initiation: snacks the main china packaged food course as...

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■ Investment case We initiate coverage of the China Packaged Food and Beverage Sector with a Neutral rating. While the companies in the sector are trading at high valuations, we believe this is justified for some of them by high earnings visibility and their resilience to macroeconomic headwinds. Among the different sub-segments, we prefer the snack and instant-food companies to the non-alcoholic beverage (soft drinks) ones given less fierce competition in the former. Want Want, on which we initiate coverage with a Buy (1) rating, is our top sector pick on the back of the recent share-price sell-off (it is down 22% from its peak in April this year) and the acceleration we expect in revenue over 2H14. We forecast the company to maintain an operating margin of more than 22% over 2014-16, compared with 4-6% for the soft-drink players and a range of -3% to 13% for the instant-noodle makers.

In the drinks segment, we expect the bottled-water players to fare better than the juice-drink and carbonated-drink producers over the near term, on the back of downtrading by consumers and increased health awareness. We prefer Tingyi, on which we initiate coverage with an Outperform (2) rating, to UPCH – Hold (3) rating – as Tingyi has a more diverse soft-drink portfolio. ■ Catalysts China has a low per-capita consumption rate for snacks, at less than 10% of the global average. Given this, and the significant room we see for product diversification through new product launches, we expect sales growth in the country’s snack market to maintain momentum over the next 3 years (2006-12 sales CAGR of 16%), while we expect single-digit sales growth for the instant-noodle and soft-drink markets over the same period. We believe the success of new products will be important in driving earnings and serve as positive share-price catalysts for stocks. Want Want and Tingyi have begun launching new products to diversify their customer bases, supported by their strong execution capabilities and distribution networks. Further declines in the costs of raw materials, such as imported milk powder, sugar, and PET chips, should continue and be favourable for the snack and some soft-drink producers. We expect the pricing power of the leading instant-noodle

players to rise in 2015 as their market shares increase. ■ Valuation Our target PERs are based on, or at a premium to, the companies’ average past-5-year 12-month forward PERs, as we see operating margins improving gradually and restoring earnings growth. Trading at 27% below its past-5-year PER average, we believe Want Want is the most attractively valued among the companies in the sector. China Packaged F&B Sector: target PERs Company Target PER (x) 2014-15E EPS averageWant Want 24.6 USD0.068Tingyi 27.0 USD0.109UPCH 30.0 CNY0.151

Source: Daiwa ■ Risks The main downside risks to our view are food-safety issues, sharp rises in commodity costs, and aggressive promotions and discounts. The main upside risks are falls in raw-material costs and successful price rises.

25 June 2014

Initiation: snacks the main course as drinks lose fizz

• Although expensive, China F&B companies offer strong earnings growth and resilience to macroeconomic headwinds

• We prefer the snack producers to beverage brands given better competitive landscape and product-mix diversification potential

• Want Want is our top pick in the sector

China Packaged Food and Beverage Sector

Key stock calls

Source: Daiwa forecasts.

Consumer Staples / China

Positive

Neutral (initiation)

Negative

Anson Chan(852) 2532 [email protected]

Alison Law, CFA(852) 2532 [email protected]

New Prev.Want Want China (151 HK)Rating BuyTarget 13.00Upside 27.2%

Tingyi Cayman Islands (322 HK)Rating OutperformTarget 22.90Upside 8.8%

Uni-President China (220 HK)Rating HoldTarget 5.60Downside 3.4%

How do we justify our view?How do we justify our view?

China Packaged Food and Beverage Sector 25 June 2014

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How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook China Packaged F&B Sector: revenue and reported net profit

Revenue. Due to its exposure to snacks, we believe Want Want will see the greatest revenue-growth momentum in the sector over 2014-16. We expect Tingyi’s revenue to grow faster than UPCH’s on the back of market-share gains in the instant-noodle segment. Margin and profit. We forecast Tingyi’s net profit to rise at a 26% CAGR over 2014-16 on the back of efficiency gains in the Pepsi unit and reduced promotion expenses for noodles. For Want Want, we forecast a 2014-16 EPS CAGR of 18% on the back of price rises and new product launches. We forecast UPCH’s adjusted EPS CAGR over the period to be 20% (excluding one-off items) as the noodles segment turns around in 2015E.

Reported EPS growth Revenue growth

(YoY %) 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016EWant Want 32 24 20 19 17 14 14 16 15 14Tingyi 10 -14 34 31 14 17 19 15 10 10UPCH 160 -49 2 38 23 26 9 7 7 5

Source: Company, Daiwa forecasts

China Packaged F&B Sector: revenue breakdown by product category (2014E)

Snacks* Instant noodles Dairy beverages Soft drinks

Want Want 45% <1% 55% 0%Tingyi 3% 38% 0% 59%UPCH 1% 32% 0% 67%

Source: Daiwa forecasts

Note:*Include rice crackers for Want Want

Valuation 12-month forward PER (x) band of China F&B companies vs. index

The packaged F&B companies are trading currently at a 2014E PER of 24.0x, compared with 2014 PERs of 10.6x for the Hang Seng Index and 9.0x for the MSCI China, based on our and the Bloomberg consensus forecasts. Although the valuation looks rich, we expect the sector’s resilience to macroeconomic headwinds and high earnings visibility to continue. Our 6-month target prices for Want Want and Tingyi are based on the averages of the companies’ past-5-year 12-month forward PERs, as we expect the stocks to be re-rated to these average levels as operating margins improve. UPCH is trading currently at a 2015E PER of 27x, which we believe has priced in an operating-margin recovery for the noodles segment in 2015.

Source: Bloomberg, Daiwa forecasts

Earnings revisions EPS forecasts: Daiwa vs. consensus (%)

Compared with the Bloomberg consensus, our 2014-16 EPS forecasts for Want Want are 5-14% higher. We are more optimistic than the market on the profit margins of the company’s new products and its ability to pass on cost increases. Supported by market-share gains, we expect the consensus to raise Tingyi’s 2015 EPS forecast as the company’s pricing power for noodles, and hence the operating margin of the noodle segment, improves. Given the weak market-share gains we expect and the lack of new revenue engines, our 2015-16 EPS forecasts for UPCH are respectively 17% and 1% below those of the consensus.


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Sector stocks: key indicators

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Tingyi Cayman Islands 322 HK 21.05 Outperform 22.90 0.094 0.123

Uni-President China 220 HK 5.80 Hold 5.60 0.127 0.175

Want Want China 151 HK 10.22 Buy 13.00 0.062 0.074

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


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Competitive landscape by sub-segment ....................................................................................... 5 Overview .................................................................................................................................... 5 Snacks ....................................................................................................................................... 6 Instant noodles – competition likely to abate ......................................................................... 8 Soft drinks – we like diversified players ................................................................................. 12

Valuations and recommendations ............................................................................................. 16 Sector valuation sustainably high ........................................................................................... 16 Valuation methodology ........................................................................................................... 18 Want Want .............................................................................................................................. 18 Tingyi ....................................................................................................................................... 18 UPCH ....................................................................................................................................... 19

Key financials to monitor .......................................................................................................... 20 Revenue .................................................................................................................................. 20 Operating margins ................................................................................................................. 20 Cash flow and ROE ................................................................................................................. 21

Investment risks ........................................................................................................................ 22 Company Section

Want Want China ................................................................................................................... 23 Tingyi Cayman Islands ........................................................................................................... 38 Uni-President China ...............................................................................................................56

Contents


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Competitive landscape by sub-segment

We prefer the snack and instant-food producers to the soft-drink manufacturers as they have greater potential to raise ASPs and the per-capita consumption level is low.

Overview

Our stock recommendations and industry analysis are based on the following 5 criteria.

1) ASP outlook. We assess the outlook for ASPs based on: 1) a comparison of the retail prices of different packaged food items with those in overseas markets and similar domestic products, and 2) the potential for upgrades in quality or product mix to drive price rises. We see greater room for ASP increases among the snack players on the back of new product launches. In addition, we believe that it will be easier for the snack players to raise the ASPs of their products than noodle and beverage producers as the former face less fierce competition.

2) Volume-growth outlook. We compare the per-capita consumption levels of different food and packaged items in China and with their averages globally. Snack consumption in China is less than 10% of the average for developed countries. Meanwhile, the consumption of instant noodles is above the global average but below the average for Asia. Per-capita soft-drink consumption in China is 30% of the global average.

3) Cost-reduction potential. The potential for cutting costs over the near term depends on commodity prices. Over the long run it should depend on technology levels, such as the use of automation and advanced machinery.

4) Cash flow and balance sheet. Due to the snack companies’ higher ROEs and profit margins, we see their cash flow and balance sheets as being stronger than those of the other packaged-food companies. The dividend-payout ratios of 65-80% we forecast for Want Want over 2014-16 are the

highest in the packaged-food universe. The dividend-payout ratios of the other packaged-food companies, based on the Bloomberg-consensus forecasts over the same period, range from 20-50%.

5) M&A potential. We analyse the M&A opportunities and how they can enlarge a company’s product portfolio and revenue base. The instant food industry in China is more fragmented than the beverage segment and provides more opportunities for M&A.

Overview of investment potential for different sub-segments

Source: Daiwa

As shown in the preceding radar chart, the snack segment ranks higher in every aspect compared with the instant-noodle and non-alcoholic beverage segments (soft drinks). Snacks Snack companies in China have considerable room to increase their revenue and operating margin through product diversification and direct price rises. Compared with the average level globally, the consumption of snacks in China is still very low. Snack companies’ operating margins are also higher than those of players in other segments due to better pricing power and less fierce competition. Instant noodles We believe the competitive landscape is favourable for the market leader, Tingyi, which has a more than 50% share of the market. However, we believe the market volume-growth potential is not as good as for the other 2 segments given an already high per-capita consumption level. The pricing power of small players is meanwhile inferior to that of the big players given an inability to differentiate their products and a lack of financial resources for advertising and promotions. Soft drinks This market is an oligopoly, shared between Coca-Cola and a few domestic players (including the Tingyi-Pepsi

012345

ASP upsidepotential

Volumeexpansion

Cash-reductionpotential

M&As

Cash flow &profitability

Instant noodles

Non-alcoholicbeverages

Snacks


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joint venture). However, price competition is intense in China as consumers are highly price-sensitive. The operating margin in this market in general is lower than those in the other packaged-food segments.

Snacks

ASP and volume-growth outlook Snacks include a wide variety of product categories, including savoury, confectionery, nuts, and baked products. For 2012, per-capita consumption of packaged snacks in China was less than 30g/year, far below the average of 3.2kg/year for developed countries, according to the Institute of Economics of the Chinese Academy of Social Sciences. The consumption levels in China of confectionery items such as chocolate and soft candies are only one-tenth of the average level globally. According to AC Nielsen, China’s packaged-snack market increased at a 16.4% CAGR from 2006-12, and exceeded CNY19bn for 2012. The main drivers of this included rises in per-capita consumption and new product launches. We expect increased urbanisation to raise the demand for branded and packaged snacks over the coming years, as consumers move away from home-made snacks (for convenience) or unbranded products (due to concerns about food safety and health issues) to packaged products and well-known brand products. China: packaged snacks market growth in terms of revenue

Source: AC Nielsen, Calbee annual report 2013

New-product potential As there are a lot of sub-segments in the snack segment, the room for snack companies to develop new products and diversify their product portfolios is large. For example, Want Want already had about 400 stock keeping units (SKU) at the end of 2013 and plans to add another 50-70 SKUs in 2014.

Want Want: some new snack products launched in 2014

Source: Want Want

Competitive landscape As shown in the following chart, the top-5 snack brands accounted for about 65% of the market in China. However, we observe that they have different product focuses. Want Want enjoys strong brand recognition in rice crackers, nuts, soft candy, popsicles and Chinese-style crispy snacks. Pepsi Co. mainly distributes potato chips (under the brand Lays) in its snack segment. Liwayway and Orion have diversified snack portfolios, including pies, biscuits, potato chips, and gum. Dali has strong brand recognition in biscuits, potato chips and bakery products. China: snack segment market-share breakdown (2012)

Source: Calbee, Nielsen

We believe domestic players such as Want Want have a better knowledge of Chinese-style snacks and understanding of regional flavour preferences compared with their international competitors. The domestic companies’ relationships with distributors and retailers also put them in a better position when it comes to new-product development. Meanwhile, international players can leverage on their product portfolios in other countries and introduce these products to China consumers quickly.

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Want Want23.0%

Pepsi Co.15.0%

Orion10.0%

Liwayway9.0%

DaLi8.0%

Others35.0%


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Pricing power We believe snack companies have greater pricing power than other food and beverage players. By launching new flavours, new packaging, or new product categories, snack companies have the flexibility to adjust their products’ ASP should raw-material costs rise sharply. Although snacks are not daily necessities, we observe that young snack consumers are usually willing to try new products from their favourite brands, which means there is room for new-product launches and hence product-mix improvements. Rising wages in China also support the consumption of inexpensive food items, such as snacks. As the leader in China’s snack market, Want Want’s pricing power is stronger than that of its domestic peers. According to AC Nielsen, the company’s share of the rice-cracker market stood at 70% for 2007 and it has remained dominant since then. Meanwhile, Want Want claimed to rank No.1 in soft candies (such as milk candies), crispy snacks, and dairy beverages for 2010. As a result of its strong brand recognition, Want Want is able to attract consumers’ attention when it launches new products, and is able to pass on raw-material cost rises through direct price increases if needed. For example, the company’s gross margin (for snacks and rice crackers) dropped to 36.1% for 2010 from 40% for 2009 due to a sharp rise in the costs of a wide range of raw materials, such as sugar and packaging. However, through gradual price rises and new-product launches, the gross margin returned to about 40% a year later. Want Want: gross and operating margins (%) of snack and rice-cracker segments

Source: Want Want

Want Want’s international snack-company peers also have stable profit margins. We observe that the profit margins of Modelez (Not rated), an international snack firm, has been steady at 36-37% for the past 5 years, despite volatile global commodity prices.

Modelez: gross margin and operating margin (%)

Source: Modelez, Bloomberg

Cost trends Diversification For snack companies with diversified product portfolios, their gross margins are more resilient than those of single-product players. For example, Want Want has a diversified cost of goods sold (COGS) structure, with no food items accounting for more than 20% of its COGS. The largest single item, milk powder, is mainly used in its dairy beverage production and is not related to the profit margin on snacks. Even the packaging segment, which accounts for about 28% of its COGS, includes a wide variety of packaging materials, such as plastic film, tetrapak, metal cans, etc. Want Want: COGS breakdown (2013E)

Source: Want Want, Daiwa estimates

Technology upgrades can reduce the wastage of raw materials and the use of manpower. For example, Want Want is investing in packaging machines and other technologies to automate labour-intensive production procedures. We estimate labour costs accounted for 7-8% of the COGS of our packaged food coverage universe.

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Packaging27.5%

Milk powder18.4%

Sugar16.4%

Rice4.6%

Palm oil1.7%

Other raw materials

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Other overhead costs13.6%


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Cash flow and balance sheet As a result of the higher operating margin on snacks and lower capex requirements for the snack producers compared with the beverage and noodles makers, we see the former as having stronger cash flow and higher dividend payouts. This strong cash flow provides them with a strong war chest for acquisitions should opportunities arise. As shown below, Want Want can generate more than USD470m in free cash flow per year over 2014-16E, based on our estimates. Its high ROCE also suggests that it enjoys a high return on its assets and investments compared with other food companies. Want Want: free cash flow and ROCE


M&A potential As discussed above, the top-5 snack player brands accounted for about 65% of the market share in China for 2013. The remaining 35% market share is highly fragmented and was shared among a lot of players. According to the CEIC, as of 1Q14, there were 659 baked goods producers and 359 candy/chocolate producers in China. Many of them are focused on just one product category and have become No.1 or No.2 in that sub-category. For example, Strong Food Group (not listed), which is based in Guangzhou, is the No.1 jelly snacks maker in China, with about a 23% market share in 2012, according to Euromonitor. Such producers make good acquisition targets for large companies seeking product diversification. Below we show some of the acquisitions of Chinese snack companies in the past, many undertaken by foreign companies or listed companies. Private-equity firms have also been active in acquiring small-sized, single product snack manufacturers in China.

Selected acquisitions in the China snacks industry Acquirer Target Date Size Valuation Industry Nestle Hsu Fu Ji 2011 USD1.7bn

for 60% stake

25x past-1-year PER Candy

Hershey Golden Monkey 2014 USD498m for 80% stake

2.8x price/sales Candy

Qia Qia Food

Qiakang Foodstuff 2013 CNY96m for 60% stake

13x past-1-year PER Food sauces

Lunar Capital

Guizhou Yonghong Food

2013 n.a. n.a. Meat snacks

Lunar Capital

Sichuan Zhiqiang 2012 n.a. n.a. Walnut products

Source: Daiwa

Tingyi could soon be included in the above list, having been actively looking for acquisition targets in China’s instant food segment since 2012, in order to diversify its revenue and further tap its strong distribution network.

Instant noodles – competition likely to abate

Over the next 3 years, we expect ASPs to continue to be the main revenue driver for the instant-noodle brands rather than sales volume. Following on from the fierce price competition in 2012-13, we expect promotional budgets and pricing strategies to be scaled back in 2014, and product ASPs to trend up as a result of product mix upgrades. ASP outlook Prices likely to trend up on easing competition and product mix upgrades Since 2010, revenue growth for the instant noodles industry has accelerated more rapidly than sales-volume growth. According to AC Nielsen, sales volume for the instant-noodle market has been declining since 2011, yet revenue has continued to rise, showing that consumers have been willing to pay higher prices for better products, but did not consume more noodles over the past 3 years. Note that since AC Nielsen data just captures the information and trade data from chain stores such as supermarkets and convenience stores, we believe the data has captured the price trend of the products in the country, but underplayed the growth in rural areas. According to the World Instant Noodles Association, noodles consumption volume has been growing in China over the past 5 years (see the next section for more details).

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China instant-noodle market growth (% YoY)

Source: AC Nielsen

Instant-noodle revenue growth in China decelerated significantly in 2012 and 2013, due to fierce competition and cannibalisation among new and old products. In 4Q12, both Tingyi and UPCH started offering price discounts of 10-15% on pickled vegetable spicy flavoured noodles, and in 2013, started offering free sausages with that product to gain market share in that category. This flavour of noodles is a fast-growing sub-category of the noodles market in China (sales value up 30% YoY for 2012 and 10% YoY for 2013), accounting for 16-18% of the total instant noodles market in China in 2013, according to AC Nielsen, up from 10.7% in 2011. We estimate that the share of the No.1 flavour – roast beef noodles – declined to 20% in 2013 from more than 25% in 2010. However, we believe the aggressive promotion of various noodle products over the past 2 years has dragged down both the average price and pace of volume growth of the overall instant noodles market, as consumers have moved to the pickled vegetable and spicy categories from others, and demand for discounts has risen. Revenue growth for the industry decelerated to just 4% YoY in 2013, down from a range of 12-16% YoY during 2009-12. That said, we have seen signs of improvement in revenue since 2H13. Take Tingyi as an example. Its noodles revenue growth was 12% YoY for 2H13, up from 6% YoY for 1H13. Tingyi has successfully reaccelerated its revenue growth by launching more new products.

At the same time, UPCH’s noodles’ revenue growth decelerated to 5% YoY for 2H13 from 22% YoY for 2012, after sales of its core product (pickled vegetable spicy flavour) lost steam. In our view, UPCH lacks new products to sustain its revenue growth momentum over the next few years, as it is focused on promoting its existing star products, and lacks the financial resources to develop and promote new noodle products. Tingyi and UPCH: revenue changes (% YoY)

Source: UPCH, Tingyi

Looking forward, we expect more high-priced noodle products to be launched in China over 2014-16, such as non-fried noodles, large-bowl noodles with extra ingredients (eg, pieces of meat), and snack noodles. Most instant-noodle products in China are priced below CNY4/bowl or CNY3/pack. Non-oil fried products (which have a higher ASP than other noodle products but also perceived as more healthy) account for less than 2% of China’s instant-noodle consumption, versus 10-20% in Japan. We believe that such high-ASP products will gradually attract new consumers to the segment due to their healthy image and further drive up consumption and the noodle ASP in China. We see the instant-noodle segment as a winner-takes-all market. Tingyi’s operating margin is far above that of the second largest player, UPCH. Although the third and fourth largest players, Hualong and Baixiang, are not publicly listed, we believe their financials and cash flow condition have been deteriorating over the past three years as a result of their declining market share (hence revenue).

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Tingyi vs. UPCH: instant noodles’ operating margin (%) comparison

Source: Tingyi, UPCH, Daiwa forecasts

Volume outlook Per capita consumption in China is below that of other Asian countries According to the World Instant Noodles Association, an international organisation formed in 1997 by instant-noodle manufacturers, 46bn packs of instant noodles were consumed in China (including Hong Kong) in 2013, making it the largest noodle-consuming country in the world. Although noodles consumption on a per capita basis in China is already much higher than the global average, it is still low in comparison with Asian countries in which noodles (not just instant noodles) are usually served as a key source of carbohydrate. Based on World Instant Noodles Association data, consumption volume in China has been growing slightly over the past 5 years and is expected to grow steadily over the next 3 years. Asia: per-capita consumption of instant noodles in 2013 (packs)

Source: World Instant Noodles Association, Daiwa

China (including Hong Kong) instant noodles consumption

Source: World Instant Noodles Association

Cost-reduction potential We expect mild raw-material cost pressure on instant noodles over the next 2 years on the back of likely rebounds in the prices of palm oil and flour in China in 2H14. Even so, we believe most players’ operating margins will improve slightly over 2015-16 as a result of the scaling back of promotional expenses and discounts. Palm oil and flour are key cost items for noodle manufacturing. Other items include packaging and a number of food ingredients and other flavourings and food additives. Noodle manufacturers’ COGS breakdown (2014E) As a ratio of COGS (%) Lower limit Upper limit Palm oil 10 15 Flour 14 20 Packaging (paper, plastic etc) 20 Other food ingredients 37 46 Fixed cost 10 10


Palm oil (10-15% of instant noodles COGS) In Tianjin, a major port for importing palm oil into China, the palm-oil price fell by 3% for 5M14. In addition, the price of palm oil has trended down 3% YTD on the futures market, easing the cost pressure for instant noodles’ producers in China in 2Q14 and 3Q14. The main reason for this is that China imports most of its palm oil needs, and the production volume of palm oil in Malaysia (which accounted for about 40% of world palm oil supply for 2013) rose by 7.4% YoY for 5M14. The Malaysian Palm Oil Council (MPOC) expects supply growth for 2014 of just 0.9% YoY (to 19.20m tonnes from 19.18m tonnes for 2013), while next year’s harvest of palm oil may be affected by El Niño and recent droughts; hence palm oil prices may go up in 2015 from the current level.

