Infant Milk Formula China by Macquarie

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

CHINA

Inside
Turning sour, switch to mothers milk 2
Valuation 4
Volume consumption to peak in 2017 8
Policy directed consolidation,
price ceiling 13
Distribution channel revolution 18
Biostime 23
Yashili International 42
Mengniu 59

China infant formula stocks
Ticker Company Rating Price TP
Up/
Down
side
1112 HK Biostime UP 51.40 38.50 -25%
1230 HK Yashili UP 2.87 1.45 -50%

Mkt Cap ADTV PER (x)
Company US$m US$m CY14E CY15E
Biostime 4,004 10.1 25.7 21.3
Yashili 1,318 2.2 34.4 29.8
Source: Bloomberg, Macquarie Research, June 2014;
pricing date 10 June 2014

Analyst(s)
Jamie Zhou, CFA
+852 3922 1147 jamie.zhou@macquarie.com

11 June 2014
Macquarie Capital Securities Limited
China infant formula
Turning sour, switch to mothers milk
We initiate coverage on Chinas infant formula sector with a cautious view and
Underperform ratings on Yashili and Biostime. A falling fertility rate and already
high market penetration (85%) would limit volume growth to barely a 5% CAGR
through 2018 before total consumption starts to decline, by our estimates. Recent
policy moves would further cap pricing power in an increasingly competitive
market as young Chinese parents bargain-hunt for imported brands online and
shy away from local brands such as Yashili. Nonetheless, a consumption upgrade
trend to the mid-to-high tier segment should create opportunities for brands, like
Biostime, that can continue to innovate.
2-child policy no silver bullet, volume CAGR to slow to 5%
We believe market excitement over a potential baby boom from relaxation of the
One Child Policy is overdone. Total formula consumption is likely to peak in 2018
while the volume CAGR would be barely 5%, and a mix shift would drive about
8% sales CAGR. Demographic expert Dr. Clint Laurent expects a temporary boost
of 3m new babies by 2017 would be insufficient to reverse a multi-decade falling
fertility profile. Chinas fertility rate of 1.7 (already below the world average of 2.8),
compared to most developed Asian cities, indicates the rate could fall even further
(HK 1.3, Shanghai 0.7). Meanwhile, Chinas formula penetration already reached
85% in 2013 and the government is promoting breastfeeding, hoping to raise the
low ratio from 16% (2012) to 50% by 2020.
Government investigation, competition cap pricing power
Beijing has been on the move over the past year to consolidate the fragmented
domestic infant formula industry. We believe the governments end goal is to build
a strong domestic industry with high quality and safety standards to restore
Chinese consumers confidence in domestic infant formula. In the interim, policy
makers are concerned about the affordability of infant formula, with retail prices
double those of equivalent products overseas and in HK. Beijing has taken firm
measures against brands that are making excessive profits and this has sparked
price cuts. Coupled with intensifying competition, we see downside risks to the
high margins currently being earned (Biostime GM 65%, Yashili 53% (FY13).
Maternity, ecommerce rapidly eroding supermarket sales
The post-80s generation of convenience-seeking and tech-savvy consumers are
increasingly shopping at neighbourhood maternity shops and online. Infant
formula sales at supermarkets fell by 4% YoY in 2013, for the first time ever, and
companies that rely heavily on supermarket sales suffered market share loss
(Yashili). We expect this consumption habit shift to accelerate, particularly towards
ecommerce as parents bargain hunt for imported brands. The proliferation of
ecommerce has effectively lowered the entry barriers in lower-tier markets
previously dominated by local brands with offline distribution.
Earnings downside, 31% for Biostime, 60% for Yashili
We initiate on Biostime and Yashili with Underperform ratings. We believe the
market remains too optimistic: our FY14/15E forecasts are 16%/31% below
Consensus on Biostime and 55%/60% on Yashili; upcoming interim results should
catalyse Street downgrades. While we believe Biostime can maintain its market
leadership with the Adimil and O2O model, its valuation is rich at 26x/21x
FY14/15E PER. Yashilis shares appear significantly overvalued at 34x/30x PER;
a 43% decline in FY14E earnings would mean its dividend is at risk.
Macquarie Research China infant formula
11 June 2014 2
Turning sour, switch to mothers milk
Volume consumption to peak in 2017E, opportunities exist in
upgrade to mid-to-high tiers, driving 8% total market CAGR
Based on demographic expert Dr. Clint Laurents forecasts, we project Chinas infant formula
consumption to grow at barely a 5% volume CAGR through 2018. With an expected
consumption upgrade from lower tier to mid- and high-tier categories, we expect the overall
market size to grow at a faster pace of 8% CAGR. Our cautious view on the industry growth
potential is mainly due to:
Relaxation of the one child policy, which will temporarily add up to 3m births, before
starting to decline in 2018E
Expectations of Chinas fertility rate of 1.7 continuing to fall; HK/SG are at 1.3,
Shanghai is at 0.7
Infant formula consumption penetration already being high at 85% as of 2013
The Chinese government actively encouraging breastfeeding (16% in urban China vs.
world avg 37% in 2013) and banning hospitals from marketing infant formula products.
Fig 1 # of infants to peak with births in 2017 Fig 2 85% penetration, volume CAGR only 5%

Source: Global Demographics, Macquarie Research, June 2014 Source: Global demographics, Macquarie Research, June 2014
Consolidation, price investigation and competition to erode margins
Various policy measures have been announced in the past 12 months aimed at reforming the
infant formula industry. We believe the governments goal is to build a strong domestic
industry with high quality and safety standards to restore Chinese consumers confidence in
local brands. In the domestic industry, the government has taken the following actions:
Strengthening safety standards, banning OEM production of infant formula
Increase accountability, requiring players to own or control their upstream milk sources
Eliminating weak, smaller players production licenses
As of June 2014, 82 out of 133 domestic infant formula makers have successfully
passed China FDAs quality examination and have production permits renewed
In the interim, policy makers are concerned about the affordability of infant formula and have
taken measures against imported brands that are making excessive profits:
NDRC investigation of six brands over monopolistic pricing behaviour (reaping above-
normal profits), resulting in heavy penalties and price cuts (up to 20%)
Requiring all imported products to be packaged in final retail format with labels printed
in Chinese, thus banning the cheaper repackaging methods previously used
As of June 2014, 94 foreign infant formula brands have received import approval from
the General Administration of Quality Supervision, Inspection and Quarantine.
10
11
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17
18
19
20
25
30
35
40
45
50
55
60
# of babies age 0-3 New birth
# of babies age 0-3 (million) # of new births
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0
100
200
300
400
500
600
700
Market potential Market consumption
Infant formula volume (000 ton) Penetration %
11 June 2014 3
Local brands that rely on supermarket sales have lost market share
Infant formula sales at supermarkets dropped by 4% YoY in 2013, for the first time ever, and
companies that rely on significant sales from supermarkets suffered. Despite the overall
market still growing in the low-teens, sales of infant formula in supermarkets were largely flat
over the past three years. We expect the shift towards to maternity shops and ecommerce to
accelerate and that the beneficiaries will be those that can successfully capture this
consumption habit change.
The generation born after 1980 are typically technology-savvy and convenience seeking
consumers. They were the first to develop online shopping habits and when they have
babies, they are increasingly buying infant formula from two emerging channels (Fig 31):
Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barriers,
very fragmented. Early mover brands have secured an advantage in terms of shelf
space
Ecommerce: infant formula sold through Chinas leading B2C sites, a brand driven
model where brand awareness attracts sales.
Fig 3 Selective growth opportunities in Mid-High Tier Fig 4 Sales shifting to maternity and ecommerce

Source: Nielsen, Global Demographics, Macquarie Research, June 2014 Source: Nielsen, June 2014
Biostime the rising star; Yashili the fallen angel
Between the two HK listed plays, Yashili has a higher reliance on supermarket (>60% of
sales) while Biostimes success was attributable to its early entry into maternity channels
(74% of sales), but it lacks in ecommerce which it plans to counter with its O2O sales model.
Fig 5 Biostime: a miracle infant formula growth story Fig 6 China infant formula top 12 players, Jan 2014

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014
13%
17%
18%
24%
17%
-8%
11% 11%
7%
8%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
Low Mid High Supreme Overall
market
09-13 13-18E
Market growth (5-year CAGR)
44% 43%
36%
33%
41%
42%
23%
16%
22%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2011 2012 2013
Supermarkets Maternity stores Ecommerce
%of infant formula sales, China
0
1
2
3
4
5
6
7
8
9
2008 2009 2010 2011 2012 2013
Biostime Yashili Beingmate Mead Johnson (China)
Infant formula sales (RMB billion)
Mead
Johnson,
14.5%
Wyeth, 13.3%
Beingmate,
8.5%
Biostime,
7.5%
Abbott, 7.0%
Yili, 6.2%
Nestle, 4.4%
Yashili, 4.1%
Friso, 3.9%
Dumex, 3.6%
Feihe, 3.5%
Synutra, 3.2%
Others, 20.3%
11 June 2014 4
Valuation
Our primary valuation is based on PER, which we then cross check against our DCF fair
valuation.
Biostime (Underperform) with HK$38.50/sh target, 16x FY15E PER
Our 12-month target price of HK$38.50/sh is based on 16x FY15E PER, the average of its
valuation since listing. We like the 34% ROE, strong FCF generation and consistent dividend
payout of 70%, however we are cautious on the rich valuation given we expect growth to slow
down significantly to just an 11% earnings CAGR for FY13-15E. Our FY14/15E earnings
forecasts are 16%/31% below Consensus. The founders lock-up expired on May 20
th
which
may also pose a sell-down overhang for the stock.
We cross-check with our DCF model, which suggest a fair valuation of HK$40/sh.
Yashili (Underperform) with HK$1.45/sh target, 15x FY15E PER
Our target price is based on 15x FY15E PER. Yashilis profitability and return on capital have
fallen significantly (low teens EBIT margin and high single digit ROIC) since 1H13. Yashili has
been losing market share since the 2008 Melamine Crisis, particularly in Tier 1 & 2 cities, and
continues to be weak in two increasingly dominating channels: maternity and ecommerce.
Our Yashili DCF fair valuation is HK$1.29/sh. FCF turned negative in FY13 and with the
ongoing capex commitment with the New Zealand plant, we expect FCF to stay negative until
at least FY16. Prior to the takeover by Mengniu in Aug 2013, a special dividend representing
229% of FY13 NP was paid out to shareholders, which reduced the cash position by
RMB1bn. We believe the regular dividend is likely to be reduced significantly by 76% from
RMB11 cents in FY13 to just 3 cents in FY14.
Fig 7 Infant formula valuation comps
Price TP Mkt Cap PER (x)
EV/EBITDA
(x)
EPS
growth
(%)
EBIT
margin
ROE
(%)
Div
yield
(%) P/Bk
Ticker Company Rec lc lc % US$m CY14E CY15E CY14E CY15E 13-15E CY13 CY13 CY13 FY13
1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 16.3 13.9 11.3 23.5 33.9 2.9 9.9
Biostime at TP 38.50 19.2 16.0 11.5 9.8
1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 19.3 14.4 -19.0 9.6 12.2 15.4 2.6
Yashili at TP 1.45 17.4 15.0 8.5 6.3

Infant formula pure-plays
MJN US Mead Johnson NR 87.39 17,662 23.6 21.1 15.6 14.0 7.6 23.9 418.4 1.6 51.1
002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4
1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9
1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6
Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1

Diversified dairies
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8
600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5
NESN VX Nestl NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5
BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2
FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4
Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0

China large cap staples
151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4
322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5
1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
168 HK Tsingtao Brewery NR 61.70 9,866 30.2 25.5 15.2 12.7 5.9 7.2 14.9 0.9 4.6
Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4

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

11 June 2014 5
Among the listed dairy companies globally that have infant formula businesses in China, we
identify two baskets of comps:
Biostime (1112.HK) China based, premium products made in France, imported. #4
in market share (Jan 2014)
Yashili (1230.HK) China based, imported ingredients from NZ. #8 in market share.
Mead Johnson (MJN.US) U.S. based global infant formula maker, imported into
China. #1 market share holder in China
Beingmate (000257.CH) China based infant formula maker, ingredients sourced
50/50 from domestic/imported sources. #3 in market share, highest among local
brands.
Diversified dairies
Mengniu (2319.HK) Chinas largest liquid milk maker, holds 68% stake in Yashili
Yili (600887.CH) Chinas largest liquid milk maker, #6 market share in infant formula
Nestl (NESN.VX) Global dairy giant, two brands in China: Wyeth (#2 market share)
and Nestl (#7)
Danone (BN.FP) Global dairy giant, owner of the Dumex brand (#10 in China)
Bright Dairy (600597.CH) Shanghai based national diversified dairy, sells imported
infant formula, not a top 10 brand.
Fonterra (FSF.NZ) Global dairy giant, sells imported powder in China, not a top 10.
We also examined Abbott Laboratories (ABT.US) whose Abbott brand of infant formula
commands 7% market share in China at the #5 spot. However, given that 70% of the listcos
revenue is from the healthcare segment, we chose not to include it in the comps.

11 June 2014 6
With growth slowing, rising competition and government price caps, we believe infant formula
plays should trade at the low-end of their historical valuation range of 16-22x forward PER.
We think the price data over the past three years shows a fair representation of the infant
formula industrys risks and opportunities.
The three domestic infant formula pure-plays were all were listed in late-2010/early-2011.
However, their forward valuations fluctuated greatly in 2013, due to three major industry
catalysts:
Positive: Mid-2013 Chinese government announces infant formula consolidation plans
Negative: July 2013 NDRC investigation which resulted in fines and price cuts
Positive: November 2013 relaxation of One Child Policy
Mead Johnsons average forward PER is also a good proxy in our view, due to its global
diversification, which limits short term noise in the China market. MJNs forward PER has
been steady in the range of 18x to 25.5x since mid 2009.
Fig 8 Biostime has traded on 16x PER on average Fig 9 Yashili has traded on 22x PER on average

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

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

Fig 11 Beingmate has traded on 22x PER on average

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

0
5
10
15
20
25
30
35
Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14
1112.HK forward PE ratio (x)
mean
-1
+1
0
10
20
30
40
50
60
mean
-1
+1
10
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14
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May-09 May-10 May-11 May-12 May-13 May-14
MJN.US forward PE ratio (x)
mean
-1
+1
5
10
15
20
25
30
35
40
May-11 May-12 May-13 May-14
002570.CH forward PE ratio (x)
mean
-1
+1
11 June 2014 7
Diversified dairies trading on lower valuation than infant formula
As a group, diversified dairies have been trading at a lower valuation than infant formula pure-
plays due to lower margins on the liquid milk business. The average EBIT margin of our
diversified dairies for FY13 was only 8% vs. 17% for infant formula pure-plays.
Most of the diversified dairies traded around 18x forward earnings on average over the past
five years. The exception is Mengniu, which traded on average at 25x PER. This is largely
due to a number of high profile M&A catalysts over the past few years (COFCO stake,
Danone JV and stake, Modern Dairy acquisition, Yashili acquisition, Arla partnership, White
Wave partnership).
Fig 12 Mengniu traded on 25x PER on average Fig 13 Yili traded on 17x PER on average

Forward earnings are based on Bloomberg Consensus estimates.

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

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

15
20
25
30
35
40
mean
-1
+1
5
10
15
20
25
30
600887.CH forward PE ratio (x)
mean
-1
+1
12
13
14
15
16
17
18
19
20
21
22
NESN.VX forward PE ratio (x)
mean
-1
+1
10
12
14
16
18
20
22
BN.FP forward PE ratio (x)
mean
-1
+1
11 June 2014 8
Volume consumption to peak in 2017
Opportunities exist in upgrade to mid-to-high tiers
Based on Dr. Clint Laurents demographic forecasts, we project Chinas infant formula
consumption to grow at barely a 5% volume CAGR through 2018. With an expected
consumption upgrade from lower tier to mid- and high-tier categories, the overall market size
should grow at a faster pace of 8% CAGR.
Our cautious view on the industry growth potential is mainly due to:
The dismal outlook for the fertility rate despite relaxation of the one child policy
Infant formula consumption penetration being already high at 85% as of 2013
Limited upside to per-capita consumption as the government is actively encouraging
breastfeeding
Our volume forecasts are based on 2014 per-capita consumption of 11 kg/baby/year. The
typical infant formula consumption age for a baby is from 6 months to 2 years old. Upside
exists in wealthier families feeding infant formula to babies 2 years old and above.
Fig 16 # of infants to peak with births in 2017 Fig 17 Penetration of 85% in 2013 has little upside

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

10
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13
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25
30
35
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45
50
55
60
# of babies age 0-3 New births
# of babies age 0-3 (million) # of new births
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0
100
200
300
400
500
600
700
Market potential Market consumption
Infant formula volume (000 tonne) Penetration %
11 June 2014 9
Fig 18 Volume demand to peak in 2017 Fig 19 Upgrade trend to drive higher sales growth

Historical figures on market size and breakdown by tier from Euromonitor. Forecasts are Macquaries based on Global Demographics.
Tier breakdown by retail ASP for 900g can: Low: <RMB100, Mid: RMB100-200, High: RMB200-300, Supreme: >RMB300.
Source: Euromonitor, Global Demographics, Macquarie Research, June
2014
2014
Out of the four price segments, we see Low Tier (below RMB100 per can) seeing the biggest
decline with an -8% market CAGR through 2018E. The Supreme Tier (above RMB300 per
can) market, which was the fastest growing in the past five years, is slowing down to just 7%
CAGR for the next five.
Selective opportunities still exist in the Mid- and High- tiers where growth could be sustained
above 10% CAGR. However, competition has already intensified within these segments.
Fig 20 Market growth to shift to Mid- to High- tiers Fig 21 Mid tier accounts for 42% of total market

2014
2014

0
100
200
300
400
500
600
700
Low Mid High Supreme
Infant formula volume (000tonne)
0
20
40
60
80
100
120
Infant formula market size (RMB billion)
13%
17%
18%
24%
17%
-8%
11% 11%
7%
8%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
market
09-13 13-18E
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Breakdown of infant formula market by tier
11 June 2014 10
Two Child Policy to only temporarily boost births by 3m until 2017
To forecast the market growth potential for infant formula, we need to understand Chinas
demographic profile on birth rates. We turned to demographic expert and the Founder of
Global Demographic Ltd, Dr. Clint Laurent, for clues on future birth trends.
In October 2013, the Chinese government relaxed the One Child Policy such that if either of
a couple is a single child they are allowed to have a second baby. However, this is not the
first time the Policy was relaxed by the government; as early as 2002, families where both
spouses were a single child were already allowed to have two children.
Dr. Laurent sees the crucial distinction in the new policy definition changing from AND to OR
having a less profound impact on the birth rate than first meets the eye. Only 4.9 million urban
and 23 million rural women fall under the new definition who were not qualified under the old
one.
Those newly qualified must also satisfy the below conditions:
Is a Han Chinese and a single child herself
Already has a child
And if they are a rural Hukou, the first child is male (rural women with a daughter could
already have a second child)
Dr. Laurent calculates only 1.6m urban and 0.9m rural incremental births under the relaxed
rule. He expects the birth rate to rise from 14m as of 2012 to a peak of 18m in 2017 before
declining. At the max, he does not expect Chinas total child bearing capacity to exceed 18
million. The maximum uplift of 3 million addition births per year would be insufficient to offset
what is otherwise a declining birth profile.
Fig 22 Relaxed rule to temporarily boost births up to
3m before falling again in 2018
Fig 23 More than half of the new births would be from
rural families

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

0
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Births (old case) Births (new case)
# of births
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E
Urban Rural
# of births (million)
11 June 2014 11
Low fertility rate poised to drop further
According to the World Bank and Chinas National Health and Family Planning Commission
(the government body that implements and oversees the One Child Policy), as of 2013
Chinas fertility rate was 1.7 (births per woman), lower than 1.9 in the United States and far
below the global average of 2.8.
If developed Asian populations are any indication for China, fertility rates could go much lower
towards 1.1. Shanghai, as an extreme example, has a fertility rate of only 0.7 and ranks
globally the lowest.
Chinese fertility rates have been declining for the past five decades due partly to the one child
policy (1978) but also in recent decades to the decreasing propensity to have children,
particularly because of:
High urban property prices
High cost of raising a child (education, maternity, healthcare).
Fig 24 Chinas fertility profile in structural decline,
due to policy and declining propensity to have children
Fig 25 Developed Asian populations indicate Chinas
fertility has much downside

*2010 Census
Source: World Bank, Macquarie Research, June 2014 Source: World Bank, Macquarie Research, June 2014
This New York Times article illustrates the challenge for many families: sky high real estate
prices (home ownership is often a prerequisite for men to provide before marriage) and the
subsequent high cost of infant formula, medical expenses and education are putting many
young urban couples off from having children.

