china dairy stats 2012

8/12/2019 China Dairy Stats 2012

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CompanyResearch|HK&ChinaModernDairy(1117.HK)

Forratingsdefinitionsandotherimportantdisclosures,refertotheInformationDisclosures attheendofthisreport. 1

June 5, 2012

Modern Dairy (1117.HK)BUY| Share price: HK$2.02 | Target price: HK$2.80 | Upside: 39%

A growing cash cow

Investment highlights

Modern Dairy is the largest dairy producer in China. By the end of 2011,

Modern Dairy had 128,759 dairy cows on 16 farms (four more farms are under

construction) producing 288,620 tonnes of milk annually, as of June 30, 2011.

Huge growth expected in dairy industry. Per capita fluid milk consumption in

China is only 18.6 kg, which is lower than the global average. The huge

potential demand will drive development of dairy farms. Modern Dairy is

expanding rapidly by building replicable standardised farms and purchasing

heifers and calves from overseas.

Cooperation with Mengniu Dairy. Modern Dairy signed a 10-year supply

agreement with Mengniu in 2008. Based on the agreement, Mengniu has to

purchase all the raw milk supplied by Modern Dairy and offer it the most

favourable treatment. Due to the outstanding quality of Modern Dairys raw milk

and the close proximity of its farms with Mengnius factory, the two companieshave some inter-dependent relationship.

Selective breeding wil l drive unit milk y ield.As more heifers become dairy

cows and enter the peak lactation cycle, we expect raw milk production will

increase sharply. Furthermore, the genetic improvement will continue to drive

unit milk yield over the next 10 years at least.

Changes in the formula for the feed to reduce cost.Feed accounts for more

than 70% of production costs. Replacing expensive feed ingredients with

cheaper alternatives will help reduce costs.

Buy rating. Modern Dairy is undergoing a rapid expansion phase and weexpect its growth to remain strong. We initiate coverage with a Buy rating and

TP of HK$2.80, which corresponds to 0.6x PEG and 38.9x PE for FY 2012.

Exhibit 1: Financial summary

Year to Jun e 2010A 2011A 2012E 2013E 2014E

Turnover (RMB mn) 589 1,113 1,829 2,644 3,437

Chg (%) N/A 89 64 45 30

Core net profit (RMB mn) 23 174 345 549 778

Chg (%) N/A 650 118 59 42

EPS (RMB) 0.011 0.04 0.072 0.114 0.162

CFO per share (RMB) 0.06 0.07 0.11 0.16 0.26

P/E (x) 63.3 44.7 22.8 14.3 10.1

Dividend per share (HK$) N/A 0 0 0 0

Note: our forecasts exclude the impact from gains arising from changes in fair value less costs

associated with sale of dairy cows

Source: Guosen Securities (HK)

Analyst

Todd Yang(852)[email protected] CE No.:AYJ777

Price performance vs. HSI

Source: Bloomberg, data as at May 31, 2012

Sales Contact

Dan WeilGlobal Head of InstitutionalSales and TradingManaging Director+852 2248 [email protected]

Chris BerneyManaging Director+852 2248 3568

[email protected]

Roger ChimanManaging Director+852 2248 [email protected] Joe ChanDirector+852 2248 3578

[email protected]

Cancy KongVice President+852 2248 [email protected]

0

5,000

10,000

15,000

20,000

25,000

1.0

1.3

1.6

1.9

2.2

2.5

2.8

May/2011 Oct/2011 Feb/2012

HK$

1117.HK (HK$ LHS) HSI (RHS)


2/18

ModernDairy(1117.HK)June5,2012|HK&China

GuosenSecurities(HK)BrokerageCo.,Ltd. 2

1 The largest dairy cow breeder in China

by herd size

1.1 Core business: rearing dairy cow s and sale of raw milk

Modern Dairy was established in July 2008 and listed on the main board of the HK stock

exchange on November 26, 2010. The rearing of dairy cows and sale of raw milk

represent Modern Dairys core businesses. As of December 31, 2011, Modern Dairy had

128,759 dairy cows on 16 farms (four more farms are under construction) producing

288,620 tonnes of milk annually. For financial year1 2011, it sold 288,620 tonnes of milk,

while for 1H 2012, milk sales volume increase by 66.5% y-o-y to 195,321 tonnes. It

reported RMB1.113 billion in revenue and RMB244 million in net profit for FY 2011.