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Ong Keng Wee, plantation analyst at our alliance partner in Malaysia, Affin Investment Bank, forecasts Malaysian palm oil prices of RM2,700/tonne for 2014E and RM2,850/tonne for 2015E, implying 14% YoY and 5.6% YoY increases, respectively. We expect the unit cost increase for the noodles companies we cover to be lower at 5% YoY and 10% YoY for 2014E and 2015E, respectively, as they can make use of low-cost inventory and efficient stock management to mitigate the surge in costs. Palm oil price trend

Source: Bloomberg

Flour (14-20% of COGS) The price of wheat (the raw material for flour) has trended up consistently in China over the past 4 years as a result of government support. The China Government has kept raising the official floor auction price for grains in China to provide incentives for farmers to increase plantation sizes. Wheat output in China rose at a CAGR of 1.5% between 2009 and 2013, while the government auction price was up 9% during the period. We forecast a mild increase in the flour price of 2-4% YoY over 2014-16 for the companies within our coverage, in line with the gradual increase of the government auction price of wheat. China Government’s purchase price of grains from farmers (CNY/50kg)

Date of announcement Official auction price Nov-13 May-13 2012 2011 2010 2009Corn 222-226 210-214 n.a. n.a. n.a. n.a.Wheat (mixed) 118 112 102 93 86 83Early rice 132 n.a. 120 102 93 90Late rice 135 n.a. 125 107 97 92Hard rice 150 n.a. 140 126 103 93Soybean n.a. n.a. 230 200 190 187

Source: National Development and Reform Commission of the PRC

Flour and wheat prices in China

Source: Bloomberg

Other food ingredients These include dried vegetables, MSG and flavourings (natural and artificial), etc. In general, food inflation pressure in China is low at present as indicated by food manufacturing PPI. We also expect less use of expensive supplemental ingredients as promotion tools, such as ham sausage in bowl noodles, to lower the food ingredient cost of noodles in 2014 and 2015. Food PPI in China

Source: Bureau of Statistics of China, CEIC

Cash flow and balance sheets The cash-generating capabilities are not the same between different noodles companies, as utilization rates and market segments vary significantly. Thanks to Tingyi’s focus on the mid-to-high-end segment, and its economies of scale, the noodles business is its main cash cow. The segment contributes around USD500m in operating cash flow for Tingyi every year. On the other hand, UPCH’s noodles business has been loss-making for the past 2 years, and we estimate its utilisation rate is below 50% on average, making it even more inefficient than many peers. For most smaller competitors in China, their balance sheets and operating cash flow are even weaker, as they focus on the low-margin low-end segment.

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Wheat (LHS) Flour (RHS)

(CNY/tonne) (CNY/kg)

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PPI - Food


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M&A potential According to AC Nielsen, the top-4 players in China accounted for over 85% of the China instant-noodle market for 2013. As such, we think opportunities for M&A in the segment are low due to the little incremental impact on revenue and inferior financials and brand recognition of small players. China instant noodles market share trends

Source: AC Nielsen

Soft drinks – we like diversified players

We prefer the soft drink companies with a diversified product portfolio to single-product players in the face of fast-changing consumer tastes and the diversified companies’ economies of scale. We believe the pace at which operating margins and product prices of the China soft-drink makers catch up with those of their global peers will be very slow over the next few years, due to the fierce competition among the players in China, both domestic and international brands, and hence their weak pricing power. ASP outlook Beverage prices in China have remained steady in recent years. On average, the retail prices of bottled tea and juice have been kept below CNY3/500ml bottle for the past 5 years, with occasional promotional activities offered such as up-sizing offers and free gifts. In the face of economic headwinds and fierce competition, brands are reluctant to raise their product prices directly. Over the past 2 years, some brands have launched products with high retail prices, such as sugar-free tea, sports drinks, and spring water to raise the overall ASP of their product portfolio. However, such products only account for a small proportion of the market at present. For example, retail sales of premium bottled water totalled CNY6.1bn in 2013, according to Euromonitor,

translating into less than 8% of the total bottled water market in 2013, based on our estimates. We believe high-end products will not be important growth drivers for soft drink companies over 2014-16. More interestingly, Chinese beverage players’ operating margins are lower than those of their global peers, such as Coca Cola and Pepsi. This is due to: 1) the more competitive landscape in China, 2) differences in operational models. Global carbonated drink companies often adopt a franchisee model and outsource production procedures to bottlers, while Chinese beverage players’ operating margins are closer to those of bottlers of international brands than to brand owners, and 3) contributions from other higher profit margin businesses, such as snacks. We believe Chinese beverage players’ operating margins will remain low in the near term. Long-term upside catalysts include: 1) the launch of higher-value and higher-margin products, such as energy drinks and 100% juice, and 2) direct ASP rises on better brand recognition and increasing wage levels. Operating margin trends of different beverage players (%)

Source: Companies, Daiwa forecasts, Bloomberg consensus for Pepsi and Coca Cola

We expect UPCH’s operating margin to remain at 5.8-5.9% only over the next few years, as cost trends remain steady (see the next section for details). For Tingyi, we expect its operating margin to gradually increase due to its continuous cost-saving incentives and efficiency improvement at the Pepsi unit. Sales-volume growth outlook Changes in consumer preference among different categories We expect sales growth in the soft-drink market to continue to slow over 2014-16 due to strong economic headwinds. For Tingyi and UPC, we forecast respective beverage revenue-growth rates of 9-11% YoY over 2015-16, down from our forecasts of 10-17% YoY for 2014.

54.9 55.7 57.4 56 57.1 57.1 57.1 56.2 56.7 56.3 56.5 56.3 56.5 55.6 56 56.4 57.2

8 8.9 10 10.7 12.1 13.1 13.9 14.1 14.6 15.6 16.4 16.4 16.6 17.3 17.6 17.4 17.5

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Tingyi UPCH Hualong Baixiang

(%)

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Tingyi UPCHChina Foods - bottling PepsiCoca Cola


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However, if it is a hot summer (which leads to consumers drinking more water or beverages) and rainfall is low (increasing the likelihood of outdoor activities and hence bottled-beverage consumption), revenue growth may exceed our expectations. As the retail prices of beverages have been steady in the past few years, we believe revenue is a good proxy for volume growth. Tingyi vs. UPCH: YoY beverage revenue growth (%)

Source: UPCH, Tingyi, Daiwa forecasts

We believe the key challenge for beverage companies is to keep up with ever-changing consumer tastes. For example, juice drinks’ share of the total beverage market rose rapidly from 2007-10 on the back of increasing demand for traditional Chinese juices such as kumquat lemon juice and pear juice. However, its share fell in 2012 and 2013 as consumers bought more bottled water and other drinks. For 2014, we expect bottled water sales to continue to be higher than for the other major beverage categories due to lower prices and the products’ appeal to health-conscious consumers. Over the long term, we believe the sales growth in the various market segments and changes in consumer tastes between major product categories – carbonated drinks, ready-to-drink tea, juice drinks, and water – are difficult to predict. Promotional and marketing capabilities, as well as an ability to develop new flavours and packaging will be the key to earnings growth for the beverage companies over the next few years, in our view. Given this, we prefer companies with the following characteristics.

1. A diversified portfolio, which can: 1) reduce revenue and utilisation-rate volatility when consumers’ preferences change from one category to another or as a result of seasonal changes, and 2) cater to distributors’ and restaurant chains’

preference for using just one supplier for a wide variety of beverages.

2. Strong R&D and marketing capabilities, which are important for a company to be able to launch new products regularly and respond to market changes quickly.

China: soft-drink market breakdown by category (%)

2007 2010 2012 2013 YTD sales- growth trend Remarks

Bottled tea 11.4 19.1 16.9 16.4 Steady Dominated by Tingyi

Bottled water 52.4 30.9 31.2 32.2 Growing Shared by a few market leaders

Carbonated drinks 22.4 28.5 23.6 22.6 Declining Dominated by Coca Cola

Diluted Juice 12.6 18 17.8 16.6 Declining Shared by a few market leaders

Others (sports drinks, herbal teas) 1.2 3.5 10.5 12.2 Raising

Shared by a few market leaders

Source: AC Nielsen, Daiwa

Cost-reduction potential In general, PET chips and sugar are the main raw materials for bottled drinks, respectively accounting for about 60% and 10% of COGS for soft drinks in China. Sugar. China is the second-largest sugar producer in the world, but still imports about 10% of its sugar needs every year. We expect the sugar price to trend down in 2014 for 2 main reasons. First, the global cane sugar surplus is standing at a 3-year high currently. The US Department of Agriculture (USDA) expects the global sugar supply surplus to be 11.6m tonnes by September 2014 on the back of abundant supply. Second, China’s sugar stock is high. It stood at 8.5m tonnes as at the end of September 2013, which was equivalent to about 50% of the country’s annual consumption that year. The USDA expects global sugar production over 2014-15 to be 176m tonnes, with a reduction of supply in Brazil largely offset by an increase in supply in India. China and global sugar price trends

Source: Bloomberg

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Brazil Nanning (RHS)

(CNY/m tonnes)(USD/m tonnes)


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PET chip (polyethylene terephthalate). PET plastic bottles are the major containers for ready-to-drink soft drinks in China. As a result of the abundant supply of petrochemicals (raw materials) and a weak economy, the PET-chip price has fallen by 12% YTD and dropped by 16% YoY for May 2014. Based on our discussions with some beverage producers, we believe the favourable cost outlook for PET chip will continue for the remainder of 2014 due to the abundant supply in China. China: PET-chip price

Source: Wind

Cash flow and balance sheet In our view, soft-drink production is capital-intensive and has high financial entry barriers compared with other packaged-food segments due to the high start-up capex. For example, we estimate Tingyi’s capex on beverage capacity will be USD600m for 2014, accounting for over 70% of the company’s total capex. UPCH has said its capex for 2014 will amount to CNY4.5bn, and most of this will be spent on beverage-plant construction. Hence, we also expect UPCH’s free cash flow to be negative for 2014. The soft drinks business is, in general, more leveraged than that of other packaged-food businesses. Based on Tingyi’s disclosed segmental information, the asset-to-equity ratio of the company’s beverage segment was higher than its noodles segment, as the following chart shows.

Asset / equity ratio of Tingyi’s business units (x)

Source: Tingyi, Daiwa estimates

M&A potential The soft-drinks market in China is highly consolidated. The top-4 players of bottled tea, bottled water, and bottled diluted juice respectively accounted for 90%, 67%, and 81% of the market for 1Q14, according to AC Nielsen data. The market leaders have a presence in all the major beverage categories, and have national brand recognition and nationwide distribution networks. The major reason for M&A, if any, would be to enrich their product portfolios, such as Tingyi’s joint venture with Pepsi 2 years ago to gain exposure to carbonated drinks. International players can quickly enter new product categories (such as Chinese traditional drinks and functional drinks, which include sports drinks and herbal teas) and improve their product sales in China by working with domestic players. However, we observe that they are more likely to form joint ventures or other forms of alliances with domestic partners rather than take a majority stake in a local player. China: major M&As in the soft-drinks business

Date Foreign partner

China player Nature Remarks

2014 Suntory Huiyuan JV Pending official approval 2012 Pepsi Tingyi JV Achieved the target for the loss-making Pepsi

China unit to break even in 2013 2011 Kirin CRE JV 2008 Coca Cola Huiyuan Acquisition Failed to obtain anti-trust approval

Source: Daiwa

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Beverage -2013 Beverage -2012 Noodles - 2013 Noodles -2012


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China: ready-to-drink tea market shares

Source: AC Nielsen

China: bottled water market shares (%)

Source: AC Nielsen

China: diluted juice drinks market shares

Source: AC Nielsen

47.450.9

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Tingyi UPCH Wahaha Coca Cola

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Tingyi Farmer's Spring Wahaha

Yibao Coca Cola

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Tingyi UPCH Coca ColaWahaha Huiyuan

(%)


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Valuations and recommendations

Our top pick is Want Want with a target price of HKD13. We have Outperform and Hold ratings for Tingyi and UPCH, respectively.

Sector valuation sustainably high

PER The China F&B Sector was rerated after the 2008 financial crisis. The average 12-month forward PER of the major F&B players were rerated from about 16x to 28x over 2009. Since then they have been trading at 20-28x. Over the past 5 years, the Hang Seng Index and MSCI China have traded at 12-month forward PERs of 9-16x and 9-15x, respectively, based on Bloomberg data. The pool of stocks we use to calculate the packaged F&B sector average comprises Want Want, Tingyi, UPCH, China Mengniu (2319 HK, HKD34.85, Hold [3]), China Resource Enterprise (Not rated) (CRE), and Tsingtao Brewery (Not rated). These companies have made profits over the past 5 years, and each has a market cap exceeding USD3bn at present. 12-month-forward PER: China packaged F&B Sector vs. MSCI China and Hang Seng Index

Source: Bloomberg, Daiwa

PEG In terms of PER-to-long-term EPS growth ratio (PEG), most F&B stocks are trading currently between 1-1.9x, compared with past-5-year averages of 0.9-1.4x. In the following chart, we do not include UPCH and CRE as the consensus forecasts for their 3-year EPS growth rates have been volatile in the past 2 years, sometimes assuming no growth or even declines. There are no meaningful PEG consensus forecasts for them over the past 2 years. PER-to-long-term growth rate ratio (x) yearly average

2010 2011 2012 2013 2014 YTDWWC 1.06 1.11 1.23 1.21 1.35Tingyi 1.32 1.29 1.21 1.26 1.33Tsingtao 1.23 1.08 1.44 2.18 1.76Mengniu 1.85 1.05 1.65 2.97 1.16

Source: Bloomberg

Valuation premium justified As shown in the following table, the China F&B players listed in Hong Kong are trading at a 2014E PER of 24.0 and a 2015E PER of 18.9x. These are at premiums of 95-126% to the Hang Seng Index, which is trading currently at a 2014E PER of 10.6x and a 2015E PER of 9.7x. They also represent premiums of 128-166% to the MSCI China index, which is trading at 2014E and 2015E PERs of 9.0x and 8.3x, respectively. We believe the valuation premium of the China F&B Sector relative to other sectors will continue to be justified by the following. High revenue-growth visibility. In the face of economic headwinds, demand growth for many staple items is more resilient than for other products, in particular for basic food items. Moreover, a rising minimum wage, a low per-capita consumption level of some F&B items compared with the global average, and ongoing urbanisation are all favourable and visible long-term business-growth drivers for the sector. Room for margin expansion. The operating margins of most F&B companies in China are only at mid-to-high single digits, which compares with mid-teen percentages to more than 20% for their major international peers. We see the following long-term drivers for an increase in the operating margins of the China players: 1) excluding infant formula, retail (and ex-factory) prices of most F&B items in China are below those in developed countries – upside should come from product-mix improvements, increasing consumption power, and the brand recognition of leading players, and 2) scale expansion, automation and other

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Sector's PER average HSI MSCI China


- 17 -

production-technology developments that improve the operating efficiency of the industry. Strong balance sheets and cash flow. With the exception of UPCH, we expect all downstream F&B companies under our coverage to have a net cash position at the end of 2014. Most of the revenue for the packaged-food companies comes from distributors (on a cash-on-delivery basis) and is generated in China.

This has resulted in strong cash flow and low credit risk in the sector.

China Packaged Food and Beverage Sector: valuation comparison

Bloomberg Mkt. cap Share price

Stock Δ % PER (x) EPS change YoY ( %) EV/EBITDA (x) Revenue YoY (%) EBIT margin (%)

ROE(%)

Name code Rating (USDm) 23 June 14 3M 1M 2013 14E 15E 16E 2013 14E 15E 16E 2014E 15E 2013 14E 15E 2013 14E 15E 14E

China packaged F&B players HKD Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 CRE 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Tenwow 1219 HK NR 760 2.86 -21 -8 10.7 9.8 8.1 6.3 n.a. 9 21 30 8.5 7.0 11 17 17 9.6 9.7 9.9 15.7 Sector average 27.0 24.0 18.9 15.7 -1 13.8 24.5 16.2 11.8 9.7 15.4 18.5 15.4 8.7 11.5 12.2 16.5Dairy-farm operators HKD China Modern Dairy* 1117 HK Buy 1,931 3.12 -11 -9 24.0 12.2 9.4 7.5 23 97 30 25 10.5 8.8 62 34 20 29.6 36.0 36.2 15.9 China Huishan Dairy* # 6863 HK Buy 3,233 1.75 -22 -7 10.4 7.5 5.9 n.a. 111 32 55 40 8.5 6.7 38 39 34 42.2 51.0 52.6 13.8 Yuanshengtai Dairy 1431 HK NR 611 1.22 -22 -10 9 6.7 5.0 4.1 n.a. 32 33 22 3.7 2.8 28 35 32 39.5 37.3 34.9 9.3 Average 14.5 8.8 6.8 5.8 67 54 39 29 7.6 6.1 43 36 29 37.1 41.4 41.2 13.0Mainland-listed F&B players CNY Yili Industries 600887 CH NR 10,382 31.56 -13 -10 19.1 17.2 14.1 11.8 54 11 22 19 11.7 9.5 14 13 12 5.3 7.9 8.8 20.3 Bright Dairy 600597 CH NR 3,105 15.75 -10 -13 47.7 30.2 21.3 17.6 18 58 42 21 16.3 12.7 18 23 20 4.2 4.5 5.3 12.6 Henan Shuanghui 000895 CH NR 12,356 34.87 -11 2 19.9 15.9 13.3 11.3 34 26 19 18 10.7 9.0 13 20 20 10.7 11.5 11.5 29.8 Yantai Changyu - A 000869 CH NR 2,241 23.84 -8 -6 15.6 14.5 14.8 14.0 (38) 7 (2) 6 8.4 8.2 (23) 10 6 32.9 29.3 28.3 17.4 Yantai Changyu - B 200869 CH NR 2,222 16.68 -13 -9 10.9 10.2 10.4 9.8 (38) 7 (2) 6 8.4 8.2 (23) 10 6 32.9 29.3 28.3 17.4 Yanjing Brewery 000729 CH NR 2,899 6.41 -4 -6 25.6 20.5 18.7 16.0 2 25 10 17 n.a. n.a. 6 23 9 7.2 7.6 7.8 6.9 Zhejiang Beingmate 002570 CH NR 2,364 14.36 -12 11 20.3 19.4 15.6 11.8 112 5 24 32 13.3 11.1 14 9 21 14.7 14.2 14.8 16.8 Average 22.7 18.3 15.4 13.2 20 20 16 17 11.5 9.8 3 15 14 15.4 14.9 15.0 17.3

Source: Bloomberg, *Daiwa forecasts

Note: #Denotes 31 March year-end

Global packaged food and beverage companies: valuations

Bloomberg FY Mkt. cap. Share price

(USD) Stock Δ % PER (x) EPS change (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) ROE

(%)Company code end (USDm) 23 June 14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 14E 15E 2013 14E 15E 2014ENestle NSRGY US Dec 251,857 78.10 0 4 n.a. 19.4 18.1 n.a. -2 n.a. 7 n.a. n.a. n.a. 3 1 6 16.0 16.1 16.3 n.a.Coca Cola KO US Dec 183,411 41.73 3 8 21.5 20.0 18.6 17.3 -3 8 7 8 15.3 14.4 (2) 0 4 21.8 23.9 24.6 5.6 Pepsi PEP US Dec 134,004 88.39 3 7 20.2 19.5 18.1 16.8 10 4 8 8 12.1 11.4 1 1 4 14.6 15.1 15.4 5.9 Kraft KRFT US Dec 35,569 59.75 2 7 13.1 18.7 17.3 16.4 64 -30 8 6 11.7 11.1 (0) 1 3 25.8 18.1 18.6 6.7 Mondelez MDLZ US Dec 62,973 37.23 0 8 16.8 21.6 18.8 16.3 44 -22 15 15 13.8 12.8 1 1 2 11.9 12.8 13.6 2.0 General Mills GIS US May 33,348 54.27 0 5 19.0 18.9 17.5 16.4 18 0 8 7 11.7 11.2 7 2 3 16.2 16.3 16.4 4.6 Kellogg K US Dec 23,851 66.43 -3 7 13.3 16.6 15.7 14.5 86 -20 6 8 11.3 10.9 4 2 2 19.2 14.8 15.1 6.8 Average 17.3 19.2 17.7 16.3 31 (10) 8 9 12.6 12.0 2 1 3 17.9 16.7 17.2 5.3

Source: Bloomberg


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Valuation methodology

We believe a PER methodology is suitable when valuing F&B companies given their earnings-growth visibility, and steady profit margins. To derive our target prices, we first consider the past-5-year average PER of the individual companies and apply a premium or discount to the trading average to derive our PER. We believe that any premium or discount is justified by changes in the operating margin, while any discount is usually a result of potential market-share losses or profit-margin pressure due to commodity-price volatility. We then compare the company’s current trading PER with those of its peers in China to see whether or not the valuation appears attractive or demanding. In general, we believe that a premium for large-cap companies is justified by leading market positions in their respective segments. China Packaged F&B Sector: past 5-year average PER trading range

Past-5-year 12M forward PER Standard PER (x)

Average PER

Company High-end Low-end Average deviation 2014E 2015E 2014-15

Want Want 29.6 17.90 24.6 2.7 21.2 17.9 19.6Tingyi 33.5 21.30 27.1 1.9 28.9 22.1 25.5UPCH 44.5 8.6 23.8 7.1 36.8 26.6 31.7

Source: Bloomberg, 2014-15 EPS numbers are Daiwa’s forecasts

Want Want

We initiate coverage of Want Want with a Buy (1) rating and 6-month target price of HKD13.0. Our target price is based on a target PER of 24.6 (which is equivalent to the average of the stock’s 12-month forward PERs over the past 5 years) on the average of our 2014 and 2015 EPS forecast of USD0.068. Our target price translates into a 2014E PER of 26.8x, which is equivalent to a 3% premium to the sector average. We believe the premium is supported by Want Want’s higher ROE, operating margin and strong cash flow. The share price has fallen (down 22% since the April 2014 peak) due to concerns in the market about the slowing revenue-growth momentum for 1H14E. We view the current share-price weakness as a good opportunity to accumulate the stock, as: 1) we expect earnings growth to remain at 20% and 17% YoY for 2014-15E, respectively, driven mainly by an expansion in the operating margin, 2) we expect Want Want’s new products to gradually contribute to the top line for 2H14E, driving annual revenue growth by 5% YoY. Our 2014-16 EPS forecasts are 5-14% above those of the

Bloomberg consensus as we expect higher operating margins. As shown in the following chart, Want Want is trading at close to the middle of its past-5-year PER trading range of 18-30x. We expect the stock to be rerated over the coming 6 months: 1) as we expect lower raw-material costs to kick in gradually in 2H14 once the company has used up its relatively high-priced milk-powder inventory, and 2) given the success of new product launches. Want Want: 12-month forward PER bands

Source: Bloomberg

Tingyi

We initiate coverage on Tingyi with an Outperform (2) rating and 6-month target price target of HKD22.9. Our target price is based on a target PER of 27x (which is equivalent to the average of the stock’s 12-month forward PERs over the past 5 years) on the average of our 2014 and 2015 EPS forecasts, of USD0.109. Our target price translates into a 2014E PER of 31x, which is at a 24% premium to the sector average (based on our and the Bloomberg consensus forecasts). We believe the premium is supported by Tingyi’s dominant shares in many of its key F&B markets, and given its strong scale advantages when it comes to cost controls. All of this supports our expectation of sustainable earnings growth over 2014-16. The stock is trading currently at close to the middle of its past-5-year PER trading range of 21-33x. We expect a gradual rerating of the stock in 2H14 and 2015 if Tingyi can gain further share in the instant-noodle market, as this would result in the operating margin returning to growth in this segment. Our 2015-16 EPS forecasts are 5-7% higher than those of the Bloomberg consensus, because we expect Tingyi’s pricing power in noodles to improve faster than the market expects, while our 2014 forecast is in line with that of the consensus.