1.0
2.0
3.0
4.0
5.0
6.0
7.0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
China U.S.
Births per woman
One Child Policy introduced
One Child Policy relaxed
0.7
1.7
1.3
1.1
1.3 1.3
1.4
1.9
1.9
1.6
1.9
0.5
1.0
1.5
2.0
Births per woman (2012)
11 June 2014 12
Per-capita consumption capped by already low breastfeeding ratio
We think the current per-capita consumption of infant formula has very little upside due to the
already low breastfeeding ratio in China. The government has been taking proactive
measures to encourage breastfeeding.
The ratio of babies being exclusively breastfed (ie not given infant formula as well) for up to
six months old in China was only 28% as of 2013 vs. the world average of 39%. This is even
lower is for urban Chinese babies, where less than 16% are exclusively breastfed.
We see several reasons for this in urban China:
High female labour participation ratio
Lack of public or workplace nursery facilities
Aggressive promotion by infant formula makers, and in some instances illegal activities
taking place to promote infant formula (Sept 2013 CCTVs uncovering of illegal bribes
given to hospital staff)
Fig 26 Breastfeeding ratio in Urban China is among the lowest in the world

Source: World Bank, National Health and Family Planning Commission, Macquarie Research, June 2014
Breastfeeding is now being encouraged in many countries around the world as extensive
research has proven the natural health benefits over artificial infant formula. During the first
six months after birth, the mothers breast milk provides essential ingredients critical for the
infants immune system development that isnt provided by infant formula substitutes.
Governments and institutions around the world have been advocating breastfeeding over
infant formula, through initiatives such as UNESCO/WHOs 1992 Innocenti Declaration.
Chinese government taking action to increase breastfeeding ratio
The Chinese government recognizes the health benefits of breastfeeding and has been
taking action to increase the ratio:
To achieve a 50% breastfeeding ratio by 2020: set out by the 2020 China Children
Development Plan in 2011 (see official link in Chinese)
Ban on healthcare professional marketing and promoting breastfeeding
substitutes (infant formula): Following the Sept 2013 CCTVs uncovering of illegal
sales practices by certain infant formula makers, the National Health and Family
Planning Commission set out a new regulation (see official link in Chinese)

67%
51%
28% 28%
16%
30%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
1998 2003 2008 2013
China average Urban China Rural China
% of new borns with exclusive breast feeding up to 6 months old
World average 39%
11 June 2014 13
Policy directed consolidation, price ceiling
Visible hand directing industry consolidation, capping prices
Various policy measures have been announced in the past 12 months aimed at reforming the
infant formula industry. We believe the governments end goal is to build a strong domestic
industry with high quality and safety standards to restore Chinese consumers confidence in
domestic infant formula. In the interim, policy makers are concerned about the affordability of
infant formula and have taken measures against imported brands making excessive profits.
In the domestic infant formula industry, the Chinese government is taking the following steps:
Strengthening safety standards, banning OEM production of infant formula
Increasing accountability, requiring players to own or control their upstream milk
sources
Eliminating weak, smaller players production licenses
Establishing a list of national champion brands
Consolidating the industry from the current 200+ players to just 50
As of June 2014, 82 out of 133 domestic infant formula makers have successfully
passed the China FDAs quality examination and had their production permits renewed
The government has also taken action against the imported infant formula brands:
NDRC investigation of six imported brands over monopolistic pricing behaviour
(reaping above-normal profits) which resulted in heavy penalties and price cuts of up
to 20%
Requiring all imported products to be packaged in final retail format with labels printed
in Chinese, thus banning the cheaper repackaging methods previously used
Banning hospital staff from marketing infant formula products
As of June 2014, 94 foreign infant formula brands have received import approval from
the General Administration of Quality Supervision, Inspection and Quarantine.

11 June 2014 14
Fig 27 Major policy announcements/events in the dairy industry over the past 12 months
Date Regulatory body Announcement, event and implication
May 2013 Premier Li Keqiang and the
State Council
Exploring Options to Further Strengthening Quality and Safety of Infant
Formula
June 2013 Ministry of Industry and
Information Technology
Plan to Improve Infant formula Quality Standards, to Raise Public Consumer
Confidence
June 2013 State Council and 9
ministries
Opinion on Further Strengthening Quality and Safety of Infant Formula,
first major blueprint for industry consolidation
July 2013 National Development and
Reform Commission
Investigating six infant formula brands on violating Anti Monopoly Law,
resulted in 5-20% price drop and hefty fines
August 2013 China Customs Fonterras contaminated whey powder incident prompted Chinese Customs
to temporarily suspend imports. Fonterra later admit it was a false alarm
September 2013 China Central Television Exposed certain global infant formula brands illegal bribes paid to hospital
employees to promote sales of infant formula products
September 2013 National Health and Family
Planning Commission
Ban on healthcare professional marketing and promoting breastfeeding
substitutes (infant formula)
September 2013 China Dairy Industry
Association
Held new product launch conference. First batch of infant formula 'National
Team' brands announced: Yili, Mengniu Yashily, Wonderful Sun, Feihe,
Wissun, and Treasure of Plateau
September 2013 General Administration of
Quality Supervision,
Inspection and Quarantine
Guidelines on Strengthening the Management of Imported of Infant Formula,
requiring all imported infant formula to be prepared in final retail packaging
with Chinese labels on and after April 1, 2014
December 2013 China Food and Drug
Administration
Infant Formula Production License Examination Details, requiring all infant
formula players to undergo strict re-examination under pharmaceutical
standards in order to gain renewal of production licenses.
January 2014 China Dairy Industry
Association
Second batch of infant formula 'National Team' brands: Sanyuan,
Beingmate, Yinqiao, Huishan, and Baiyue
May 2014 China Food and Drug
Administration
Report on Infant Formula Production License Examination: 82 of 133
domestic infant formula makers passed the test and had their licenses
renewed while 51 failed or were postponed.
June 2014 General Administration of
Quality Supervision,
Inspection and Quarantine
94 foreign infant formula brands have received import approval, including
Dumex, Abbott, Nestl, Wyeth and Biostime
Source: Chinese government and its various ministries, Macquarie Research, June 2014

11 June 2014 15
State Councils Opinion marks the start of industry consolidation
On June 20, 2013, the State Council and its nine ministries, including the State Food and
Drug Administration and Ministry of Industries and Information Technology (MIIT), issued a
joint-communiqu, Opinions on further strengthening the quality and safety of infant formula.
The general aim of this policy announcement is to encourage domestic infant formula
producers to consolidate and strengthen supply chain quality control. Specifically, it called for
the following actions:
Producers of infant formulas to operate and control their own raw milk sources
Strengthen quality inspection throughout the supply chain
Consolidate processing industry and eliminate sub-standard players through production
license renewal starting May 2014
Ban repackaging or OEM production of infant formula
Strengthen and promote standardisation of scaled dairy farming
NDRC investigation of pricing power abuse and subsequent price
cuts
On July 2, 2013, the National Development and Reform Commission (NDRC) launched an
investigation into six imported infant formula brands on the grounds of monopolistic pricing
behaviour. Prior to this, imported premium infant formulas were sold for RMB300-500/900g,
representing 50% more than equivalent products sold overseas and in the HK market.
NDRC announced in early August the results of its investigation: six infant formula brands
were found guilty of manipulating retail prices and were ordered to pay a total penalty of
RMB668m. Out of the six brands, Mead Johnson was ordered to pay the highest penalty of
RMB204m, however Biostimes RMB163m penalty represented the most severe based on
percentage of sales.
Fig 28 NDRC investigation: hefty penalty, price cuts
Brand Company Penalty (% of sales) Company reaction
Biostime Biostime RMB163m (6%) 5-10% price reduction, 50% extra rewards for members
Enfamil Mead Johnson RMB204m (4%) 10-20% price reduction
Dumex Danone RMB172m (3%) 5-20% price reduction
Similac Abbott RMB77m (3%) 4-12% price reduction
Friso FrieslandCampina RMB48m (3%) 5% reduction
Fonterra Fonterra RMB4m (3%)
Wyeth Nestl No penalty Average 11% reduction, max 20%
Nestl Nestl No penalty Up to 20% reduction
Beingmate Beingmate No penalty 5-20% price reduction
Meiji Meiji No penalty
Source: NDRC, Company data, June 2014

11 June 2014 16
Policy and competition to drive infant formula prices, margins lower
We think the NDRC investigation was targeted squarely at the imported brands that have
been charging high prices and earning superior profitability on the back of Chinese
consumers concerns over domestic quality.
On the one hand, NDRC is buying time for the domestic players to consolidate and regain
market share. On the other hand, these price cuts should improve affordability for average
income families and thus ease one of the factors that have lowered young Chinese parents
propensity to have children.
The latter has much larger implications for Chinas looming demographic crisis, where the
ageing population has already started to shrink the size of the workforce. The last thing the
government would want to see is foreign brands benefitting excessively from Chinese
consumers long standing concerns over domestic food safety by reaping above-normal
profits. For details on Chinas looming demographic crisis, please read Jake Lynchs
Demographic Techtonics.

11 June 2014 17
Junlebaos RMB130/can price war
The initial price cuts among major players in 2H2013 were just the beginning. New
competitors will likely further drive prices lower. Hebei based Junlebao (in which Mengniu
owns a 50% stake) surprised the industry in April 2014 by introducing a RMB130/can retail
price infant formula product (see the products on Junlebaos own ecommerce site).
Fig 29 Junlebaos RMB130/can, direct channel-only infant formula

Source: Company data, May 2014
Comparable products from most major brands retail for at least RMB200/can, and Junlebaos
products are likely to be appealing to price sensitive consumers.
Different from traditional offline channels such as supermarkets or maternity shops,
Junlebaos newly launched infant formula will be sold exclusively through direct channels
(telephone or online). In the chart below, we calculate two major cost components Junlebao
can eliminate: distributor costs and retail discounts.
Fig 30 Direct selling model cuts out middleman

Source: Macquarie Research, June 2014
Junlebao has expressed confidence in its unique selling model. We think Junlebaos key
challenge will be the lack of brand awareness, given that this is its first infant formula product
launched. Without offline A&P, it may be difficult to gain meaningful market share in this
competitive industry.
Nevertheless, the Junlebao case indicates that industry players have already begun looking
for ways to undercut the already high prices to gain market share given the limited upside
potential from future ASP hikes.

0 50 100 150 200 250
Traditional
Direct selling
Ex-factory price VAT S&D cost Distributor discount Retail mark-up
RMB per 900g can of high grade infant formula
Retail price RMB130
RMB220
11 June 2014 18
Distribution channel revolution
Local brands that rely on supermarkets have lost market share
Infant formula sales at supermarkets dropped by 4% YoY in 2013, for the first time ever, and
companies that have significant sales from supermarkets suffered. Despite the overall market
still growing in the low-teens, sales of infant formula in supermarkets were largely flat over the
past three years. We expect the shift towards maternity shops and ecommerce to accelerate
and the beneficiaries to be those that can successfully capture this consumption habit
change.
consumers. They were the first to develop online shopping habits and when they have babies
they are increasingly buying infant formula from two emerging channels:
Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barriers,
very fragmented. Early mover brands can secure an advantage in sales
model where brand awareness attracts sales.
Fig 31 Infant formula purchases are shifting from
supermarkets to maternity shops and ecommerce
Fig 32 Supermarket sales on the decline, Ecommerce
growing rapidly

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

44% 43%
36%
33%
41%
42%
23%
16%
22%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2011 2012 2013
%of infant formula sales, China
5%
-4%
36%
17%
23%
60%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
2012 2013
Channel growth YoY
11 June 2014 19
Between the two HK listed plays, Yashilis reliance on supermarket sales is the highest
(>60% of sales) while Biostimes success in recent years was attributable to its early-mover
entry into the maternity channels. However, Biostime lacks in terms of Ecommerce.
Fig 33 Biostimes early move in maternity was instrumental to its success

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

23%
70%
43%
26%
64%
36%
77%
30%
41%
74%
36%
42%
16%
22%
0%
20%
40%
60%
80%
100%
Biostime Yashili Industry Biostime Yashili Industry
2012 2013
% of infant formula sales
11 June 2014 20
Chinese consumers prefer imported brands
Hundreds of foreign brands have entered Chinas infant formula market since the 2008
Melamine Scandal which killed six babies and caused thousands of others to fall sick.
Domestic brands that were once market leaders, such as Yashili, Synutra and Feihe, have all
conceded significant market share to companies such as Mead Johnson, Danone and Nestl.
Fig 34 Infant formula market share, March 2012

Fig 35 Infant formula market share, January 2014

Source: Nielsen, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014
According to the Dairy Association of China, the infant formula market in China was evenly
split between domestic and foreign brands before the 2008 Melamine Scandal. As of 2013,
domestic brands total market share has dropped to below 40%, while in 1
st
tier cities
imported brands control more than 80% share.
The imported powder premiumisation drive came at the expense of domestic players. Not
only did domestic players lose market share to foreign ones, the industry actually became
more fragmented as a result.
We believe this consumer behaviour phenomenon that rapidly transformed the infant formula
industry was due to the following inter-related causes:
Imported infant formulas perceived superior quality assurance
The medias negative portrayal of domestic infant formula following numerous
incidents, fuelling already high mistrust of domestic products
Rising outbound travel (including to Hong Kong) of Chinese citizens, increasing
access to and awareness of foreign brands
Strong marketing capability of foreign brands
Emergence of ecommerce, and specifically online maternity shops and overseas
group-buying sites
Consumers willingness to pay a premium for quality for their children, particularly
among the younger generation of Chinese parents (those born after 1980).
The only exception is Biostime, the Guangzhou based company which entered the infant
formula market only in the wake of the Melamine Incident, as it was able to capture significant
market share with its European sourced premium product positioning and innovative
membership sales strategy. As of January 2014, Biostime commanded 7.5% market share
and was the #4 player in the infant formula market and dominated the top spot in the supreme
segment (>RMB300/can ASP).