Exhibi t 2: The sales volume of raw milk rose by a CAGR of 73%

over 2008-2011

Exhibi t 3: Modern Dairys net pro fit enjoyed an 86% CAGR over

2008-11

Source: company information, Guosen Securities (HK)

2 Modern Dairy is expected to achieve

exponential growth in the short term

2.1 Growing downstream demand represents considerable

opportunities for large-scale dairy farm operators

Per capita liquid milk consumption has significant potential for growth

According to USDA statistics for 2010, an average urban dweller in China consumed

merely 18.6 kg of liquid milk, significantly less than that in the US, Europe, as well as the

worlds average of 24.7 kg. As the quality of life of Chinese citizens improve, we believe

per capita dairy consumption in China has considerable growth potential, given dairy

products are important sources of protein.

1 ModernDairysfinancialyearendisJune30.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

FY 2008 FY 2009 FY 2010 FY 2011 1st half

of FY2012

tonne

Sales volume of milk (tonne, LHS)

Y-o-y growth rate (RHS)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

FY 2008 FY 2009 FY 2010 FY 2011 1st half of

FY 2012

RMB '000

Sales (RMB'000) Net profit (RMB'000)

CAGR over FY2008-11

Sales: 82.3%

Net profit: 86%

Modern Dairys 1H 2012 milk sales

volume surged by 66.5% y-o-y.


3/18



Dairy cow popu lation and milk output li kely to continue to increase in the

coming years

A melamine milk scandal hit China in 2008 and caused a temporary slump in Chinas

dairy farming market. Chinas dairy cow population dropped significantly in the following

years but total milk output remained stable thanks to an increase in unit milk yield. Acleanup in Chinas milk industry ensued. Large dairy farms sprung up and many breeders

were introduced in China, which contributed to a surge in herd size and advancement of

breeding techniques in China. As such, we expect Chinas milk output is on track to rise

further in the years ahead.

Exhibit 4: Per capita liquid milk consumption in Chinas urban

areas has substantial room to grow

Exhibit 5: Chinas raw milk outpu t is poised to regain growth

momentum

Source: National Bureau of Statistics, USDA, Guosen Securities (HK)

2.2 A golden era for large-scale and modernised dairy farming

Chinas dairy farming industry has grown substantially in the past decade, as supporting

husbandry has been high on the governments agenda. The herd size in China grew from

4.432 million heads in 1999 to 14.201 million heads in 2010, equivalent to a CAGR of

11.2%. We estimate the high growth rate will be sustained in the coming years.

Exhibit 6: Herd size in China continues to rise quickly Exhibit 7: Herd sizes at most dairy farms in China are small

Source: Chinas Ministry of Agriculture, Guosen Securities (HK)

102.0

91.3

83.6

67.159.1

40.632.7 31.7

24.718.6

0

20

40

60

80

100

120

Australia

theU.S.

Russia

EU-27

Brazil

India

Japan

Korea

World

China

kg

0

1

2

3

4

5

67

8

9

5

10

15

20

25

30

35

40

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

millionheads

milliontonnes

Milk output in China (million tonnes, LHS)

The population of milkable cows (million heads, RHS)Dairy cow population in China (million heads, RHS)

0

2

4

6

8

10

12

14

16

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

millionheads

Cow population (million heads)

41%

28%

17%

2%

7%

4%

900 heads

Growing dairy product consumption

in China will d rive increase in dairy

cow population and milk output.


4/18



Overall, Chinas dairy farming is still in a nascent stage, as around 70% of dairy herds in

China are reared by dairy farmers who own less than 20 cows. The rapid development in

the industry has further exacerbated the mismatch between demand by modern dairy

processors and supply by small-scale dairy farms. After the melamine milk scandal in

2008, the government pushed for modernisation and expansion in upstream dairy

farming. We think agri-businesses like Modern Dairy are the epitome of Chinas drive tomodernise and industrialise its husbandry industry.

2.3 Replicable large-scale industrialised dairy farming model

Modern Dairy adopts an industrialised and large-scale farming model, which features

standardised procedures and farm design. One Modern Dairy farm can rear up to 10,000

cows. Modern Dairy adopts standardised design of milking parlors, loafing barns and

waste treatment facilities, and installs special facilities in some farms based on local

conditions (e.g. LPCV cowsheds are installed in the companys farms located in Southern

China in order to maintain a constant temperature), which we believe is conducive to

hygiene maintenance and milk quality improvement.