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- 19 -

Tingyi: 12-month forward PER bands

Source: Bloomberg

UPCH

We initiate coverage of UPCH with a Hold (3) rating and 6-month target price of HKD5.60. Our target price is based on a target PER of 30x, which is at about a 30% premium to the average of the company’s 12-month forward PERs over the past 5 years (23.8x). The premium is in line with the average at which UPCH has traded in 2012, when it reported a 160% YoY increase in reported EPS. We believe UPCH has the potential to trade at similar premium again, given the significant improvement in EPS growth expected for 2015-16E. Our premium reflects: 1) the removal of concerns among investors about equity fund raising and the strengthening of the company’s balance sheet following the recent share issuance (one rights share was issued at HKD4.56 for every 5 existing shares in early June), 2) the turnaround we expect in the noodle segment in 2015, and 3) the fact that UPCH’s PER has been relatively volatile in the past 5 years, with much higher multiples seen when operating and financial conditions have improved (for example, the rerating of the stock in 2012 and 1H13). We expect the company’s operating margin to return to the positive for 2015, at 0.2%, versus minus 3.3% for 2014. Our 6-month target price translates into PERs of 35x for 2014E and 26x for 2015E. The UPCH stock is trading above the middle of its 12-month forward PER range over the past 5 years (10-45x), which looks stretched to us. Our 2014-16 EPS forecasts are 24%, 17% and 1% lower than those of the Bloomberg consensus, respectively, because we expect low operating margins for the noodle segment. In order for the stock to be rerated, we believe UPCH would have to improve the economies of scale for both its beverage and noodle businesses, as well as manage the related execution risks.

UPCH: 12-month forward PER bands

Source: Bloomberg

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- 20 -

Key financials to monitor

Snack company Want Want’s operating margin and ROE are higher than those of the other packaged-food producers.

Revenue

We have found that revenue growth of the packaged-food companies has slowed gradually over the past 3 years as their overall revenue bases have expanded. We expect Want Want’s revenue growth over 2014-16 to be slightly faster than those of its China peers, as Want Want plans more new product launches and price hikes this year. We expect UPCH’s revenue growth to be the slowest of the 3 companies in our sector coverage due to its less diversified product mix and our expectation of sluggish market-share gains. We expect Tingyi’s revenue growth to be faster than UPCH’s over 2014-16, on market share gains. China Packaged Food and Beverage Sector: revenue growth (YoY %)


Operating margins

COGS Raw materials generally account for about 80-85% of the annual COGS of the packaged food companies, on our estimates. Labour costs and utility costs generally account for around 8-10% and 2-4%, respectively, of

the companies’ annual COGS. The depreciation costs of the beverage companies are usually higher than those of other packaged-food companies due to their higher initial fixed asset investment costs. However, the beverage companies usually have lower labour costs than the instant-food companies as they tend to have more automated production processes. We believe the raw-material cost outlook for Want Want is more stable than for UPCH and Tingyi, given Want Want’s more diversified raw-material cost structure, which makes its gross margin less sensitive to price fluctuations of one single commodity. SG&A expenses Want Want’s SG&A expenses are the lowest among the 3 companies we cover in the sector, thanks to: 1) its more effective control of sales personnel costs and more efficient use of distributors, and 2) its lower advertising and promotional expenses given the less competitive landscape for its snack foods compared with the competitive environment for the instant-noodle and soft-drink markets. UPCH’s ratio of SG&A expenses to revenue is higher than Tingyi’s due to UPCH’s smaller production scale and revenue base. China Packaged Food and Beverage Sector: breakdown of SG&A expenses as a percentage of revenue for 2014E (%)


As a result, Want Want’s operating margin has been higher than Tingy’s and UPCH’s over recent years (as the next chart shows). We expect the operating margins for the packaged-food companies to expand over 2014-16, on the back of new product launches and better economies of scale. We forecast Tingyi’s operating margin to expand each year over 2014-16 (as the next chart shows), on the back of promotion cost reductions at its noodles unit and efficiency improvements at its beverage unit. Given UPCH’s smaller production scale and aggressive promotional strategy for its noodles business, its operating margin has remained low and volatile over 2011-13.

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- 21 -

China Packaged Food and Beverage Sector: operating margins


Net profit growth and dividend payouts We expect Want Want’s net profit growth to remain steadier and more consistent than those of its peers since 2011 and we expect it to remain so over 2014-16. UPCH’s net profit growth has been the most volatile since 2011, and we see this continuing out to 2016, due to: 1) UPCH’s low operating margin in the range of just 1.5-4.2% over 2011-16E, and 2) its rapid capacity expansion, which has pushed up its interest expenses We expect Tingyi’s net profit growth to accelerate over 2014 and 2015 to 34% YoY and 31% YoY, respectively, from a decline of 14% YoY for 2013, as we project continuous operating margin expansion on the back of promotion cost reductions at its noodles unit and efficiency improvements at its beverage unit. Tingyi and Want Want’s dividend-payout ratios have remained at above 50% annually for the past 5 years, while UPCH’s dividend payout has ranged from 20-30%, due to its heavy capex needs over the period. China Packaged Food and Beverage Sector: reported net profit growth (YoY %)

Source: Companies, Daiwa forecasts

Cash flow and ROE

ROE trends Want Want’s ROE is the highest among the 3 major packaged food and beverage companies in China, which we attribute to its elevated operating margin and relatively lower fixed asset investment requirements for its production of snack foods. Though UPCH has a stretched balance sheet currently, we expect its ROE to remain the lowest among the 3 companies over 2014-16 (as has been the case since 2011), due to the poor profitability of its noodle business. We believe Tingyi’s ROE of 14.5% for 2013 marked a trough level and forecast a gradual improvement to 17.3% for 2014 and 20.1% for 2015, as we expect the Pepsi beverage unit in China (part-owned by Tingyi) to become profitable (following the breakeven reached in 2013). China Packaged Food and Beverage Sector: ROE comparison


Cash conversion cycles As about 90% of the packaged-food companies’ revenue is generated by their distributors, who are paid on a cash-on-delivery basis, the receivable days for these packaged-food companies are generally very low (as can be seen in the following table). Want Want’s inventory turnover days are higher than those of its peers, as it has an inventory of imported milk powder that is equivalent to about 3 months. China Packaged Food and Beverage Sector: cash conversion cycles


(No. of days) 2013 2014E 2013 2014E 2013 2014EInventory days (a) 81 81 23 23 33 34Receivable days (b) 16 15 8 8 8 8Payable days (c) 42 43 60 60 33 30Cash conversion cycle (a+b-c) 55 52 -29 -29 8 12


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- 22 -

Investment risks

Food safety hazards, commodity price volatility and changing consumer preferences are the key risks to our investment thesis. Food safety – the main risk to our investment case Food-safety hazards or negative talk in the market about the companies’ products could have an adverse effect on their sales volumes, causing the latter to fall below our current forecasts. For example, in October 2008, the Slovakia Government said it found that the level of melamine in Want Want’s products had exceeded the maximum standard set by the EU. However, Want Want has never exported to or marketed its Hot-kid milk beverage in Slovakia, and thus we are not sure if the product in question was an authentic Want Want product or was illegally exported. The PRC Government has declared that Want Want’s products comply with China’s requirements. Similar reports of food-safety issues, regardless of whether the China packaged food and beverage companies are responsible or not, could undermine their brand value and sales volumes. Extreme weather changes A cooler-than-expected summer could dampen demand for bottled drinks. Heavy rainfall could curb outdoor activities, which in turn could lower demand and thus consumption of bottled drinks and packaged food. Commodity prices As raw materials (including many types of agricultural products and packaging) account for over 80% of the COGS of the China packaged food and beverage companies in general, our profit-margin assumptions for the companies that we cover factor in commodity-price risks. Many of the raw materials they use, such as juice concentrates and palm oil, are imported into China, and hence the companies are exposed to fluctuations in the global supply of these commodities.

Changes in consumer preferences and greater awareness of health issues Changes in the public’s awareness of health issues and attitudes towards snack foods and soft drinks could affect adversely the demand for packaged food and beverages. Companies can manage such risks by launching new products (such as sugar-free tea and non-oil fried noodles) to target health-conscious consumers. Changes in regulations and price intervention Direct price interventions by the China Government could put pressure on ASPs and subsequently on the revenue of the packaged food and beverage companies. We believe the risk of this is greater for the instant-noodle players than for the other packaged-food segments, as instant noodles are a basic food item and any price hikes could create more public concern than a price increase for non-essential items such as snacks. That said, given low inflation pressure that Daiwa’s economics team sees in the near term (it forecasts 2.5% YoY inflation for 2014), we see a very low risk of official price intervention at present. Note that the government intervened on pricing in 2008 and 2011 (when inflation was high), so there is a potential risk of this occurring again if inflation is high in the future. China CPI and food CPI (%)

Source: CEIC

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■ Investment case We initiate coverage on Want Want China (Want Want) with a Buy (1) rating. Want Want is the top pick in our China Packaged Food and Beverages universe, and we see a good entry point post its 22% share-price correction from its all-time peak in April 2014. It trades at an 17.9x 2015E PER, at a 27% discount to its past-5-year average 12-month forward PER, and we expect a re-rating in the coming months, driven by a sales growth recovery from 2H14 and operating margin expansion. Pricing power supported by brand strength. We forecast its beverage ASP to rise by 5% YoY for 2014, and expect price rises and new product launches this year to drive a 15% revenue CAGR for 2013-16. Further margin expansion. Want Want’s focus on niche and

differentiated snacks and beverages where it enjoys first-mover advantages should enable it to maintain a higher 24% operating margin for 2014E, vs. 14% on average for its China packaged F&B peers. Along with a falling milk powder cost and price hikes, we forecast operating margin expansion of 0.9pp YoY for both 2014-15 (24.9% for 2015E), and to 25.4% for 2016. How we are different. Our 2014-16E EPS are 5-14% above the Bloomberg consensus as we are more optimistic on operating margins. We believe Want Want’s past-2-month share-price weakness on concerns of a revenue slowdown in 1H14E is overdone, as we expect 2014 earnings to be driven by margin expansion rather than revenue growth. ■ Catalysts Along with operating margin drivers, we see share-price catalysts from a further successful diversification of its revenue base with new products and continuous share buybacks. ■ Valuation Our 6-month target price of HKD13 is based on our average 2014-15E EPS and a 24.6x PER (past-5-year average). Our target PER is at a premium to China peers’ current 2015E average (20.7x), given Want Want’s: 1) double-digit YoY EPS

growth since its 2008 IPO and we expect it to sustain for 2014-16, 2) higher-than-peers 2014E ROE and operating margin, and 3) the expected high dividend payout. ■ Risks We see key risks as food-safety issues, and selling and production cost rises.

Consumer Staples / China151 HK

25 June 2014

Want Want China

Initiation: good entry point now

• We forecast a 21% YoY revenue rebound for 2H14 (vs. +9% YoY for 1H14E) on new products and beverage growth recovery

• Operating margin should expand in 2014-16 on declining milk powder cost, new product launches and beverage price hikes

• Post recent correction, 2015E PER looks attractive at 27% discount to past-5-year mean; top sector pick, initiate with Buy

Source: FactSet, Daiwa forecasts


Want Want China151 HK

Target (HKD): 13.00Upside: 27.2%23 Jun price (HKD): 10.22

Buy (initiation)

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Share price performance

Want Want (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 10.04-13.06Market cap (USDbn) 17.423m avg daily turnover (USDm) 21.63Shares outstanding (m) 13,212Major shareholder Eng-meng Tsai (48.0%)

Financial summary (USD)Year to 31 Dec 14E 15E 16ERevenue (m) 4,425 5,078 5,782Operating profit (m) 1,061 1,265 1,469Net profit (m) 820 972 1,133Core EPS (fully-diluted) 0.062 0.074 0.086EPS change (%) 19.7 18.5 16.5Daiwa vs Cons. EPS (%) 5.2 8.2 14.3PER (x) 21.2 17.9 15.4Dividend yield (%) 3.1 4.5 5.2DPS 0.041 0.059 0.069PBR (x) 7.6 6.4 5.6EV/EBITDA (x) 14.0 11.5 9.8ROE (%) 38.7 38.7 39.0





- 24 -

Growth outlook Want Want: net profit and net profit growth

Want Want looks well positioned to tap further into what we regard as strong long-term growth potential for the China snacks and beverage market, by leveraging on its strong brand and extensive distribution network built up over more than 20 years. Per capita consumption of snacks in China is still low compared with the global average (below 30 grams per year, 1% of the level in Japan in 2011, according to data from Calbee, suggesting substantial further sales-growth potential for Want Want’s wide range of snacks and beverages. We forecast robust EPS growth of 20% YoY for 2014, 19% YoY for 2015 and 17% YoY for 2016, with a 15% revenue CAGR for 2013-16E.


Valuation Want Want: 12-month forward PER bands

The Want Want stock has been re-rated since its IPO in Hong Kong on 2008, reflecting its track record of consistent profit growth. Based on our EPS forecast, it now trades at a 2015E PER of 17.9x, at a 27% discount to its past-5-year average, which we consider undemanding given our 2013-16E EPS CAGR of 18%. We believe Want Want deserves to trade at a premium to its China peers’ average trading 2015E PER of 20.3x, given its high payout ratio (above 65% for 2014E on our forecast) and elevated ROE (2014E: 39% vs. 14% on average for its China peers). Continuous good execution of new product developments, revenue diversification, network expansion and cost control would also drive a re-rating, in our view.

Source: Bloomberg

Earnings revisions Want Want: consensus EPS forecast revisions (2014-15E)

Since 3Q13, the Bloomberg consensus 2014-15 EPS forecasts for Want Want have been generally steady, on caution about the company’s new product launches. Our 2014-16 EPS forecasts are 5-14% above the consensus ones, due to our higher operating margin assumptions. Thanks to its diversified raw-material cost structure, Want Want’s gross margin and thus earnings are less volatile vs. its China packaged food and beverage peers to raw-material cost rises. Our sensitivity analysis detailed in the Financial analysis section further on indicates a limited impact on our current 2014E EPS from potential rises in raw-material unit costs.

Source: Bloomberg


Growth outlook

Valuation

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- 25 -

Key assumptions

Profit and loss (USDm)

Cash flow (USDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales growth YoY - rice crackers (16.6) 34.3 30.0 (0.6) 12.0 11.3 11.8 9.1Sales growth YoY - beverages 48.8 33.8 30.6 22.6 17.0 20.7 15.7 16.2Sales growth YoY - snacks (2.7) 22.0 36.1 14.8 8.4 10.1 15.7 13.1Gross margin % - rice crackers 44.1 40.8 37.6 39.0 40.8 41.9 42.4 42.7Gross margin % - beverages 36.0 34.6 33.4 39.5 41.3 42.9 43.9 44.1Gross margin % - snacks 45.5 40.7 34.5 40.4 43.0 42.8 42.2 42.0

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ERice crackers 468 629 817 812 910 1,013 1,132 1,235Beverages 798 1,067 1,394 1,709 1,999 2,412 2,791 3,241Other Revenue 445 548 736 838 909 1,000 1,155 1,306Total Revenue 1,711 2,244 2,947 3,359 3,818 4,425 5,078 5,782Other income 40 41 61 46 78 73 75 76COGS (1,019) (1,400) (1,922) (2,031) (2,232) (2,537) (2,884) (3,277)SG&A (376) (447) (564) (664) (781) (900) (1,003) (1,112)Other op.expenses 0 0 0 0 0 0 0 (3)Operating profit 356 439 522 711 883 1,061 1,265 1,469Net-interest inc./(exp.) 4 4 16 38 49 65 67 83Assoc/forex/extraord./others (7) (6) (5) (3) (1) (0) 1 2Pre-tax profit 353 437 533 745 931 1,126 1,333 1,553Tax (47) (84) (119) (195) (247) (304) (360) (419)Min. int./pref. div./others 1 0 0 0 (1) (1) (1) (1)Net profit (reported) 307 353 415 550 683 820 972 1,133Net profit (adjusted) 307 353 415 550 686 820 972 1,133EPS (reported)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086EPS (adjusted)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086EPS (adjusted fully-diluted)(USD) 0.023 0.027 0.031 0.042 0.052 0.062 0.074 0.086DPS (USD) 0.021 0.023 0.020 0.029 0.035 0.041 0.059 0.069EBIT 356 439 522 711 883 1,061 1,265 1,469EBITDA 407 500 596 798 988 1,184 1,407 1,626

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 353 437 533 745 931 1,126 1,333 1,553Depreciation and amortisation 51 61 74 88 105 124 141 154Tax paid (40) (72) (82) (186) (222) (304) (360) (419)Change in working capital 249 (16) 54 (14) 191 56 50 58Other operational CF items (11) (10) (21) (42) (53) (69) (70) (84)Cash flow from operations 602 400 558 590 952 932 1,094 1,261Capex (127) (171) (224) (243) (273) (458) (250) (250)Net (acquisitions)/disposals 0 0 0 0 0 0 0 0Other investing CF items 0 0 0 0 0 0 0 0Cash flow from investing (127) (171) (224) (243) (273) (458) (250) (250)Change in debt 190 287 381 (22) 255 0 0 0Net share issues/(repurchases) (7) (14) (5) (4) (8) (17) (1) 0Dividends paid (260) (317) (259) (299) (419) (478) (617) (822)Other financing CF items (11) (20) 36 (29) (20) (0) 63 24Cash flow from financing (88) (63) 153 (353) (192) (496) (555) (798)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 388 166 487 (7) 486 (22) 289 213Free cash flow 476 229 335 347 679 474 844 1,011

Financial summary


- 26 -

Balance sheet (USDm)

Key ratios (%)


Company profile

Want Want China is the leading producer of rice crackers and flavoured milk drinks in China, with market shares of about 70% and 40%, respectively, in terms of revenue for 2013, based on our estimates. The company also makes dairy products and savoury and sweet snack foods.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 706 906 1,437 1,499 2,060 2,127 2,504 2,817Inventory 223 339 410 461 534 591 672 763Accounts receivable 73 101 160 166 164 191 219 249Other current assets 74 107 96 142 152 152 152 152Total current assets 1,076 1,454 2,103 2,268 2,911 3,061 3,547 3,982Fixed assets 624 758 891 1,046 1,236 1,573 1,685 1,784Goodwill & intangibles 1 1 1 1 1 1 1 1Other non-current assets 58 77 128 146 201 201 201 201Total assets 1,758 2,290 3,123 3,461 4,348 4,836 5,434 5,968Short-term debt 217 294 775 350 410 410 410 410Accounts payable 109 184 211 231 281 320 364 413Other current liabilities 300 386 531 599 823 924 1,039 1,168Total current liabilities 625 864 1,517 1,181 1,515 1,654 1,813 1,992Long-term debt 140 350 250 653 847 847 847 847Other non-current liabilities 0 0 24 24 34 34 34 34Total liabilities 765 1,214 1,791 1,858 2,396 2,535 2,694 2,873Share capital 264 264 264 265 265 265 265 265Reserves/R.E./others 724 809 1,065 1,331 1,679 2,028 2,467 2,821Shareholders' equity 988 1,073 1,330 1,595 1,943 2,292 2,731 3,086Minority interests 5 3 3 8 9 9 9 9Total equity & liabilities 1,758 2,290 3,123 3,461 4,348 4,836 5,434 5,968EV 17,074 17,158 17,008 16,927 16,618 16,550 16,173 15,860Net debt/(cash) (349) (262) (413) (496) (802) (870) (1,247) (1,560)BVPS (USD) 0.075 0.081 0.101 0.121 0.147 0.173 0.207 0.234

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) 10.1 31.2 31.3 14.0 13.7 15.9 14.8 13.9EBITDA (YoY) 15.8 22.7 19.3 33.9 23.8 19.8 18.8 15.6Operating profit (YoY) 16.1 23.4 19.0 36.0 24.3 20.1 19.3 16.1Net profit (YoY) 20.1 15.1 17.4 32.7 24.7 19.6 18.5 16.5Core EPS (fully-diluted) (YoY) 19.4 15.1 17.4 32.5 24.6 19.7 18.5 16.5Gross-profit margin 40.5 37.6 34.8 39.5 41.5 42.7 43.2 43.3EBITDA margin 23.8 22.3 20.2 23.8 25.9 26.8 27.7 28.1Operating-profit margin 20.8 19.6 17.7 21.2 23.1 24.0 24.9 25.4Net profit margin 17.9 15.7 14.1 16.4 18.0 18.5 19.1 19.6ROAE 32.0 34.3 34.5 37.6 38.8 38.7 38.7 39.0ROAA 19.3 17.4 15.3 16.7 17.6 17.9 18.9 19.9ROCE 29.0 28.6 25.6 28.6 30.4 31.3 33.5 35.2ROIC 42.2 48.6 46.9 51.8 57.5 59.9 63.1 70.8Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate 13.3 19.2 22.3 26.2 26.5 27.0 27.0 27.0Accounts receivable (days) 18.3 14.2 16.2 17.7 15.8 14.6 14.7 14.8Current ratio (x) 1.7 1.7 1.4 1.9 1.9 1.9 2.0 2.0Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Net dividend payout 90.4 84.6 62.4 68.7 67.4 65.3 80.2 80.1Free cash flow yield 2.7 1.3 1.9 2.0 3.9 2.7 4.8 5.8

Financial summary continued …


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Further diversifying and differentiating its product mix

Want Want’s focus on niche products and differentiation should underpin high operating margins and robust revenue growth for 2014-16 and beyond. Want Want has a diversified mix of packaged food and beverage products, with more than 400 stock-keeping units (SKU) currently, which reduces its reliance on a single product. We expect the company to maintain a balanced revenue split between its beverages and food items over the coming years. For 2014, we forecast rice crackers and other snack foods to account for 23% and 22%, respectively, of its total revenue, and beverages to represent 55%. Within beverages, we forecast the company’s Hot-kid milk (its flavoured milk products) to account for 80% of its beverage revenue this year. Want Want: revenue breakdown by product category (2014E)


Should generate steady revenue growth amid a tough macro climate Want Want’s management targets organic (ie, excluding new product launches) revenue growth by segment for 2014 as follows: 1) a high-single digit percentage YoY increase for rice crackers, 2) high-teen percentage YoY growth for beverages, and 3) low-teen percentage YoY growth for snacks. In addition, management expects new products to account for about 5% of the company’s total revenue for 2014.