Mead
Johnson,
13.8%
Wyeth, 9.8%
Beingmate,
9.6%
Abbott,
7.1%
Yili, 10.4%
Nestle, 4.0%
Yashili, 5.1%
Dumex, 13.5%
Feihe, 4.6%
Synutra, 5.2%
Others, 16.9%
Mead
Johnson,
14.5%
Wyeth, 13.3%
Beingmate,
8.5%
Biostime,
7.5%
Abbott, 7.0%
Yili, 6.2%
Nestle, 4.4%
Yashili, 4.1%
Friso, 3.9%
Dumex, 3.6%
Feihe, 3.5%
Synutra, 3.2%
Others, 20.3%
11 June 2014 21
Lack of offline retail presence drives ecommerce sales
According to Alibabas IPO prospectus, Chinas offline physical retail infrastructure lags
behind developed nations, particularly in lower tier cities. Official statistics show that 19% of
Tier 1 & 2 urban consumers accounted for 41% of total retail sales in 2013, or three times
more on a per-capita basis. Ecommerce allows consumers in less developed regions to
leapfrog underdeveloped offline retail infrastructure to meet their consumption needs.
In the infant formula industry, this is demonstrated first in the lack of supermarkets in lower
tier cities, where much smaller maternity shops have found an opportunity to penetrate and
gain market share. More recently, ecommerce has allowed imported brands to penetrate
lower tier markets that they were previously unable to access due to traditional distribution
channels limitations.
Fig 36 Chinas ecommerce market to grow at double
digits, while penetration remains low
Fig 37 Under-developed offline retail presents
opportunities for ecommerce to tap unmet demand

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

0%
2%
4%
6%
8%
10%
12%
14%
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Ecommerce revenue Penetration
Total online sales(RMB billion)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
China U.S. U.K. Japan Germany
Retail space square meter per-capita
11 June 2014 22
Imported brands dominate ecommerce
Although two of the top five infant formula brands by sales are domestic companies
(Beingmate and Biostime), imported brands capture the top five spots in ecommerce with
60% market share.
Global brands with higher perceived quality and strong A&P capabilities are highly
recognized by Chinese consumers. With the proliferation of social media and ecommerce,
consumers in lower tier cities can now conveniently make their purchases online.
Fig 38 Overall infant formula sales spread between
domestic and imported brands

Fig 39 Imported brands dominate ecommerce

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

Mead
Johnson,
14.5%
Wyeth,
13.3%
Beingmate,
8.5%
Biostime,
7.5%
Abbott, 7.0%
Yili, 6.2%
Nestle, 4.4%
Yashili, 4.1%
Friso, 3.9%
Dumex,
3.6%
Feihe, 3.5%
Synutra,
3.2%
Others,
20.3%
Infant formula (Jan 2014)
Mead
Johnson
14.8%
Wyeth
12.3%
Friso
11.2%
Abbott
11.0%
Dumex
10.5%
Others
40.2%
Ecommercemarket share, infant formula (2013)

11 June 2014 23
HONG KONG

1112 HK Underperform
Price (at 13:45, 10 Jun 2014 GMT) HK$51.40

Valuation HK$ 40.01
- DCF (WACC 13.4%, beta 1.2, ERP 7.0%, RFR 5.0%, TGR 2.0%)
12-month target HK$ 38.50
Upside/Downside % -25.1
12-month TSR % -22.0
Volatility Index High
GICS sector Food, Beverage
& Tobacco
Market cap HK$m 31,040
Market cap US$m 4,004
Free float % 25
30-day avg turnover US$m 6.3
Number shares on issue m 603.9

Investment fundamentals
Year end 31 Dec 2013A 2014E 2015E 2016E
Revenue m 4,561.3 5,416.6 6,307.8 7,090.0
EBIT m 1,284.8 1,389.7 1,625.7 1,876.7
EBIT growth % 24.2 8.2 17.0 15.4
Reported profit m 820.7 987.3 1,189.6 1,364.5
Adjusted profit m 961.0 987.3 1,189.6 1,364.5
EPS rep Rmb 1.34 1.61 1.94 2.23
EPS rep growth % 10.3 20.3 20.5 14.7
EPS adj Rmb 1.57 1.61 1.94 2.23
EPS adj growth % 31.3 2.8 20.5 14.7
PER rep x 30.9 25.7 21.3 18.6
PER adj x 26.4 25.7 21.3 18.6
Total DPS Rmb 1.23 1.15 1.39 1.59
Total div yield % 3.0 2.8 3.4 3.9
ROA % 31.5 19.9 16.5 17.8
ROE % 39.7 36.6 38.3 38.3
EV/EBITDA x 18.3 16.3 13.9 12.0
Net debt/equity % -36.3 -37.1 -34.8 -36.3
P/BV x 9.9 8.6 7.5 6.5
Source: FactSet, Macquarie Research, June 2014
(all figures in Rmb unless noted, TP in HKD)

Analyst(s)
Jamie Zhou, CFA

11 June 2014
Biostime
No longer the new kid on the block
Initiating with Underperform, TP HK$38.50, 25% downside
We believe Biostime is Chinas most extraordinary infant formula growth story in
recent years: born in the midst of the 2008 Melamine Scandal as the new kid on
the block and through its premium positioning, innovative membership strategy,
unique supply chain and early mover advantage in capturing the rapid growth of
the maternity channel, it has quickly grown to become the #4 player with 7.6%
market share (2013). However, Biostime is facing challenges from muted industry
volume growth with falling fertility rates, limited pricing power from government-led
consolidation, and rising competition from proliferation of ecommerce. The stock is
expensive at a 26x/21x FY14/15E PER; our target HK$38.50 implies 16x FY15E
EPS, on par with the historical average. Founders lock-up expiration poses a sell-
down overhang on the stock.
Growth slows <20%, margins under pressure with mix shift
After an extraordinary streak (FY09-13 sales CAGR 69%), we project growth is
slowing to 19% in FY14. The July 2013 NDRC investigation has already reduced
firm-wide ASP by 1%. Margins will be under pressure; having dominated the
Supreme category (retail ASP >RMB300/can) with 55% market share, Biostime is
looking for growth in the high (RMB200-300) and mid-tier (RMB100-200). Mid/high
tier have lower margins (GM 56% and 62%) vs. Supreme (69%). We forecast OP
margin to drop by 160bps to 26.6%.
Market share scenario suggests downside is meaningful
While we believe Biostime can continue to maintain its market leadership with the
newly launched Adimil brand and the O2O sales model, with growth slowing faster
than expected, we see 16%/31% downside to Consensus estimates for
FY14/15E. Our base case scenario assumes Biostime 1) maintains market share
in the High Tier, 2) has a slight share loss in Supreme and 3) establishes a
presence in the Mid Tier. Our Bear Case suggests a further 8-15% earnings
decline should the company lose Supreme market share quicker than can be
offset with Adimil.
O2O (online-to-offline): killing two birds with one stone
Biostime launched its O2O sales model (online ordering to offline home delivery
by member shops) in September 2013 and targets deriving 10% of its FY14
revenue from O2O. The initiative may at first appear as a defensive strategy
against rapidly rising ecommerce sales of imported infant formula brands (total
sales up 60% in 2013). We think Biostime is achieving two goals in one: 1)
offering consumers the convenience shopping experience of online/mobile and 2)
strengthening relationships with its most important offline partners, the maternity
shops, by sharing value chain profits with participating stores.
Mama100 monetisation with horizontal expansion
Biostime hopes to develop the Mama100 membership program into an
ecommerce ecosystem of maternity products. The Dec 2013 JV with Coco Health
may be a major step in penetrating the lucrative diapers market (penetration
remains low at 40%) which has a high cross-selling ratio (19%) to infant formula
sales. Biostime intends to make more horizontal acquisitions into other maternity-
related FMCG categories, and the newly issued RMB2.4bn CB puts it in a strong
balance sheet position to do so.
11 June 2014 24
Inside

Market share scenario: downside risk is
meaningful 25
Valuation 27
O2O: killing two birds with one stone 30
Mama100 monetisation 32
Management and corporate governance 33
Financials 36

1112 HK rel HSI performance


A miracle born in the midst of a crisis
Company profile
Founded in Guanzhou in 1999, we believe Biostime is Chinas most
extraordinary infant formula growth story in recent years: infant formula
products were launched in the midst of the 2008 Melamine Scandal and
through its innovative membership sales strategy, unique supply chain model
and early mover advantage in capturing the rapid growth of the maternity
channel, the company has quickly grown to become the #4 player, capturing
7.6% market share (2013). The company also sells a range of infant care,
probiotic supplements, infant food and nutritional products under the BM Care
brand. In September 2013, the company introduced the specialty function
infant formula brand Adimil.
Biostime pioneered the Supreme-tier category with the introduction of
>RMB300/can retail priced infant formula products and commanded 69%
market share in 2013. The company operates on a unique asset light supply
chain model with three key European OEM partners: Montaigu, Isigny
(Biostime owns 20% stake) in France and Arla in Denmark.
The company was successfully listed on the Stock Exchange of Hong Kong in
December 2010 under the ticker 1112.HK and raised HK$1.6bn in equity
capital. In February 2014, the company raised HK$3bn from the issuance of a
5-year zero-coupon convertible bond with a strike price of HK$90.84/sh.
Corporate governance and shareholding structure
Nine directors: two executive, four non-executive and three independent
Shareholding structure: 75% by co-founders (Biostime Pharmaceutical), 25%
free float. 5% potential dilution upon exercise of the 2019 Convertible Bond.
Auditor: Ernst & Young
Fig 1 Biostimes extraordinary growth in infant formula since 2008


0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
2008 2009 2010 2011 2012 2013 2014E 2015E 2016E
Infant formula Others (probiotics, baby food) Infant formula market share
Revenue (RMBmillion) Market share %
11 June 2014 25
Market share scenario: downside risk is
meaningful
Defend share in Supreme, capture share in Mid and High Tiers
Biostimes market share capture since the launching of infant formula in 2008 is remarkable.
It went from just 1.1% total market share in 2009 to 7.6% share in 2013. This was
accomplished with Biostime capturing significant growth opportunities in the Supreme and
High Tiers.
With a 17% CAGR over the past five years and we estimate slowing to just 8% over the next
five, Biostime recognizes it may be difficult for them to replicate their earlier success. Instead
they will focus on defending market share in Supreme, hoping to continue gaining incremental
share in High and launching Mid Tier products to enter the fastest growing segment.
Supreme tier (>RMB300/can): Biostime pioneered the segment and maintains a
dominate market share of 55% (2013). Increasing competition from Mead Johnsons
new products in the segment poses the risk losing some market share
High tier (RMB200-300/can): Biostimes biggest earnings contributor tier. Accounts for
60% of its revenue and it captured 12% market share as of 2013.
Mid tier (RMB100-200/can): Biostime previously didnt want to be in this segment due
to the lower margins, 56% vs. 62% and 69% for High and Supreme tier, but this is
where we expect the market growth will be: low tier consumption upgrade to mid will
drive an 11% CAGR, in our view, and this tier accounts for 42% of total industry sales.
Fig 2 Biostime is competitively positioned in the remaining growth tiers
% of sales (2013) Biostime GP margin
Tier
Price
RMB/can Industry Biostime Industry growth outlook
Market share
(2013) Strategy FY13
Low <100 14% 0% Declining tier, consumers are
upgrading to mid-to-high tiers
0.0% Not a target segment NA
Mid 100-200 42% 0% Bright spot in the industry, could
continue to grow >10% CAGR
0.0% Entering 2014 with domestic produced
Adimil (Retail ASP RMB180)
56%
High 200-300 39% 60% Bright spot in the industry, could
continue to grow >10% CAGR,
intensifying competition
11.8% Key driver for Biostime 62%
Supreme >300 5% 40% Slowing growth, but still has
opportunities, 7% CAGR
55.4% Maintain market share, and ward off
competition from Mead Johnson
69%
Source: Nielsen, Euromonitor, Company data, Macquarie Research, June 2014

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

Source: Nielsen, Global Demographics, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014
13%
17%
18%
24%
17%
-8%
11% 11%
7%
8%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
market
09-13 13-18E
0%
10%
20%
30%
40%
50%
60%
2009 2010 2011 2012 2013 2014E 2015E 2016E
Mid High Supreme
Biostimemarket share
11 June 2014 26
Market share scenario analysis
We model three scenarios on Biostimes market strategy. Our effective market share
calculation excludes the declining Low Tier, given that this is a market Biostime avoids.
Fig 5 Biostimes market share scenario
Scenario Execution outcome 2013A 2014E 2015E 2016E
BASE CASE
Mid Slight market entry success with Changsha Yingke produced RMB180/can Adimil 0.0% 0.8% 1.8% 2.3%
High Intensifying competition in high-tier is countered by the market success of the
RMB250/can Adimil and thus the company maintains market share
11.8% 12.3% 12.3% 12.3%
Supreme lose some market share to Mead Johnson, but maintain >50% share 55.4% 53.4% 52.4% 51.4%
Total market share 7.6% 8.2% 8.5% 8.8%
Total market share (Ex-low tier) 8.8% 9.3% 9.6% 9.7%
Effective market share gain/loss +0.7% +0.4% +0.3% +0.1%

BULL CASE
Mid Major breakthrough in capturing market share with new product introduction 0.0% 3.0% 6.0% 9.0%
High O2O exceeds expectations, share gain from domestic players through Mama100 11.8% 13.3% 14.8% 16.3%
Supreme Maintaining market share with the RMB350 Adimil 55.4% 55.4% 55.4% 55.4%
Effective market share gain/loss +2.1% +2.0% +2.1%

BEAR CASE
Mid Fail to meaningfully launch mid-end product 0.0% 0.3% 0.6% 0.9%
High Losing market share due to competition, weak O2O, imported brands steal share from
Biostime through ecommerce
11.8% 10.8% 9.8% 8.8%
Supreme Little success with the more expensive Adimil, lose market share to Mead Johnson 55.4% 50.4% 45.4% 40.4%
Effective market share gain/loss -0.7% -0.7% -0.7%
Fig 6 Three scenarios on Biostimes total market
share change
Fig 7 Adj. EPS are 10-33% above Base case for Bull
scenario and 8-21% below for Bear scenario

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014
Fig 8 Our bear case indicate a further downside of 8-21% on FY14-16 EPS
Adj. EPS RMB/sh % vs. base
2014E 2015E 2016E 2014E 2015E 2016E

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

2.1%
2.0% 2.1%
2.6%
2.1%
0.7%
0.4%
0.3%
0.1%
-0.7% -0.7% -0.7%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
2011 2012 2013 2014E 2015E 2016E
Bull Base Bear
Changein Biostime market share (+/- %)
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
2011 2012 2013 2014E 2015E 2016E
Bull Base Bear
Adj. EPS
11 June 2014 27
Valuation
Our primary valuation is based on a PER; we then cross check against our DCF fair
valuation.
Biostime (Underperform) with HK$38.50/sh target, 16x FY15E PER
Our 12-month target price of HK$38.50/sh is based on a 16x FY15E PER, the average of its
since-listing average valuation. We like the 34% ROE, strong FCF generation and consistent
dividend payout of 70%, however we are cautious on the rich valuation given we expect
growth to slow down significantly to just an 11% earnings CAGR. Our FY14/15E earnings
forecasts are 16%/31% below Consensus. Founders lock-up expired on May 20
th
which may
also pose a sell-down overhang on the stock.
EV/EBITDA
(x)
EPS
growth
(%)
EBIT
margin
ROE
(%)
Div
yield
(%) P/Bk
1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 16.3 13.9 11.3 23.5 33.9 2.9 9.9
Biostime at TP 38.50 19.2 16.0 11.5 9.8

002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4
1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9
1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6
Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1

Diversified dairies
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8
600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5
NESN VX Nestl NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5
BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2
FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4
Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0

151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4
322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5
1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4
Price date June 10, 2014. Valuations and forecasts for non-rated stocks are from Bloomberg.
With slowing growth, rising competition and government price caps, we believe infant formula
plays should trade at the low end of its historic valuation range of a 16-22x forward PER. We
think the price data over the past three years captures a fair representation of the infant
formula industrys risks and opportunities.
The three domestic infant formula pure plays were all listed in late-2010/early-2011. However,
their forward valuations fluctuated greatly in 2013, due to three major industry catalysts:
Positive: Mid-2013 Chinese government announces infant formula consolidation plans
Negative: July 2013 NDRC investigation which resulted in fines and price cuts
Positive: November 2013 relaxation of One Child Policy
Mead Johnsons average forward PER is also a good proxy, due to its global diversification
which limits short-term noise in the China market. MJNs forward PER has been steady in the
range of 18x to 25.5x since mid-2009.

11 June 2014 28
Fig 10 Biostime forward PER band Fig 11 Currently trading on 23x forward PER

Mead Johnson the global comp, 18-25x PER range
We believe Mead Johnson is a good valuation comparable for Biostime, because:
31% of Mead Johnsons FY13 revenue comes from China.
China contributed to 62% of Mead Johnsons revenue growth over the past 4 years.
Both are market leaders gaining market share from the rest (Mead Johnson #1,
Biostime fast rising #4).
Both players command the highest margins among peers and have the highest ROIC.
Both players are leaders in product innovation and derive most of their profits from the
high-tier and supreme-tier infant formula category.
Both were investigated and fined by the NDRC in July 2013, hence they have a similar
policy risk profile (Mead Johnson received the highest absolute fine, Biostime the
highest in percentage of revenue).
However, we also note the crucial difference is brand awareness and channel exposure.
Mead Johnson is not only the #1 brand nationwide in China, but also the #1 in the fast
growing ecommerce channel, which is a competitive threat to Biostime. Thus, our target
valuation is 16x forward PER, a fair discount to MJNs.
Fig 12 Mead Johnson trades on 21.8x PER on average Fig 13 Biostimes margins more volatile

Forward earnings are based on Bloomberg Consensus estimates.

0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
Dec-10 Dec-11 Dec-12 Dec-13 Dec-14
Share price (HK$)
10x
20x
30x
0
5
10
15
20
25
30
35
40
Forward PE ratio (x)
mean
-1
+1
10
12
14
16
18
20
22
24
26
28
MJN.US forward PE ratio (x)
mean
-1
+1
0%
5%
10%
15%
20%
25%
30%
2008 2009 2010 2011 2012 2013
Biostime Yashili Beingmate Mead Johnson
EBIT margin
11 June 2014 29
DCF fair value HK$40/sh
We cross check Biostimes valuation using a DCF model. Our fair valuation is HK$40/sh.
We like the 40% ROE, strong FCF generation capabilities and consistent dividend payout of
70%, however we are cautious in the near term given 16%/31% FY14/15E earnings downside
from Consensus. Founders lock-up expired on May 20
th
which may also pose a sell-down
overhang on the stock.
Fig 14 Biostime cash flow projection
RMB million 12A 13A 14E 15E 16E 17E 18E 19E 20E
Sales 3,382 4,561 5,417 6,308 7,090 7,793 8,440 9,148 9,920
... Growth 54% 35% 19% 16% 12% 10% 8% 8% 8%
Gross Profit 2,229 2,975 3,460 3,943 4,408 4,817 5,188 5,592 6,031
... GP Margin 66% 65% 64% 63% 62% 62% 61% 61% 61%
EBITDA 1,075 1,199 1,482 1,868 2,136 2,392 2,642 2,918 3,106
Margin 32% 26% 27% 30% 30% 31% 31% 32% 31%
Less: Tax 244 345 367 419 448 518 442 509 565
Less: WC -115 167 -47 33 -40 33 -40 32 -41
Less: Capex 39 136 100 100 100 100 100 100 100
Less: Other 2 309 116 213 259 262 409 423 322
Free Cash Flow 905 243 946 1,103 1,369 1,479 1,731 1,855 2,160
... FCF Growth -73% 290% 17% 24% 8% 17% 7% 16%
PV of FCF 881 906 992 945 975 921 946
Source: Company data, Macquarie Research, June 2014
Fig 15 DCF valuation metrics
WACC DCF Valuation
Risk Free Rate 5.0% Sum of PV of FCF 6,565
Market Risk Premium 7.0% PV of Terminal Value (RMBm) 8,461
Equity Beta 1.2 Enterprise Value (RMBm) 15,025
Cost of Equity 13.4% Less: Net Debt -4,406
Cost of Debt (Pre-tax) 9.0% Market Cap (RMBm) 19,431
Cost of Debt (After tax) 6.8% No. of Ord shares (m), fully diluted 602
Target Debt weight 0.0% Terminal as % total 56%
Target Equity weight 100.0% Foreign exchange (HKD/RMB) 1.24
Tax Rate 25% Market Cap (HKDm) 24,090
WACC 13.4%
Terminal Growth 2.0% Value per share, HK$ $40.01

11 June 2014 30
O2O: killing two birds with one stone
Proliferation of ecommerce threatening offline retail
Infant formula sales in supermarkets dropped by 4% for the first time in 2013, and companies
that had significant sales from supermarkets suffered. Despite the overall market still growing
at low-teens, sales of infant formula in super markets were largely flat over the past three
years. We expect the shift towards maternity shops and ecommerce to accelerate and
winners will be those that can successfully capture this change in consumption habits.
The generation born after 1980 is typically technology-savvy and convenience-seeking
consumers. They were the first to develop habits of shopping online, and when they have
babies, they are increasingly buying infant formula from two emerging channels:
Maternity shops: neighbourhood Mom & Pop baby product shops, low-entry barrier,
very fragmented. Early mover brands secure advantage in shelf space.
Ecommerce: infant formula sold through Chinas leading B2C sites, a brand-driven
model where brand awareness attracts sales
Fig 16 Infant formula purchases are shifting from
supermarkets to maternity shops and ecommerce
growing rapidly

Source: Nielsen, June 2014 Source: Nielsen, June 2014
Biostime has been an early mover in the maternity channel and its phenomenal success in
recent years was attributable to its member store channel management system. However,
Biostime lacks in Ecommerce.
Fig 18 Biostime is strong in maternity channel, but negligible in ecommerce

20 21 20
14
20
23
6
7
12
0
10
20
30
40
50
60
2008 2009 2010 2011 2012 2013
Retail sales value (RMB billion)
5%
-4%
36%
17%
23%
60%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
2012 2013
Channel growth YoY
23%
70%
43%
26%
64%
36%
77%
30%
41%
74%
36%
42%
16%
22%
0%
20%
40%
60%
80%
100%
2012 2013
11 June 2014 31
Proliferation of ecommerce threatening offline retail
Biostime launched its O2O sales model (online ordering to offline home delivery by member
shops) in September 2013 and targets deriving 10% of its FY14 revenue from O2O.
The initiative may at first appear as a defensive strategy against rapidly rising ecommerce
sales of imported infant formula brands (total sales up 60% in 2013). We think Biostime aims
to achieve two goals in one:
1) offering consumers the convenience shopping experience of online/mobile, and
2) strengthening relationships with its most important offline partners, the maternity shops, by
sharing value chain profits with participating stores.

