1std -2std +2std

5

10

15

20

25

30

35

40

45

50

Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Yili 12x 15x

20x 25x 35x

Source: the BLOOMBERG PROFESSIONAL™ service Source: the BLOOMBERG PROFESSIONAL™ service

12 January 2015


Fast-growing high-margin product

Yili produces and markets around 1,000 products under around 30 brands. The star

products are Satine (high-end UHT), QQ Star (UHT kid milk), Shuhua (UHT function milk),

Pro-Kido (IMF) and Qiaolezi (ice cream). We estimate the star products accounted for

35% of Yili's total sales revenue in 2013.

We expect these star products to continue serving as growth and margin expansion

drivers for Yili in the next 3-5 years.

Figure 44: 2013 Yili sales revenue mix Figure 45: 2013 Yili gross profits mix

- Liquid milk78%

- Milk powder and other dairy

products12%

- Ice cream product

9%

- Feedstock1%

- Liquid milk71%

- Milk powder18%

- Ice cream10%

- Feedstock1%

Source: Company data Source: Company data

Figure 46: Yili high-end products sales contribution

QQ star (QQ星)

15%

Satine (金典)

8%

Pro-Kido (金领冠)

4%

Qiaolezi (巧乐兹)

3%

Other high-end products5%

Other products65%


12 January 2015


■ Satine (金典, high-end UHT milk, priced nearly 60% higher than plain UHT milk)

was launched in March 2007, competing with Mengniu's Deluxe (特伦苏) launched in

2006. Satine fell behind Deluxe for long time. Satine's sales amounted to Rmb3.8 bn

in 2013, representing Yili's 10% liquid milk revenue and 8% of total revenue. This

compared with Deluxe' sales size of Rmb6.6 bn in 2013, accounting for Mengniu's

17% liquid milk revenue and 15% of total revenue. However, Satine started to catch

up rapidly. In 1H14, Satine sales increased nearly 50% YoY, vs Deluxe's 14%.

■ QQ Star (QQ 星, priced nearly 70% higher than plain UHT milk) accounted for 19%

total liquid sales revenue and 15% of total sales in 2013. QQ Star was launched in

2006, competing with Mengniu's Future Star (未来星) launched in 2008 and Want

Want's Hot-Kid milk. We estimate QQ Star sales increased nearly 40% YoY in 1H14.

■ Shuhua (舒化奶, priced nearly 40% higher than plain UHT milk) accounted for 6%

total liquid sales revenue in 2013. Shuhua was launched in 2007, competing with

Mengniu's Xinyangdao (新养道) launched in 2008 and Bright Dairy's Youshu (优舒奶)

launched in end-2009.

■ Pro-kido (金领冠, IMF) was launched in 2008. GP margin was over 60% in 2013, vs

Yili's milk powder segment margin of 44% and Yashili's 53% in 2013. We estimate

Pro-kido sales increased over 50% in 2013, contributing 34% of Yili's milk powder

segment sales and 4% of total sales in 2013. According to Euromonitor, Yili is the

eighth-largest IMF company in China with a 3.8% market share, after Mead Johnson's

10%, Beingmate's 9.4%, Wyeth's 8.2%, International Nutrition's 7.8%, Biostime's 6%,

Yashili's 5.4% and Abbott's 4.1%.

■ Anmuxi (安慕希, UHT yoghurt) was lunched in end-2013, competing with Bright

dairy's Mosilian (莫斯利安 ) launched in 2009 and Mengniu's Chunzhen (纯甄 )

launched in 2H13. Anmuxi achieved over 100% QoQ growth in 2Q14. Management

expected it to achieve a Rmb1 bn sales revenue in 2014 (vs Mosilian's sales target of

Rmb6 bn). Yili planned to expand production lines up to 22 in 2015 from 5 in 2014. We

estimate Anmuxi will achieve Rmb3 bn sales in 2015.

■ Perfectlands (培兰, imported UHT milk) was launched in September 2014. It is

branded and distributed by Yili in China and manufactured by Sterilgarda in Italy. The

unique filter membrane technology helps save the protein level to the greatest extent.

The Perfectlands is mainly distributed through e-commerce platform. Given the cost

advantage in Europe and premium pricing in China (priced at high-end of imported

UHT price range, and even higher than Satine and Deluxe), we expect it to become

one of earnings and growth contributor in the coming 2-3 years.

12 January 2015


Figure 47: Yili sales breakdown by product category (2004-13)

67%74% 71% 69% 67% 68% 71% 72%

77% 78%

13%

11% 12% 14% 15%16%

16% 15%11% 12%

16%12% 14% 14% 15% 13% 12% 11% 10% 9%

3% 3% 2% 3% 3% 2% 1% 1% 2% 1%

0%

20%

40%

60%

80%

100%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Liquid milk Milk powder and other dairy products Ice cream product Feedstock Snack food


Extensive and efficient distribution network

Yili started to penetrate into rural area in China in 2007. It has established extensive

distribution network cross the whole country.

■ In terms of POS count, we estimate both Yili and Mengniu have nearly 2 mn, covering

more than 50% of total POS in China. We estimate Bright Dairy has nearly 700k POS.

■ In terms of geographic reach, we estimate Yili has greater coverage in direct sales

(modern trade) and rural area. Most of Bright Dairy's POS are located in modern trade

in Eastern China area.

■ In most of our distributor and industry expert interviews, Yili is highly rated for strong

management in display, inventory, pricing and working capital.

■ In 2013, Yili had 1.6% higher GP margin than Mengniu and 0.4% lower Opex ratio,

leading to a 1.2% higher OP margin. We attribute Yili's lower opex ratio to its strong

distribution and operation management.

12 January 2015


Figure 48: No. of POS comparison-Bright dairy, Mengniu

and Yili

Figure 49: OPEX ratio comparison-Yili and Mengniu (2010-

13)

c.700

c.2,000 2,000+

-

500

1,000

1,500

2,000

2,500

Bright dairy Mengniu Yili

'000

28.1%

24.7% 25.2%

22.9%24.6%

20.3% 20.9% 21.6%23.3%

28.7%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2010 2011 2012 2013 1H14

Yili OPEX raio Mengniu OPEX ratio

Source: Credit Suisse research Source: Company data

Figure 50: GP margin comparison—Yili and Mengniu

(2010-13)

Figure 51: OP margin comparison—Yili and Mengniu

(2010-13)

30.2%29.2% 29.6%

28.6%

33.2%

25.7% 25.7% 25.1%27.0%

32.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2010 2011 2012 2013 1H14

Yili GP margin Mengniu GP margin

2.0%

4.5%4.0%

5.5%

9.0%

6.3%

5.5%

4.2% 4.3%4.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

2010 2011 2012 2013 1H14

Yili OP margin Mengniu OP margin

Source: Company data Source: Company data

12 January 2015


Strategic alliance with global peers ■ Partnership with DFA for the milk power business

In July 2013, Yili entered into the strategic partnership with Dairy Farmers of America

(DFA), for procuring raw material and managing dairy farms.

DFA is the largest dairy cooperative in the US. It is owned by nearly 16,000 dairy farmer

members covering more than 9,000 dairy farms in 48 states, accounting over 30% of US

overall milk supply. It is Kraft and Dean Food's supplier. The production volume of liquid

milk was 27.5 mn t in 2013, which is 1.2x of China's total liquid milk production amount

(22.8 mn t) in 2013.

On 11 November 2014, Yili inked another deal with DFA to establish a milk powder JV

plant in Kansas with an annual capacity of 80,000 tonne. The total registered investment

amounted to US$100 mn. Yili invested US$30 mn for a 30% stake, and DFA 70%. Once

the plant commences operation in 2017, it would become the largest milk powder plant in

the US. The milk powder product will not only be exported into China (exact volume

number of the power to Yili is not disclosed), but also other countries.

With this strategic partnership, Yili is able access the international upstream milk/milk

powder source, lower/stabilise raw material cost, and improve execution and R&D skills.

Figure 52: Milk production volume comparison—DFA vs China as a whole

28.5 28.6 28.6 27.9 27.5

16.3

18.3

20.4 21.5

22.8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

2009 2010 2011 2012 2013

DFA China

mn ton

Source: CEIC, Credit Suisse

12 January 2015


Figure 53: A DFA dairy farm Figure 54: DFA membership network—more than 9,000

dairy farms in 48 states

Source: Company website Source: Company website

■ Partnership with Sterilgarda for imported UHT milk

In November 2013, Yili established a strategic partnership with Sterilgarda Alimenti.

Sterilgarda is the largest dairy company in Italy. It is reputed for its high quality milk source

and advanced filter membrane technology for UHT milk production (which saves protein

level to the greatest extent).

In September 2014, Yili launched Perfectlands, a new brand name that Yili created for its

imported UHT milk products. The UHT milk is produced by Sterilgarda in Italy, with 100%

raw milk sourced from Europe and through its unique filter membrane technology.

Perfectlands UHT milk is mainly distributed through the e-commerce platform. It is priced

at the high end of the price range of imported UHT milk, even higher than Yili's Satine and

Mengniu's Deluxe that are made of fresh premium raw milk in China.

Given the cost advantage in Europe and premium pricing in China, we expect decent

margin for Perfectlands once the production materialises.

Figure 55: Sterilgarda's UHT milk—advance filter

technology with longer life

Figure 56: Sterilgarda's dairy product portfolio—Yoghurt,

cream and cheese


12 January 2015


Figure 57: Price comparison—Perfectlands, Satine and Deluxe

Name Company Package size Retail price

(Rmb)

Equivalent price

(Rmb/L)

Deluxe Mengniu 250ml*12 63.8 21.3

Satine Yili 250ml*12 64.9 21.6

Perfectlands Yili 1L*4 95.2 23.8

Source: Yihaodian; Note: price as at Dec.23, 2014

12 January 2015


Figure 58: Imported UHT whole milk price comparison

Brand name Company/

product origin

Package

size

Retail price

(Rmb)

Equivalent price

(Rmb/L)

Price/avg.-1

Oldenburger Nordmilch

(made in Germany) 1L 10.9 10.9 -28.1%

Arla Mengniu

(made in Denmark) 1L 12.9 12.9 -14.9%

Devondale Murray Goulburn

(made in Australia) 1L 13.9 13.9 -8.4%

Lactel Lactalis

(made in France) 200ml*24 23.9 16.5 8.8%

Anchor Fonterra

(made in New Zealand)

1L 16.9 16.9 11.4%

U+ Bright Dairy

(made in Australia) 250ml*10 49.8 19.9 31.2%

Perfectlands Yili

(made in Italy) 1L*4 95.2 23.8 56.9%

Average 15.2

Note: Listing price as of 23 December 2014 at Yihaodian; Source: Credit Suisse

12 January 2015


■ Cooperation with Netherlands Wageningen University for R&D

In February 2014, Yili opened its European R&D Centre at Wageningen Campus in

Netherlands. The campus is located in the 'food valley' area, where a large number of

international food companies and research institutes are based. Taking advantage of the

location, Yili works with the university on farm management, dairy product processing and

food safety control.