Modern Dairys management has a sound track record in dairy farm construction and has

a clear-defined expansion plan. We believe management should be able to transfer their

managerial expertise and rearing techniques to newly constructed dairy farms.

2.4 Modern Dairy imported a large number of heifers and

managed to expand its dairy herd size within a short period of

time

Modern Dairy has become the largest dairy farm operator in China since 2009. In 2009, ithad 65,000 dairy cows on its farms, accounting for 0.52% of the total number of cows in

China. We estimate that the share will rise to over 2% by 2015. The combined number of

dairy cows of the top 5 and top 7 dairy farm operators accounted for 1.39% and 1.63% of

Chinas dairy herd in 2009. We believe the low concentration rate in the industry indicates

good expansion opportunities for Modern Dairy through M&A. In addition, its easier to

achieve intensive management for Modern Dairy, as its herd size per farm is larger than

that of other major dairy farm operators in China.

Exhibit 8: A growing herd size boosted by heifer imports Exhibit 9: Modern Dairys herd accounts for a very small share

of Chinas total


24,358

107,576

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Jun/08 Jun/09 Dec/09 Jun/10 Dec/10 Jun/11 Jul/05

head

Modern Dairy's herd size (head)

0.52%

0.62%

0.46%

0.48%

0.50%

0.52%

0.54%

0.56%

0.58%

0.60%

0.62%

0.64%

2009.12 2010.12

Modern Dairy's herd size as % of China's total

The 2008 melamine milk scandal has

accelerated themodernisation andexpansion in upstream dairy

farming.


5/18



Exhibi t 10: Dairy herd sizes (December 2009)

Dairy companies No. of dairy farmsDairy herd size

(total)Herd size per farm No. of dairy cows

Unit milk yield(tonne/year)

Modern Dairy 11 65,000 5,909 19,300 8.5

Beijing Lvhe Dairy 27 35,000 1,296 18,769 9Huishan Dairy 15 30,000 2,000 15,000 8

Shanghai Dairy Group 18 25,000 1,389 15,000 8

Shanghai Bright Holstan Co., Ltd 8 20,000 2,500 12,000 8

Tianjin Jialihe Dairy 14 1,6000 1,143 N/A 8

Heilongjiang Feihe Dairy 3 14,000 4,667 N/A 7.5

Hebei Fucheng Wufeng 2 7,000 3,500 N/A 9

Jilin Guangze Milk Industry 7 6,000 857 N/A 8.5

Beijing Shuangwa Dairy 7 5,300 757 N/A 7

Inner Mongolia Dairy United 5 5,000 1,000 N/A 6Ji Nan Jiabao Milk Co. ,Ltd. 2 4,000 2,000 N/A 7.8

Shanxi Gucheng Dairy 2 2,500 1,250 N/A 6Source: China Dairy Industry Yearbook, www.hesitan.com, Guosen Securities (HK)

3 Tremendous growth potential and

win-win cooperation with Mengniu

3.1 Its quality raw milk is sold at a considerable premium

The advanced and scientific dairy farming approaches adopted by Modern Dairy enable

it to produce safe and quality raw milk at a relatively low cost. Both CFU/mL

(colony-forming units per milliliter) and somatic cell count (SCC), which are two important

indicators of milk quality, of the companys products surpass EU standards and Chinas

national standards. Besides, its products enjoy obvious advantages in terms of protein

and fat contents. Through its long-standing supply agreement with Mengniu, Modern

Dairy can sell its quality products at a considerable premium.

Exhibit 11: The quality of Modern Dairys liquid milk surpasses the EU standards

Modern Dairy Other large dairy farms Chinas national standards EU standards

Protein content 3.1% N/A 2.8% N/A

Fat content 3.7% N/A 3.1% N/A

CFU 50,000/milliliter N/A 2,000,000/ milliliter 100,000/milliliter

Somatic cell count 300,000/milliliter 592,000/milliliter NA 400,000/ milliliter

Note: Data on other large dairy farms are calculated based on statistics for 62 dairy farms in 2009.

Source: company information, GB19301-2010, China Dairy Industry Yearbook for 2010, Guosen Securities (HK)

Safe and quality products are

expected to enable Modern Dairy to

maintain high ASP.