11 June 2014 32
Mama100 monetisation
Biostimes success is instrumental to its Mama100 membership program, entailing a point
reward program and a mobile app with maternity social media functions. With 1.8m active
members as of Dec 2013, Biostime hopes to develop Mama100 to reach 3m active users by
2016 and become a powerful ecommerce ecosystem of maternity products.
To fully unlock the potential of Mama100, Biostime looks to:
Immediately: launching an O2O sales model allowing consumers to place orders
online/mobile and receive offline delivery from member shops.
Near future: expand into other infant FMCG categories that it currently doesnt have a
significant presence. The company is searching for horizontal expansion M&A targets.
In the long run: Open Mama100 to third parties by charging a platform fee.
Fig 19 Mama100 active members to reach 3m by 2016 Fig 20 Already seeing strong cross-selling rates

Source: Company data, June 2014 Source: Company data, June 2014
Eyeing the lucrative yet underpenetrated diaper market
The Dec 2013 JV with Coco Health may be a major step in penetrating the lucrative diaper
market (penetration remains low at 47% vs. 85% for infant formula). Biostime intends to make
more horizontal acquisitions into other maternity-related FMCG categories, and the newly
issued RMB2.4bn CB puts it in a strong balance sheet position to do so.
Fig 21 Infant formula to reach 85% penetration Fig 22 Diaper penetration remains low at 40%

*based on 11kg/infant/year *based on three diapers per infant per day (conservative)
Source: Global Demographics, Nielsen, Macquarie Research, June 2014 Source: Euromonitor, CNHPIA, Macquarie Research, June 2014
0
500
1,000
1,500
2,000
2,500
3,000
2010 2011 2012 2013 2016E
Mama100 active members (000's)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0
10
20
30
40
50
60
70
80
90
100
2009 2010 2011 2012 2013 2014E 2015E 2016E
Infant formula market (RMB billion) Penetration ratio*
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0
10
20
30
40
50
60
70
80
90
100
2009 2010 2011 2012 2013 2014E 2015E 2016E
Baby diaper market (RMB billion) Penetration ratio*
11 June 2014 33
Management and corporate governance
Strong shareholder return since IPO
Biostime was founded by Mr. Luo Fei and five co-founders, including his brother Luo Yun.
Collectively, the co-founders holding company Biostime International owns 75% of listco
Biostime International with the remainder 25% as free float.
The company issued a HK$3bn 5-year zero coupon Convertible Bond with a conversion price
of HK$90.84/sh in February 2014. Upon full conversion, the CB will represent 5.36% of
enlarged shares outstanding.
Biostime Pharmaceutical entered into a voluntary lock-up for three years after the IPO. The
lock-up was further extended by three months after the 2019 CB issuance, and was expired
on May 20, 2014. Potential co-founder sell-down will pose an overhang on the shares.
Fig 23 Shareholding structure as of May 2014


Biostime International
(1112.HK)
Biostime
Pharmaceutical
Free Float
75% 25%
LUO Fei
28%
WU Xiong
26%
LUO Yun
20%
CHEN
Fufang
20%
ZHANG
Wenhui
10%
KONG
Qingjuan
4%
11 June 2014 34
Fig 24 Biostimes Corporate history and major events
Date Event Note
Aug 1999 Company founding Biostime Guangzhou was founded by Luo Fei and Luo Yun to engage in the research,
development and production of probiotic supplement products
2002 Lallemand partnership Partnership with Lallemand to develop probiotic supplement products
2003 Biostime launch Biostime brand of probiotic supplement was formally launched in China
2006 Mama100 Established the Mama100 Membership Program to provide catered customer service, a
membership points accumulation program, a monthly magazine subscription and other exclusive
services
2008 Infant formula launch Launched infant formula product line from supplier Montaigu with high quality French source
2009 BM Care Registered and launched BM Care line of infant care products, including baby diapers
Dec 2010 IPO Raised HK$1.6bn through successful initial public offering on the Hong Kong Stock Exchange,
listing under the stock code 1112
Nov 2011 Share option scheme Board approves share option scheme to motivate and retain senior management
Jun 2012 Arla partnership Biostime enters a 10-year financing and supply agreement with Arla Foods and provided
DKK81.5 million of financing to expand infant formula production facilities
Jun 2012 CTO resignation Dr. Zhang Wenhui, the company's Chief Technology Officer, Executive Director and a
shareholder of Biostime Pharmaceutical resigned and was redesignated as Non-executive
Director
Jul 2013 Isigny investment Biostime invested EUR2.5m for a 20% stake in its infant formula OEM partner Isigny Sainte
Mre. The fund will be used for Isigny's capacity expansion and R&D spend
Jul 2013 NDRC investigation Biostime was found guilty of NDRC's investigation on monopolistic pricing behavior. The
company paid a total fine of RMB163m and cut prices on some of its prices up to 10%.
Sept 2013 Adimil and O2O The company introduced the nutritional fortification brand of infant formula Adimil. At the same
time, Biostime launched its Online-to-Offline (O2O) sales model.
Dec 2013 Changsha Yingke acquisition Acquired Changsha Yingke for RMB350m in cash. The acquired target will be used to
manufacture lower-end Adimil infant formula products.
Jan 2014 Diaper JV Established a joint venture with Hangzhou Coco Healthcare to manufacture baby diapers. JV
60% owned by Coco, 40% by Biostime.
Feb 2014 2019 CB Issuance of HK$3.1bn 5-year zero-coupon Convertible Bond, conversion price HK$90.84/sh

11 June 2014 35
Fig 25 Biostimes Board of Directors (as of April 2014)
Name Title Age Responsibilities and bio
Executive Directors
Mr. LUO Fei

Chairman, CEO 50 Primarily responsible for overall strategies, planning & business development
Founded Biostime in 1999 and served as general manager since
Prior to 1999, Luo established Biohope, a personal care/household raw materials
trading company
Graduated from South China University of Technology (1988) and EMBA from
CEIBS (2008)
Ms. KONG Qingjuan

COO 52 Appointed Executive Director in May 2010, mainly responsible for overall
procurement, logistics, production, internal compliance & control
Prior to joining Biostime in 2000, Kong worked for hospitals and a bio-cosmetic
company
Bachelor degree in medicine from Hebei Medical Institute (1985)
Non-executive Directors
Dr. ZHANG Wenhui

Non-executive director 49 Redesignated to Non-executive Director in June 2012
Was previously an executive director and Chief Technology Officer (2005-2012) in
charge of R&D
Zhang was an assistant research professor of chemical engineering with University
of Nebraska-Lincoln
Bachelor in biochemical engineering from East China University of Science and
Technology (1985)
Master's in industry fermentation, doctorate in fermentation engineering from South
China University of Technology (1988 and 1994)
Mr. WU Xiong

Non-executive director 58 Appointed as Non-executive Director in May 2010
Was the general manager of Hainan Junjie Automobile (2000-2009)
and Haikou Market Properties Development (1997-2000)
and employed by the Administration of Industry and Commerce of Haikou City
(1980-1997)
Graduated from Haikou No.1 Middle School (1975)
Mr. LUO Yun

Non-executive director 53 Elder brother of founding chairman Luo Fei
Appointed Non-executive Director in May 2010
Worked in various divisions of Biostime, including GM of Biostime Health &
Nutrition (2009-2011), Mama100 membership center (1999-2009)
EMBA from Fudan University (2012)
Mr. CHEN Fufang

Non-executive director 50 Appointed Non-executive Director in May 2010
Bachelor's (1985) and master's (1988) in chemical fibre from South China
University of Technology
Independent Non-executive Directors
Dr. NGAI Wai Fung

INED, Chairman of
Audit
52 Appointed INED in July 2010
MD of MNCOR Consulting, CEO of SWCS Corporate Services, VP of HK Institute
of Chartered Secretaries
Hold directorships in: BaWang (1338.HK), Bosideng (3998.HK), China Coal Energy
(1898.HK), CRCC (1186.HK), Juda (1329.HK), LDK Solar (LDK.US), Powerlong
Real Estate (1238.HK), SANY Heavy (631.HK), SITC (1308.HK)
Mr. TAN Wee Seng

INED, Chairman of
Remuneration
58 Appointed INED in July 2010
Hold directorships in: Xtep (1368.HK), Sa Sa (178.HK), CIFI Holdings (884.HK),
ReneSola (SOL.US), CIFI (884.HK)
Also was a director of 7 Days (SVN.US) prior to delisting in July 2013 and was the
Chairman for the delisting review committee
Prof. XIAO Baichun

INED 66 Appointed INED in July 2010
A professional and scholar in management science. Professor at Secton Hall
University (1990-1999), Long Island University (1998-now)
Senior management
Mr. ZHAO Li

Chief Marketing Officer 45 Also General Manager of 'Parenting Power', one of the four brand project
departments of Biostime
Joined Biostime in October 2004
Mr. Frank CAO Wenhui

Chief Financial Officer 36 Joined Biostime in March 2007
Previously a senior accountant with Mead Johnson (2005-2007)

11 June 2014 36
Financials
Entering new era of slowing growth
After an extraordinary streak (FY09-13 revenue CAGR 69%), we expect growth to slow to
19% this year. The July 2013 NDRC investigation, which led to a 10% price drop on some
products, has reduced firm-wide ASP by 1%. We believe 1H14s growth will stall to 15% due
to high YoY base.
Fig 26 FY14 revenue growth to slow to 19% Fig 27 Tough 1H14

Margins under pressure from mix-shift towards mid/high tiers
Margins will be under pressure as well; having already dominated the Supreme category
(retail ASP >RMB300/can) with 65% market share, Biostime is increasingly looking for growth
in the high (RMB200-300) and mid-tier (RMB100-200). Mid/high tier have lower margins (GM
56% and 62%) vs. Supreme (69%).
We forecast OP margin to drop by 160bps to 26.6%.
Fig 28 Mid/high tiers have lower GM than Supreme
(FY14E)

Fig 29 Mix shift to lower blended infant formula GM


0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
FY11 FY12 FY13 FY14E FY15E FY16E
Revenue (RMBm) YoY growth
0%
10%
20%
30%
40%
50%
60%
0
500
1,000
1,500
2,000
2,500
3,000
3,500
2H12 1H13 2H13 1H14E 2H14E 1H15E
56%
62%
69%
40%
45%
50%
55%
60%
65%
70%
75%
Mid High Supreme
Gross margin by tier
56%
58%
60%
62%
64%
66%
68%
70%
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E
Mid High Supreme Blended GM (infant formula)
Infant formula revenue (RMBm) Blended GM
11 June 2014 37
Fig 30 Biostime - Annual P&L (Rmb m, except per share)
2011 2012 2013 2014E 2015E 2016E
Revenue 2,189 3,382 4,561 5,417 6,308 7,090
YoY growth 77% 54% 35% 19% 16% 12%

Cost of sales 733 1,153 1,586 1,956 2,365 2,682
Gross profit 1,456 2,229 2,975 3,460 3,943 4,408
Gross margin 66.5% 65.9% 65.2% 63.9% 62.5% 62.2%

Selling and distribution costs 709 1,078 1,513 1,860 2,085 2,273
Administrative expenses 82 117 177 210 232 258
Total SG&A 791 1,195 1,690 2,071 2,317 2,531
SG&A margin 36.1% 35.3% 37.1% 38.2% 36.7% 35.7%

Operating profit 665 1,034 1,285 1,390 1,626 1,877
YoY growth 96% 55% 24% 8% 17% 15%
Operating margin 30.4% 30.6% 28.2% 25.7% 25.8% 26.5%
-2.5%
Other income and gains 72 57 106 78 219 225
Other expenses -23 -39 -56 -66 -77 -86
NDRC fine -163
EBIT 714 1,053 1,173 1,401 1,768 2,015
EBIT margin 33% 31% 26% 26% 28% 28%

Finance costs 2 11 30 115 120
Pre-tax profit 714 1,051 1,162 1,371 1,652 1,895
Income tax 187 307 341 384 463 531
Tax rate 26% 29% 29% 28% 28% 28%

Net profit 527 743 821 987 1,190 1,365
Net margin 24% 22% 18% 18% 19% 19%

Adjustments -163 0 0 0
Tax on adjustment -48 0 0 0
Adjusted profit 527 743 936 987 1,190 1,365
Adjusted margin 24% 22% 21% 18% 19% 19%
YoY growth 98% 41% 26% 6% 20% 15%

Adj EPS (diluted) 0.86 1.22 1.53 1.61 1.94 2.23
YoY growth 49% 41% 26% 6% 20% 15%

Depreciation 13 22 26 80 101 121
EBITDA 727 1,075 1,199 1,482 1,868 2,136
EBITDA margin 33% 32% 26% 27% 30% 30%

11 June 2014 38
Fig 31 Biostime - Semi-annual P&L (Rmb m, except per share)
1H12 2H12 1H13 2H13 1H14E 2H14E 1H15E 2H15E
Revenue 1,363 2,019 2,061 2,500 2,367 3,050 2,756 3,552
YoY growth 57% 53% 51% 24% 15% 22% 16% 16%

Cost of sales 469 684 692 894 855 1,101 1,033 1,332
Gross profit 894 1,335 1,370 1,606 1,512 1,948 1,723 2,221
Gross margin 65.6% 66.1% 66.4% 64.2% 63.9% 63.9% 62.5% 62.5%

Selling and distribution costs 475 602 667 846 828 1,032 919 1,166
Administrative expenses 50 67 79 99 93 117 103 129
Total SG&A 525 669 746 944 922 1,149 1,022 1,296
SG&A margin 38.5% 33.2% 36.2% 37.8% 38.9% 37.7% 37.1% 36.5%

Operating profit 368 666 624 661 590 799 701 925
YoY growth 62% 52% 69% -1% -5% 21% 19% 16%
Operating margin 27.0% 33.0% 30.2% 26.4% 24.9% 26.2% 25.4% 26.0%

Other income and gains 22 35 62 45 34 44 96 123
Other expenses -17 -22 -25 -31 -29 -37 -34 -43
NDRC fine -163
EBIT 373 680 498 675 595 806 763 1,005
EBIT margin 27% 34% 24% 27% 25% 26% 28% 28%

Finance costs 0 2 4 7 13 17 50 65
Pre-tax profit 373 678 494 668 582 789 712 940
Income tax 99 209 196 145 168 216 202 261
Tax rate 27% 31% 40% 22% 29% 27% 28% 28%

Net profit 274 469 298 523 415 573 510 679
Net margin 20% 23% 14% 21% 18% 19% 19% 19%

Adjustments 0 0 -163 0 0 0 0 0
Tax on adjustment
Adjusted profit 274 469 460 475 512 678 687 846
Adjusted margin 20% 23% 22% 19% 22% 22% 25% 24%
YoY growth 40% 41% 68% 1% 11% 43% 34% 25%

Adj EPS (diluted) 0.45 0.77 0.75 0.78 0.84 1.11 1.12 1.38
YoY growth 39% 41% 68% 1% 11% 43% 34% 25%

Depreciation 10 12 13 13 35 45 44 57
EBITDA 384 692 511 689 631 851 807 1,061
EBITDA margin 28% 34% 25% 28% 27% 28% 29% 30%

11 June 2014 39
Fig 32 Biostime - Balance sheet (Rmb m)
2011 2012 2013 2014E 2015E 2016E
Inventories 297 523 972 968 1,377 1,283
Trade and bills receivables 10 0 15 3 18 6
Prepayments, deposits and other receivables 29 86 111 123 150 156
Due from a director 2 2 2 2
Derivative financial instrument 6 6 6 6
Loans receivable 13 27 27 27 27
Restricted cash 70 70 70 70
Cash and cash equivalents 1,814 1,669 1,663 6,364 6,561 6,840
Current assets 2,150 2,291 2,866 7,563 8,211 8,390

PP&E 59 77 322 496 596 696
Intangible assets 1 1 6 6 6 6
Deposits paid for PP&E 30 13 15 15 15 15
Time deposits 160 942 855 855 855 855
Deferred tax assets 36 79 124 218 415
Prepaid land lease payments 20 84 84 84 84
Goodwill 143 143 143 143
Bonds receivable 98 98 98 98
Loans receivable 110 85 85 85 85
Held-to-maturity investment 21 21 21 21
Non-current assets 288 1,242 1,754 1,804 2,122 2,419
Total assets 2,438 3,533 4,620 9,367 10,332 10,809

Trade payables 67 263 362 409 523 534
Other payables and accruals 265 444 720 715 1,020 948
Interest-bearing bank loan 271 751 2,883 2,993 3,047
Tax payable 83 156 213 6
Current liabilities 415 1,133 2,045 4,013 4,535 4,529

Deferred tax liabilities 45 77 60 60 60 60
2019 CB 2,411 2,411 2,411
Non-current liabilities 45 77 60 2,471 2,471 2,471
Total liabilities 461 1,211 2,104 6,484 7,007 7,001

Issued capital 5 5 5 5 5 5
Reserves 1,679 1,904 2,143 2,436 2,789 3,193
Proposed final dividend 293 414 367 442 532 611
Total equity 1,978 2,323 2,516 2,883 3,326 3,809
Total liabilities and equity 2,438 3,533 4,620 9,367 10,332 10,809