We forecast Want Want to generate total revenue growth of 16% YoY for 2014, of which 12% would be from existing products and 4-5% from new products. We forecast total revenue growth of 15% YoY for 2015 and 14% YoY for 2016, supported by the company’s programme of new product launches for this year that we detail further on. Want Want: revenue and revenue growth


We believe the market’s concerns about a likely slowdown in Want Want’s revenue growth for 1H14 due to unfavourable macro headwinds in China (eg, slower consumer spending growth) have been overdone. We forecast revenue growth of 9% YoY for 1H14 but a strong rebound of 21% YoY for 2H14. The key reasons for sluggish 1H14E top-line growth are as follows: 1) most of the orders related to this year’s Lunar New Year (eg. gift packs) took place in 4Q13 (rather than in 1Q14) due to the early Lunar New Year (January), and 2) price hikes put through by the company in its beverage segment in 4Q13 and 1Q14 prompted distributors to stock up on its dairy beverages, thereby contributing to slower sales to its distributors. We expect Want Want’s organic revenue growth for 1H14 to be driven by its product price increases. Also, most of the company’s new product launches planned this year (which we detail further on in this report) will take place in 2Q14 and 3Q14, and hence should drive revenue growth acceleration in 2H14 and also 2015.

Diversified product mix to tap snack and instant food markets

We describe Want Want’s major product categories and its key development strategies for these categories in the following table. Since the company was established in China in the early 1980s, its management has developed several product-development strategies that have proved effective at

Rice crackers22.9%

Dairy products and beverages

54.5%

Snack foods 22.4%

Others0.2%

31.2% 31.3%

14.0% 13.7%15.9% 14.8% 13.9%

0%

10%

20%

30%

40%

0

2,000

4,000

6,000

8,000

2010 2011 2012 2013 2014E 2015E 2016E

Rice crackers Dairy products and beveragesSnack foods OthersYoY (RHS)

(USDm) (YoY)


- 28 -

differentiating the company from its domestic competitors. These have enabled Want Want to develop strong brand power and generate high operating margins, and we expect it to enable Want Want to continue to enjoy these advantages over the coming years, backed by its product strategies that we discuss below.

Want Want’s current product portfolio Product categories Product details Target customer groups Current position Strategy and latest developments Rice crackers Core brand- Want Want (旺旺)

Sweet, savoury, spicy, seaweed flavours, available in various packages

Mid-to-high-end consumers Market leader with about a 70% market share

New flavours and packaging

Gift packs (大禮包) Selection of Want Want branded products (mainly rice crackers) in appealing packaging

Festival gifts Brand enhancement and strong sales during festivals

More promotions and new festival themes, eg, for China’s mid-autumn festival

Sub-brands – Mitailong (米太郎), Yappy (黑皮)

Lower-priced than its core-brands Low-end market 3% of 2013 segmental sales

Raised prices in 2013 to improve profit margins and gain market share in mid-tier markets

Dairy products and beverages Hot-Kid milk (旺仔奶) (Flavoured milk)

Dairy products of various flavours. They contain docosahexenoic acid (DHA), which is widely believed to support healthy brain development.

Children and their parents Market leader with about a 40% market share

More promotions among school children and adults

Others Coffee, yoghurt drinks, herbal tea and other non-carbonated drinks

Children, teenagers and adults

About 10% of its total 2013 beverage sales

Developing new products (eg, functional drinks) and flavours (eg, banana-flavoured milk); JVs with firms offering specific expertise (eg, Natori Co., Ltd and Marubeni Corporation) to strengthen its research and development capability

Snack foods Candies Gummy sweets and milk candies Children and adults One of the leading

brands in soft candy Cross-promotions with its beverages; launches of new flavours

Popsicles and jellies Fruit-flavoured iced-bars; jellies Children and adults Fourth-largest jelly brand in China

New flavours and packages such as 'Rock n Roll' series, cup jellies, liquid-fruit jellies

Ball cakes Snacks made from potato starch, eggs and honey; milk- and sweet-flavoured

Children Launches of new products and flavours

Beans & nuts; biscuits Selected beans and nuts, produced in cooperation with Kobayashi's technology

Children and adults Launches of new products and flavours

Other products Instant food: Rice noodles, oatmeal, etc. New customers Launches during 2014 Targeting health-conscious consumers Plum wine, sake, distilled liquor Export markets Less than 1% of sales

Source: Company, compiled by Daiwa

Capturing a first-mover advantage. Want Want seeks to avoid head-on competition with its peers by developing new products that do not have a major presence in China. This has given the company a significant first-mover advantage for many of its products (its dairy beverages and its new “sip-and-slurp” yoghurts). Thanks to its well-established brand, Want Want is able to defend its market share in the face of price wars by late-comers. According to AC Nielsen, Want Want had domestic market shares of about 70%, 40% and 29% in rice crackers, flavoured dairy beverages and soft candies, respectively, based on revenue for 2013. Eye-catching product packaging. Want Want aims to attract consumers’ attention with new visually appealing package designs for products that are not new consumers. For example, Want Want was among the first few beverage players in China to use soft packaging, with its launches of fruit juices in soft packs in 2009. It then introduced room-temperature yoghurts in soft packs in 2012 and received a very good response from the market for both the above soft pack launches. It plans to expand its soft-pack production

capacity 10-fold this year in order to handle the strong growth in demand. Want Want’s soft-packaging for its yoghurt drinks

Source: Company

Thematic product developments. These include gift packs targeting sales during festival periods, such as the Lunar New Year, which accounts for over 40% of Want Want’s annual sales of rice crackers, based on our estimates. The company’s gift packs contain rice crackers, candies or its other snack foods and are available in different sizes and packaging. Want Want has been able to so far, and in our view should continue


- 29 -

to easily increase its gift pack ASPs and attract new customers each year by adjusting the content and adding its latest products to the packs to promote the new products. In addition, during 1Q14 Want Want launched other thematic and festival products, such as soft candies in large packs (for banquet gifts) and gift boxes of yoghurt drinks. Want Want’s gift pack products

Source: Want Want

2014: an active year for new product launches

Want Want plans to launch more than 50-70 new SKUs in 10 product categories during 2014, which is considerably more than its track record of about 20 new SKU launches a year in 10 product categories on average over the past 5 years. Management targets the company’s new products to account for about 5% of Want Want’s total revenue for 2014, compared to 1-2% a year for the past few years. Management believes the company’s new product launches in 2014 will have an even better success rate compared to past years, as the company has carried out detailed research and upgrades to quality ahead of official launches. Some of the products are developments of its existing and most popular products, such as new rice cracker flavours. We are confident in Want Want’s ability to launch and promote such new products, given its good track record on this front over recent years and ongoing product differentiation from those of its competitors. The next 2 tables that detail the company’s new product line-up for this year show that Want Want maintains a focus on differentiating its new products from those of competitors – either these products have no close substitute in the market at present (eg, its “sip and slurp” fruit juices and yoghurts), or they offer very

different flavours from others (eg, Thai-style genmai-flavoured milk tea). Also, we note that many of its new products are priced at a premium to competitors’ products in the same category, signalling to us that Want Want seeks to continue to avoid price competition and preserve profitability. Want Want’s new beverage product line-up for 2014

Beverage Differentiating features vs. competitors Proposed retail price

Milk tea Thai-style milk tea with a genmai taste CNY4.5/450ml PET bottle

Nectar Mixed fruit juices and vegetable juices targeting children and health-conscious consumers

CNY4.5/250ml PET bottle

O-bubble drinks in PET bottles

Launching these products (previously only available in tetrapaks) in PET bottles to attract new consumers


Room-temperature yoghurts

Produced from imported milk powder and special lactobacillus bacteria

CNY54/16x132g tetrapack

Sports drinks Contain L-carnitine additives to speed up weight reduction


"Sip and slurp" fruit juices

Sorbet if chilled and juice drink if served at room temperature

About CNY2.1/60ml soft pack

Source: Company

Want Want’s new product line-up of snack foods and instant foods for 2014 Product Differentiating features vs. competitors Proposed retail price Q - Rice noodles Target health-conscious consumers CNY7/bowl (106-118g) "Sip and slurp" yoghurts

Ice-cream if chilled and yogurt drink if served at room temperature

CNY2.5/80ml soft pack

Oatmeal New flavours such as chocolate, available in bowl and cup containers

CNY2/35g pack

New packages for candies

For banquets and gift purposes CNY45/300g box

Rice crackers New flavours such as cinnamon and cheese n.a. Baby rice crackers Snacks for babies aged above 6 months CNY20/50g Small-pack mini-rice crackers

Convenience packs targeting children CNY1.8/27g

Source: Company

Examples of Want Want’s new beverage products for 2014: PET-bottled O-bubble, room-temperature yoghurt, sports drink

Source: Company

Examples of Want Want’s new snack food products for 2014: baby snacks, small rice crackers, new flavoured rice crackers

Source: Company


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Strong brand and thus strong pricing power

We believe Want Want will maintain its strong pricing power, supported by its high brand recognition, good execution record for product launches, cost control, and well-established sales network.

Strong pricing power supported by brand and product mix

A brand that is easy to remember and recognise More than 20 years on from Want Want’s establishment in China, both its core brand, Want Want (“旺旺”) and its Hot-Kid flavoured milk drink logo have become very popular with Chinese consumers. Want Want means prosperity and good fortune in Chinese. This auspicious association means Want Want’s products are easily remembered by customers, and make them popular gift items for adults and children. This branding also helps to boost the company’s sales during traditional Chinese festivals such as the Lunar New Year. Children are an important customer group for Want Want, which targets many of its products and tastes, such as sweet milk beverages, candies etc., to the children’s market. Want Want's brand portfolio (selected sub-brands) and Hot-Kid logo

Source: Company

Strong track record of pricing power Over recent years, Want Want has consistently been able to raise its prices during periods when raw-material costs have increased. In the following table we show the company’s ex-factory price increases implemented since 2009, based on data from the company’s annual reports and our estimates. By virtue of its ability to raise prices, the company’s gross margin has ranged from 38-41% over the past 10 years (except in 2011), a higher level compared to most food and beverage players listed in Hong Kong. Want Want: YoY price hikes in its segments and raw-material cost trends (2009-1Q14)

Rice crackers Beverages Snack foods

General raw-material cost trend in the year (YoY )

2009 Up 11% n.a. n.a. Packaging, milk powder, sugar, rice: up 5-6%, 10%, 2.5% and 20%, respectively

2010 Up 1% and 9% for core brand and gift packs, respectively

Up 1-2% on average

n.a. Packaging, milk powder, sugar, rice: flat, up 7%, 45% and 19%, respectively

2011 2H11: up 8% Up 4% on average

Up 11% in aggregate

Packaging, milk powder, sugar, rice: up 7-8%, 10%, 35% and 15%, respectively

2012 Up a mid-single-digit percentage

Up 7% Up 10% Packaging, milk powder, sugar, rice: -3%, -3%, -10% and flat, respectively

2013 Rises for non-core brands

Oct: up 8% None Milk powder cost up 50% YoY

2014 n.a. 1Q14: up 3%

None

Source: Company, Daiwa estimates for cost changes

We expect the company’s price increases in beverages put through in 4Q13 and 1Q14, along with new product launches, and declining costs for some of its some raw materials, to bring about further gross margin expansion to 42.7% for 2014, 43.2% for 2015 and 43.3% for 2016, compared with 41.5% recorded for 2013. Want Want: gross margin trend by product


34.8

39.5

41.542.7 43.2

43.3

30

35

40

45

2011 2012 2013 2014E 2015E 2016ERice crackers Beverage Snacks Average


- 31 -

Good cost control and penetration of retail channels

Our research shows that Want Want spends less than its China packaged food and beverage peers on direct advertising and on-site promotions. Based on our estimates, Want Want spends 3-4% of its annual advertising and promotional (A&P), compared to more than 6% on average for its peers. We believe this can be attributed to the company’s efficient cost control. As a result, Want Want has generated a higher operating margin annually (above 20%) compared with its major peers (3-15%) since 2011, and we expect its operating margin to remain above those of its peers for 2014-16, as the next chart shows. Also, our research indicates that Want Want generally has better control over distributors in terms of price control, inventory management and new product promotions. Want Want vs. other major China F&B players: operating margin comparison


Note: Tingyi = Tingyi Cayman Islands, UPCH = Uni-President China

Want Want has continued to improve its distribution network since its establishment in the early 1990s, notably through the following: 1) enhancing its services and connections with points of sale (POS), such as stepping up the frequency of visits by its sales personnel to retail channels, and 2) expanding its penetration into rural areas. Like most large food and beverage brands, Want Want depends on distributors to sell its products and get a national presence. At the same time, it continues to improve its penetration and network management; the subsequent table shows the history and statistics associated with Want Want’s distribution network. The company’s 13,000 sales representatives (2012 data) frequently visit retailers served by the distributors, taking orders and promoting new products to the retailers directly. The distributors manage inventory levels and provide logistics services.

Building and maintaining close and direct relationships with its distributors and key retailers is important for Want Want to compete effectively in order to secure shelf space and better product displays at the POS, in particular for traditional retail channels, which account for 85-90% of its total revenue. Many traditional channel POS are standalone stores or small-scale chain stores run by individuals. In our view, they welcome the support and advice they receive from a large supplier like Want Want, on how and what to promote in their stores in order to enhance their revenue. Want Want: Paradise and product stacks at a POS

Source: Company

8.1% 8.4%

6.7% 7.5% 8.

6% 9.2%

1.5%

4.1%

2.0% 2.4% 3.

7% 4.2%

17.7

% 21.2

% 23.1

%

24.0

%

24.9

%

25.4

%

0%

5%

10%

15%

20%

25%

30%

2011 2012 2013 2014E 2015E 2016E

Tingyi UPCH Want Want


- 32 -

Development history of Want Want’s distribution network

Year Achievements Direct-

delivery POS

Product display at

POS

Jun Dec

2007 The "Delivering Want Want to villages" programme kicked off

n.a. n.a. n.a.

2008 Obtained direct control of 1m+ POS through the "Delivering Want Want to villages" programme

2009 SAP system installed fully in sales and production systems

Consolidation of distribution channels in first-tier and second-tier cities to clear up overlap issues and price competition among distributors

Number of county-level cities covered by "Delivering Want Want to villages" programme reaches 1,500+

2010

Use of "Want Want Paradise”, "National Pillar Display" and other eye-catching marketing decorations and product stacks in large POS. Different seasonal themes used throughout the year to promote products

300

2011 Expansion of direct deliveries to county-level POS and urban POS

400 ~50

Set-up of on-site promotion counters

Enhanced product portfolio and sales force to ensure products at POS occupy eye-catching shelf space in stores across the nation throughout the year

2012 Upgrades done for distributors by setting up several standards for quality verification

600 71 158

Built an direct-sales initiatives in treating small and medium POS

2013

The sales network was sub-divided into over 2,800 sales regions (mainly county-level cities with populations of over 500k each). Aside from promoting existing strong products, such as rice crackers and Hot-kid Milk, sales start to focus on improving the sales performance of less popular products (eg, snacks) and new products (eg, the banana beverage).

Detailed sales information analysis and sales representative team support are given at each sales region. Want Want encourages distributors to develop more sub-distributors to enhance its presence in retail channels.

SKUs were sub-divided into 10 categories (from 3 previously) for more detailed management of each category.

Above changes focus on currently weak items (in terms of sales), such as selected snacks and pocket drinks

A Sales Force Assessment System (SFA) was set up to provide more efficient, high-frequency services to distributors and to provide timely information. All sales personnel were equipped with hand-held devices to deliver timely information and for promotions of products to obtain better shelf space at POS.

Source: Company, compiled by Daiwa

Increased A&P spending for modern retail channels not a major concern to us Want Want believes its extensive product portfolio can help it to penetrate the modern retail channels (eg, hypermarkets, supermarkets and convenience stores) more quickly. Currently, its ice cracker product depends more on modern channels (20% of revenue) than other segments. Retailers in the modern channels usually incur higher A&P and channel expenses, such as product display fees, entry fees for new products, etc. However, we expect Want Want’s A&P budget to be contained at its past-9-year range of 3-4% of revenue, by: 1) re-allocating some of its A&P budget from existing to new products and from traditional retail channels to modern ones, and 2) absorbing the extra costs through enhanced operating leverage. Since 2012, management has aimed to boost sales per POS, rather than just increase the number of POS, through more advertising, product stacks and well-planned promotional activities at the POS. This should help Want Want control fixed costs (sales personnel) and enhance efficiency. Leverage on existing facilities for new products Want Want aims to generate a high gross margin (more than 40%) on its new products. Though the company already has over 350 SKUs in hand, it still has considerable room for new product development by, for example, adding new flavours to existing categories (eg, rice crackers or beverages) or launching completely new items. Making use of its existing facilities and its production units designed and constructed in-house to develop new products should enable Want Want to maintain both an elevated net margin and ROE over 2014-16, as has been the case in past years, in our view (demonstrated in the following chart). Want Want: trend in ROE and net margin (%)


32.0%34.3% 34.5%

37.6% 38.8% 38.7% 38.7% 39.0%

0%

5%

10%

15%

20%

25%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2009 2010 2011 2012 2013 2014E 2015E 2016E

ROE (LHS) Net margin (RHS)


- 33 -

Financial analysis

We forecast net profit growth of 20% YoY for 2014, 19% YoY for 2015 and 17% YoY for 2016, to USD820m, USD972m and USD1.13bn, respectively. We forecast Want Want to generate robust net profit growth of 20% YoY for 2014, 19% YoY for 2015 and 17% YoY for 2016, driven mainly by: 1) revenue growth of 16% YoY for 2013, 15% YoY for 2014 and 14% for 2015, and 2) operating margin expansion of 0.9pp/0.9pp YoY for 2014 and 2015, respectively, thanks to higher gross margins supported by new products in all its segments, and by price increases in its beverage segment. Want Want: reported net profit and YoY growth (USDm)


Diversified cost structure Due to the numerous types of products and packaging it produces, Want Want uses more than 10 kinds of major raw materials. Except for packaging and milk powder, no one raw material accounts for more than 20% of its COGS; hence fluctuations in individual commodity prices only have a mild impact on its earnings.

Want Want: breakdown of cost of goods sold

Source: Daiwa estimates

Costs of most of the company’s raw materials have been steady or on a slight downward trend since the beginning 2013, except for milk powder. As a result of the raw milk supply shortage in China and short-term supply disruption in New Zealand, international milk powder prices rose by more than 48% YoY in 2013, according to data from New Zealand’s Fonterra (FCG NZ, unrated). As Want Want usually keeps 6 months of milk powder inventory (including those in shipment), and due to its effective use of low-cost inventory and practice of making bulk purchases during periods when the milk powder price is low, we estimate that the unit cost increase for Want Want was 5% YoY in 2013, and look for a further 10-15% rise in 1H14, before a fall starting from 2H14. In particular, Want Want already raised the ASP of its dairy beverages by 8% in 4Q13, and by a further 3% in 1Q14. We believe these increases are more than enough to offset a likely sharp rise in costs, as our sensitivity analysis that follows shows that a 1% ASP increase could enhance the company’s 2014E net profit by about 2% relative to our current forecast. Our sensitivity analysis also indicates limited earnings sensitivity to fluctuations in raw material prices. It indicates that a 1% rise in the unit costs of milk powder, sugar and packaging would only reduce Want Want’s 2014E net profit by 0.5%, 0.1% and 0.7%, respectively, relative to our current forecasts. A 1% rise in the ASP of its rice crackers, beverages and snack foods would imply respective 2014E net profit uplifts of 0.9%, 1.9% and 0.8% relative to our current forecasts.

17%

33%

25%

20% 19%17%

0%

5%

10%

15%

20%

25%

30%

35%

0

200

400

600

800

1,000

1,200

2011 2012 2013 2014E 2015E 2016E

Net profit YoY

Packaging25.6%

Milk powder17.2%

Sugar15.3%

Rice4.3%

Palm oil1.6%

Other raw materials

(starch, flour etc)

16.6%

Depreciation3.0%

Employee expenses

9.7%

Utility3.2%

Others3.6%


- 34 -

Want Want: Daiwa sensitivity analysis of gross margin and net profit to ASP increases Gross margin (%) Net profit (USDm) 2014E 2015E 2014E 2015EBase case 42.7 43.2 823 974 Impact +/- pp +/- % 1% increase in ASP for: 2014E 2015E 2014E 2015EPackaging -0.16 -0.16 (0.68) (0.66)Milk powder -0.11 -0.11 (0.46) (0.48)Sugar -0.07 -0.07 (0.11) (0.10)Rice -0.03 -0.03 (0.30) (0.28)ASP hike Rice crackers 0.14 0.13 0.89 0.83 Beverages 0.32 0.33 1.89 1.94 Snack foods 0.12 0.12 0.80 0.76

Source: Daiwa estimates

We believe declining imported milk powder costs will lift Want Want’s gross margin from 2H14 onwards. As shown below, global whole-milk powder prices dropped by 17% YoY in May 2014, according to Global Dairy Trade. Thanks to an abundant global supply of milk powder, we expect imported milk powder prices to continue to decline in 2H14 and 2015, providing a strong cushion for the company’s profit margin in case costs of its other items rise sharply in 2015. Whole milk powder price: China imports and global prices

Source: Global Dairy Trade, China Customs

On operating costs, we forecast the ratio of selling costs to revenue to come down gradually to 11.8% in 2015, from our forecast of 12.3% for 2014 and 11.9% reported for 2013. In our view, the channel restructuring and product display enhancement Want Want completed at its POS in 2013 will bear fruit in 2014 and bring about positive operating leverage.

Want Want: operating margin and selling costs/revenue ratio


Want Want’s cash-generating capability is strong due to its high operating margin and ROE. As such, we forecast operating cash flow of USD932m for 2014, rising to USD1.09bn for 2015 and USD1.26bn for 2016. The company targets to distribute all of its free cash flow (net operating cash flow minus capex) as dividends. We believe this will translate into a payout ratio of 65% in 2014E. We forecast an increase in the payout ratio to 80% for each of 2015 and 2016, as we project rising operating cash flow and stable capex needs. Want Want: DPS and net cash position


Although Want Want is in a strong net cash position, it issued senior debt notes worth USD600m in May 2013 at a coupon rate of 1.875% per year. The notes will mature in 5 years. We believe these notes will help the company to contain the level of its financial costs over 2014-16. Want Want bought back some of its shares in January and May this year when its share price was between HKD10.40 and HKD11. It has bought back 31m shares in aggregate since June 2013, 27m this year-to-date. We believe it will carry out further share buybacks if its share price should weaken further, given its strong net cash position.

