20141027-高盛-Near-term_industry_troubles_offset_by_longer-term_positives__Buy_19页_474kb

Huishan Dairy Summary

Core Content

Huishan Dairy (6863.HK) continues to refine its strategy to become a premium dairy brand in China, despite facing near-term industry challenges. The report highlights both the short-term pressures and long-term growth opportunities for the company, with a reiteration of the "Buy" recommendation based on its strong brand positioning and attractive valuation.

Main Points

• Strategic Developments:

  • Increased self-sufficiency in feed through prepayment of additional land.
  • Added focus on pasteurized milk, aiming to expand into the Eastern China market.
  • Entered into a 50/50 IMF joint venture (JV) with FrieslandCampina, which is expected to strengthen its branded component in the long term.

• Earnings Forecasts:

  • Reduced FY15E/FY16E NPAT (excluding biological assets) by 16% and 17%, respectively, due to intensifying downstream competition and global over-supply of raw milk.
  • Adjusted 12-month target price (TP) to HK$2.10/share, down 8.7%, incorporating a 3% share buy-back and a DCF model updated to FY03/16E.

• Business Model:

  • Less susceptible to raw milk price fluctuations due to higher exposure to downstream sales (60% of total raw milk volumes).
  • More defensive cost base due to higher self-sufficiency in feed.
  • Cash operating margin is expected to be around 22% in FY03/14 and 17% in FY03/15E, compared to 56.9% accounting margin, due to capitalized feed costs.

• Market Position:

  • The company is not currently competitive in the UHT milk market, which is dominated by Mengniu and Yili.
  • The pasteurized milk market is more fragmented in Shanghai, offering Huishan a potential competitive edge.

• Valuation:

  • DCF-based 12-month TP of HK$2.10/share implies 11.7X FY16E P/E (excluding biological assets) or 21.3X including biological assets.
  • Compared to CMD, Huishan offers a more attractive valuation with similar CROCI (13.8% vs. 14%) and higher growth potential (22% recurring NPAT vs. CMD's 8.5%).

Key Financials

Key Risks

• Raw Milk Prices: Worse-than-expected raw milk prices could negatively impact earnings.
• Competition: Increased competition in the liquid milk and infant milk formula (IMF) markets.
• Weather and Execution: Potential disruptions due to adverse weather conditions and challenges in executing expansion plans.

Investment Profile

• Sector: Asia Pacific Consumer Peer Group
• Price (HK$): 1.74
• 12-Month Price Target (HK$): 2.10
• Market Cap (HK$ mn / US$ mn): 25,069.6 / 3,231.6
• Foreign Ownership (%): Not disclosed
• Dividend Yield (%): 0.0
• Free Cash Flow Yield (%): (14.0) / (17.6) / (12.1) / (10.8)

Strategic Initiatives

• Land Expansion: Secured an additional 200,000 mu of land in Liaoning Province, bringing total land bank to 444,000 mu.
• Herd Growth: Expected to double its herd size from 144,200 in FY03/14 to 290,000 by FY03/17E, aided by the import of 30,000 heifers over 3 years.
• New Project: Launched a vertically integrated dairy value chain in Sheyang, Jiangsu Province, targeting pasteurized milk sales in Eastern China.

Industry Trends

• Global Over-Supply: Global over-supply of raw milk and influx of cheaper imports are hurting the domestic dairy industry.
• Pasteurized Milk Growth: The pasteurized milk market is growing faster than UHT milk, with a 15% year-over-year increase in 2013.
• Market Share: Pasteurized milk currently accounts for 27% of total liquid milk volumes in China, up from 68% 14 years ago due to improved cold-chain logistics and consumer preferences.

Key Takeaways

• Huishan's strategic focus on premium branding and pasteurized milk positions it well for long-term growth.
• Despite near-term headwinds, the company's valuation and business model make it an attractive investment in the dairy sector.
• The JV with FrieslandCampina and land expansion initiatives are expected to provide long-term benefits.