11 June 2014 40
Fig 33 Biostime - Cash flow (Rmb m)
2011 2012 2013 2014E 2015E 2016E
Profit before tax 714 1,051 1,162 1,371 1,652 1,895
Adjustments for: 2 27 12 82 46 65
Bank interest income -17 -43 -83 -78 -219 -225
Interest income from loans receivable -1 -5
Interest from guaranteed deposits -12
Finance costs 2 11 30 115 120
Depreciation 13 22 26 80 101 121
Changes in working capital: -77 115 -167 47 -33 40
Inventories -192 -226 -452 4 -409 94
Trade and bills receivables -5 9 -15 12 -15 12
Other receivables -4 -42 -1 -11 -27 -7
Amounts due from directors -2
Rental deposits -5 0 0
Trade and bills payables 1 196 99 47 114 11
Other payables and accruals 127 177 205 -5 304 -71
Due to a related company
Gross operating cash flow 639 1,192 1,008 1,500 1,665 2,000
Tax paid -123 -245 -347 -384 -463 -531
Net Operating cash flow 516 947 660 1,116 1,203 1,469

Purchases of PP&E -39 -39 -136 -100 -100 -100
Proceeds from disposal of PP&E 0 0 0
Additions to intangible assets 0 0 -2
Acquisition of a subsidiary -280 -70
Increase in deposits paid for capex -21 -3
Held-to-maturity investment -21
Investment in bonds -123 -98
Repayment of loans receivable 1 9
Interest received 14 29 60
Principal guaranteed deposits 12
ST time deposits -324 -945 370
LT time deposits -160 -782 87
Restricted cash -70
Investing cash flow -529 -1,850 -81 -170 -100 -100

Proceeds from issue of shares 21
Share issue expenses -10
Shares for option scheme -57 -64 -64 -64 -64
New bank loans 271 645 2,132 111 54
Repayment of bank loans -165
CB 2,411
Interest paid -1 -9 -30 -115 -120
Dividends paid -180 -404 -622 -695 -837 -960
Financing cash flow -169 -192 -215 3,755 -906 -1,090

Increase/decrease in cash -182 -1,095 365 4,701 197 279
Period beginning cash 1,728 1,490 401 765 5,466 5,663
Foreign exchange -56 5 -1
Period end cash 1,490 401 765 5,466 5,663 5,942
Non-pledged time deposits (>3m) 324 1,269 898 898 898 898
Balance sheet cash 1,814 1,669 1,663 6,364 6,561 6,840

Free cash flow 456 905 243 946 1,103 1,369

11 June 2014 41

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

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

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

EPS (rep) 0.85 0.68 0.93 0.83 EPS (rep) 1.34 1.61 1.94 2.23
EPS (adj) 0.85 0.68 0.93 0.83 EPS (adj) 1.57 1.61 1.94 2.23
EPS Growth yoy (adj) % 11.8 -6.4 10.5 23.1 EPS Growth (adj) % 31.3 2.8 20.5 14.7
PE (rep) x 30.9 25.7 21.3 18.6
PE (adj) x 26.4 25.7 21.3 18.6

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

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

Revenue Growth % 34.9 18.8 16.5 12.4 EBITDA m 1,311 1,470 1,726 1,998
EBITDA Growth % 24.1 12.1 17.4 15.7 Tax Paid m -347 -384 -463 -531
EBIT Growth % 24.2 8.2 17.0 15.4 Chgs in Working Cap m 117 -47 33 -40
Gross Profit Margin % 65.2 63.9 62.5 62.2 Net Interest Paid m -11 -30 -115 -120
EBITDA Margin % 28.7 27.1 27.4 28.2 Other m -409 107 21 162
EBIT Margin % 28.2 25.7 25.8 26.5 Operating Cashflow m 660 1,116 1,203 1,469
Net Profit Margin % 21.1 18.2 18.9 19.2 Acquisitions m -280 -70 0 0
Payout Ratio % 78.6 71.6 71.6 71.6 Capex m -136 -100 -100 -100
EV/EBITDA x 18.3 16.3 13.9 12.0 Asset Sales m 0 0 0 0
EV/EBIT x 18.7 17.3 14.8 12.8 Other m 335 -0 0 0
Investing Cashflow m -81 -170 -100 -100
Balance Sheet Ratios Dividend (Ordinary) m -622 -695 -837 -960
ROE % 39.7 36.6 38.3 38.3 Equity Raised m 0 0 0 0
ROA % 31.5 19.9 16.5 17.8 Debt Movements m 480 2,132 111 54
ROIC % 98.2 62.4 64.5 62.3 Other m -73 -94 -179 -184
Net Debt/Equity % -36.3 -37.1 -34.8 -36.3 Financing Cashflow m -215 1,343 -906 -1,090
Interest Cover x nmf nmf nmf nmf
Price/Book x 9.9 8.6 7.5 6.5 Net Chg in Cash/Debt m 364 2,289 197 279
Book Value per Share 4.2 4.8 5.5 6.3
Free Cashflow m 525 1,016 1,103 1,369

Balance Sheet 2013A 2014E 2015E 2016E

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

All figures in Rmb unless noted.


11 June 2014 42
HONG KONG


Valuation HK$ 1.29
- DCF (WACC 13.2%, beta 1.4, ERP 7.0%, RFR 5.0%, TGR 2.0%)
Volatility Index High
& Tobacco
Free float % 12
Number shares on issue m 3,559

Year end 31 Dec 2013A 2014E 2015E 2016E
Revenue m 3,890.0 3,738.8 4,173.0 4,572.4
EBIT m 467.2 279.3 354.8 425.3
EBIT growth % -13.0 -40.2 27.0 19.9
Reported profit m 437.6 240.3 277.9 325.2
Adjusted profit m 423.1 240.3 277.9 325.2
EPS rep Rmb 0.12 0.07 0.08 0.09
EPS rep growth % -7.1 -45.1 15.6 17.0
EPS adj Rmb 0.12 0.07 0.08 0.09
EPS adj growth % -5.7 -43.3 15.6 17.0
PER rep x 18.9 34.4 29.8 25.4
PER adj x 19.5 34.4 29.8 25.4
Total DPS Rmb 0.40 0.03 0.03 0.04
Total div yield % 17.1 1.2 1.4 1.6
ROA % 9.3 6.0 6.8 7.6
ROE % 11.8 7.6 8.3 9.2
EV/EBITDA x 13.8 19.3 14.4 12.0
Net debt/equity % -19.6 2.8 7.1 1.0
P/BV x 2.6 2.5 2.4 2.3

Analyst(s)
Jamie Zhou, CFA

11 June 2014
Yashili International
Between a rock and a hard place
Initiate with Underperform, HK$1.45 target, 50% downside
We initiate coverage of Yashili with an Underperform rating and a target price of
HK$1.45/sh, which implies 50% downside. With sales declines in 4Q13, we see
multiyear headwinds for Yashili and significant earnings downside. We forecast
FY14 EPS to fall by 43% and only to rebound by 16% in FY15E, which is 55%
and 60% below consensus estimates. With lower visibility of a turnaround and
negative FCF until at least the end of FY15, we see a high probability of a
dividend cut.
Sales plummet on combination of unfavourable factors
Revenue went from 29% YoY growth in 1H13 to -12% in 2H13, with the decline
largely in 4Q. Poor sales were hit by three main negatives: 1) Fonterras false
alarm whey powder incident in August, which harmed brand reputation (Yashili is
branded as 100% from New Zealand), 2) NDRC investigation led to industry wide
price cuts and sales promotions, 3) the State Councils industry consolidation
order to eliminate weak players led to inventory dumping at heavy discounts. YTD
sales have not improved much from 4Q due to price adjustment impact and a
stabilized 2H14 remains a hope at this point.
Channel trouble: weak in maternity, minimal in ecommerce
We think Yashilis real trouble lies in its channel exposure. Yashili is a latecomer
to two of the increasingly dominant sales channels that convenience-seeking
young Chinese parents buy their infant formula from: maternity shops and
ecommerce. 64% of Yashilis FY13 sales came from supermarkets, which saw a
3% yoy decline in total infant formula sales. Yashili remains weak in maternity
stores with revenue of RMB43k/store, far below Biostimes RMB183k/store. More
threatening to Yashilis home game in the lower tier markets is the proliferation of
ecommerce allowing global brands to leapfrog into previously underpenetrated
markets; total sales of infant formula online jumped >60% in 2013. Yashili is
introducing a points and membership sales system; however, we doubt it can
generate a meaningful turnaround this year.
55-60% EPS downside, negative FCF risks dividend cut
FCF turned negative in FY13 and with the ongoing capex commitment with the
New Zealand plant, we expect FCF to stay negative until at least FY16. Prior to
Mengnius takeover, a special dividend representing 229% of FY13 NP was paid
out to shareholders, which reduced the cash position by RMB1bn. We forecast
the regular year-end dividend payout will likely to be cut by 76% from RMB11
cents in FY13 to just RMB3 cents in FY14E.
Management turnover to pose further operational risks
The majority of Yashilis directors and executive team has been replaced with
Mengniu/COFCOs and only two members of the founding Zhang family remain
with the Board, with total effective stake reduced from 51% to just 9% after the
takeover deal. Share options granted to the companys long-serving senior
management team were cancelled without immediate plan of a new one. At its
FY13 results briefing, Mengniu continued to reiterate keeping Yashili largely
autonomous while looking to exert control via the Board. We see increasing risks
of further management turmoil that could disrupt already weak sales trends before
Mengniu can fully install its team on board.
11 June 2014 43
Inside

Valuation 44
Yashilis multi-year struggle 47
Management and corporate governance 50
Financials 53

1230 HK rel HSI performance


A fallen angel and its former glory
Company profile
Headquartered in Chaozhou, Guangdong Province, Yashili was founded in
1998 by the Zhang family. The company manufactures and sells infant
formula products under the Yashili and Scient brands, as well as soymilk
powder, cereal, rice flour and milk powder for adults and teenagers.
Yashili used to command leading market share in infant formula sales in
China with 100% of its raw milk sourced domestically. After the 2008 Chinese
Melamine Scandal of tainted milk products that killed six infants and sickened
thousands, the company made a successful and swift shift to New Zealand
sources and began to brand as such. However, due to rising competition from
imported infant formula from global brands in China, the company lost
significant market share and retreated to a lower-tier market focus.
In March 2008, Carlyle invested RMB650m in the company for a 17% stake.
The company successfully listed on the Stock Exchange of Hong Kong in
October 2010 under the ticker 1230.HK and raised HK$2.4bn. In August
2013, Mengniu (2319.HK) acquired a 68% stake in Yashili at HK$3.50/sh.
Corporate governance and shareholding structure
The Board is comprised of nine directors three executive, three non-
executive and three independent. Five of the nine directors are/were
Mengniu/COFCO related, including non-executive Chairwoman Sun Yiping,
who is Mengnius incumbent CEO.
As of April 2014, Yashili is owned 68% by Mengniu, 9% by Zhang
International, 6% by Temasek, 5% by Hopu and the remainder by public free
float.
The company changed its auditor from KPMG to Ernst & Young in 2014 to
align with Mengnius auditor.
Fig 1 Melamine aftermath: from Chinas #1 infant formula brand to #8

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

0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
0
1,000
2,000
3,000
4,000
5,000
2008 2009 2010 2011 2012 2013 2014E 2015E 2016E
Infant formula Others (nutrition, baby food) Infant formula market share
Revenue (RMBmillion) Market share %
11 June 2014 44
Valuation
Our primary valuation is based on PER; we then cross check against our DCF fair valuation.
Yashili (Underperform) with HK$1.45/sh target, 15x FY15E PER
Our 12-month target price on is based on 15x FY15E PER. Yashilis profitability and return on
capital have fallen significantly (low-teens EBIT margin and high-single-digit ROIC). Yashili
have been losing market share, particularly in Tier 1 & 2 cities and continues to be weak in
two increasingly dominating infant formula channels: maternity and ecommerce.
EV/EBITDA
(x)
EPS
growth
(%)
EBIT
margin
ROE
(%)
Div
yield
(%) P/Bk
1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 19.3 14.4 -19.0 9.6 12.2 15.4 2.6
Yashili at TP 1.45 17.4 15.0 8.5 6.3

002570 CH Beingmate NR 13.10 2,152 13.4 11.0 13.7 11.4 28.2 13.3 16.8 2.0 3.4
1112 HK Biostime UP 51.40 38.50 -25% 4,004 25.7 21.3 15.7 13.4 11.3 23.5 33.9 2.9 9.9
1230 HK Yashili UP 2.87 1.45 -49% 1,318 34.4 29.8 18.8 14.0 -19.0 9.6 12.2 15.4 2.6
Average 21.6 18.3 15.8 13.1 7.0 17.6 120.3 5.5 5.1

Diversified dairies
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
600887 CH Yili NR 31.99 10,498 14.4 12.0 8.4 NA 21.0 7.4 20.3 2.0 3.8
600597 CH Bright NR 16.27 3,200 21.4 17.6 NA NA 30.5 5.1 12.8 1.6 4.5
NESN VX Nestl NR 69.55 249,344 20.0 18.6 13.5 12.5 5.3 15.8 16.2 3.3 3.5
BN FP Danone NR 54.76 47,750 19.8 17.9 12.3 11.2 6.8 13.2 12.4 2.8 3.2
FSF NZ Fonterra N 5.95 6.65 12% 8,094 35.1 21.5 11.8 9.7 -31.3 3.1 3.5 2.1 1.4
Average 21.6 17.9 11.7 11.4 7.4 8.2 13.0 2.1 3.0

151 HK Want Want OP 10.70 13.00 21% 18,237 23.1 19.9 15.6 13.2 15.4 23.0 37.9 2.9 9.4
322 HK Tingyi OP 21.90 24.40 11% 15,817 32.6 27.0 11.7 10.3 19.7 7.4 16.0 1.5 5.5
1044 HK Hengan N 81.70 84.00 3% 12,945 22.9 19.2 16.4 13.5 23.3 20.2 25.2 2.6 6.1
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 4.6 12.6 0.7 3.7
Average 27.2 23.0 14.6 12.4 15.2 12.5 21.3 1.7 5.4
Among listed dairy companies globally that have infant formula business in China, we identify
two baskets of comps:
Diversified dairies
Diversified dairies trading on lower valuation than infant formula
As a group, Diversified dairies trade at a lower valuation to Infant formula pure-plays due to
lower margin on liquid milk business. The average EBIT margin for our Diversified dairies for
FY13 was only 8% vs. 17% for infant formula pure-plays.
Most of the diversified dairies traded around 18x forward earnings on average over the past
five years. The exception is Mengniu, which traded, on average, at 24x PER. This is largely
due to a number of high profile M&A catalysts over the past few years (COFCO stake,
Danone JV and stake, Modern Dairy acquisition, Yashili acquisition, Arla partnership, White
Wave partnership).

11 June 2014 45
Fig 3 Yashili currently trading on 37x forward PER Fig 4 3.0x trailing P/Bk

We believe Yashilis forward multiple should be trading at discount to the diversified dairies at
18x PER, a discount to its infant formula pure play:
Yashilis profitability and return on capital have fallen to levels more comparable to
Diversified dairies
Yashili have been losing market share, particularly in Tier 1 & 2 cities
Yashili is weak in maternity channel and non-existent on ecommerce, two increasingly
dominating channels for infant products
Fig 5 Yashili's margins fallen to diversified dairies
levels

Fig 6 So has the return on capital

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

0
10
20
30
40
50
60
Forward PE ratio (x)
mean
-1
+1
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14
Trailing P/Bk ratio (x)
mean
-1
+1
0%
5%
10%
15%
20%
25%
2008 2009 2010 2011 2012 2013
IMF pure-plays Diversified dairies Yashili
EBIT margin
0%
10%
20%
30%
40%
50%
60%
70%
2008 2009 2010 2011 2012 2013
IMF pure-plays Diversified dairies Yashili
ROIC
11 June 2014 46
DCF fair value HK$1.29/sh
Our Yashili DCF fair valuation is HK$1.29/sh. FCF turned negative in FY13 and with the
ongoing capex commitment with the New Zealand plant, we expect FCF to stay negative until
at least FY16.
Prior to Mengnius takeover, a special dividend representing 229% of FY13 NP was paid out
to shareholders, which reduced cash position by RMB1bn. We believe regular dividend will
likely to be cut by 76% from RMB11 cents in FY13 to just RMB3 cents in FY14E.
We use equity beta of 1.4 to factor in the increasing uncertainty in sales trend and margin
visibility.
Fig 7 Yashili cash flow projection
RMB million 12A 13A 14E 15E 16E 17E 18E 19E 20E
Sales 3,655 3,890 3,739 4,173 4,572 4,896 5,096 5,295 5,490
... Growth 24% 6% -4% 12% 10% 7% 4% 4% 4%
Gross Profit 1,962 2,080 1,916 2,139 2,321 2,461 2,535 2,608 2,677
... GP Margin 54% 53% 51% 51% 51% 50% 50% 49% 49%
EBITDA 619 553 395 529 635 700 756 814 874
Margin 17% 14% 11% 13% 14% 14% 15% 15% 16%
Less: Tax 127 196 80 93 108 124 138 152 167
Less: WC -242 257 109 -42 20 -48 16 -50 14
Less: Capex 208 255 800 500 137 147 153 159 165
Less: Other -38 -40 0 0 0 0 0 0 0
Free Cash Flow 564 -114 -594 -22 370 477 449 553 528
... FCF Growth -120% 420% -96% -1785% 29% -6% 23% -4%
PV of FCF -554 -18 269 306 255 277 234
Fig 8 DCF valuation metrics
WACC DCF Valuation
Risk Free Rate 5.0% Sum of PV of FCF 769
Market Risk Premium 7.0% PV of Terminal Value (RMBm) 2,134
Equity Beta 1.4 Enterprise Value (RMBm) 2,904
Cost of Equity 14.8% Less: Net Debt -801
Cost of Debt (Pre-tax) 9.0% Market Cap (RMBm) 3,705
Cost of Debt (After tax) 6.8% No. of Ord shares (m), fully diluted 3,559
Target Debt weight 20.0% Terminal as % total 74%
Target Equity weight 80.0% Foreign exchange (HKD/RMB) 1.24
Tax Rate 25% Market Cap (HKDm) 4,593
WACC 13.2%
Terminal Growth 2.0% Value per share, HK$ $1.29

11 June 2014 47
Yashilis multi-year struggle
An uphill battle since 2008
Prior to the 2008 melamine scandal, Yashili was a 100% domestic infant formula maker
sourcing from local upstream suppliers. In the wake of the scandal, Yashili swiftly changed
milk sources to overseas (mainly to New Zealands Fonterra) and rebranded its products as
containing imported ingredients to lift consumer perception of its quality. Although ingredient
mixing and packaging remained in China, Yashili is the only domestic brand that has 100%
of its raw milk sourced from overseas, in contrast to other major domestic players such as Yili
and Beingmate.
However, the last six years have been anything but smooth sailing for domestic infant formula
players, due to consumers lack of trust in domestic brands quality. The milk powder market
in China was evenly split between domestic and foreign brands before 2008. As of 2013,
domestic brands total market share has dropped to below 40%, while in first-tier cities
imported brands enjoy a market share of more than 80%.
Yashilis growth was mainly driven by its strong lower-tier distribution channel of its mid-range
products, while premium and top-tier city sales continue to shrink.
Fig 9 Yashili's growth is mainly from lower-tier cities Fig 10 Low contribution from Premium segment

Source: Company data, Macquarie Research, July 2013 Source: Company data, Macquarie Research, July 2013
Mengnius opportunity
Yashili currently operates a 50,000 ton/year processing capacity in China. It is investing in a
new 50,000 ton plant in New Zealand that is expected to commence production of premium
products by the end of 2014.
In addition to providing a solid footing into the milk powder segment which Mengniu lacks, we
see the following synergies of this combination:
Top-tier market penetration: Mengniu could help Yashili in opening up top-tier cities
where it has been losing market share. Mengniu has strong relationships with its
distributors and key accounts while Yashili has simple product offerings that do not
overlap much with Mengnius own.
Raw material procurement: Yashili could benefit from Mengniu and COFCO from
higher collective negotiation power of the combined platform.
Technology partnership with Arla to develop premium products: Mengnius JV
partner and major shareholder Arla Foods will work together with Yashili in improving
its technology and develop premium products (Scient).