In May 2014, Yili launched TOFER, a new high-end IMF brand and also the very first

product developed by the European R&D Centre. TOFER is made of 100% imported raw

materials. It is marketed through free trial, online marketing, and word-of-mouth.

Figure 59: TOFER infant milk formula series Figure 60: Online marketing through free trail


Management's personal interest aligned with share

price performance

In 2006, Yili issued 50 mn share options to the president, three president assistants and

other 29 core management members. This accounted for 9.7% of total share base then.

Upon option exercised in July 2013, management owned 8.6% of Yili, ahead of the second

largest shareholder of Hohhot Investment Company's 8.05%.

On 29-30 July 2014, the top-four management (including President Pan Gang) bought

another 48.8 mn share from the secondary market at an average price of Rmb24.81/share.

Post transaction, whole management owns 11% of Yili, ahead of the second-largest

shareholder of Hohhot Investment Company's 9.3%.

As the largest shareholder, management's personal interest is closely aligned with Yili's

fundamental development and share price performance. This ownership favours the

minority shareholders of Yili, in our view.

12 January 2015


Figure 61: Management owns 11% of Yili, the largest shareholder

Shareholders Percentage of total shares

Management team 11.0%

(1) Top 4 management 7.87%

- Gang Pan (President) 3.85%

- Chengxiao Zhao (CFO) 1.37%

- Chunhai Liu (VP) 1.36%

- Liping Hu (VP) 1.29%

(2) the rest of management 3.12%

Hohhot investment company 9.31%

A-share investors 79.7%

Total 100.0%


Figure 62: Yili shareholding structure

11.0% 9.3% 79.7%

-1% of 1H14 sales

- 0.4% of 1H14 GP

Feedstock and snack food

- 76% of 1H14 sales

- 72% of 1H14 GP

- 11% of 1H14 sales

- 15% of 1H14 GP

- 11% of 1H14 sales

- 12% of 1H14 GP

Management Hohhot invesment Public shareholder

Liquid milk Milk powder Ice cream

Inner Mongolia Yili (600887.SS)


Yili's incentive scheme and ownership compares with Mengniu.

■ Incentive scheme: Mengniu used to issue share options to motivate management.

After COFCO took over the control from founder Niu Gengshen, Mengniu switched to

the restricted share reward scheme (17.6 mn free shares vested to the management

team if business targets met; of which, nearly 48% goes to CEO Sun Yiping).

■ Ownership: COFCO owns 18% of Mengniu. Old Mengniu people (mainly founders,

suppliers, distributors, etc.; some are not involved in Mengniu operations any more)

own 3.9%. Assuming CEO Sun Yiping received all restricted share rewards, she would

own 0.43% of Mengniu.

Figure 63: Restricted share rewards

Restricted shares reward No. of shares As % of total shares

(1) 2013 reward scheme 17,569,400 0.90%

- Vested to Sun Yiping (CEO) in 5 years 8,425,800 0.43%

- Vested to other management 9,143,600 0.47%

(2) 2014 reward scheme (no breakdown) 6,055,000 0.31%

Shares of scheme (1)+(2) 23,624,400 1.21%

Total shares outstanding 1,958,326,175


12 January 2015


Figure 64: A glance at Mengniu's ownership and strategy

3.9% 18.0% 5.9% 4.1% 68.0%

100% 80% 51% 28%

Management

China Mengniu Dairy (2319.HK)

Free-float

Arla Foods

(1) Danone ow ns 25% of YSL;

(2) brands of "Yashily" and

"Scient"; (3) leading position in

2nd & 3rd-tier cities; (4) market

share (value): 2nd among

domestic, 5th in all

a JV w/ WhiteWave

(1) 51/49 by MN/WW; (2)

the initial assets w as YSL

Zhengzhou (priced at

Rmb510mn); (3) the JV to

produce and sell nutritious

products in China

COFCO

Existing biz CMD (1117.HK)

More than 70%

of CMD's quality

raw milk should

be supplied to

MN

UHT, milk beverage,

ice cream, yoghurt;

under brand name of

MN and JLB

a 80/20 JV w ith Danone for mid/high-end Yoghurt;

prepare to integrate in Sept; JV to establish in Dec;

1 plant in SH + 1 plant in GZ; Danone's old sales

team focus on SH&GZ; to leverage MN's distribution

coverage in the rest of China

a 80/20 JV with Danone Yashili (1230.HK)

Cooperation w ith Arla Foods

in (1) UHT organic milk; (2)

Baby & me (high-end

formula); (3) ice cream; (4)

farming

Arla Foods Danone


Upstream raw milk source management

Yili secures and controls the raw milk resource in Hulun Buir (呼伦贝), Xilingol (锡林郭勒)

and Tiansha (新疆天山), which are perceived as one of the best regions for raw milk

production. Currently, Yili has over 800 dairy farms in China, most of which are located in

the three regions.

Yili's first large scale dairy farm with 15k cows was constructed and commenced operation

in 2009. Yili was also the cornerstone investor of Huishan IPO in September 2013. Yili

invested Rmb310 mn for a 1.1% stake in Huishan. Currently, Huishan owns 162,394 cows

and 63 dairy farms in Liaoning province, which is the second largest dairy herd in China.

Figure 65: Yili's raw milk source arrangement

Hulun Buir

(呼伦贝尔)

Xilingol

(锡林郭勒)

Tiansha

(新疆天山)


In addition to that, Yili invested Rmb3.1 bn to develop the world's largest dairy base in

New Zealand.

12 January 2015


Phase I: In April 2013, Yili bought the 100% stake of Oceania Dairy Limited and started to

build a new infant milk formula production project. The total investment amounts to

Rmb1,103 mn for a total capacity of 47,000 tonne.

Phase II: In November 2014, Yili invested another Rmb2,000 mn on four different projects,

namely NZ milk powder project (Rmb1,005 mn), NZ Infant milk formula packaging project

(Rmb332 mn), NZ raw milk processing project (Rmb201 mn), and NZ UHT milk project

(Rmb462 mn). The capacity of milk powder is up to 56,000 tonne.

The NZ dairy production base (total investment of over Rmb3 bn) covers 380,000 sq m,

with the ability to process 1,400 tonne of raw milk per day. It will be the largest dairy base

in the world, with functions from processing, production to packaging. The Phase I IMF

project has already started to work with the ability to process 215k tonne each year under

full operation. Currently Yili has signed purchasing contracts with 47 local dairy farmers to

meet the production capacity.

Figure 66: Summary of Yili's projects in New Zealand

Investment time Project name Investment value

(Rmb mn)

Capacity

(tonne)

Construction period

(month)

Phase 1: 2013 April IMF project 1,103 47,000 Operational now

Phase 2: 2014 Nov Milk powder project 1,005 56,000 19

Phase 2: 2014 Nov IMF packaging project 332 N/A 34

Phase 2: 2014 Nov Raw milk processing project 201 N/A 22

Phase 2: 2014 Nov UHT milk project 462 N/A 22

Total 3,103 380k sq m; 1,400 tonne

raw milk output/day


Valuation

Our target price of Rmb40 is based on 24x 2015 P/E (implying 1.2x PEG), which is in line

with the average of China's dairy product companies' 2015E P/E. We also crosscheck with

a DCF methodology. Yili trades at 17x 2015 P/E (low-end of historical forward P/E band)

and 0.9x PEG. This also compares with Mengniu's 21.7x, Bright's 27x, Tingyi'x 22x, UPC's

30.5x, Want Want's 20.6x, Hengan's 21.2x, Sunart's 18x and Tsingtao's 24.5x.

Yili differentiates from Mengniu on: (1) Yili has higher margin (6.7% net margin in 2013, vs

Mengiu's 3.8%) and ROE (27%, vs Mengniu's 12%), on product mix, execution and 40 bp

lower Opex ratio; (2) Yili management is well motivated (the largest shareholder with 11%

stake, vs Mengniu's ~5%, including 3.9% old Mengniu management). President Pan Gang

and others bought 1.6% in Jul 2014 at Rmb24.81 (vs current price of Rmb30); and (3) Yili

trades at 17x 2015 P/E or 16x ex-cash (vs Mengniu's 21.7x and Bright's 27.5x).

Major investment risks

(1) Food safety

The 2008 melamine scandal had a negative impact on the China daily industry, including

Yili, which suffered a Rmb1.7 bn loss in 2008. The sales growth YoY decelerated to 11.9%

which is the lowest point during 2005-13. With consumer's rising concern about the health

issue, any food safety incident could negatively affect Yili's reputation, leading to the

decrease in sales volume of dairy products.

12 January 2015


Figure 67: Sales YoY growth was the lowest in 2008

12,175

16,580 19,360

21,659 24,324

29,665

37,451

41,991

47,779

39.4%

36.2%

16.8%

11.9% 12.3%

22.0%

26.2%

12.1%

13.8%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

-

10,000

20,000

30,000

40,000

50,000

60,000

2005 2006 2007 2008 2009 2010 2011 2012 2013

Yili sales revenue Sales YoY

Rmb mn


Figure 68: Huge loss in 2008 due to the melamine scandal

293 325

(21)

(1,687)

648 777

1,809 1,717

3,187

(2,000)

(1,000)

-

1,000

2,000

3,000

4,000

2005 2006 2007 2008 2009 2010 2011 2012 2013

Rmb mn


(2) Raw milk price fluctuation

We estimate that raw milk accounts for 50% of Yili's COGS, thus significant raw milk price

fluctuations or the failure to pass cost pressure to customer through price hike would

adversely affect Yili's GP margins.

12 January 2015


Figure 69: Yili cost structure Figure 70: China raw milk price

Raw milk50%

Packing cost23%

Other raw material

15%

Other manufacture

cost6%

Depreciation2%

Staff cost2% Utilities

2%

1.50

2.00

2.50

3.00

3.50

4.00

4.50

Jan-

06

Jun-

06

Nov

-06

Apr

-07

Sep

-07

Feb

-08

Jul-0

8

Dec

-08

May

-09

Oct

-09

Mar

-10

Aug

-10

Jan-

11

Jun-

11

Nov

-11

Apr

-12

Sep

-12

Feb

-13

Jul-1

3

Dec

-13

May

-14

Oct

-14

(Rmb/kg)

Source:Credit Suisse research Source: Wind

Figure 71: Liquid milk sales value breakdown by high-end liquid milk and mass market liquid milk

19% 21% 24% 26% 29% 32% 35% 38% 41% 45%

81% 79% 76% 74% 71% 68% 65% 62% 59% 55%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E

High-end liquid milk Mass market liquid milk

Source: Shengmu prospectus

(3) Industry competition

The China dairy industry is very competitive. Yili and Mengniu are the two largest national

players, with nearly a 40% market share. In each region, they compete with local players.