0

1,000

2,000

3,000

4,000

5,000

6,000

Jan-

09

Apr-0

9

Jul-0

9

Oct

-09

Jan-

10

Apr-1

0

Jul-1

0

Oct

-10

Jan-

11

Apr-1

1

Jul-1

1

Oct

-11

Jan-

12

Apr-1

2

Jul-1

2

Oct

-12

Jan-

13

Apr-1

3

Jul-1

3

Oct

-13

Jan-

14

Apr-1

4

China import Global Dairy Trade

(USD/tonne)

19.6%17.7%

21.2%23.1% 24.0% 24.9% 25.4%

0%

5%

10%

15%

20%

25%

30%

10.6%

10.8%

11.0%

11.2%

11.4%

11.6%

11.8%

12.0%

12.2%

12.4%

12.6%

2010 2011 2012 2013 2014E 2015E 2016E

S&D ratio (LHS) Operating margin (RHS)

0.0226 0.0196

0.0286 0.0348

0.0405

0.0590

0.0687

0

300

600

900

1,200

1,500

1,800

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

2010 2011 2012 2013 2014E 2015E 2016E

DPS (LHS) Net cash (RHS)

(USDm)(USD)


- 35 -

Valuation

We initiate coverage with a Buy (1) rating and target price of HKD13, based on a 24.6x PER applied to the average of our 2014 and 2015 EPS forecasts. Our target price implies 27% upside from the current share price. We believe PER is a suitable methodology to value Want Want given its profile as a downstream food and beverage company, with what we regard as good earnings visibility and stability. To value Want Want, we use the average of our 2014-15 EPS forecasts and assign a target PER of 24.6x, which is in line with the stock’s past-5-year average 12-month forward trading PER. Our target PER corresponds to a 21% premium to the major China food and beverage companies’ average 2015E PER at current share prices, of 20.3x (based on our and the Bloomberg consensus EPS forecasts). In our view, this premium is justified by Want Want’s: 1) quality earnings growth record of consistent double-digit YoY EPS growth since its IPO that we expect it to maintain over 2014-16, 2) higher-than-peers ROE and operating margin for 2014E, and 3) high payout ratio (past-5-year average of 74%) that we expect it to maintain over 2014-16. Trading currently at a PER of 17.9x (based on our EPS forecast), Want Want’s valuation looks attractive compared with other large-cap China food and

beverage companies, such as Tingyi (322 HK, HKD21.05, Outperform [2]). Want Want is also trading at a discount to its past-5-year PER average, due we believe to investor concerns about a slowdown in revenue growth in 1H14. We believe such concerns are unwarranted, as 1) a slowdown in revenue growth that we expect for 1H14 (we forecast growth of 9% YoY) should be compensated by a strong 21% YoY pick-up for 2H14, driven by the new products that are being rolled out in 2Q14 and 3Q14, and 2) we expect net profit for 2014 to be driven by 0.9pp YoY operating margin expansion. Want Want: 2012-13 revenue and earnings and Daiwa forecasts vs. Bloomberg consensus

2012 2013 2014E 2015E 2016ERevenue (USDm) 3,359 3,818 4,425 5,078 5,782 YoY growth (%) 14 14 16% 15% 14% vs. consensus (%) n.a. n.a. 0.4% -0.4% 0.1%Net profit (USDm) 550 686 820 972 1,133 YoY growth (%) n.a. n.a. 20% 19% 17% vs. consensus (%) 32 24 6.3% 8.5% 11.9%EPS (USD) 0.042 0.052 0.0621 0.0736 0.0858 YoY growth (%) n.a. n.a. 20% 19% 17% vs. consensus (%) 33 23 5.2% 8.2% 14.3%

Source: Company, Bloomberg, Daiwa forecasts

Want Want: 12-month forward PER bands

Source: Bloomberg

Want Want and peers: valuation comparison Bloomberg Mkt.Cap. Price Stock Δ % PER (x) EPS Growth (%) EV/EBITDA (x) Revenue Growth (%) EBIT margin (%) ROE(%)

Name Code Rating USDm 6/23/14 3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E

Major China Food and beverage players Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 average except Want Want China 29.2 26.1 20.3 17.1 (4) 14 26 14 11.9 9.7 16 19 15 6.8 10.1 10.9 13.8

Source: Bloomberg, *Daiwa estimates

2

4

6

8

10

12

14

Feb-

09

May

-09

Aug-

09

Nov

-09

Feb-

10

May

-10

Aug-

10

Nov

-10

Feb-

11

May

-11

Aug-

11

Nov

-11

Feb-

12

May

-12

Aug-

12

Nov

-12

Feb-

13

May

-13

Aug-

13

Nov

-13

Feb-

14

May

-14

151.HK 14x 18x

22x 26x 30x


- 36 -

Investment risks

Food safety issues This constitutes the main risk to our positive investment case on Want Want. Food safety hazards, or talk in the market about perceived food safety issues with the company’s products, could have an adverse effect on the company’s sales volume and take it sales below our forecasts. For instance, on October 2008 the Government of Slovakia said it found melamine levels in some of Want Want’s products of a concentration that exceeded the EU’s maximum standard. However, Want Want has never exported or marketed its Hot-Kid flavoured milk products in Slovakia, so we are not sure whether the above products were Want Want’s or illegal exports that were not checked by the authorities. China’s General Administration of Quality Supervision, Inspection and Quarantine and the authorities in Want Want’s export markets have declared its products to be in compliance with the applicable requirements. Given this incident, if similar cases were to occur in the future, and whether or not Want Want were responsible, might undermine the company’s sales volume and brand value. Commodity price rises Want Want has a diversified cost structure and is therefore less sensitive to the volatility of costs for a single item than its packaged food and beverage China peers. However, a rebound in raw-material costs, which could be driven by supply disruptions, foreign exchange fluctuations or significant rises in production costs (eg, oil or energy costs), would have an adverse impact on Want Want’s gross margin if a wide variety of commodities were affected.

Competition Want Want faced fierce competition in the rice cracker segment from 2000 to 2004, which led to market share erosion for its core rice cracker brand as a result of the ensuing price war from low-end products. As Want Want’s production costs are now much higher, and the public in general is more aware of brand and food safety issues, we believe a similar price war is less likely going forward. Still, the company faces continuous competition as more substitutes become available and new competitors enter the market, which could translate into pricing pressure and a decline in its market share in the future. Ageing of its brand Want Want has always used TV advertising as its main promotional medium. In our view, however, its TV ads today are still similar to those it aired in the 1980s. As such, its brand position may be weakened if its competitors come out with more innovative and stylish advertising to boost short-term sales growth (in the long run, we believe continuous and sustainable growth is dependent on product quality and customer loyalty.


- 37 -

Company background Want Want started producing rice crackers in 1983 in Taiwan, after the chairman collaborated with Iwatsuka Confectionery (Not rated), a leading Japanese producer of rice crackers. Want Want began selling rice crackers in China in 1992, making it one of the pioneers in introducing these products to the China market. Want Want subsequently entered the beverage and snack food market in the Greater China region in the late 1990s, expanding its geographical coverage and distribution network. As at December 2012, Want Want had 365 sales offices and 96 factories throughout China. About 85-90% of Want Want’s sales are generated through its 8,000 distributors, with the remaining sales derived from the modern channels and e-commerce. Distributors mainly provide logistics services and watch for over-stocking in the channels. Want Want was listed on the Singapore Stock Exchange from 1996 to 2007 then was delisted in 2007. It was subsequently listed via an IPO on the Hong Kong Stock Exchange in 2008. Iwatsuka has remained a strategic investor in Want Want since it was listed in Singapore. Since June 2013, Want Want bought back about 31m shares at a price of between HKD9.63 and HKD11. Want Want: current shareholding structure

Source: Company

Public Tsai Eng-meng

Want Want China

(151.HK)

Rice crackersDairy and

other beverages

Snacks Others

Iwatsuka (2221.JP)

48%47.3% 4.7%


■ Investment case We initiate coverage of Tingyi Cayman Islands (Tingyi), the largest instant noodles, bottled tea and bottled water brand in China, with an Outperform (2) rating. After a year or so of aggressive promotional activity in the noodles segment, which led to declining margins, we expect Tingyi to stage a recovery in 2015 and regain market share in this segment over 2015-16E. This, coupled with a further enhancement of the operational efficiency of the Pepsi unit, should drive a further re-rating of the shares over the next 6-12 months. Noodles segment: the strongest becomes stronger. We estimate that Tingyi’s noodles revenue is at least 3x that of the second player in China. This gives it much greater financial resources to carry out

short-term aggressive promotions on selected products to squeeze out competitors yet maintain its segment’s profitability. We forecast the company’s noodles’ operating margin to trough in 2014 at 11.2%, and gradually expand from 2015 onwards as it regains pricing power. We look for Tingyi’s market share in this segment to reach 60% in 3 years, up from 56% in 2013. Pepsi – from a drag to a contributor: Pepsi China’s bottling operation reached break-even at the net profit level in 2013 following a cost-reduction push. We expect unit output increases for the Pepsi unit, coupled with Tingyi’s emerging scale in bottled water and its other beverage activities, to lift its beverage operating margin from 3.2% in 2013 to 4.7-6.6% in 2014-16E, respectively. ■ Catalysts In our view, continuous market-share gains for the noodles segment and further cost reductions for the Pepsi unit will drive up Tingyi’s share price and earnings over the next 2 years. ■ Valuation Our 6-month target price of HKD22.9 is based on the average of our 2014-15E EPS and a 27x PER, in

line with the stock’s past-5-year 12-month forward average PER. ■ Risks The major risks we see are food safety issues and further profit margin erosion due to increases in promotional costs.


25 June 2014

Tingyi Cayman Islands

Initiation: widening its lead

• With its competitive pricing strategy and effective promotions, Tingyi looks poised to pull further ahead of its peers

• Its product diversification and strong scale advantages in both beverages and noodles deserve a premium valuation

• Initiating with an Outperform (2) rating and target price of HKD22.90, based on 27x PER



Tingyi Cayman Islands322 HK

Target (HKD): 22.90Upside: 8.8%23 Jun price (HKD): 21.05

BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5

84

89

95

100

105

18

19

21

22

24



Tingyi Hdg (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 18.38-23.30Market cap (USDbn) 15.193m avg daily turnover (USDm) 10.48Shares outstanding (m) 5,594Major shareholder Wei Ing-chou (36.9%)

Financial summary (USD)Year to 31 Dec 14E 15E 16ERevenue (m) 12,548 13,850 15,298Operating profit (m) 943 1,188 1,400Net profit (m) 527 688 784Core EPS (fully-diluted) 0.094 0.123 0.140EPS change (%) 33.6 30.7 13.9Daiwa vs Cons. EPS (%) (0.9) 6.9 4.5PER (x) 28.9 22.1 19.4Dividend yield (%) 1.7 2.3 2.6DPS 0.047 0.062 0.070PBR (x) 4.7 4.2 3.7EV/EBITDA (x) 11.9 9.6 8.1ROE (%) 17.3 20.1 20.3

Anson Chan(852) 2532 4350

[email protected]




- 39 -

Growth outlook Tingyi: net profit YoY growth and breakdown

We expect Tingyi’s instant noodles segment to account for 72-75% of its net profit over 2014-16E. We look for net profit growth for instant noodles to accelerate from 5% YoY in 2013 to 18% YoY for 2014, 24% YoY for 2015 and 13% YoY for 2016, as the operating margin should expand gradually as promotional activity slows, market share likely increases, and new products are launched. With the Pepsi unit having turned around in 2013, we expect the beverage business to become the key earnings growth engine for Tingyi, with the segment’s net profit rising by 93% YoY, 39% YoY and 21% YoY for 2014E, 2015E and 2016E, respectively. We forecast Tingyi’s total recurring net profit growth to accelerate to 34% YoY, 31% YoY and 14% YoY over 2014-16E, respectively, up from -3% YoY for 2012 and 7% YoY for 2013.


Valuation Tingyi: historical 12M-forward PER bands

Over the past 5 years, Tingyi has traded at an average 12-month forward PER of 27x, based on the Bloomberg consensus data. The stock has traded at a premium to its China food and beverage peers over the same period due to its strong scale advantage, No.1 market share in a number of sub-segments, and cost-control capability. It is now trading at a PER of 28.9x for 2014E and 22.1x for 2015E, based on our EPS forecasts. We expect Tingyi to rerate further if it successfully expands its noodles market share to protect its pricing power and profit margins, and further enhances the operational efficiency of the Pepsi unit.

Source: Bloomberg

Earnings revisions Tingyi: consensus EPS

The Bloomberg consensus has revised down its 2014-15E EPS continuously since the beginning of 2013, as the gross margin for Tingyi’s noodles business continued to deteriorate. However, the consensus numbers have turned slightly more positive since Tingyi’s 1Q14 results announcement in late-May. We expect the consensus to turn more positive on Tingyi’s operating margin upon the successful launch of new products and as its production scale for beverages and noodles expands further. Our 2014-15E EPS are 1% below and 7% above the consensus figures, respectively (the 2015E variance is likely due to our higher noodle operating-margin forecast). Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

0.0%

11.9%

-2.9%

6.7%

33.7%30.7%

13.9%

(20%)

0%

20%

40%

(500)

0

500

1,000

2010 2011 2012 2013 2014E 2015E 2016E

Others (LHS) Beverages (LHS)

Noodles (LHS) Recurring profit growth YoY % (RHS)

5

10

15

20

25

30

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

(x)

322.HK 17 21 25 29 33

0.080

0.100

0.120

0.140

0.160

0.180

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14

2014E 2015E

(USD)

BuyOutperform (initiation)

HoldUnderperformSell

1

2

3

4

5


- 40 -

Key assumptions

Profit and loss (USDm)

Cash flow (USDm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales growth YoY - instant noodles 10.7 27.0 22.5 10.2 9.4 10.5 9.0 9.1Sales growth YoY - beverages 32.1 38.9 13.2 23.3 27.1 17.3 11.6 11.5Gross margin % - instant noodles 31.5 28.8 27.2 30.0 29.2 29.2 29.5 29.9Gross margin % - beverages 36.9 28.5 25.7 29.6 30.8 32.2 32.3 32.6

Sellling and distribution expense ratio (%)

0.0 16.8 16.8 20.3 21.1 20.9 19.9 20.0

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EInstant noodles 2,308 2,932 3,592 3,960 4,332 4,788 5,221 5,695Beverage 2,542 3,532 3,999 4,931 6,268 7,355 8,208 9,154Other Revenue 232 218 266 321 341 406 421 449Total Revenue 5,081 6,681 7,857 9,212 10,941 12,548 13,850 15,298Other income 80 46 131 255 201 133 125 163COGS (3,322) (4,782) (5,770) (6,457) (7,631) (8,629) (9,502) (10,438)SG&A (1,129) (1,247) (1,512) (2,164) (2,663) (3,029) (3,205) (3,543)Other op.expenses (82) (92) (73) (75) (118) (80) (80) (80)Operating profit 628 606 633 771 730 943 1,188 1,400Net-interest inc./(exp.) (13) (7) (9) (33) (37) (55) (30) (30)Assoc/forex/extraord./others 10 147 39 94 30 11 11 11Pre-tax profit 625 747 663 832 723 899 1,169 1,381Tax (125) (134) (163) (228) (229) (252) (316) (373)Min. int./pref. div./others (117) (136) (80) (145) (86) (121) (165) (224)Net profit (reported) 383 477 420 460 409 527 688 784Net profit (adjusted) 383 340 380 369 394 527 688 784EPS (reported)(USD) 0.069 0.085 0.075 0.082 0.073 0.094 0.123 0.140EPS (adjusted)(USD) 0.069 0.061 0.068 0.066 0.070 0.094 0.123 0.140EPS (adjusted fully-diluted)(USD) 0.069 0.061 0.068 0.066 0.070 0.094 0.123 0.140DPS (USD) 0.034 0.043 0.038 0.032 0.035 0.047 0.062 0.070EBIT 628 606 633 771 730 943 1,188 1,400EBITDA 833 810 911 1,092 1,118 1,396 1,680 1,927

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 625 747 663 832 723 899 1,169 1,381Depreciation and amortisation 205 203 278 321 388 452 492 527Tax paid (56) (96) (130) (138) 386 (223) (225) (281)Change in working capital 141 215 464 (158) 273 284 224 201Other operational CF items (4) (9) 4 25 18 42 18 19Cash flow from operations 911 1,059 1,279 882 1,788 1,455 1,678 1,847Capex (507) (966) (1,349) (882) (896) (700) (700) (700)Net (acquisitions)/disposals 0 0 0 0 0 0 0 0Other investing CF items 0 0 0 0 0 0 0 0Cash flow from investing (507) (966) (1,349) (882) (896) (700) (700) (700)Change in debt (232) 299 616 234 192 (915) 0 0Net share issues/(repurchases) 0 0 0 0 0 0 0 0Dividends paid (130) (192) (239) (210) (180) (197) (263) (344)Other financing CF items 44 93 (36) (85) 57 (100) (93) (117)Cash flow from financing (318) 201 341 (61) 69 (1,212) (357) (461)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 86 294 271 (60) 961 (457) 621 686Free cash flow 404 94 (70) 1 892 755 978 1,147

Financial summary


- 41 -

Balance sheet (USDm)

Key ratios (%)


Company profile

Tingyi Cayman Islands (Tingyi) is the world’s largest producer of largest instant noodles, and has a leading 56.4% market share in China (in terms of revenue for 2013). The company’s beverage unit, owned jointly with Pepsi and Asahi Group, has shares of 52%, 26% and 24% of the China markets for ready-to-drink (RTD) tea, juice drinks and bottled water, respectively, by revenue, for 2013.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 520 893 600 838 1,250 391 970 1,652Inventory 213 310 313 478 481 544 599 658Accounts receivable 116 128 155 233 260 293 317 343Other current assets 176 357 368 419 419 419 419 419Total current assets 1,025 1,688 1,436 1,968 2,410 1,647 2,304 3,071Fixed assets 2,217 2,923 4,030 5,002 5,485 6,082 6,263 6,408Goodwill & intangibles 7 0 0 29 28 28 28 28Other non-current assets 159 281 343 474 501 501 501 501Total assets 3,408 4,891 5,809 7,473 8,424 8,258 9,096 10,009Short-term debt 218 457 701 500 1,017 102 102 102Accounts payable 622 1,084 974 1,043 1,252 1,415 1,559 1,712Other current liabilities 468 687 753 1,252 1,357 1,513 1,649 1,796Total current liabilities 1,308 2,228 2,428 2,795 3,625 3,030 3,310 3,610Long-term debt 117 177 549 985 660 660 660 660Other non-current liabilities 74 117 145 197 213 239 274 313Total liabilities 1,499 2,522 3,123 3,976 4,498 3,929 4,243 4,582Share capital 27 27 28 28 28 28 28 28Reserves/R.E./others 1,435 1,794 2,072 2,523 2,852 3,182 3,607 4,047Shareholders' equity 1,463 1,821 2,100 2,551 2,880 3,210 3,635 4,075Minority interests 446 548 587 946 1,046 1,118 1,217 1,351Total equity & liabilities 3,408 4,891 5,809 7,473 8,424 8,258 9,096 10,009EV 15,392 15,482 16,429 16,701 16,556 16,572 16,093 15,545Net debt/(cash) (185) (259) 650 647 426 370 (208) (890)BVPS (USD) 0.262 0.326 0.376 0.457 0.515 0.574 0.650 0.728

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) 18.9 31.5 17.6 17.2 18.8 14.7 10.4 10.5EBITDA (YoY) 33.1 (2.8) 12.5 19.9 2.3 24.9 20.4 14.7Operating profit (YoY) 32.1 (3.5) 4.4 21.8 (5.3) 29.2 26.0 17.9Net profit (YoY) 47.2 (11.3) 11.9 (2.9) 6.7 33.7 30.7 13.9Core EPS (fully-diluted) (YoY) 47.2 (11.3) 11.9 (2.9) 6.6 33.6 30.7 13.9Gross-profit margin 34.6 28.4 26.6 29.9 30.3 31.2 31.4 31.8EBITDA margin 16.4 12.1 11.6 11.9 10.2 11.1 12.1 12.6Operating-profit margin 12.4 9.1 8.1 8.4 6.7 7.5 8.6 9.2Net profit margin 7.5 5.1 4.8 4.0 3.6 4.2 5.0 5.1ROAE 28.7 20.7 19.4 15.9 14.5 17.3 20.1 20.3ROAA 12.0 8.2 7.1 5.6 5.0 6.3 7.9 8.2ROCE 28.9 23.1 18.2 17.3 13.8 17.6 22.2 23.7ROIC 29.2 26.0 17.5 15.0 11.7 15.0 18.6 22.3Net debt to equity net cash net cash 31.0 25.3 14.8 11.5 net cash net cashEffective tax rate 19.9 18.0 24.6 27.4 31.6 28.0 27.0 27.0Accounts receivable (days) 8.8 6.6 6.6 7.7 8.2 8.0 8.0 7.9Current ratio (x) 0.8 0.8 0.6 0.7 0.7 0.5 0.7 0.9Net interest cover (x) 49.7 93.1 67.6 23.6 19.5 17.2 39.0 46.0Net dividend payout 50.0 50.0 50.0 39.2 48.2 50.0 50.0 50.0Free cash flow yield 2.7 0.6 n.a. 0.0 5.9 5.0 6.4 7.5



- 42 -

Noodles – the strongest becomes even stronger

We expect Tingyi’s operating margin to recover slightly YoY in 2014E and resume its expansion from 2015E onwards, as the company’s pricing power and market share improve.

More market share, more pricing power

Tingyi has one of the largest sales networks in China (110,000 direct distributors as of end-2013), giving it a substantial competitive advantage in terms of new product penetration and a sound platform for its promotional efforts (using discounts and ham sausage gifts for selected products only). The company is the largest instant noodles, bottled tea and bottled water brand in China, with market shares of with 56%, 52% and 24%, respectively, in 2013, according to AC Nielsen. Tingyi targets to reach a 60% total market share in China by: 1) cementing its leadership in roast-beef flavoured and spicy beef flavoured noodles, in which it has dominant market shares (more than 80%), by advertising and building a young and trendy image among young consumers, and 2) continuing with its consumer promotional activities to gain market share in the sub-categories that it does not dominate (eg, spicy pickled vegetables, braised meat, etc.). As shown in the table below, in 2013, Tingyi was the No.2 brand in 3 of the top-4 flavours of instant noodles in China, based on comments from Tingyi’s management, AC Nielsen’s data and our estimates. Tingyi: position in the major flavours of noodles in China

Rank Flavour Category’s share

in total market Tingyi's segmental

share in 2013 (%)1 Roast beef 紅燒牛肉 20 90

2 Spicy pickled vegetable & beef 老坛酸菜牛肉 ~15% 45

3 Spicy beef 香辡牛肉 ~15% 80

4 Braised meat 卤肉 <5% 50

Source: Company’s management comments, AC Nielsen, Daiwa

By achieving market shares of more than 70% in all 4 major instant noodle flavours, Tingyi’s pricing power and economies of scale should improve further over our forecast horizon, on our estimates. By 2015, we believe Tingyi could consider reducing the use of discounts and free sausage gifts.