6/18



Exhibit 12: Modern Dairys liquid mil k has been sold at a considerable premium

Note: major production areas include Heilongjiang, Liaoning, Inner Mongolia, Hebei,Shanxi, Henan, Shangdong, Xinjiang, Shaanxi, Ningxia provinces

Source: Chinas Ministry of Commerce, company information, Guosen Securities (HK)

3.2 Long-term cooperation wi th Mengniu expected to create a

win-win situation

Modern Dairy has been cooperating with Mengiu for more than five years. Modern Dairy

became Mengnius raw milk supplier in 2006, and Mengniu has accounted for a growing

proportion of its sales income ever since. In October 2008, the company entered into a

10-year supply deal with Mengniu. Key provisions are as follows:

Exhibit 13: Important provisions in the supply deal between Modern Dairy and

Mengniu

Purchasing

commitment

Both parties should negotiate and sign a deal within the first 3 months of each

year regarding the purchase amount for the entire year. Otherwise Mengniu is

obliged to purchase all the raw milk produced by Modern Dairy.

Sale to a

third party

Mengniu allows Modern Dairy to sell 30% of daily output to a third party except the

top two competitors designated by Mengiu.

Pricing

mechanism

The base purchasing price is calculated via a formula in reference to Mengnius

purchasing prices for milk of similar quality produced by other medium to large

sized dairy farms. The base price will be raised accordingly if Mengnius

purchasing price for milk sourced from other dairy farms increases. Mengniu will

pay a premium if protein and fat contents of Modern Dairys raw milk are abovepar or if Modern Dairys farms are located within an agreed distance from

Mengnius dairy plants.


2.00

2.50

3.00

3.50

4.00

4.50

Mar/09

May/09

Jul/09

Sep/09

Nov/09

Jan/10

Mar/10

May/10

Jul/10

Sep/10

Nov/10

Jan/11

Mar/11

May/11

Jul/11

Sep/11

Nov/11

Jan/12

RMB/kg

Average raw milk price at major production areas (RMB/kg)

Average selling price of milk produced by Modern Dairy (RMB/kg)

Modern signed a 10-year supply deal

with Mengiu in 2008, which is expected

to create a win-win situation.


7/18



Exhibit 14: A vast majority of Modern Dairys sales are to Mengniu


We expect the win-win cooperation between Modern Dairy and Mengniu will be

sustainable. Under the agreement, Modern Dairys sales are largely guaranteed for the

remaining 6-7 years of the contract period. As Modern Dairys raw milk supplies to

Mengniu account for less than 10% of Mengnius total demand, Modern Dairys share in

the companys total raw milk purchase volume may rise as their cooperation deepens.

As for the issue of overdependence on Mengniu, we think Modern Dairy can easily find

other high-end milk purchasers if its cooperation with Mengniu ends, because

high-quality liquid milk is in short supply in China. Besides, Mengniu also plans to use up

to 30% of its milk output to produce self-branded high-end dairy products.

As the largest producer of dairy products in China, Mengniu also needs to co-operate

with large dairy farm operators to ensure ample supply of quality raw milk. Government

regulations stipulate that dairy companies must control 70% of the raw milk source

needed for production. As such, Mengniu, as a going concern, would not have incentives

to cancel the agreement with Modern Dairy. Rather, Mengniu is more dependent on

Modern Dairy for the supply of quality milk to produce high-end dairy products. In addition,

most of Modern Dairys farms are located no more than 100 km away from Mengnius

dairy factories, which we believe can facilitate milk transport and help quality control.

Under such a circumstance, we believe the cooperation between Modern Dairy and

Mengniu will last for a long period.

98.9%

99.6%

97.6% 97.5%

96%

97%

97%

98%

98%99%

99%

100%

100%

2008 2009 2010 2011

Sales to Mengniu as a share of Modern Dairys total sales revenue

Under the agreement wi th Mengniu,

Modern Dairys sales are largely

guaranteed for the remaining 6-7

years of the contract period.


8/18

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9/18


10/18



4.3 Milk production is expected to keep growing for a decade

The increasing number of dairy cows wi ll drive up mil k production at Modern

Dairy in the next three years

The 10 to 15-month-old heifers Modern Dairy bought from New Zealand over 2010-11,coupled with the large number of calves bred at Modern Dairys own farms, are expected

to gradually enter their lactation phase around 2012 and 2013. We estimate Modern

Dairys dairy cow population will increase at a CAGR of 29% over FY2011-15 to 129,000

head of cows at the end of 2015. In our opinion, the share of dairy cow population as a

percentage of the companys total herd size will be on an uptrend and peak at around

69% in 2017, before it sides moderately and levels off.