For example, Bright Dairy is the largest player in Shanghai, with above 50% market share.

12 January 2015


Figure 72: Key milestones of Yili

Year Event

1993 Inner Mongolia Yili was established

1996.3 Listed on Shanghai stock exchange

1999 Established first Liquid milk department in China

2003-2004 Yili's brand was ranked first position in the F&B sector in the most valuable brand ranking

2005 The first dairy company to reach Rmb10 bn sales revenue

2005.11 Became the exclusive dairy company to provide milk to Beijing Olympic Game

2009 Became the exclusive dairy company to provide milk to Shanghai EXPO

2010 Announced the new logo and vision; promoted to become the world class healthy food company

2012 Become the exclusive milk provider for China team in London Olympic Game

2014.2 Set up highest standard oversea R&D centre in Holland among China dairy companies

2014.7 Ranked No.10 among the global dairy companies


12 January 2015


Figure 73: Income statement (2010-16E)—Yili

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Gross revenue 29,665 37,451 41,991 47,779 54,408 60,795 67,881

- Product revenue 29,545 37,266 41,736 47,454 54,034 60,366 67,387

** Liquid milk 20,985 26,933 32,271 37,116 42,684 48,019 54,021

** Milk powder & others 4,623 5,642 4,484 5,512 6,174 6,791 7,402

** Ice cream 3,544 4,222 4,294 4,243 4,582 4,949 5,345

** Feedstock 393 469 687 583 595 607 619

- Other revenue 120 186 255 325 373 429 494

Revenue YoY 22.0% 26.2% 12% 14% 14% 12% 12%

- Product revenue 22.0% 26.1% 12% 14% 14% 12% 12%

** Liquid milk 26.8% 28.3% 20% 15% 15% 13% 13%

** Milk powder & others 16.6% 22.1% -21% 23% 12% 10% 9%

** Ice cream 8.6% 19.1% 2% -1% 8% 8% 8%

** Feedstock -7.7% 19.2% 46% -15% 2% 2% 2%

- Other revenue 4% 55% 37% 27% 15% 15% 15%

Sales revenue mix 100% 100% 100% 100% 100% 100% 100%

- Product revenue 100% 100% 99% 99% 99% 99% 99%

** Liquid milk 71% 72% 77% 78% 78% 79% 80%

** Milk powder & others 16% 15% 11% 12% 11% 11% 11%

** Ice cream product 12% 11% 10% 9% 8% 8% 8%

** Feedstock 1% 1% 2% 1% 1% 1% 1%

- Other revenue 0% 0% 1% 1% 1% 1% 1%

Business tax (88) (233) (249) (234) (272) (304) (339)

Business tax rate -0.3% -0.6% -0.6% -0.5% -0.5% -0.5% -0.5%

COGS (20,686) (26,486) (29,505) (34,083) (36,743) (40,673) (45,291)

Gross margin (%) 30.3% 29.3% 29.7% 28.7% 32.5% 33.1% 33.3%

- Product GP margin 30.2% 29.2% 29.6% 28.6% 32.4% 33.0% 33.2%

** Liquid milk 28.8% 26.5% 28.1% 26.1% 30.5% 31.0% 31.0%

** Milk powder & others 39.0% 42.6% 39.5% 43.8% 46.0% 48.0% 50.0%

** Ice cream 29.2% 29.8% 32.3% 32.8% 35.0% 35.0% 35.0%

** Feedstock 12.4% 13.7% 16.0% 11.3% 12.0% 12.0% 12.0%

- Other GP margin 42.2% 51.5% 53.7% 43.6% 35.0% 40.0% 40.0%

Product GP mix 100.0% 100.0% 100% 100% 100% 100% 100%

- Liquid milk 67.7% 65.7% 74% 71% 74% 75% 75%

- Milk powder & others 20.2% 22.1% 14% 18% 16% 16% 17%

- Ice cream 11.6% 11.6% 11% 10% 9% 9% 8%

- Feedstock 0.5% 0.6% 1% 0% 0% 0% 0%

SG&A / Sales (%) -28.1% -24.7% -25.2% -22.9% -24.6% -24.2% -23.8%

- Selling exp -22.9% -19.5% -18.5% -17.9% -19.2% -18.9% -18.6%

- Admin exp -5.1% -5.3% -6.7% -5.0% -5.4% -5.3% -5.2%

Operating profit 585 1,697 1,665 2,626 4,433 5,581 6,570

OP Profit YoY -14.9% 190.1% -1.9% 57.7% 68.8% 25.9% 17.7%

OP margin 2.0% 4.5% 4.0% 5.5% 8.1% 9.2% 9.7%

Financial expense 21 49 (49) 33 93 48 41

- Income tax rate (%) -7% -14% -17% 5% -14% -15% -15%

Minority interest -19 -23 -19 -14 (23) (25) (25)

Net earnings 777 1,809 1,717 3,187 4,165 5,103 5,938

Net earnings YoY 20.0% 132.8% -5.1% 85.6% 30.7% 22.5% 16.4%

Net margin 2.6% 4.8% 4.1% 6.7% 7.7% 8.4% 8.7%


12 January 2015


Figure 74: Balance sheet (2010-16E)—Yili

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Cash 3,342 3,921 2,004 8,173 9,561 11,685 14,700

Total current assets 7,558 8,727 6,207 16,467 17,671 20,916 23,788

Total non-current assets 7,805 11,202 13,608 16,410 17,838 19,072 20,160

Total Assets 15,362 19,930 19,815 32,877 35,508 39,989 43,948

Total current liabilities 10,199 12,866 11,478 15,517 15,614 17,008 17,379

Long-term borrowing 60 7 5 0 - - -

Account payable 5 0 0 0 - - -

Provision 70 58 64 102 102 102 102

Deferred tax liability 3 2 2 4 4 4 4

Other non-current liabilities 514 691 742 942 942 942 942

Total LT liabilities 652 758 813 1,048 1,047 1,047 1,047

Total Liabilities 10,850 13,624 12,290 16,565 16,661 18,055 18,426

Share capital 799 1,599 1,599 2,043 2,043 2,043 2,043

Additional paid-in capital 2,654 1,851 1,845 7,539 7,539 7,539 7,539

Surplus reserve 407 532 683 914 914 914 914

Retained earnings 359 2,043 3,209 5,641 8,140 11,202 14,765

Shareholder equity 4,219 6,024 7,335 16,125 18,637 21,698 25,261

Minority interest 294 282 190 188 211 236 261

Total liabilities and equity 15,362 19,930 19,815 32,877 35,508 39,989 43,948


Figure 75: Cash flow (2010-16E)—Yili

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Net earnings 795.8 1,832.4 1,736.0 3,201.3 4,188 5,128 5,963

OP cash flow before WC 1,414.9 2,349.5 2,758.9 3,935.4 5,629 6,690 7,667

Change in working capital 59.7 1,320.8 (350.3) 1,539.4 (133) 272 14

Net cash flow from

operating

1,475 3,670 2,409 5,475 5,496 6,963 7,681

FCF (118) (693) 2,234 2,746 4,213 4,931

CAPEX (1,987) (3,789) (3,102) (3,241) (2,750) (2,750) (2,750)

Net cash flow from

investing

(2,181) (3,476) (3,057) (6,260) (2,776) (2,750) (2,750)

Net cash flow from

financing

(87) (132) (905) 7,241 (1,345) (2,089) (1,916)

Net increase/(decrease) in

cash and cash equivalents

(793) 62 (1,554) 6,451 1,388 2,124 3,014


12 January 2015



Food Producers

Bright Dairy & Food Co., Ltd

(600597.SS / 600597 CH) INITIATION

UHT yoghurt to drive sales and margin

expansion; a national player in the making

■ Initiate coverage with OUTPERFORM. We initiate coverage on Bright Dairy

with an OUTPERFORM rating and a Rmb24 target price, implying 32% upside

potential. Established in 1996, Bright is the largest dairy company in Shanghai

(above 50% share), the third-largest dairy company in China (an 8% share),

the largest pasteurised milk producer in China (a 36% share), and the second-

largest yoghurt marker in China (a 16% share). We forecast Bright's earnings

will see a 46% CAGR over 2014-16, on a sales CAGR of 14%.

■ Mosilian: A great chance for Bright to go national. Bright created this UHT

yoghurt product in 2009. It has similar texture as chilled yoghurt, offers certain

nutrition, requires no cold-chain support, and enjoys a 40-50% gross margin.

Mosilian sales surged a 115% CAGR over 2011-13. We forecast a 27% sales

CAGR over 2014-16 (implying a 45% segment share in 2016). We expect

segment margin to expand from a negative 3.3% (2011) and 3.1% (2013) to

3.3-4.2% (2014-16), on economy of scale and operating leverage.

■ Expanding out of home market. East China contributes 60% revenue and

70% earnings, in our estimates. We believe the popularity of the new UHT

yoghurt would help Bright expand national coverage. To facilitate that, Bright

added additional 500k POS in 2014, lifting total POS count to 700k from

200k in 2013. We expect Mosilian's sales contribution to increase from 20%

(2013) to 36% (2016), the major growth and margin expansion contributor.

■ Our target price of Rmb24 is based on 36x 2015E P/E (implying 0.8x

PEG). This compares with: (1) our target 24x P/E and 1.2x PEG for Yili, (2)

target 25.5x P/E and 1.2x PEG for Mengniu, and (3) trading 1.5-2x PEG for

Tingyi, UPC, Hengan, Want Want, Sunart, and Tsingtao. Investment risks

include food safety, competition and inflation. Risks include stronger-than-

expected Mosilian sales and operating leverage.