0
500
1,000
1,500
2,000
2,500
3,000
3,500
2007 2008 2009 2010 2011 2012 2013
First-tier Second-tier Third-tier and others
Formula sales (RMB million)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2007 2008 2009 2010 2011 2012 2013
Mid-high end formula (Yashili) Premium formula (Scient) Others
% of EBIT
11 June 2014 48
Chinese consumers prefer imported brands
Hundreds of foreign brands have entered Chinese infant formula markets since the 2008
Melamine Scandal which killed six and sickened thousands of babies. Domestic brands that
were once market leaders, such as Yashili, Synutra and Feihe have all conceded significant
market share to companies such as Mead Johnson, Danone and Nestl.
Fig 11 Infant formula market share, March 2012

Fig 12 Infant formula market share, January 2014

Source: Nielsen, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014
According to the Dairy Association of China, the infant formula market in China was evenly
split between domestic and foreign brands before the 2008 Melamine Scandal. As of 2013,
domestic brands total market share has likely dropped to below 40%, while in 1
st
tier cities
imported brands controlled more than 80% share.
The imported powder premiumisation drive came at the expense of domestic players. Not
only did the domestic players lose market share to foreign companies, the industry actually
became more fragmented as a result.
We believe this consumer behaviour phenomenon that rapidly transformed the infant formula
industry was due to the following inter-related causes:
Imported infant formula carries perceived superior quality assurance
Media negatively portrayed domestic infant formula following numerous incidents,
fuelling already high mistrust on domestic products
Rising outbound travel (including to Hong Kong) of Chinese citizens increases access
to and awareness of foreign brands
Strong marketing capability of foreign brands
Emergence of ecommerce, and specifically online maternity shops and overseas
group-buying sites
Consumer willingness to pay a premium for quality for their children, particularly for the
younger generation of Chinese parents (those that are born after 1980).

Mead
Johnson,
13.8%
Wyeth, 9.8%
Beingmate,
9.6%
Abbott,
7.1%
Yili, 10.4%
Nestle, 4.0%
Yashili, 5.1%
Dumex, 13.5%
Feihe, 4.6%
Synutra, 5.2%
Others, 16.9%
Mead
Johnson,
14.5%
Wyeth, 13.3%
Beingmate,
8.5%
Biostime,
7.5%
Abbott, 7.0%
Yili, 6.2%
Nestle, 4.4%
Yashili, 4.1%
Friso, 3.9%
Dumex, 3.6%
Feihe, 3.5%
Synutra, 3.2%
Others, 20.3%
11 June 2014 49
Yashilis channel trouble: late in maternity, minimal in ecommerce
Infant formula sales in supermarkets dropped by 4% for the first time in 2013, and companies
such as Yashili that had significant sales from supermarkets suffered. Despite overall market
still growing at low-teens, sales of infant formula in super markets were largely flat over the
past three years. We expect the shift towards to maternity shops and ecommerce to
accelerate and winners will be those that can successfully capture this consumption habit
change.
consumers. They were the first to develop habits of shopping online and when they have
babies, they are increasingly buying infant formula from two emerging channels:
Maternity shops: neighbourhood Mom & Pop baby product shops, low entry barrier,
very fragmented. Early mover brands secure advantage in sales
model where brand awareness attracts sales

Fig 13 Per maternity store sales far below Biostimes
growing rapidly

Source: Company data, Macquarie Research, June 2014 Source: Nielsen, Macquarie Research, June 2014
Yashili had strong reliance on supermarket with >60% of sales coming from them. As of
FY13, Yashili had minimal existence in ecommerce, recording less than 1% of sales online.
Fig 15 Yashilis reliance on supermarkets hurt its market share


0
20
40
60
80
100
120
140
160
180
200
2011 2012 2013
Yashili Biostime
Revenue per maternity shop (000's RMB/store/year)
5%
-4%
36%
17%
23%
60%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
2012 2013
Channel growth YoY
23%
70%
43%
26%
64%
36%
77%
30%
41%
74%
36%
42%
16%
22%
0%
20%
40%
60%
80%
100%
2012 2013
11 June 2014 50
Management and corporate governance
Zhang brothers cashed out from Mengniu takeover, special dividend
Mengniu acquired an 89% stake in Yashili in August 2013. Following a share placement in
November 2013 to Temasek and Hopu, Mengniu (2319.HK) now controls 68% effective stake
in Yashili (1230.HK).
From the deal, Zhang International (holding co of the founding Zhang siblings) have cashed
out ~HK$5.3bn/US$680m and retained only 8.6% effective stake in Yashili post completion of
the deal. Prior to the takeover, Zhang International held 51.3% stake in Yashili and approved
a RMB1bn special dividend payout in June 2013.
Yashilis financials have been consolidated into Mengnius from September 2013. According
to Mengniu, Yashili will continue to be managed independently for the first two years (though
Mengniu will exert control through the Board) but the aim is to have Yashili eventually
consolidated into Mengnius platform.
Fig 16 Shareholding structure as of May 2014


Fig 17 Yashilis Corporate history and major events
Date Event Note
Mar 1998 Company founding Yashili was founded by twelve shareholders including the six Zhang brothers and their
respective spouses
2002 Scient launch Yashili launched the Scient premium infant formula brand
Mar 2008 Carlyle investment Carlyle invested RMB649.7 million for 17% stake in the company
Sept 2008 Melamine Crisis Nationwide milk safety scandal prompted Yashili recalled and wrote off RMB787m worth of
goods
2009 Shift to New Zealand source In the wake of the 2008 Melamine Crisis, Yashili shifted 100% of its raw milk powder from
domestic sources to New Zealand
Oct 2010 IPO Successfully listed on Hong Kong Stock Exchange, raising HKD2.4bn
June 2013 Special dividend Company paid special dividend of RMB1bn to shareholders, representing ~214% payout ratio
on FY12 reported net profit of RMB470m
Aug 2013 Mengniu acquires majority stake Mengniu acquired 68% effective stake in Yashili for HK$3.50/sh from the founding brothers
and Carlyle
Mengniu replaces Yashilis board with its own directors
Sept 2013 National brand Yashilis Ambery () brand was selected by CDIA as the first batch of the so-called
National brand of infant formula
Dec 2013 Change of auditor KPMG was replaced by Ernst & Young as the companys auditor

China Mengniu
International (unlisted)
Yashili International
(1230.HK)
Zhang International
Mengniu Dairy
(2319.HK)
Temasek Hopu Free Float
89% 11%
77% 6% 5% 12%
11 June 2014 51
Fig 18 Yashilis Board of Directors (as of May 2014)
Name Title Age Responsibilities and bio
Executive Directors
Mr. ZHANG Lidian

CEO and Executive
director
49 Founding brother of Yashili
Ceased to be the Executive Chairman as of July 2013
Mr. LI Dongming

Executive director 44 Appointed ED on July 24, 2013
Joined from COFCO with 20 years of M&A experience
Mr. ZHANG Yanpeng

Executive director 37 General Manager of Scient
Joined Yashili in 2003
Nephew of Zhang Lidian
Non-executive Directors
Ms. SUN Yiping

Non-executive director,
Chairman of the Board,
Chairman of Nomination
47 Appointed NED, Chairman on July 24, 2013.
CEO of Mengniu since April 2012, Yashili's controlling parent company
Previously with COFCO Group since 1993 and served in management of
COFCO's Coca Cola and property businesses
Over 20 years of experience in FMCG and real estate
Bachelor's and Master's from China Agricultural University
Mr. BAI Ying

Non-executive director 43 Appointed NED on June 6, 2014
Executive Director of Mengniu since 2008, in charge of its UHT division
Mr. WU Jingshui

Non-executive director 48 Appointed NED on July 2013
Was previously the CFO of Mengniu (2010-2013)
Independent Non-executive Directors
Mr. Ben MOK Wai Bun

INED, Chairman of
Remuneration
65 Appointed on November 15, 2013
Executive director of Max Sun Enterprises
Consultant for COFCO Coca-Cola
Mr. CHENG Shoutai

INED 46 Appointed on November 15, 2013
Chief partner of Tahota Law Firm, qualified lawyer
Mr. Conway LEE Kong
Wai

INED, Chairman of
Audit
59 Appointed on November 15, 2013
Was a partner of Ernst & Young
Source: Company data, Macquarie Research, July 2013

11 June 2014 52
Board and potential senior management shake-ups
Board and senior management shake-ups over the next year could result in sales channel
disruption before Mengniu fully integrates Yashili into its platform.
Senior management sell-down: Zhang International (Yashilis executive directors
who are also siblings) sold down its 51% stake in Yashili to just 11% in the deal.
Board has been replaced: After Mengnius acquisition, only two out of 11 directors on
Yashilis old Board stayed. Mengniu replaced the rest with its own or COFCOs
personnel, including Mengniu CEO Sun Yiping herself as the Non-Executive
Chairman.
Share options have been cancelled: share option scheme that was put in place to
incentivise management through 2015 has been cancelled as part of the Mengniu
takeover. These options were granted to 181 employees of Yashili, and represented
~1.5% of total shares outstanding. Eight out of the nine senior management
personnel listed below were part of the scheme; the cancellation will effectively
eliminate their stake in the company. Many of these key senior management
personnel have been with Yashili for significant period of their careers.
Fig 19 Mengniu/COFCO have replaced the board with its directors
Board before Mengniu acquisition (June 2013) Board after Mengniu acquisition (November 2013)
Executive directors Executive directors
ZHANG Lidian Chairman Zhang Brother >>> ZHANG Lidian Executive director/CEO Yashili
ZHANG Yanpeng ED, GM of Scient Zhang Nephew >>> ZHANG Yanpeng Executive director Yashili
ZHANG Likun ED, Sales & Marketing Zhang Brother
ZHANG Liming ED, Finance Zhang Brother
ZHANG Libo ED, Administration Zhang Brother
LI Dongming Executive director COFCO
Non-executive directors Non-executive directors
CHANG Herman NED Carlyle
ZHANG Chi NED Carlyle
SUN Yiping Non-executive Chairman Mengniu's CEO
BAI Ying NED Mengnius ED
WU Jingshui NED Ex-CFO of Mengniu
Independent Non-executive Directors Independent Non-executive Directors
YU Shimao INED Independent
CHEN Yongquan INED Independent
WONG Samuel INED Independent
LIU Jinting INED Independent
Ben MOK Wai Bun INED ex-COFCO
CHENG Shoutai INED Independent
Conway LEE Kong Wai INED Independent
Fig 20 Yashili Board and Senior Management prior to the Mengniu acquisition
Yashili stake Part of option
scheme? Name Position Age Note Before After
Board of Directors
ZHANG Lidian ED, CEO 49 Co-founder, Zhang sibling 9.2% 1.8% Yes
ZHANG Yanpeng ED, GM of Scient 37 Zhangs nephew Yes
Senior management
WU Dinian VP, Sales and Marketing 45 Served Yashili since 2001 (13 years), previously with
Tingyi
Yes
WU Xiaonan GM of Investment, Legal 40 Joined in 2008 with legal background Yes
XIE Xunpeng GM of Sales and Marketing 42 Served Yashili since 1993 (21 years) Yes
PAN Jingzhi Assistant to President 38 Served Yashili since 1996 (18 years) Yes
WEN Jieping CFO 37 Joined in 2011 Yes
CHEN Xiaohong GM of External Affairs 39 Served Yashili since 1997 (17 years) Yes
TONG Chengfu GM of R&D 47 Served Yashili since 2000, previously with Weiquan
(14 years)
Yes
LI Mengchun GM of QC 41 Served Yashili since 2004 (10 years) Yes
JIANG Weijian Finance Controller 34 Joined in 2008 with accounting background
11 June 2014 53
Financials
Sales plummeting on combination of unfavourable factors
Revenue dropped from 29% YoY growth in 1H13 to -12% in 2H13, with the decline largely in
4Q. Poor sales were hit by three main negatives:
Fonterras false alarm whey powder incident in August harmed brand reputation
(Yashili is branded as 100% from New Zealand);
NDRC investigation led to industry wide price cuts and sales promotions;
The State Councils industry consolidation order to eliminate weak players led to
inventory dumping at heavy discounts.
YTD sales have not improved much from 4Q due to price adjustment impact; a stabilized
2H14 remains the companys hope at this point.
Fig 21 Sales plunged in 2H13 Fig 22 Hoping for a recovery in 2H14


-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
0
500
1,000
1,500
2,000
2,500
2H12 1H13 2H13 1H14E 2H14E 1H15E
-10%
-5%
0%
5%
10%
15%
20%
25%
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
FY11 FY12 FY13 FY14E FY15E FY16E
11 June 2014 54
Fig 23 Yashili - Annual P&L
2011 2012 2013 FY14E FY15E FY16E
Turnover 2,958 3,655 3,890 3,739 4,173 4,572
YoY change 0% 24% 6% -4% 12% 10%

Cost of sales 1,420 1,693 1,810 1,822 2,034 2,252
Gross profit 1,538 1,962 2,080 1,916 2,139 2,321
...GP margin 52.0% 53.7% 53.5% 51.3% 51.3% 50.8%

Selling and distribution expenses 1,062 1,223 1,394 1,411 1,544 1,646
Administrative expenses 185 202 219 226 240 249
Total SG&A 1,247 1,425 1,613 1,637 1,784 1,895
SG&A ratio 42.2% 39.0% 41.5% 43.8% 42.8% 41.5%

Operating profit 291 537 467 279 355 425
Operating margin 9.8% 14.7% 12.0% 7.5% 8.5% 9.3%

Other revenue 29 38 26
Other net loss 0 0 -1
Other expenses -6 -15 -11
EBIT 313 559 482 279 355 425
EBIT margin 10.6% 15.3% 12.4% 7.5% 8.5% 9.3%

Finance income 65 90 108 49 35 42
Finance costs -3 -3 -13 -8 -19 -34
Profit before taxation 375 646 577 320 370 434
Income tax expenses 67 176 137 80 93 108
Tax rate 18% 27% 24% 25% 25% 25%

Net profit 308 470 439 240 278 325
Net margin 10% 13% 11% 6% 7% 7%
Minority interests 2 2 2
Net profit attributable 306 468 438 240 278 325

Adjustments 22 23 15 0 0 0
Adjusted profit attributable 284 446 423 240 278 325
Adjusted NP margin 9.6% 12.2% 10.9% 6.4% 6.7% 7.1%
YoY change -37.3% 56.9% -5.1% -43.2% 15.6% 17.0%

Adjusted EPS (basic) 0.081 0.127 0.119 0.068 0.078 0.091
Adjusted EPS (diluted) 0.080 0.125 0.118 0.067 0.078 0.091
YoY change -45.6% 57.2% -5.7% -43.3% 15.6% 17.0%

EBITDA 370 619 553 395 529 635
EBITDA margin 12.5% 16.9% 14.2% 10.6% 12.7% 13.9%

11 June 2014 55
Fig 24 Yashili - Semi-annual P&L
1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15
Turnover 1,689 1,966 2,153 1,737 2,002 1,737 2,240 1,933
YoY change 17% 30% 27% -12% -7% 0% 12% 11%

Cost of sales 772 921 961 849 973 849 1,089 945
Gross profit 917 1,045 1,192 888 1,028 888 1,151 988
...GP margin 54.3% 53.1% 55.4% 51.1% 51.4% 51.1% 51.4% 51.1%

Selling and distribution
expenses
566 657 712 682 755 656 834 710
Administrative expenses 98 104 114 105 121 105 129 111
Total SG&A 664 761 826 787 876 761 963 821
SG&A ratio 39.3% 38.7% 38.4% 45.3% 43.8% 43.8% 43.0% 42.5%

Operating profit 253 284 366 101 152 127 188 167
Operating margin 15.0% 14.4% 17.0% 5.8% 7.6% 7.3% 8.4% 8.6%

Other revenue 19 19 11 16
Other net loss 0 0 0 0
Other expenses -13 -2 -3 -7
EBIT 259 301 373 109 152 127 188 167
EBIT margin 15.3% 15.3% 17.3% 6.3% 7.6% 7.3% 8.4% 8.6%

Finance income 48 42 42 67 27 22 19 16
Finance costs -1 -2 -4 -10 -4 -4 -11 -9
Profit before taxation 306 341 411 166 175 146 197 174
Income tax expenses 86 90 115 22 44 36 49 43
Tax rate 28% 26% 28% 13% 25% 25% 25% 25%

Net profit 220 251 295 144 131 109 147 130
Net margin 13% 13% 14% 8% 7% 6% 7% 7%
Minority interests 1 1 2 0
Net profit attributable 219 250 294 144 131 109 147 130

Adjustments 6 17 7 8 0 0 0 0
Adjusted profit attributable 213 233 287 136 131 109 147 130
Adjusted NP margin 12.6% 11.8% 13.3% 7.8% 6.5% 6.3% 6.6% 6.7%
YoY change 34.6% -41.5% -54.3% -19.8% 12.5% 19.3%

Adjusted EPS (basic) 0.060 0.066 0.081 0.038 0.037 0.031 0.041 0.037
Adjusted EPS (diluted) 0.060 0.065 0.080 0.038 0.037 0.031 0.041 0.036
YoY change 33.9% -41.9% -54.4% -19.8% 12.5% 19.3%

EBITDA 294 325 406 147 216 179 284 245
EBITDA margin 17.4% 16.5% 18.8% 8.5% 10.8% 10.3% 12.7% 12.7%

