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DBS Group Research Summary: Dairy and Food & Beverage Sector Analysis (November 2013)

Core Content Overview

This report provides an analysis of the dairy and food and beverage (F&B) sector in China, highlighting trends in pricing, production, and investment strategies for various sub-sectors. The report focuses on the impact of rising raw milk prices and how this affects different segments of the industry, particularly upstream dairy farm operators and downstream dairy producers.

Main Points and Key Information

Dairy Sector

• Raw Milk Prices: Raw milk prices in November 2013 rose to Rmb3.96/kg, representing a 4% month-over-month (m-o-m) increase and a 19% year-over-year (y-o-y) increase.
• Downstream Pressure: Dairy producers like Mengniu (2319 HK), Bright Dairy, Yili, and Sanyuan are planning to raise their average selling prices (ASPs), which could help margins but may lead to reduced volume growth.
• Supply Shortage: The increase in raw milk prices is mainly due to a supply shortage, which raises concerns about the availability of products for consumers.
• Upstream Advantage: Large-scale industrialised dairy farm operators, such as CMD (1117 HK), are experiencing growth in supply and benefit from higher ASPs, while feedstuff costs remain stable.
• Competitiveness: Local milk products are becoming less competitive compared to imported offerings, especially UHT milk.
• Investment Strategy: The report recommends preferring upstream dairy farm operators over downstream producers due to the current supply and pricing dynamics.

F&B Industry Dynamics

• Sector Performance: The F&B industry has seen mixed performance across sub-sectors, with some showing growth and others experiencing declines.
• Sub-sector Analysis:
  • Beer: Positive outlook with steady growth and improving margins, particularly for Tsingtao Brewery and CRE.
  • Dairy: Margins are under pressure due to rising raw milk prices and reduced volume growth.
  • Instant Noodle: Tingyi is highlighted as a top pick due to its improving margins.
  • Slaughter: Hog prices and slaughter profits are fluctuating, with some indicators showing signs of correction.
  • Wine: The domestic wine industry remains weak, with some companies showing negative growth.
  • Other Sub-sectors: Includes confectionary, edible oil, and others, with varying levels of performance.

Sensitivity Analysis

• Raw Material Impact: The sensitivity analysis highlights how changes in raw material prices affect company margins and profits.
• Key Raw Materials:
  • Sugar: Affects beverage and instant noodle producers.
  • Palm Oil: Has a significant impact on the beverage and instant noodle segments.
  • PET: Influences beverage and instant noodle companies.
  • Corn and Soybean Meal: Remain stable, providing a favorable cost environment for upstream dairy farms.
  • Barley: Affects beer producers, with a stable cost trend.

Investment Picks

• Top Picks:
  • Tingyi (322 HK): Recommended for its improving margins.
  • CRE (291 HK): Showcases steady growth and improving margins in the beer and beverage industry.
  • Mengniu (2319 HK): Positive outlook due to the benefits of its product line restructuring.
  • Modern Dairy (1117 HK): Recommended for its improving cash flow.
• Other Picks:
  • Tsingtao Brewery (168 HK): Highlighted for its steady growth and improving margins.
  • China Resources Ent (291 HK): Showcases a positive outlook for the beer industry.

Summary Table of Key Players

Risks and Considerations

• Downstream Pressure: Downstream producers may suppress milk prices using their strong bargaining power.
• Government Intervention: There is a risk that the government might step in to regulate prices.
• Market Trends: The report notes that the F&B industry is in a slack season, which may affect overall performance.

Conclusion

The report concludes that the dairy sector is experiencing a significant shift in pricing dynamics, with upstream producers benefiting from rising prices and stable costs, while downstream producers face margin pressures and reduced volume growth. The F&B industry as a whole shows a mix of performance across sub-sectors, with a focus on beer, instant noodles, and dairy as the most promising areas. Investment recommendations are based on the current trends, with a preference for upstream players and those with improving margins and financial health.