Scale advantages to suppress competitors

As discussed in the industry section of this report, revenue growth in the noodles market has slowed significantly since the end of 2012 in terms of value. As competition has intensified, both Tingyi and rival Uni-President China (UPCH) have aggressively promoted their new products by giving away free sausages and offering price discounts, in particular for the new Laotan flavour, first launched by UPCH in 2009 and then by Tingyi in 2011. That said, the impact of such promotions on gross margins and operating margins has been much less for Tingyi than for UPCH, because in Tingyi’s case, the profit contributions from its other products have been enough to cover the expenses related to promoting Laotan. We estimate that Laotan accounted for less than 15% of Tingyi’s noodles sales in 2013, versus more than 60% for UPCH. As a result, Tingyi’s operating margin is still much higher than UPCH’s. Tingyi vs. UPCH: noodles operating margin and revenue comparison


Pricing and promotions gradually being scaled back As most of Tingyi’s domestic competitors are either losing market share or under significant profit margin (and hence financial) pressure at present, they will not be able to sustain expensive promotions like Tingyi for very long, in our view. We believe the aggressive promotional war involving free sausage gifts will ease gradually over 2H14E and 2015E. Hence, we expect a

12.711.6 11.7 11.3 11.2

12.5 13.1

-0.3

2.8 3.1

-1.8-3.3

0.2 0.5

0

1

2

3

4

5

6

7

(5)

0

5

10

15

2010 2011 2012 2013 2014E 2015E 2016E

Tingyi (LHS) UPCH (LHS) Tingyi/UPCH revenue (RHS)

(%) (x)


- 43 -

mild operating margin recovery for both Tingyi and UPCH from 2015E onward. However, if the price war and aggressive promotions continue for longer than we expect, we believe Tingyi would be able to maintain its operating margin at the current level, with slight upside potential, given it has much greater financial resources than peers to spend on promotions. If we assume Tingyi spends 10% of the revenue generated by its noodles segment on advertising and promotions (A&P), its A&P budget in 2014E would exceed USD470m, almost 40% of UPCH’s noodles revenue, based on our estimates. We expect Tingyi’s noodles revenue to remain 3x higher than that of UPCH over 2014-16E. In fact, Tingyi has already gradually allocated some of its A&P budget to products other than Laotan and braised beef noodles. In 4Q13, it launched new TV and online advertisements for its core roast beef noodle products, and in 1Q14 it introduced advertisements for its snack noodles and other new products in an effort to establish new revenue growth engines.

New products to enlarge the customer base

Tingyi has launched 3 new products in 1H14: 1) non-oil fried noodles under the “Fresh Banquet” name, 2) a new cooked noodle called “Mian Ba Cooked Noodles”, and 3) snack noodles under the “Crispy Fatty” name. We are more positive on these new products than those launched over the past 3 years, such as Laotan. These new, higher-quality products, in our view, target new customers with relatively high disposable incomes, and hence could enhance the per-capita consumption of noodles in China rather than cannibalising the company’s existing products.

Tingyi: new products

Source: Company

Fresh Banquet: These steamed noodles are mono-sodium glutamate (MSG)-free, and target health-conscious consumers who are not frequent consumers of instant noodles at present. The retail ASP is about CNY6 per bowl, versus CNY3.5-3.8 for Tingyi’s other bowl noodle products. Dried vegetable and meat pieces are also added to justify the higher retail ASP. Mian Ba cooked noodles: This product targets home consumption. Emphasising Mian Ba’s improved taste compared with some of Tingyi’s other high-end pack products, the retail price is around CNY3 per pack, versus CNY2.3-2.5 for other high-end packs. Crispy Fatty: This product is an improved version of the fried crispy noodles known as Cui Xuan Feng launched in 1Q13. It targets consumers who want a small portion of noodles as a snack. The revenue contribution from this snack noodle product is small at present (1Q14: 2.6% of segment’s revenue), but is growing fast (sales volume up by 50% YoY for 1Q14). Tingyi: noodle revenue breakdown by product: 1Q13 vs. 1Q14 (USDm)


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- 44 -

A rebound in revenue and profit growth would serve as a cash-cow We forecast Tingyi’s noodles’ revenue to rise by 11% YoY for 2014, 9% YoY for 2015 and 9% YoY for 2016, faster than the industry averages for those years. With the gradual reduction in promotional discounts on selected products and the launch of new products, we assume a mild ASP increase of 3% YoY for 2015E With further operating leverage, we forecast the net margin to improve slightly over 2014-16, and hence drive the segment’s net profit to rise by 18% YoY, 24% YoY and 13% YoY over 2014-16E, versus 5% YoY growth reported for 2013. We expect noodles to remain the major net profit contributor for Tingyi, accounting for about 72-75% of its total net profit over 2014-16E, versus 85% in 2013. Tingyi: noodle segment’s revenue and net margin


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Beverage – multiple engines to diversify risk

After merging with Pepsi (2012), Tingyi’s beverage business has a big product portfolio and strong R&D capabilities, which is important to tap the long-term growth of the China market and satisfy the ever-changing consumer tastes.

A diversified product portfolio

As shown in the following chart, Tingyi’s beverage portfolio consists of 4 major types of beverage categories – tea, water, juice drinks and carbonated drinks. Those categories accounted for over 95% of revenue for the soft drinks market in China in 2013, according to AC Nielsen. Tingyi achieved No.1 or 2 position in all these major categories. Based on AC Nielsen’s data, we estimate Tingyi’s market share in non-alcoholic beverages in China at around 28% in 2013, making it the largest player in China. Tingyi is the only beverage player in China with significant exposure to all the major soft-drink categories in the country. The beverage portfolios of the second-largest player, Coca-Cola (little presence in bottled tea), and the third, UPCH (no carbonated drinks), in China are inferior to Tingyi’s, in our view. As discussed in our industry section, consumers’ preferences for beverages shift between different categories almost every year, depending on the weather, affordability, the availability of new products and marketing campaigns. Diversification lowers product concentration risk, and provides a comprehensive portfolio for distributors and customers in the catering industry.

Revenue breakdown by category


Tingyi: diversified beverage portfolio

Tingyi’s original products

Pepsi’s product portfolio

Source: Company

Moreover, together with Pepsi, Tingyi has a strong portfolio in categories that are seeing fast revenue growth in China, such as sports drinks, 100%-pure juice, and spring water. In 2014-15E, these products will likely account for a small proportion of the segment’s revenue as they are not affordable for many consumers. However, we see long-term potential in such products as consumers become more health conscious, income levels rise, and the westernisation of Chinese consumers’ drinking habits and tastes continues.

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Tea Water Juice drinks Carbonated drinks and others


- 46 -

Tingyi: potential star products: sports drink, spring water, 100% juice

Source: Company

Rapid expansion in the water business

For 2014-15E, we expect water to be the key revenue driver for Tingyi’s beverage unit, as sales momentum should remain robust (following 1Q14: up 33% YoY) and Tingyi continues to expand its bottled water capacity. Tingyi plans to increase its number of bottled water plants in China from 83 at present to 100 by end-2014 and to 120 by end- 2016, to gain scale advantages. We forecast water sales growth to exceed that of its other beverage categories over 2014-16E at 30% YoY for 2014E, 21% YoY for 2015E and 20% YoY for 2016E. Spring water is another high-value item under development by the company. Tingyi is looking to secure safe and quality natural spring water sources in China to develop its spring water business in the future. Tingyi: beverage sales growth by category (YoY %) 2011 2011 2012 2013 2014E 2015E 2016E

Tea 37 9 -26 25 16 8 8Water 27 23 7 27 30 21 20Juice drinks 70 19 74 13 10 7 7Carbonated drinks and others n.a. n.a. n.a. 47 15 15 10


Pepsi unit should help to improve operating margin

In 1Q12, Tingyi’s beverage unit merged with Pepsi China. Following Pepsi’s injection of its China bottling plants into the unit, Pepsi now owns a 5% stake in Tingyi’s unit and Tingyi owns 47.5%. The beverage unit’s other shareholders are: 1) Japanese partner Asahi Group (Asahi) (2502 JP, JPY3,121, Outperform [2]), which has been investing in the unit since 2004 and owns a 30.4% stake, and 2) Tingyi’s parent

company, Ting Hsin (not listed), with a 17.1% stake. Pepsi has the option to increase its stake in the business to 20% in October 2014 or October 2015, for a consideration of USD3.7bn. Current shareholding structure of Tingyi’s beverage unit

Source: Company

As a result of what we see as inefficient management, Pepsi China was loss-making between 2008 and 2012. Tingyi’s operating margin was also impacted adversely as it had to absorb such losses. However, besides product portfolio enhancements and an immediate boost in revenue, Tingyi is considering potential synergies with Pepsi China through the sharing of a production and distribution network with Pepsi. Through a series of changes implemented since 2012 to operations and the management system, Tingyi is using its cost control expertise and scale to lift the profit margin of the merged beverage unit. Phase 1 – immediate direct cost reductions post the Pepsi deal. Immediately after the deal was completed in 1Q12, Pepsi brand-related advertising promotional expenses and raw material costs were reduced, as Pepsi provided discounts for its concentrate sales (essential raw materials for carbonated drinks production) to the merged unit and provided more A&P resources. Moreover, Tingyi has started central procurement of major raw materials, such as sugar and PET chips, to lower Pepsi’s production costs through Tingyi’s scale. As a result, the Pepsi unit reached breakeven at the net-profit level in 2013, from loss-making in 2012. Phase 2 – from 2012 onwards. Since 3Q12, Pepsi and Tingyi have been sharing their beverage production and distribution channel resources. As a result of this drive, Tingyi was able to launch in 2013 Pepsi’s non-carbonated drinks (Topicana juice, Lipton milk tea, etc.) though its national production and distribution network without incurring extra capex.

47.5%

Tingyi 322.HK

Brands: Master Kong, Pepsi, 7-up, Gatorade, Mirinda, Tropicana, New Taste for Traditional Drink

Asahi Pepsi 33%

5% 30.4%

Products: bottled tea, juice drinks, water, carbonated drinks and other beverages

Ting Hsin

17.1%


- 47 -

Phase 3 (2014E-16E) – revenue enhancements. Currently, the Pepsi China beverage unit is not as efficient as Tingyi’s other beverage operations, with revenue per staff only about one-third that of Tingyi’s other beverage units. Tingyi plans to train staff coming from the original Pepsi China unit and simplify the unit’s management structure – not by shedding junior sales or production staff but by restructuring the sales and distribution units. In view of the above measures, we are optimistic that Tingyi’s beverage unit should stage an improvement in profitability over 2014-16E. As such, we forecast the unit’s gross margin to improve to 32.6% by 2016E, (from 30.8% for 2013), and its operating margin to expand to 4.7% for 2014, 5.8% for 2015 and 6.6% for 2016 (from 3.2% reported for 2013). We project faster operating-margin than gross-margin expansion as we assume operating leverage and improving efficiency among the sales force. Tingyi’s beverage unit: gross and operating margins (%)


We also expect the above measures to drive a rapid net margin improvement for the beverage unit over the next 3 years (as shown in the following chart), and forecast net profit growth for the unit of 93% YoY for 2014, 39% YoY for 2015 and 21% YoY for 2016. Our forecasts imply that Tingyi’s beverage unit should account for 20-25% of the company’s total net profit over 2014-16E (vs. a minimal contribution for 2013).

Tingyi’s beverage unit: revenue and net-profit margin


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- 48 -

Strong scale advantage

Tingyi has one of the most extensive distribution and production networks in China, which keeps down its logistics costs and gives it a good platform to distribute new products and co-operate with joint venture partners.

A strong distribution and product network

Tingyi started producing and distributing instant noodles during the year it was founded and later expanded into the beverage businesses in 1996. It now has about 35,000 wholesalers and over 110,000 directly serviced retailers, giving it one of the largest distribution networks in China’s food and beverage industry. Tingyi also has about 120 production plants in China which distribute Tingyi’s products nationwide, even to 6-or-below tier cities. Tingyi: production and distribution capability in China (period-end) (Number) 2009 2010 2011 2012 2013 1Q14Sales offices 493 548 555 571 566 584Warehouses 79 89 91 95 75 85Wholesale distributors 5,798 6,155 6,188 32,424 33,504 35,500Directly-serviced retailers 72,955 73,282 86,755 107,131 110,355 114,421Employees 50,023 64,436 64,309 79,419 80,541 n.a.Production lines 414 457 510 607 654 668Production centres 56 53 65 108 119 n.a.

Source: Company

Our analysis indicates that Tingyi has a high level of operational efficiency, based on our assessment of the company’s operating margin and selling cost control. In terms of selling and distribution expenses (excluding its beverage unit owned jointly with Pepsi and others), we estimate that Tingyi’s annual selling and distribution costs as a percentage of revenue are the lowest of the major food and beverage companies in China, except at Want Want China (Want Want). We believe Tingyi’s bottled-water business has a higher ratio of selling and distribution costs to revenue than most of Want Want’s products due to the lower value of bottled water products on a weighted basis compared with other beverages.

Tingyi and major China peers: comparison of revenue per staff member and size (2013)

Revenue(CNYm) No. of staff

No. of wholesale distributors

Revenue per staff (CNY/person)

Tingyi 67,834 80,541 33,504 842,661UPCH 23,329 38,453 n.a. 606,688Huiyuan 4,504 7,121 5,000 632,495Want Want 23,670 53,500 8,000 442,425Tsingtao 28,291 42,235 n.a. 669,847

Source: Companies, Bloomberg, Daiwa

Note: Huiyuan = China Huiyuan Juice Group, Tsingtao = Tsingtao Dairy; the data excludes Mengniu given its inclusion of the infant formula business, which operates using a very different distribution model compared with other F&B products.

Tingyi and major China peers: comparison of selling and distribution expenses as a percentage of revenue (2013)

Source: Companies, Daiwa estimate for ex-Pepsi unit

Note: Mengniu – China Mengniu Dairy

Pepsi China’s higher operating cost structure, as evidenced by its loss-making condition during 2010-2011, caused Tingyi’s ratio of selling and distribution expenses to revenue to increase from about 17% in 2011 (ie, prior to the merger of its beverage unit with Pepsi’s China unit) to 20.3% in 2012 and 21.1% in 2013. However, we forecast this ratio to come down gradually to close to 20% for 2015 as we expect Pepsi’s efficiency to improve, on the back of the measures discussed in an earlier section. That said, Tingyi’s operating margin is still substantially above that of UPCH, its major competitor in both the beverage and instant noodles segments, as the next chart shows, and we expect it to remain so over 2014-16 as synergies continue to be unlocked.

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- 49 -

Tingyi and UPCH: operating margin comparison


Developing more long-term business-growth drivers

We believe Tingyi’s distribution network assets still offer substantial potential for further operating leverage, and that Tingyi is one of a very few food and beverage companies in China with such strong distribution and a product presence in most parts of the country. This should enable the company to continue to launch new products swiftly and at lower costs compared with most of its competitors, in our view. To further utilise such assets and resources, in 2012, Tingyi formed a new instant-food business unit (for instant foods excluding noodles), which is responsible for introducing new products (mainly international brands) into China. Leveraging on its existing network and sales expertise in China, Tingyi distributes these instant-food brands through its existing sales channels (supermarkets and wholesale distributors) and sells these brands to develop its presence in new channels (eg, catering). So far, the company has embarked on 3 projects in the form of joint ventures with other companies that we go on to describe. Joint venture with Calbee In 2012, Tingyi formed a joint venture with Japanese instant-food producer/snack producer Calbee (2229 JP, JPY2,828, Buy [1]) and Japanese trading company Itochu (8001 JP, JPY1,296, Outperform [2]). Tingyi, Calbee and Itochu own respective stakes of 45%, 51% and 4% in the venture. The venture’s production plant is in Hangzhou Province and started production in 2Q13. Based on Calbee’s disclosures, about 49% of the joint venture’s sales come from Jagabee, which is Calbee’s sub-brand of potato sticks packaged in cups, followed by potato chips (under the brand BQ) and prawn chips

(under the brand Ebisen). Tingyi plans to launch new potato-based snacks via this joint venture to further enhance its profitability over the next 2 years. Revenue breakdown of Calbee-Tingyi JV (FY14, ie, year-end 31 March 2014)

Source: Calbee

Joint venture with Prima Prima (Not rated) processes and sells ham and sausages, and is the third-largest ham processor in Japan. Tingyi formed a joint venture with Prima in 2012 and owns a 60% stake in it. The plant is located in Jiangsu Province and has been producing ham, bacon and sausages since 4Q13. Its current customers are mainly business-to-business (B2B) customers. Tingyi’s management believes this joint venture can help Tingyi to diversify its product mix further in the future. Joint venture with Wakodo In 1H14, Tingyi established a joint venture with Wakodo to engage in marketing and sales of infant formula and baby foods and owns a 45% stake. The joint venture will import original packaging infant formula from Japan to sell in China, starting from 2H14. Wakodo is the third-largest baby food brand in Japan with a 12.8% market share for 2013. Considering other acquisitions in instant foods According to management, Tingyi is considering domestic acquisition targets in instant foods, which: 1) generate sales of more than CNY 3bn per year, 2) have a niche product portfolio, 3) sell to consumers rather than industrial users, and 4) preferably have a No. 2 market share in their product categories. Tingyi believes several attractive targets could become available over the next 5-10 years, as many entrepreneurs who started their businesses in China in the 1980s-2000s, when China’s economy was booming, will likely gradually retire and therefore may be interested in selling their businesses.

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Tingyi UPCH

Jagabee49.0%

BQ20.0%

Ebisen31.0%


- 50 -

Instant foods should remain a small revenue and earnings contributor over 2014-16E The instant foods segment overall is still a small contributor to Tingyi’s revenue and earnings, and the segment has seen its operating costs increase since 2012 due to start-up costs for its new business initiatives. We forecast the segment to remain loss-making at the net level in 2014E and contribute about 2% to Tingyi’s total revenue and less than 1% to its total net profit over 2015-16. Management targets to grow the instant food (ex-noodles) segment so that it contributes about 10% to the company’s total revenue by 2020. Tingyi’s instant food segment (ex-noodles): revenue and net profit


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Financial analysis

We forecast Tingyi’s recurring net profit growth to accelerate to 34% YoY for 2014 (vs. 7% YoY for 2013), 31% YoY for 2015 and 14% YoY for 2016.

Profit growth accelerating

The strong pick-up that we project in Tingyi’s recurring net profit growth for 2014-16E compared to 2013 is driven by: 1) revenue growth that we forecast at 15% YoY for 2014 and 10% YoY for each of 2015 and 2016, and 2) operating margin expansion at both the noodles and beverage segments. Tingyi: recurring net profit and YoY growth in revenue and recurring net profit


Gross margin should improve gradually We forecast mild gross margin improvements for both the beverage and noodles segments over 2014-16, as shown in the following chart. For the beverage segment, we expect efficiency gains at the Pepsi unit, economies of scale through Tingyi’s planned expansion of its water production network expansion, along with sustainably low sugar and PET-chip costs, to lead to gross-margin expansion of 1.5pp YoY to 32.2% for 2014, 0.1pp YoY to 32.3% for 2015, and 0.3pp YoY to 32.6% for 2016. For the noodles segment, we expect to see gradual declines in promotion expenses for noodles and product mix enhancements, which should bring about a gross margin improvement to 29.5% for 2015 and

29.9% and 2016E, up 0.3pp and 0.4pp YoY, respectively. Note that we assume no segmental gross margin improvement for 2014, as competition remains keen for some categories such as Laotan flavours. Tingyi: gross margin by segment


Operating costs. Tingyi’s ratio of selling and distribution expenses to revenue rose sharply to 20% in 2012 and 21% in 2013 from 17% in 2011) due to the inclusion of the less-efficient Pepsi unit from 2012. We forecast the ratio to come down from 21% in 2013 and 2014E to close to 20% for 2015, driven primarily by the company’s drive to improve efficiency at the Pepsi unit. We believe that the ratio could improve further to 18-19% in the long-run, although this would still be above the level of 17% pre-merger of part of the beverage business with Pepsi’s in China, due to rising labour costs and intensified competition in the beverage unit. We expect Tingyi’s administrative costs to be contained at 3.2% of revenue over 2014-16E, in-line with the 2013 level. Tingyi: ratio of selling and distribution expenses to revenue, and operating margin


Tax. We forecast Tingyi’s reported effective tax rate to come down from 31.6% in 2013 to 28% in 2014 and then to 27% in both 2015 and 2016. This reflects the fact that some of its loss-making subsidiaries (in

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Instant noodles Beverage

Instant foods Company

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particular the Pepsi operation) reached breakeven in 2013 and we expect some (eg, bakery units) to do so in 2014-15E. As their losses are not eligible for tax reductions, while loss-making, such businesses raised the company’s effective tax rate. Dividend. Tingyi has paid out 50% of its core profit (reported net profit ex-valuation gain and other non-cash earnings) in the form of dividends over the past 5 years. We expect it to maintain its dividend payout ratio at 50% per year over 2014-16. Capex and cash flow We forecast the company’s capex to amount to USD700m per year over 2014-16E, in the middle of its guidance range for 2014 of USD600m-800m and down from USD896m in 2013. As Tingyi has already built a strong production network in China, we believe its upcoming capex will mainly be spent on new water production lines (for beverages) and modernising its noodle production facilities (to enhance both efficiency and its product mix). In 2Q14, Tingyi acquired 4 office buildings (under construction) from its parent Ting Hsin for a consideration of CNY2.48bn (USD406m). The buildings, located in the town of Hongqiao in Shanghai, will be used as Tingyi’s new headquarters, offices, research and development centre, education and training centre and related amenities for executive catering and accommodation. Tingyi’s declared purpose of moving its headquarters from Tianjin to Shanghai is to attract talent. The new location will also give the company closer ties with its business partners both domestically and overseas, as well as savings on transportation costs for staff and international business partners. The company plans to move to Hongqiao in 2015. Despite the capex outlay, we expect Tingyi’s balance sheet to remain healthy and forecast the company’s free-cash flow to exceed USD700m each year over 2014-16 (2013: USD892m) after the above investments. In addition, we forecast its ROE to improve gradually over 2014-16, as shown in the following chart, from a trough level of 14.5% in 2013. Tingyi’s ROE has been dragged down substantially since 2012 due to the merger of part of its beverage business with that of Pepsi China, which has lower efficiency metrics than Tingyi, and intensified competition since 2012.