11 June 2014 56
Fig 25 Yashili - Balance sheet
2011 2012 2013 FY14E FY15E FY16E
Inventories 578 653 886 891 1,070 1,039
Trade and bills receivables 52 27 32
Prepayments and other receivables 138 136 171 212 229 230
Amounts due from related parties 2 1
Income tax recoverable
Other investments
Restricted bank deposits 72 300 42 42 42 42
Short-term bank deposits 612 199 199 199 199
Other investments 180 200 445 445 445 445
Cash and equivalents 2,582 2,073 611 199 414 324
Total current assets 3,604 4,001 2,387 1,988 2,399 2,278

Property, plant and equipment 730 744 1,195 1,880 2,207 2,297
Intangible assets 5 4 6 6 6 6
Investment properties 76 112 116 116 116 116
Lease prepayments 133 130 216 216 216 216
Deferred tax assets 77 80 85 92 127 170
Prepayments for PP&E 11 184 54 54 54 54
Pledged deposits 150 150 150 150
Other non-current assets 7 8 7 7 7 7
Long-term bank deposits 306 300 300 300 300
Total non-current assets 1,040 1,569 2,130 2,822 3,184 3,316
Total assets 4,644 5,570 4,517 4,811 5,582 5,594

Trade and other payables 720 1,029 1,140 1,044 1,282 1,231
Loans and borrowings 31 331 154 374 655 554
Amounts due to related parties 2 2
Income tax payables 53 89 41
Provision for sales return
Total current liabilities 806 1,451 1,335 1,418 1,937 1,785

Loans and borrowings 47 114 200 169
Deferred income 31 19 12 12 12 12
Deferred tax liabilities 3 18 13 13 13 13
Amounts due to related parties
Total non-current liabilities 33 37 72 139 224 194
Total liabilities 840 1,488 1,407 1,556 2,162 1,978

Capital 301 303 306 306 306 306
Reserves 3,501 3,776 2,804 2,949 3,115 3,310
Minority interests 1 3 0
Shareholders' equity 3,804 4,082 3,110 3,254 3,421 3,616
Total liabilities and equity 4,644 5,570 4,517 4,811 5,582 5,594

11 June 2014 57
Fig 26 Yashili - Cash flow
2011 2012 2013 FY14E FY15E FY16E
Profit before tax 375 646 577 320 370 434
Adjustments: 42 11 16 75 158 202
Depreciation and amortisation 79 82 86 116 174 210
Loss on disposal of PP&E 0 0 1
Impairment for PP&E 6 -1
Write-down of inventories 3 0 0
Share-based transactions 20 8 6
Interest income -44 -43 -54 -49 -35 -42
Interest expense 3 3 13 8 19 34
Foreign exchange difference, net -11
Gains on other investments -18 -47 -24
Change in working capital: 123 242 -257 -109 42 -20
Inventories -190 -75 -233 -5 -180 32
Trade receivables 140 26 -5 -9 -17 -1
Other receivables -36 3 -55
Pledged deposits -6 0 -5 0 0 0
Payables 231 300 48 -96 238 -51
Deferred income -12 -12 -7 0 0 0
Amounts due to related parties -3 0 0 0
Gross operating cash flow 541 899 337 286 571 615
Income tax paid -82 -127 -196 -80 -93 -108
Operating cash flow 458 772 141 206 478 507

Interest received 44 26 33
Acquisition of PP&E -107 -208 -255 -800 -500 -137
Proceed from PP&E disposal 1 3 5
Proceeds from sales of other
investments
173 1,396 2,763
Receipts of other bank deposits 1,208
Payment of other bank deposits -903 -789
Acquisition of intangible assets 0 -1 -4
Acquisition of land use right -91 -11
Acquisition of non-current assets -5 -4 -125
Acquisition of other investments -335 -1,369 -2,984
Deposit for performance bond related
to land use right
-11
Other effect from investing activities -1 5
Investing cash flow -229 -1,145 -168 -800 -500 -137

Proceeds from share issued for
exercise share option
31
Payment for repurchase of shares -16
Proceeds from loans 36 361 615 287 367 -132
Repayments of bank loans -163 -62 -742
Receipts of pledged deposits -24 66 495
Payment of pledged deposits -293 -384
Acquisition of minority interests -28
Interest paid -3 -3 -5 -8 -19 -34
Dividends paid -235 -200 -1,408 -96 -111 -130
Dividend of prior year paid to non-
controlling shareholder
-20
Financing cash flow -404 -130 -1,445 182 236 -296

Change in cash -175 -503 -1,472 -412 215 73
Cash year beginning 2,759 2,582 2,073 611 199 414
Effect of exchange rate changes -3 -5 10
Cash year end 2,582 2,073 611 199 414 487

Free cash flow 352 564 -114 -594 -22 370

11 June 2014 58

Yashili International (1230 HK, Underperform, Target Price: HK$1.45)

Gross Profit m 888 1,028 888 1,151 Gross Profit m 2,080 1,916 2,139 2,321
Cost of Goods Sold m 849 973 849 1,089 Cost of Goods Sold m 1,810 1,822 2,034 2,252
EBITDA m 147 216 179 284 EBITDA m 553 395 529 635
Depreciation m 38 64 52 96 Depreciation m 74 116 174 210
EBIT m 101 152 127 188 EBIT m 467 279 355 425
Net Interest Income m 57 23 18 9 Net Interest Income m 95 41 16 8
Exceptionals m 8 0 0 0 Exceptionals m 15 0 0 0
Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0
Pre-Tax Profit m 166 175 146 197 Pre-Tax Profit m 577 320 370 434
Net Profit m 144 131 109 147 Net Profit m 439 240 278 325
Minority Interests m 0 0 0 0 Minority Interests m -2 0 0 0

Reported Earnings m 144 131 109 147 Reported Earnings m 438 240 278 325
Adjusted Earnings m 136 131 109 147 Adjusted Earnings m 423 240 278 325

EPS (rep) fen 4.0 3.7 3.1 4.1 EPS (rep) fen 12.2 6.7 7.8 9.1
EPS (adj) fen 3.8 3.7 3.1 4.1 EPS (adj) fen 11.8 6.7 7.8 9.1
EPS Growth yoy (adj) % -41.9 -54.4 -19.8 12.5 EPS Growth (adj) % -5.7 -43.3 15.6 17.0
PE (rep) x 18.9 34.4 29.8 25.4
PE (adj) x 19.5 34.4 29.8 25.4

EBITDA Margin % 8.5 10.8 10.3 12.7 Total DPS fen 39.6 2.7 3.1 3.7
Earnings Split % 32.2 54.5 45.5 53.1 Weighted Average Shares m 3,579 3,582 3,582 3,582
Revenue Growth % -11.6 -7.0 0.0 11.9 Period End Shares m 3,559 3,559 3,559 3,559
EBIT Growth % -64.3 -58.5 25.7 23.7


Revenue Growth % 6.4 -3.9 11.6 9.6 EBITDA m 553 395 529 635
EBITDA Growth % -10.6 -28.5 33.8 20.2 Tax Paid m -196 -80 -93 -108
EBIT Growth % -13.0 -40.2 27.0 19.9 Chgs in Working Cap m -321 -109 42 -20
Gross Profit Margin % 53.5 51.3 51.3 50.8 Net Interest Paid m -95 -41 -16 -8
EBITDA Margin % 14.2 10.6 12.7 13.9 Other m 200 41 16 8
EBIT Margin % 12.0 7.5 8.5 9.3 Operating Cashflow m 141 206 478 507
Net Profit Margin % 10.9 6.4 6.7 7.1 Acquisitions m -2,984 0 0 0
Payout Ratio % 334.5 40.3 40.3 40.3 Capex m -255 -800 -500 -137
EV/EBIT x 16.3 27.3 21.5 17.9 Other m 3,065 0 0 0
Investing Cashflow m -168 -800 -500 -137
Balance Sheet Ratios Dividend (Ordinary) m -1,408 -96 -111 -130
ROE % 11.8 7.6 8.3 9.2 Equity Raised m 31 0 0 0
ROA % 9.3 6.0 6.8 7.6 Debt Movements m -127 287 367 -132
ROIC % 20.6 8.4 8.0 8.7 Other m 59 -8 -19 -34
Net Debt/Equity % -19.6 2.8 7.1 1.0 Financing Cashflow m -1,445 182 236 -296
Interest Cover x nmf nmf nmf nmf
Price/Book x 2.6 2.5 2.4 2.3 Net Chg in Cash/Debt m -1,462 -412 215 73
Free Cashflow m -114 -594 -22 370


Cash m 810 398 613 686
Receivables m 32 0 0 0
Inventories m 886 891 1,070 1,039
Investments m 1,010 1,010 1,010 1,010
Fixed Assets m 1,250 1,935 2,261 2,188
Intangibles m 6 6 6 6
Other Assets m 522 570 622 665
Total Assets m 4,517 4,811 5,582 5,594
Payables m 1,140 1,044 1,282 1,231
Short Term Debt m 154 374 655 554
Long Term Debt m 47 114 200 169
Provisions m 13 13 13 13
Other Liabilities m 53 12 12 12
Minority Interests m 0 0 0 0
Other m 0 0 0 0
Total S/H Equity m 3,110 3,254 3,421 3,616



11 June 2014 59
HONG KONG


Valuation HK$ 27.90
- Sum of Parts
Volatility Index Low
& Tobacco
Free float % 34
Number shares on issue m 1,958

Year end 31 Dec 2013A 2014E 2015E 2016E
Revenue m 43,357 50,569 57,243 63,928
EBIT m 1,990 2,558 2,956 3,514
EBIT growth % 25.1 28.6 15.6 18.9
Reported profit m 1,631 1,992 2,382 2,860
Adjusted profit m 1,746 1,992 2,382 2,860
EPS rep Rmb 0.90 1.02 1.20 1.44
EPS rep growth % 26.0 13.7 17.7 20.1
EPS adj Rmb 0.96 1.02 1.20 1.44
EPS adj growth % 26.4 6.2 17.9 20.1
PER rep x 34.2 30.1 25.5 21.3
PER adj x 32.0 30.1 25.5 21.3
Total DPS Rmb 0.20 0.23 0.28 0.66
Total div yield % 0.7 0.8 0.9 2.2
ROA % 6.5 6.3 6.7 7.1
ROE % 12.6 10.4 9.6 10.1
EV/EBITDA x 18.2 14.9 12.6 10.6
Net debt/equity % 26.0 3.9 -3.2 -2.6
P/BV x 3.7 2.6 2.2 2.0

2319 HK rel HSI performance, & rec
history

Note: Recommendation timeline - if not a continuous line, then there was no
Macquarie coverage at the time or there was an embargo period.

Analyst(s)
Jamie Zhou, CFA

11 June 2014
Mengniu
Overvalued for its intrinsic worth
Event
We incorporate our negative outlook from our Yashili initiation and lower our
Mengniu forecasts by 6%/13% for FY14/15E. We cut our TP by 30% to
HK$27.90/sh based on our new sum-of-parts valuation and downgrade the
stock from Neutral to Underperform. Current market cap implies that
Mengnius core business is overvalued at 33x/28x PER vs. large cap staples
27x/22x.
Two new threats have changed our view on the stock: 1) imminent and
significant downward earnings risks on Yashili (our forecasts are 55-60%
below consensus), and 2) emerging threat of imported UHT milk, which could
potentially erode Milk Deluxes long-term competitiveness and profitability.
Impact
Yashili plummeting on multiple woes, 55-60% earnings downside:
Mengnius 68%-controlled infant formula subsidiary Yashili (1230.HK, UP) is
having the worst combination of fortune: positioned unattractively in the soon-
to-be ex-growth infant formula industry as a lower-tier city player with majority
exposure in the declining supermarket channels. Yashili is now risking losing
more market share to imported brands as the proliferation of e-commerce
lowers the entry barrier to its lower-tier city stronghold. Profits already fell 42%
in 2H13 and will further decline by 43% in FY14 on our forecasts. These
negatives are the main drivers of our 6%/13% earnings downgrade on
Mengniu, where our forecasts are now 8%/14% below Street consensus.
Import invasion! 13% of premium UHT market to come from imports: We
see competitive risks from imported UHT in the long run, as its been selling at
least 25% cheaper than Mengnius. Growing at 126% CAGR 2010-13 and
hitting fresh records in April 2014, imports should account for 13% of the
premium UHT market in 2014. This market is currently dominated by
Mengnius Milk Deluxe (~50% share), Mengnius single biggest earnings
contributor (~24% of GP). But the risks are not imminent, given much is
parallel imports sold mostly through ecommerce that remains confined to just
Tier 1 cities.
Earnings and target price revision
Lower FY14/15E EPS by 6%/13% to reflect significant weakness in Yashilis
earnings contribution. Cut TP by 30% to HK$27.9/sh on SOTP valuation.
Price catalyst
12-month price target: HK$27.90 based on a Sum of Parts methodology.
Catalyst: Yashilis interim results in August should catalyse consensus
earnings downgrades
Action and recommendation
Mengniu has completed a handful of high-profile acquisitions over the past 12
months (Yashili, CMD, Danone, Arla) that firmly solidifies its lead in the
Chinese dairy industry. However, delivering only 13% ROE and low-teens
organic growth, Mengnius core business appears overvalued at 33x/28x
FY14/15E PER. We suggest investors take profits and revisit later.
11 June 2014 60
Sum-of-the-parts valuation target price: HK$27.90/share
We change our valuation methodology from PER to sum-of-parts, considering that Mengniu holds
stake in three listed companies under our coverage:
Yashili (1230.HK, UP) 68% stake, consolidated financials,
China Modern Dairy (1117.HK, OP) 28% stake, associate income, and
YuanShengTai Dairy Farm (1431.HK, OP) 4.2% stake, associate income.
We take our target valuation on Yashili, Modern Dairy and YuanShengTai as proxy for fair value for
Mengnius stakes worth. We then assign a 20x FY15E PER target valuation on Mengnius core
business, average of Large Cap China consumer staples comp and global dairy comp groups. We
derive a total equity valuation of HK$60.8bn or HK$27.90/sh target price.
Fig 1 SOTP valuation: HK$27.90/sh
Segment
Methodology
(FY15 PER)
Macquarie target
valuation Mengniu stake
Attributable
equity valuation
(RMBm)
Yashili (1230.HK) 15.0x 4,163 68% 2,831
Modern Dairy (1117.HK) 15.0x 19,822 28% 5,550
YST Dairy (1431.HK) 13.5x 4,351 4% 183
Mengniu's core biz 20.0x 35,488 100% 35,488
Total equity valuation (RMBm) 44,052
CNYHKD 1.2398
# of shares 1,957
Per share price (HK$/sh) 27.90
Reasons for higher valuation on Mengnius core business
Strong market leadership in premium liquid milk, particularly in high end with Milk Deluxe brand
Strongest among peers in upstream raw milk, 96% sourced from scaled farms; ownership stakes
in Mengniu, YST, Fuyuan Farming
Danone joint venture on chilled dairy products could have upside on new product introduction in
FY15 and beyond
International partnership with Arla and White Wave to pave way for further international
opportunities
Reasons for lower valuation on Mengnius core business
Yashili is struggling with declining sales and falling market share, our forecasts are ~60% below
Consensus
Core business growing at only low-teens organic rate while delivering just 13% ROE
Fig 2 Current market caps imply Mengnius core-biz is overvalued on 33x/28x earnings
Current market cap
(RMB million) Mengniu stake
Attributable equity
value (RMB million)
Yashili 8,233 68% 5,599
Modern Dairy 13,229 28% 3,704
YST Dairy 4,285 4.2% 180
Mengniu 60,054 60,054
Implied Mengniu core-biz valuation 50,571

Mengniu core-biz (Macquarie forecasts) FY14E FY15E
Adj. net profit (RMBm) 1,527 1,774
Implied PER (x) 33.1x 28.5x

Market cap as of closing price of June 10, 2014
Source: Bloomberg, Company data, Macquarie Research, June 2014

11 June 2014 61
Fig 3 Mengniu (2319.HK) 13% ROE, 12% growth vs. comps trading on 20-21% ROE, 17-20% EPS CAGR
Price TP Mkt Cap PER (x) EV/EBITDA (x)
EPS
growth
(%)
ROE
(%)
Div
yield
(%) PEG P/Bk
Ticker Company Rec lc lc % US$m CY14E CY15E CY14E CY15E 13-15E CY13 CY13 CY14E FY13
2319 HK Mengniu UP 38.05 27.90 -27% 9,612 30.1 25.5 14.9 12.6 11.9 12.6 0.7 2.5 3.7
Mengniu at TP 27.90 22.1 18.7 11.0 9.4 1.9

China large cap consumer staples
151 HK Want Want OP 10.68 13.00 22% 18,200 23.4 20.2 15.8 13.4 15.4 37.9 2.9 1.5 9.5
322 HK Tingyi OP 22.20 24.40 10% 16,027 32.9 27.2 11.8 10.4 19.7 16.0 1.5 1.7 5.5
1044 HK Hengan N 83.50 84.00 1% 13,254 23.1 19.3 16.5 13.6 23.3 25.2 2.6 1.0 6.1
Average 27.0 22.5 14.3 12.1 16.9 20.9 1.7 1.6 5.3

China dairy comps
1117 HK CMD OP 3.21 5.12 60% 1,999 12.5 9.6 11.5 8.8 48.6 16.2 0.8 0.3 2.2
1431 HK YST OP 1.38 2.73 98% 696 9.8 7.2 5.3 3.9 41.0 10.4 0.0 0.2 1.2
151 HK Want Want OP 10.68 13.00 22% 18,200 23.4 20.2 15.8 13.4 15.4 37.9 2.9 1.5 9.5
1112 HK Biostime UP 51.00 38.50 -25% 3,971 25.5 21.2 15.6 13.3 11.3 33.9 2.9 2.3 9.9
1230 HK Yashili UP 3.19 1.45 -55% 1,464 38.3 33.1 21.1 15.8 -19.0 12.2 15.4 NA NA
6863 HK Huishan NR 1.86 3,457 12.6 9.5 9.4 7.5 NA 16.7 0.0 NA NA
600887 CH Yili NR 31.32 10,229 14.1 11.9 8.2 NA 20.6 20.1 2.0 0.7 3.7
600597 CH Bright NR 16.79 3,287 21.9 18.2 NA NA 30.1 12.8 1.5 0.7 4.7
002570 CH Beingmate NR 13.53 2,212 14.0 NA 8.4 NA 27.0 16.8 1.9 0.5 3.5
Average 17.0 13.8 10.4 8.8 20.8 19.0 2.8 1.1 3.8
ex-A Share 17.4 13.6 11.2 8.8 18.2 20.0 3.2 1.4 3.7

Global dairy comps
FSF NZ Fonterra N 6.08 6.65 9% 8,221 36.0 22.0 12.0 9.8 -31.3 3.5 2.1 NA 1.5
SML NZ Synlait N 3.25 4.00 23% 402 16.2 16.4 9.5 8.5 35.0 21.5 0.0 0.5 5.0
NESN VX Nestl NR 70.45 252,869 20.2 18.8 13.7 12.7 5.4 16.2 3.3 3.7 3.6
BN FP Danone NR 54.26 47,437 19.6 17.8 12.2 11.1 7.0 12.4 2.8 2.8 3.2
DF US Dean Foods NR 17.06 1,595 31.3 16.7 7.9 6.5 -74.9 151.8 0.0 NA 2.4
SAP CN Saputo NR 58.33 10,436 18.8 17.4 12.1 11.4 7.7 23.2 1.5 2.4 4.4
PLT IM Parmalat NR 2.50 6,207 21.0 19.7 7.9 7.3 -2.0 7.3 1.2 NA 1.5
2269 JP Meiji Dairies NR 6,750 5,032 19.0 18.2 7.4 7.0 20.0 6.9 1.4 0.9 1.6
2264 JP Morinaga Milk NR 398 987 17.2 NA NA NA 2.5 5.1 1.9 6.9 0.8
2270 JP Megmilk Snow NR 1,324 915 13.9 12.1 6.4 5.9 -25.0 6.3 2.2 NA 0.8
Average 20.1 17.6 9.7 8.7 -4.4 61.1 1.6 1.5 1.8


Fig 4 Mengniu trading on blended 28x Forward PER Fig 5 One standard deviation above its 5-year mean


15
20
25
30
35
40
45
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
Share price (HK$)
20x
25x
30x
15
20
25
30
35
40
mean
-1
+1
11 June 2014 62
Fig 6 Mengniu trading at premium to its biggest
competitor Yili (600887.CH, not rated)

Fig 7 Current premium of 77% at three-year high

Forward estimates on Yili based on Bloomberg consensus.