0

100

200

300

0

20

40

11-Jan-13 11-Jan-14



Shanghai Shenzhen CSI300 index which closed at 3559.26 on

09/01/15

On 09/01/15 the spot exchange rate was Rmb6.21/US$1

Performance Over 1M 3M 12M Absolute (%) 9.0 7.1 -15.8 — Relative (%) 3.5 -2.6 -28.3 —


Year 12/13A 12/14E 12/15E 12/16E Revenue (Rmb mn) 16,290.9 20,436.2 23,824.3 26,675.6 EBITDA (Rmb mn) 1,003.7 1,152.4 1,610.4 2,125.7 EBIT (Rmb mn) 679.3 736.6 1,123.0 1,575.4 Net profit (Rmb mn) 406.0 533.0 805.4 1,134.6 EPS (CS adj.) (Rmb) 0.33 0.44 0.66 0.93 Change from previous EPS (%) n.a. Consensus EPS (Rmb) n.a. 0.47 0.67 0.91 EPS growth (%) 30.4 31.3 51.1 40.9 P/E (x) 54.9 41.8 27.7 19.6 Dividend yield (%) 1.1 1.4 2.2 3.1 EV/EBITDA (x) 21.3 19.3 13.8 10.6 P/B (x) 5.2 5.0 4.6 4.2 ROE (%) 9.8 12.2 17.3 22.5 Net debt/equity (%) net cash net cash net cash 3.9


Rating OUTPERFORM* Price (09 Jan 15, Rmb) 18.20 Target price (Rmb) 24.00¹ Upside/downside (%) 31.9 Mkt cap (Rmb mn) 22,398 (US$ 3,609) Enterprise value (Rmb mn) 22,185 Number of shares (mn) 1,230.64 Free float (%) 99.8 52-week price range 22.7 - 14.4 ADTO - 6M (US$ mn) 55.5




Research Analysts

Kevin Yin

852 2101 7655

[email protected]

12 January 2015


Focus charts and tables Figure 76 Dairy product market share in 2013 Figure 77: 2013 Bright Dairy sales breakdown by product

Yili

20%

Mengniu

19%

Bright

Dairy

8%Huishan

6%

Xiajin

3%

Sanyuan

3%

Others

41%

Low-temp dairy44%

UHT milk29%

Milk powder and others

27%

Source: AC Nielson, Credit Suisse Source: Company data, Credit Suisse

Figure 78: High-end products structure by sales revenue Figure 79: Mosilian sales, UHT NPM and overall NPM

Mosilian 20%

Changyou 7%

Ubest 6%

Other high-end prodcuts

7%

Others60%

200700

1,559

3,220

5,957

8,042

9,650

11,098

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

0

2000

4000

6000

8000

10000

12000

2009 2011 2013 2015E

Mosilian sales (Rmb mn) UHT product NPM

Overall NPM

Rmb mn

Source: company data, Credit Suisse Source: Company data, Credit Suisse estimates

Figure 80: Bright Dairy—forward P/E (standard deviation) Figure 81: Bright Dairy—12M forward P/E band

0

10

20

30

40

50

60

'09 '10 '11 '12 '13 '14

P/E mean -1std

+1std -2std +2std

5

10

15

20

25

30

Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Bright Dairy 20x 25x

35x 45x 55x


12 January 2015


Difference from Yili and Mengniu Established in 1996, Bright Dairy is the third largest dairy company in China, with an 8%

market share (in terms of sales) in 2013, after Yili's 20% and Mengniu's 19%.

Figure 82: Dairy product market share in 2013

Yili

20%

Mengniu

19%

Bright Dairy

8%Huishan

6%

Xiajin

3%

Sanyuan

3%

Others

41%

Source: AC Nielson, Credit Suisse

Bright Dairy differentiates itself from Yili and Mengniu in product portfolio and geographic

coverage.

■ Product portfolio: Bright focuses on low-temperature dairy (pasteurised milk, chilled

yoghurt), while Yili and Mengniu focus on UHT products (UHT milk, milk beverage,

and others).

Low-temperature products accounted for 44% of Bright's total sales in 2013, vs 8% for

Yili and 13% for Mengniu.

UHT products accounted for 29% of Bright's total sales in 2013, vs 70% for Yili and

51% for Mengniu.

40% of Bright sales come from high-end products, including UHT yoghurt Mosilian (莫

斯利安), chilled yoghurt Changyou (畅优) and pasteurised milk Ubest (优倍).

■ Geographic coverage: As a home market for Bright, Shanghai is the major sales and

earnings contributor for Bright.

Shanghai contributed 56% of total sales in 2013.

East China region contributed c.70% of milk and yoghurt sales, 73% of low-temp milk

and yoghurt sales, and 86% of low-temp milk and yoghurt net earnings in 2013.

Yili and Mengniu are national players. Their distribution network is relatively evenly

distributed cross the whole country. North and East China contributed c.70% of Yili's

sales in 2013.

■ A national player in the making: Given different strategy and disadvantage in raw

milk sourcing, Bright missed the opportunity of expanding out of Shanghai with UHT

milk products in 2009. The UHT milk market has been further consolidated by Yili and

Mengniu. In 2011, Bright created a brand new product—UHT yoghurt, providing

similar texture as chilled yoghurt, offering certain nutrition level, and requiring no cold

12 January 2015


chain support. This product was well received by Chinese consumers and became a

star product. Yili and Mengniu followed Bright and launched similar products in late

2013. Leveraging its strong sale momentum, we expect Bright to develop into a

national player in the next 5-10 years.

Figure 83: 2013 Bright Dairy sales breakdown by product Figure 84: 2013 Bright Dairy sales breakdown by region

Low-temp dairy44%

UHT milk29%

Milk powder and others

27%

- Shanghai56%

- Other regions of China

29%

- Overseas15%

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

Figure 85: Bright Dairy high-end products structure by sales revenue

Mosilian (莫斯利安, room-

temperature yoghurt)20%

Changyou (畅优, chilled yoghurt)

7%

Ubest (优倍, pasteurized milk)

6%

Other high-end prodcuts7%

Others60%

Source: company data, Credit Suisse

12 January 2015


First-mover advantage in UHT yoghurt…

In 2009, Bright created a brand new UHT yoghurt product—Mosilian (莫斯利安). Mosilian

provides similar texture as chilled yoghurt, offers a certain nutrition level, and requires no

cold chain support.

Upon launching, Mosilian was well received by the Chinese consumers.

■ Mosilian's sales revenue jumped from Rmb200 mn in 2010 (2% of total product sales)

to Rmb3.2 bn in 2013 (20% of total product sales), representing a 153% CAGR over

2010-13. In 1H14, Mosilian's sales revenue increased 95% YoY to Rmb2.8 bn.

■ We estimate Mosilian sales of Rmb6 bn (2014), Rmb8 bn (2015) and Rmb9.6 bn

(2016), representing a 27.3% CAGR.

■ To facilitate the growth potential, Bright has been rapidly expanding its distribution

network. It added nearly 500K POS in 2014, ramping up the total POS count to 700k

as of end-2014 (vs Yili and Mengniu's 2 mn each).

■ We estimate Mosilian has nearly 50% gross margin, vs 34% for its low-temp products,

30% for room-temp products, and 34.7% for group level. The 50% gross margin

provides lots of buffer to compensate for the incremental SG&A expense when

expanding out of East China regions. We expect the economy of scale and operating

leverage to drive up Bright's profitability in 204-16E.

Figure 86: Mosilian sales and market share forecast

2010 2011 2012 2013 2014E 2015E 2016E

Mosilian sales (Rmb mn) 200 700 1,559 3,220 5,957 8,042 9,650

- as % of UHT yoghurt 100% 100% 101% 101% 74% 56% 45%

- as % of UHT total 0% 1% 1% 2% 4% 5% 5%


Figure 87: Bright's Mosilian—once critical mass established, margin would pick up

200700

1,559

3,220

5,957

8,042

9,650

-0.1%

-3.3%

2.9%3.1%

3.3%3.8%

4.2%

2.0%2.0%

2.3%

2.5% 2.6%

3.4%

4.3%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

0

2000

4000

6000

8000

10000

12000

2010 2011 2012 2013 2014E 2015E 2016E

Mosilian sales (Rmb mn) UHT product NPM Overall NPM

Rmb mn


…Yili and Mengniu are catching up

Mengniu and Yili followed Bright and launch similar UHT yoghurt products—Chunzhen (纯

甄) and Anmuxi (安慕希)—at end-2013.

■ Yili's Anmuxi is priced nearly 12% cheaper than Bright's Mosilian. Mengniu's

Chunzhen is priced nearly 4% more expensive than Bright's Mosilian.

12 January 2015


■ We estimate each of Yili's and Mengniu's UHT yoghurt will record sales of around

Rmb1 bn and Rmb3 bn in 2014E and 2015E, respectively, vs Bright's Rmb8 bn and

Rmb9.6 bn.

■ We estimate UHT yoghurt segment will witness a 42% CAGR over 2014-18, outpacing

China overall dairy sales growth CAGR of 8-10%. We expect Bright to have a 50%

market share in the next five years.

Figure 88: Room temperature yoghurt price comparison—Anmuxi, Mosilian and Chunzhen

Name Company Package size Retail price

(Rmb)

Equivalent price

(Rmb/g)

Price/average-1

Anmuxi (安慕希) Yili 205g*12 49 19.9 -9.1%

Mosilian (莫斯利安) Bright Dairy 200g*12 53.9 22.5 2.7%

Chunzhen (纯甄) Mengniu 200g*12 55.9 23.3 6.4%

Average 21.9

Source: Yihaodian, Note: Price on 8 January 2015

Low-temp products: A long way to go for China

Low-temp products (pasteurised milk and chilled yoghurt) are growing rapidly in China,

especially in high-tier cities. However, given the cold-chain system bottleneck (leading to

higher selling price and availability), the contribution would remain lower than UHT milk for

the next five years. We believe low-temp products would dominate the China market in the

next 20 years.

■ We forecast pasteurized milk sales will see a 11.2% CAGR over 2014-18, accounting

for 5% of China total dairy consumption in 2018.

■ We forecast chilled yoghurt sales will see an 18% CAGR over 2014-18, accounting for

20% of China total dairy consumption in 2018.

Bright is the largest pasteurised milk producer and the second-largest chilled yoghurt

producer in China, with a more geographic focus in East China.

■ Pasteurised milk

Bright is the largest pasteurised milk producer in China, with a 36% market share in

terms of sales volume in 2013, vs the second player Sanyuan's 15%.

Ubest (优倍 , premium pasteurized milk) was launched in 2006. It is priced at

Rmb19.5/litre, around 27% higher than Bright's plain pasteurised milk. Despite the

high pricing, Ubest has been well received by consumers in the East China region.

Ubest sales revenue increased 38.3% YoY to Rmb900 mn, representing 6% of total

product sales or 13% of low-temp product sales.

■ Chilled yoghurt

12 January 2015


According to Euromonitor, Bright is the second-largest yoghurt producer in China, with

a 16% market share in terms of sales value. Mengniu (including contribution from

Junlebao) is the largest player, with a 19% market share.

Changyou (畅优, chilled yoghurt) was launched in 2007. It was priced at Rmb25.8/kg,

around 29% higher than Bright Dairy's plain chilled yoghurt and 10% higher than UHT

yoghurt Mosilian. Changyou's sales revenue increased 35.2% YoY to Rmb1.2 bn in

2013, representing 7% of total product sales or 17% of low-temp product sales.

Expanding out of East China is challenging, but

Mosilian is a chance

Bright's low-temp dairy products sales are highly concentrated in the East China region. In

2013, East China region contributed 73% of low-temp product sales, vs 16% for Central

China, 6% for South China and 5% for North China.

OP margin of East China is also the highest among all regions—14.1% vs 4.3% for

Central China, 3.1% for South China and negative 27.3% for North China in 2013.