As we expect synergies with Pepsi’s China unit to materialise gradually and the instant noodle segment’s net margin to rebound progressively, we forecast Tingyi’s ROE to improve to 17.3% in 2014, 20.1% in 2015 and 20.3% in 2016, and expect the company to have a net cash position for 2015-16, with higher free cash flow. Tingyi: net gearing and ROE


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Valuation

We have an Outperform (2) rating with a target price of HKD22.90, based on a 27x 2015E PER and implying 9% upside potential from the current share price.

Sustainable valuation premium to peers

We consider a PER method as the most appropriate way to value Tingyi, given its profile as a downstream food and beverage company with what we regard as good earnings visibility and stability. To value Tingyi, we use the average of our 2014 and 2015 EPS forecasts and assign a target PER of 27x, which is in line with the company’s past-5-year average trading PER. Our target PER also represents a 36% premium to the major China food and beverage companies’ average 2015E PER at current share prices of 19.8x (based on the Bloomberg consensus EPS forecasts, and on our forecasts for the companies we cover). In our view, the premium is justified by what we see as Tingyi’s strong earnings-growth prospects for 2014-16 and leading market-share position and scale advantages over its peers. Based on our EPS forecasts, Tingyi is trading currently at PERs of 28.9x for 2014E and 22.1x for 2015E. We believe Tingyi deserve a re-rating from its current multiples as its operating margin gradually recovers. For noodles, we believe Tingyi will gradually regain

pricing power in 2H14 and 2015 as we believe its competitors lack the financial resources to continue price war and free gifts. In beverages, Tingyi looks well positioned to benefit from the trend of rising bottled water consumption in China given its nationwide presence, with the largest bottled water/beverage production network in China. As shown below, our 2015-16 EPS forecasts are slightly above those of Bloomberg consensus. We expect its operating margin to exceed expectations as the company sees a continuous improvement in its pricing power for noodle products. Our revenue forecasts are largely in line with those of the consensus. Tingyi: revenue and earnings trend and forecasts vs. consensus 2012 2013 2014E 2015E 2016ERevenue (USDm) 9,212 10,941 12,548 13,850 15,298 YoY (%) 17 19 15 10 10 Var. vs. consensus (%) n.a. n.a. 2 0 -2Net profit (USDm) 369 394 527 689 785 YoY (%) -3 7 38 31 14 Var. vs. consensus (%) n.a. n.a. -3 7 5EPS (USD) 0.082 0.070 0.094 0.123 0.140 YoY (%) -3 7 34 31 14 Var. vs. consensus (%) n.a. n.a. -1 7 5Source: Bloomberg, Daiwa forecasts

Tingyi: 12-month forward PER bands

Source: Bloomberg

Tingyi and peers: valuation summary

Name BB code Rating

Mkt. cap USDm

Price 23-Jun-14

Stock Δ % PER (x) EPS Growth (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) ROE(%)3M 1M 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E

Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Average (Ex-Tingyi) 27.6 25.1 19.8 16.5 1 12 24 15 12.1 10.0 16 19 16 8.9 12.2 13.0 16.4

Source: Bloomberg,* Daiwa forecasts

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322.HK 17 21 25 29 33


- 54 -

Investment risks

Food safety issues We consider food safety issues to be the main risk to our positive investment view on Tingyi. As far as we are aware, Tingyi’s products have not been caught up in food safety concerns in recent years, and the company has invested significant sums in quality and safety control equipment to reduce such risks. However, food safety issues, together with talk in the market about perceived food safety issues, could have an adverse effect on the company’s sales volume. We believe such risks are higher for the noodles segment than the beverage segment, as noodles come in a wide range of flavours and use numerous ingredients procured from many suppliers. Further intensification of competition We assume that the promotion war in the China’s noodles market will ease gradually in 2015 and that Tingyi will continue to gain market share in all its segments. If its competitors do not stop their aggressive promotions or even offer further discounts in effort to drive revenue, Tingyi’s market share and operating margin could be lower than we expect currently for 2H14-16E. Commodity price increases We forecast flour and palm oil to account for about 15% and 10%, respectively, of the company’s instant noodles production, and PET chips and sugar to represent about 60% and 10%, respectively, of its beverage segment’s COGS, in 2014. Its beverage production costs have been on a declining trend since 2013. Any rebound in sugar and PET chip costs could lead to gross margin erosion (in contrast with our forecasts for gross margin expansion for 2014-16). M&A execution Tingyi has been active in acquisitions and joint ventures projects with international food and beverage companies since 1Q12, notably its deal with Pepsi in China and joint ventures for instant foods discussed in this report. Such expansion could divert management resources and lead to near-term net-margin pressure due to start-up expenses.


- 55 -

Company background Founded in 1992 and listed on the Hong Kong Stock Exchange in 1996, Tingyi is the world’s largest producer of instant noodles, and had a 56.4% market share in China in terms of revenue for 2013. Its beverage unit, owned jointly with Pepsi and Asahi (as illustrated earlier in this report) has approximate shares of 52%, 26% and 24% of the China markets for ready-to-drink (RTD) tea, juice drinks and bottled water in terms of revenue in 2013. As at the end of 2013, Tingyi had 566 sales offices and more than 600 production lines in 119 production centres throughout China. Chairman Mr. Ing-chou Wei (with his family) and Sanyo Food are Tingyi’s major shareholders currently, with stakes of about 33% and 32%, respectively. Tingyi: current shareholding structure

Source: Company

Development history Under the brand Master Kong, Tingyi developed its first instant noodles product, Noodles with Braised Beef, in 1992. Since then Tingyi has gradually developed another 3 classic instant noodles products, namely Noodles with Spicy Beef, Noodles with Stewed Mushroom and Chicken, and Noodles with Fresh Shrimp and Fish. These brands have been well received by consumers throughout China. The company also makes and sells different noodle flavours tailored to specific regions (which have proved popular, such as spicy flavours in Sichuan Province, Chinese-style soup-based flavours in Guangdong Province, etc.). Tingyi subsequently entered the beverage and snack food markets in the Greater China region after 1995, and expanded its geographical coverage and distribution network to cover all areas of the country.

In 2003, Tingyi restructured its business units and sold just below 50% of its interest in the beverage business to 2 Japanese companies, Asahi Breweries (Not rated), a leading Japanese manufacturer of alcoholic beverages and soft drinks, and Itochu (Not rated), a trading company in Japan with offices in more than 80 countries and operations covering a broad spectrum of industries (such as textile, machinery and utilities). In 1Q12, Tingyi’s beverage unit was merged with Pepsi China, as discussed earlier in this report. As a result of that merger, Tingyi currently owns 47.5% of its beverage operation.

17.1% 47.5%

33%

Ting Hsin

Tingyi (Cayman Island) Holding (322 HK)

Public

35%

35.4%

Beverage

32%

Sanyo Food

Intant noodles

Pepsi and Itochu

100%

Instant food businessJV with Wakado: 45%JV with Prima: 60%JV with Calbee: 45%

Bakery business: 100%


■ Investment case We initiate coverage of UPCH, the second-largest manufacturer of instant noodles in China, with a Hold (3) rating. Noodle quandary. We expect UPCH to continue with its heavy promotion of Laotan (spicy and sour vegetable flavour noodles) and braised-beef products in 2014 before winding down such activity in 2015 and deploying its financial resources elsewhere. In turn, we forecast the operating margin for its noodles to remain negative in 2014 and recover mildly in 2015. On our forecasts, its noodle revenue growth should decelerate to 2-3% YoY in 2015-16 (from 23%/8% in 2012/2013) and its market-share gains in the segment will come to an end. In our view, there are no new products in the pipeline that will drive revenue to the same extent as Laotan.

Steady profit from beverages. We forecast its beverage revenue to grow by 7-10 % YoY in 2014-16, on the back of market growth and product-mix upgrades. Assuming stable raw material costs, we forecast a beverage operating margin of 5.8-5.9% over 2014-16, backed by our expectation of an increased revenue contribution from high-value items such as spring water and coffee. How we differ. Our 2014-16 revenue forecasts are 1-24% below those of the Bloomberg consensus, as we think UPCH lacks new star products and could lose market share. ■ Catalysts We see little scope for upside in the share price on a 6-month view. While the likely scaling-back of promotions in 2015 should enhance UPCH’s operating margin, the stock may be derated if aggressive discounts continue. ■ Valuation We have a 6-month target price of HKD5.60, based on a PER of 30x, the average of our 2014-15E EPS. Our target multiple is at about 30% premium to the stock’s past-5-year average 12-month forward PER, as we believe the recent rights issue will alleviate concerns about possible equity fundraising and the

noodle segment will stage a turnaround in 2015. ■ Risks A lower-than-expected utilisation rate is the main downside risk to our call. Lower-than-expected selling expenses are the main upside risk.


25 June 2014

Uni-President China

Initiation: torn between growing earnings and market share

• We believe the stock’s outlook is clouded by a lack of new products and limited visibility on noodle profit margins

• Recent right issue alleviates concern about stretched balance sheet; beverage earnings should cushion noodle losses

• Initiating with Hold (3) rating and target price of HKD5.60, based on 30x 2014/15E EPS



Uni-President China220 HK

Target (HKD): 5.60Downside: 3.4%23 Jun price (HKD): 5.80

BuyOutperformHold (initiation)

UnderperformSell

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Uni-Pres C (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 5.56-8.17Market cap (USDbn) 3.233m avg daily turnover (USDm) 3.99Shares outstanding (m) 4,319Major shareholder President Enterprise (1216.TT) (70.3%)

Financial summary (CNY)Year to 31 Dec 14E 15E 16ERevenue (m) 24,943 26,671 28,113Operating profit (m) 601 976 1,193Net profit (m) 502 756 928Core EPS (fully-diluted) 0.127 0.175 0.215EPS change (%) 2.3 38.2 22.7Daiwa vs Cons. EPS (%) (23.6) (16.6) (0.7)PER (x) 36.8 26.6 21.7Dividend yield (%) 0.5 1.1 1.4DPS 0.023 0.053 0.064PBR (x) 1.8 1.7 1.6EV/EBITDA (x) 12.5 9.7 8.3ROE (%) 5.2 6.6 7.6





- 57 -

Growth outlook UPCH: reported and recurring net profit (CNYm)

In 2013, UPCH’s recurring profit declined 49% YoY to CNY446m amid margin erosion, but its reported net profit was up 6% YoY to CNY920m thanks to gains on the disposal of 2 production plants and Want Want China shares. We forecast its recurring profit to grow by 13%, 51% and 23% YoY in 2014-16, respectively. On our forecasts, EPS growth will be slower, at 2% and 38% YoY for 2014-15, respectively, due to dilution from the rights issue. We forecast revenue growth of 7%, 7% and 5% YoY for 2014-16, respectively, down from 26% YoY for 2012 and 9% YoY in 2013, as we believe the company lacks promising new products and market growth is likely to slow. Source: Company, Daiwa forecasts

Valuation UPCH: 5-year 12-month forward PER bands

The stock was rerated in 2011-12, likely due to the success of UPCH’s new products (milk tea and Laotan noodles). We do not foresee another rerating over our investment horizon. Based on Bloomberg-consensus forecasts, the stock is trading at a 5% discount to the 12M forward PER of Tingyi, its largest competitor in China, versus an average discount of 22% over the past 5 years. The discount should narrow if, as we expect, UPCH sees a turnaround in its operating margin for noodles. Our target PER of 30x marks about 30% premium to the stock’s past-5-year average, given our expectation of a gradual improvement in the balance sheet and operating margin on noodles.

Source: Bloomberg

Earnings revisions UPCH: consensus EPS-forecast revisions (CNY)

The Bloomberg-consensus forecasts for 2014-15 EPS have been revised down steadily since 2013 as a result of UPCH’s lower-than-expected interim and full-year results, slowing market-share growth, and worsening balance sheet. Our EPS forecasts for 2014 and 2015 are respectively 24% and 17% below those of the Bloomberg consensus; we see further downside risk to the consensus forecasts as we believe UPCH lacks revenue-growth drivers following the success in the market of its Laotan noodles and milk tea in 2010-13.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

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174%

-48%

13%

51%23%

(100%)

(50%)

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1,000

2011 2012 2013 2014E 2015E 2016E

Reported net profit (LHS) Recurring net profit (LHS)

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- 58 -

Key assumptions

Profit and loss (CNYm)

Cash flow (CNYm)


Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales growth YoY - Instant noodles (6.0) 67.4 67.3 22.5 7.7 2.0 3.0 2.0Sales growth YoY - Beverage (0.2) 27.0 21.5 30.2 8.9 9.8 8.9 7.0Gross margin % - instant noodles 29.6 28.1 29.3 33.2 29.2 27.4 29.2 29.0Gross margin % - beverage 42.9 34.1 29.8 35.6 35.8 35.8 35.9 36.5

Sellling and distribution expense ratio (%)

28.3 26.1 25.4 28.2 29.3 28.3 27.4 26.9

Advertising and promotion expense 13.3 11.3 10.0 13.0 12.3 11.5 11.1 10.8

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EInstant noodles 2,120 3,549 5,936 7,270 7,826 7,979 8,220 8,386Tea beverage 4,170 5,005 4,992 5,597 6,143 6,757 7,371 7,740Other Revenue 2,818 4,037 6,047 8,539 9,328 10,206 11,080 11,988Total Revenue 9,109 12,591 16,975 21,406 23,297 24,943 26,671 28,113Other income 77 131 159 246 343 483 483 463COGS (5,492) (8,548) (12,032) (14,004) (15,518) (16,803) (17,763) (18,596)SG&A (2,927) (3,616) (4,841) (6,766) (7,665) (8,022) (8,415) (8,787)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 767 558 261 882 458 601 976 1,193Net-interest inc./(exp.) 47 55 95 64 99 (28) (66) (64)Assoc/forex/extraord./others 83 69 63 146 563 70 60 60Pre-tax profit 896 682 419 1,091 1,120 643 970 1,190Tax (192) (163) (84) (221) (200) (142) (213) (262)Min. int./pref. div./others 0 0 0 0 0 0 0 0Net profit (reported) 705 519 335 870 920 502 756 928Net profit (adjusted) 705 519 335 870 446 502 756 928EPS (reported)(CNY) 0.178 0.144 0.093 0.242 0.256 0.127 0.175 0.215EPS (adjusted)(CNY) 0.178 0.144 0.093 0.242 0.124 0.127 0.175 0.215EPS (adjusted fully-diluted)(CNY) 0.178 0.144 0.093 0.242 0.124 0.127 0.175 0.215DPS (CNY) 0.098 0.043 0.026 0.048 0.051 0.023 0.053 0.064EBIT 767 558 261 882 458 601 976 1,193EBITDA 1,089 930 800 1,693 1,522 1,896 2,433 2,726

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016EProfit before tax 896 682 419 1,091 1,120 643 970 1,190Depreciation and amortisation 323 372 538 811 1,064 1,295 1,457 1,532Tax paid (192) (157) 37 (202) (259) (142) (213) (262)Change in working capital 122 197 503 646 (572) (323) (54) (45)Other operational CF items (130) (124) (135) (195) (188) (42) 6 4Cash flow from operations 1,019 971 1,363 2,151 1,165 1,432 2,166 2,419Capex (580) (1,412) (4,162) (3,578) (4,746) (4,500) (2,000) (1,000)Net (acquisitions)/disposals (120) 0 0 0 950 0 0 0Other investing CF items 0 0 0 0 0 0 0 0Cash flow from investing (700) (1,412) (4,162) (3,578) (3,796) (4,500) (2,000) (1,000)Change in debt (9) 166 2,930 875 2,033 1,496 0 (300)Net share issues/(repurchases) 0 0 0 0 0 2,665 0 0Dividends paid (172) (352) (156) (97) (171) (183) (100) (227)Other financing CF items (59) (354) (37) 470 55 (94) (132) (129)Cash flow from financing (239) (540) 2,738 1,247 1,917 3,885 (232) (656)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 80 (981) (61) (180) (714) 817 (66) 763Free cash flow 439 (441) (2,799) (1,427) (3,581) (3,068) 166 1,419

Financial summary


- 59 -

Balance sheet (CNYm)

Key ratios (%)


Company profile

Listed in Hong Kong in 2007, Uni-President China (UPCH) is the second-largest instant-noodle manufacturer in China, with a 17.2% market share (2013), according to AC Nielsen. In addition, it was the second-largest ready-to-drink tea brand (24.6% market share) and the largest milk tea brand (60%) in the domestic market in 2013.

As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ECash & short-term investment 3,384 2,432 2,387 2,295 1,420 2,367 2,421 3,303Inventory 688 1,139 1,274 1,285 1,514 1,611 1,703 1,783Accounts receivable 273 401 513 513 548 586 627 660Other current assets 147 429 443 824 1,026 1,026 1,026 1,026Total current assets 4,493 4,402 4,617 4,917 4,508 5,590 5,777 6,773Fixed assets 2,174 3,121 5,579 7,912 10,186 13,397 13,945 13,418Goodwill & intangibles 13 11 8 7 17 17 17 17Other non-current assets 1,474 2,047 3,533 3,704 4,258 4,258 4,258 4,258Total assets 8,154 9,581 13,737 16,540 18,968 23,261 23,996 24,465Short-term debt 0 166 1,584 409 902 2,000 2,000 1,700Accounts payable 507 1,020 1,196 1,442 1,410 1,381 1,460 1,528Other current liabilities 1,172 1,718 2,307 3,098 3,024 2,866 2,866 2,866Total current liabilities 1,680 2,904 5,087 4,948 5,336 6,247 6,326 6,094Long-term debt 0 0 1,512 3,562 5,102 5,500 5,500 5,500Other non-current liabilities 20 17 328 358 388 388 388 388Total liabilities 1,700 2,921 6,926 8,869 10,826 12,135 12,214 11,982Share capital 34 34 34 34 34 41 41 41Reserves/R.E./others 6,420 6,625 6,777 7,637 8,108 11,085 11,741 12,442Shareholders' equity 6,454 6,660 6,811 7,671 8,142 11,126 11,782 12,483Minority interests 0 0 0 0 0 0 0 0Total equity & liabilities 8,154 9,581 13,737 16,540 18,968 23,261 23,996 24,465EV 16,003 17,030 19,652 20,471 23,209 23,758 23,704 22,521Net debt/(cash) (3,384) (2,266) 709 1,675 4,584 5,133 5,079 3,897BVPS (CNY) 1.793 1.850 1.892 2.131 2.262 2.576 2.728 2.890

Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016ESales (YoY) (1.4) 38.2 34.8 26.1 8.8 7.1 6.9 5.4EBITDA (YoY) 23.9 (14.6) (14.0) 111.7 (10.1) 24.6 28.3 12.0Operating profit (YoY) 47.6 (27.2) (53.2) 237.4 (48.0) 31.3 62.2 22.3Net profit (YoY) 105.0 (26.4) (35.5) 159.7 (48.7) 12.5 50.7 22.7Core EPS (fully-diluted) (YoY) 105.0 (19.0) (35.5) 159.7 (48.7) 2.3 38.2 22.7Gross-profit margin 39.7 32.1 29.1 34.6 33.4 32.6 33.4 33.9EBITDA margin 12.0 7.4 4.7 7.9 6.5 7.6 9.1 9.7Operating-profit margin 8.4 4.4 1.5 4.1 2.0 2.4 3.7 4.2Net profit margin 7.7 4.1 2.0 4.1 1.9 2.0 2.8 3.3ROAE 11.6 7.9 5.0 12.0 5.6 5.2 6.6 7.6ROAA 9.2 5.9 2.9 5.7 2.5 2.4 3.2 3.8ROCE 12.6 8.4 3.1 8.2 3.6 3.7 5.1 6.1ROIC 21.8 11.4 3.5 8.3 3.4 3.2 4.6 5.6Net debt to equity net cash net cash 10.4 21.8 56.3 46.1 43.1 31.2Effective tax rate 21.4 23.9 20.1 20.3 17.8 22.0 22.0 22.0Accounts receivable (days) 9.9 9.8 9.8 8.7 8.3 8.3 8.3 8.4Current ratio (x) 2.7 1.5 0.9 1.0 0.8 0.9 0.9 1.1Net interest cover (x) n.a. n.a. n.a. n.a. n.a. 21.4 14.8 18.8Net dividend payout 55.0 30.0 27.9 19.7 19.9 18.3 30.0 30.0Free cash flow yield 2.2 n.a. n.a. n.a. n.a. n.a. 0.8 7.0



- 60 -

Noodles — torn between growing earnings and market share

We believe that UPCH risks losing market share if it discontinues discounts and promotional gifts for its star products. Its operating margin on noodles is likely to remain negative this year.

No new revenue drivers on the horizon

UPCH’s noodle division recorded losses in most years between 2004 and 2010. However, after it eliminated loss-making low-end products and upgraded its product mix in 2008, its profitability in the noodle segment began to improve. Underpinned by its launch of Laotan noodles in 2010, the company’s noodle revenue saw a CAGR of 51% between 2009 and 2012. However, growth in its noodle sales slowed significantly in 2013 as competitors launched similar products and some consumers shifted to other flavours. UPCH: noodle revenue and contribution from Laotan


We estimate that Laotan currently contributes about 65% of UPCH’s revenue in the noodle segment. Although the company followed up on the success of Laotan with a new star product (braised beef flavour

noodles) in 2H12, we believe this will have less impact on UPCH’s revenue given: 1) competitors quickly launched similar products, meaning that UPCH did not establish first-mover advantage, and 2) braised beef noodles are not so different from existing products. In our view, Laotan noodles, mixed with pickled cabbage, have a distinctive spicy and sour flavour that consumers embraced, whereas braised beef flavour was seen not as a product upgrade but rather as an incremental change. UPCH: Laotan and braised beef noodles

Source: Company

In our view, UPCH has launched few new products in the year-to-date. According to the management, it has extended the free sausage promotion from Laotan and braised beef noodles to roasted beef flavour noodles, a product it has sold for many years but which has a market share of only 10% (vs. 90% for Tingyi). As the company has limited financial resources to promote new products, we believe it has little scope to launch products in 2014, even if it has successfully developed them. Moreover, we believe it has become more difficult to devise and establish distinctive new products in the market, as competitors now react quickly by launching similar offerings. For example, Tingyi launched its version of Laotan noodles in 2012, almost 3 years after UPCH introduced its version. However, Tingyi launched its braised beef flavour noodles in 4Q12, just 2 quarters after UPCH had done the same. In our view, the risk for Uni-President is that launching new noodle products may not be economically prudent if it does not first attain economies of scale. Aggressive promotions set to continue As competitors have launched similar products, UPCH’s domestic market share in the Laotan category has gone from 100% to 50-60% currently, on our estimates. To defend its market share and drive sales of its latest products, UPCH began offering a free sausage with every bowl of Laotan and braised beef noodles in 2H12. As a result, its operating margin in the noodle segment declined from 5.2% in 1H12 to 1.2% in 2H12, and turned negative in 2013.

