Investment view
We initiate coverage on China Shengmu with a Neutral rating and a 12-month target price of HK$2.27. We forecast an attractive 2013-16E NPAT CAGR of 53%, or 67% excluding biological asset revaluations (vs. Modern Dairy’s 26%, Huishan’s 35%) on continued upstream investments. Moreover, premium prices charged for organic dairy products enables superior CROCI of 31%-32% (2014-16E) vs. mid-high teens for peers. However, as our target price (1% downside potential) already implies a higher 2014E P/E of 17.6x vs. Huishan’s and Modern Dairy’s 12-15X, we see limited share price upside in the near term. Neutral.
Core drivers of growth
We expect strong sales CAGR of 65% in 2013-2016E for Shengmu driven by: 1) raw milk volume CAGR of 46% as the company aims to triple its herd size from c.60K heads in 2013 to c.170K heads by 2016, and 2) ASP CAGR of 5.2% over the same period as Shengmu focuses on growing its branded organic liquid milk business. Our estimated EBIT CAGR of 54% factors in 6.7ppt EBIT margin erosion to 29.1% by 2016E on: 1) higher SG&A for marketing, and 2) biological asset losses as non-organic raw milk prices fall.
Risks to the investment case
1) Limited control over organic feed supply; 2) milk price volatilities; 3) sales concentration; 4) failure to obtain/renew certifications; 5) increase in competition; 6) volatility of biological asset value adjustments.
Valuation
We value Shengmu based on DCF as it is least prone to accounting volatilities associated with biological assets, in our view.
Industry context
We expect rising consumer demand for premium organic dairy products and shortage of high-quality raw milk to benefit Shengmu.