Bright has nearly 700k POS, vs 2 mn POS for each of Yili and Mengniu. Most of Bright's

POS are concentrated in East China. Outside East China, Bright is relatively weak, but Yili

and Mengniu are more dominant.

It is challenging to explore new markets with chilled dairy products, as in each market that

has a developed cold-chain system there is a strong local player. For example, Sanyuan

(三元) is in Beigjing, Tianyou (天友) in Chongqing and Qinpai (琴牌) in Chongqing.

However, Mosilian created a business opportunity for Bright to develop out of East China,

even though Bright has to bear more advertising and marketing expenses for its adventure

in the rest of China, in our view.

Mosilian was launched in 2009. The incremental opex in the initial stage dragged down the

UHT segment net margin from 1.4% in 2009, to negative 0.1% in 2010 and negative 3.3%

in 2011. But once a critical mass is established, margin turned around to 2.9% in 2012 and

3.1% in 2013. We estimate Mosilian's sales will witness a 27% CAGR over 2014-16, and

segment margin to expand to 4.2% in 2016.

Global alliance for milk powder and UHT milk

Equity investment in Synlait NZL for milk powder business

■ Established in 2005, Synlait is one of the five independent milk processing companies

based in the Canterbury region of New Zealand. It mainly manufactures ingredients

and nutritional milk powders. The milk processing plant commenced production in

August 2008 with an annual milk processing capacity of 50,000 tonne.

■ In July 2010, Synlait Milk Limited spun off its milk production business, and retained

full ownership in its farming business. Synlait's milk production division then issued

26,021,658 new shares to Bright for NZ$82 mn. Bright then become the largest

shareholder of Synlait with a 51% stake.

■ In July 2013, Synlait was listed on the New Zealand Exchange. The company raised

NZ$75 mn through issuing 34 mn new shares. Post IPO, Bright Dairy remained the

largest shareholder of Synlait with a 39.12% stake. Synlait's IPO pricing implies nearly

a 25% annualised return for Bright.

■ In late 2011, Bright launched a high-end IMF product, Pure Canterbury. The new

product is manufactured by Synlait with local ingredients in New Zealand. It is then

marketed by Bright in China under Bright's brand name. Pure Canterbury sales

volume amounted to 625 tonne in 2013 and 1,250 tonne in 2014.

12 January 2015


Figure 89: Bright Dairy's stake in Synlait

Bright Dairy's investment in 2011

Old no. of shares 25,001,201

New issued no. of shares to Bright Dairy 26,021,658

Total no. of shares 51,022,859

Bright Dairy's stake 51%

Purchase price (NZ$/share) 3.15

Investment amount (NZ$ mn) 82

After IPO in 2013

Total no. of shares after split (1:2.2) 112,250,289

New issued no. of shares via IPO 34,090,910

Total no. of shares after IPO 146,341,199

IPO price (NZ$/share) 2.2

IPO proceeds (NZ$ mn) 75

No. of shares held by Bright Dairy 57,247,648

Bright Dairy's stake 39.12%

Bright Dairy's stake value as of IPO 126

Investment return 53.7%

Source: Company data, Credit Suisse

Partnership with Pactum Australia for UHT OEM

■ In April 2014, Bright Dairy signed a strategic agreement with Pactum Dairy Group

(PDG), a leading Australia dairy company.

■ Based on the agreement, Bright imports PDG's UHT milk product from Australia, and

then distributes products in China under the brand name of U+.

■ U+ is priced at the high end of the retail price range (66% higher than Bright Dairy's

plain UHT milk and 50% higher than domestic U+) on the e-commerce platform.

Figure 90: Pure Canterbury IMF series Figure 91: Premium raw milk source in Canterbury


12 January 2015


Figure 92: Bright Dairy UHT milk price comparison

Name Origin Package size Retail price

(Rmb)

Equivalent price

(Rmb/L)

Price premium

Pure milk China 1L 12 12 66%

U+ China 250ml*12 39.9 13.3 50%

Imported U+ Australia 250ml*12 49.8 19.9

Source: Yihaodian. Note: price on 7 January 2015

Valuation

Our target price of Rmb24 is based on 36x 2015 P/E (implying 0.8x PEG). We also

crosscheck with a DCF methodology. This compares with: (1) our target 24x PE and 1.2x

PEG for Yili, (2) target 25.5x PE and 1.2x PEG for Mengniu, and (3) trading 1.5~2x PEG

for Tingyi, UPC, Hengan, Want Want, Sunart, and Tsingtao.

We expect Bright to deliver 46% earnings CAGR over 2014-16E, benefiting from its first-

mover advantage in UHT yoghurt/Mosilian – a unique star category with 40-50% GP

margin. Mosilian sales surged 115% CAGR over 2011-13, and we expect 27% CAGR over

2014-16E (40% market share and 36% sales contribution in 2016).

Investment risks

1) Food safety

The 2008 melamine scandal had a negative impact on the Chinese industry, including

Bright, which suffered Rmb286 mn loss in 2008. With consumers' rising concern on health

issues, any food safety incident could negatively affect Bright's reputation, leading to the

decrease in sales volume of dairy products.

(2) Raw milk price fluctuation

We estimate that raw milk accounts for 50% of Bright's COGS, thus significant raw milk

price fluctuation or the failure to pass cost pressure to customer through price hike would

adversely affect Bright's GP margin.

3) Industry competition

China dairy industry is very competitive. Yili and Mengniu (the two largest national players)

are quickly catching up with Bright’s UHT yoghurt (accounting for 20% total sales in 2013),

which could negatively affect Bright’s sales growth.

12 January 2015


Figure 93: Income statement—Bright

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Total revenue 9,572 11,789 13,775 16,291 20,436 23,824 26,676

(1) Product sales revenue 9,299 11,576 13,630 16,179 20,335 23,718 26,564

- Dairy products 8,995 11,092 13,052 15,412 19,415 22,659 25,378

** Liquid milk 8,481 9,888 11,620 15,054 17,776 20,006

Mosilian (莫斯利安) 200 700 1,559 3,220 5,957 8,042 9,650

Changyou(畅优 ) 880 1,190 1,428 1,642 1,839

Ubest(优倍 ) 651 900 1,170 1,463 1,755

Other liquid milk 6,797 6,310 6,499 6,629 6,762

** Powder & ice cream 2,611 3,164 3,792 4,361 4,884 5,372

- Others 305 484 579 767 921 1,059 1,186

(2) Other revenue 273 213 145 112 101 106 111

Revenue growth YoY % 21% 23% 17% 18% 25% 17% 12%

(1) Product sales revenue 20% 24% 18% 19% 26% 17% 12%

- Dairy products 20% 23% 18% 18% 26% 17% 12%

** Liquid milk 17% 18% 30% 18% 13%

Mosilian (莫斯利安) 107% 85% 35% 20%

Changyou(畅优 ) 35% 20% 15% 12%

Ubest(优倍 ) 38% 30% 25% 20%

Other liquid milk -7% 3% 2% 2%

** Powder & ice cream 21% 20% 15% 12% 10%

- Others 21% 59% 20% 33% 20% 15% 12%

(2) Other revenue 21% -22% -32% -23% -10% 5% 5%

Product revenue mix 100% 100% 100% 100% 100% 100% 100%

- Dairy products 97% 96% 96% 95% 95% 96% 96%

** Liquid milk 0% 73% 73% 72% 74% 75% 75%

Mosilian (莫斯利安) 2% 6% 11% 20% 29% 34% 36%

Changyou(畅优 ) 6% 7% 7% 7% 7%

Ubest(优倍 ) 5% 6% 6% 6% 7%

Other liquid milk 50% 39% 32% 28% 25%

** Powder & ice cream 0% 23% 23% 23% 21% 21% 20%

- Others 3% 4% 4% 5% 5% 4% 4%

Gross margin (%) 34.5% 33.5% 35.1% 34.7% 34.6% 35.3% 35.7%

(1) Products 35.5% 34.1% 35.5% 34.9% 34.8% 35.5% 35.9%

- Dairy products 35.5% 34.4% 36.2% 36.0% 35.9% 36.6% 37.0%

** Liquid milk 40.4% 43.3% 42.9% 42.0% 42.5% 42.8%

** Powder & ice cream 15.0% 14.0% 15.0% 15.0% 15.2% 15.5%

- Others 33.7% 28.3% 20.9% 12.1% 11.0% 11.0% 11.0%

(2) Other 1.9% -3.8% -5.6% 13.5% 2.0% 2.0% 2.0%

SG&A / Sales (%) -31.4% -30.5% -30.9% -30.0% -30.1% -29.9% -29.2%

- Selling exp -28.5% -27.5% -27.7% -27.1% -27.1% -27.0% -26.3%

- Admin exp -2.9% -3.0% -3.2% -3.0% -3.0% -2.9% -2.9%

Operating profit 235 247 420 679 737 1,123 1,575

OP YoY 38.1% 5.1% 69.8% 61.8% 8.4% 52.5% 40.3%

OP margin 2.5% 2.1% 3.0% 4.2% 3.6% 4.7% 5.9%

Financial expense (27) (47) (65) (53) (53) (67) (73)

Income tax rate (%) 6% -13% 20% 33% 25% 25% 25%

Net earnings 194 238 311 406 533 805 1,135

Net earnings YoY 58.7% 22.4% 30.9% 30.4% 31.3% 51.1% 40.9%

Net margin 2.0% 2.0% 2.3% 2.5% 2.6% 3.4% 4.3%


12 January 2015


Figure 94: Balance sheet—Bright

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Cash 1,139 1,114 2,339 2,600 2,180 2,331 1,947

Total current assets 3,107 3,751 4,962 6,411 6,721 7,180 7,367


Total Assets 5,975 7,374 9,339 11,568 12,483 13,480 14,142

Total current liabilities 2,562 3,817 3,960 5,948 6,547 7,152 7,300

Total long-term liabilities 726 722 955 596 659 679 679

Total liabilities 3,288 4,539 4,915 6,544 7,206 7,831 7,979

Ordinary shares 1,049 1,049 1,225 1,225 1,225 1,225 1,225

Additional paid-in capital 448 454 1,677 1,756 1,756 1,756 1,756

Statutory reserves 256 277 321 364 364 364 364

Retained earnings 577 668 777 920 1,133 1,455 1,909

FX statement translation (1) 3 13 13 13 13 13

Shareholder equity 2,329 2,452 4,014 4,278 4,491 4,813 5,267

Minority interest 357 383 411 746 786 836 896

Total liabilities and equity 5,975 7,374 9,339 11,568 12,483 13,480 14,142


Figure 95: Cash flow—Bright

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Net earnings 228 271 335 475 573 855 1,195

OP cash flow before WC 498 606 760 830 1,042 1,410 1,818

Change in working capital 36 (516) 482 475 (485) 96 (422)

Net cash flow from operating 534 89 1,242 1,305 553 1,496 1,384

FCF 191 (888) 150 111 (461) 482 370

Cash paid for buying fixed assets,

intangible assets and other long-term

assets

(344) (977) (1,091) (1,195) (1,014) (1,014) (1,014)

Net cash flow from investing (319) (931) (910) (1,040) (1,016) (1,014) (1,014)

Net cash flow from financing 9 821 893 (4) 42 (331) (753)

Balance of foreign currency statement

translation

(0) (1) (1) (1) (0) - -

Net increase/(decrease) in cash and

cash equivalents

223 (21) 1,225 260 (421) 151 (383)


12 January 2015



Food Producers

China Mengniu Dairy

(2319.HK / 2319 HK) UPGRADE RATING

Apprehension of slowdown and earnings miss

fairly discounted; upgrade to OUTPERFORM

■ Upgrade to OUTPERFORM from Neutral. We believe that the market has

fairly factored in apprehensions of a consumption slowdown and Mengniu's

earnings miss in its share price, after plenty of discussion on supply/demand

and CMD's raw milk price. The situation turned out to be: (1) dairy

consumption slowdown was not the worst within the whole consumer industry;

and (2) Mengniu's 2014 earnings are likely to be above market expectations.