Changes in herd composition wil l boost milk yield

Modern Dairys milk yield is limited, as a large proportion of cattle are too young for first

calving (AFC). However, these calves and heifers will become 3 to 5-year-old dairy cows

ready for lactation between 2112-2014. As more heifers become dairy cows and enter the

peak lactation cycle, we expect raw milk production will increase sharply in the following

three years.

Exhibit 19: The proportion of mature dairy cows wil l gradually

rise

Exhibit 20: The pace of growth in Modern Dairys milk outpu t

will exceed dairy cow population growth


22%

25%

31%

35%33%

36%33%

36%

47%

20%

25%

30%

35%

40%

45%

50%

2011

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

Dairy cow at stage 3 and 4 in their lactation cycle as %

-20%

0%

20%

40%

60%

80%

100%

2009

2010

2011

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

Growth rate of dairy cow population

Growth rate of milk output

We estimate Modern Dairys dairycow population will increase at a

CAGR of 29% over FY2011-15 to

129,000 head of cows at the end o f

2015.


11/18



Exhibit 21: The proportion of dairy cows in the companys overall herd size has

been on an uptrend s ince 2010


4.4 Selective breeding will further improve milk yield per head in

the next 10 years

The growth in milk yield of dairy cows comes from the following two sources:

1) The proportion of dairy cows entering the peak lactation cycle (stage 3 and 4) will

rise, as mentioned above.

2) The 2nd and 3rd generation of highly-productive dairy cows bred at Modern Dairys

farms will enter lactation and gradually replace the 1st generation of cows.

We think the latter factor will be the primary force driving the increase in Modern Dairys

milk yield per head. Below are our two core assumptions:

1) Drawing on its advanced breeding technologies, Modern Dairy is able to select

high-quality frozen bull semen before conducting artificial insemination. As a result,

we believe calves bred at Modern Dairys farms will be more productive than the first

generation of dairy cows. We assume the growth in milk output will be boosted by

increase in the milk yield of the 2nd and 3rd-generation cattle, and the milk yield perhead for later generations will remain stable.

2) Modern Dairy has two farms with a large number of mature dairy cows. We expect

some of the 2nd-generation cattle there will gradually enter lactation in 2012. Based

on information provided by Modern Dairy, we assume that around 20,000 dairy cows

in the two farms will be 2nd-generation cows by the end of June in 2012, while the

rest of the dairy cows in the two farms as well as calves and heifers the company

plans to import from overseas are all 1st-generation dairy cattle.

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

50,000

100,000

150,000

200,000

250,000

300,000

2008

2009

2010

2011

2012E

2013E

2014E

2015E

2016E

2017E

head

Dairy cow population (head, LHS)

Heifer population (head, LHS)

Share of dairy cows as % of total herd size (RHS)

The rise in proportion of dairy cows

entering the peak lactation cycle

and increase in the number of

highly-productive dairy cows will

drive the growth in milk yield.


12/18



Exhibit 22: Annual milk yield per dairy cow will keep growing

for a decade

Exhibit 23: Average annual mil k yi eld per dairy cow in China

was 4.88 tonnes in 2010

Source: company information, Guosen Securities (HK) Source: NBS, USDA, Guosen Securities (HK)

Exhibit 24: A comparison of milk yield of different generations of dairy cows at

different stages in the lactation cyc le


Based on the aforementioned two assumptions and our analysis, the rise in the milk yield

of an average dairy cow at Modern Dairy before 2014 should be aided by the fact that

more cows enter their peak lactation period. We estimate the milk yield per dairy cow to

grow at a faster pace starting from 2015, as the 2nd and 3rd generation of cattle born at

Modern Dairys farms will enter the lactation cycle. We expect that Modern Dairys milk

yield per dairy cow will remain on an uptrend at least in the next 10 years, and the growth

of milk yield will speed up before 2017.

6.10

6.907.30

7.738.15 8.37 8.46

8.638.90

9.269.63

10.01

5

6

7

8

9

10

11

2008

2009

2010

2011

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

tonne

Annual milk yield per dairy cow (tonne)

-5%

0%

5%

10%

15%

20%

2.5

3.0

3.5

4.0

4.5

5.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

tonne

Annual milk yield per dairy cow in China (tonne, LHS)

Growth rate of annual milk yield per dairy cow in China (RHS)

0

2

4

6

8

10

12

1 2 3 4 5 6 7

tonne

Age

1st generation 2nd generation 3rd generation

We expect that Modern Dairys milk

yield per dairy cow will remain on an

uptrend at least in the next 10 years.


