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Mainta in BUYNP to grow 19% YoY on 70% sales rally in 1H15;liquid milk ASP lowered to battle rising compeitionOver-supply continued to be a headwind in 1H15, but Shengmuoutperformed most upstream peers thanks to its relativelyresilient organic raw milk price (-4% YoY) and risingdownstream (self-use ratio to reach 26% though ex-factoryASP of its liquid milk -20% YoY) .
Trends to watch
China raw milk price has almost no downside risk aroundRmb3.4/kg, though it may take another one or two quarters tosee a rebound after on-shore raw milk powder inventorynormalizes with collapsed global dairy prices an ineffective proxyat the moment. Look into 2H, the company’s upstream wouldthus have limited price/margin pressure.
Margins will likely recover from 2H15 on the back of arapidly growing downstream sector (sales target: Rmb1.6bn)though whose ex-factory ASP and A&P may stay at 1H15 levelsto spin downstream growth. The company finished nationaldeployment in seven key business regions in 1H15 and hasextended product offerings from organic UHT milk to organickids’ milk (20% downstream sales share) and organic yogurtproducts (room-temperature and onsite-made).
Strategic partnerships with global brands likely to kickin soon. Cooperation could be in the form of joint ventures orbrand franchises and mainly focus on kids’ organic dairy productssuch as milk, infant formula, yogurt and cheese. Such strategicprojects will help increase its internal raw milk use ratio andimprove profitability and cash flows.
Valuation and recommendation
As China’s largest organic dairy company with downstreamearnings share rising to 33%/40% in 2015/16e, Shengmu istrading at 11.6x 2015e & 8.2x 2016e EPS, far below its A-sharepeers and attractive to southbound funds, despite an earningscut by 19%/22% for 2015/16e and end-2015 TP trim by22% to HK$3.0 from HK$3.8 (DCF-based). Maintain BUY.
Risks
Raw milk price to correct; downstream competition to escalate.