■ 2014 OP margin likely to expand 100 bp. Mengniu's management guided

at the reverse roadshow that: (1) 2014 sales up 15-16% YoY (in line with our

assumption of 15.6%); (2) OP margin up 100 bp (vs our 30 bp); and (3) net

margin up 100 bp (vs our 20 bp). Margin improvement came from price lifts,

mix upgrade and efficiency. For 2015, management targets: (1) double-digit

growth (vs our 9%) and (2) margin improvement (vs our 40 bp).

■ Distribution reform ongoing. In high-tier cities, Mengniu introduced "CBU"

model—MN's own sales team will replace third-party distributors who are

downgraded to the logistics providers. CBU contributes 13% of total revenue.

In 2015, it is to be rolled out to the entire Shanghai and a part of Beijing. This

new model requires a higher level of managerial skills and causes sales

disruption, especially when demand is sluggish. However, upon the system

well established, Mengniu is able to manage the distribution network more

effectively and efficiently.

■ Our target price of HK$40 (from HK$35) is based on 26x 2015E P/E

(implying 1.2x PEG). Mengniu trades at 21.7x 2015E P/E (mid-point of the

historical forward P/E band) and 1.0x PEG. This also compares with Yili's

17x, Bright's 27x, Tingyi'x 22x, UPC's 30.5x, Want Want's 20.6x, Hengan's

21.2x, Sunart's 18x and Tsingtao's 24.5x. The investment risks include food

safety, competition and inflation. Catalysts are stronger-than-expected sales

growth, margin and contribution from YSL and CMD.


80

130

180

20

30

40

50

60

Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14



MSCI CHINA F IDX which closed at 6950. on 09-01-15

On 09-01-15 the spot exchange rate was HK$7.75/US$1

Performance Over 1M 3M 12M Absolute (%) 14.8 0.5 -8.3 — Relative (%) 9.4 -9.3 -20.7 —


Year 12/13A 12/14E 12/15E 12/16E Revenue (Rmb mn) 43,356.9 50,134.0 54,638.3 60,951.1 EBITDA (Rmb mn) 2,940.5 3,635.9 4,401.9 5,174.9 EBIT (Rmb mn) 1,724.7 2,430.0 3,007.0 3,609.5 Net profit (Rmb mn) 1,630.9 1,995.6 2,418.0 2,953.5 EPS (CS adj.) (Rmb) 0.90 1.02 1.23 1.50 Change from previous EPS (%) n.a. 3.4 6.8 2.0 Consensus EPS (Rmb) n.a. 1.07 1.31 1.56 EPS growth (%) 26.0 13.4 21.2 22.1 P/E (x) 29.7 26.2 21.7 17.7 Dividend yield (%) 0.6 1.9 2.8 3.4 EV/EBITDA (x) 19.3 15.2 12.3 10.0 P/B (x) 3.2 3.2 3.0 2.8 ROE (%) 11.7 12.6 14.4 16.5 Net debt/equity (%) 26.0 15.1 10.5 net cash


Rating (from Neutral) OUTPERFORM Price (09 Jan 15, HK$) 33.30 Target price (HK$) (from 35.00) 40.00¹ Upside/downside (%) 20.1 Mkt cap (HK$ mn) 65,221 (US$ 8,411) Enterprise value (Rmb mn)

55,120 Number of shares (mn) 1,958.59 Free float (%) 68.0 52-week price range 42.8 - 27.6 ADTO - 6M (US$ mn) 22.5




Research Analysts

Kevin Yin

852 2101 7655

[email protected]

12 January 2015


Focus charts and tables Figure 96: A glance at Mengniu's ownership and strategy

3.9% 18.0% 5.9% 4.1% 68.0%

100% 80% 51% 28%

Management

China Mengniu Dairy (2319.HK)

Free-float

Arla Foods

(1) Danone ow ns 25% of YSL;

(2) brands of "Yashily" and

"Scient"; (3) leading position in

2nd & 3rd-tier cities; (4) market

share (value): 2nd among

domestic, 5th in all

a JV w/ WhiteWave

(1) 51/49 by MN/WW; (2)

the initial assets w as YSL

Zhengzhou (priced at

Rmb510mn); (3) the JV to

produce and sell nutritious

products in China

COFCO

Existing biz CMD (1117.HK)

More than 70%

of CMD's quality

raw milk should

be supplied to

MN

UHT, milk beverage,

ice cream, yoghurt;

under brand name of

MN and JLB

a 80/20 JV w ith Danone for mid/high-end Yoghurt;

prepare to integrate in Sept; JV to establish in Dec;

1 plant in SH + 1 plant in GZ; Danone's old sales

team focus on SH&GZ; to leverage MN's distribution

coverage in the rest of China

a 80/20 JV with Danone Yashili (1230.HK)

Cooperation w ith Arla Foods

in (1) UHT organic milk; (2)

Baby & me (high-end

formula); (3) ice cream; (4)

farming

Arla Foods Danone


Figure 97: 2015 sales breakdown Figure 98: 2015 net earnings breakdown

UHT milk

47%Milk

beverages

23%

Yogurt

15%

Ice cream

7%

Dairy

products

2%

Yashili

6%

Mengniu

core

82%

Yashili

9%

CMD

9%

Source: Credit Suisse estimates Source: Credit Suisse estimates

Figure 99: Mengniu—forward P/E (standard deviation) Figure 100: Mengniu—12M forward P/E band

5

15

25

35

45

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Mengniu 12m fwd PE Average -1 stdev +1 stdev

(X)

+1 stdev = 30.3x

Average = 22.9x

-1 stdev = 15.4x

5

10

15

20

25

30

35

40

Jan/

06

Jun/

06

Nov

/06

Apr

/07

Sep

/07

Feb

/08

Jul/0

8

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/08

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/09

Oct

/09

Mar

/10

Aug

/10

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11

Jun/

11

Nov

/11

Apr

/12

Sep

/12

Feb

/13

Jul/1

3

Dec

/13

May

/14

Oct

/14

(HK$)

10x

18x

26x34x42x


12 January 2015


Figure 101: Income statement—Mengniu

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Total Sales 30,265 37,388 36,000 43,357 50,134 54,638 60,951

Sales YoY 17.7% 23.5% -3.7% 20.4% 15.6% 9.0% 11.6%

Liquid milk 18.2% 25.4% -4.1% 17.2% 12.9% 9.1% 11.5%

- UHT 18.3% 24.1% -5.4% 11.9% 11.4% 5.0% 8.0%

- Milk beverages 14.9% 13.3% -3.3% 29.7% 12.7% 8.0% 9.0%

- Yogurt 27.5% 65.9% 0.8% 18.1% 19.6% 26.5% 26.5%

Ice cream 15.9% 4.7% -2.7% -4.7% 6.4% 7.0% 12.0%

Dairy products -2.5% 51.7% 15.1% 393.5% 69.2% 9.5% 11.5%

- Dairy products -2.5% 51.7% 15.1% 89.1% 7.3% 8.0% 10.0%

- Yashili 107.6% 10.0% 12.0%

Sales mix 100% 100% 100% 100% 100% 100% 100%

Liquid milk 89% 90% 90% 87% 85% 85% 85%

- UHT 55% 56% 55% 51% 49% 47% 46%

- Milk beverages 24% 22% 22% 24% 23% 23% 23%

- Yogurt 9% 12% 13% 13% 13% 15% 17%

Ice cream 10% 9% 9% 7% 6% 6% 6%

Dairy products 1% 1% 1% 6% 8% 8% 8%

- Dairy products 1% 1% 1% 2% 2% 2% 2%

- Yashili 0% 0% 0% 3% 6% 6% 6%

Gross margin 25.7% 25.7% 25.1% 27.3% 28.3% 28.4% 28.6%

Liquid milk 26.5% 26.1% 25.4% 26.0% 25.9% 26.0% 26.3%

- UHT 26.4% 26.5% 25.0% 25.6% 25.6% 25.6% 25.6%

- Milk beverages 27.0% 25.0% 25.0% 26.5% 26.0% 26.2% 26.5%

- Yogurt 25.5% 26.0% 27.5% 26.5% 27.0% 27.2% 28.0%

Ice cream 25.5% 22.0% 24.5% 24.5% 25.0% 25.0% 25.0%

Dairy products 28.0% 29.0% 11.8% 52.0% 55.0% 55.0% 55.0%

SG&A (6,159) (7,818) (7,798) (10,134) (14,313) (15,490) (17,005)

SG&A as % of sales -20.3% -20.9% -21.6% -23.4% -28.6% -28.4% -27.9%

OP 1,821 2,070 1,513 1,852 2,430 2,952 3,609

YoY 14.7% 13.7% -26.9% 22.3% 31.2% 21.5% 22.3%

OP margin 6.0% 5.5% 4.2% 4.3% 4.8% 5.4% 5.9%

Finance costs (45) (61) (42) (160) (295) (295) (295)

PBT 1,538 2,061 1,685 2,204 2,775 3,301 4,102

Income tax (182) (276) (245) (367) (472) (561) (697)

Profit for the year 1,356 1,785 1,440 1,838 2,303 2,740 3,404

Profit for the year from

discontinued operations

24

Minority (119) (195) (182) (231) (307) (363) (451)

Reported earnings 1,237 1,589 1,257 1,631 1,996 2,377 2,953

Earnings growth (%) 10.9% 28.4% -20.9% 29.7% 22.4% 19.1% 24.2%

Net margin (%) 4.1% 4.3% 3.5% 3.8% 4.0% 4.4% 4.8%


12 January 2015


Figure 102: Balance sheet—Mengniu

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Non-current assets 7,642 9,815 11,230 24,018 24,025 26,172 25,440