13/18



Exhibit 25: Genetic improvement will push Modern Dairys milk output to grow at a

rapid pace for a long time


Exhibit 26: Forecast of key data and revenue

As at the end o f Ju ne 2008.06 2009.06 2010.06 2011.06 2012.06 2013.06 2014.06

Survival rate of newborn calves / 89% 89% 89%

Birth rate / 90% 90% 90%

Age 0-1: Weaning period and puberty 19,655 50,098 55,774 49,853

Age 1-2: Age at first calving 41,654 32,088 42,358 49,639

Age 2-3: Stage 1 in the lactation cycle 25,000 29,366 30,162 39,817



Age 5-6: Stage 4 in the lactation cycle 0 7,800 7,734 15,787

Age 6-7: Stage 5 in the lactation cycle 0 0 6,084 6,032

Age7: Senescence phase 0 0 0 0

Herd size 24,358 43,959 72,191 107,576 152,267 189,369 212,652

Growth rate of herd size 80% 64% 49% 42% 24% 12%

No. of dairy cows 14,964 20,427 26,607 46,267 70,081 91,237 113,160

Growth rate of dairy cow population 0% 37% 30% 74% 51% 30% 24%

Share of dairy cows as % of total herd size 61% 46% 37% 43% 46% 48% 53%

No. of newly purchased heifers 28,000 27,000 27,000 15,000 0

Total milk production (tonne) 55,888 96,306 158,081 288,620 473,942 674,739 864,404

Growth rate of milk production 72.3% 64.1% 82.6% 64.2% 42.4% 28.1%

No. of dairy cows 17,696 23,517 36,437 58,174 80,659 102,199

Assumed milk yield per head (tonne) / 5.44 6.72 7.92 8.15 8.37 8.46

Actual milk yield per head (tonne) 6.10 6.90 7.30 7.73 / / /

Milk price (RMB/kg) 3.29 3.47 3.73 3.86 3.86 3.92 3.98

Sales revenue (RMB 000) 183,882 334,015 589,775 1,113,354 1,829,486 2,643,662 3,437,582

Revenue growth 82% 77% 89% 64% 45% 30%


0 15,212 34,448 50,45679,427 126,681

200,379268,295 309,938

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E

tonne

Growth in milk output due to genetic improvement (tonne)

Estimated milk output (tonne)

Milk output excluding the impact from genetic improvement (tonne)


14/18



5 Improved feed formula and better costs

control

5.1 FeedcostsaccountforthemajorityofoverallcostsModern Dairys operating costs consist of feed costs, salary and other costs, which

include depreciation and insurance costs (its cows aged over 14 months are covered

against losses from disease, natural disasters and other incidents, as insurance

companies only insure cows aged above 12-15 months), etc. Feeds account for over

70% of the companys operating costs.

5.2 Optimising feed formula to reduce costs

In order to raise rearing efficiency, Modern Dairy sets different rearing standards and

uses different feeds based on the characteristics of specific herds. It also considers thefluctuation in the prices of feed ingredients to adjust feed formula to minimise costs.

For example, a cow normally consumes at least one tonne of clover in a year on a

Chinese farm. At Modern Dairy, the costs for producing 1 tonne of milk is RMB2,900 and

an average cow produces 7.73 tonnes of milk in a year. Given one tonne of clover

imported from the US costs RMB1,460 on average as in January 2012, clover costs

account for 6.5% of the overall costs. However, a new feed formula on track to be

adopted by Modern Dairy starting from 2012 is expected to enable the company to save

half of its clover costs.

5.3 More efficient use of human resources

As the herd size expands, economies of scale can be achieved in terms of human

resources. Its cow-to-employee ratio is 30:1 in 2010, and we expect the ratio to rise to

60:1 over 2014-15.

We think as the milk yield per dairy cow at Modern Dairy edges up and rearing costs are

under tight control, the costs of producing one tonne of milk at Modern Dairy are

expected to remain stable or to decline slightly.

Feeds account for more than 70% of

operating costs. Replacing

expensive feed ingredients wi th

cheaper alternatives wi ll help lower

costs.