42%

61%64% 65% 65% 64% 65%

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Revenue (LHS) Laotan as % of segment's revenue (RHS)

(CNYm)


- 61 -

UPCH scaled back its promotions in 1Q13 but resumed them soon after in the face of aggressive promotional activity and product launches by competitors. According to AC Nielsen, the company gained 1.4pp of market share in the noodle segment in 2013. However, we believe such promotions won’t be as effective in winning market share in 2014, as growth in the market seems to be shifting from UPCH’s star products to new flavours offered by rivals. In 2H13, the company’s noodle revenue growth decelerated to 5% YoY, from 10% YoY in 1H13, while its competitor Tingyi’s revenue growth accelerated to 12% YoY, from 6% YoY. Hence, we assume that UPCH will maintain its market share throughout 2014 by continuing with its aggressive promotions and free gifts. UPCH: operating loss and margin in the noodle segment


Gross margin forecast to remain under pressure We estimate the free sausage promotion has increased UPCH’s production cost for a bowl of noodles by 7-10% and hence has a 2-3pp impact on its gross margin in the segment. Factoring in other marketing campaign expenses as well, we forecast UPCH’s operating loss in the noodle segment to widen to CNY266m in 2014, from CNY143m in 2013. Assuming that UPCH stops offering free sausages and scales back its other promotional expenses, we forecast its operating margin in the noodle segment to turn slightly positive in 2015. The risk is that the curtailment of promotional activity puts downward pressure on UPCH’s market share and leads to a slowdown in revenue growth.

UPCH: market share and gross margin in noodle segment (%)

Source: Company, AC Nielsen, Daiwa forecasts

165225

-143

-266

1343

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0%

1%

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4%

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2011 2012 2013 2014E 2015E 2016E

Operating profit (LHS) Operating margin (RHS)

(CNYm)

28.129.3

33.2

29.2

27.4

29.2 29.09.5

13.3

15.817.2 17.2 17.0 16.7

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2010 2011 2012 2013 2014E 2015E 2016E

Gross margin (LHS) Market share (RHS)


- 62 -

Beverages – steady outlook for revenue and margins

The launch of innovative new beverages should help maintain a steady operating margin in the segment of 6%. We forecast a beverage revenue CAGR of 9% for 2013-16E.

Strong R&D capability

We believe UPCH has a sound track record of launching differentiated beverages that build its market share and broaden its customer base. In 2009, for example, it launched a milk tea (Asamu brand) in a market formerly dominated by Japan players. The product saw a 78% CAGR in revenue in 2009-13 and by 2013 had a 62% share of the milk-tea segment. Compared with international brands, we think UPCH has stronger brand recognition and a broader distribution network in China, which is reflected in the company’s market share nationally. The company plans to launch 8-10 new beverage stock-keeping units (SKUs) each year. We are particularly positive on the prospects for its recently launched sea-salt lemonade product, which we expect to help it to sustain 5% pa growth in revenue in the juice segment, even assuming no growth in the overall market over 2014-16.

UPCH: sea-salted lemonade, sugar-free tea, and high-end milk tea

Source: Company

Going high-end To drive its profit margin in the beverage segment, UPCH is focusing on launching high-end products. In 2H13, it introduced a new milk tea brand (CITEA), which has a retail ASP of CNY8 per 500ml bottle, compared with CNY3.5-4 for the Asamu brand. Moreover, it intends to exit the mass-market bottled water segment (retail ASP: CNY1 per bottle) and shift its attention to the high-margin spring water segment. Across the market as a whole, we expect other high-margin products, such as coffee, to see faster revenue growth than other products, given a low base currently in terms of revenue and per-capita consumption.


- 63 -

UPCH: high-margin beverage portfolio

Source: Company

We forecast UPCH’s beverage revenue to grow by 10% YoY in 2014, 9% YoY in 2015, and 7% YoY in 2016. These growth rates are well below the 30% YoY growth in beverage revenue recorded in 2012, given that market growth is slowing and the company has little exposure to fast-growing categories such as functional drinks and mass-market bottled water. Considering its brand equity and ability to charge high-end prices for some products, we forecast UPCH’s operating margin in the beverage segment to remain at 5.8-5.9% over 2014-16. Revenue growth by segment and proportion of milk tea


Revenue growth and operating margin of beverage business


Investing in production capacity to maximise economies of scale

Production plants UPCH has been investing significantly in its production facilities since 2010, and the number of its plants has increased from 13 in 2011 to 28 in 2013. Its goal is to realise economies of scale more effectively while reducing logistics costs by cutting the distance between plants and markets. However, as a result of this initiative, we see a risk to profit margins in the near term if the company cannot utilise its new capacity and maintain its utilisation rate (2013: 60%-70% for beverages, 60% for noodles). We assume that over 2014-16 UPCH will reduce its ratio of outsourced production in order to maintain its utilisation rate.

27

22

30

9 10 9 7

0

10

20

30

40

02,0004,0006,0008,000

10,00012,00014,00016,00018,00020,000

2009 2010 2011 2012 2013 2014E 2015E 2016E

Others Milk teaJuice Drinks Bottled teaYoY % (RHS) Milk tea as % of segmetn's revenue

(CNYm) (%)

7.2%

2.1%

5.5% 5.6% 5.8% 5.9% 5.8%

0%

1%

2%

3%

4%

5%

6%

7%

8%

0

5,000

10,000

15,000

20,000

25,000

2010 2011 2012 2013 2014E 2015E 2016E

Revenue (LHS) Milk tea as % of segmetn's revenue


- 64 -

UPCH: production expansion from 13 plants in 2011 to 28 in 2013

Source: Company

Distribution Reflecting UPCH’s brand recognition, and the popularity of its beverages, the company’s products’ penetration of modern retail channels (hypermarkets, supermarkets and convenience store chains) is high and comparable to that of major international and domestic players. Its products are also widely available in urban areas. However, despite its status as the second-largest instant noodle player in China, we believe the penetration of UPCH products in terms of distribution is less than that of market leader Tingyi. We attribute the company’s weakness in this regard to the following factors: 1) its less efficient product distribution, particularly in northern and north-eastern China, where it has only 4 plants currently, which makes delivery of products to rural areas and lower-tier cities more costly, 2) its less extensive product portfolio compared with Tingyi, which is therefore better placed to meet retailers’ demand for a wide variety of products, and 3) its relative lack of financial and human resources, given its smaller scale at present.


- 65 -

Financials

We forecast UPCH’s reported net profit to grow by 13%, 51% and 23% YoY in 2014-16, respectively. Following its rights issue in June 2014, we expect net gearing to decline to 46% in 2014, from 56% in 2013.

ROE likely to remain weak

UPCH’s recurring net profit fell by 48% YoY in 2013, due largely to its operating loss in the noodle segment. We forecast its recurring net profit to grow by 13% YoY for 2014, 51% YoY for 2015, and 23% YoY for 2016. Despite the rapid increase in its net gearing, from 22% in 2012 to 56% in 2013, we forecast the company’s ROE to remain subdued, at 5.2-7.6% over our forecast horizon, given our expectation of weak operating margins, particularly for noodles. Our forecast for a sharp YoY increase in its net profit for 2015 reflects our assumption that UPCH will cut promotional expenses for the noodle business. UPCH: ROE and net profit


Gross-margin trends Assuming further product-mix upgrades and an increase in its in-house production, we forecast UPCH to maintain a gross margin on beverages of more than 35% over 2013-16. For the noodle operation, we expect the gross margin in 2014 to decline by 1.8pp YoY (from 29.2% in 2013) as heavy promotional activity continues. However, we expect the free sausage gift to come to an end in 2015, as UPCH needs to return to profitability within the segment and strengthen its cash flow. UPCH: gross margin by segment


Operating margin and selling expenses UPCH’s operating margin has come under pressure in recent years in the face of keen competition in the noodle market. Assuming its free cash flow remains weak over 2014-16, we expect UPCH to maintain its full-year advertising expenses at CNY2.9-3bn over the same period; such expenses as a proportion of overall revenue should fall from 12.3% in 2013 to 11.5% in 2014 and 11.1% in 2015. On our forecasts, the selling expense ratio will improve from 29.3% in 2013 to 28.3% in 2014 and 27.4% in 2015 as the company’s production is gradually built up. UPCH: operating margin and selling expense ratio


7.9%

5.0%

12.0%

5.6% 5.2%6.6%

7.6%

0%

2%

4%

6%

8%

10%

12%

14%

0

200

400

600

800

1,000

2010 2011 2012 2013 2014E 2015E 2016E

Reported net profit (LHS) Exceptional item (LHS) ROE (RHS)

(CNYm)

28.129.3

33.2

29.227.4

29.2 29.0

34.1

29.8

35.6 35.8 35.8 35.9 36.5

20

22

24

26

28

30

32

34

36

38

2010 2011 2012 2013 2014E 2015E 2016E

Instant noodles Beverage

(%)

4.4%

1.5%

4.1%

2.0%2.4%

3.7%

4.2%

0

0

0

0

0

0

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2010 2011 2012 2013 2014E 2015E 2016E

Advertising expenses (LHS) Other selling expenses (LHS)

Operating margin (RHS)


- 66 -

Tax. We forecast UPCH’s effective tax rate to be 22% over 2014-16E, versus 18% in 2013. Its effective tax rate is lower than the standard tax rate for China enterprises (25%), as some of its subsidiaries enjoy favourable tax treatment as part of the government’s efforts to support the development of the country’s western regions. Dividend. We expect UPCH to maintain a 30% payout ratio (of recurring net profit) over 2015-16E. Free cash flow remains negative, gearing to improve slowly On 12 May 2014, UPCH announced a rights issue (one share issued at HKD4.56 per share for every 5 shares held). The company’s major shareholder, Uni-President Enterprises, has taken up the rights issue, and we expect UPCH to realise total proceeds of CNY2.7bn before the end of June. However, as UPCH has budgeted CNY4.5bn of capex for 2014, we expect its net gearing to remain high, at 43-46% over 2014-15, due to weak free cash flow. Net gearing and free cash flow


0.0%

10.4%

21.8%

56.3%

46.1%43.1%

31.2%

0%

10%

20%

30%

40%

50%

60%

(4,000)

(3,000)

(2,000)

(1,000)

0

1,000

2,000

2010 2011 2012 2013 2014E 2015E 2016E

Free cashflow (LHS) Net gearing (RHS)


- 67 -

Valuation

We initiate coverage of UPCH with a Hold (3) rating and a target price of HKD5.60, based on 30x the average of our 2014-15E EPS forecasts. Implied downside stands at 3%.

Risk of further equity fundraising has receded

To value UPCH, we use the average of our 2014-15 EPS forecasts and assign a target PER of 30x, which is about 30% above the stock’s past-5-year average multiple. The premium is in line with the average at which UPCH has traded in 2012, when it reported a 160% YoY increase in reported EPS. We believe UPCH has the potential to trade at similar premium again, given the significant improvement in EPS growth expected for 2015-16E. We believe the 30% premium is justified by: 1) the recent rights issue, which should alleviate investors’ concerns on further equity fund raising, the proceeds of which will be used to reduce the company’s net gearing (we forecast it to drop from 56% for 2013 to 46% for 2014), and 2) the turnaround that we expect in its operating margin for the noodle segment in 2015. UPCH: revenue and earnings trend and our forecasts vs. consensus 2012 2013 2014E 2015E 2016ERevenue (CNYm) 21,406 23,297 24,943 26,671 28,113 YoY (%) 26 9 7 7 5 Var. vs. consensus (%) n.a. n.a. -5 -10 -13Recurring net profit (CNYm) 870 446 502 756 928 YoY (%) 160 -48 13 51 23 Var. vs. consensus (%) n.a. n.a. -23 -4 0EPS (CNY) 0.24 0.12 0.13 0.18 0.22 YoY (%) 160 -49 2 38 23 Var. vs. consensus (%) n.a. n.a. -23 -17 0


UPCH: 12-month forward PER bands

Source: Bloomberg

UPCH has traded at a discount to its major competitor, Tingyi, for much of the past 5 years. The discount narrowed gradually between 2009 and 2012 before becoming a premium for around 1 year beginning in mid-2012, as UPCH closed the market-share gap between it and Tingyi and expanded its operating-profit margin. In addition, its earnings growth exceeded that of Tingyi in 2011-12, albeit from a lower base. However, we believe the stock’s discount to Tingyi will narrow in 2H14 and 2015 if, as we expect, UPCH catches up with its rival in terms of its operating margin and improves its balance sheet. Tingyi’s operating margin has been higher than UPCH’s since 2009 (for Tingyi it has ranged from 6.7-9.1%, and for UPCH it has ranged from 2-4.4%) due to the latter’s lack of economies of scale. We see the potential over the long term for UPCH’s margin to improve if its economies of scale improve. UPCH: 12-month forward PER discount (premium) to Tingyi (%)

Source: Bloomberg, Daiwa

3

4

5

6

7

8

9

10

11

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

May

-12

Nov

-12

May

-13

Nov

-13

May

-14

220 HK 9 18 27 36 45

(HKD)

(80)

(60)

(40)

(20)

0

20

40

60

80

J-09

A-09

J-09

O-0

9

J-10

A-10

J-10

O-1

0

J-11

A-11

J-11

O-1

1

J-12

A-12

J-12

O-1

2

J-13

A-13

J-13

O-1

3

J-14

A-14


- 68 -

UPCH and peers: valuation summary Bloomberg Daiwa Mkt. cap Share price Stock Δ % PER (x) EPS change (%) EV/EBITDA (x) Revenue YoY % EBIT margin (%) ROE (%)Company code rating (USDm) 23-June-14 3M 1M 2013 2014e 2015e 2016e 2013 2014E 2015E 2016E 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E

Uni-President China* 220 HK Hold 3,212 5.80 -10 -2 37.3 36.8 26.6 21.7 7 2 38 23 12.5 9.7 9 7 7 2.0 2.4 3.7 5.2 Tingyi* 322 HK Outperform 15,109 21.05 1 -3 38.3 28.9 22.1 19.4 -14 34 31 14 11.9 9.6 19 15 10 6.7 7.5 8.6 17.3 Want Want China* 151 HK Buy 17,311 10.22 -10 -6 25.3 21.2 17.9 15.4 24 20 19 17 14.0 11.5 14 16 15 23.1 24.0 24.9 38.7 Mengniu Dairy* 2319 HK Hold 8,749 34.85 -7 -11 30.9 25.9 21.8 17.8 14 20 19 23 14.2 11.8 20 18 11 4.3 4.9 5.2 11.1 Tsingtao Brewery 168 HK NR 9,392 58.90 4 -5 32.1 28.6 24.3 n.a. 12 12 18 6 14.9 12.8 11 25 12 7.2 7.9 8.7 14.4 China Resources Enterprise 291 HK NR 6,442 20.90 5 -13 26.5 28.5 24.3 21.2 -52 -7 17 14 7.5 6.6 16 16 15 3.0 2.9 2.9 4.1 Biostime 1112 HK NR 3,441 44.45 -22 -10 25.8 19.4 15.5 13.1 10 33 25 18 13.3 10.6 35 24 28 23.5 29.0 29.1 40.9 Yashili International 1230 HK NR 1,250 2.74 -33 -25 17.7 22.1 14.8 14.9 (8) 1 19 (1) 10.3 8.5 6 9 14 9.6 14.6 16.7 12.4 Huiyuan 1886 HK NR 1,090 4.25 -29 -8 25.1 18.3 13.3 11.3 n.a. n.a. 38 18 10.4 8.4 13 38 25 (1.8) 11.8 12.4 4.8 Average (ex-UPCH) 27.7 24.1 19.2 16.2 -1.8 16.1 23.1 13.6 12.1 10.0 16.7 20.1 16.3 9.4 12.8 13.6 18.0

Source: Bloomberg,* Daiwa forecasts


- 69 -

Investment catalysts and risks

Upside risks Earlier-than-expected reductions in budget for aggressive promotions and capex We forecast UPCH’s advertising and promotion expenditure (as a percentage of revenue) to decline from 12.3% in 2013 to 11-12% in 2014-16. We also note the company has budgeted for CNY4.5bn in capex for 2014 for expansion, which is well below our forecast for its operating cash flow of CNY1.4bn. If these expenses were to decline, investors’ concerns about UPCH’s stretched balance sheet would likely be alleviated. Downside risks Product concentration For 2013, we estimate that Laotan contributed about 60% of the company’s revenue in the noodle segment, while milk tea accounted for about 30% of its beverage revenue. A sudden shift in consumers’ preferences or food-safety issues affecting the noodle or beverage segments could have a big impact on UPCH, given it has a less diverse product range than the other major F&B players. Decline in utilisation rate UPCH has expanded its production capacity rapidly in recent years, particularly for beverages. According to management, it had capacity utilisation rates of only 60% for beverages and 60-70% for noodles in 2013. If sales volumes were to fall below the company’s expectations, we believe the decline in its utilisation rate would have a bigger impact on UPCH than its rivals in terms of operating leverage. Commodity prices We forecast flour and palm oil to account for 15% and 10%, respectively, of UPCH’s COGS for noodles in 2014. As for beverages, we forecast PET chips and sugar to account for 60% and 10%, respectively, of the company’s COGS in the segment in 2014. Beverage production costs have been declining since 2013, and a rebound in sugar and/or PET chip costs could lead to gross-margin erosion for the company.

Company background

Listed in Hong Kong in 2007, UPCH is the second-largest instant-noodle manufacturer in China, with a 17.2% market share in 2013, according to AC Nielsen. It is also the second-largest ready-to-drink (RTD) tea

brand and the largest milk-tea brand, with market shares of 24.6% and 60%, respectively, in 2013. Its parent company, Uni-President Enterprise (1216 TT, TWD52.8, Outperform [2]), which has a 70% stake, is one of the largest food and beverage producers in Taiwan. UPCH’s major beverage products include RTD tea, juice, milk tea, coffee and bottled spring water. As of 31 December 2013, UPCH owned 28 plants in 25 provinces in China. UPCH: shareholding structure

Source: Company

UPCH: revenue breakdown by segment (2013)

Source: Company

Among its best-known products are More brand juices, Iced brand and Unif Green Tea in the RTD tea segment, and Lai Yi Tong (來一桶), Unif-100 (統一100) and Qiaom Mian Guan (巧麵館) instant noodles. In addition to its core businesses, UPCH has invested in various F&B enterprises, including the Jinmailang Beverage joint venture, and holds minority stakes in Andre Juice (08259 HK, Not rated) and Wondersun Dairy (not listed).

Instant noodles33.6%

RTD tea26.4%

Juice18.3%

Other beverage20.4%

Others1.4%

40%

70% 30%

Public shareholders

Instant noodlesBeverage

Uni-President China (220.HK)

Uni-President Enterprises (1216.TT)

Jinmailang JV

Nissin Hualong Foods

0.5% - 15%

Wondersun Dairy, Andre Juice (8259.HK). etc


- 70 -

Daiwa’s Asia Pacific Research Directory

HONG KONG

Hiroaki KATO (852) 2532 4121 [email protected] Regional Research Head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected] Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected] Deputy Head of Regional Economics; Macro Economics (Regional)

Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Taiwan)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong Research; Head of Hong Kong and China Property

Jerry YANG (852) 2773 8842 [email protected] Banking (Taiwan); Insurance (Taiwan and China)

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong, China); Broker (China)

Alison LAW (852) 2532 4308 [email protected] Head of Regional Consumer; Consumer (Hong Kong/China); Gaming and Leisure (Hong Kong, China)

Jamie SOO (852) 2773 8529 [email protected]

Consumer (Hong Kong/China)

Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China)

Eric CHEN (852) 2773 8702 [email protected] Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional)

Lynn CHENG (852) 2773 8822 [email protected]

IT/Electronics (Semiconductor)

Felix LAM (852) 2532 4341 [email protected] Head of Materials (Hong Kong, China); Cement and Building Materials (China, Taiwan); Property (China)

Dennis IP (852) 2848 4068 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected] Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China)

Jackson YU (852) 2848 4976 [email protected]

Small/Mid Cap (Regional)

Joey CHEN (852) 2848 4483 [email protected] Steel (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong, China); Transportation (Regional)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group; Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

SOUTH KOREA

Chang H LEE (82) 2 787 9177 [email protected] Head of Korea Research; Strategy; Banking

Sung Yop CHUNG (82) 2 787 9157 [email protected] Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Jun Yong BANG (82) 2 787 9168 [email protected] Tyres; Chemicals

Mike OH (82) 2 787 9179 [email protected] Capital Goods (Construction and Machinery)

Sang Hee PARK (82) 2 787 9165 [email protected] Consumer/Retail

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game

TAIWAN

Mark CHANG (886) 2 8758 6245 [email protected] Head of Taiwan Research

Steven TSENG (886) 2 8758 6252 [email protected]

IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (Automation); Cement; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected] IT/Technology Hardware (Handsets and Components)

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Head of India Research; Strategy; Banking/Finance

Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities

SINGAPORE

Adrian LOH (65) 6499 6548 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore)

Benjamin LIM (65) 6321 3086 [email protected]

Oil and Gas (ASEAN and China); Capital Goods (Singapore)

Angeline LOH (65) 6499 6570 [email protected] Banking/Finance, Consumer/Retail

David LUM (65) 6329 2102 [email protected] Property and REITs

Evon TAN (65) 6499 6546 [email protected] Property and REITs

Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (China, ASEAN & India)

Jame OSMAN (65) 6321 3092 [email protected] Telecom (ASEAN & India); Pharmaceuticals and Healthcare (Singapore)


- 71 -

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This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Capital Markets Co. Ltd., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship

Within the preceding 12 months, The subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Blackgold International Holdings Ltd (BGG AU); Tosei Corporation (8923 JP); Modern Land (China) Co. Ltd (1107 HK); China Everbright Bank Company Limited (6818 HK); econtext Asia Ltd (1390 HK); Lotte Shopping Co (023530 KS); Rexlot Holdings Ltd (555 HK).

*Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd. Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage. DHK market making DHK may from time to time make a market in securities covered by this research.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research. Australia This research is distributed in Australia by Daiwa Capital Markets Stockbroking Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. India This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to, or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited. Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research. Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE Link at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively. United Kingdom This research report is produced by Daiwa Capital Markets Europe Limited and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.


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This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory . Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Germany This document has been approved by Daiwa Capital Markets Europe Limited and is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany. Bahrain

This research material is issued/compiled by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000). Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions. Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in

the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the

amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices,

real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants.

*The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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