Cash and cash equivalents 6,698 6,523 5,778 7,102 8,867 9,608 12,383

Current assets 9,664 10,387 9,761 15,225 14,069 13,805 17,009

Current liabilities 6,238 7,226 6,981 17,860 15,227 15,789 16,617

Non-current liabilities 850 927 938 4,265 3,550 3,558 3,569

Minority interests 459 578 629 2,650 2,958 3,320 3,771

Issued capital 179 181 181 186 186 186 186

Retained earnings and

other reserves

9,579 11,290 12,262 15,174 16,172 17,123 18,304

Final dividend

Shareholders' equity 9,758 11,471 12,443 15,361 16,359 17,310 18,491

Total equity (mi + sh's eq) 10,218 12,049 13,072 18,011 19,316 20,630 22,262


Figure 103: Cash flow—Mengniu

(Rmb mn) 2010 2011 2012 2013 2014E 2015E 2016E

Net profit before tax 1,538 2,061 1,685 2,229 2,775 3,301 4,102

Operating profit before working

capital change

2,474 2,725 2,393 3,181 3,355 4,041 4,833

Net cash from operating activities 2,485 2,520 2,007 3,284 2,698 4,663 3,925

Capex (1,138) (2,387) (2,299) (2,857) (2,857) (2,857) (2,857)

Net cash from investing activities (2,204) (1,645) (3,239) (15,269) (2,158) (2,141) (2,040)

Net cash from financing activities (396) (238) (181) 12,331 (998) (1,426) (1,772)

Increase in cash and cash equivalents (115) 637 (1,414) 346 (458) 1,096 113

Other adjustments 663 (812) 669 978 2,223 (356) 2,662

Cash and cash equivalents at beginning

of year

6,150 6,698 6,523 5,778 7,102 8,867 9,608

Cash and cash equivalents at end of

year

6,698 6,523 5,778 7,102 8,867 9,608 12,383


12 January 2015



Agricultural Products & Agribusiness

China Modern Dairy Holdings Ltd (1117.HK / 1117 HK)

UPGRADE RATING

Close to the end of tunnel with low visibility;

upgrade to NEUTRAL on attractive valuation

■ Upgrade to NEUTRAL from Underperform on attractive valuation. Modern's

share price dived from the recent peak of HK$4.19 (17 Sep) to trough HK$1.88

(9 Dec), discounting: (1) raw milk price weakness and (2) negative media reports

on the farm shut-down and inappropriate waste management. Dust settles;

valuation becomes attractive.

■ Fundamental close to the bottom; visibility remains low. Mengniu and

Modern recently set 1Q15 raw milk price at Rmb4.6-4.7/kg. Rmb4.3-4.5/kg is

likely the bottom, as we see: (1) some loss-making farmers already started

slaughtering cows for beef; (2) Beijing is stepping in, urging local

government to offer help (including subsidy); and (3) NZL auction price is

picking up (China's dairy downstream companies still sit on high-cost powder

inventory. Once out of stock, they are to import powder, leading to a higher

international price, which favours Modern's raw milk price.

■ Next catalyst to come in 4Q15. We believe the raw milk price pick-up is the

key catalyst for the share price rebound, despite nearly 20% sales coming

from the downstream UHT business. We expect milk price to stabilise in

summer and trend up in 4Q15. However, before that, we will likely experience

some turmoil, given (1) high 1H14 (both mill price Rmb5.14/kg and OPM

33.5% are historical high) would cause a massive 1H15 decline; and (2) bio-

assets loss would enlarge (lower milk price leading to lower NPV for cows).

■ Our DCF-based TP of HK$2.80 (from HK$3.25) implies 12.3x/9.8x 2015E

reported/recurrent earnings. Modern Dairy trades at 1.2x 2015E P/B, low-

end of the historical range. 2015 is a transitional year. We forecast 2015

reported earnings will decline 3% (operating deleverage) on sales growth of

12% (an 8% ASP drop wiping off volume growth). We estimate 2016

earnings and sales will grow 19% and 18%, respectively.


0

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150

200

0

2

4

6

Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14



MSCI CHINA F IDX which closed at 6950. on 09-01-15

On 09-01-15 the spot exchange rate was HK$7.75/US$1

Performance Over 1M 3M 12M Absolute (%) 12.7 -25.9 -36.3 — Relative (%) 7.2 -35.6 -48.8 —


Year 12/13A 12/14E 12/15E 12/16E Revenue (Rmb mn) 3,289.3 4,893.0 5,498.6 6,479.5 EBITDA (Rmb mn) 929.4 1,500.2 1,402.1 1,584.7 EBIT (Rmb mn) 760.5 1,305.8 1,196.8 1,374.3 Net profit (Rmb mn) 481.4 897.0 873.1 1,037.9 EPS (CS adj.) (Rmb) 0.10 0.19 0.18 0.22 Change from previous EPS (%) n.a. -3.2 -9.5 -8.1 Consensus EPS (Rmb) n.a. 0.21 0.23 0.27 EPS growth (%) 17.2 87.1 -2.7 18.9 P/E (x) 20.0 10.7 11.0 9.2 Dividend yield (%) 0 0 0 0 EV/EBITDA (x) 15.4 9.7 10.4 8.9 P/B (x) 1.7 1.4 1.2 1.1 ROE (%) 8.9 14.3 11.9 12.2 Net debt/equity (%) 80.1 70.6 61.8 48.5


Rating (from Underperform) NEUTRAL* Price (09 Jan 15, HK$) 2.49 Target price (HK$) (from 3.25) 2.80¹ Upside/downside (%) 12.4 Mkt cap (HK$ mn) 12,020 (US$ 1,550) Enterprise value (Rmb mn)

14,514 Number of shares (mn) 4,827.34 Free float (%) 28.4 52-week price range 4.18 - 2.01 ADTO - 6M (US$ mn) 9.6




Research Analysts

Kevin Yin

852 2101 7655

[email protected]

12 January 2015


Focus charts and tables Figure 104 China raw milk price Figure 105: NZ milk powder price vs China raw milk price

1.50

2.00

2.50

3.00

3.50

4.00

4.50

Jan-

06

Jun-

06

Nov

-06

Apr

-07

Sep

-07

Feb

-08

Jul-0

8

Dec

-08

May

-09

Oct

-09

Mar

-10

Aug

-10

Jan-

11

Jun-

11

Nov

-11

Apr

-12

Sep

-12

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-13

Jul-1

3

Dec

-13

May

-14

Oct

-14

(Rmb/kg)

3.00

3.20

3.40

3.60

3.80

4.00

4.20

4.40

2500

3000

3500

4000

4500

5000

5500

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6500

11/3

/201

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2/3/

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/201

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/201

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2/3/

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5/3/

2014

Intl milk poder price China raw milk price

(USD/metric tonne) (Rmb/kg)

Source: Wind Source: Bloomberg and CEIC

Figure 106: CMD ASP, Cash EBIT margin and net margin Figure 107: Sales mix change (2013-16E)

4.7

5.0

4.6

4.7

12%

17%

22%

27%

32%

4.4

4.5

4.6

4.7

4.8

4.9

5.0

5.1

2013 2014E 2015E 2016E

CMD ASP Cash EBITDA margin Net margin

Rmb

Net

external

raw milk

90%

liquid milk products

10%

Net

external raw milk

74%

Sales of

cows 2%

Lliquid

milk products

24%

Source: company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 108: Modern—forward P/E (standard deviation) Figure 109: Modern—12M forward P/E band

10.0

15.0

20.0

25.0

30.0

35.0

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-14

Aug-

14

Nov-

14

12m fwd PE Average -1 stdev +1 stdev

(X)

Average=20.4x

-1 stdev = 15.4x

+1 stdev = 25.4x

1.5

2

2.5

3

3.5

4

4.5

Nov

/10

Feb/

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/14

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/14

(HK$) 26x

22x

20x

24x

18x


12 January 2015


Figure 110: Income statement—Modern

Rmb mn 2010 2011 2012 2013 2014E 2015E 2016E

Total sales 782 1,392 2,035 3,289 4,893 5,499 6,479

(1) Net external raw milk sales 1,978 2,968 4,093 4,189 4,798

* Sales to Mengniu 2,360 2,865 2,932 3,359

* Sales to others 608 1,228 1,257 1,440

(2) Sales of dairy cows 0 100 110 121

(3) liquid milk products 56 321 700 1,200 1,560

Sales YoY (%) 78% 46% 62% 49% 12% 18%

(1) Net external raw milk 50% 38% 2% 15%

* Sales to Mengniu 21% 2% 15%

* Sales to other external 102% 2% 15%

(2) Sales of dairy cows 10% 10%

(3) liquid milk products 470% 100% 100% 30%

Sales mix 100% 100% 100% 100% 100% 100% 100%

(1) Net external raw milk 90% 84% 76% 74%

* Sales to Mengniu 97.6% 97.0% 96.0% 72% 59% 53% 52%

* Sales to other external 2.4% 3.0% 4.0% 18% 25% 23% 22%

(2) Sales of dairy cows 0% 2% 2% 2%

(3) liquid milk products 10% 14% 22% 24%

Gross profit margin(%) 34.6% 31.1% 32.1% 38.2% 35.9% 31.6% 30.8%

- Upstream 38.1% 34.1% 33.2%

* Raw milk 39.0% 35.0% 34.0%

* Dairy cow 0.0% 0.0% 0.0%

- Downstream 23.0% 22.5% 23.5%

SG&A/sales -6.2% -6.8% -6.7%

- Selling exp -2.0% -2.3% -2.3%

* Upstream -1.5% -1.4% -1.3%

* Downstream -5.3% -5.3% -5.3%

- Admin exp -4.2% -4.5% -4.4%

Income from operations 139 331 423 843 1,506 1,417 1,616

YoY (%) 138% 28% 99% 79% -6% 14%

Operating margin (%) 17.8% 23.7% 20.8% 25.6% 30.8% 25.8% 24.9%

Gain arising from changes in fair

value less costs to sell of dairy

cows

63 76 96 (82) (200) (220) (242)