15/18



Exhibit 27: Feeds account for 74% of total costs

(December 2011)

Exhibit 28: Cash cos ts per tonne of milk are expected to fall


Exhibit 29: The composition of feed for cow s at Modern Dairy

Feeds Main components Proportion

Concentrated feeds Corn, soybean flour and cottonseed meal 60%

Roughage Sweet corns, silage, guinea grass and clover 40%


6 Earnings forecasts & recommendation

6.1 Earnings forecasts

As Modern Dairy has bought many heifers to expand the herd size since its IPO in 2010,

many of these heifers are expected to enter stage 1 in their lactation cycle in FY2012,

and more dairy cows will enter their peak lactation period. As such, we estimate Modern

Dairy is likely to sell 473,942, 674,739 and 864,404 tonnes of liquid milk and gross

RMB1.83 billion, RMB2.64 billion and RMB3.44 billion in sales accordingly over

FY2012-14 respectively.

6.2 Valuation

Modern Dairys growing herd size and rising milk yield per cow will create economies of

scale. We expect the feed costs will be well controlled in 2H 2012, while the price of raw

milk will slightly rise. We forecast the companys core profits attributable to shareholders

(which factor out the impact from gains arising from changes in fair value less costs

associated with sale of dairy cows) to reach RMB345 million, RMB549 million and

RMB778 million respectively, equivalent to a CAGR of 70%. We forecast EPS to reach

RMB0.072, RMB0.114 and RMB0.162 respectively over FY2012-14, representing a

CAGR of 64%. At the current price level, the stock corresponds to a PE of 22.8x, 14.3x

and 10.1x for the following three years.

We think the next 5-10 years would be a golden era for Chinas dairy industry and

Modern Dairys high growth rate may be sustainable. We estimate its PEG to be 0.35x for

FY2012, based on its latest stock price and our assumption about its EPS growth for the

74%

7%

9%

7%3%

Feed costs

Other farm operating costs

Employee benefits

Depreciation

Other expenses

2,400

2,600

2,800

3,000

3,200

3,400

3,600

Jun/08

Oct/08

Feb/09

Jun/09

Oct/09

Feb/10

Jun/10

Oct/10

Feb/11

Jun/11

Oct/11

Feb/12

Jun/12

Oct/12

Feb/13

Jun/13

Oct/13

Feb/14

Jun/14

RMB

Cash costs per tonne of milk (RMB)

Modern Dairy is undergoing a rapid

expansion phase and we expect it s

growth to remain strong.


16/18



next three years. We initiate coverage and applied a target price of HK$2.80, which

corresponds to 38.9x PE for FY2012 and implies 39% upside potential.

6.3 Risk factors

A large-scale outbreak of ser ious diseases: Although Modern Dairy insures its cowsaged over 14 months against diseases, insurance compensation may not cover direct

losses in the event of an outbreak of diseases and will cause disruptions to operations.

Surging feed costs.Feed accounts for 74% of the production costs. Although Modern

Dairy grows some fodder on its own farms, it still needs to buy most of its feed from

suppliers and may struggle to control operating costs if feed costs surge.

Selective breeding measures may fall short of expectation. Modern Dairy breeds

calves through artificial insemination with high-quality frozen sperm imported from

abroad. If the process is disrupted, the breeding of calves will be negatively affected.

Contamination of dairy products: Many procedures at dairy farms face the risk of

contamination. Liquid milk becomes undrinkable once contaminated, which would tarnish

the companys brand reputation.

Exhibit 30: Income statement

RMB 000 2010A 2011A 2012E 2013E 2014E

Sales of milk produced 589,775 1,113,354 1,829,486 2,643,662 3,437,582

Other income 65,371 101,850 100,000 56,444 35,000

Farm operating expenses (437,616)) (730,307) (1,245,450) (1,731,087) (2,209,086)

Employee benefits expenses (66,695) (89,649) (111,767) (150,175) (162,381)

Depreciation (44,174) (67,304) (84,130) (105,163) (126,195)

Share of loss of associates 0 0 (966) 0 0

Net foreign exchange loss (1,174) (17,367) (4,967) 0 0

Other gains and losses 561 (1,197) (840) 0 0

Other expenses (29,474) (61,871) (47,567) (52,873) (58,439)

Profit before finance costs and tax 76,574 247,509 433,799 660,809 916,481

Finance costs (29,765) (59,141) (81,250) (100,500) (122,500)

Profit before tax 46,809 188,368 352,549 560,309 793,981

Income tax charge (73) (8) 0 0 0

Profit and total comprehensive income 46,736 188,360 352,549 560,309 793,981

Owners of the Company 23,130 173,460 345,498 549,103 778,101

Non-controlling interests 23,606 14,900 7,051 11,206 15,880

Note: The profit excludes the impact from the impact from gains arising from changes in fair value less costs associated with sale of

dairy cows.



