1H15 net profit in line with our expectations
Shengmu’s top line grew 53% YoY on 6% growth in blended ASP(-8%/-24% up-/downstream due to oversupply) and a 44%sales volume rally (+16%/+263% up-/downstream).Downstream sales surged 177% YoY and its self-use ratioreached 24% (vs.11% in 1H14). Overall GPM slid 2.9ppt due toASP cuts despite lower feeding costs and rising economics ofscale downstream .
Trends to watch
Pressures on ASP in up-/downstream could at leastremain in 2H15, given the current oversupply, though thedownside may be limited. We expect Shengmu’s ASP for raw milkto slide a bit in 3Q15 with the ASP for organic milk being moreresilient, while downstream ASP will likely remain competitive tosupport its continuous rapid volume growth.
Downstream sales growth was strong fromMay~August, according to management and our modernchannel data , mainly because the national deploymentin seven key business regions is completed and its pricing andpromotion strategies were adjusted timely in 1H15. So wemaintain our 2015 downstream sales forecast ofRmb1.6~1.7bn, which may contribute to a mild HoH recoveryin net margin in 2H15.
Strategic partnerships with global brands will likely startfrom 4Q15 onwards and will mainly focus on downstreamproducts (milk, infant formula, yogurt, cheese, etc.). Theseprojects could help lift Shengmu’s internal use ratio and improveits profitability and cash flow.
Valuation and recommendation
As China’s largest organic dairy company with its share ofearnings from downstream rising to 42%/46% in 2015/16e,Shengmu is trading at only 9.9x/7.5x 2015/16e P/E. Wemaintain our 2015e forecast but cut 2016e NP estimateby 7% to be prudent. We also trim our end-2015 TP by 8%to HK$2.75 (DCF). Maintain BUY. Risks: further cuts in ASPare larger than expected; total yield misses expectations.