Fig 8 Mengniu and Yashili are the most expensive
dairy stocks with the lowest earnings growth
Fig 9 ROE also among the lowest within the dairy
sector


-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
5
10
15
20
25
30
35
Jun 2011 Jun 2012 Jun 2013 Jun 2014
Mengniu premium Mengniu Yili
Mengniu premium over Yili Forward PER (x)
-20%
0%
20%
40%
60%
80%
Jun 2011 Jun 2012 Jun 2013 Jun 2014
Mengniu 's valuation premium over Yili
average
29%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
- 10.0 20.0 30.0 40.0
Mengniu
CMD
YST
Want Want
Biostime
Yashili
Yili
Bright
Beingmate
FY14EPER (x)
E
P
S

C
A
G
R

F
Y
1
3
-
1
5
E
Avg 17x PER
Avg 21%
EPS CAGR
0.0
2.0
4.0
6.0
8.0
10.0
12.0
0.0 10.0 20.0 30.0 40.0
Mengniu
CMD
YST
Want Want
Biostime
Yashili
Yili
Bright
Beingmate
P
r
i
c
e
-
t
o
-
b
o
o
k

(
F
Y
1
3
)
ROE% (FY13)
Avg 19% ROE
Avg 5x P/Bk
11 June 2014 63

Fig 10 Breakdown of Macquarie Mengniu NP forecast
Fig 11 Breakdown of Consensus Mengniu NP
forecast

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

Fig 12 Attribution of Macquarie Mengniu NP forecast
Fig 13 Attribution of Consensus Mengniu NP
forecast

Source: Company data, Macquarie Research, June 2014 Source: Bloomberg, Macquarie Research, June 2014
Fig 14 Our Yashili Adj. NP forecasts are 55-60% below
Street consensus
Fig 15 Yashili earnings downside accounts for
majority of our below consensus view on Mengniu

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

1,556
1,385
1,521 1,527
1,774
129 163
189 96
283
392 20
26
0
500
1,000
1,500
2,000
2,500
3,000
3,500
FY11 FY12 FY13 FY14E FY15E
Mengniu core biz Yashili CMD YST
Net profit (RMBm)
1,556
1,385
1,521 1,500
1,871
129
348
447
96
259
333
19
25
0
500
1,000
1,500
2,000
2,500
3,000
3,500
Net profit (RMBm)
100% 100%
87%
77%
74%
7%
8%
8%
6%
14%
16%
1%
1%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Breakdown of NP
100% 100%
87%
71% 70%
7%
16% 17%
6%
12% 12%
1%
1%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Breakdown of NP
2%
-5%
-55%
-60%
9%
18%
1%
4%
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
FY14E FY15E
Adj. NP Macquarie vs. Street (+/- %)
-350
-300
-250
-200
-150
-100
-50
0
-400
-350
-300
-250
-200
-150
-100
-50
0
50
100
FY14E FY15E
Mengniu core biz Yashili CMD
YST Mengniu Adj. NP
Adj. NP Macquarie vs. Street (RMBm) Mengniu blended (RMBm)
11 June 2014 64
Imported UHT invasion, 126% volume CAGR
We see competitive risks from imported UHT, which has been selling for at least 25% cheaper than
Mengnius.
After a few rounds of price hikes in 2013 (Mengniu raised Milk Deluxe ASP three times), Chinas
retail price of premium UHT milk has now reached above RMB22/litre. The high prices have attracted
many importers to reap profits.
According to a study done by China Dairy Industry Association, most of the imported UHT have been
selling competitively at RMB16/litre to capture market share from domestic brands such as
Mengnius Milk Deluxe and Yilis Satine.
In the below cost structure breakdown, everyone along the value chain (parallel importers, retailers,
distributors) can all make decent 10-15% profits off imported UHT milk.
Fig 16 Premium UHTs value chain profit distribution: Milk Deluxe vs. imported UHT

Source: CDIA, Company data, Macquarie Research, June 2014
Yihaodians Guinness World Record
In March, Chinas largest FMCG e-tailer YHD.com (51% controlled by Walmart) broke the Guinness
World Record selling 30 ocean containers of milk in less than 53 minutes. This is followed only by
YHD.com stepping up the game again on May 29th, topping its own record by selling 100 ocean
containers of milk within 51.5 minutes.
Fig 17 Imported UHT priced competitively at
RMB16/L vs. domestic premium UHT selling for
>RMB20/L

Fig 18 YHD.com broke Guinness record in March:
selling 30 ocean containers of UHT milk in 53 minutes

Source: Macquarie Research, June 2014 Source: Yihaodian.com, June 2014

0.00 5.00 10.00 15.00 20.00 25.00
Milk
Deluxe
Parallel
imports
RMB per Litre of premium UHT
Consumers buy at
RMB16 on Yihaodian.com
RMB22 in
supermarket
cost, insurance and
freight (CIF)
raw material cost
tariff &
VAT
SG&A
Mengniu's
profit
distributor
mark-up
retail
mark-up
retail
mark-up
distributor
mark-up
11 June 2014 65
126% volume CAGR and setting fresh highs
According to China Customs trade data, total UHT import volume jumped from barely 7k tons in
2010 to 143k tons in 2013, registering a 126% CAGR. Latest data shows that total imports hit
another record high in April 2014 at 26k tons imported in just one month (annualises to >300k ton or
doubling 2013s).
Fig 19 Import UHT hitting fresh high in April 2014 Fig 20 Half of the imports are from Germany

Source: China Customs, Macquarie Research, June 2014 Source: China Customs, Macquarie Research, June 2014
To account for 13% of premium UHT market
Compared with total liquid milk consumption volume of 26m tons, total imports of 130k ton is barely
meaningful, representing just 50bps. However, if we narrow down to just premium UHT (we estimate
~2m tons consumption in 2013 and growing at 9% per annum), the imported numbers then become
meaningful: up from <1% in 2010 to 7.3% in 2013 and could reach 13% in 2014.
Fig 21 Import accounted for an insignificant 0.5% of
total liquid milk volume
Fig 22 But is becoming an increasingly meaningful
portion of premium UHT, to rise to 13% in 2014

Macquarie forecast of 9% total volume growth in 2014 *Macquarie estimate based on 8% volume share in 2013.
Source: China Custom, MOA, Macquarie Research, June 2014 Source: China Custom, MOA, Macquarie Research, June 2014

0
5
10
15
20
25
30
35
2010 2011 2012 2013 2014
UHT milk Other liquid milk
Monthly liquid milk import (000 ton)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2010 2011 2012 2013 2014
Germany New Zealand France Australia Rest of world
0.0% 0.0%
0.0%
0.1%
0.3%
0.5%
1.0%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
0
5
10
15
20
25
30
35
2008 2009 2010 2011 2012 2013 2014E
Total liquid milk Imported UHT % imported
Liquid milk volume (million ton) % imported
0.6% 0.8% 0.6%
1.8%
4.2%
7.3%
13.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2008 2009 2010 2011 2012 2013 2014E
Premium UHT Imported UHT % imported
Premium UHT volume* (million ton) % imported
11 June 2014 66
Milk Deluxe beware
We are seeing competitive risks which could structurally limit Mengnius long-term pricing power.
The premium UHT market was created by Mengniu with the successful introduction of Milk Deluxe in
2006. The market to date remains dominated by Mengnius Milk Deluxe (~50% market share). Milk
Deluxe is also Mengnius single biggest earnings contributor (~24% of FY13s GP).
Fig 23 Mengniu currently controls 50% of the
premium UHT market with Milk Deluxe brand
Fig 24 Milk Deluxe is a major earnings driver for
Mengniu

Source: MOFCOM, Euromonitor, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014
But the threat is not imminent
According to our channel checks:
Most UHT milk is sourced through parallel imports (third party import/wholesale agents)
78% sold on e-commerce sites, YHD.com remains largely a Shanghai/Beijing platform
Importers lack comprehensive distribution to compete head to head against Mengniu and Yili
Imported milks quality is being disputed:
Foreign milk not necessarily from premium raw milk sources compared with Mengnius Milk
Deluxe, which only sources from the highest quality upstream raw milk (e.g. Modern Dairy)
6-8 weeks ocean freight time + 3-4 weeks China custom inspection and quarantine means 3-4
months of shelf life wouldve been expired
Imported UHT is given one year total shelf-life, where domestic brands typically put conservatively
6-9 months on the packaging
But Tier-1 city consumers will still buy imported UHT, because:
They are foreign
They are cheaper

Milk Deluxe
(Mengniu)
50%
Satine (Yili)
30%
Others
20%
Approximate market share of premiumUHT
Milk Deluxe
(Premium
UHT)
24%
Other star
brands
30%
Rest of
Mengniu
46%
Approximate breakdown of Mengniu's GP (2013)
11 June 2014 67

China Mengniu Dairy Company (2319 HK, Underperform, Target Price: HK$27.90)

Gross Profit m 6,178 7,111 7,219 8,027 Gross Profit m 11,697 14,331 16,173 17,882
Cost of Goods Sold m 16,511 17,667 18,571 20,022 Cost of Goods Sold m 31,660 36,238 41,070 46,046
EBITDA m 1,659 1,867 2,163 2,180 EBITDA m 3,193 4,030 4,704 5,582
Depreciation m 589 721 750 856 Depreciation m 1,202 1,471 1,747 2,067
EBIT m 1,070 1,146 1,412 1,324 EBIT m 1,990 2,558 2,956 3,514
Net Interest Income m 100 -37 -38 13 Net Interest Income m 199 -75 28 64
Exceptionals m -126 0 0 0 Exceptionals m -138 0 0 0
Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0
Pre-Tax Profit m 1,168 1,251 1,534 1,534 Pre-Tax Profit m 2,205 2,786 3,403 4,115
Net Profit m 987 1,004 1,269 1,205 Net Profit m 1,838 2,273 2,717 3,249
Minority Interests m -118 -142 -139 -168 Minority Interests m -207 -280 -335 -389

Reported Earnings m 869 862 1,130 1,038 Reported Earnings m 1,631 1,992 2,382 2,860
Adjusted Earnings m 974 862 1,130 1,038 Adjusted Earnings m 1,746 1,992 2,382 2,860

EPS (rep) 0.47 0.45 0.57 0.52 EPS (rep) 0.90 1.02 1.20 1.44
EPS (adj) 0.53 0.45 0.57 0.52 EPS (adj) 0.96 1.02 1.20 1.44
EPS Growth yoy (adj) % 50.9 3.7 8.2 16.6 EPS Growth (adj) % 26.4 6.2 17.9 20.1
PE (rep) x 34.2 30.1 25.5 21.3
PE (adj) x 32.0 30.1 25.5 21.3

EBITDA Margin % 7.3 7.5 8.4 7.8 Total DPS 0.20 0.23 0.28 0.66
Earnings Split % 55.8 43.3 56.7 43.6 Weighted Average Shares m 1,820 1,956 1,987 1,987
Revenue Growth % 28.0 19.9 13.7 13.2 Period End Shares m 1,835 1,957 1,957 1,957
EBIT Growth % 59.1 24.5 32.0 15.5


Revenue Growth % 20.2 16.6 13.2 11.7 EBITDA m 3,193 4,030 4,704 5,582
EBITDA Growth % 22.8 26.2 16.7 18.7 Tax Paid m -367 -513 -686 -866
EBIT Growth % 25.1 28.6 15.6 18.9 Chgs in Working Cap m 517 -971 775 -1,065
Gross Profit Margin % 27.0 28.3 28.3 28.0 Net Interest Paid m 199 -75 28 64
EBITDA Margin % 7.4 8.0 8.2 8.7 Other m -258 30 176 256
EBIT Margin % 4.6 5.1 5.2 5.5 Operating Cashflow m 3,284 2,501 4,996 3,970
Net Profit Margin % 4.0 3.9 4.2 4.5 Acquisitions m -7,592 0 0 0
Payout Ratio % 20.9 22.8 23.2 46.1 Capex m -2,846 -2,125 -2,370 -2,484
EV/EBIT x 28.4 22.6 19.2 16.0 Other m -4,858 0 0 0
Investing Cashflow m -15,269 -2,125 -2,370 -2,484
Balance Sheet Ratios Dividend (Ordinary) m -385 -545 -652 -1,559
ROE % 12.6 10.4 9.6 10.1 Equity Raised m 2,005 3,867 0 0
ROA % 6.5 6.3 6.7 7.1 Debt Movements m 7,880 -7,822 -271 -248
ROIC % 21.0 9.2 8.8 9.5 Other m 2,831 -0 0 0
Net Debt/Equity % 26.0 3.9 -3.2 -2.6 Financing Cashflow m 12,331 -4,500 -923 -1,808
Interest Cover x nmf 34.2 nmf nmf
Price/Book x 3.7 2.6 2.2 2.0 Net Chg in Cash/Debt m 9,008 3,369 9,198 7,173
Free Cashflow m 438 376 2,626 1,486


Cash m 7,102 2,977 4,680 4,359
Receivables m 3,240 3,959 4,275 4,965
Inventories m 2,577 3,380 3,821 4,757
Investments m 0 0 0 0
Fixed Assets m 11,608 13,984 16,323 18,772
Intangibles m 5,695 5,695 5,695 5,125
Other Assets m 10,119 11,226 12,395 13,565
Total Assets m 40,339 41,220 47,190 51,542
Payables m 9,217 10,096 11,932 12,795
Short Term Debt m 8,554 748 491 257
Long Term Debt m 3,236 3,236 3,236 3,236
Provisions m 235 274 310 346
Other Liabilities m 1,087 1,031 1,182 1,345
Minority Interests m 2,650 2,931 3,265 3,654
Other m 0 0 0 0
Total S/H Equity m 18,011 25,836 30,039 33,563


11 June 2014 68
Important disclosures:
Recommendation definitions
Macquarie - Australia/New Zealand
Outperform return >3% in excess of benchmark return
Neutral return within 3% of benchmark return
Underperform return >3% below benchmark return

Benchmark return is determined by long term nominal
GDP growth plus 12 month forward market dividend
yield
Macquarie Asia/Europe
Outperform expected return >+10%
Neutral expected return from -10% to +10%
Underperform expected return <-10%
Macquarie First South - South Africa
Outperform expected return >+10%
Neutral expected return from -10% to +10%
Underperform expected return <-10%
Macquarie - Canada
Outperform return >5% in excess of benchmark return
Neutral return within 5% of benchmark return
Underperform return >5% below benchmark return
Macquarie - USA
Outperform (Buy) return >5% in excess of Russell
3000 index return
Neutral (Hold) return within 5% of Russell 3000 index
return
Underperform (Sell) return >5% below Russell 3000
index return

Volatility index definition*
This is calculated from the volatility of historical
price movements.

Very highhighest risk Stock should be
expected to move up or down 60100% in a year
investors should be aware this stock is highly
speculative.

High stock should be expected to move up or
down at least 4060% in a year investors should
be aware this stock could be speculative.

Medium stock should be expected to move up
or down at least 3040% in a year.

Lowmedium stock should be expected to
move up or down at least 2530% in a year.

Low stock should be expected to move up or
down at least 1525% in a year.
* Applicable to Asia/Australian/NZ/Canada stocks
only
Recommendations 12 months
Note: Quant recommendations may differ from
Fundamental Analyst recommendations
Financial definitions
All "Adjusted" data items have had the following
adjustments made:
Added back: goodwill amortisation, provision for
catastrophe reserves, IFRS derivatives & hedging,
IFRS impairments & IFRS interest expense
Excluded: non recurring items, asset revals, property
revals, appraisal value uplift, preference dividends &
minority interests

EPS = adjusted net profit / efpowa*
ROA = adjusted ebit / average total assets
ROA Banks/Insurance = adjusted net profit /average
total assets
ROE = adjusted net profit / average shareholders funds
Gross cashflow = adjusted net profit + depreciation
*equivalent fully paid ordinary weighted average
number of shares

All Reported numbers for Australian/NZ listed stocks
are modelled under IFRS (International Financial
Reporting Standards).

Recommendation proportions For quarter ending 31 March 2014
AU/NZ Asia RSA USA CA EUR
Outperform 51.32% 60.23% 41.25% 40.21% 58.52% 48.74% (for US coverage by MCUSA, 8.21% of stocks followed are investment banking clients)
Neutral 34.54% 24.97% 40.00% 53.19% 35.56% 32.77% (for US coverage by MCUSA, 6.67% of stocks followed are investment banking clients)
Underperform 14.14% 14.80% 18.75% 6.60% 5.92% 18.49% (for US coverage by MCUSA, 0.00% of stocks followed are investment banking clients)

Company-specific disclosures:

Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.

Analyst certification:
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compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The
analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd ABN 94
122 169 279 (AFSL No. 318062) (MGL) and its related entities (the Macquarie Group) and has taken reasonable care to achieve and maintain
independence and objectivity in making any recommendations.
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