17/18



Exhibit 31: Balance sheet

RMB 000 2008A 2009A 2010A 2011A

Property, plant and equipment 458,328 947,508 1,578,395 2,221,265

Land use rights 15,970 41,185 63,616 62,863

Goodwill -- 301,354 301,354 310,426

Long-term prepaid rentals -- 259 194 130

Deposit for acquisition of biological assets -- 37,381 13,028 1,094

Biological assets 446,153 936,816 1,742,891 2,651,407

Total of non-current assets 920,451 2,264,503 3,699,478 5,247,185

Current assets -- -- -- --

Inventories 8,527 83,138 139,407 212,719

Trade and other receivables 18,661 78,618 76,772 136,779

Land use rights 709 930 1,184 1,440

Pledged bank balances 48,696 36,350 287,119

Bank balances and cash 6,492 733,720 250,959 1,021,691

Total of current assets 34,389 945,102 504,672 1,659,748

Current liabilities -- -- -- --

Trade and other payables 106,182 188,306 351,050 482,811

Amount due to a related party 2,094 6,622 1,247 --

Interest payable 811 1,424 1,249 --

Borrowings-due within one year 166,000 251,595 384,647 303,797

Deferred income 9,942 -- 3,868 4,943

Total of current liabilities 285,029 447,947 742,061 791,551

Net current assets (250,640) 497,155 (237,389) 868,197

Total assets less current liabilities 669,811 2,761,658 3,462,089 6,115,382

Capital and reserves -- -- -- --

Share capital 202,180 272 272 413,075

Reserves 95,008 1,383,330 1,436,462 4,254,933

Equity attributable to owners of the Company 297,188 1,383,602 1,436,734 4,668,008Non-controlling interests 2,296 1,077,461 1,133,005 54,700

Total equity 299,484 2,461,063 2,569,739 4,722,708

Non-current liabilities -- -- -- --

Borrowings-due after one year 227,088 300,595 840,470 1,219,137

Deferred income 143,239 -- 51,880 100,000

Total of non-current liabilities 370,327 300,595 892,350 73,537

Non-current liabilities and total equity 669,811 2,761,658 3,462,089 1,392,674

Non-controlling interest 23,606 14,900 6,098 6,115,382



18/18


Information Disclosures

Stock ratings, sector ratings and related definitions

Stock Ratings:

Buy:A return potential of 10 % or more relative to overall market within 6 12 months.Neutral:A return potential ranging from -10% to 10% relative to overall market within 6 12 months.

Sell:A negative return of 10% or more relative to overall market within 6 12 months.

Sector Ratings:

Buy: The sector will outperform the overall market by 10% or higher within 6 12 months.

Neutral: The sector performance will range from -10% to 10% relative to overall market within 6 12 months.

Sell: The sector will underperform the overall market by 10% or lower within 6 12 months.

Interest disclosure statement

The analyst is licensed by the Hong Kong Securities and Futures Commission. Neither the analyst nor his/her associates serves as anofficer of the listed companies covered in this report and has no financial interests in the companies.

Guosen Securities (HK) Brokerage Co., Ltd. and its associated companies (collectively Guosen Securities (HK)) has no disclosable

financial interests (including securities holding) or make a market in the securities in respect of the listed companies. Guosen Securities

(HK) has no investment banking relationship within the past 12 months, to the listed companies. Guosen Securities (HK) has no

individual employed by the listed companies.

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made as a result of buying and selling securities.

The content of this report does not represent a recommendation of Guosen Securities (HK) and does not constitute any buying/selling or

dealing agreement in relation to the securities mentioned. Guosen Securities (HK) may be seeking or will seek investment banking or

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Clients are wholly responsible for any investment decision based on this report. Clients are advised to consider whether any advice or

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This report (including any information attached) is issued by Guosen Securities (HK) Brokerage Co., Ltd, a member of Guosen Securities

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