Cash EBITDA 197 383 544 1,021 1,700 1,622 1,827

YoY (%) 94.7% 42.0% 87.8% 66.5% -4.6% 12.6%

Cash EBITDA margin (%) 25.1% 27.5% 26.7% 31.0% 34.7% 29.5% 28.2%

Finance costs -47 -60 -101 -208 -250 -250 -250

Effective tax rate (%) 0.0% 0.0% 0.8% 2.0% 2.0% 2.5% 2.8%

Minority interests -50 -7 -14 -26 -40 -50 -55

Reported net earnings 105 313 409 481 897 873 1,038

YoY (%) 198.5% 30.7% 17.7% 86.3% -3% 19%

Net margin (%) 13.4% 22.5% 20.1% 14.6% 18.3% 15.9% 16.0%

Recurrent earnings 66 237 313 564 1,097 1,093 1,280

YoY (%) 262% 32% 80% 95% 0% 17%

Net margin (%) 8.4% 17.1% 15.4% 17.1% 22.4% 20% 20%


12 January 2015


Figure 111: Balance sheet—Modern

Rmb mn 2010 2011 2012 2013 2014E 2015E 2016E

Cash and cash equivalents 251 1,022 518 369 782 827 1,082

Total current assets 505 1,660 1,099 2,037 2,821 3,347 4,230


Total assets 4,204 6,907 8,652 12,494 14,657 16,391 18,138

Total current liabilities 738 787 1,493 4,472 4,899 5,440 6,143

Total non-current

liabilities

892 1,393 2,018 2,150 2,790 2,890 2,690

Total liabilities 1,631 2,179 3,511 6,622 7,689 8,330 8,833

Minority interests 1,133 55 66 118 143 183 216

Share capital 0 413 413 415 415 415 415

Reserves 1,436 4,255 4,653 5,328 6,395 7,448 8,670

Total shareholders’

equity

1,437 4,668 5,066 5,743 6,810 7,863 9,085

Total liabilities and

shareholders' equity

4,200 6,902 8,644 12,483 14,642 16,376 18,134


Figure 112: Cash flow—Modern

Rmb mn 2010 2011 2012 2013 2014E 2015E 2016E

Profit before taxation 107 225 407 350 956 947 1,124

Operating cash flows before movements in

working capital

116 282 422 663 1,550 1,802 2,309

Cash from operations 118 292 544 669 1,622 1,888 2,412

Income tax paid 0 0 0 -3 -19 -24 -31

Net cash provided by operating activities 118 292 543 666 1,603 1,864 2,380

Free cash flow -1,160 -1,206 -1,708 -1,604 -53 112 628

Purchases of items of PPE -535 -655 -842 -854 -600 -600 -600

Net cash (used in)/ provided by investing

activities

-1,268 -1,718 -2,076 -2,552 -1,616 -1,710 -1,708

Net cash provided by/(used in) financing 579 2,120 941 1,511 426 -110 -417

Net cash increase (decrease) in cash and

cash equivalents

-571 693 -591 -375 413 44 256


12 January 2015


Companies Mentioned (Price as of 09-Jan-2015)

Abbott Laboratories (ABT.N, $45.68) Beingmate (002570.SZ, Rmb16.57) Biostime (1112.HK, HK$16.54) Bright Dairy & Food Co., Ltd (600597.SS, Rmb18.2, OUTPERFORM, TP Rmb24.0) China Mengniu Dairy (2319.HK, HK$33.3, OUTPERFORM, TP HK$40.0) China Modern Dairy Holdings Ltd (1117.HK, HK$2.49, NEUTRAL, TP HK$2.8) Dairy Crest (DCG.L, 453.4p) Danone (DANO.PA, €53.22) Dean Foods Company (DF.N, $18.76) Fonterra (FSF.NZ, NZ$6.0) Huishan (6863.HK, HK$1.38) Inner Mongolia Yili Industrial Group (600887.SS, Rmb28.15, OUTPERFORM, TP Rmb40.0) Mead Johnson Nutrition Co. (MJN.N, $101.41) Meiji Holdings (2269.T, ¥11,330) Morinaga Milk (2264.T, ¥404) Nestle (NESN.VX, SFr72.65) Parmalat (PLT.MI, €2.358) RoyalGroup (002329.SZ, Rmb27.85) Sanyuan Foods (600429.SS, Rmb8.57) Sun Art (6808.HK, HK$7.82) Synutra Int (SYUT.OQ, $5.53) Tingyi (0322.HK, HK$17.7) Tsingtao (0168.HK, HK$52.8) U-Presid China (0220.HK, HK$6.9) Vietnam Dairy Products Joint Stock Company (VNM.HM, D103000.0) Want Want China Holdings Ltd. (0151.HK, HK$10.06) Western Animal (300106.SZ, Rmb12.72) Yakult Honsha (2267.T, ¥6,310) Yashili (1230.HK, HK$2.36) YuanShengTai Dairy Farm (1431.HK, HK$0.83)

Disclosure Appendix

Important Global Disclosures

I, Kevin Yin, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for China Mengniu Dairy (2319.HK)

2319.HK Closing Price Target Price

Date (HK$) (HK$) Rating

16-Jan-12 19.98 18.00 U

17-Jun-12 19.80 23.00 O

28-Aug-12 23.10 27.00

08-May-13 21.80 25.70

20-May-13 27.05 30.00

08-Jul-13 28.60 31.50

30-Aug-13 32.80 38.00

19-Sep-13 33.95 39.50

12-Feb-14 37.95 47.50

27-Mar-14 39.15 49.00

14-Jul-14 37.25 46.50

28-Aug-14 35.45 45.00

02-Oct-14 32.00 35.00 N

* Asterisk signifies initiation or assumption of coverage.

U N D ERPERFO RM

O U T PERFO RM

N EU T RA L

12 January 2015


3-Year Price and Rating History for China Modern Dairy Holdings Ltd (1117.HK)

1117.HK Closing Price Target Price

Date (HK$) (HK$) Rating

16-Jan-12 1.71 3.25 O

18-Sep-12 2.04 2.80

27-Feb-13 2.61 3.10

08-Jul-13 2.19 2.80

19-Sep-13 2.73 3.40

31-Oct-13 3.61 4.50

05-Jun-14 3.36 4.10

02-Oct-14 3.60 3.25 U

* Asterisk signifies initiation or assumption of coverage. O U T PERFO RM

U N D ERPERFO RM

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As of December 10, 2012 Analysts’ stock rating are defined as follows:

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*Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector , with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12 -month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total retu rn relative to the average total return of the relevant country or regional benchmark.

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Rating Versus universe (%) Of which banking clients (%)

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Underperform/Sell* 14% (43% banking clients)

Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.

12 January 2015


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Price Target: (12 months) for Bright Dairy & Food Co., Ltd (600597.SS)

Method: Our target price of Rmb24 for Bright Dairy & Food Co., Ltd is based on 36x 2015 P/E (implying 0.8x PEG). This compares with: (1) our target 24x PE and 1.2x PEG for Yili, (2) target 25.5x PE and 1.2x PEG for Mengniu, and (3) trading 1.5~2x PEG for Tingyi, UPC, Hengan, Want Want, Sunart, and Tsingtao.

Risk: Risks that could impede achievement of our Rmb24 target price for Bright Dairy & Food Co., Ltd include: food safety, raw milk price fluctuations, industry competition (other players are quickly catching up to Bright's UHT yoghurt, which accounted for 20% of total sales in 2013) and inflation.

Price Target: (12 months) for Inner Mongolia Yili Industrial Group (600887.SS)

Method: Our target price of Rmb40 for Inner Mongolia Yili Industrial Group is based on 24x 2015 P/E (implying 1.2x PEG), which is in line with the average of Chinese dairy product companies' 2015 P/E. Yili trades at 17x 2015 P/E (mid-point of historical forward P/E band) and 0.9x PEG.

Risk: Risks that could impede achievement of our Rmb40 target price for Inner Mongolia Yili Industrial Group include food safety, competition and inflation.

Price Target: (12 months) for China Modern Dairy Holdings Ltd (1117.HK)

Method: We use a DCF (discounted cash flow) model as our primary matrix to value China Modern Dairy Holdings Ltd (CMD). Compared with the multiple method, a DCF model is better to capture CMD's long-term growth rather than focus on current and next year earnings, given (1) CMD's earnings visibility is high, on the back of its ten-year off-take agreement with Mengniu; and (2) it will take some years for CMD to reach a normalised stage when it will have 30 dairy farms in operation. Assuming a WACC of 13.4% and terminal growth of 2%, our DCF-based target price of HK$2.80 implies 12.3x/9.8x 2015E reported/recurrent earnings.

Risk: Our DCF-based target price for China Modern Dairy Holdings Ltd is HK$2.80. We believe downside risks include: (1) food safety; (2) animal disease; (3) over-reliance on one product and one customer; and (4) short history and track record. Upside risks include: (1) stronger-than-expected milk yield improvement; (2) faster ramp-up of new dairy farms; and (3) stronger sales growth of Mengniu.

Price Target: (12 months) for China Mengniu Dairy (2319.HK)

Method: Our TP of HK$40 for China Mengniu Dairy is based on 24x 2015E P/E (implying 1.1x PEG) vs Tingyi’s 23x, WW’s 21x, Hengan's 21x,

Sunart’s 19x, and Tsintao’s 26x (all on consensus).

Risk: Risks that could impede achievement of our target price of HK$40 for China Mengniu Dairy include worse-than-expected sales recovery and deteriorating consumer confidence on dairy products due to the food safety issue.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names

The subject company (600597.SS, 0322.HK, NESN.VX, MJN.N, FSF.NZ, VNM.HM, 1431.HK) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.

Credit Suisse provided investment banking services to the subject company (NESN.VX, MJN.N, 1431.HK) within the past 12 months.

Credit Suisse provided non-investment banking services to the subject company (NESN.VX) within the past 12 months

Credit Suisse has managed or co-managed a public offering of securities for the subject company (NESN.VX) within the past 12 months.

Credit Suisse has received investment banking related compensation from the subject company (NESN.VX, MJN.N, 1431.HK) within the past 12 months

Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (600597.SS, 0322.HK, 0151.HK, NESN.VX, ABT.N, MJN.N, FSF.NZ, VNM.HM, 1431.HK) within the next 3 months.

12 January 2015


Credit Suisse has received compensation for products and services other than investment banking services from the subject company (NESN.VX) within the past 12 months

As of the date of this report, Credit Suisse makes a market in the following subject companies (ABT.N, MJN.N, DF.N).

As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (NESN.VX).

Credit Suisse has a material conflict of interest with the subject company (NESN.VX) . Credit Suisse AG is acting as an agent in relation to the company's announced share buy-back program for capital reduction purposes.

For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.

Important Regional Disclosures

Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.

The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (600597.SS, 600887.SS, 1117.HK, 2319.HK, 0322.HK, 0151.HK, NESN.VX, ABT.N, DANO.PA, MJN.N, FSF.NZ, VNM.HM, DF.N, DCG.L, 1431.HK) within the past 12 months

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares.

Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.

For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml.

The following disclosed European company/ies have estimates that comply with IFRS: (NESN.VX, DANO.PA, DCG.L).

Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (NESN.VX, FSF.NZ, 1431.HK) within the past 3 years.

As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.

Principal is not guaranteed in the case of equities because equity prices are variable.

Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.

Credit Suisse has entered into a strategic partnership with First NZ Capital ("FNZC"). Pursuant to this agreement, (FSF.NZ) is jointly covered by Credit Suisse and First NZ Capital.

To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

Credit Suisse (Hong Kong) Limited ............................................................................................................................................................ Kevin Yin

For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.

12 January 2015

China Dairy Sector CS0781.doc

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